西南航空 (LUV) 2017 Q3 法說會逐字稿

Welcome to the Southwest Airlines Third 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 Mr. Ryan Martinez, Managing Director of Investor Relations.

Please go ahead, sir.

Thank you, Tom, and welcome, everyone, to our third quarter earnings call.

Joining me today, we have Gary Kelly, Chairman and CEO; Tom Nealon, President; Mike Van de Ven, Chief Operating Officer; Tammy Romo, Executive Vice President and CFO; and other members of senior management.

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

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

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

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

(Operator Instructions)

At this time, I'd like to turn the call over to Gary.

Thank you, Ryan, and thank you, everyone, for joining us to discuss our third quarter results.

I want to start out with a shout-out to all the Southwest people.

We've had really unprecedented storm challenges, fires, the Las Vegas situation.

And I don't know that we've ever had a 60-day period in our history where we had to deal with so many different external events like that.

They did a phenomenal job.

And of course, I'm very proud of the response that Southwest had for the communities that we serve.

And we're continuing to keep all the folks that are impacted in our thoughts and prayers and continuing to do the best we can to support them in their recovery efforts.

So despite all these challenges, it was a very strong quarter, and fourth quarter looks better.

2018 is also set up very well for unit revenue growth as well as margin expansion.

Now I found the third quarter and fourth quarter a bit challenging to interpret, and there were a lot of moving parts.

We have a reservation system.

New labor contracts went into effect in the intervening 12 months.

Hurricanes, earthquakes, we grounded the 737-300 fleet.

And the year-ago comps have some items in them as well.

And I would say that, that applies to both revenues as well as costs.

So Tammy is going to cover in more detail.

And I suspect that we'll be redundant on some of these points, but, hopefully, that will be helpful to you.

So first of all, I just want to start out on revenues.

Revenues were down -- unit revenues were down 0.5 percentage point in the quarter, and there's no real surprise there.

Without the $100 million hurricane impact, RASM would have been flat.

As also what is not new news is that the new reservation system created a temporary onetime drag of roughly 0.5 point, a little bit more than that.

For several reasons: school calendars, our new reservation system, just the number of aircraft deliveries that we were accumulating in August, we extended our summer schedule farther than we typically do, and that proved to be a drag as well of roughly 0.5 point.

That's not something that I anticipate we would repeat next year.

So you put all those things together and take those things into account, and it was a good result.

The third quarter was more challenging on yields than the second quarter was.

But again, overall, a very solid quarter.

And I think we're positioned well now for the fourth quarter.

The yield environment in the fourth quarter appears to be improved compared to where we were in third.

The onetime effect of the new res system should not be repeated in the fourth quarter.

The storms, the fires, the Las Vegas situation are certainly improved from where we were in third quarter, although there's still some recovery taking place, especially in Las Vegas.

We have a more aggressive schedule per aircraft because of the Classic fleet grounding.

That does present some drag, although, overall, we'll definitely have a cost benefit of the grounding of the Classics.

But all in, we're expecting positive unit revenue comparisons versus a year ago and a sequential improvement to third quarter as well.

And I'll just repeat again, we'll be watching Houston and Florida and Las Vegas recoveries very closely.

Our revenue outlook for 2018 is stable as well.

Our goal, which I believe is realistic, is positive unit revenue growth for 2018 compared to 2017.

Our new reservation system synergies of $200 million for 2018 is intact.

So a solid revenue performance and a solid revenue outlook.

On the unit cost front, ex fuel and profit sharing, we were up 3.3%.

There's no surprise there, maybe, perhaps, some good news compared to what we were expecting.

But overall, actually, a very good performance.

Costs were down across the board on a unit basis, except for the salaries category.

So just remembering that the new labor contracts went into effect after last year's third quarter with snap-ups, that was 3.6%, meaning that unit costs would have been down, except for the new labor contracts.

Of course, those are real costs, and they are continuing.

But more important for your analysis is the onetime effect of the storms on the third quarter, and that was 2%.

So if you take those 2 things into account, a very, very good cost performance for third.

As for the fourth quarter, we expect unit costs, ex fuel and profit sharing, to be in a range of flat to up 1.5.

That's somewhat higher than our previous expectations, and I would say it's mostly timing.

There is a -- the remaining is still a year-over-year effect in the fourth quarter of roughly 0.5 point, a little bit more from the new labor contracts.

We'll realize a nice benefit, as I mentioned earlier, from the grounding of the Classics fleet.

But our schedule is not fully optimized because we are trying to maintain as many flights with a fewer number of aircraft in the fleet.

So I would expect that, that would be more optimized by the time we get into the second half of next year.

So a solid cost performance and a very solid cost outlook.

Overall, through the first 9 months, now almost 10 months of the year, I'm very pleased.

We had successfully deployed our new reservation system.

We've had successfully launched international flying out of a new terminal in Fort Lauderdale.

We retired 67 airplanes for the Classic fleet in the third quarter, which was a huge effort and done very successfully.

And of course, we launched the MAX on October 1.

Our growth is very manageable both for this year and for next year.

There's only about 3% of our system that we define under development, and I'm very comfortable with that.

It's a very competitive environment out there, as everyone knows.

But I would also say that, that, at least for us, is very manageable, and especially considering the diverse and very solid and very strong route system that we have.

The economy and travel demand look very solid.

And again, I'll just repeat, we'll -- we're continuing to watch carefully Houston, Florida, Las Vegas and I should also mention Puerto Rico.

The energy price outlook for the near term and for next year looks very favorable.

I'm very happy with the hedging position that we have built for the next several years.

No change in our growth plans.

No change in our fleet plans.

We're just getting to work on Hawaii, as you know -- you all now know, and we'll have more to report on that in the first quarter.

So with that very quick overview, I'd like to talk it -- turn it over to our Chief Financial Officer, Ms. Tammy Romo.

Thank you, Gary, and welcome, everyone.

And I would like to start off by congratulating Mr. Kelly on his well-deserved Wings Club Distinguished Achievement Award last week.

And I'd also like to start out by thanking all of our employees for their incredible efforts during the quarter.

Our thoughts and prayers are with all of those who have been impacted by the hurricanes and earthquakes, the Las Vegas community and those impacted by the fires in California.

And while our third quarter operations were certainly impacted by the unprecedented number of natural disasters, we were very pleased to report strong third quarter profits of $503 million.

Excluding special items largely related to the retirement of the Classics fleet, our third quarter profits were a strong $528 million.

(technical difficulty)

which earned them $127 million in profit sharing.

Jumping right into revenues, our operating revenues were a strong $5.3 billion, despite the significant impact from the hurricanes.

Our third quarter RASM decreased 0.5% year-over-year, which was in line with our most recent guidance.

This included a revenue headwind from the implementation of our new reservation system of less than 1 point.

The minor issues from the reservation system that caused the revenue impact in the third quarter have been remedied, and we don't expect an unfavorable impact in -- here in the fourth quarter.

Third quarter started off with a positive year-over-year RASM growth in July.

However, August and September were both impacted by the significant weather events and the competitive fare environment impacting closed-in yields.

As we noted in the earnings release, the hurricanes and natural disasters caused approximately 5,000 flight cancellations in third quarter, which negatively impacted our third quarter revenue by $100 million.

Nearly 15% of our system ASMs touched Houston and the other stations in Texas that were impacted by Hurricane Harvey.

And about 25% of our system ASMs touched Florida and other sates nearby as well as near international destinations that were impacted by Hurricane Irma.

However, both our Houston and Florida operations and employees are resilient.

And the impacted stations and passenger demand have rebounded quite well.

All things considered, including our difficult year-over-year comparisons due to our strong industry outperformance over the last few years, we are very pleased with the overall resiliency of our revenue performance.

Our freight revenues were also solid, and third quarter other revenues increased approximately 13% year-over-year, driven primarily by the continued success of our Rapid Rewards loyalty program.

And although the fare environment remains competitive here in October, it does appear to be stabilizing.

October passenger revenue yields are currently trending up nicely year-over-year, which is an improvement from August and September year-over-year yields.

And I'll just point out that November and December are expected to have more challenging year-over-year unit revenue comparisons due to the boost in travel demand and yields last year, particularly between the holiday periods.

And while the December holidays fall similarly year-over-year, we are monitoring whether we'll see any negative impact from school holidays beginning later in the month, which may postpone more travel into January, but it's a little too early to tell.

That said, overall travel demand for the fourth quarter is solid, and we are very pleased with our current outlook for positive year-over-year unit revenue in fourth quarter.

Based on current bookings and revenue trends so far in October, we currently expect fourth quarter RASM to be up slightly to up 1.5% year-over-year.

We also expect both freight revenue and other revenues to increase year-over-year in the fourth quarter.

Turning now to cost.

Our third quarter cost performance was within our expectations.

Our third quarter economic fuel price per gallon was $2, which was at the lower end of our guidance.

The retirement of the Classics fleet and other ongoing fleet modernization initiatives drove a nearly 2% improvement in fuel efficiency year-over-year.

Since our last call, crude prices, as you know, are up.

And for fourth quarter, we are estimating approximately $2.10 per gallon based on market prices last Friday and our current fourth quarter hedge position.

This fourth quarter fuel cost estimate includes a $0.25 per gallon hedging loss.

At the end of this year, our fuel hedging losses will burn off, providing meaningful tailwinds in 2018.

All of our hedges in 2018 and beyond are call options and cost spreads, with no floor risk.

Excluding fuel and special items, our unit cost trends improved sequentially, as expected, with the continued benefits from the retirement of the Classics and the wind down of costs associated with the implementation of our reservation system.

With the retirement of the Classics, we recorded 2 special items during the quarter.

As expected, we had a $63 million aircraft grounding charge related to the remaining lease payments.

We also recorded a $20 million lease termination charge related to the acquisition of 4 of our Classic aircraft previously under operating leases.

And as a quick reminder, these charges were contemplated in the estimated $200 million EBIT improvement that we've been communicating from accelerating the Classics retirements from 2021 to 2017.

Excluding fuel, profit sharing and special items, our third quarter unit cost increased 3.3% year-over-year, which came in at the lower end of our guidance.

The year-over-year increase was driven by the hurricane and wage rates from labor contracts, partially offset by Classic retirement benefits.

Looking to fourth quarter.

We continue to expect our unit cost inflation to ease considerably as compared with the first 3 quarters of the year.

As we've stated before, this is due to the cost benefits associated with the retirement of the Classic fleet and the lapse of the step-up in wage rates from our -- from the labor agreements.

Based on current trends, we now expect fourth quarter year-over-year CASM, excluding fuel, special items and profit sharing, to be in the range of flat to up 1.5% year-over-year.

The primary drivers of this increase include a shift in advertising spend and incremental cost associated with technology investments, including ETOPS authorization in preparation for our Hawaii service.

And adjusted for the hurricane and our investment in ETOPS, our full year CASM is in line with where we were in July on our last conference call.

Our investment-grade balance sheet remains very strong and continues to differentiate us in the airline industry.

We are very proud of our recent rating agency upgrade from S&P to BBB+ in August, which is on the heels of our upgrade to A3 from Moody's in June.

Our liquidity is strong, with cash and short-term investments at quarter end of $3 billion.

And our cash flows remain very healthy, with operating cash flow of $3.4 billion for the 9 months ended September 30.

Our CapEx guidance for 2017 is unchanged at $2.3 billion, which allows for healthy returns for our shareholders.

And in August, we repurchased $300 million of common stock through an accelerated share repurchase program, leaving $1.7 billion remaining under our current $2 billion authorization.

Thus far, in 2017, we have returned $1.5 billion to shareholders through share buybacks and dividends.

Our leverage, including off-balance sheet aircraft leases, is approximately 30%.

And our goal remains to keep leverage in the low- to mid-30% range.

And moving on to fleet.

I am very proud of the many employees that were involved in the management of retiring our Classic fleet.

We started the year with 87 Classics and retired 69 in third quarter alone, as planned.

That brought us to 687 aircraft at the end of the third quarter after the delivery of 20 new and used aircraft during the quarter.

We are thrilled to introduce the MAX 8 into our network.

We have 10 of them in our fleet currently, and we'll have 14 by the end of this year.

We continue to expect to end this year with 707 total aircraft, and our fleet plans remain unchanged in 2018, with 750 aircraft.

On the capacity front, we continue to expect fourth quarter capacity to increase in the 1% to 2% range year-over-year.

And our 2018 capacity plans remain unchanged, with expected ASM growth of less than 5.7% year-over-year.

We expect first half 2018 ASM growth to be in third -- in 3 to 4 -- in the 3% to 4% range, as we noted in our earnings release.

And as a recap, our return on invested capital for the last 12 months is a strong 26.8%.

And 2017 is shaping up to be another just really stellar year.

I am excited about 2018, including our future plans to serve Hawaii.

And I want to thank our employees again for their hard work and perseverance in a challenging quarter and for all that they do on the front lines each and every day, and congratulate them on these great results, again.

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

(Operator Instructions) We'll now begin with our first question from Hunter Keay with Wolfe Research

Sorry, can you hear me?

I can hear you now.

Sorry about that.

Okay.

So, 2018 costs, Gary, you said you feel good about the RASM outlook for 2018.

That's great.

I wouldn't imagine you guys are enough through the budget process at this point to give us a preliminary look.

Do you feel like the expense behind you with the PSF cut over, that we should start think about CASM ex fuel next year as being down?

I do feel really good about the cost outlook for 2018.

Tammy, would you like to go through that?

I would be delighted to.

So, yes, Hunter, we're still finalizing our 2018 plans, so I'm not prepared to provide guidance today.

We'll -- we plan to cover that on our January call.

However, I'd be happy to provide you some thoughts and goals that we have for 2018.

On the cost front, we're still working through our multiyear plan, including how we want to invest in technology and other areas of the business.

We have some wonderful tailwinds in 2018 related to benefits and depreciation, maintenance and aircraft rentals from the Classic retirements and onetime costs associated with Lone Star as well as significant tailwinds for fuel with our hedges loss -- hedging losses burning off this year.

And with the Classic retirements and launch of the MAX 8, we should have a meaningful fuel efficiency improvement in 2018.

As we move through our planning process for next year, some headwinds have also materialized, including costs such as landing fees.

And as our -700 aircraft age, of course, you'll -- we'll have some increasing maintenance costs there as well and just other typical inflationary cost pressures.

Netting all of this out and considering that we will still be transitioning through the Classic retirement as far as the network schedule goes, I think CASM, excluding fuel, profit sharing and special items, would be a reasonable goal for us versus 2017.

Of course, as always, we will continue to look for ways to manage those costs down.

But I think down year-over-year costs per available seat miles, excluding fuel, profit sharing and special items, would be a stretch based on what we know today, which is, of course, a little more than what we knew at the time of our last call.

Overall, I am quite pleased with our early outlook for 2018.

We are -- as you -- on the revenue front, too, as well, we're working hard to realize the benefits from our investments in our new reservation system.

And we'll continue to be diligent on the cost front.

And then kind of back to fuel, with the tailwinds I mentioned there and our goal to grow RASM, I do think that we are well positioned to expand our margins next year.

And certainly, fuel -- excuse me, comps are a big part of that story.

Okay.

That's helpful.

And then -- and, Gary, on the positive RASM comment that you made, well, can you just -- what kind of gives you the confidence about that?

And how much of that has to do with your view on industry conditions versus some of the Southwest Pacific stuff?

And on the Southwest Pacific stuff, is it a load factors play?

Is it a yield play?

I mean, what are sort of the components of that, that give you the confidence to put that out there at this point in time?

Very fair questions, because nobody has a crystal ball.

I think it is just recapping some of my opening comments.

It's our view that the economy will continue to be stable.

It's our view that the travel demand will continue to be very strong.

And then, of course, we're overlaying that, what is the competitive supply of seats that are out there?

And we're looking at the things that we have in the pipeline to bring it online next year.

Of course, you all are well aware of our One Res synergies that we've been talking about for some time.

And then just looking at current trends, we -- there's a lot of strength throughout the Southwest system.

And I'm very happy with the progress that our development markets are showing.

Andrew Watterson and his team have been very active in pruning out some of the nonperformers in our system.

And of late, of course, you're familiar that we eliminated flying to Varadero and Santa Clara.

So -- it was -- I was unhappy doing that, but it's clearly the right thing to do.

So we'll continue to be active in managing the network.

At the same time, I want to let them take some risk and be aggressive.

But overall, it feels like we're set up very well.

Next year is fun in the sense that compared to, gosh, the last 5 years, it's just more stable.

There just aren't as many moving parts.

We're not retiring fleets.

We're not introducing new res systems.

We're not opening up brand new international terminals.

The big-ticket item right now is just working on Hawaii, and I think that, that will be less ambitious than what some of these other things have been.

But the -- I -- my hats off to our folks for managing this well, and there -- I think they'll continue to manage with better tools next year.

And we'll take our next question from Jack Atkins with Stephens.

Just to clarify, Tammy, on your comments on the CASM outlook or framework for next year, at least on my line, it sort of cut out when you were talking about the expectation.

I think you said you're not expecting it to be -- or I think you said down year-over-year would be a stretch.

But I didn't hear, I guess, your exact comments on sort of your outlook for 2018 CASM ex.

Could you just maybe go over it again for a moment?

Sure, Jack.

Sure and I'll be happy to.

No, just on our CASM, excluding fuel, profit sharing and special items, as I said, getting down may be a stretch.

But I do think that a flat CASM, excluding fuel, profit sharing and special items, is a reasonable goal versus 2017.

Okay.

That's helpful.

I wanted to make sure that, that was out there.

Great.

And then just sort of -- as my follow-up question, going back to the $200 million in pretax incremental profitability from the new reservation system next year, could you help us think through the -- sort of the cadence of how that will flow through the P&L as we move through the year?

is that going to be sort of evenly distributed throughout 2018?

Or is it more second-half weighted?

And then how should we think about that incremental profitability coming from revenue or costs?

Just trying to think through how that's going to show up in the P&L next year.

Sure, Jack.

I -- well, first of all, as we've indicated this year, we're really focused on just implementing the -- getting the new reservation system in.

And as you know, that's gone very well.

We actually have a couple of releases coming up here this year.

And -- so we're -- we remain very pleased with the progress, the rollout that we would like to get a little further down the road before we provide an additional breakdown of the $200 million EBIT.

So we'll come back more later and fill in some of the blanks.

But certainly, with the ramp-up, I think it's reasonable to assume you'll see more of that as we get to a more -- more in the back half.

But in terms of breaking it down any further for you, we'll come back as we finalize our plan and provide that likely on our January call.

That's our current plan at the moment.

But everything's going well.

We're pleased with the progress, and that's where we sit today.

Okay.

That's great.

And one quick housekeeping item, if I could squeeze this one in.

Could you provide us with the hedge asset or liability as things stand today for 2019, if that's possible?

Yes, absolutely.

For 2019, it is just about $50 million.

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

I'm a little mad at Tammy.

She beat me to the punch on the Wings Club award.

But coming from somebody, Gary, that's also known you for over 25 years, I sincerely hope that you accept my congratulations as well.

Very, very cool.

Question on Hawaii -- you're welcome -- a question on Hawaii, and I know you're not ready to discuss routes and schedules and all that, but when I think about the time of day that most flights depart the West Coast to the number of time zones you cross and the applied -- implied arrival time back in California or on the West Coast, if you did maybe a 60-, 65-minute turn, I don't know.

I sketched out several single aircraft patterns.

And in most of the scenarios, it looks to me like you'd have adequate time to do some interisland turns.

And of course, shorter-haul flying is Southwest's bread and butter.

And I know you're not going to say whether you'd consider interisland, but can you point me to anything in the work rules, the pilot duty rigs, anything that would, at least, allow me to rule out the feasibility of running a couple of turns before you turn back to the mainland?

Yes.

There's nothing that would rule it out.

And I think now that we are public with all of this exciting topic, that is an item of interest that customers in Hawaii have, that the state of Hawaii has.

And obviously, it's something that Andrew and his team are intrigued with as well.

It's -- step 1, of course, is getting from California to Hawaii.

But it is absolutely -- everything you said is right.

And it is -- it has been down our priority list, but it will -- we'll have serious consideration for that.

Who knows, it -- even if we don't do that initially, it's something that we would obviously continue to consider over time.

But I think everybody understands where we are.

This is very high-profile work, and we just can't keep it a secret.

So we're letting the world know early on that we're working on it.

And there are a lot of questions to be answered with it being one of the major questions that we just don't have those answers yet.

But like I indicated in my earlier remarks, it feels like first quarter, we might be in a position where we're prepared to reveal details there.

But -- yet, no, there's nothing that would prohibit us from doing that, that we know of at this time.

Okay, I appreciate the sanity check.

Second, as it relates to pricing, I just want to confirm that the older system puts some limits on your ability to price match by channel.

But the new system does give you more flexibility.

So if an ultra-low-cost competitor has a single daily flight at, I don't know, noon, you can match on your 12:20 departure, but you don't need to match at 9 in the morning or 5 in the afternoon.

Is my understanding of the new system correct?

And if so, is this what you're broadly doing or not?

And I'm not asking about future pricing, just what's in the market right now.

Well, we -- first of all, our folks have done an amazing job in managing revenues in what is a very sophisticated art and science, with not the best tools.

So I don't think it's a fair characterization to say that we could not do certain things.

It is, I think, more accurate to say that we have far better tools now to do things along the lines that you're describing than what we've had in the past.

Whether that will show up as a material difference in the future, I'd rather not comment on.

But it is absolutely accurate to admit that we'll -- well, that we have much better up-to-date, state-of-the-art tools today than what we've been using.

And what we've been trying to share is that it's a really good airline that has produced really good results.

And we're just going to have better tools going forward.

So clearly, that is one of the tools that we'll want to make good use of.

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

Just on the international side, I was just wondering if you can provide an update on how that expansion has gone and just any opportunity to be a bit more aggressive in growing those regions.

Well, Savi -- and Tom and Tammy can pitch in here, too -- it's gone very well.

The -- clearly, they -- those markets have similarities to domestic markets in the sense that they struggle a bit when we start.

And then over time, if we're managing it well, then they develop very nicely.

So we have a little bit over 3% of our available seat miles transborder.

The -- I just have a few notes here handy.

The capacity increase in the third quarter year-over-year was just under 19%.

And the revenues far outpace that.

So we're seeing -- which is an indication, again, to my point to you that these markets are -- they're in the development phase, but they are developing very nicely.

Some of it is what Andrew has been doing, which is trimming out some of the underperforming routes, which aren't very many of them.

But our RASM was up, on a stage length and gauge-adjusted basis, almost 8% year-over-year, so feeling really good about that.

Load factors are really strong, I think.

So the net answer to your question is, absolutely, we have a lot of opportunities to grow there.

We have a wealth of opportunities all over the place.

So we have domestic opportunities.

Everyone knows about Hawaii.

We've got international.

So we'll try to be as coy as we can about giving our competitors advanced notice of where we intend to go next.

But with the -- we're struggling with our capacity here in the fourth quarter and the first quarter to be able to grow, for the obvious reasons, with the Classic fleet retirement.

So we'll have to see where Hawaii settles in.

And the nice thing is we've -- again, we've got plenty of opportunities.

If we're constrained in a certain region, then we've got more than ample opportunities to grow somewhere else.

We are following through with our announcement to open up service to Turks and Caicos, and that will be next month.

So we've done a full assessment after hurricane Irma there, and all systems are go.

But that Turks and Caicos is the last city that you know of -- or destination that you know of that we're adding, but we have plenty more to choose from.

But admittedly, right now, we're looking at Hawaii and what it's going to take to start that service.

And clearly, that will be our next priority.

If we have room to add some more international destinations next year, that would be fantastic.

We do want to continue to support our growth in Houston and Fort Lauderdale, in particular.

If I may follow up on that, Gary, so next year, I think your previous comments have been that you'd be accelerating domestic growth and focusing on that and letting international to adjust itself.

Is that still the case?

And how -- what are -- at what levels do you think is going to have domestic acceleration?

Savi, I think that's very fair and that is what we have done, thus far, with the schedules that we've produced.

We're about to publish the schedule next month, Andrew, that would take us through August, I believe?

At least August.

Beginning of August for next year.

So at least, with what you've seen through the first half of the year, yes, that's been more of a domestic focus.

And we haven't opened anything beyond Turks and Caicos.

So we'll -- as per usual, we'll continue to wait until the very last minute to commit.

But certainly, that's been -- that has been our focus for the first half of the year and may very well prove to be -- we may very well not add any more new destinations.

Hawaii is the thing for us to answer right now.

We'll take our next question from Duane Pfennigwerth with Evercore ISI.

Can you talk about the next maybe 2, 3, 4 IT systems that are in the pipeline, what the most material contribution from those would be?

Now that you've got the big res migrated, what are your next 2 or 3 priorities?

I would say that the reservation system, by the way, is still a huge focus for us.

And we've got a major release coming out next month.

But let me let Tom take you through that.

Okay.

Well, so let's talk about res for a second.

So in mid-November, we'll be releasing, at least, 2.5, which really cleans up all the operational revenue leakage stuff that we've been dealing with.

So that's going to be -- that's going great.

It's all I can assess.

It's going well.

I think the next set of big investments are really not on the commercial side.

I think we have a very good set of capabilities there now.

It's going to be more on the operational side.

We have work going on, right now, replacing our maintenance systems.

Our aircraft maintenance portfolio is under development right now.

Flight planning and scheduling is being upgraded and replaced, as well as crewing systems.

So those are the 3 big platforms.

If you think about an airline, I think that you get all 4 of those, res, crewing, maintenance and flight operations, that is the foundation.

We're building this.

In fact, I would tell you if we were not planning to grow, what we have today is really pretty darn solid.

It's pretty good.

But if you do intend to grow, which we do, we need to have a foundation that can grow with us.

So that's what we're doing and Mike and I are really closely linked on and what does the operation look like with those new capabilities.

So those are the priorities right now.

The only thing for that is that In terms of the benefits, we have opportunities to continue with our fleet modernization efforts that have a cost benefit.

And then also, these systems that Tom was describing, it's Mike's goal to create an opportunity for our operations to become more and more and more efficient.

So we've changed a lot over the last 15 years.

We have much higher load factors than we did 1.5 decades ago.

We have more connecting passengers.

The bags per passenger, Mike, I think are about the same, but it's just the volumes are greater.

And some of our operational systems struggle to keep up with that, very much in line with Tom's point.

So there'll be an investment.

But I'm also very hopeful that there will be tangible financial benefits that will flow from these operating system enhancements.

And maybe just to dig in a little bit further there with respect to flight planning and scheduling, can you speak to when that would go live?

And maybe next year or 3 quarters from now, like, how will that improve your ability to be tactical within the month or within the quarter on capacity changes?

Could you just contrast the flexibility that you'll have in the future relative to what you're dealing with right now?

Well, it's early.

But what I would tell you is unlike the One Res, which really went into 2 big releases, now we have kind of minor release going in, but it's kind of -- I wouldn't call it big bang, but it was kind of a big bang.

Unlike One Res, I think what you're going to see with things like crewing systems and flight planning, flight control is getting more of an incremental function being added in over time.

And it's still early days, but it's going to transcend or really transpire over several years.

But we're fairly well into it, but I'm not sure if I could really give you more definitive answer than that.

But I don't -- Duane, I don't remember, Tom, that we have any major operational functionality that's deploying next year, maybe aside from the mostly maintenance (inaudible)

Yes, we have maintenance.

We have our IT system.

Our tech op system will be deploying late, late in the year.

But we've already deployed some really good recovery tools.

It's called the Baker AOROPS tools.

And we're going to continue to put functionality into that.

And that's pretty meaningful for us.

So I think, again, to summarize the -- for the near term, we'll be continuing to implement follow-on releases of the reservation system.

And obviously, we want to finish what we started there.

And there is tremendous value to be earned from that.

That will need to continue to be a priority.

We'll take our next question from Darryl Genovesi with UBS.

Mostly, I wanted to ask you if you've seen legacy carriers, United and America, in particular, deploy their basic economy product in scale in your markets.

and if so, whether you believe you are gaining market share in those markets as a result.

It's -- I get the implications.

We can kind of argue this from both ways in theory.

Is it good for us?

Is it bad for us?

So far, I don't sense that we can tell one way or the other.

It's certainly not hurting us.

Whether it's helping us, I don't know at the margin.

In terms of our brand, I can assure you it is helping us.

We have a lot of fans, and we're grateful for that.

So they love Southwest Airlines, and we're trying to be their most loved airline.

But here in the meantime, I'm just giving you an honest answer.

I don't sense that it's moving the needle one way or another.

Do you agree, Tammy?

I completely agree.

Do we have another question?

Yes.

Our next question comes from Brandon Oglenski with Barclays.

So, Gary, just want to come back to the pricing comments you guys made -- or it might have been Tammy, I'm sorry.

But you did say that it appears the fares are improving in your markets from August into September and into the fall.

Do you think that's just a function of improving demand?

Or is it capacity dynamics that are more impacting your network than maybe others?

Well, I -- from month to month, I just don't know that the markets are quote -- or that dynamic.

So I think it's just pricing, to be blunt.

I think pricing is very dynamic and hard.

And our just speaking as one carrier, it's impossible for us to predict what behaviors we'll have from our competitors.

And then as a consequence of that, what moves we'll need to make to react.

So overall, it just feels like the yield environment is better.

Well, it doesn't feel like; it is.

It is better in October than it was during the third quarter, which was a wild ride, I think, as everybody knows.

Second quarter was pretty darn good.

And then all of a sudden, things got off the rails a little bit.

I think the point I was trying to make in my earlier comments is that we're fine with that.

We are very -- we have a very low-cost structure.

We have a very diverse route system.

We're continuing to strengthen it with flights where we need them, and we're trimming out where we don't.

And we can handle all this.

So we'll have ups and downs to a degree.

But in the grand scheme of things, our revenue production all year has been quite good, softer in some periods than others.

Right now, we're on a bit of an upswing.

And just to make sure you caught what I said earlier, we have seasonally -- sequentially, rather, we are seeing improvement in the fourth quarter, so far, compared to where we were in the third quarter.

And then obviously, Tammy and I have made the point several times that the year-over-year comps are, so far, looking pretty good.

The holiday travel for November looks strong.

The December is a little far out and a little less definitive right now how we'll compare.

As usual, we always struggle a little bit with how holiday travel will occur on the calendar.

Whether it's December, January, that flips a little bit.

I think the calendar is pretty close.

I think it's just -- well, obviously, just 1 day different than last year.

But right now, we're -- again, we're looking for an improved yield environment and good compares versus a year ago.

I appreciate the thorough response.

And I think one of your smaller competitors out in California called out some weakness, specifically in that market.

So that could have gotten investors worked up a little bit.

But I guess, the longer-term issue or question I have for you...

Well, I can fairly comment -- yes, I can comment on that if you -- if that's a question.

The -- as we look regionally, it -- the -- there's no question that where there is vigorous fare activity, there's more of an impact on us.

And Tammy shared that earlier this morning on a media interview, Chicago, Houston, even Denver to some degree.

California is very competitive, but it performed very well in the third quarter, pretty close to in line with the system average.

But we're -- I certainly wouldn't say that we're seeing weakness in California.

But it just harkens back to my earlier comment.

We're the #1 airline in California.

We have a very strong fan base there.

We're continuing to add flights to meet the needs of our customers in those markets and grow where we can.

And those results look very good, particularly considering that we've added quite a bit of capacity out there of late.

Well, I think that's very helpful for your investor base.

I'm sorry, I'm going to sneak one more, and I very rarely violate that rule.

But you are going to be in an asset position on your hedge book.

So does that change your philosophy at all on pricing when you think about fares in '18?

I know you want to have up unit revenues, but...

Yes, we're going to go crazy.

No, I think as we have said for years, we want to be disciplined about how we manage our growth and how we set expectations for revenue production in our markets.

And our goal for next year is positive unit revenue production, even knowing that our CASM will be down next year, assuming that fuel prices behave themselves.

Tammy has already mentioned that her goal for the -- all the rest of the cost structure ex profit sharing and all that stuff that she lists is flat.

So yes, we want to continue to boost our unit revenues and maintain that discipline.

We're very leveraged to fuel prices.

I don't have to tell you all that.

I'm happy with our hedge position.

But I think it would be foolish to behave in such a way that doesn't recognize -- that wouldn't recognize that fuel could change course and all of a sudden create problems.

So that would be our goal.

And I -- as I said earlier, I think that is a realistic goal.

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

Gary or Tammy, can you provide a bit more color on what you're including in your 4Q RASM guide?

Are you reflecting demand hits from places like Houston and Vegas?

Is there a calendar hit in there?

I think, Gary, you mentioned something about elongated schedules.

Is that something that's hitting the results?

Just some color will be great.

Yes, all of those things are in there.

And I -- the only cautionary note that I offered up, I'll let Tammy speak for herself, is that Las Vegas isn't back to 100%.

I am assuming that it will be here at some point.

Houston and Florida look to me like they're still lagging a bit.

I think our guys are pretty happy with where we are there.

But I think it's just the recognition that those situations are a little volatile.

And I just -- and Puerto Rico, in particular, I was asked earlier this morning what our prediction about Puerto Rico is a year from now.

I just don't know.

I don't know when that will fully recover.

But with those caveats, we're -- I don't think we are implying that we're expecting miracles in any of these markets, whatsoever.

If anything, maybe we've got a little bit of a cautious approach there.

But, Tammy, anything you want to add?

No, I think we've covered all the highlights for fourth quarter.

And I agree, we've got our best estimates incorporated in the guidance that we've given you here today.

And the drag on the schedule from the retirement of the Classics, I don't see any upside there.

I think that, that will continue to be a bit of a drag because there's simply later or earlier flights in the day from what people really want, and we're very familiar with that.

But my point is that as we tighten up the schedule, the objective will be to tighten up the schedule as time goes by and we get more aircraft deliveries, that our target would be to see some improvement there.

Okay.

And then just those headwinds that you're talking about, Gary, Tammy, is that like 1 point or so?

Can you put maybe a finer point on it?

Yes.

0.5 point on that particular item.

On Las Vegas, Houston or Florida, Tammy, I don't know if you have a number in mind or not.

I didn't.

Yes, if I'm quantify just for -- on that route on the revenue side, Las Vegas, and then probably throw the California fires in that, maybe that was probably a $10 million to $15 million impact.

So again, not too significant.

Okay.

And then just a second question.

In terms of the capacity side of things, what's the latest thinking on growth on the back half of next year and the factors that will drive that range?

Obviously, you guys have done a good job of providing the first half, but any more color would be great.

As we said earlier, Rajeev, we're going to update as we publish our schedules.

So it's -- we're not prepared to give you specific guidance today on the second half of next year.

So I think I'll just stick to what we already shared.

Yes, there's no change.

I think Hawaii maybe -- whatever happens with Hawaii may impact our available seat miles.

But there is no change in the airplanes.

We have schedules out there.

Tammy said 3 to 4 for the first half for next year.

Obviously, if we're 5.7 -- less than 5.7, it means we would grow more than that in the second half.

So you should absolutely expect that, but...

But that should -- that's really driven by the Classics fleet retirement.

Right.

Exactly.

So nothing really new there.

Yes, that's right.

It's just year-over-year comps.

And we have time for one more question, and it comes from Michael Linenberg with Deutsche Bank.

Just a quick one here.

Gary, do you -- at this point, do you have the capability, I know Tom talked about the systems and maybe Tom can chime in as well, just the capability to do red eyes?

And if you don't -- if you can't do red-eye flying now, is that something that you would want to be able to do at the time that you started Hawaii?

Or do feel like you could serve those markets without flying red eyes?

We are going forward, and I want Mike to, if he has something he wants to add to this, to chime in.

We are going forward with our Hawaii work without red eyes.

Right now -- I'll just speak for Gary right now, but we don't really desire to fly red eyes right now.

So, just for our style of operation, it would complicate things.

I'm assuming, Mike -- both Mikes, Michael and Mike, that, at some point, we will want that capability.

Tom went through the list of technology priorities earlier, and it's just down the list.

So we can do Hawaii without the red eyes, whether we feel strongly that there's a revenue benefit from having the red eyes, I don't think we've judged that yet.

And then Mike Van de Ven, of course, has to deal with all the complications of doing that.

But, Mike, you -- anything you want to add?

No, I don't really have anything else to add.

We've got those capabilities identified that we'd like.

We've got them a little bit lower on our priority list.

And it does introduce some operational complexity in terms of the crew scheduling and the maintenance programs that we all want to work through and just make sure that we have that capability being delivered in the year we really want it.

So as you can tell, Mike Linenberg, it's just not a -- it's not a priority for us.

And it's not a factor, in our view, with our Hawaii service.

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

Thank you for joining.

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

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

Thank you, Tom, and welcome to the media members of our call -- on our call today.

We can go ahead and get started with the Q&A.

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

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

Gary, I just wanted to know kind of where the things stand in Washington, D.C., with all the different discussions that are going on up there, specifically with air traffic control reform.

Is there sort of a path forward to see if you get some momentum?

Are you waiting on your people in D.C. to kind of take that up?

Conor, the House has been attempting all month, as I recall, to get the FAA reauthorization to the House floor.

And so far, they have not done that.

And I think that, that is just an indication that, perhaps, all the votes aren't lined up yet.

Now the focus, as we know, has turned to tax reform.

And so I don't know how that might or might not interfere with this effort.

But overall, I've been encouraged this year.

And it is the fact that the administration is behind exactly what we would like to do is a plus.

The House leadership, I think, is behind the reform effort that members of the FAA, our leaders of the FAA have actually come out in support of the effort.

So it's not done yet, but I don't know any more about it than that.

I don't know if there is a desire to have a vote this year or not.

I hope there is.

We'll take our next question from Dawn Gilbertson with the Arizona Republic.

Gary, you mentioned a couple of times, Vegas is still not 100% where you -- from where it was.

Can you add any color to that?

I mean, is this business, leisure, short haul, long haul, all across the board, anything regional?

Can you give any more color on that front?

Well, I think it's pretty straightforward.

I think it is, obviously, a huge vacation destination.

It is traffic related and, I think, totally understandable.

So we're very close with the Las Vegas Convention and Visitors Bureau and the entire community there, and we'll all work together.

I think -- I -- quite frankly, I'd be surprised if we weren't back to 100% by the end of this quarter, if not before.

But it's not...

Are you making any adjustments?

Well, adjustments in terms of our flight schedule?

Yes, flight schedules, fares.

I mean, anything to maybe get people that maybe have some...

I think, in fairness, we're always making adjustments.

But in terms of a major change with our flight schedule or a major change with our fares, no, No.

We're mainly just making sure that everybody knows, again, working with Las Vegas, that we're open for business.

And I'm confident that the traffic will come back and grow.

Can you say how much the traffic is down?

I'd be happy to if I knew it off the top of my head.

Tammy, do you have a number on your mind?

I don't have the traffic number in my mind.

But as I mentioned earlier, our -- the impact that we're expecting here in the fourth quarter is pretty minimal, in the $10 million to $15 million range.

And that's what we're estimating.

So beyond that, I don't have the traffic numbers top of mind.

Dawn, if it were 100%, if that were the standard, it's not that we're down by 50%.

We may be down 10% or 15%, something of that order of magnitude.

But I'd be surprised if we were down that much now, quite frankly.

(Operator Instructions) We'll take our next question from Ghim-Lay Yeo with Flightglobal.

I have a question about the Hawaii service.

Could you talk a little bit about just the ETOPS certification?

And maybe Mike can chime in if he's still on the line, but how soon after getting initial ETOPS for the 737-800 will we see Boeing 737 next service?

Yes.

So we have been -- we've been -- we've got a team of people working on our policies and procedures.

The great thing is we don't have to invent them.

They're out there.

We just need to gather them and write them in a manner that works in our procedure manuals and then get -- training them.

So what we've been doing is sitting around doing tabletop exercises with the FAA, making sure that we have those procedures and training requirements and clearly written.

We're going to take that package and we will actually apply for an ETOPS certification added to our ops spec early next year.

And then the FAA will go through their approval process.

And that could take anywhere from maybe 6 to 12 months with them, just depending on their staffing and their challenges and what they need to do.

So we are going to launch with the 800 there.

We have that airplane today.

It's ETOPS-capable.

And it's our quickest path to Hawaii.

And then we will begin discussing with the FAA what we need to do to have the MAX ETOPS certified.

It will be our Hawaii airplane for the future for us and then the foundation for our service.

Okay.

But how soon after launching Hawaii service initially?

I mean, how many more months would you have to wait before we can actually get them next onboard?

Do you have an idea about that?

How long before we can do what?

How do we....

How -- yes, before you can actually get the next plane to Hawaii.

Yes, so that's what we need to work with the FAA on and understand what they need to see from us in order to get that certified to do that.

So I don't have an answer to that question until we get more information from the FAA.

And we have time for one more question.

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

Mike, I wanted to ask you how the MAX is performing.

So far, you had a few issues on the initial flights.

Can you talk about how it's been going since then?

Sure.

Yes.

We have 10 airplanes in service today, Mary.

And what I've been saying is it's as advertised.

So we've got a 14% fuel burn improvement on the -- as compared to the 800.

Just -- we've flown over 1,000 flights with it so far.

We've had 152,000 customers on it.

It's been through about 2/3 of our system domestically.

And the reason I just -- and so we haven't had any surprises or unexpected issues with that airplane.

So we do have the typical newness on the airplane, a lot of first-time experiences and slightly different procedures on the airplane.

But it has just been performing, as I said, as advertised.

And I'm very excited about adding the airplane to the fleet.

Do you have any kind of a number, like a dispatch reliability number or anything like that for the MAX so far?

They are right in line with the rest of the system, the rest of that.

Like our 800s, they're right in line with the 800s.

Of course, as you mentioned, we did have -- on one of the airplanes that we launched service, we had a fairly unique maintenance issue on that airplane.

It hasn't been reproduced across the global fleet.

We've been working with Boeing on that, got that fixed.

It's back in service.

And it's performing just exactly in line with the dispatch reliability of the -- at the 800s.

Great, great.

And if I could also ask, there was a local article yesterday about AMFA trying to or threatening to try to block Hawaii service.

I wanted to see if you all would confirm.

You've said in the past that there's nothing in your labor contracts that would prohibit Hawaii service.

I just want to see if that's correct for that group as well?

That's correct.

And that is our final question.

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

Thanks, Tom.

As always, if you have any follow-up question or need anything, you can reach us at swamedia.com or by calling the Communications Department at (214) 792-4847.

Thank you all so much.

And that concludes our conference for today.

Thank you for joining.