Southwest Airlines Co.
Q3 2017 Earnings Call Transcript

Published: 26 Oct 2017

[Operator:]

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.

[Ryan Martinez:]

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. And we ask that you please limit yourself to one question and one follow-up, so that we can accommodate as many question as possible. At this time, I'd like to turn the call over to Gary.

[Gary C. Kelly:]

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 of 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. I found the third quarter and fourth quarter a bit challenging to interpret and there were a lot of moving parts. We have a new 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 it 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. 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

[Tammy Romo:]

Thank you, Gary, and welcome, everyone. And I would like to start off by congratulating Mr. Kelly on his well-deserved The Wings Club's 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 profit of $503 million. Excluding special items largely related to the retirement of the classic fleet, our third quarter profits were a strong $528 million [with healthy margins. My congratulations to our Employees for their resilience and hard work this quarter to produce these strong results] (10

[Operator:]

Thank you. And thank you for waiting. We'll now begin with our first question from Hunter Keay with Wolfe Research. Hello. Mr. Keay?

[Hunter K. Keay:]

Hi. Sorry. Can you hear me?

[Gary C. Kelly:]

I can hear you now.

[Hunter K. Keay:]

Sorry about that. Okay, thanks. So 2018 costs, Gary, you said you feel good about the RASM outlook for 2018. That's great. I would imagine you guys are enough through the budget process at this point to give us a preliminary look. Do you feel like having the expense behind you with the PSS cutover that we should start thinking about CASM ex fuel next year as being down?

[Gary C. Kelly:]

I do feel really good about the cost outlook for 2018. Tammy, would you like to go through that?

[Tammy Romo:]

I would be delighted to. So yes, Hunter, we're still finalizing our 2018 plan. So I'm not prepared to provide guidance today. 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 multi-year 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 retirement and onetime cost associated with Lone Star as well as significant tailwinds for fuel with our hedging losses burning off this year. And with the classic retirement 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, we'll have some increasing maintenance cost 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 cost per available seat mile 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 costs are a big part of that story.

[Hunter K. Keay:]

Okay. That's helpful. Thanks, Tammy. And, Gary, on the positive RASM comment that you made, what 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 specific stuff? And on the Southwest specific stuff, is it a load factors play? Is it a yield play? What are sort of the components of that that give you the confidence to put that out there at this point in time? Thank you.

[Gary C. Kelly:]

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, 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 non-performers in our system. And off late of course, you're familiar that we eliminated flying to Varadero and Santa Clara. 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 five 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 my hats off to our folks for managing this well, and I think they'll continue to manage it with better tools next year.

[Hunter K. Keay:]

Okay. Thanks.

[Operator:]

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

[Jack Atkins:]

Hey, guys, good afternoon. Thank you for the time. 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 – I think you said down year-over-year will be a stretch. But I didn't hear it, I guess, your exact comments on sort of your outlook for 2018 CASM ex. Could you just maybe go over that again a little bit?

[Tammy Romo:]

Sure, Jack. Sure, and I'd be happy to. Just on our CASM excluding fuel, profit sharing and special items, as I said, getting down might be a stretch. But I do think that a flat CASM excluding fuel, profit sharing and special items is a reasonable goal versus 2017.

[Jack Atkins:]

Okay. That's helpful. I just wanted to make sure that that was out there great. And then just kind of...

[Tammy Romo:]

Thank you.

[Jack Atkins:]

Absolutely. And then just sort of as my follow-up question, going back to the $200 million in pre-tax incremental profitability from the new reservation system next year, could you help us think through 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 cost? Just trying to think through how that's going to show up in the P&L next year.

[Tammy Romo:]

Sure, Jack. 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 remain very pleased with the progress of the rollout that we would like to get a little further down the road before we provide 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 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 is going well, we're pleased with the progress and that's where we sit today.

[Jack Atkins:]

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?

[Tammy Romo:]

Yes, absolutely. For 2019, it is just about $50 million.

[Jack Atkins:]

Thank you very much.

[Operator:]

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

[Jamie N. Baker:]

Hey, good afternoon. I'm a little mad at Tammy. She beat me to the punch on the Wings Club Award, 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. 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, the implied arrival time back in California or on the West Coast, if you did maybe a 60-minute, 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 would consider inter-island. But can you point me to anything in the work rules, the pilot duty regs, 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?

[Gary C. Kelly:]

Yes. There's nothing that would rule it out.

[Jamie N. Baker:]

Okay.

[Gary C. Kelly:]

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. Step one, of course, is getting from California to Hawaii, but it is absolutely, everything you said is right, and it has been down our priority list, but we'll have serious consideration for that. And who knows, 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, when 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, no, there's nothing that would prohibit us from doing that that we know of at this time.

[Jamie N. Baker:]

Okay. I appreciate the sanity check. Second, as it relates to pricing, I just want to confirm that the older system put 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 fight at, I don't know, noon, you can match on your 12

[Gary C. Kelly:]

Well, 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.

[Jamie N. Baker:]

Okay.

[Gary C. Kelly:]

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 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.

[Jamie N. Baker:]

Okay. Perfect. And sorry again to miss you last week, Gary. Congrats.

[Gary C. Kelly:]

Thanks, Jamie.

[Operator:]

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

[Savanthi N. Syth:]

Thanks. Good afternoon. 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 in those regions?

[Gary C. Kelly:]

Well, Savi, and Tom and Tammy can pitch in here too. It's gone very well. Clearly 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 trans-border. 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 outpaced 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 advance notice of where we intend to go next. But 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, 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.

[Savanthi N. Syth:]

If I might 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 digest itself. Is that still the case? What level do you think is going to see acceleration?

[Gary C. Kelly:]

Savi, I think that's very fair, and that is what we have done thus far with the schedules that we produced. We're about to publish the schedule next month. Andrew, that would take us through August, I believe?

[Andrew Watterson:]

Beginning of August.

[Gary C. Kelly:]

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.

[Savanthi N. Syth:]

All right. Thank you.

[Operator:]

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

[Duane Pfennigwerth:]

Hey. Thanks. Can you talk about the next maybe two, three, four IT systems that are in the pipeline, what's the most material contribution from those would be? Now that you've got the big res migrated, what are your next two or three priorities?

[Gary C. Kelly:]

I would say that the reservation system, by the way, is still a huge focus for us. We've got a major release coming out next month. But let me let Tom take you through that.

[Thomas M. Nealon:]

Okay. Well, so let's talk about res for a second. So in mid-November, we'll be releasing release 2.5, which really cleans up all the operational revenue leakage stuff that we've been dealing with. So that's going great. All that kind of stuff is 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 three big platforms. If you think about an airline, I think you get all four of those, res, crewing, maintenance and flight operations. That is the foundation. And we're building this. In fact, I would tell you that 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. That's what we're doing. And Mike and I are really closely linked on what does the operation look like with those new capabilities. So those are the priorities right now.

[Gary C. Kelly:]

And the only thing I'd add 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 will be an investment, but I'm also very hopeful that there will be tangible financial benefits that will flow from these operating system enhancements.

[Duane Pfennigwerth:]

Thanks. And may be 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 three 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?

[Thomas M. Nealon:]

Well, it's early, but what I would tell you is unlike the one res, we truly went in two big releases. Now we have kind of minor release going in. But it was kind of – let me 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 going to be more of an incremental function being added in over time. It's just too early days, but it's going to transcend or really transpire over several years. We're fairly well into it, but I'm not sure I can really give you a more definitive answer than that.

[Gary C. Kelly:]

Duane, I don't remember, Tom, that we have any major operational functionality that's deploying next year maybe aside from the maintenance record keeping system...

[Thomas M. Nealon:]

Yes, we have our tech ops system, we'll be deploying late, late in the year. But we've already deployed some really good recovery tools. It's called The Baker IROPS tools. And we're going to continue to put functionality into that and that's pretty meaningful for us.

[Gary C. Kelly:]

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.

[Duane Pfennigwerth:]

Thank you very much.

[Operator:]

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

[Darryl Genovesi:]

Hi, guys. Thanks for your time. Mostly I wanted to ask if you've seen legacy carriers, United and American in particular, deploy their basic economy product and scale in your markets? And if so, whether you believe you are gaining market share in those markets as a result?

[Gary C. Kelly:]

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 them. 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 the other. Do you agree, Tammy?

[Tammy Romo:]

I completely agree.

[Darryl Genovesi:]

Okay.

[Gary C. Kelly:]

But I love...

[Darryl Genovesi:]

Sorry, go ahead. Sorry, Gary.

[Gary C. Kelly:]

Tom, do we have another question?

[Operator:]

Yes. Our next question comes from Brandon Oglenski with Barclays.

[Brandon Oglenski:]

Hey. Good afternoon, everyone. Thanks for taking my question. So, Gary, just want to come back to the pricing comments that you guys made – 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 to maybe others?

[Gary C. Kelly:]

Well, from month to month, I just don't know that the markets are that dynamic. So I think it's just pricing, to be blunt. I think pricing is very dynamic and hard as 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 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 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 made the point several times that the year-over-year comps are so far looking pretty good. The holiday travel for November look strong. The December is a little far out and a little less definitive right now how it will 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 one day different than last year. But right now, well again, we're looking for an improved yield environment and good compares versus a year ago.

[Brandon Oglenski:]

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...

[Gary C. Kelly:]

I can comment on that if that's a question. As we look regionally, 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 I certainly wouldn't say that we're seeing weakness in California, but it just harkens back to my earlier comment, we're the number one 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 off late.

[Brandon Oglenski:]

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 the 2018? I know you want to have up unit revenues, but...

[Gary C. Kelly:]

Yeah. 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 all the rest of the cost structure ex profit sharing, all that stuff that you list is flat. So yeah, 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 it create problems. So that will be our goal. And as I said earlier, I think that is a realistic goal.

[Brandon Oglenski:]

Thank you.

[Operator:]

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

[Rajeev Lalwani:]

Good afternoon.

[Gary C. Kelly:]

Good afternoon.

[Rajeev Lalwani:]

Gary or Tammy, can you provide a bit more color on what you're including in your 4q RASM guide? Are you reflecting demand hedge 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 would be great.

[Gary C. Kelly:]

Yeah, all those things are in there. And the only cautionary note that I offered up, I'll let Tammy speak for herself, is that Las Vegas isn't back to a 100%. I'm assuming that it will be here at some point. Houston and Florida looked 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 in 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, 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 out there. But, Tammy, anything you want to add?

[Tammy Romo:]

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.

[Gary C. Kelly:]

And the drag on the schedule from the retirement of the classics, I don't see any upside there. I think that will continue to be a bit of a drag because there are 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. Our target would be to see some improvement there.

[Rajeev Lalwani:]

Okay. And then just those headwinds that you're talking about, Gary, Tammy, is that like a point or so? Can you put maybe a finer point on it?

[Gary C. Kelly:]

Yeah. 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.

[Tammy Romo:]

Yeah. If I – quantifying just for on the revenue side, the Las Vegas, and it probably drove the California fires in that, maybe that was probably a $10 million to $15 million impact, so again, not too significant.

[Rajeev Lalwani:]

Okay. And then just the second question. In terms of the capacity side of things, what's the latest thinking on growth in the back half of next year, and the factors that will drive that range? Obviously, you guys have done a good job with providing the first half, but any more color will be great.

[Tammy Romo:]

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

[Gary C. Kelly:]

Yeah, there's no change. I think Hawaii may be – 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 three to four for the first half for next year. Obviously, if we're less than 5.7, it means we would grow more than that in the second half. So you should absolutely expect that, but.

[Tammy Romo:]

But that's really driven by the classic fleet retirement.

[Gary C. Kelly:]

Right, exactly.

[Tammy Romo:]

So, nothing really new there.

[Gary C. Kelly:]

Yeah. That's right. That's just year-over-year comps.

[Rajeev Lalwani:]

Gary, Tammy, thank you much.

[Tammy Romo:]

Thank you.

[Operator:]

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

[Michael J. Linenberg:]

Hey, thanks for squeezing me in. Hey, just a quick one here. Gary, 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 you feel like you could serve those markets without flying red eyes?

[Andrew Watterson:]

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 complication of doing that. But Mike, do you have anything you want to add?

[Michael G. Van de Ven:]

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.

[Gary C. Kelly:]

So as you can tell, Mike Linenberg, it's not a priority for us. And it's not a factor, in our view, with our Hawaii service.

[Michael J. Linenberg:]

Okay, very good. That's all I needed to know. Thank you.

[Operator:]

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.

[Linda B. Rutherford:]

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:]

Yes, ma'am. And thank you for waiting. We'll now begin with our first question from Conor Shine with The Dallas Morning News.

[Conor Shine:]

Good afternoon, guys. Gary, I just wanted to know kind of where 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 they get some momentum? Are you waiting on your people in D.C. to kind of take that up?

[Gary C. Kelly:]

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.

[Conor Shine:]

Thank you.

[Operator:]

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

[Dawn Gilbertson:]

Good morning. Gary, you mentioned a couple times Vegas is still not 100% 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?

[Gary C. Kelly:]

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, 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...

[Dawn Gilbertson:]

Are you making any adjustments?

[Gary C. Kelly:]

Well, adjustments in terms of our flight schedule?

[Dawn Gilbertson:]

Yeah, flight schedules, fares, I mean anything to maybe get people that, maybe have some.

[Gary C. Kelly:]

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.

[Dawn Gilbertson:]

Okay.

[Gary C. Kelly:]

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.

[Dawn Gilbertson:]

Can you say how much the traffic is down?

[Gary C. Kelly:]

I'd be happy to if I knew it off the top of my head. Tammy, do you have a number in your mind?

[Tammy Romo:]

I don't have the traffic number in my mind. But, as I mentioned earlier, 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 Gilbertson:]

Okay. Thank you.

[Gary C. Kelly:]

Dawn, if it were a 100%, if that were the standard, it's not that we're down by 50%, we may be down 10% or 15% something in that order of magnitude. But, I'd be surprised if we were down that much now quite frankly.

[Dawn Gilbertson:]

Thank you.

[Operator:]

We'll take our next question from Ghim-Lay Yeo with FlightGlobal.

[Ghim-Lay Yeo:]

Hi. Thanks for taking my question. I have a question about the Hawaii service. Can you talk a little bit about just the ETOPS certification and maybe Mike could chime in if he is still on the line. But how soon after getting initial ETOPS for the 737-800s where we see Boeing 737 MAX service? Thanks.

[Michael G. Van de Ven:]

Yeah. So we have 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 done. 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 clearly written. We're going to take that package and we will actually apply for an ETOPS certification, add it to our ops specs 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 that'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.

[Ghim-Lay Yeo:]

Okay. But how soon after launching Hawaii service initially? I mean, how many more months do you have to wait before you can actually get the MAX on board? Do you have an idea about that?

[Michael G. Van de Ven:]

How long before we can do what? Oh, how do we?

[Ghim-Lay Yeo:]

Yeah. Before you can actually get the MAX flying to Hawaii?

[Michael G. Van de Ven:]

Yes, 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.

[Ghim-Lay Yeo:]

Okay. Thank you.

[Michael G. Van de Ven:]

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

[Ghim-Lay Yeo:]

All right, great. Thank you.

[Operator:]

And we have time for one more question. We'll take our last question from Mary Schlangenstein with Bloomberg News.

[Mary Schlangenstein:]

Great. Hey, 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?

[Michael G. Van de Ven:]

Oh, sure. Yes. We have 10 airplanes in service today, Mary. And what I've been saying is it is as advertised. So we've got a 14% fuel burn improvement as compared to the 800. We've flown over 1000 flights with it so far. We've had 152,000 customers on it. It's been through about two-thirds 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. I'm very excited about adding the airplane to the fleet.

[Mary Schlangenstein:]

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

[Michael G. Van de Ven:]

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 800s.

[Mary Schlangenstein:]

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?

[Michael G. Van de Ven:]

That's correct.

[Mary Schlangenstein:]

Okay. Thank you.

[Operator:]

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.

[Linda B. Rutherford:]

Thanks, Tom. As always, if you have any follow-up questions or need anything, you can reach us at swamedia.com or by calling the Communications Department at [phone]. Thank you all so much.

[Operator:]

And that concludes our conference for today. Thank you for joining. **Editor's note