西南航空 (LUV) 2016 Q1 法說會逐字稿

Welcome to the Southwest Airlines first quarter 2016 conference call.

My name is Tom, and I'll be moderating today's call.

Today's conference is being recorded, and a replay will be available on Southwest.com in the Investor Relations section.

At this time, I'd like to turn the call over to Ms. Marcy Brand, Managing Director of Investor Relations.

Please go ahead, ma'am.

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; and Mike Van De Ven, Executive Vice President and Chief Operating Officer.

Please note today's call will include forward-looking statements, and because these statements are based on the Company's current intent, expectations and projections, they are not guarantees of future performance and a variety of factors could cause actual results to differ materially.

As this call will include references to non-GAAP results, excluding special items, please reference this morning's press release in the Investor Relations section of Southwest.com for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results.

At this time, I'd like to go ahead and turn the call over to Gary for opening remarks.

Thank you, Marcy, and 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 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 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 tail wind 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 royalty program.

So we have a strong, profitable network.

We have great service, low fares with nothing to hide, and 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, ma'am.

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 profit.

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 margin, 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 of 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 their record first-quarter profit-sharing of $155 million.

Our strong revenue performance in 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 1 point net tail wind to RASM in first quarter.

International markets also performed in line with our expectations, including our new Houston markets, and Dallas continues to produce solid results with load factor expansion and strong margins in 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 continued 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 1 to 2 point impact from our stage and gauge increase in first quarter.

All around, very pleased with our first-quarter revenue performance.

While the weak yield environment has continued into 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.

And just as a reminder again, this outlook includes roughly $125 million from the Chase agreement and 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 Early-Bird 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 cost, we are very pleased with our first-quarter cost performance.

Our operating unit cost, excluding special items, decreased 2.6% year over year from ongoing fleet modernization benefits, a milder weather and lower jet fuel prices.

Our economic fuel price per gallon declined 11% year over year to $1.78.

This 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 guide at the beginning of March, simply due to the increase in the crude and heating oil since that time.

And 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.

And 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 first quarter last year, and down slightly when you also include -- excuse me, 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 1 point of the year-over-year increase is driven by accelerated depreciation from our Classic retirements.

And the remainder of the cost inflation is largely the result of 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, which again is driven entirely by the accelerated depreciation.

Our balance sheet and cash flows remain very strong, and 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, and 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.

And 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.

And 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 aircraft leases, remains in the low to mid 30% range, and we are very proud of our strong balance sheet.

And we remain the only domestic airline with an investment grade rating from all three rating agencies.

So 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.

So 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 third quarter 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 of operating the Classic/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.

So in order 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.

So as a result of this decision, we'll have about 50 fewer aircraft than previously planned in fourth quarter 2017, which obviously also creates less capacity.

And 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.

So with that in mind, 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'll 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.

And while I mentioned that before, our preference, for a number of reasons, would have been to segment our fleet, however, we still estimate EBIT improvement of at least $200 million from accelerating the Classics from the 2021 time frame to 2017, again 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.

And of course, accelerating our Classic retirements results in an improved Customer Service, even faster, with a fully equipped Wi-Fi fleet, by the end of third quarter of next year.

So with regards to capacity, just again, to be clear, we continue to plan for 5% to 6% year-over-year growth this year.

Our second- 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.

And as we've noted previously, the majority of 2016's capacity growth is related to the annualized impact of 2015's unique expansion opportunities.

So 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.

So 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 remains strong, producing record revenues, and our outlook for 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 a 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.

And we will continue to prudently manage our capital spend, and will remain disciplined in our evaluation of future growth opportunities.

Again, our pre-tax return on invested capital was an exceptional 33.4%.

Our outlook for second quarter supports another quarter of strong margins, likely in excess of first quarter's 19.7%.

And with that, I'd like to close by thanking our employees again for another fantastic quarter.

So Tom, we'll be happy to open it up for questions now.

Thank you.

(Operator Instructions)

Thank you for waiting.

We'll now begin with our first question from Rajeev Lalwani with Morgan Stanley.

Hi, guys.

Thanks for the time.

Can you just talk about the RASM trend from here?

Obviously, you got a nice increase going into the second quarter.

But as we think about just the rest of the year and lapping the credit card deal, is it going to be hard for you to stay in that positive territory?

That is the first question.

And then the second is, you talked about 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 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 lapping?

I think that's the one -- 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 lapped the benefit of 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's the usual suspects that are available to us.

We can tweak the utilization of the aircraft, which translates to a longer duty day of the airplane.

I'm not sure that's what we want to do, but that is an option.

In other words, it's flying later -- earlier and later in the day.

We can search the used market for more 700s, and we can -- we 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.

In other words, the capital spending guidance does not assume the exercise of any options, to be clear.

And 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, 30-ish.

So the 50 is not quite as large as it might sound, although again, that is a real number, but we were already going to retire a fair number of aircraft in 2018.

So as I said in the press release, this is all manageable.

It's not preferable, but it's all manageable.

And we're just not -- the first thing that we wanted to share with all of our team, and of course you all as well, is that is going to happen, that being the Classic retirement acceleration.

Now the Company can go to work on translating that into maintenance programs for that fleet to now retire earlier.

That will avoid some maintenance spending, as Tammy has already made clear.

And then we can explore other options, as far as bringing either leased equipment in, or exercising some options and spending a little bit more capital.

But I think the other thing, just to make sure that everybody is clear in their head on, is that we -- 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 the [solve] for us a little bit easier, and another reason why we'll want to be thoughtful about bringing on more airplanes to replace them.

So all of that is still an open question, and as soon as we make some choices there, I'm sure we will be sharing those.

Helpful.

Thanks, Gary, thanks, Tammy.

We'll take our next question from Jamie Baker with JPMorgan.

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 if 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?

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.

Okay, duly noted.

And that's -- you know that.

I just wanted to be sure that all of our listeners know that, that's not what this is all 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.

It's not a bad thing, but we're not at war with our people.

We are at war with our competitors, number one.

With respect to whether it is negotiable, in that spirit, of course, we want to continue to work with the pilots 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 -- 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 have got to get working on that.

And I'm sure that sooner than later, we will want to make commitments there.

So as a practical matter, I think that's a done deal.

And just 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 the pilot -- or on the topic of SWAPA and the pilot offer from last month, it did look pretty rich to us.

Represented over 2 points of CASM by our analysis, and 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 4 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.

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 and 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.

But 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.

So 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.

(laughter) So thanks again.

(multiple speakers) So I would never miss it.

(laughter) All right, take care everybody.

We'll go next to Hunter Keay with Wolfe Research.

Hi guys, thanks for taking the question.

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 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 of those connections?

And is that an opportunity that is new for you guys that maybe has a little bit of under-appreciated upside that even you yourselves aren't able to quantify right now?

I'm going to let Bob speak to that, as well, and he is here.

He's sitting right by me here.

Great.

Thank you.

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.

So simply meaning, Hunter, that it is -- I would not call Dallas in development.

Clearly, Bob's going to disagree and say there's 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.

It sounds like you've been studying this.

But as -- our intent would be to have Chicago, St.

Louis, Phoenix, Baltimore, all of those very large -- Houston, all of those very large operations look roughly the same.

And I don't -- I've not seen anything that says that it is remarkably different.

And I certainly haven't seen anything so far to suggest that there's any disappointment whatsoever in Dallas.

Hunter, this is Bob, and 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 of tranches of adding flights, and so some groupings of flights are more mature than others.

So 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, always -- you have to always 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 an unconstrained large city like a Chicago, for example.

So we do -- because we could have more capacity in Dallas, Dallas will always, I think, slightly under-weight the flow and connect traffic compared to what it could be if we were not constrained.

Because we have got to make room for local traffic, which again, there's more local traffic demand than we have room for at the gates and flights that we have in Dallas.

Hunter, the only thing I would add to what we've both said is that we are conscious of this.

We -- 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.

Yes, that'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 about 35%.

So first, is that right?

And if so, what is that?

I know you mentioned Early-Bird 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, I'm just curious -- first of all, correct my underlying math.

And how should we think about beyond, once we lap the credit card?

Thank you.

Yes, Hunter, I'll be happy to help with that.

Yes, we are seeing strong growth in our other.

The -- just as a reminder of our -- just so you know where the components of the benefit from our credit card fall.

If you'll -- about -- the net is the $124 million, and other revenues were increased by about, call it, $175 million.

And passenger revenues were decreased by about $50 million.

So 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 Early Bird revenues, and

We'll had more bag fees, we had more Wi-Fi, we had more pets.

We had -- there's a collection.

But your -- I can't attest to your math either, but I am certain that we had a very strong growth in the, quote, group of ancillary revenue.

And I would think -- I think your question was, should that continue.

Tammy, I would think that you would continue to see that.

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

Okay, thanks a lot.

We'll take our next question from Andrew Didora with Bank of America.

Hi, good afternoon.

Thanks for the time and the questions.

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.

It 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's quite a bit of artwork that we are debating internally about how to find a development market.

So we're seeing really broad strength in our cities.

And Bob, I don't think we call an additional frequency in a market that's existing, we don't call that, quote, 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 that's being added between now and the end of the year.

And that will help, as well.

So the tail wind 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 also just wanted to 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 pickup in the pace of buybacks?

Particularly as I guess fuel stays lower -- 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 will 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.

And 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 return 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.

The only thing that I would add to that very thorough answer is that obviously, free cash flow is a very significant guard rail in the way we think about all of this.

And if one -- if you believe that our free cash flow was going to continue to grow, 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, 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 will revisit this question with the Board.

And just the only other comment I would add, just to round out the discussion, is just on our leverage.

We've been managing to low to mid 30% range, and [in about] -- we don't really have any plans to change that, at least at this juncture.

Great, thank you very much.

We'll take our next question from Julie Yates with Credit Suisse.

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, Julie, because Bob Jordan is shaking his head as you're talking about all of these opportunities.

He's laddering up here, have to cool him off.

I think we have a tactical challenge to work through a step-down in the fleet in the third -- late third quarter next year, I think is the primary challenge.

So by the end of the next year, by the end of 2018, we'll be back to our fleet plan.

And 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, is 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.

So those are questions that we will 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 to launch 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 as I've 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 I don't see any -- 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, but a lot of what you mentioned, we are going to always pace our growth here.

And so some of the things you mentioned are already in our sights 2018 or beyond anyway.

So those are really unaffected, because once you get into the mid to late 2018, we're back to where we expected.

So it's really just a short-term challenge, but it will be painful.

It will definitely be painful.

We'll have hard decisions.

And the thing that we've liked here in 2016, as a pretty vivid example, the plan that we have 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.

So we may have to forgo 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, Gary, can you just remind us the timing on the expansion out of Fort Lauderdale?

If there's any update on the construction of the new facility?

I don't believe we have any new updates.

It's first half of next year.

I think a decent assumption, I think that we've been sharing publicly, is mid year, and -- but we don't have a precise date yet.

That's right.

Okay.

Great.

Thanks for the color.

We'll go next to Savi Syth with Raymond James.

I just wanted to ask about Houston, as since the international gates opened there, I've been a little surprised.

I think there's maybe up to ten daily flights out of Houston internationally.

Was wondering how many gates you're 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?

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 us.

But 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.

And I think today, we're maybe 11, 12 international departures out of Hobby.

And I'm pretty sure that our folks at the airport will also use those gates as they need to for domestic flights.

So I think, if I'm understanding your question, we're where we expected to be, by the way, at Houston Hobby, not yet a year later, just months into operation there.

We did not expect to be at capacity that fast.

And I know 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 -- and would not want to give you a prediction yet -- as to 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 add 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 dissimilar from what I've described, at least in concept.

It's another five gate facility.

Bob, off the top of my head, I don't recall exactly how many gates we have access to.

I believe it's all five.

I think it's the same scenarios we have in Houston.

So I'm going to guess that we have roughly the same kind of 25 departure a day capacity there.

And now Cuba, assuming it 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 wasn't our original plan.

But -- so 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 the -- because they -- 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.

It's right on what we expected.

Fort Lauderdale and Houston, there will be some synergy when Fort Lauderdale opens, because you'll have flight schedules that work together because it's also a gateway.

So you'll have customers that connect over Fort Lauderdale that could potentially have a return flight that connects over Houston.

So they will actually complement each other, in terms of the schedule for folks who are connecting in those airports.

So that's a great thing, as well.

So Fort Lauderdale will help Houston, and Houston will help Fort Lauderdale.

Thank you, and if I might just follow-up on the revenue front.

Tammy, I know you've provided color.

So if I'm thinking about 2Q correctly, you do have a nice 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.

Great, thank you.

We'll take our next question from Helane Becker with Cowen & Company.

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.

I think 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 consideration the Rapid Rewards impact of that.

But when you adjust for that, there's 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's nothing new there.

Where it stands is, the judge ruled and Southwest is in the process of appealing that ruling.

So there's really no new news and nothing further to discuss on that.

But I was just curious by your cash flow question on air traffic liability.

I'll bet you that it's just the timing of Easter.

That could be.

[multiple speakers) burned off earlier, but you ask good -- but everything looks really good, but I am analytically curious about your question.

And one other just point on our air traffic liability.

We've also seen that grow, just simply because we're publishing our schedule out a little further.

So there's a few things that are impacting that on a year-over-year basis.

Okay.

Are you seeing any trends in air fares that you could comment on?

Improving, staying the same, declining?

Maybe that's an effective air traffic liability?

I don't think so.

It's a very competitive environment, and I'm very pleased with our results and especially in light of that.

Our yields or the comps are a little distorted because of the credit card deal and the accounting change, but I don't -- I will say, I think, Tammy, that consistent with what we are reporting on today, which are booking trends and revenue trends for April, there's nothing new to report there.

So the trends are continuing.

Not better, not worse.

Okay, that's all fair.

Thank you very much, guys.

And we have time for one more question today.

We'll take our final question from David Fintzen with Barclays.

Hey, good afternoon everyone.

On the Classics, how practical 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 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.

(multiple speakers) So it will be a hard stop?

Yes, it will be a hard stop.

And so in reference to Julie's earlier question, that's really the task at hand, is to figure out how to smoothly do that, and I'm confident we can.

It will be painful, but we'll try to -- at least seasonally, it steps down post Labor Day.

So we have less flying in September than we do early August anyway.

So we'll manage it, and there will be a little bit of pain.

But hopefully, we'll be able to contain that and get over it.

And then by a year later, it will all be behind us.

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 a -- I'm so glad you mentioned that.

Because the point is, we have had practice at this, and know how to do it.

And I don't think the world knew a thing.

Now, we knew it internally, but we got through it and everything worked out just fine.

So I think everything is -- like I said, I think we can manage it, and I'm not overly concerned about it.

Yes, to Bob's point and Gary's point, if I remember correctly, that was about 27 airplanes.

So again, this is all -- we believe this is all very manageable.

Okay.

Shifting gears a little bit, Long Beach, I know it's a small new city open.

But can you talk a little bit -- obviously well established in California.

How does Long Beach fit in?

Is that somewhere you'd like to turn into a more full size Southwest city?

Or what happens there?

I think we're ecstatic to get a foothold into Long Beach here, so we had no avenue for a long time.

And so 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 cannibalism or anything like that, so I think this will really be new traffic for us.

Obviously, there are constraints.

We would 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.

And you probably know this, David, but we're the number one airline in the Five County area.

Yes.

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, and 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 worst.

Is that right?

Or is it -- just any color around what you're seeing around the country?

No, 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.

So some of the markets that have come on more recently, those are ramping up.

But no, general strength across the system.

And I think you're referring, I guess, to oil and gas?

And --

Yes.

And Houston looks fantastic.

Midland looks fantastic.

So our business has held up quite well.

I think it would be fair to say that it is 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 broad and very consistent across the US.

And again, we're really pleased.

We're pleased with our network.

Its 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, I think, is just -- no one has asked us about it, but I think the Marketing and the messaging has been absolutely superb, presenting Southwest's competitive advantages in a very clear and colorful way.

And they are going to continue on that course, and I think it's going to continue to drive strong revenues for us, as well.

Okay, and just one clarification on a place like Midland.

Are you talking absolute performance, or is that relative to the system right now?

When you say fantastic?

Absolute performance.

Yes.

No, it's very good.

It's not as good as it was, but--

Right, okay, that's what I was trying to make sure that I understood.

Right, no, and we've been clear about that.

But it is still very, very good, and the same applies to Houston.

Okay, great, appreciate the color.

And that concludes the Analyst portion of the call today.

Thank you for joining.

Ladies and Gentlemen, we'll now begin our media portion of today's call.

I'd like to first introduce Ms. Linda Rutherford, Vice President and Chief Communications Officer.

Good day, Tom.

We can go ahead and get started, if you want to give instructions on how to queue up for questions.

Yes, ma'am.

(Operator Instructions)

Thank you for standing by.

We'll take our first question from Susan Carey with the Wall Street Journal.

Hey everybody, two little ones.

Tammy, you mentioned earlier that this operating margin in the first quarter of 19.7% was the highest in I believe you said 35 years.

Is that correct?

That is correct.

And is this -- what is your -- what was your pretax margin in the quarter?

Or is this the pretax margin?

That was our operating margin.

I know, I'm really obsessed lately with pretax.

Pretax was 18.7%.

18.7%.

And secondly, I noticed that you give your guidance in terms of RASM.

So you guys don't break out PRASM guidance?

No, we don't, but that's simply because of the distortions that the impact of our Chase co-brand agreement has.

We -- because of the re-classifications resulting from just the accounting change of that, it's much more meaningful just to provide it at a RASM level.

So you're correct.

We're just providing guidance based on RASM.

We did, Susan, provide PRASM guidance until third quarter last year, when it got confusing because of this new credit card deal and it changed the accounting.

And so it rendered the PRASM numbers irrelevant, but maybe one of these days Tammy will get back to that.

I can be happy to walk you through that, if you're --

Because you gave us the actual PRASM number of minus 3.6% in the current guidance, the release.

And Susan, if you backed out the Chase benefit, PRASM would have been down 2.4%.

Okay, fair enough.

Thank you so much.

You're very welcome.

We'll take our next question from Conor Shine with the Dallas Morning News.

Thanks for the time.

I just was wondering if there was any comment on what a stronger Alaska, with the pending acquisition of Virgin America, means for Southwest, both in the California market but then also at Love Field?

And what the potential with the two gates Virgin currently has there is?

Thank you.

You bet, Conor.

No, we really don't have a (technical difficulty) comment on that.

And we'll await to see what the government approval process reveals.

And then if there are assets that are for sale, we'll obviously do our duty and take a look at them.

But otherwise, I don't have any comment on [that].

Thank you.

We'll take our next question from David Koenig with the Associated Press.

Hi Gary.

David.

You said just a minute ago that Houston and Midland are performing -- I think fantastic was the word you used, right?

That seems to be very different from United's experience right now in Houston.

So why are you doing well there and they are not?

Is it a different type of passenger?

Or what can you say to explain that?

We don't really compare ourselves to United, first of all, so I don't know that I have an explanation.

You might ask United that question.

But we have had great success in Houston, in particular, over the past four years, as we have been working with the city to reestablish international service at Houston Hobby.

That generated a significant amount of grassroots support locally to convince the city to add that service, which we were very pleased with.

What we had discovered at the time, when we started this in 2012, is that the air fares, especially internationally out of Bush, were extraordinarily high.

Double, in fact, the air fares compared even to Chicago on the same airline, to Point South.

So I think what we've been able to do is build a brand new five gate terminal, and the City of Houston and the community are very excited about that.

We've been able to add a lot of new flights at lower fares, and the community has been very excited about that.

And our low costs are such that we can offer that very profitably.

We have a decades long business built up in Houston, including connecting it to Midland, and we just had a real strong franchise there.

We have a lot of loyal customers, we have a lot of Rapid Rewards members.

So anywhere from one-third to 40% of our customers fly on us on business so I can assure you it's not because we don't have business customers.

We probably carry more business customers in the United States than any other airline.

But I would just attribute it, again, to great service by our people, the great network that we offer.

[That we're] offering a great product, excellent on time performance, and we've really made a very significant investment in the community, and I think the community is appreciative of that.

And can you say how much of the -- what you're seeing there is due to the international flying you're now doing out of Hobby?

I think the international component, in fairness to your question, is relatively small.

I believe, Bob, we've got about 160 daily departures, so -- what, 5% of that would be international?

So it's small, but it's new product, it's exciting, it causes people in Houston to take notice, and maybe to try Southwest when they haven't flown on us in awhile.

So there's a halo effect.

If you look back, Bob, over a five year time period, we've added quite a few new domestic non-stops, as well.

I want to say we've added Newark and Laguardia, Boston.

And I'm sure there are more, David, that I just can't recall.

But I guess the point is, we are growing in Houston.

We've made a very significant commitment.

We're adding new product, our people are doing a great job, and we just have a lot of momentum.

So I don't know how that compares to our competitors in the market, but I don't sense that they have momentum.

Thanks very much.

And you need to talk to them to figure out why that is, I guess.

Great, thank you.

We'll take our next question from Jeffrey Dastin with Reuters.

Thank you very much.

At what point do you see passenger yields for domestic travel becoming positive?

I'll let Tammy explain that, but we are predicting positive unit revenues in the second quarter.

So we were actually slightly positive, although in fairness, I'd 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're already seeing that.

But Tammy, do you want to explain?

Yes, so if you're referring to our yields for 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 strong demand for our service.

And so 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.

So 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 as favorable here in the second quarter.

But in other words, the yields are distorted year over year, due to an accounting change.

(multiple speakers) You can make a lot of sense out of that by -- redirecting you to look at total revenues per available seat mile, I think, is a better way to evaluate our performance right now.

Yes, and 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.

Great, thank you.

I guess two brief follow-ups.

One, has the airports where the capacity has exceeded demand changed?

Or is it the same picture it's been for the past several months?

And then secondly, I guess how could you -- could you characterize corporate bookings, in particular?

I would say that our -- the main thing that is happening -- I don't know how much of the Analyst call you listened to.

But the main thing that's been happening over the course of the last 12 months is that we had grown aggressively in 2014 and 2015, and added a lot of new markets.

So let's call those developing markets.

Those markets have begun to mature, and I think that addresses your question about capacity exceeding demand.

So virtually all of our markets now are performing well, where we feel pretty good about the capacity that we have relative to the demand.

And the markets where we are continuing to see -- which aren't very many.

But those markets where we are seeing softness, they are the same culprits.

So they are mostly in that development stage.

They're new, we're creating awareness with customers, trying to get people to fly us, and that's all very, very expected.

There are fewer of those today than there were a year ago.

And on the corporate booking side, it's strong?

Or I guess how would you characterize it?

I would characterize that as strong.

We're seeing a growth in our corporate sales in the high-single-digit percent range.

So I would characterize our corporate bookings as strong, as well as our business mix.

Our business mix, we've seen really no change there.

That represents about one-third of our passengers.

Great, thank you both.

You bet.

We'll take our next question from [Gimla Yell] with Flight Global.

Hi guys, thanks for taking the time.

I have a question about just the ongoing difference in opinion with your pilots unions, over whether their contract is going to allow for the operation of the 737 MAX.

Has that been resolved?

And how has today's (inaudible) retirement of the Classics changed that?

Thanks.

The Boeing 737-8 is covered by our contract, and we are working with Boeing to put that aircraft into service next year.

Okay.

Do you have more clarity on when you plan to take delivery of the first aircraft, and when it would be placed in revenue service?

Boeing has told us -- and I believe they've stated publicly -- they are comfortable with their contractual commitment, which with us is the third quarter of next year.

There have been rumors that they might actually have the aircraft earlier, and obviously we continued to have a conversation with Boeing.

But our plan, which we reiterated this morning with our Classic announcement, is that we'll plan to put it into revenue service after Labor Day next year.

So we're anxious to get our hands on the airplane and put it through its proving runs, and get all of our training done in advance of that.

But that will be our plans.

But as far as we know, so far, everything looks really good.

It looks like it's going to be a great airplane.

Okay.

So just one quick follow-up.

In the event that the FAA training requirements for the MAX are not finalized, say, about May, does that impact your entry into service for the aircraft?

Yes, so let me be clear on that, and Mike, I'll let you comment here, too.

The May information, the May date that we shared with you, was relative to training for both the MAX and the Classic aircraft.

Since we are now not going to be flying the Classic, that vastly simplifies the training.

And we do know the training that's required for the MAX -- or the 737-8, I should say, and that training is very small.

And that is in development, but that will be done and ready well in advance of May of next year.

Okay.

Mike, do you have a date when you're going to start that training?

No, not yet.

But it will be -- the differences between the 737-8 and the 737-800 are very modest, and we're very comfortable that will be ready and approved by the FAA and approved by Boeing.

Okay.

Thank you so much.

Yes.

And we have time for one more question.

We'll take our last question from Mary Shlangenstein with Bloomberg.

Thank you.

Gary, the Wall Street Journal has out a story that Boeing is considering yet another version of the 737, and that it would be dubbed the 737 MAX 7X, and would fly quite a bit distance further.

Have you guys been in talks at all with Boeing about that?

And do you have any idea at all whether that might be something that you would convert some of your pending orders to?

Mary, I'm going to let our good friend Mike Van De Ven answer that question.

Mary, there's been no decisions from Boeing about -- so we have firm orders, as you know, for 30 of the 737-7 versions of that.

And there have been no decisions or agreements or thoughts on Boeing on adjusting those firm orders at this point in time.

Okay, are you familiar with this new version that they're talking about?

I've heard rumors, but there are -- but we're not in a position to comment about any of it.

Okay, is it something that you would look at?

I realize you said you haven't made a decision of any kind, but it is it something you would look at and consider?

Yes, absolutely we would want to go consider different options out there.

Okay, great, thank you.

At this point, I'd like to turn the call back over to Ms. Rutherford for any additional or closing remarks.

Thanks a lot, Tom.

If anybody has any follow-up questions, you know where to find the communications department, 214-792-4847, or www.swamedia.com.

Have a great day.

And that concludes today's call.

Thank you for joining.