西南航空 (LUV) 2017 Q1 法說會逐字稿

Welcome to Southwest Airlines First Quarter 2017 Conference Call.

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

This call 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 2017 performance.

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.

Joining me on the call today, we have Gary Kelly, Chairman of the Board and Chief Executive Officer; Tom Nealon, President; Mike Van de Ven, Chief Operating Officer; Tammy Romo, Executive Vice President and Chief Financial Officer; and Bob Jordan, Executive Vice President and Chief Commercial Officer.

We will begin with Gary providing an overview of our performance, followed by Tammy providing a more detailed review of our first quarter results and current outlook.

Following Tammy's remarks, all of our call participants will be available to answer your questions.

(Operator Instructions) And with that, I'll turn the call over to Gary.

Yes, thank you, Marcy, and good morning, everybody, and thanks for joining our first quarter earnings call.

It was another strong performance with an operating margin of almost 13%, despite higher fuel prices.

For the first time in a while, the First Call consensus estimate for the quarter was too high by $0.02, however, our revenue and cost performances were both within our expectations.

Our revenue expectations were reset, of course, in March, down 2% to 3% for the quarter.

For cost ex fuel and profit sharing, we came in always slightly over our budget and at the high end of the range, but the quarter includes a lot of noise with year-over-year union contract increases and settlements as well as our final readiness for the launch of our new reservation system, which is in 12 days.

Our revenue trends were solid for the quarter in that they improved slightly compared to fourth quarter, and I was hoping for more improvement than that, but it appears that first quarter GDP was soft, and we also had a lot of weather impacts in the quarter as well, and that was particularly in California.

But at least we didn't lose any momentum that was gained in the fourth quarter.

But importantly, the second quarter trends suggest a significant improvement, benefiting somewhat from the Easter holiday timing but more significantly from a strengthening yield environment.

So I feel like we're experiencing an inflection point between the fourth, first and second quarters.

We have positive unit revenue trends in April thus far, and we're estimating to be up 1% to 2% for all of the second quarter on a RASM basis.

Second quarter cost trends are pretty similar to first quarter but better year-over-year.

We were at the same cost drivers in that we have the snap-up in union labor rates and costs associated with our technology implementations.

So these year-over-year trends improve dramatically in the second half of the year, that is the year-over-year unit cost trends.

And as we said in the release, we are on plan for the year with our unit cost, ex fuel and profit sharing.

So with improving revenue trends, despite somewhat higher fuel cost per gallon than a year ago, once again, we're hopeful that our second quarter EPS will compare much better to the year ago than the first quarter did versus a year ago.

Our goal is positive year-over-year comparisons for EPS in the second half of this year.

And of course, that's dependent on a lot of things but certainly on the yield environment and fuel prices, but that is our goal is to have second half EPS growth.

With respect to capacity, there is no change from our year-end report in January.

We've got 3.5% available seat mile growth planned for this year and we're scheduled out into the third quarter, and that's including less than 1% year-over-year growth in the fourth quarter this year.

Following fourth quarter, I expect the first half next year to come in less than 4% and also each quarter.

And along those lines, there's been no change to our fleet plans for 2017 or 2018, other than the fact that we exercised 5 -800 options, as planned, for 2018 delivery.

So we're still retiring all of the Classics by the end of September of this year.

There's 79 of them remaining.

We started this year with 723 aircraft in the fleet.

We still plan to end this year, after grounding the Classics, with 703 aircraft.

We are -- we're firmly -- with the firm commitments that we have to -- for deliveries for next year, that will take us to 746 aircraft at the end of 2018, which is within our fleet growth target of no more than 2% through the end of next year.

We have 4 unexercised options for 2018, so if we exercised those, of course, that would put us at 750 airplanes, which is what we have in the press release.

So we're approaching our 2017 and 2018 growth cautiously.

We're managing the grounding of the Classics, which potentially makes for some comparability noise in late 2018.

But as we said in the release, in any event, our full year growth will be below 2016, as we had previously indicated, so no new news on any of those fronts.

We're very excited about this year.

We're ready to deploy our new reservation system in 12 days.

We're on track to open the new international concourse at Fort Lauderdale's Terminal 1 in June.

We're ready to launch international flights out of that new terminal, including Grand Cayman as a new destination.

And as we reported this morning, we'll be adding another new destination to Fort Lauderdale, and that will be Turks and Caicos, and that will be in fourth quarter this year.

Separately, we're very excited to round out our 48-state route map with new service to Cincinnati cranking up in June.

And finally, we're excited and on track to launch the Boeing 737 MAX 8, and that's scheduled for October 1. My thanks and congratulations to Boeing and GE for producing a magnificent airplane and one that we are confident will be the low-cost leader of the narrow-body market.

Now this is the best start that we've had to a year, in my memory, and that's considering our operations, our customers and our economics all in the aggregate.

I am very proud of our people.

They run a great airline every single day.

Last week, we just celebrated our annual profit sharing day, and today, we celebrated another strong performance, so again, congratulations to all of them and thank you to all 54,000-plus Southwest warriors.

So Tammy, with that quick overview, I'll turn it over to you.

All right.

Thanks, Gary, and welcome, everyone.

I'd like to start by extending my thanks and congratulations as well to our employees on a strong start to the year.

Our first quarter profits were a strong $351 million, and excluding special items, $372 million.

This produced first quarter operating margins of 13.5%, and 12.8%, excluding special items, which were very strong and looks to be among the industry-leading performances, and would have been even stronger without our fuel hedge losses, which will burn off by year-end.

Coming into the quarter, we faced difficult year-over-year comparisons.

The revenue yield environment, which was stable but still competitive, and the Easter shift to April from March last year created challenging comparisons.

And as Gary mentioned, we were also impacted by the severe weather in California.

On the cost side, last year's first quarter fuel prices were much lower.

We also had cost pressures from higher wage rate associated with our amended union contracts as well as various costs associated with the upcoming implementation of our new reservation system.

Our balance sheet, liquidity, cash flows and ROIC were also strong in the first quarter.

On balance, I'm very pleased with the strength of our first quarter results, which enabled the continuation of significant returns for our shareholders and $99 million of profit sharing for our employees.

We're off to a great start here in the second quarter with encouraging revenue trends.

Our first quarter revenue performance was strong with record passenger revenues and a strong demand environment.

Operating revenues were also a first quarter record and declined 2.8% on a unit basis.

This RASM performance was within our range of guidance and relatively in line on a sequential basis.

While the biggest driver of the year-over-year decline in first quarter RASM was the competitive yield environment, it does feel like we have hit an inflection point here in April.

Other revenues also had another strong performance, driven by Rapid Rewards and other ancillary sources of revenues, especially early bird and upgraded boarding products.

And we expect another year-over-year increase in other revenues in second quarter 2017.

Overall, as we noted in our earnings release, second quarter RASM is estimated to increase in the 1% to 2% range year-over-year.

And even without the Easter benefit of approximately $10 million, our year-over-year unit revenue trends are currently positive.

Our second quarter RASM outlook is encouraging and represents roughly 4 points of year-over-year sequential improvement.

Turning to cost.

Our first quarter cost performance was within our expectation.

Low fuel prices in first quarter last year drove challenging year-over-year fuel comparisons and a 10.1% increase in our economic fuel price.

In the current environment of higher fuel prices, our fleet modernization and other fuel saving initiatives are meaningful, especially as we get to the second half of the year and our Classics are retired.

In first quarter, our fuel gallons increased less than our capacity, resulting in fuel efficiency gains year-over-year.

Based on market prices last Friday and our current second quarter hedge position, we expect our second quarter fuel price per gallon to be in the $1.95 to $2 per gallon range.

Our second quarter fuel cost estimate includes $0.29 in hedging losses, which is also the amount of hedging loss we expect for third and fourth quarters, based on our current hedge position and market prices.

With fuel hedge losses significantly below where they were last year, we currently expect our economic fuel price per gallon in second half of this year to decrease year-over-year.

So for the full year 2017, we currently estimate a fuel price per gallon in the $1.95 to $2 range.

Excluding fuel, our unit costs increased largely due to higher wage rates from labor contracts as well as approximately $40 million in costs associated with our new reservation system and operational initiative.

Our second quarter CASM, excluding fuel, special items and profit sharing is expected to increase approximately 6% year-over-year, with about 3.5 points of this increase related to the labor contracts amended last year.

The remaining increase relates to costs associated with our technology and operational initiative, as well as the rollout of our new uniforms.

Our full year 2017 unit cost outlook remains unchanged.

And excluding fuel, special items and profit sharing, we expect 2017 unit costs to increase approximately 3% year-over-year, almost entirely driven, when it's all said and done, by the one snap-up in wage rates from the new labor contracts.

This includes our expectation that unit costs will trend to flat year-over-year in the fourth quarter.

Considering our modest capacity growth plan for fourth quarter, our unit cost outlook is quite notable.

And we are not stopping there.

We are very focused on controlling our costs to drive incremental efficiencies and widen our competitive cost advantage.

Turning to the balance sheet.

We ended the quarter with our industry-leading investment-grade balance sheet, which is strong as ever.

Similar to last year's first quarter, we allowed our cash to build as we funded our 2016 profit sharing accruals, as Gary mentioned, earlier this month.

Our strong operating cash flow and manageable CapEx resulted in a record first quarter free cash flow of $1.2 billion.

For full year 2017, our cash flow outlook remains strong, and we continue to expect capital expenditures to be approximately $2.3 billion.

Aircraft CapEx is estimated to be $1.4 billion, and non-aircraft spend is estimated to be in the $800 million to $900 million range, which includes $250 million of technology spend on our reservation system and operational initiatives.

During first quarter, we returned $673 million to shareholders through buybacks and dividends.

Our shareholder returns increased almost 13% year-over-year and in the first quarter alone.

We have given back more than 1/3 of our total shareholder returns for all of last year.

In addition to completing the $300 million accelerated share repurchase launched in fourth quarter of '16, we launched and completed a $500 million acceleration of repurchase during first quarter.

We also repurchased $50 million of common stock in open market transaction, which leaves $400 million remaining under our current $2 billion buyback authorization.

In March, we paid our 162nd consecutive dividend at an annual payout ratio of nearly 11%.

Our leverage, including off-balance sheet aircraft leases, is now just over 30%.

And as ever, preserving our strong balance sheet and cash flows remains a priority, and we also remain committed to returning significant value to shareholders.

Turning now to fleet and capacity.

Our plans continue to support prudent and profitable network growth.

We ended the quarter with 727 aircraft in our fleet and continue to expect our total fleet to decline to just over 700 by year-end.

This incorporates the retirement of the remaining 79 Classics by the end of September, and the addition of 41 more NG aircraft and 14 MAX-8s this year.

We're very excited about the launch of the MAX into service this October, which we expect will bring continued fuel efficiency gains.

Just on the network side, it's performing very well.

Our upcoming consolidation of our Ohio operations, including the launch of service to Cincinnati, is a prime example of how we continue to optimize our network to meet the needs of our customers.

And with the transformative strategic initiatives behind us, including the May 9 implementation of our new reservation system, we are well-positioned to consider the exciting growth opportunities ahead.

We're monitoring our new market development closely and we'll continue to add markets at a pace that supports our revenue and profitability targets.

Our 2017 capacity growth remains unchanged at approximately 3.5% year-over-year.

With this brief overview, I'll just close here again by congratulating our employees on a great quarter and exciting year ahead.

So with that, Tom, we are ready to take questions.

(Operator Instructions) We'll now begin with our first question, comes from Jack Atkins with Stephens.

So Gary, if I can go back to your prepared comments for a moment, you referenced the 2018 capacity plans.

And I know you don't want to get into those in too much depth because the plan is still coming together.

But you said the plan was to have around 4% ASM growth in the first half, but then, you referenced quarterly growth, and then, I think, you said more challenging comps in the fourth quarter.

If you could just expand on that for a moment, if you would, just to make sure we're all on the same page on what '18 should look like from a capacity growth perspective.

I'd be happy to, and I'm just going to repeat what I said, Jack.

There is no more than -- it will be less than 4%.

It won't be 4%, it will be less than 4% for the first quarter and for the second quarter and, obviously, for the first half combined.

And I'm comfortable in sharing that with you at this point.

And beyond that, I'm not willing to give any specific targets.

My only reference on the fourth quarter is that because fourth quarter this year may be closer to flat year-over-year, and once we start restoring the flying that we were doing with the grounded Classics, we'll see some growth that is higher than normal in the fourth quarter, for sure.

However, and I want to be clear on this, we have not committed to a schedule for the second half of 2018 where, as time goes by, we're getting more and more committed, of course, to the first half.

But I think the overriding message is the same as what we've been saying in that we're still approaching our capacity growth cautiously.

One of the things that we were trying to accomplish in 2017, and if necessary, by extension, into 2018, is to give our developing markets an opportunity to mature and put ourselves in a position where we are confident that positive unit revenue growth is realistic.

So those will continue to be the guiding principles.

Okay.

That's really helpful.

And then, for my follow-up question, if I could ask about the new reservation system rollout.

Just sort of curious, what sort of preparations have you guys been making sort of going into this rollout here over the next couple of weeks?

And if you could help us think about the incremental costs that maybe flows to the P&L related to training and that sort of thing that maybe roll off, I guess, as we get into the back half of the year.

And then, just the priorities around utilizing the new system because I know it will give you significantly increased capabilities once it's rolled out.

Well, I'd be happy to, and I'll defer to Tammy to give you some further insights on the cost implications here.

But this is a multiyear effort, Tom.

This has been under development for 3 years.

Three years.

And so it is fair to assume that a lot of technology construction occurred prior to this year.

But they're still in the finishing up phases, so we have a fairly significant spending in the first quarter related to the technology efforts.

A lot of testing, of course, is taking place at this point.

And then, from Mike Van De Ven's perspective, Mike, I think, you were training 20,000 employees, weren't you?

So we have a lot of our call agents already prepared to take orders on the first part of the release, which was back in December, but they still had continued training here this year.

And then, all of our airport employees, we refer to as ground operations, are undergoing the training for the new departure systems.

So it's very significant.

It's all hands on deck.

It's a fairly significant amount of spending.

The other thing that is beyond just -- as you can imagine, the training is additional time on our employees' part.

So both the commercial departments previously and our operations departments have increased their staffing to make sure that, number one, we have the time available for the training, and then, number two, to be prepared for a learning curve where transactions might take more time.

So you do note that the employee headcount is up roughly 7 -- I think, it's 7.3% year-over-year.

And that's a lot of that -- that's a lot of the cost for that increase.

Tammy, you want to speak more directly to the cost implications of that?

Sure, I'd be happy to do that.

As I mentioned in my comments, we had about $40 million in costs in the first quarter associated with our new reservation system and operational initiatives.

And so as I think about our comparisons in the first half versus the second half, we have probably 1 to 2 points related to the wind-down of our reservation system and timing of efficiencies related to our operational investments.

So it is significant and we'll get some relief here as we move into the second half of the year.

So I think, to summarize, we've definitely staffed up for the effort.

And then, there's sort of a final push with technology people, our technology partners.

And it's -- it shows up in our spending.

There's no question.

If you look in the other operating expenses line, you'll see that it's up, I don't have it in front of me, I think, it's 12 point -- maybe 11%.

But in any event, there's a pretty large increase in that category, so there are a lot of the technology-related costs that are hitting in that line item.

We'll go ahead and move on to Duane Pfennigwerth with Evercore ISI.

Sorry for a modeling question but to get to the full year guide, it looks like it also implies that the third quarter is going to be a pretty muted growth rate in CASM X as well.

Could you explain what would be driving that?

Sure.

And just to kind of help you as we progress here from the first half to the second half on our unit costs, we already mentioned that about 1 to 2 points of the cost pressures were experienced here in the first quarter is related to our reservation system and the timing of efficiencies related to our operational investments.

We have probably 1 point related to the timing of our union contracts.

And then, also, as you move into the fourth quarter, we'll continue to see savings associated with the retirement of our classic fleet.

So that's about 1 point, which you'll see reflected in lower depreciation and maintenance costs.

And then, that probably accounts for most of it.

I'm not ready to give you specific guidance on third quarter versus fourth quarter.

But I do think that by the time we get to the fourth quarter, we should be, call it, roughly flat to year-ago levels, excluding fuel, profit sharing and special items.

And then, just for my follow-up, is there a plan to update your thinking on capital allocation at your Annual Shareholders Meeting, are you going to follow that typical cadence?

And if so, any new thoughts, or looking backwards, buyback versus dividends, any new thoughts in that perspective?

Well, we haven't done anything so far so there's nothing to report today.

We have a board meeting in May, and of course, that is a board-level decision.

And we would -- we've had discussions, as you would expect, with our board.

We meet every other month, so we meet 6x a year, so we had a March meeting but have made no firm decisions or commitment -- made no commitments yet.

So it's something that we'll take up in May, Duane.

It's a very fair question.

And I think, all I would say is, to reiterate what Tammy said and I think I said, which is we're very focused on shareholder returns.

Those are 2 key questions and we'll certainly discuss that again in May.

And we'll take our next question from Brandon Oglenski with Barclays.

Gary, I appreciate the outlook on capacity here, at least through the first half of '18, but as you're going through your reservation system cutover and the fleet transition, should we be thinking that this is more an outlook on load capacity growth because you're physically constrained?

Or should we be thinking that, actually, this is what's the market fill in so this is where we're growing, and if we saw better opportunities, we'd be growing faster even with those constraints today?

Well, I've tried to be clear on that.

So you quiz me if I'm not hitting the mark here.

I think, first of all, there's a fairly long cycle between the time that you decide that you want to add capacity and when it finally shows up.

So there is some physical nature to all of this.

We are growing 3.5% this year.

Some of that, admittedly, is because we're accelerating the retirement of the Classics.

However, we've been straightforward with you all and said that we did want to slow our growth this year, so that was -- it was a factor in us arriving at the decision to go ahead and accelerate the retirement of that fleet, if you understand my point.

Said a different way, if we really felt like we needed to be growing faster this year and we just had to have lift, I bet we would probably have tried to find a way, Mike, to keep those airplanes.

So the stars aligned pretty well for us there.

The other thing that Mike has done a beautiful job of, especially over the last 4 to 5 years, is creating more fleet flexibility for us.

And so I mentioned purposefully with my remarks that right now, we're fully committed with deliveries that would suggest that we'll end 2018 at 746 airplanes.

We have the option to get 4 more and we haven't exercised that yet.

We haven't made that decision yet.

So there -- the answer to your question is both of those are inputs but what we're trying to do mostly is match our capacity to the demand.

We want to grow our route system.

We want to grow it in a way that we can sustain positive unit revenue growth as well as hit our ROIC and our profit targets.

I think it's been articulated, Gary.

I think it's helpful for investors to hear that message over and over.

I guess, the fear would be though that as your fuel hedge losses run out next year is there to be temptations as well, I know we're just naturally making more money, so maybe we should be growing more than we had?

Or is that not really factoring into the outlook?

Well, of course, it is.

In other words, if you just took -- logic would say the reverse.

If we weren't making money, would we be going out and growing?

Well, of course not.

You need to fix what you have first before you think about growing.

But our margins are really good right now.

They're near industry-leading margins that everybody here has worked hard for and is very proud of.

So we just -- we don't want to extrapolate record returns on capital into infinity and adjust growth plans to that notion.

That would be very imprudent to do.

So we're not doing that.

We haven't done that.

We've tried to be clear that, in particular, the growth rates that we realized in 2015 and '16 were unusual, and you should not expect that we think that we should be growing at those rates going forward.

But I think, it's mainly a matter of just -- we want to grow and we need to grow.

We need to strengthen our route system.

It's a very competitive industry out there, and that's one of the key weapons that we have, but we need to do that in a way that we can make sure that we sustain our profitability, our balance sheet, shareholder returns, all of those things.

I think, we've done a nice job of balancing all that, and there's a 46-year history here and there's no reason to believe that we're going to deviate from those objectives.

And we'll take our next question -- actually, we'll go back to Michael Linenberg with Deutsche Bank.

I guess, 2 quick ones.

I guess, Gary, back to the -- your introductory remarks, you talked about a real strengthening in yields, which you saw coming into the June quarter.

And I think, Tammy, you mentioned about an inflection point in April.

And I think, if we can move Easter aside, is this just -- are you seeing it on the close-end booking side?

Is it leisure-driven?

Like what's -- like this uptick, where are you seeing it?

What passenger segments?

Do you want to speak to that?

I'd be happy to speak to that.

Yes, I know, I'm delighted to speak about revenues because we are encouraged by our outlook here in the second quarter.

And Mike, we're really seeing -- it's pretty broad-based improvement in our sequential trends.

So yes, it's -- I think, it's really just a broader comment.

Okay.

And then, just my second question on, Gary, for 2018 first half, you said less than 4% in the March and June quarter, how do we think about the split between domestic and international?

Like what -- is it 1/3, 2/3?

Let me just -- I'm going to think out loud with you because I don't know.

I can give you at least a sense of direction there, but we're going to end this year with a capacity split of about 96% domestic and 4% -- not quite 4%, so it's about 96%-plus and a little bit less than 4% international.

We're growing international pretty aggressively here in 2017.

It feels to me like it will grow less aggressively in 2018.

And that's understanding that we haven't made firm commitments here and we'll debate those as long as we can.

We've decided recently that we were going to go ahead and commit to Turks and Caicos.

This relates somewhat to the previous question about how much of this is fixed versus variable.

Well, we're committed to this 5-gate concourse construction in Fort Lauderdale.

We obviously want to follow that through with having a decent array of international flying.

And so that's a pretty aggressive launch of international for us this year because of that.

And then, next year, we're purposefully going to throttle back a bit to, again, allow these new markets some time to develop.

But we don't have a lot of new flying that we're adding this year.

A lot of the year-over-year increase is simply the full year effect of adding routes last year.

So this is a pretty conservative year.

And I think, next year, except for some of the comparability issue, maybe fourth quarter year-over-year, it's going to be a pretty routine year, it feels like.

And we'll take our next question from Jamie Baker with JP Morgan.

Gary, last quarter, you referred to potential ATC reform as being -- I take these per your words, I'm paraphrasing here, highly beneficial for your customers and your employees, something along those lines.

My concern obviously is that it would potentially free up airplane time, that would lead to higher capacity, and we kind of know how that movie plays out.

How does ATC reform help Southwest?

And how much capacity would it potentially free up?

Well, Jamie, let's not make a good thing a bad thing.

It's (inaudible) to be more efficient.

The problem that we have today, and I'm sure my colleagues, if you ask them, or you may have already -- they may have already made these comments, but we're already seeing increased delays this year being imposed by the FAA because of staffing shortages.

So the on-time performance of the industry is pretty good and inarguably very good.

What all that means is that we've simply adjusted our flight times to be longer, anticipating increasing inefficiencies.

And every year, we get more.

So it's as simple as taking city A to city B and those en route times are just far greater today -- or the total block time I should say, far greater today than they were 10, 20, much less 30 years ago.

So what I would argue for our investors and certainly for the company is that we'll provide better customer service, which ought to be healthier demand, and we'll be able to provide these flights far more efficiently, which ought to be less cost and more affordable for our customers, so it's a double win for the customer, but it's just a -- what company would choose to operate less efficiently?

It's just nonsensical.

So the other thing I would tell you is that we know that there is a premium part of the day that people want to fly.

And to the extent that we can push more of our flying into the meat of the day, we know that, that will also be more productive.

Will it create the opportunity for more capacity?

Yes, but we have that opportunity already, so we already choose to fly more or less in a given period this year.

We could be flying more and we're choosing not to for a variety of reasons.

So I wouldn't make a good thing a bad thing.

I think, back to the good thing, it's going to be -- it's going to take a huge effort to realize the benefits of ATC modernization.

And right now, it's not being realized whatsoever that we're getting less efficient, not more.

So you don't have to worry about that anytime soon, unfortunately, but that is the right goal, and I think, the President is behind that and we've got a long way to go to actually realize it.

Okay.

That's helpful.

And second, on the red system, I thought, you suggested somewhere that it's the current red system that explains why you don't fly red-eyes.

And that doesn't really make sense to me because you have something like, I don't know, 75, 80 flights every day that leave on 1 day and arrive after midnight the next.

So I always thought it was how you've flown aircraft for maintenance, which explain the aversion to red-eyes.

Was I just mistaken all these years?

No, I don't think you're totally mistaken.

But Mike, you want to talk about some of this current mechanics and restrictions that we have?

Yes, so Jamie, on the operating side, we do have flights that go across midnight, but our flight planning systems are designed to take that to a certain point.

So let's say -- I don't know that I have the hour right in my head, but let's say, to 2:00 in the morning but it goes through the day and after that, our systems aren't set up to go do that.

And Jamie, you are right.

I mean, the airline does have an AM, it has a PM, and then, that sort of a third shift of the day, we do dedicate to overnight maintenance.

So once we under -- under the assumption that we're going to undertake a significant amount of "red-eye flying", we would have to figure all that out.

We have to negotiate with our flight crews over that other crewing period or...

We have those covered in our contracts but they're difficult because it's hard to put together 3-day pairings if you don't have a sufficient number of red-eye flying.

And you're exactly right, Jamie, it introduces complexity with respect to the maintenance programs at night.

We can navigate through all those things, but we just haven't had to do that at this point in time in our lives.

And it doesn't sound like it's going to be a priority either.

Or is -- am I mistaken on that as well?

Well, again, if you're wondering whether we truly have the capability today, we don't, in our minds.

We don't have the tools that we would need.

And then, if that would -- then, if you're concerned that, that capability now leads to yet more capacity, we've got a lot of discussion that we need to have before we decide to commit to any meaningful amount of red-eye flying.

And it is not -- as we sit here in the second quarter of '17, it is -- we got a lot of other things we're working on and it's not a priority for us.

And we'll take our next question from Rajeev Lalwani with Morgan Stanley.

This might be for you, Gary.

But as far as the new reservation system that's set to come into place in, I guess, 12 days or so, can you talk about some of the more prominent features you're seeing benefits from, whether it's scheduling or something else?

Tom, do you want to talk about that?

Yes, so let me cover that one.

So you guys know, December, we rolled out the first release, right?

And that was where we last published and sell the schedule.

With R2, which is 12 days away, well, the function is there, those are the functions that are really going to be used by the frontline for check-in, boarding passengers, re-accomm, that kind of stuff.

The third release, which is on track for the second half of '17, that's where you really begin to see the value come through, all right?

So the kind of capabilities you're talking about there, and this is what gets you the $200 million in EBIT, what you really get to there are the revenue enhancements, probably 2 big capabilities, O&D controls and improved fare flexibility and such.

There's schedule optimization with that third release, which is schedule variation, days of inventory, things like that.

And it also sets the foundation for the international work.

So 1 res sets the foundation for airline coach share, foreign point-of-sale, language currency, that kind of stuff.

But that's really the back half of '17 when that will begin to come online, the value begins to be -- really kick in, in '18 and beyond.

Very helpful.

And then, a quick question on capacity.

Gary, would it be fair to say that, essentially, what you're trying to point to for next year is that capacity growth will be between '15 and '16 levels, so that's 3.5 and 5.5, or is that getting too granular at this point?

That's too early to say.

And we'll take our next question from Savi Syth with Raymond James.

Just on the -- just a little bit on the pricing side to go back to that, and Tammy, I think, you mentioned that things are improving and looking very encouraging.

How much of that -- and you mentioned competitive pricing still prevalent.

What I'm trying to figure out is, is this just a fact of peak season is good and strong, and in the off-peak, we just have too much capacity and thinking through what the implications are close to summer season then for pricing?

I don't think so, but I think, anything is possible.

If you go back to last June, you might remember that we were a bit surprised at the sort of sudden weakening in demand.

And that seemed to continue all the way until the fourth quarter, at which time, we were pleasantly surprised at the strengthening in demand.

I really thought we would do a little better in the first quarter this year.

It wasn't bad.

It didn't slip but it didn't improve as much as we thought.

And I made my GDP comment earlier.

We've all read about the delay in tax refunds and the impact that, that had on consumer spending.

I don't know if that had some impact.

But we're trying to take all those questions, Savi, into account.

And taking that into account, we're saying that there is a trend improvement sequentially, period.

And I'm not attributing that to the seasonality.

We've got years of history here and we've moved holidays around and take all those kinds of things into effect, our own growth rate, et cetera, et cetera.

So the yield environment is improving.

And in terms of the competition, that's about all we can say on that point, but it is definitely improving compared to what we were seeing last year.

Very helpful, Gary.

And then, if I just might, as a follow-up quickly, ask on the hedge assets in 2018 and '19, just how much of that is in '18 and how much '19?

Yes.

So on -- for 20 -- you said 2018 and 2019 volume cycle?

Exactly.

Yes, so 2018 is about $75 million of that.

So that would leave $33 million for 2019.

We'll take our last question from Helane Becker with Cowen and Company.

So as I think about your growth on the West Coast in California, is that more opportunity out there?

Is it kind of defending the market against incursion from Alaska and Virgin?

Is it neither of the above and something else entirely?

It's a very strong market.

I would say, postrecession, sort of post-2007, there was a kind of the typical recessionary effect on short-haul travel.

And there's a lot of short-haul travel in the Southwest system in California.

So we optimized our route system.

And I'd say, over the last several years, we've seen a resurgence in the travel demand there.

And we've struggled a bit to keep up with it.

So that's one.

The travel demand is quite strong and we see a lot of opportunities.

I would couple that though with real estate challenges.

So LAX, we're capacity constrained on the ground.

We have that problem in Orange County.

It's just 2 quick examples.

So we're -- we have more opportunities to grow, except that we just don't have the physical capability to do that with some of our airport constraints there.

But where we don't have that, yes, we've had great opportunities and I think that you'll continue to see us very focused on California.

And it's not just us.

There's a handful of competitors that are also eyeing California.

But it's a great, healthy market and we remain the #1 share within and out in 2. So -- and any way you look at it, so we're very proud of our position there.

And we're going to work hard to stay on top.

Okay.

And then, can I just follow-up one question on something you said about facility constraints?

As we think about this over the next -- or as you think about it, right, and your plans for the next 3 to 5 years as you think about the fleet planning and the growth and so on, how -- should we think about this in terms of infrastructure?

How does the infrastructure keep up with the demand that's out there?

And is that line being a very expensive proposition for the industry or the government or the industry because the government can't afford to do it?

Well, great question, and of course, you've known us for a long time.

If you go back to 30 years ago, we didn't have the array of physical constraints on the ground that we face today.

Some of that is just because we -- from the sheer fact that we've lowered fares, stimulated demand and we've built facilities, and we've now filled out that capacity.

It's an issue and I -- it's easy to take LAX as a specific example.

LAX has billions of dollars' worth of construction programs that are planned probably over the next decade and maybe even beyond.

We've got one that -- we have 2 in effect that are underway, and we're hopeful that we'll get a third in order to create capacity.

I want to say that the -- over the last decade, don't quote me on this, but I think I'll get this right, over the last decade, there've been about $100 billion worth of airport projects undertaken.

So the money is there.

And I think, the -- if we can sort of remove some barriers so that we can proceed more expeditiously at certain airports, that would be very, very helpful.

But if you just take a specific -- and all these need to be taken up specifically, there are a lot of airports where we have plenty of capacity.

And we're trying to take full advantage of that and expand there.

There are airports like Dallas Love Field, which is at capacity under federal law.

So that's sort of off the table in terms of increasing capacity for the airport because it's limited to 20 gates.

And there's every flavor in between across the country.

The nice thing for us, selfishly, is because we're a point-to-point network and we have a very significant position in dozens of cities, if we're constrained in one market, we've got opportunities in another, and quite frankly, that helps us prioritize because we have far more things that we want to do than we have airplanes.

But it's just the fact that we live with.

We have an airport affairs department that is focused on working airport by airport in helping to develop master plans that are sensible so that these communities can grow.

You'd hate to live in a city that said, "No, we're forevermore capped at the current level of travel and tourism." So you just have to ask yourself as a civic leader, "What are we going to do for the next generation?

Are we going to promote travel or not in our community?" And again -- but that's the way it works.

But the money is there.

We just want to make sure that the money is spent wisely and spent in the right places.

And that concludes the analyst portion of today's call.

Thank you for joining.

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

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

Thanks, Tom.

Welcome today to the members of the media who are on the call.

I think, we can go ahead and get started in our Q&A session.

So Tom, if you'll give them some instructions on how to queue up.

(Operator Instructions) We'll now begin with our first question from Conor Shine with The Dallas Morning News.

Gary, I wanted to ask you a little bit more about that comment from CNBC today about Southwest ending the practice of overbooking.

How soon do you think that policy will go into effect?

And can you talk a little bit about the tradeoffs?

My understanding is there's at least some revenue implication to overbooking flights.

How much do you guys think you might be giving up by not doing that anymore?

Well, what I was trying to convey, and thanks for the question, what I was trying to convey this morning on that is it's not a topic that is brand new to us.

So for quite some time, we have been challenging ourselves to make the travel experience better for our customers and just make the service better for our employees to deliver, and that's one of the pain points that we'd like to eliminate.

The issue is the economic effect.

As time has gone by, we have been fortunate to have fewer and fewer and fewer no-shows, so the gross amount of the problem is far less today than it was 20 years ago.

We don't overbook much at all already.

My recollection, Bob, is that it's about, on a 143-seat airplane, we might overbook by 1. So it's -- and it's hard to generalize, but at least gives you some frame of reference that this isn't a vast issue.

And we don't -- I never get complaints from our customers about overbooking.

I get complaints about any other variety of things.

I'm not saying there aren't complaints, so don't get me wrong, but it's just not an issue the way the company has been managing that, and I'm very proud of our folks for doing that.

But to give you a specific answer, not quite ready to give you an exact timeline but we're going to move on this very quickly, so certainly, during the second quarter.

And it's -- we've got Tom Nealon, our President; Bob Jordan, our EVP of Commercial, are both personally working on this.

It turns out that it's a little more complicated than perhaps we would like, but I think, our employees will be delighted with this and I know our customers will be.

Then again, understanding that we don't have that many oversales in the first place.

The economic effect of it, Tammy, you want to speak to that?

Yes, the economic impact is really fairly, fairly small.

Yes, there is a little bit of a revenue impact but that's been embedded in all the guidance that we've discussed this morning.

But there's also some cost savings that will occur that will offset the revenue benefit.

So the net impact is really not that meaningful.

So I don't -- I really don't think you'll even see it in our results.

One of the other questions I got, Conor, this morning, which might help put in perspective, we -- well, isn't this going to cost you money?

Well, what we're trying to do is be the world's most loved airline, and we feel like just putting this in with no change fees, no bag fees, no overbooking, that's who we are, and we're at a point now where we can do all of that and still stay true to our low-fare brand.

And obviously, the reason that we do overbooking is because it helps generate revenue on that flight and keep the rest of the fares lower.

So we don't want to do this in a way that would cost our customers more money.

And we think we're at a point now where we can do that at will.

It just makes sense.

So we've been thinking about it for a long time and feel like right now is the time to do it.

If I could just ask one more follow-up.

How much did the United Airline incident with the overbooking have to play in announcing that, now, you guys speed up your timeline as a result of that?

It was -- I'll be honest with you, it wasn't on my list this month to work on.

It wasn't on Tom's, it wasn't on Bob's list, but it is something that we have had on our list over the last couple of years.

But it puts the question under our bright light and hey, why not do it now?

I would ask.

And we're ready to do it and we're going to get it done.

We'll take our next question from Andrea Ahles with Fort Worth Star-Telegram.

I was wondering, Gary, if you might be able to comment on the pay increases that American announced yesterday.

We've seen some Wall Street analysts say this sets a dangerous precedent or a worrying precedent, I should say, through the industry.

I know you just signed the 4-year agreement with your pilot group at the end of last year.

Is that something you guys have ever considered, or do you think your pilots might be coming back and asking now for additional raises when they're not in the contract negotiation?

Well, I'm going to answer your question in 2 ways.

Number one is just, philosophically, we've always worked with our employees that way.

Contracts are a framework to work together.

And that's a true partnership.

And things come up in between contract negotiation dates.

We approach union leadership and union leadership approaches us.

And so we make changes historically "all the time." And we've had instances in my recollection where we felt like we needed to make some change to pay along the way.

And it's just remembering that nothing is simple when it comes to a labor contract or a labor contract negotiation.

So it -- we'll just have to see how simple it is for American to actually execute what they want.

I've read their communication, I thought it was very well done.

But is it a dangerous precedent?

No.

I mean, it is a framework, it's a living document.

And only way that works though is if you have a true partnership where issues can, in a dynamic way, can continue to be addressed.

At the same time, I think, everybody understands that it is a contract.

Both parties to a contract want to and need to honor what's in the contract, and there needs to be very good reasons to contemplate a change.

But is it dangerous?

No.

And I think it's just part of ongoing negotiations.

And Herb always said that we negotiate our contracts every single day, and I agree with that.

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

Gary, back to the overbooking issue.

One little thing, my understanding is, okay, so you're not going to do oversales at some point but you might still have to bump people if you have crews showing up that need to be accommodated.

And secondly, was this change motivated by the fact that last year, you bumped -- you had more IDBs than anybody else?

The answer to the latter one is no, and if you want, I can -- again, by my memory, I can talk to that, and Bob may know off the top of his head -- well, no doubt, knows a lot more about than I do.

But the -- and I think, overbooking is different than having an oversale.

So if we have a rule that says we won't take any more bookings than there are seats on the airplane, that's one thing.

But you're right, David, there's other things that can cause an oversale.

For one thing, we have different airplane sizes.

So if, for whatever reason, we took bookings for an 800, which has more than 143 seats, and then that airplane type is not available and we substitute a smaller airplane with 143 seats, well, you would have an oversale in that situation.

The flight crew part, Mike, I'm sure we have those circumstances, but we work very hard to avoid displacing our customers.

We have the ability to add an extra pilot on the airplane in the cockpit, an extra flight attendant.

You want to -- since that was David's specific question, do you want to address that?

Yes, David.

The industry, just in general, has needs for unexpected crew movements every day.

So there's weather, there's mechanicals, there's recursion.

So that need is going to exist and it always has.

And generally speaking, I'll bet you, we have a lot of customers that may have an opportunity to take a flight 1 hour or 2 later and be compensated for, they like that.

We haven't had issues historically about dealing with our flight crews.

We usually know that well in advance.

We can talk to our customers as they're getting up into the gate area and seeing whether or not they're amenable to taking a different flight.

And I would say that 99% of the time, they are.

David, this is Bob.

Let me just add 2 quick things.

The denied boarding rate is really small, it happens to about 0.1% -- less -- actually, less than 0.1% of our customers.

So it's a very small number.

Now if you're caught up in that, that's no fun, but it's a very small number that are denied boarding to start with.

But about 80% of those are actually from the revenue management practice of overbooking or overselling.

So that's what we're going to stop, and so the vast majority of denied boardings will go away because the vast majority of the overbookings are going to go away.

And we'll take our last question from Mary Schlangenstein with Bloomberg News.

Oh man, I'm really sorry to say my questions have already been answered so I'm going to let you guys off easy today.

All right.

And at this time, I'd like to turn the call back over to Ms. Rutherford for any closing remarks.

Thanks, Tom.

We appreciate your time today.

If you guys have any follow-up questions, we can always be reached at (214) 792-4847 or questions through our media portal at swamedia.com.

Thanks so much.

Have a great afternoon.

Ladies and gentlemen, this does conclude our conference for today.

We appreciate your participation.