Southwest Airlines Co. (LUV) Q4 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Southwest Airlines Fourth Quarter and Annual 2019 Conference Call. My name is Chad, 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. After today’s prepared remarks, there will be an opportunity to ask questions. [Operator Instructions] At this time, I’d like to turn the call over to Mr. Ryan Martinez, Managing Director of Investor Relations. Please go ahead, sir.

Thanks, Chad, and thank you all for joining us. I know it’s a busy airline earnings day. But we’re going to start out with prepared remarks from Gary Kelly, our Chairman and CEO; Mike Van de Ven, Chief Operating Officer; Tom Nealon, our President; and Tammy Romo, Executive Vice President and CFO. And then we’ll open it up for Q&A. A few quick disclaimers before we get started here. We will make forward-looking statements in our remarks, which are based on our current expectations of future performance, and of course, our actual results could differ from current expectations for a number of reasons. We called out special items in 2018, and we will make reference to 2019 results that compare to prior year non-GAAP results. Both of these topics are covered in great detail, as always, in our earnings release disclosures as well as on our IR website. And we are also providing commentary today regarding the ongoing MAX groundings and our current estimations of time lines and current planning assumptions for 2020. Keep in mind, these time lines and estimations could change materially with impacts on the amount of financial damages we incur, our published flight schedule beyond June 6 and our fleet capacity and CapEx assumptions, to name a few. With all of that said, we’ll go ahead and get started, and I’m turning over the call to Gary.

Thank you, Ryan, and thanks to everyone for joining us for our fourth quarter and year-end 2019 earnings call. Straight away, I want to thank our employees. This is our 49th year, and they’re – at least in my experience, there is no more remarkable year than 2019. The grounding of effectively 75 of our airplanes, which is about 10% of our fleet presents a crisis-like challenge. And our people were ready work with the best planning tools and technologies in our history, but more importantly, with the right fortitude and the right resolve to get through this crisis. Our objectives were to run a great airline, serve our customers exceptionally well, protect our finances and our jobs and follow through with our capital projects that were underway. And we were able to do all those things. The MAX groundings reduced our annual operating income of $828 million. Our earnings were still a record on a per share basis, non-GAAP basis, at $4.27. And that is truly remarkable. But they would have been 28% higher and 20% – 27% more than a year ago but for the MAX. You can do the math on the stock price effect, but we settled with Boeing for the 2019 MAX groundings, and the settlement seems to have zero effect on the price per share, by the way. But we also intend to settle up 2020 as well. So we’re three months later since our last earnings call, and unfortunately, we’re still talking about the MAX unhappily. I’m confident about the MAX. More importantly, our pilots are confident about the MAX. Boeing needs to get the work done and get the certification flight done, give the FAA a chance to do their work and unground this airplane. But right now, we’re scheduled for a June 6 return, which implies an ungrounding several months before Boeing surprised us all this week with their June, July predictions about the ungrounding. And obviously, that would make our and other airlines’ June dates unworkable. So the timing remains uncertain, and we’re working through all of that right now. Our goals for 2020, given all of this, are very straightforward. We want to return the MAX to service. We want to continue to run a great operation, in fact, even better. We want to continue to serve our customers very well with exceptional hospitality, and in fact, even better. We want to protect our finances and our jobs and continue to keep costs low and slow the rate of inflation and do that even better. We want to settle with Boeing for 2020 compensation. We want to continue on with the capital projects that are underway. And then finally, we want to keep our network intact and continue making what modest tactical adjustments we’re able to do. Having said all those things and all assumed that demand and the economy remains strong and that the oil prices remain stable and low, if we can continue to execute against all these goals, that means that we only have one problem, and that’s fleet growth. So with regard to the fleet, we’re assuming that the MAX grounding is short-lived, meaning there are months to go and not years to go. And with that in mind, we are aggressively pursuing a couple of tactical ideas. Number one is mainly our 700 retirement schedule where we have a lot of flexibility. So we’re actively deferring retirements where it makes sense. Secondly, we’re always monitoring the used 737 aircraft market. We’ll continue to do that. Our issue is simple. It is our seat growth is not keeping up with demand, much less allowing us to expand. And we’re losing share, but all that is temporary, and we plan to aggressively recapture it once the MAX is ungrounded and are in a superb position, given our return on invested capital. There is no change in our efforts to evaluate the risk/reward of a single aircraft type or supplier. We’ll do that. It’s just a lower 2020 priority, so there’s no update there. I’ll also preempt the M&A question by repeating what I’ve said earlier: I do not agree that the MAX crisis compels us to acquire another carrier. We would not overpay. We would not commit us to a course that’s inconsistent with our strategy. And of course, as is our policy, we do not comment on rumors or speculation, about any M&A activity. And then finally, I want to thank our Board for making an amendment for our 2019 profitsharing. And even though the Boeing compensation is for 2019, it is not included in 2019 profits. And that’s not fair to our people for their profitsharing. So as a result of that, $124 million was added. And of course, that reduced our fourth quarter profits, but that makes the total annual profitsharing contribution a record $667 million. And our folks earned it, and I just wanted to congratulate them. So taking that notable item into account, we beat consensus. So with that quick overview, I’d like to turn it over to Mr. Van de Ven to take us through our operations.

Well, thanks, Gary. And as Gary was mentioning, given all of our headwinds that we were facing, it was extremely important that we run a reliable customer-friendly operation in the fourth quarter. And our people certainly delivered. They produce the best overall operation we’ve had in over a decade. Our system-wide on-time performance for the fourth quarter was 82.4%, and we accomplished that with the least amount of block and turn time in the industry. And that’s a big factor in our operational efficiency that lowers our cost through superior aircraft utilization. It’s the low cost coupled with the great service that allows us to win. On the service front, this was the first quarter where we had bag scanning implemented throughout our domestic network. We emplaned 30.9 million bags in the quarter, and 99.6% of those bags were carried on flights as checked. That is a record fourth quarter performance for Southwest Airlines. And our customers noticed. Through November, Southwest, again led the industry with the lowest customer complaint ratios reported by the DOT. And based on our preliminary December results, we expect to close out the year in a similar fashion. And frankly, our people have been delivering this kind of exceptional service the entire year and all the while dealing with the significant activities associated with the MAX grounding. So in that environment, we grew our Hawaii service to over 1 million customers in just 9.5 months. We implemented plane-side scanning for bags across the domestic network, and we continue to implement technology enhancements across all of our operating and functions. So for all of 2019, excluding Hawaiian Airlines, Southwest finished in the top three in the industry in on-time performance and bag handling and with the lowest customer complaint ratio, all as measured by the DOT. And that’s the best combined yearly industry performance since 1999. And our people believe that they can improve from there. Through yesterday, our January on-time performance was 87.7%. That is just a superb start to the year. It’s one of our best. In fact, we’ve only achieved an 85% January on-time performance or better five times since 1988. And it’s the on-time performance that sets the foundation for bag handling, for customer complaints and for cost control. There’s no better team in this industry than our Southwest people. And they support our customers, our company, each other, and they are just relentless in execution. And they are the heart and the soul and the spirit of Southwest. So turning to the MAX for a moment. Our guiding principle of relaunching this aircraft continues to be an orderly and controlled manner, one which we can execute with a high degree of confidence and certainty. And that’s been a critical focal point for our team, and we planned and we’ve replanned our return to service activities as new information becomes available. So since the beginning of the year, we have learned of two significant additional considerations: first, the Boeing recommendation for both simulator and CBT training for our pilot prior to their operation of the airplane; and then secondly, Boeing’s most recent estimate of a mid-2020 return to service date. As you know, we have presently removed all MAX flying from our schedules through June 6. And with this new information, it seems pretty clear that we’re going to need to make further schedule adjustments into the summer. So we’re replanning yet again using the best set of facts and insights and all the necessary activities, and we’ll make the appropriate adjustments well in advance so that our customers’ travel plans aren’t significantly disrupted. We have 34 MAX aircraft on our operating certificate. They’re in Southwest Airlines’ control, and they’re stored in Victorville, California. Those aircraft must go through maintenance and make-ready work before they’re ready for service. We also have 27 MAX aircraft that Boeing has built, and they’re being stored by Boeing until the aircraft are certified to fly. Those 27 must still go through the delivery and acceptance process in addition to any make-ready work to be added to the Southwest Airlines operating certificate. Those combined 61 aircraft are our most reliable source of lift once the aircraft is cleared to fly. And as I’ve stated in earlier calls, we believe that we can manage around 5 to 10 aircraft a week from this collective pool to be reintroduced to the operation. So it will take at least a couple of months for those aircraft to return to service. And our crewing is in place today to operate them. Boeing still contractually owes us 51 more aircraft this year. That’s the 2019 carryover plus the 2020 deliveries. And with our production line shutdown, the delivery quantities and the dates are in flux. We’re going to continue discussions with them to work through what’s reasonable for both of us as their plans become better defined. So turning to training. Our initial training plans included the 30-day period for all of our pilots to complete the expected CBT training before we begin flying the aircraft and revenue service. Boeing is now recommending the additional simulator training. And the training requirements will be finalized at a later date after the JOEB completes their testing. These requirements will dictate the time it takes for us to complete our pilot training. We currently have three MAX sims on property, and we have worked with our simulator manufacturer, CAE, to provide us with three additional MAX simulators to be training-ready before the summer. That will give us at least six MAX simulators available for training by the time the aircraft is released to fly, and that will significantly reduce our training time from where we started. Beyond these six, we have three more simulators deliveries planned for the second half of 2020, and we’re working on expected in-service dates for them. That will close 2020 for us with nine MAX simulators. I cannot thank CAE enough for their partnership and support. We have had a strong relationship with them for many, many years, and they have helped create one of the leading flight ops training centers in the world. Assuming for a second that the simulator training maybe two hours, this as a baseline, it will take us at least a couple of additional amounts from where we were to get all of our pilots through that training. So there’s still a lot of moving parts to nail down the return-to-service plan. The FAA is in control of the regulatory ungrounding process, and our plans begin once they clear the aircraft to fly. From that date, we’re assuming it will take several weeks to get our manuals updated and our CMO to approve our changes. And then once that is accomplished, we can begin training our pilots and bringing the aircraft into their operational state. And as I mentioned, it will take at least a couple of additional months before the aircraft are ready for revenue service and our pilots are trained. In the meantime, we still plan on performing extensive validation flights to work out any effects of the aircraft for sitting so long to also reintroduce them to our people and to make sure that we are completely comfortable with the aircraft performance before any customer set foot on the aircraft. Wrapping up, our operation is running very, very well. We have a detailed plan to relaunch the MAX, and we’ll be adjusting it as we get better information. Our people are taking great care of our customers and each other, and they’re delivering a safe, reliable product. They are the best team that I have ever been around. And it is a pleasure to support them. And with that, over to you, Tom.

Okay. Thank you, Mike. I just really have to echo Mike and Gary and also share my congratulations and my thanks to all of our employees. They are absolute warriors, and they are Southwest heros. 2019 was a very challenging year with the MAX, but we also had a great year. We really did have a great year in our people across every work group just kept rising to the challenge time and time and time again. When the MAX was grounded, as Gary said, in March of last year, we were very clear about our priorities. First, we are absolutely committed to running a great operation. We’re absolutely focused on taking great care of our customers. And third, we are very focused on delivering very strong financial results. And we did all three. And we did it very, very well. As Mike said, the operation was rock solid, arguably the best operation in a decade. Also, as Mike said, our DOT customer sat score is at the very top of the industry. And what I didn’t say is, keep in mind, that’s the year when we had to proactively re-accommodate, literally, millions of customers. And our brand scores also remain the highest in the industry and among the highest in the world for any company, not just airlines. So the customer service and the hospitality that we’re so famous for is stronger than ever, and our people just continue to take great care of our customers and one another. So our fourth quarter RASM results were right in line with our original October guidance of flat to up 2%. Our fourth quarter revenue grew 40 basis points to a record of $5.7 billion, and that was despite a nearly 1% decline in capacity. And we also grew our RASM 1.3%, which is also a record performance. Our base business was very strong and was the driver of our Q4 RASM performance. This was really the result of strength in both demand and yield. We also had very strong performance in our other revenues. More specifically, our Rapid Rewards program performed very well, which I’ll talk about more in just a minute. We also had very strong performance from our early bird and upgraded boarding products, both of which had double-digit growth in the quarter. Now as I said on our third quarter call, we made the decision in the fall 2019 to republish our November and December schedules, really with two objectives in mind. First, we want to minimize any customer disruption and inconvenience during the holiday travel season. And second, we wanted to ensure that we ran a great operation with lower capacity. And we achieved both objectives, but we also knew that we weren’t optimizing RASM for the peak versus off-peak seasonality in the fourth quarter. And as expected, the two to three points of temporary year-over-year RASM benefit that we saw in the third quarter from the removal of the MAX didn’t occur in the fourth quarter because of the suboptimized Q4 schedules. Now none of that was a surprise to us. The net effect of this is that there was no material year-over-year MAX impact to Q4 RASM, which, again, is what we expected and shared with you on the last call. And I got to say, once again, our network planning team just did a phenomenal job of developing workable solutions to protect the strength of our network and to minimize customer disruption. And the same call out to our revenue management team, did an equally incredible job of managing the revenue and yields throughout the quarter. We also had very strong revenue growth in our other revenues. Our Rapid Rewards program continues to perform extremely well. For the full year, our other revenue grew nearly 11%. In the fourth quarter, performance was a strong 9% growth. And we’re continuing to see record passenger mix continued – I’m sorry, we’re seeing the reward pass-through mix continue to grow, which really speaks to the strength and the value of the program for our customers. Now we’re also continuing to see very strong growth in spending on our co-brand credit cards. And the sheer size and growth of our credit card portfolio is very healthy with nearly double-digit growth and very low attrition. So we continue to be very pleased with the economics in the structure of our program, as well as with our partnership with Chase. So to sum up Q4, the bottom line is very simple, very steady, strong demand for both leisure and business, continued strength in pricing, strength in our other revenues and continued industry leading strength in our customer and brand scores. The story line for Q1 is very similar to what we experienced in Q4. The underlying trends around demand and pricing that we experienced in Q4 have continued into Q1. Everything that we’re seeing for the quarter shows very solid shopping and bookings. So demand remains solid for both leisure and business travel and pricing also remain steady and strong. So we have a very good read on first quarter revenue in RASM trends. Obviously, we continue to be impacted by the MAX, we pulled the MAX out of our April schedule, which runs through June 6. And as you know, March is the peak month in the first quarter and our MAX aircraft deficit grows from 34 aircraft in March of 2019 to roughly 60 aircraft short by March of 2020. Now that said in Q1, we don’t have the flight schedule variations in the capacity and demand mismatch complications that we have in the fourth quarter. So because of that, we expect a 2-point year-over-year RASM benefit in Q1 from the MAX cancellations. We also have roughly 0.5 point year-over-year RASM tailwinds in the first quarter from prior year negative impacts, 1 point due to the government shutdown and 0.5 point due to the unscheduled maintenance cancellations in Q1 of last year. So based on the strength of our base business as well as the Q1 MAX RASM impact in the year-over-year tailwinds, we expect a strong Q1 RASM performance in the range of up to 3.5% to 5.5%. I’ve said this before, but I think it’s worth repeating as we continue adjusting the flight schedules for MAX cancellations, our focus is to maintain depth and frequency of service to key markets. And we’re also very focused on maintaining a high degree of point-to-point direct flying, as well as maintaining high quality connecting itineraries. Now when you look at our schedule, you’ll see that we’ve trimmed some capacity from longer haul markets and we’ve added more capacity into our short and medium haul flying, which is a real core strength of our network. Just to be clear, in no way, we’re walking away from long haul flying, but with the MAX out of service, we have opportunities to replace profitable, but below system average RASM, long haul, non-stop itineraries with high quality connecting itineraries. We will do that. And with the strength of our point to point network, we have the flexibility to do that. Now, once the MAX returns to service, we’ll certainly restore the vast majority of flights that have been taken out of our schedules and we’ll do so in a way that lines up their operations and commercial objectives. We have the world’s largest and strongest point-to-point network and we intend to leverage our cost structure and our scale and we certainly intend to resume our growth. And we tell you, we have a long runway of growth opportunities still in front of us. Now despite the MAX cancellations, we’ve continued to add additional flights into some of our key markets. We have near-term growth focus will continue to be in Baltimore, Denver, Houston, Hawaii. Hawaii continues to perform very well from both long haul and interisland markets and this is totally consistent with our plans and our expectations. Now looking beyond Q1, obviously, our 2020 growth will be determined by the MAX return-of-service. Until that occurs, we’ll just continue to adjust our plans accordingly. And our objectives are no different than what they were in 2019. We’ll run a great operation. We’ll take great care of our customers and we’ll deliver strong financials. And as Mike alluded to, if we need to make further adjustments to our June schedule, which runs from June 7 through early August, we’ll do so. And that would like to include further trends to our non-stop long haul flights and potentially a modest thinning of high-frequency markets, which is essentially the same playbook that we’ve been running for the past several schedules. We also have a full pipeline of revenue and cost initiatives, most of which we won’t discuss yet for competitive reasons. But I can tell you that we’re on track to implement our new GDS capabilities for corporate travel by mid-year with Travelport and Amadeus, which we expect to drive incremental EBITDA between $10 million and $20 million in the second half of 2020 and there’s clearly a very large opportunity to grow that substantially over the next several years. So that’s where we are. Q1 is off to a strong start. Trends remain strong and we’re guiding our RASM to be up 3.5% to 5.5%. And once the MAX return-to-service, we are ready to bring it back into service with all the operational and commercial discipline that you would certainly expect in Southwest Airlines. So with that, I’m going to turn it over to Tammy.

Thank you, Tom, and hello everyone. I’d also like to thank all of our employees for their tremendous efforts managing through a very challenging year. The MAX grounding have had a significant impact on our company, but our employees continue to rise to the occasion and the strong results we reported this morning simply would not have been possible without their hard work and incredible focus and teamwork. With the MAX return-to-service timeline shifting frequently, it has been difficult to anchor our full year 2020 forecast to support meaningful guidance for the full year. So I’ll focus primarily on first quarter guidance and my comments today regarding our cost performance, fleet capacity and CapEx plans, and our strong financial position. During fourth quarter, as a Gary of covered, we reached a confidential agreement with Boeing for compensation related to 2019 financial damages due to the MAX groundings. The compensation from Boeing will be accounted for as a reduction of the purchase price of our 31 owned MAX aircraft and future MAX from orders, which reduces property and equipment on our balance sheet and will result in lower depreciation expense over the useful life of the aircraft. In light of this agreement, our Board of Directors authorized a $124 million pre-tax profitsharing award. This incremental award was accrued in fourth quarter and reduced fourth quarter earnings by $97 million or $0.18 per diluted share as we covered in the release. A record $264 million in fourth quarter profitsharing expense included a $124 million discretionary award and will be paid later this quarter as part of the record $667 million full year 2019 profitsharing distribution to employees. So now that I’ve covered profitsharing, I’ll go ahead and cover fuel costs before I move into our cost performance, excluding fuel and profitsharing. Our fourth quarter fuel price of $2.09 per gallon, decreased $0.16 or 7.1% year-over-year, and that’s primarily due to a roughly an 8% decrease in market prices. We have a great fuel hedging protection in place this year with a 66% hedge for first quarter and 59% hedge for full year 2020. We’ve been adding some protection to future years and are currently about 54% hedge for 2021 and about 31% hedge for 2022. We also recently began adding modest protection to 2023 and expect to continue our systematic approach to building a meaningful multi-year hedging portfolio at a reasonable cost to provide some insurance on around what’s about a third of our cost structure. For our first quarter 2020, based on market prices as of January 17, we expect our fuel price to be in the range of $2.05 to $2.15 per gallon with a modest $0.01 hedging gain at current prices. Our fuel efficiency continues to be significantly impacted by the MAX groundings. We came into 2019 expecting a solid year-over-year improvement in our fuel efficiency, largely driven by the operating performance of the 75 MAX aircraft we should have had in 2019. As a reminder, the MAX produces a 20% fuel burn improvement over our retired classic fleet and a 14% improvement over our NG fleet. However, our fourth quarter and full year 2019 ASMs per gallon declined 0.8%. So we lost some ground last year. We’ll continue to be impacted until the return of the MAX in first quarter 2020 ASMs per gallon are also expected to decline year-over-year in the range of down 2% to 3%. We look forward to reversing this trend and getting back on track with our fuel efficiency improvement goal. Excluding fuel and profitsharing, the 5% year-over-year increase in our fourth quarter CASM-Ex was right in line with our most recent guidance. And as we outlined in our release, the primary driver of the year-over-year increase was the temporary underutilization of overhead combined with the lower than planned capacity from the MAX grounding. For full year 2019, our CASM-Ex increased 7.7% year-over-year. The MAX grounding impact drove approximately 5 points of this year-over-year inflation, which is what we expected. Excluding the MAX impact, our cost control was very solid with core year-over-year 2019 unit cost performance, slightly below our original CASM-Ex guidance range of 3% to 3.5%. And that includes the incremental $10 million of maintenance expense to keep seven of the -700 aircraft that we were originally going to retire in 2019, as well as the incremental $42 million ratification true up for mechanics contract. Looking at first quarter 2020, we expect our CASM-Ex to increase in the 6% to 8% range year-over-year. Our outlook includes an estimated 7-point unit cost penalty from the MAX grounding as our fleet deficit grows relative to our cost base. We will continue to have temporarily unabsorbed overhead that will be utilized upon the MAX return-to-service. Setting the MAX aside, our first quarter CASM-Ex outlook also includes 1 to 2 points of inflation, primarily due to increases in salary wages and benefits, maintenance expense and operating expenses related to technology and facility investments. As you know, we have year-over-year tailwinds related to the first quarter 2019 impact associated with the ratified labor agreement with our mechanics and cost associated with unscheduled maintenance disruptions and flight cancellations, which offset inflationary pressures here in the first quarter. Turning to an overview of our fleet plan, this has obviously been a focus for us this year with the MAX grounding. So I’ll spend a little more time walking you through all the moving parts. Prior to the MAX groundings, our 2019 plans were for 44 MAX deliveries. That was 37 MAX 8s and seven MAX 7s along with 18 -700 retirement. This would have resulted in a fleet of 776 at year-end 2019. Instead, we had three MAX 8 deliveries plus six -700 retirements, and therefore, ended 2019 with a total fleet of 747 aircraft. We took delivery of three 737 MAX 8 aircraft in first quarter before the MAX groundings in mid-March. We have not taken any delivery since then and as a result we decided to postpone seven of the 18 planned retirements for 2019 to help mitigate a portion of our fleet deficit. We’ll operate these seven aircraft for around two more years and they are scheduled retired by the end of 2021. As the remaining 11 -700 retirement plan for 2019, we retired six of them, one in third quarter and five during fourth quarter. The remaining five retirements have shifted to first half 2020. We have not updated our contractual delivery schedule with Boeing. The 41 MAX aircraft that we didn’t receive in 2019 are still in flux. But in our contractual order book schedule shown in our earnings release this morning, we reflected 40 of those deliveries as part of our 2020 firm orders and one as a 2021 firm order. However, I will provide some context as far as our current planning assumptions, because we do not expect to receive 78 aircraft deliveries at this point in 2020. The news from Boeing two days ago that the MAX will likely not return-to-service until mid-2020 has us now reevaluating our fleet and capacity plans further. Mike has already taken you through some of the details of our MAX return-to-service plan and he referenced the two sources of MAX aircraft that we are currently focused on as part of our 2020 fleet planning assumptions. Mike is working through the plan to safely return the 34 MAX 8s already in our fleet. We will also be working with Boeing and the FAA to deliver the 27 MAX 8 aircraft that are built-in in storage. At this juncture, our current planning scenario is for 27 MAX deliveries in 2020. That brings us to around 60 MAXs, which we are currently staffed to operate. We also expect to retire 16 -700 aircraft this year. The five that shifted from 2019 and 11 more planned throughout the year. This is less than the 20 to 25 that we previously communicated and that’s simply due to the slower assumed ramp up of MAX production and delivery catch-up. We will invest approximately $12 million this year into those 11 aircraft that we’re extending for a few years. Based on our planning assumption that I walked through, we would add a modest 11 net aircraft to our fleet in 2020 at 758 total aircraft. Of course, we don’t have certainty on the timing of the MAX return-to-service, that production timeline from Boeing or our aircraft delivery timeline. So this is all subject to change and we’ll keep you updated accordingly. Shifting to capacity. Fourth quarter 2019 ASM declined 0.9% year-over-year, which as expected was about 8 points lower than our original plan. Our full year 2019 capacity declined 1.6% year-over-year and was significantly lower than our original plan to grow nearly 5% in 2019. For first quarter 2020, we currently expect our ASM capacity decline in the range of down 1.5% to 2.5% year-over-year. We currently have MAX flying removed through June 6, but with Boeing’s latest guidance, we’ll likely extend our MAX related flight adjustments further. So based on the flight schedule adjustments through June 6, we expect second quarter 2020 capacity to increase no more than 2%. So now turning to the balance sheet and cash flow, we ended the quarter with robust cash and short-term investments of approximately $4.1 billion. Our cash balance continues to be higher than what we usually carry as we haven’t been making aircraft delivery payments since mid-March 2019. Delayed delivery payments also lowered our CapEx to $1 billion in 2019 versus our original plan of $1.9 billion to $2 billion. The majority of the 2019 spend related to technology and facility investment. And we also received $400 million in supplier proceeds, which we consider an offset to our capital expenditures. For 2020, if you assume we get the 27 MAX 8s from Boeing, that are already built for us, that would result in total CapEx of approximately $1.4 billion to $1.5 billion, which is net of a supplier proceeds owed to us at year-end. 2019. Our cash flow generation in 2019 was very strong, despite the $828 million operating income reduction due to the MAX groundings. During 2019, we generated $4 billion in operating cash flow and a record $3.4 billion in free cash flow with $2 billion of share repurchases and $372 million in dividends. We have $1.35 billion remaining on our current share repurchase authorization, net of the $550 million accelerated share repurchase currently underway that is expected to wrap up no later than mid-February. We have very healthy cash and liquidity, low leverage, manageable debt obligations this year and remain focused on a balanced approach to investing in our employees and the company and returning cash and value to our shareholders. In closing, I’d like to extend another huge thank you to all of our employees. Taking into consideration, the significant impact the MAX grounding had on our operational and financial performance. Our 2019 results were truly superb. We did not lose ground on our very strong financial position, maintaining our investment grade balance sheet, ample liquidity, strong cash flows and healthy shareholder return. And we also continue investing in our business and we’re well positioned for the future. Absent the impact of the MAX groundings in first quarter of 2019 unique items, we achieved our unit revenue growth goal of greater than 3% for 2019. Likewise, we beat our unit cost guidance for 2019, which is just tremendous. Of course, the MAX did significantly impact 2019 and 2020 will also be significantly impacted by the ongoing MAX situation, but our focus on solid execution remains unchanged. We look forward to getting past these near-term challenges and temporary headwinds, safely returning the MAX to commercial service and leveraging our low cost and robust route network to resume our growth. So with that, Chad, we are ready to take analyst questions.

Certainly. We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Andrew Didora with Bank of America. Please go ahead.

Hi, good afternoon, everyone, and thank you for the questions. Tammy, it seems like you were able to offset the 1 to 2 points of inflationary pressures in 1Q partially due to some of the easier comps, I think, partially due to maybe some of your cost initiatives that you have. But going forward, do you think you have a similar ability, the rest of the year, which would allow you to keep – I guess, do you think you have a similar ability or the rest of the year to continue to offset these cost pressures and keep it more contained to what the MAX impact is? Or do you think inflation will continue to ramp over the course of the year? Thanks.

Thanks for your question, Andrew. So yes, we certainly have abnormal capacity trends this year again. But as we drill down into our core costs and strip out the estimated impact of the MAX grounding and all the other noise, we do see core business unit cost inflation in that, call it, close to 2% range. That said, we don’t know exactly when the MAX will return, and our second half 2020 capacity plan is very much in flux. So again, that’s our best read at this point. We’ve reported our analysis of the unit cost impact each quarter from the MAX groundings. So along those lines, we’ve done our best to get a sense of what our true CASM-Ex run rate is from 2019 to 2020. So normalizing for the MAX and the other unique items for both 2019 and 2020, we believe we could have reached our CASM-Ex year-over-year growth in 2020 of less than 2%, which is in line with the goals. But admittedly, we have a lot of moving parts try to tease out. So I guess, in summary, I’d just say, I’m very pleased with how we executed against our cost plan in 2019, and we are very focused on being even more efficient. So I think it’s reasonable to assume or think we should be able to improve our trajectory here in 2020 relative to 2019, excluding the MAX. But just again, including the MAX, obviously, the year-over-year comparisons are very skewed, and we’re incurring costs that we didn’t expect such as extending retirements and incurring the related maintenance investment and have some timing items such as deferring flight crew hiring from 2019 into 2020, et cetera. But overall, I’m just really proud of our folks. They’re really doing a great job with their budgets and controlling costs. And I’ll add by just saying, we’re all definitely looking forward to the safe return of the MAX, resuming our growth, utilizing our unabsorbed overhead and beginning to reverse the temporary unit cost penalties that we’re incurring. So thank you again for your question.

Great, thank you for that detail Tammy. And then maybe my second question just for Gary or for Mike. Look, I know it’s difficult to comment on full year capacity, given a lot of the moving pieces. But based on what Mike explained in his prepared remarks, what could growth look like once the MAX returns to service? Could it be that high single-digit growth rate that, I think, many were maybe expecting few months back? And then how does sim training change the time line for a full kind of return to optimal utilization for your fleet? Thanks.

Tammy, you’re probably in the best position to answer that. We – Andrew, as you know, we didn’t – we purposefully did not put any guidance for the year, for the obvious reasons, but Tammy…

That’s right. Yes, it is tough to answer for all the reasons we’ve all laid out. In terms of the second quarter, we’ve given you our guidance there for ASM growth, if you strip out the – if you assume the MAX gets pushed beyond the second quarter, I just offered that probably gets you to roughly flat capacity year-over-year for the second quarter. And then really, it’s just a function of the return-to-service plan. And we’ve told you, we’ve got a good line of sight on the 61 airplanes. Mike has walked you through the ramping of all of that, which is a several month process. And from there, it’s really, I think, based on the production rates from Boeing, which we just don’t know the answer to that question yet. So it’s just premature to try to get what the capacity ramp-up year-over-year could be here in the second half of the year.

And I think Mike pointed this out, but – so Mike, you might want to comment. But we – just to be clear, we’re staffed. We’re resourced. We got gates, et cetera, for 61 more airplanes. And so what we have a line of sight on is you got 34 we own, 27 that Boeing has. The issue is there are 16 retirements that are coming. So get to fill up 61 airplanes worth of flying, we’d have to get 16 more beyond the 61 airplanes from Boeing. And whether we’ll get those in 2020, Mike, I don’t think we know. So I think that’s possible. So the point that I wanted to make with that is we want to get 61 airplanes into service as fast as we can. And that is all understanding that it needs to be safe, it needs to meet all of our other objectives, et cetera. But we’ll want to get to that 61 just as fast as we can. We just don’t know what that speed will be. And some of it may be us. We may find that we want to gate the flow of airplanes back into the operation more than what we know right now. But hopefully, that gives you a little bit of insight. But you can throw any percent out there you want. It’s certainly not going to be 10%. There’s no way. Nothing close to that. And in 2021, I got the same kinds of concerns. So we’re not so worried about the percents right now through as much as you are, but we’re certainly not going to be growing rapidly here in 2020.

Understood. Thanks for the color.

The next question will come from Savi Syth with Raymond James. Please go ahead.

Hey, good afternoon. Just a follow-up, Mike, to clarify, the color that you gave about the MAX. And I know there’s a lot of uncertainty there on the return to service, but color was helpful, but make sure I understand. It sounds like including the manual updates and kind of the concurrent training and maintenance, assuming it’s only a two hours, there’s a lot of assumptions there. It’s about four weeks from certification to – or at least four weeks from certification to when you can get the aircraft – sorry, four weeks more than the kind of two months that you have mentioned before to get the aircraft up and running. Is that right? And then also, just would you be willing to kind of train a subset of pilots if it means that you can get the MAX off the ground sooner?

Yes. So just maybe to give you a little bit more color on that. When there were – what we were thinking about when there was – when it was just a requirement of CBT training. There’s a period of time – there are really three things. There is getting the manuals approved. And so once there is a return-to-service date, we need to get the manuals. We need to get all those changes in our manuals and we have the – our CMO sign off on all that. And that could take three weeks, let’s say, three to four weeks to get that done. Once that’s done, we can begin executing on the plan. And the plan is twofold: to get the airplanes into their proper maintenance state, get the pilots trained. When there was just CBT training, we could get pilots trained within 30 days. Now that there is a potential for simulator training, I think that could add at least a couple of months to that date. So that is the best challenge with the CBT training. And that lays over really with the aircraft time at the same time. So that – hope that gives you a little bit of color from where we were to kind of where we are today. To be able to subset a group of pilots to bring the airplanes back earlier, we would need systems, we would need procedures, and then we would need an adjustment to our pilot contract to allow how all that works. So there’s a lot of work with that. We’re exploring opportunities in that area. But there is just a lot of risk and uncertainty with all of that. So that’s not an easy path here.

Sorry, but in the end, you match all that together and really, compared to what we were assuming before compared to simulator training and again – another shout out to CAE, who has been terrific to work with – we’ll have a significant amount of simulator capacity if that’s the route that we need to go and it will add a couple of months.

Yes.

It did work for you. So based – and you said it, there are a lot of assumptions there, but just trying to give you some guidance. So we won’t be up and running immediately after an ungrounding, it will be several months later.

The other – and then lastly, I just want to make clear also is we will have the year before that – we’re talking about revenue service there, which I know that’s what you’re interested in. But before that, we’re going to try – we will do validation flights out there so that we can make sure that everything that has occurred on those airplanes, they’re flying, they’re maintained, we’ve got all the cobwebs knocked out of them for such – for a long-term storage. So we will also be – so the airplanes will be up in the air flying before them.

So we can do that. In other words, without having trained our entire core of pilots.

Makes sense. No, that’s helpful. And I think I missed the four months, though. It sounds like, roughly speaking, from time of recertifications. And then maybe Tammy, just a clarification on the kind of Boeing – the kind of lower cost that you’re going to get from these compensation. Is some of that already flowing through for the aircraft that you own and are grounded today? So some of it is already reflected and that will continue to build as you go out? And then also just wondering if you can provide the breakout of the fair value for the fuel hedges between – for 2021?

Sure, Savi. The – just to answer your question first on the compensation. So it’s really pretty straightforward. The compensation will be allocated to the 34 aircraft that we have grounded, so we’ll get some benefit of that here more immediately. And it’s more for next year – or actually for this year now in the millions, call it, maybe $5 million for this year. And then…

Lower depreciation expense.

Lower depreciation expense. And then as we bring on the aircraft deliveries in the future, that will simply be spread over the useful life of the aircraft. So the benefit will be realized for, obviously, over many years here. So – but that’s kind of short and simple explanation of how that’s going to roll out.

And so we don’t have – for the 2020 settlement that we keep talking about, there’s nothing factored into any of our…

That’s right.

…forward comments for that. So the only thing that’s in 2020 is related to the deal that was done for 2019.

That’s correct. So thanks, Gary. And then on your second question, I guess, we laid out in terms of the fair value, the – it was $2 million for the first quarter and $31 million for the remainder. So just the way that rolls out is, in 2021, we’ll call it roughly another $40 million. In 2022, it’s in the same neighborhood of $40 million. And then in 2023, it’s less than $10 million.

Very helpful. Thanks, guys.

The next question will come from Hunter Keay with Wolfe Research. Please go ahead.

Hey everybody, thank you for the time. Hey Gary, you are a "never say never" guy, so you might not like this question, but I would challenge you. What are some things – one or two things that you think you’re fairly sure Southwest will never do as long as you’re CEO? And I asked this question because I’m pretty curious to some like we’re never going to have basic economy a month or two ago. So just – I’d like to know what is in that never category as long as you’re CEO?

I love all your questions always.

Thank you.

Yes, I don’t know if I can give you a comprehensive list to the nevers. And you are right, I am a "never say never." But I don’t see us ever charging for bag fees. And obviously, one of these days, somebody else could view that differently. We’re not going to do basic economy. We’ve – there’s been a couple of media stories that were way off, so we’ve tried to clean some of that up. But yes, we won’t be doing basic economy. And I don’t know, Tammy, I’m sure there are some other things that we won’t do. I don’t see us certainly in the near future doing – well, I don’t know. I was going to say something I probably shouldn’t say. So I won’t say it.

My follow-up question then, Gary, is yes, sorry. My follow-up is please tell me what you’re going to say just now.

Why is it you’re always asking questions. And that one, I won’t answer.

All right, thanks. And then just real quick, I mean, obviously, you said second fleet type decision is not for now. That’s a later discussion. I get it. But can you just run me about just the CBA restrictions around adding a second fleet type? Is that a gating item for a decision to be made across multiple CBAs? Or is that something that can happen concurrently? And just sort of pragmatically order of operations with regard to your CBAs. Thanks a lot.

Well, yes, we would need to collaborate with our employees and especially our pilots. I think all of it is contemplated with what Mike and I have been thinking about. Whether it’s a gating factor, it needs to be collaborative. So yes, I don’t know if gating is exactly the right word, but we would need to be thinking about it comprehensively. I think our pilots would be interested in supporting the company in terms of growth in the most economical manner because – so obviously, it means more jobs for them. It means more upgrades for captain. So as long as we can conclude that and then convince them that is the right case, I think we can come to an agreement on that. But Tammy and I were talking earlier this morning about this. And for us to have to arrive at a different course of action here with the fleet, we’ve got to have the right timing to meet our needs in terms of additional airplanes. We’ve got to have the right product, and it’s got to come at the right price. So those are all three, maybe two of the three, at least, are pretty big hurdles to overcome. I think if we were to reverse this and we hadn’t shared with you all that we’re going to explore the risk/reward of having a single fleet type/single supplier, I think you’d be asking us. This sort of illustrates the risk of having all of your eggs in one basket. So I think we have a duty to look at that. We’re going to look at it very seriously. And I think we have to be realistic that this can be a hard hurdle to overcome. So I don’t know, at least, Hunter, in the way I’m thinking about it, I don’t see the threshold question being the CBA. I think the threshold question is does this make sense for us or not. And if it does, well, then you sort of knocked down the other barriers that are out there. But our pilots are great. They’re fantastic, and I certainly don’t see that as a "hurdle" or obstacle.

Okay. Thank you, Gary.

Yes, sir.

The next question will come from Jamie Baker with JPMorgan. Please go ahead.

So you’re seeing there’s a chance for hot meals?

How did you know?

That’s what I heard. Yes, sorry. I respect the confidentiality around the Boeing settlement. So let’s focus on 2020, which has not been settled. How do you calculate or try to calculate the impact? Do you merely look at a pre-shutdown business plan and compare it to actual results? Do you focus on some trailing pretax margin calculus? Do you make adjustments for the fact that your growth-abled competitors now we’ll have over a year’s jump in certain markets, and it’s going to cause something to win that share back? I’m not asking about what you and Boeing might settle on. I’m just wondering how you think about what your entitlement is.

Well, I think it’s a very fair question. I don’t know that – you know and we know that this is a negotiation. This is not contractual. This is a negotiation. So I don’t see being selfish about this. I don’t see a lot of merit or wisdom and is laying out our entire strategy about this. I also don’t want to give our competitors a road map. What I don’t – if you just simply talk about the harm that the company has incurred. I wouldn’t quarrel with anything that you put out there, and as I mentioned in my remarks, there’s a lot of years, Jamie, where we’ve had a dozen issues that we needed to deal with. And right now, we’ve been blessed with having one. The operation is fantastic, and I won’t tick through everything that the four of us have been trying to drive home today. But the company is in a really, really good shape. We have one problem, and it’s a serious one. And the sitting here dog paddling for a year while our competitors grow right past us is costing us this year 6 million, 7 million customers. And yes, I’m very worried about that. And that’s not anything that we can mitigate. We can deal with the operation. We can deal with all these other things, we get the finances whole, so to speak. But that, we can’t do anything about until we get airplanes, until we can grow again. And it’s – so – and I do I think we’ve been harmed? Absolutely. And everybody knows we’re going to seek compensation from Boeing. And I’ll just – if you don’t mind, I’ll just put a period on it.

Okay. Sure, sure. That helps. I appreciate it. When I think about MAX-impacted airlines around the globe, you’re clearly one of the most profitable, if not the most profitable. So put differently, other customers are desperate to get MAXs. There’s no doubt that you want them. But as you point out, it’s not like your margins have collapsed. So as Boeing jiggers around the skyline, would Southwest have any interest in letting some of your delivery slots go to the needy, for lack of a better term? Or is it mandatory that you get what you’re entitled to as fast as humanly possible?

It’s somewhat philosophical, I assume, but I think this is a really good company. And I think part of the reason that we’re able to absorb the blow is because of five decades worth of preparation. And we went through 9/11, and I can vividly remember our competitors whining about their state, and that was their fault they weren’t prepared for the unexpected, without trying to be too harsh here. But we shouldn’t be penalized because we have run a great company for five decades taking care of all of our constituents, especially our shareholders. We shouldn’t be penalized further for that. I wouldn’t be serving all of our stakeholders today if we simply said, " Oh, well, because we’re not on the verge of collapse, we should forfeit these positions." That makes no sense to me. So no, I wouldn’t do that at all. I would say quite the contrary. I think that Boeing has benefited and the 737 program has benefited mightily because of Southwest Airlines and our success over five decades.

Very clear. Thank you, Gary.

Yes, sir.

And the next question will come from Duane Pfennigwerth with Evercore ISI. Please go ahead.

Thank you. Understand estimates are exactly that, and I think we understand how you get your arms around the cost impact from the MAX being out. But just for argument’s sake, how do you estimate the RASM benefit? As I think about some of the hard choices you’ve had to make, cutting your worst flying, focusing on your best and combined with basically no capacity growth, it feels like the RASM benefit could be very, very substantial. So for example, in the fourth quarter in the press release, I think you called out 2 to 3-point tailwind from the MAX being grounded. What does that compare to? Like what would capacity growth have been? And how do you get to that number?

Well, it’s – you’re right, there are estimates. And I think, by definition, it’s sort of a with and without, and you don’t know what it – and we admit, we don’t know exactly what life would have been like with 75 more airplanes as of the end of the year. But I think our folks through – Tom, through the year has been consistent in pointing out that, yes, we’re not growing capacity and arguably, there’s some benefit from that, at least temporarily. But the way we’ve had to reproduce schedules has been grossly inefficient and put our revenue management in a really tough position. Because we’re not building up bookings in a normal way, and we’re re-accommodating people at low prices, the fourth quarter, of course, was unique with the – gosh, over 3% was added back for lack of precision in the scheduling, so it was wholly inefficient in the fourth quarter. So anyway, I think that we’ve laid all of that out, and it’s, at most, in the quarters – in quarters two, quarters three and quarters one of 2020, it might be 2 points. In quarter four, I think, it’s 0 because it was wholly offset by having a very inefficient schedule. So I think that answers your question. Tammy, I don’t know if you or Tom any differently than I did.

No, I just agree to the things you said. I do think this, I think if you just start with the fundamentals, the trends that we saw in Q4 just flowing into Q1. And even if you take them – I’m not giving guidance on Q2, by the way, but if you begin to look at the early piece of Q2, the trends just continue to look pretty solid. So the fundamentals are good. I think go back to the MAX out of our 2019 performance, we still have performed really, really well. Not mistaken, there’s about 1 point to MAX RASM benefit. So you back that out, we’re still in the 3% range. I think if you look at 2020, I think it will be a little more modest than that, but we still have strong positive growth. I think what’s interesting is what we can’t lose sight of. I’ll tell you what the problem I’d love to have is a huge capacity plan coming against we have a RASM to deal with, right. So we need to grow, right. But don’t misunderstand, we are still flying a very, very strong schedule. In fact, just the 2020 base schedule – April base schedule has more than 4,000 daily flights, 4,016 to be precise. And that’s in comparison to last year’s 4,078. So we still have – and these are little factoids that I want you guys know because we still have a very, very strong schedule. And what’s also interesting is – and Mike and I and the operations and commercial teams are very, very tightly linked on this whole RTS thing. I mean, literally daily, right, going through this stuff. And what I do know is, as Mike and the operations team sort through the reality and the information becomes clearer and clearer, it’s really up to them to tell us when the capacity is available. And the reason I’d say that is, it’s not unusual at all for us in normal circumstances as we move between schedules from high utilization or low utilization or vice versa. It’s not unusual at all for us to flex up 40, 50 aircraft at a time, all right? So our work in terms of building the MAX back in from a commercial standpoint, I’m not saying it’s easy, but we know where we put it back in. So it’s going to be governed by how fast are the aircraft coming back into service. And then we’ll just balance the three things we keep talking about: operational stability, financial results and customer. But I think the base trends are solid. We know how to put the capacity back in. In fact, you can see where we put it back in since you can see where we took it out. So I think we’re ready to go once Mike says, okay, here’s the aircraft.

Thanks for that. And then thinking ahead optimistically to that maybe someday where you’re spooling back up for growth what’s spending, if any – and I’m talking OpEx here, not CapEx, have you deferred as you wait around the basket for Boeing to get its act together? Thanks for taking the questions.

On the – and I heard you clearly there, just another opportunity for me to reinforce. We have not deferred – and you all correct me. We haven’t deferred any of our capital projects. So we’ve got a lot of investment underway in airports around the country. We just opened up a maintenance hangar in Houston. We’ve got other hangars that we’re working on, a lot of technology efforts. So all of that continues. On the OpEx side, we’re not burning the fuel. We sort of stopped the hiring at the fleet plan that we’ve shared with you all. So we’re suspending a lot of our hiring other than attrition. And again, none of that is suboptimized. And even with that, again, the results are quite strong. But beyond that, Mike, I can’t think of any – advertising flops around here. We’re going to obviously support the reintroduction of the MAX at the appropriate time, so you have things like that. But otherwise, I can’t – unless, you have something specific that you were probing on. I can’t think of anything that you all should expect that will be a large expenditure, except for the marketing and the messaging and those kinds of things. And I’ll leave it up to you how you want to…

Yes. And then there’s timing maybe from quarter-to-quarter in terms of maintenance, but all of that, I think, we’ve got a good handle on and can manage. So no, we feel like the costs are in good shape. And other than that, it’s just unique to the return-to-service of the MAX, storage cost, that sort of thing.

Okay. Thank you very much.

The next question comes from Helane Becker with Cowen. Please go ahead.

Hi, everybody. Thank you very much for squeezing me in. I just have two questions. One is, Gary, have you talked to your pilots or anybody in the team talked to the pilots about the potential of wet leasing aircraft on an absolutely short-term basis to get through this to pick up some of those lost passengers? And my second question is, as you think about shifting from long-haul to short-haul flying, do you worry about what people will say about climate change and whether or not you’re being a good steward of the environment? So thanks very much for the time.

Well, Mike, I’ll take them both, and you can chime in here. On the first one, Helane, to be honest with you, with our executive team, we have not spent any time exploring the opportunity for wet leasing. So since we haven’t talked about it, no, we haven’t talked with anybody else in the company. We’re focused on the retirement plan, and then we’re always tuned into the used market. I think that makes the most sense because you just think about the effort involved trying to work with a third party and all the complexities that, that would bring. It’s not going to be in our configuration. We’ve got a unique business model, et cetera, et cetera. It’s – everything is sort of predicated on agreeing with our assumption that this is a short-lived issue and not something that we deal with for years. So as long as it’s months, I think we’re making the right judgment. So that’s an easy answer to your question. You may not agree with it, but it’s – but I think we can give you an accurate answer. And then on the short versus the long, we’re a short-haul specialist. And we’ve got more short-haul customers than anybody else in the country and arguably more short-haul flights. So the only point I’m making with that is what we’re tweaking here in 2019, because of this is not fundamentally changing our long/short mix at all. We’re still very, very heavily weighted with the short-haul flights. With respect to our concern about that, yes, I think we’re concerned about sustainability. And I was asked on CNBC about that this morning, and we are very focused on conservation, on fuel economy. The MAX is front and center in terms of addressing that. It’s important to get that airplane back in service, because it consumes 15% less gas. We need the air traffic control system modernized. And I think the most tangible thing our industry needs to accomplish over the next 10 years, is commercially viable alternative fuels at adequate supplies and at reasonable prices. And that would make a very significant impact. Carbon offsets are all great. But in my own opinion, there’s only so much offsetting the world can do. And eventually, we need to get it consuming less emissions. But if you look at air transportation relative to other alternatives, it compares very, very well. And so certainly, I don’t see any challenge to our short-haul business anytime soon, if ever, especially if we continue to improve our carbon footprint as we have been doing.

Great. Thank you very much for those answers. I appreciate your time.

It appears we have time for one more question. We’ll take our last question from David Vernon with Bernstein. Please go ahead.

Hey, guys. Thanks for taking the time. Gary, I think if we go back before, I recall was sort of dominated by the MAX, you guys had laid out a vision for implementing some revenue initiatives that you were very excited about. Have you guys had to delay the time line or introduction of any of those initiatives as you’ve been kind of focusing on managing through the fleet deficit? Or is the – and we should expect those to kind of come on as the MAX returns? Or has there been no change to the time line on the commercial stuff?

No, sir. There’s been no change on that. In fact, I don’t – I can’t recall a change that we’ve made because of the MAX with any of it. And again, I’m lumping that in as a capital project. Given the fact that there is a financial penalty associated with the MAX, it sort of encourages to maybe accelerate some of these revenue and other cost initiatives. And Tammy made this point, but one of our cost initiatives is fleet modernization. And what that means, at least for 2019, 2020 is the acceleration of MAXs into our fleet and the acceleration of retiring some of the older technology. And obviously, we’re not in a position to take advantage of that cost optimization opportunity right now. There was a question earlier about cost inflation. So we’ll have a little penalty because of that here in the next year or so. And then hopefully, we can get back on track on getting more MAXs in as a percentage of the mix. But except for that, I can’t think of anything that has been deferred. Certainly, as a headline, we’ve asked our officers to execute their plans and execute them well and get them deployed and will start driving the value, especially on the revenue side.

Okay. Thanks for that. And then maybe just as a quick follow-up, Tammy, the supplier proceeds number of 400, is that associated with the MAX payments? Or what exactly is that when you think about the cash flow numbers in the earnings release?

The – all I can really say there is, it’s supplier proceeds. As we’ve already mentioned, the agreement with Boeing is confidential.

Okay. So we will draw our own…

And just to be clear, we do consider that effectively an offset of CapEx. And I think we’ve made that clear as well.

And it is a reporting requirement that it would be broken out that way. And I think we would admit that with the Boeing agreement, it makes it material enough that now it is a line item without describing what suppliers are in that line item.

And as you think about the cash that might be created from this supplier proceeds category. Would this be cash that you’d be keeping on hand to fund future requirements? Or would this be something that you might accelerate into the buyback?

We will be looking at all of that. I’ll just point back to the statements that I made earlier, which is we’ll continue to take a balanced approach to our capital deployment. And I think if you look at what we’ve done in the past, we’ve used all of those. So again, I’ll just repeat, we’re going to continue investing in the business, at least at this point. We have no intention to slow down reinvestments back in the business. And I think our track record speaks to our goal to also take care of our shareholders. So we’ll just continue to take a balanced approach to all of that, as always.

And I would just state the obvious, which is it is always better to have more cash.

I love cash.

Because there’s lots of options.

Gary knows, we love cash.

Thanks a lot guys.

Thank you. Okay. Well, that wraps up the analyst portion of the call today. Thank you all for joining us. And as always, feel free to give us a call, if you have any follow-up questions.

Thank you. Ladies and gentlemen, we will 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.

Chad, thank you. I’d like to welcome the members of the media to our call today. We’ll go ahead and get started with the Q&A portion. So Chad, if you could just give them instructions on how to queue up, we’ll get started.

Sure. Thank you. [Operator Instructions] And our first question will come from Kyle Arnold with Dallas Morning News. Please go ahead.

Thanks. Can you talk a little bit about why you want to get that $124 million profitsharing payment out to employees this year? And whether as you go forward and negotiate with Boeing and move in to 2020, whether you’re going to look any kind of similarly for employees?

Well, Kyle, I think it’s really easy. It’s – we knew, we were going to settle with Boeing. We also were quite sure that the settlement would not flow through earnings in terms of the classic definition of profits for profitsharing and that – and you just put yourself an employee position here. So if you’re here as an employee in 2019 and you may not be here for the next 30 to 40 years when this benefit is realized, then you’re harmed. You’ll never see the benefit of that, and we actually got a settlement from Boeing. So it was – all of that was anticipated. We shared that early on that we were going to work to sell with Boeing, and we have a precedent over decades of making amendments to the contribution to do what’s right for our people, and that’s either plus or minus, for that matter. So going way back to 9/11 and then the government subsidies that were offered up, we paid profitsharing on that, and it did not strictly meet the definition of profits for profitsharing. So long history of doing things like that. And it was a great year. It would have easily been a record year. It was actually a record year even though we had these penalties. And I’m just delighted that we can do that. So – and so was our board, they were delighted to do it for our people.

And are you going to look for more compensation back to employees as you continue negotiating with Boeing?

This is simply a question of how to treat the settlement for profitsharing purposes, period. And we will certainly do in 2020, attempt to do in 2020, while we were able to accomplish with Boeing in 2019.

Thanks.

And the next question will be from Alison Sider with The Wall Street Journal. Please go ahead.

Hi, good afternoon. I was wondering, you mentioned that there have been a couple – just in the last couple of weeks, a few things that are Boeing that been surprising or unexpected big changes to sort of the assumptions that you’ve had. And I was wondering if you could say whether – how you think, things have changed under their new leadership, what’s improved and what hasn’t, what you’re still looking for?

I think it’s way too early. Boeing has been unstable since March of last year, and this is part of the instability. You’ve got a new CEO. You’ve got a new CEO of the commercial organization. So it’s far too early to make an assessment there. Now, both of the – as you and I have talked, we know all of us know, Stan deal, I think a lot of him. And some of us know Dave Calhoun and think a lot of him. So…

Great. Now if I could ask one follow-up. Just curious, as you sort of look ahead to return-to-service, curious if you’ve thought at all if there’s any consideration of sort of discounting MAX flights if that’s something we’re likely to see or if that’s not on the table as a possibility?

I’ll let Tom speak to that. But I don’t think that we would approach it in the way you described it, but you want to talk about how you’re thinking about reintroducing it to service?

Honestly, we’ve done a lot of research on this, right? So Alison, I think that one of the things that is interesting is we are very, very, very focused on the MAX as you are. What’s interesting is the general population is nowhere near zeroed in on this whole topic as we are in the industry. So we are doing a lot of work. We understand the customer perceptions there. So our customers that we talk to and non-customers, they are – it’s interesting. It’s really kind of a bell curve. I think I shared this with you at one point. It’s kind of a bell curve, and the vast majority of that bell curve is we intend to fly the same as we’ve always flown. And then you have the ends of the bell curve. And actually, the two ends, one end skews higher, and that’s we intend to fly more of the 737 MAX, the proof or the thought being it’s actually be the safest airplane out there, while it’s scrutiny and then some portion to say we’re going to fly less. But I think we’re going to see the customers come back pretty nicely. Some may take a little longer than others, and maybe a month or two months, but they’re going to come back. And at this point, there’s no notion of discounting MAX flights. That’s not in our consideration set at this point.

Thank you.

And the next question comes from Evan Hoopfer with Dallas Business Journal. Please go ahead.

Good afternoon, everybody. I just had a quick question for you regarding the potential renaming of the 737 MAX. Gary, I think you said last year that, that is something that you would not be interested in. I’m just wondering, consumer sentiment ever got so negative where the brand became just so toxic that you would consider that? Or is that kind of a more line in the sand that you will not cross?

Well, to me, it’s just a matter of being transparent. Notwithstanding, Tom’s earlier comment, I think the awareness of the MAX issue is very, very high, the importance they attribute to it, I think, is where Tom has hit it. But everybody knows the name, the 737 MAX, and so who’s kidding who? To me, it’s just disingenuous. Now if it’s a different airplane, and it’s a totally different product and it would be appropriate to rename it. But this is a – ironically, it’s a very minor change to a piece of software when you get right down to it, and it’s Boeing’s call. It’s not ours. And that’s what they call it. But we’ve talked to them, at least the previous management team, and they weren’t interested in doing that. And we certainly haven’t been lobbying them to do it because I think it’s just disingenuous.

Great, thank you.

The next question comes from Pilar Wolfsteller with Flight Global. Please go ahead.

Hi. I’ve got two questions about your Hawaii service. Number one, could you sort of talk a little bit about how successful it’s been or some of your plans for the future? And the second question is do you have any comment to the reports that the FAA gave Southwest preferential treatment when it approved those routes.

Well, Tom, I’ll let you talk about Hawaii. I’ll – since I’m talking, I’ll answer the second one first. Yes, we don’t know. We don’t know what that’s about. This is a whistleblower complaint. And we don’t know who the whistleblower is. We don’t know what the complaint is. So I think what I’m mostly focused on – it sure didn’t feel like we got preferential treatment, by the way, because we worked really hard, and they worked this really hard. But I was proud of the work that our team did. We were told going in that this is probably a 12 to 18-month effort. I think in the end, we kind of came in around 14 months, which is about what one would expect. It was – the government shutdown was in the middle of that, which hampered some of the efforts. What I’m most interested in is what issues are there with our ETOPS, I’m not aware of any. Our folks, I think, have done a phenomenal job developing it and then operating it on that point. So I think it’s a long way of saying we don’t know what that’s about. And then, Tom, I’ll let you talk about Hawaii, please?

Well, I think, Hawaii, first of all, it’s – keep in mind, we’ve been doing this for 10 months. We’ve been flying Hawaii over 10 months. It is doing phenomenal, right? So everything that we expected is at or better than our expectations. Keep in mind, it’s a small piece of our business. It’s right around 2%, but it has a very important role that it really supports our California business, so it’s succeeding on every dimension. I think the demand and the load factors have been very, very good. We’re very satisfied with that, both the long haul as well as the interisland. Our ramp up, honestly, has been a little slower than we originally expected because of the MAX and the capacity issue, but everything we put into service, we’re thrilled with at this point. We are – I think this is a right of and check it, but we’ve got to see, 14 daily flights in California to Hawaii across four of our big cities: Oakland, San Jose, Sacramento and San Diego. We have 38 dailies interisland. So it’s doing fantastic. We’re really happy with it. What’s interesting is we’re actually creating demand that we didn’t even see as being there. So we’re seeing more connecting itineraries within the West Coast, which is interesting because we’re creating demand, we’re growing the market and fares are lower. And what does that sound like to you? That is the classic Southwest effect. So it’s happening again. And I guess, the last point and I’ll be quiet here is just – I think one of the questions we were asked a lot is, this is a pretty long-haul flight. How do you feel like your product is going to perform on the long-haul flight? And by the way, it’s not our longest long-haul flight. We have transcon that are longer. But having said that, the scores for the customer experience and the brand scores are actually higher than our total system, right, from the mainland to Hawaii flight. So net-net, we are very, very comfortable and thrilled where we are.

Kind of a long answer to our flight attendants and the ratio as they do.

Speaking real quickly to the ETOPS process, we are involved in that, and it was not a quick process, very, very thorough, and it was very, very challenging. And you look at the quality of what we’re doing today, it is phenomenal. So I can’t speak kind of enough of the operations team, what they’ve accomplished in short period of time. Actually, it wasn’t short it’s 14 and 15 months to get done, by the way, which is 12 to 18 is the norm. So that is not a fast path.

But Mike, at this point, no one from the FAA has come to you on any issues with ETOPS, I think?

No, no. Like Gary said, it was a whistleblower complaint, I don’t really know a lot about it. Just getting an ETOPS authorization, that is automatic. And there’s a rigorous approach to that. There are advisory circulars at the FAA layoff. You take that and you follow it. We did that. And over a 14-month period, have pretty good procedures in place. After you start flying, you’re in a heightened surveillance period for six months. We’ve had over 3,000 flights since we started service there. And the indications are the procedures that we were authorized to perform were performing, we’re executing very well. And they’re doing exactly what the FAA and Southwest Airlines expected them to do.

So it’s all a surprise to us. And again, if there are issues, we want to know what they are, and we would be happy to address them. But right now, we don’t know what it’s about.

Thanks.

It appears that we have time for one last question today, and that question comes from David Slotnick with Business Insider. Please go ahead.

Hi, everyone. Thanks for taking the call. I was just wondering, because you were talking about the – I think you said nine full flight simulators by the end of 2020. I was wondering if you could talk a little bit about your future hiring plans once the MAX is ungrounded, really over the next 10 years. I know that the simulators represent a big investment. So sort of wondering how that fits into the whole thing?

You want to talk about that, Mike?

Yes. Yes, David. So we have – as we bring airplanes into the fleet, we hire a certain number of pilots and flight attendants for the airplanes that we bring into the fleet. And so that’s there’s just the math that we go through and we do that. The other thing that influences our pilot hiring are retirements. And so we’ve got probably around 300 to 400, and it grows every year as we age the 300 to 400 pilots that go through retirement. And then so we are adding our pilot hiring with – to replace retirements and the airplane to come out of the fleet. But as Gary mentioned, we’ve got – if we don’t have production airplanes from Boeing this year, we’ll only have 45 net new airplanes this year, and we’re already staffed up to 61. So we don’t need a lot of additional hiring in 2019. And let’s just start ramping up beginning in 2020 as the delivery process from Boeing resumes.

But we do plan to grow. We plan to grow and we’re up to 15 to 20 airplanes a year. And we plan to hire thousands of people every year. So even in recessionary times in our history, we’ve been able to grow and not shrink. Obviously, we – some years, we might grow less. But for the most part, 2009 may be an exception to that. But yes, we definitely plan to grow and continue to hire.

Great. Thank you.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Ms. Rutherford for any closing remarks.

Thank you, Chad. If you all have any other questions, please feel free to reach out to our communications group, 214-792-4847 or via our online newsroom at www.swamedia.com.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.