西南航空 (LUV) 2010 Q4 法說會逐字稿

Welcome to the Southwest Airlines fourth-quarter 2010 conference call.

Today's call is being recorded.

On the call today is Gary Kelly, Southwest Chairman, President and Chief Executive Officer, and Laura Wright, the Company's Senior Vice President Finance and Chief Financial Officer.

Before the Company gets started, please be advised that this call will include forward-looking statements.

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.

This call will also include references to non-GAAP results.

Therefore, please see the Company's Financial Results Press Release in the Investor Relations section of its website at southwest.com for further information regarding forward-looking statements and for a reconciliation of non-GAAP results to GAAP results.

At this time I'd like to turn the call over to Gary Kelly for opening remarks.

Please go ahead, sir.

Thanks, Cynthia.

Thanks, everyone, for joining us.

We are very pleased to be with you all this morning.

2010 proved to be a very satisfying year.

It was an upbeat end to what I think most would agree has been a lost decade for the airline industry.

Our fourth-quarter earnings were very solid and that was despite a 12.7% jet fuel price increase year over year.

Excluding items we produced $115 million in earnings, $0.15 a share.

That was a 55% and a 50% increase respectively.

We had a very strong revenue performance.

We set a number of records.

Revenues grew 14.8% year over year.

Any time we can get double-digit revenue increases that's something to be celebrated.

Unit revenues grew 8.8% year over year.

Traffic grew 10.1%.

Load factors were up 3.4 points.

Our market share continues to grow compared to the domestic industry.

Yields were up 3.5%.

We set fourth-quarter Southwest Airlines records for load factor, PRASM, RASM, revenues, RPMs, O&Ds, onboards and enplanements.

So I think that's just about every revenue statistic one can think of.

We set all-time Southwest Airlines quarterly records for PRASM and RASM.

We had a fantastic year as well.

We had a wonderful rebound from 2009, well ahead of our plan.

We had similar annual revenue records established along-- interestingly enough we had record earnings per share ex items on a split adjusted basis at $0.74.

Our return on invested capital was 10% though, pre-tax and that's short of our 15% target and previous records that we've set, but still that's a nice improvement and great progress towards our goal.

Our non-GAAP operating margin for the year was a very healthy [9.6%] (corrected by company after the call).

Our net margin was another healthy 4.5%, but still both are short of our goals but again, great progress.

I expect the strong revenue trends to continue in the first quarter and hopefully throughout 2011.

In particular, I believe business travel demand will continue to strengthen and hopefully in our short-haul markets.

Of course, the comparisons year over year will get harder but the sequential trends will hopefully be sustainable.

So, except for fuel, our outlook for 2011 is quite good.

Bags Fly Free and now our No Change Fees campaign along with our continued tuning for-- from revenue management and schedule optimization should continue to provide tremendous momentum.

Through it all our people are doing a terrific job managing our operation in a changing environment and a very challenging environment.

I am very proud of them.

Our customer brand rankings validate my claim that our people are indeed the best when it comes to domestic air service.

So next up for Southwest Airlines in March is the launch of our all new Rapid Rewards program.

I'm very, very excited about that along with the launch of three new and exciting cities, Greenville-Spartanburg, South Carolina, Charleston, South Carolina and Newark, New Jersey.

And then next quarter, subject to government and AirTran shareholder approvals, we plan to close on our Air Tran acquisition and of course work is well underway planning that ensuing integration.

So for the future, work is underway to bring in the 737-800 to our fleet.

That will occur in 2012.

Work is underway also to replace our reservation system which will come on line at a yet to be committed date, but most certainly it will be some time after 2012.

And with that very quick overview and again my thanks to all of the Southwest Airlines people, I'd like to turn it over to Laura Wright, our CFO, to take us through the quarter and the year.

Thank you, Gary, and good morning, everyone.

We're very pleased to close out 2010 with the fourth-quarter GAAP profit of $131 million.

Our fourth-quarter GAAP results included a net gain of $31 million relating to non-cash, mark-to-market and other items associated with our fuel hedges.

In addition, we have a $7 million charge before profit-sharing and taxes related to our proposed acquisition of AirTran.

Net of profit-sharing and taxes, the impact was about $3 million, less than $0.005 a share and the majority of these costs were for consulting and legal fees.

Excluding these special items, our fourth-quarter earnings were $115 million, or $0.15 per diluted share which was in line with Wall Street's expectations.

Our operating income, excluding special items, was the fourth-quarter record at [$263 million] (corrected by company after the call).

And our full-year 2010 GAAP net income was $459 million, or $0.61 per diluted share.

Excluding special items, our 2010 net income was [$550 million] (corrected by company after the call), or $0.74 per diluted share, which Gary noted was a record EPS performance ex special items.

We did make excellent progress in 2010 towards our 15% pre-tax return on invested capital realizing a pre-tax ROIC of approximately 10%.

These were tremendous results and I would also like to thank the employees of Southwest for all their hard work and many accomplishments this year that enabled the results that we're able to announce today.

Our revenue performance in the fourth quarter was outstanding.

Our passenger revenues increased by $361 million to a record $2.9 billion.

And on a unit basis, our passenger revenues grew 8.1%, while our operating revenues grew 8.8%.

With our-- with over 40% improvement in other revenues combined with the 3% improvement in freight revenues, our total operating revenues increased almost 15% to a record $3.1 billion in the fourth quarter.

Compared to two years ago, our total fourth-quarter revenues grew by $380 million on about 3% less available seat miles resulting in a two-year unit revenue increase of 17%.

Compared to three years ago, our total fourth-quarter revenues grew by $557 million on about 2% less ASMs resulting in a three-year unit revenue increase of 27%.

Our unit revenue gains over both of these time periods have far exceeded the industry average results.

We continue to gain market share with our traffic up 10% in the quarter on a 5.5% increase in available seat miles.

And we continue to have record load factors with record loads each month throughout the quarter resulting in a record fourth-quarter load factor of 80.7%.

Despite carrying record loads for the year, we will report nearly an 80% on time performance for the year and I'd like to congratulate our front line warriors for their valiant efforts to maintain operational excellence.

We previously reported favorable year-over-year unit revenue comparisons in October, November and December.

Our October passenger RASM was up approximately 11%, November was up about 8%, and December was up 5%.

Our January revenue and booking trends thus far suggest a year-over-year improvement in our January PRASM similar to or possibly slightly better than the 5% year-over-year improvement in December 2010 PRASM.

On a sequential basis, these trends suggest our January nominal PRASM will be in line with historical sequential decline from the nominal December PRASM.

Our bookings thus far for the remainder of January for February and for March all look strong and we're encouraged to begin the first quarter with sustained momentum.

However, we do anticipate that our year-over-year PRASM comparisons will become more difficult in February and March compared to January due to last years' PRASM acceleration as the quarter progressed.

We also had a PRASM benefit from weather last year, mostly in February from the flight cancellations.

We cancelled the equivalent of about one day's flights in February last year due to extreme winter weather which actually boosted our first-quarter 2010 PRASM by about 1%.

In addition, March 2010 had a small benefit from an early April Easter which we will not have this year.

Although still below our 2008 nominal passenger levels, our full fare passengers have continued to grow year over year suggesting that business travelers are returning or at least consumer spending habits are changing.

In the fourth quarter of 2010, we experienced an increase in the nominal full fare passengers versus the third quarter.

Normally, you would expect a seasonal sequential decline moving into the fourth quarter.

This suggests we're finally seeing a rebound in our business travelers.

Our fourth quarter full fare mix was 20%, which is up about two points from the fourth quarter of last year and it's up two points from the third quarter of 2010, and of course this is on a higher load factor as well.

Demand for our Business Select product remains strong with 19% more Business Select passengers than a year ago producing $21 million in incremental revenue.

Our Wright amendment revenues were strong again contributing $55 million in the quarter compared to $45 million a year ago with full year 2010 Wright amendment revenues of $216 million versus $162 million last year.

Turning to freight and other revenues, our freight revenues were $32 million and we expect that our freight revenues for the first quarter of 2011 will be in line with our fourth-quarter 2010 freight revenues.

Our other revenues were very strong.

They increased over $40 million, which was a 40% increase to $137 million.

The $40 million increase year over year was primarily due to an increase in our Early Bird revenues and our Business Partner income.

Our fourth-quarter 2010 Early Bird revenues were $29 million.

And for the full year, our Early Bird revenues totaled $98 million, which was an outstanding performance easily exceeding our expectations for the first full year to offer this product.

Our pets, unaccompanied minors and excess bag charges combined were $13 million in the fourth quarter.

We're currently expecting another year-over-year increase in our other revenues in the first quarter but at a significantly lower rate than experienced in the fourth quarter of 2010 likely the high-single digits.

And on a unit basis, we do not anticipate that our year-over-year total operating RASM change will continue to outpace our year-over-year PRASM gain in 2011 like it did in 2010 as we had easy year-over-year comps in 2010 as many of our other revenue products were not introduced until late 2009.

Turning to costs, our fourth-quarter operating expenses, excluding special items, increased 13.4% year over year.

The increase was 7.6% on a unit basis, which was in large part due to higher fuel prices.

Our economic fuel costs for the quarter increased 12.7% to $2.48 a gallon, which was slightly better than the guidance we previously provided.

The increase from our third-quarter economic fuel price of $2.38 per gallon was primarily due to higher average crude oil during the quarter, it was about $9 a barrel higher, as well as higher refinery margins, which were up almost $4 a barrel.

Our fourth-quarter $2.48 per gallon fuel price included $14 million in unfavorable cash settlements, which was a $0.04 per gallon penalty versus our unhedged fuel price of $2.44 per gallon.

Speaking to first-quarter 2011 fuel, we provided a schedule of our hedge coverage in this morning's Press Release.

Based on this hedge position and the January 18 forward curve for crude and crack spreads, we're currently expecting our first-quarter 2011 economic fuel price to be in the $2.80 per gallon range including taxes.

That price per gallon is approximately $0.02 higher than the unhedged fuel price.

And at current market levels, our post-2008 hedges have offset most of the $0.15 per gallon penalty from the unwinding of our pre-existing 2011 hedges from late 2008 and early 2009.

The premium costs associated with our first-quarter fuel hedge are estimated to be in the $31 million range.

We also provided a fuel sensitivity table in this morning's Press Release based on our existing hedge positions.

And as a reminder, the sensitivity table factors in the performance of our active hedges that we have in place at various market prices, and it also factors in the locked in losses from the hedges that were unwound in late 2008 and early 2009.

The table does not include our premium costs as they are recorded below the line in other gains and losses.

For 2011, it's difficult to give guidance with precision on fuel but again, using the January 18 forward curve which we use to forecast our fuel price, it certainly points to rising energy prices throughout the year.

Based on the current forward curve as of January 18, crude is averaging about $95 for the full year of 2011 with January at about $91 and December around $97.

Our 2011 fuel hedge is weighted heavier towards the back half of the year.

And if using the January 18 forward curve and our current 2011 fuel hedge, we're estimating our full-year 2011 fuel price per gallon to be in the $2.80 to $2.85 range, which implies no net hedge penalty or gain for the year.

If prices rise above the current forward curve projections, for the remainder of 2011, our hedges would begin to produce net gains providing for a lower hedge price per gallon versus unhedged price.

Based on this forecast, our fuel headwinds for 2011 is about $650 million adjusted for our year-over-year capacity increases.

The total net value of our hedge portfolio as of January 18 was an asset of approximately $225 million.

That's up from the December 31 value of approximately $150 million.

Our current collateral posted with counterparties is net cash of around $120 million and our aircraft collateral facility remains available but is currently undrawn.

Excluding fuel and special items, our fourth-quarter costs increased 5.8% on a unit basis.

The primary drivers of this year-over-year increase were salaries, wages and benefits, aircraft maintenance, advertising and charge sale discounts.

Higher wages contributed to over half of the year-over-year increase of salaries, wages and benefits, and higher profit-sharing accounted for approximately 25% of the increase.

We accrued approximately $33 million in profit-sharing and $48 million in 401k expense during the quarter for a total benefit to our employees of $81 million, up from $63 million last year.

And for the full year of 2010, we accrued a total benefit to our employees of approximately $350 million in profit-sharing and 401k match.

Our maintenance unit costs increased almost 15% year over year, primarily due to more airframe repair events in the fourth quarter, but also our fourth-quarter 2009 maintenance unit costs were unusually low.

Our advertising unit costs were up 8% year over year primarily as a result of our Bags Fly Free and Southwest.com campaign.

And finally, our charge sale discount, or revenue-related unit costs, were up 10% year over year due to the 14% year-over-year increase in our passenger revenues.

Looking forward to the first quarter of 2011, based on current cost trends, we expect that our unit costs excluding fuel and special items to increase in the 2% range year over year.

We continue to have cost pressure in the first quarter, most notably in maintenance, advertising and revenue-related costs.

Our maintenance unit costs are estimated to be in line with the $0.0079 realized in the fourth quarter 2010 and our advertising costs are expected to continue at a similar nominal unit cost as experienced in the fourth quarter due to our ongoing change fee advertising campaign as well as the rollout of our new improved Rapid Rewards Frequent Flier program.

For full year 2011, we expect a similar increase in our non-fuel costs as in the first quarter, primarily due to inflationary type, non-fuel cost increases.

Moving to the balance sheet, as we reported this morning, we currently have approximately $3.8 billion in core and unrestricted cash and short-term investments.

Our leverage including our aircraft leases at year end was approximately 40%.

And we had another strong quarter for cash flow from operations with $269 million in the fourth quarter and $1.6 billion for the full year.

For 2011, we are currently expecting capital spending in the $800 million to $900 million range and we have debt maturities in 2011 in the $500 million range.

Turning to our fleet, during the quarter we acquired two -700s from Boeing, which was one more than expected due to a one month shift in timing from January 2011 to December 2010.

We also acquired one leased -700 aircraft in the secondary market as previously disclosed.

We retired four of our owned -300 aircraft during the fourth quarter, which resulted in five total retirements in 2010.

So we ended the year with 548 aircraft.

Moving to 2011, we expect to take delivery of 17 -700s from Boeing this year as well as two more leased -700 aircraft from the secondary market, resulting in 19 total deliveries.

This is three more than originally planned due to an opportunity to acquire three additional delivery slots from Boeing this year, which is helpful as we manage our current and future fleet needs with our multi-year classic retirement plan which remains fluid.

Our delivery schedule by quarter is currently as follows.

In the first quarter we have five -700s, in the second quarter, five more, third quarter, seven and the fourth quarter, two.

We continue to evaluate the timing of our retirement schedule for 2011 and beyond, keeping in mind that we currently have no intention to significantly grow the fleet, absent Air Tran, until we hit our profit targets.

For 2011 we have some leased aircraft reaching expiration as well as some owned -300s slated for retirement, so it is likely we will have double-digit retirements this year.

However, as we've mentioned, it's not an exact science, so we'll likely be plus or minus a few from year to year as we manage our fleet needs with our retirement plans, our maintenance needs and protecting the overall quality of our operations.

In addition to a change in our 2011 aircraft deliveries, we also shifted some of our 2012 deliveries, that resulted in 20 firm orders now for 2012 versus the previous 23.

The three aircraft shift consisted of one delivery moving into late 2011 and the other two shifting out to 2016.

And as we previously announced, we substituted 20 of our 2012 -700 firm orders for -800s which now represents all of our 2012 scheduled deliveries.

We're currently evaluating substituting our 2013 and beyond deliveries to -800s as well.

But taking into account all of the revisions to our Boeing schedule, the net change from what we last reported is three additional aircraft.

Our quarterly capacity plan for 2011 is as follows.

The first quarter 2011 is expected to be up approximately 8% to 9%, second quarter up approximately 5% to 6%, third quarter 4% to 5% and fourth quarter up 4% to 5%.

All in, that results in an expected full-year 2011 capacity increase of 5% to 6%.

Now we have three new cities planned for March, Charleston, Greenville-Spartanburg and Newark and all combined this new service accounts for about 1% of the6% capacity growth.

The remainder of the 2011 capacity increase is primarily attributable to two factors.

First, we're taking advantage of attractive opportunities to increase our fleet utilization, especially during peak travel periods.

And second, we have a heavier weighting of capacity growth in the first half of 2011 comparable to the first half of 2010 when our capacity was down over 3%.

As we turn 40 years old this year, we have approximately 550 aircraft, we serve 72 airports and we carry more passengers in the US than any other airline.

So as you can imagine our schedule has to remain dynamic to be able to respond accordingly to changes in demand and other economic factors.

As we've shown over the last several years we now have much better tools and techniques that give us the capabilities to better match supply with demand.

And 2009 and 2010 were both prime examples of adjusting capacity to meet a changing demand environment while at the same time executing a unit revenue premium over our peers, all while still remaining Americas preferred low fare carrier as evidenced by our number one DOT ranking for customer service, which is something we're obviously very proud of.

And with that, Cynthia, Gary and I are ready to take questions.

Can you please give instructions on how to queue up?

Thank you.

(Operator Instructions)We will now begin with our first question from Hunter Keay with Stifel Nicolaus.

Please go ahead.

Thanks very much.

Can you guys hear me?

Yes.

Hi, Hunter.

How are you?

Great.

How are you?

Very good, thank you.

So Gary, excuse me, I noticed you guys have sort of shifted the tone of the advertising campaign a bit sort of turning the focus away from the bag fees a little bit more to the change fee, I've noticed the commercials I think many many people have too.

Do you think that that-- you might be--you talked about some of the RM improvements you're working on, do you think that sort of locking yourself into a lack of change fees might tie your hands a bit on sort of the yield you might be able to squeeze out of say an improved RM system?

Well, it definitely commits us to a brand strategy, I would agree with that.

In terms of locking our hands, I think our strategy is really to win more customers.

We have this opportunity to differentiate ourselves and we've used the phrase or the word that we see this as a gift and obviously we've been able to run the business very effectively with that approach.

I think to not couple that together would potentially seriously diminish the value of the Bags Fly Free campaign, which again we believe has been tremendously successful.

Said a different way, if we were to now change and begin to charge change fees, that runs the risk of destroying a lot of the goodwill and value that we've created with the no bag fees.

So I'd rather have a customer, Hunter, than a bag fee and we get a lot more money that way and obviously we've gotten a lot more customers.

So we think that's working, and we haven't charged change fees in our history and clearly with this campaign, we are emphatically saying we have no plans to change our change fees.

Okay, yes, I understand that.

Thank you for that.

And I guess the other thing I wanted to talk about a little bit was the January RASM number, which I thought was incredibly strong, and then you guys just kind of hinted a little bit that there might be upside to that given the capacity increases and given the comp.

Is that, excuse me again, does that reflect some of the recent fare hike activity?

I mean as we think about moving through the months and the comps get brutal into February and March, could we actually maybe see that rate kind of sustained maybe even sequentially increase based on some of the fare hikes that have been passed through that probably aren't in that January number just yet?

Yes, so Hunter, this is Laura.

We-- the guidance that we gave for January indicates that it could be slightly better than what we experienced in December.

Certainly as you know we did pass another fare increase last week, so we expect that the benefit from that would be in the latter part of the quarter, we won't see a lot of that real soon.

But again I think we talked through some of the comps from January to February and March, they do get more difficult.

So bookings are strong as we look forward-- as we go forward, but we do think the comps are going to be more difficult as we progress from month to month.

Okay, so it's probably reasonable just based on comps and capacity that sequentially, you could maybe-- it's going to be probably difficult to sequentially increase that year-over-year growth rate just based on comps alone?

Yes.

Okay.

Well thanks so much guys.

Appreciate it.

We will take our next question from Bill Greene with Morgan Stanley.

Please go ahead.

Yes, hi there.

I'm wondering, Gary, is there a price at which you'd reconsider this capacity growth?

Is there a fuel price you'd reconsider that, because I think generally what we've heard from the airlines so far this week is in spite of a pretty big run in fuel there's not really been an adjustment in any capacity plans that were sort of hinted at or announced at the end of last year.

So I'm curious how we should think about when we would need to adjust this, what's that point look like?

That's a great question, Bill, and a very fair one.

I don't have a bright line to give you today except for fuel.

Again, we have a great outlook for 2011 and obvious to everyone of course, that's the big issue, and I felt that for some time and that's what everybody is saying and that's no doubt what you're thinking.

I would say this.

Where the futures market is today, I'm not suggesting that we are comfortable.

That's probably not the right word, but we're not shocked by it and I think we are well prepared to absorb that level of fuel price, fuel cost and still sustain our plan for 2011.

If it goes up to $150, I think that that's pretty clear that that's on the other side of what would be a good business plan here in the near term.

So we're not expecting that that would happen.

So obviously somewhere south of there is a point that we would need to be slowing our growth.

We're published through August, so every schedule that we publish, we talk about this very thing and we don't go out for a year with our schedules, so I think that that provides us more of a natural hedge, Bill, than our counterparts who typically I think publish 330 days out.

So I don't have an answer specifically, but we have a solid year in terms of our outlook with the current fuel.

We've got a three-pronged approach to manage it which is with our hedge, with continuing focus on conserving fuel and then finally, with revenue offsets.

And I think Laura and I have both tried hard here this morning, I guess now this afternoon, to illustrate how strong our revenue momentum is.

And so at least for now, I think we're very comfortable with our plan, we wish fuel prices were lower but we'll see a nice offset to fuel price increases from here with our hedge that's in place.

And a hedge of course is pretty substantial, as you know by the schedule and by following us, it's pretty substantial through 2014.

So we'll have ample-- that's what it's for, we'll have ample time to adjust, if we need to slowdown our growth we have a lot of airplanes that we could retire, so I think we're in good shape on all those [points].

Have you seen any elasticity in the demand since these fare increases have gone through?

Well we've had record loads up through December and I-- I'm going to let Laura answer about the relative comparisons with traffic in the first quarter.

But we-- but you know what we've said, we've said we are looking at a continuing strong revenue environment from what we've seen so far in January, and that we see strong bookings for the rest of the quarter.

But do you want to provide a little more precise answer there?

Yes, I think the most recent fare increase is too early to tell, we just haven't-- it hasn't been out there long enough to know.

But certainly with the fare increases that have proceeded it we still have very strong bookings in place, we gave you where our January year-over-year PRASM is, so .

So far they've been pretty effective, certainly it's something that we'll watch and see how we

And your comments about sort of a slower growth rate on other revenue and sort of non-fare revenue, does that suggest then that maybe there's fewer buckets we can dip into there or are there things we should look at to raise fees?

Bill, I think the comment there is we just had 40% year-over-year growth is explosive so we had a lot of products that we introduced in 2009 that didn't have much revenue in 2009 and they were-- and they did terrific in 2010.

So we definitely think they have upside to grow but they're not growing from a base of almost zero, so--.

I think I would only augment what I said and what Laura is saying, and perhaps it's a little repetitive but I think it bears repeating.

I said it and Laura said it earlier, our business demand is-- it is evident that it is improving, and I would point to signs really in the third quarter that it began to pick up and the change in trend with full fare traffic from third to fourth is remarkable for us at least to take note of.

So I am bullish about that momentum continuing, and as you know that is less elastic demand.

So our short-haul markets year over year are finally beginning to outperform the rest of the markets as well on a revenue basis, so I think all that sort of hangs together.

So I don't know, in other words that the big numbers are not the fees for us.

I don't think we are so concerned that we're going to see a slowdown in the growth in the other category at all and we'll continue to dial up and tune up as best we can with pricing and load factors to drive this revenue momentum.

Okay, thanks for the time.

We' will take our next question from Helane Becker with Dahlman Rose.

Please go ahead.

Thank you very much, Operator.

Hi, everybody.

Hi, Helane.

Hi, Helane.

So Gary, I actually have a follow-up question about your business traffic mix, which is really terrific that it's going back up.

Do you think at some point your business travelers then come back to you and tell you they expect a first class cabin?

Is that something you would have to consider changing your thought process and what you offer them?

No.

I don't see that.

I-- we feel like we know our customers well, and in particular over the last 5 years, we have done more research with our customer than ever before in our history and they like the Southwest experience.

We get anecdotal evidence of winning more new customers during this time period with the product as you know it, the boarding process has vastly improved, that's made a world of difference, Business Select has made an enormous difference with passengers that might otherwise, Helane, but thinking about that kind of an alternative product.

And there are other features, just being on our A-list where you're automatically checked in, and even if you don't want to spend the money on Business Select, the Early Bird product is another good alternative.

So all of that working in tandem along with having the Number 1 customer satisfaction ranking I think has served us very well.

The number one request that business customers have had is to improve our Frequent Flier program, and so if anything I feel like that along with rolling out that and in-flight Internet connectivity, we're going to have more to offer business customers.

And we have no plans to change our seating, either with assigned seats or bigger seats and it's just not a request that we're getting.

So short answer is no, I don't think that that will be an issue with business travel demand picking up.

Okay, and then my other-- thank you very much.

My other completely unrelated question is about the Wright amendment.

Laura, thank you for the information on those revenues for this year, and I know it goes away completely in 2014, can you just say what changes will occur in 2011 and what you're thinking about in terms of revenue contribution from that for this year?

Well, make sure I understand the question.

In terms of the transition from in the repeal there's no real change in 2011 in terms of our operation and what we can offer.

So we have a significant change in 2014 when we can begin to fly the routes non-stop.

But certainly we saw a big growth during 2010 in our Wright amendment passengers and revenue and business mix there as well, so I think it'll follow along with the trends that we're seeing along the rest of the network, which is really the significant changes in 2014 when we can begin operating non-stop.

So, Gary, I don't know if you have any--?

Well, Helane, if I'm tracking your-- the nature of your question, the law was-- the compromise as I think it was called was enacted in 2006 and then 8 years later the law was going to be fully repealed with some restrictions remaining, but very minor.

There was a mid-point as I recall in 2010 where we got 1 more gate and other than that I don't think anything changes between 2006 and 2014 and that 1 more gate wasn't a material event for us in 2010, if that's answering your question.

Yes, that was exactly answering my question.

Okay, very good.

Thanks.

Okay, thank you very much.

I appreciate the time.

You bet.

We will take our next question from Michael Linenberg with Deutsche Bank.

Please go ahead.

Oh, yes.

Good morning, guys.

Mike.

Two questions here.

Laura, I just-- I want to go back.

You talked about how you wouldn't see the [set] growth in RASM outpace PRASM in 2011 because of the more difficult comps.

How does that-- when we think about the launch of the Frequent Flier, or the revamped loyalty program and the Press Release indicated that it could enhance revenue by several hundred million dollars, what should we anticipate in 2011 and kind of what's the run rate to get to when I think of several hundred million I sort of think of $300 million of maybe enhancement, is that a 3, 5-year window?

How should we think about that?

Yes, I think, Mike, the-- certainly to reach the full potential of Rapid Rewards it's a multi-year phase-in.

2011 is a transition year because you kind of have the old program and you have the new program and there's growth on converting it.

So in terms of the revenue contribution, we think 2011 will be modest.

But also in terms of you thinking about PRASM and RASM, a good portion of what we get in our Frequent Flier program via partner credits--

Yes.

Is actually recorded in the passenger revenue line.

That's a good point.

So it-- because you record it as people fly their Rewards tickets.

So in fact the majority of the Frequent Flier partner set goes through PRASM rather than RASM, so I just want to make sure you think about it that way.

But I guess still as we, if we're successful and we get more cards, then you're more Visa cards out there.

You're right, we'll see growth in our other revenue category.

Absolutely.

But the point is the majority of this new Rapid Rewards program would be in passenger revenue.

Yes, and we're not saying we don't expect to see RASM grow.

It's just-- it so outperformed PRASM in 2010 because of all of the products that we initiated from scratch, so--.

Okay, fair enough.

And then just my second, Laura, when you gave the CASM ex fuel guidance for the quarter and then for 2011 you said at this point that the increase would be something similar to the March quarter like the 2% range, right?

Did I hear that right?

You did.

Okay, so if it's 2% and then if we bake in the $2.80 to $2.85 for fuel, it seems like that your all in unit costs are up somewhere in the 6% to 7% range so, and maybe even higher.

When we think about where RASM is in January and February and we sort of think about okay, what do they need to do to keep margins flat and/or improve upon what you did in 2010 so that you can get to the 15% pre-tax ROIC, is I guess the hope here that that higher fuel price is going to be accompanied by a stronger economy and a better business mix, therefore allowing you to move fares higher?

I mean is that the way we think about that call it I think Gary you indicated on the news like a $600 million or $650 million cost headwind on the higher fuel piece.

Yes, so the answer is we've always assumed even before the $650 million, our 2011 plan always had a fuel headwind, so certainly we have got to cover the cost increases with further revenue improvements and that's certainly the game plan that we have and what we need to be able to do to cover those increases.

Okay, okay very good a nice quarter.

Thank you.

We will take our next question from Duane Pfennigwerth with Raymond James.

Please go ahead.

Hi guys.

Good afternoon.

Hi, Duane.

Just want to ask you a question on capacity and not your own capacity growth but really competing supply on your network.

On our numbers it looks like that was down pretty substantially in 2010, some quarters like Q2, Q3 down in the 6%, 7% range.

And wondering if you could just talk about how you think that competitive dynamic will play out in 2011?

It looks like on our data maybe down 3%ish this quarter and then maybe starting to turn positive in Q2 and understand Q2's a long way off, but is this a function of are we waiting for somebody to blink on the capacity front?

Do you think you're going to see reductions in competing supply going forward as you have in the past?

Yes, I think we know what you know, Duane, and your numbers are right in line with the data that we have.

We would agree with you in 2010, particularly the first part of the year, we saw some pretty significant competitive capacity increases in our markets.

We did not see the same reductions in the fourth quarter that we saw in the first three quarters of the year.

But looking at the first quarter, we're looking at competitive capacity down about 3% in our direct markets and to your point, in the second quarter that kind of turns and looks like it's basically flat after that.

So we don't have anything that we know that shows our competitors are going to continue to reduce capacity and we're certainly not building a business plan around that assumption.

Okay, that's great.

And then just a little check, on the premium expense you said $31 million.

Is that a reasonable run rate to assume for the rest of the year?

Yes, I think, Duane, somewhere in the $35 million, $35 million to $40 million range is reasonable, similar to what you saw on a quarterly basis last year.

Thanks.

We will take our next question from Ray Neidl with Maxim Group.

Please go ahead.

Yes, I was just wondering longer term here, with the aircraft with Boeing not going to re-engine their narrow body fleet but Airbus looking at possibly doing that.

Does that change your thinking about going to a dual fleet type for the fuel efficiency?

I think I understand your question, Ray, so you redirect us if we're not on the right track.

Boeing has not given us an answer.

We are interested in getting a more efficient airplane.

So just to be clear on that point, Boeing has told us and I think what I've read recently at least is they are looking for a decision on that mid-year.

And the decision, I assume, is going to be whether they will put their effort into an all new aircraft or whether they will have what one could describe as an interim step and a re-engine, but they have not given us an answer on that.

And based on what they tell us, then I think we'll have to evaluate our options, like any business people and so I think, Ray, it just depends.

If they told us that we're not going to see a more fuel efficient 737 for another 20 years, that probably would cause us to do something.

So we love the 737, we'd love for it to be more fuel efficient.

We are gaining a second fleet type of course with the Boeing 717 with the Air Tran acquisition.

And I think it's important to note and I assume you know this, Ray, but at some point we'll have a different airplane.

In other words, if Boeing comes forward with a replacement aircraft it's hard for us to fathom that it will be a 737 type rating.

So we have gotten our minds wrapped around the reality that at some point, we will likely have another fleet type.

So I think that's the fundamental question that you're asking is are we up for that and the answer is I think really answered by the Air Tran acquisition is that yes, we think we can manage multiple fleet types.

We don't want 10, but 2 or 3, I think we will be gearing ourselves up for that reality at some point.

Okay, that's exactly what I was looking for.

But if Boeing comes out with a new aircraft sooner than we expect, say 5, 6 years out, are you in a position to re-fleet your fleet very rapidly?

I know your balance sheet and cash position is very strong, but you have to make some very rapid aircraft acquisition decisions then I believe.

Well we'll have to make some decisions and I think Laura pointed out that even the current retirement plan is pretty dynamic primarily caused by the Air Tran acquisition and all of the options that it presents for us.

But there's other things going on in the world too, just the economic recovery and fuel prices and maintenance burdens and on and on and on.

So that is something that I don't feel like we have quite settled on yet.

But yes, I mean first of all we just have to understand what they can do for us and then we'll have to factor that in just as you have posed the question, what options do we have that we'll have to balance that against our CapEx affordability and on and on and on.

So the economics will I think pretty much answer that question.

We don't know what they are yet so it's just premature to try to give you much insight there.

Okay, great.

And with your new reservation system coming along, is it going to give you the ability to generate non-ticket sales such as doing more hotel room sales, car rental sales and so forth?

Off the top of my head I don't know, but I don't think that that is-- if in my opinion, I don't think that's really dependent upon a res system.

We've got those capabilities today on our website and we have the option to enhance those capabilities on our website if we choose to, so I don't really think that's a res system capability.

In addition to international, Ray, what it clearly would bring, what I am knowledgeable about is that there are re-accommodation functions and revenue management functions in the res system that we are very interested, so there are definitely other benefits besides just international.

Great.

Is that an area you think you might want to move into generating revenues away from the airline?

Yes, I think we do.

Our priorities have been different over the last 5 years.

You're obviously very familiar with what our strategy has been.

You know what we've signed up for now.

We've got 4 big ideas that'll be a lot of work for us and we'll need to do those well, that is Air Tran, all new Rapid Rewards, the 800 is a big body of work for us, and then finally the new res system.

But along the way trying to generate an extension-- a revenue stream that's an extension of Southwest.com is definitely one of our ideas.

It's-- we just have not made it a top priority at this point, for all of the reasons again that you know.

Okay.

But still no baggage fees, right?

Come on, Ray.

Thank you.

You're welcome.

We will take our next question from Jamie Baker with JPMorgan.

Please go ahead.

Afternoon, everybody.

Hi, Jamie.

I'll ask my questions quickly.

Gary on the topic of what aspects of AirTran you might keep around, first class is out, assigned seating is out but what about the use of red eyes?

It's something you've stayed away from traditionally and obviously feel free to call me a fool if I've-- if you've snuck a few red eyes in, I'm just thumbing through the OAG, and nothing popped out.

No, I don't think, we can't sneak anything past you, pal.

No I don't think we have a different view right now but what we're trying to do, and we're obviously anxious to close so we can make this all real and instead of just talking about it, we're anxious to learn from AirTran and we are trying to be as open as we can to being able to change our play book.

So that's something that I wouldn't dismiss out of hand.

There are operational challenges for us with the way we crew, with the way we maintain, with our current reservation system as a practical matter, but that's something that I think we'll want to continue to look at because we do have a goal of increasing our aircraft utilization, and that might very well prove to be an option for us.

But my view and I think our teams view has typically been that that's very low yield business and in a $90 crude oil environment it just doesn't work, but that will certainly challenge that paradigm.

Okay, makes sense.

Second question for Laura, you have a secured aircraft deal coming due year end, it would seem that you have pretty attractive access to unsecured financing.

Should we assume you pursue a secured or unsecured solution?

Jamie, I think you should assume that we'll just pay off that debt and not-- we don't have any intention at this point in time in needing to do any refinancing.

So currently-- so that's the plan as we sit here today.

If we weren't going to market it would be unsecured though.

Sure, sure.

And lastly, and I don't want to shift the focus away from Southwest here, Gary, but you have a direct connect, GDS bypass model already.

The industry or at least AMR for now is trying to move in that direction.

Since you're obviously impartial in this regard, any unique technological warnings that you think the industry might be overlooking, any IT land mines other than just the fact that some of their ticketed itineraries might be a little bit more complex than yours?

Jamie I think it is horribly complicated, terrifically expensive and I think they should just continue to do what they've been doing all these years.

Okay, you won't savor obviously, okay, fair enough.

Is that seriously your answer, Gary?

Jamie, I don't know that I have an answer.

We've obviously got a 40-year strategy.

We know how it works.

We've never really played in the other game, so I don't really know off the top of my head exactly what it would take to change from that.

We have enough experience over here to know how difficult it is to manage change so we have a fair amount of experience there.

But otherwise, no I don't really have anything of any value to you to say at this point.

Sure, well I appreciate you taking my 3 questions.

Thanks a lot, everybody.

Jamie.

Ladies and gentlemen, we have time for one more question.

And we will take our last question from Glenn Engel with Banc of America Merrill Lynch.

Please go ahead.

Good afternoon, glad I got it in under the wire.

Glenn.

Hi, Glenn.

A couple questions, first some just number questions.

If I look at the fourth quarter, the wages ex profit share were up 9.4% and the headcount was up 0.5% so that implies a 9% higher wage per employee for compensation.

That's just a lot.

What's driving that?

Glenn, I can answer that.

So on a nominal basis, our salaries, wages and benefits were up 9.3%, as you noted.

We did have a 5.5% capacity increase during the quarter which means we flew more ASMs and we flew more trips.

As you know our crews get paid based on the volume they fly, so a lot of the increase is just based on the capacity increase that we had during the quarter.

So if you strip that out and look at our salaries, wages and benefits on a unit basis and pull out profit-sharing and 401(k), it's up 3.6%.

So that 3.6% does represent the-- kind of the rate increases that are based primarily on the contractual rate increases as well as the step increases that we have in our union contract.

So that's probably a good proxy for what the real, how real pay went up.

Second number question would be if I look at the other airline expense, that enormous number, it was 10% higher than the third quarter, 20% higher than the second quarter roughly, and yet revenue and capacity was down versus the second and third quarter, so what pushes that number up so high?

Yes, so in our-- we've got a lot going on in our other operating costs.

If you look at it excluding special items, and so if you look at that GAAP statement just note that the $7 million in legal and consulting fees is going to show up in other expenses.

But if you kind of strip that out, we were up about $50 million.

A little over half of that, Glenn, was charge sale discounts.

So again just-- that's totally being driven by the increase in passenger revenues.

But that's not true versus the second or third quarter though?

No, well we had the increase in the second and third quarters.

I guess there's some other factors I'll walk through as well.

We also had a higher advertising spend in the fourth quarter relative to the prior year and what you saw even in the earlier quarters of the year.

And then the last piece of it, and that was about, I believe about $8 million, and the last piece of it was we just had higher spend in the fourth quarter on some of our initiatives that we've talked about, the res system replacement and some of those projects that-- where the expenses aren't being capitalized.

So you kind of add those 3 together you'll come up with that year-over-year increase.

And finally on fuel, if I count up the numbers in your release it was like a $0.24 hit to earnings per share in 2010 and even at the current forward curve, it would seem like it's a $0.15 hit to 2011.

And so if I put a normal earnings multiple on it, it seems like it's costing your market cap $1.5 billion and it doesn't seem like your hedges really give you that much benefit until oil is well over $110, so I'm just puzzled by just the trade-off between the benefit of the hedges and just the big impact it seems to have on earnings.

Yes so, Glenn, I think you've got to step back a couple years and realize that we started 2010 with a net negative from the 2008 hedges.

So if you look at where we started, we had it locked in $0.15 to $0.16 per gallon and so we can't undo that.

It is what it is, so we have decided and we decided this a long time ago as a Company that we're willing to incur a certain amount of expenses premium for insurance to protect against the volatility that we have with energy prices.

And I think certainly of our history, that has played out well and has allowed us to look at the unit revenue gains that we reported versus 2007 and 2008, we knew that's what we needed to do to adjust to higher fuel prices, but we couldn't do it overnight.

And certainly if we hadn't been hedged through 2008 with those gains we would have-- I think we'd be in a very different situation today, so--.

And when do those, the problem hedges that are holding you back right now, when do those start to be less burdensome?

They get less burdensome next year and the following year.

So this is the-- there's still some hangover next year but certainly 2010 and 2011 are the big years.

Thank you very much.

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

I think we are through.

If you have any questions, please call the Investor Relations team that will be ready for your calls and thank, everybody, for listening in.

Hope you all have a great rest of your week and weekend.