西南航空 (LUV) 2011 Q4 法說會逐字稿

Good day, and welcome to the Southwest Airlines fourth-quarter 2011 conference call.

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

This call is being recorded, and a replay will be available on www.Southwest.com in the Investor Relations section.

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

Marcy Brand, Director of Investor Relations.

Please go ahead, ma'am.

Thank you, Tom.

Good morning, everyone, and welcome to our fourth-quarter call.

Joining me on the call today is -- Gary Kelly, Southwest's Chairman, President and Chief Executive Officer; Bob Jordan, Executive Vice President and Chief Commercial Officer and President of AirTran Airways; and Laura Wright, Senior Vice President Finance and Chief Financial Officer.

Today's call will begin with opening comments from Gary, followed by Laura providing a review of our fourth-quarter results and current outlook, and then Bob providing an update on the AirTran integration.

As a quick reminder, Southwest's full-year 2011 consolidated results include AirTran's results since the May 2nd acquisition date.

Prior year consolidated results do not include AirTran.

However, in order to provide what we believe to be more meaningful year-over-year comparisons on today's call, we will also be discussing specified results on a combined basis.

Combined results is the sum of Southwest and AirTran standalone results for all periods prior to the acquisition, without any retrospective application of purchase accounting.

In addition, outlook commentary will be provided on a combined basis as compared to combined prior-year results unless otherwise noted.

We provided supplemental financial information on a combined basis for full-year 2011 and for prior-year results in this morning's press release, along with related reconciliations.

Please be advised that today's call will include forward-looking statements.

Because these statements are based on the Company's current intents, 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 results excluding special items or non-GAAP results.

Please reference this morning's press release and the Investor Relations section of www.Southwest.com for further information regarding forward-looking statements, and reconciliations of non-GAAP results to GAAP results.

And now, I'll turn the call over to Gary for opening remarks.

And I thank you very much, Marcy, for that very thorough introduction, and thank you all for joining us this morning.

We are obviously pleased to report a profit for the year that represents our 39th annual consecutive profit of $330 million, $0.43 a share, ex-items.

That's always a good thing in our tough business.

We are very pleased to report a fourth quarter profit of $66 million or $0.09 a share, ex-items, which is $0.01 better than Wall Street estimates.

I want to thank all of our employees; 2011 was a very historic year for Southwest Airlines.

And for the most part, we accomplished what we set out to do, and it's all due to their tremendous efforts.

So I want to thank them first and foremost.

We had an outstanding record revenue performance, and it helped blunt the very significant rise in jet fuel prices, 33% increase in jet fuel prices, but, so far at least, our strong revenue momentum is continuing in the first quarter.

For the most part, that was really the story all year long in 2011, very strong revenue growth, but not quite sufficient to completely offset what ended up being about a $1.7 billion increase year-over-year in jet fuel cost.

So the resulting decline in earnings, while is explainable, it's certainly not satisfactory.

Our plan for 2012 calls for a significant increase in revenues and profits, and that assumes -- I use that word -- that assumes that our revenue plans work, and that we contain cost increases to manageable levels.

And in particular, our outlook for fuel prices in 2012 is pretty benign.

Always subject to change, and that comes with a very quick caveat that we fully admit that energy prices are something that we just can't predict.

We have no plans to grow the fleet, and certainly until we hit our profit targets, and certainly no plans to grow in 2012.

Our network plans in that respect are conservative, and they're geared towards boosting our unit revenue performance.

Through August of this year, Southwest has only one new city planned, and that is Atlanta, as everyone knows, which will start service for Southwest Airlines at least, next month, and obviously that is an important first step of the AirTran integration.

AirTran will be closing cities this year that are not profitable, and at least through August, AirTran plans to add just two new cities, and those are international, Cabo San Lucas and Mexico City.

As I mentioned before, we accomplished a great deal in 2011.

We launched our completely revamped all-new Rapid Rewards program.

It is off to a tremendous start, and I think that we will begin to see very significant revenue benefits from that program here in 2012.

We opened up three new cities within the span of two weeks.

Of course, we closed on our AirTran deal, and then we ended the year with a very big deal with Boeing and GE.

For 2012, for many of you it may seem like it's old news, but it's going to be a huge year for us.

First of all, we'll want to continue our focus on the operation, the quality of our operation, and our Customer Service.

They are both performing at very high levels, and again, I'm very, very proud of our people.

In terms of improvement, we'll be focusing on improving our productivity, improving our efficiency to blunt cost increases.

I already mentioned all-new Rapid Rewards will continue to focus on growing our membership, and growing the revenue per member in that program.

But in terms of new business, we're planning to receive our Single Operating Certificate here in the first quarter, and at that point, the real integration of AirTran, the visible integration of AirTran can begin.

So that will be a lot of work for us this year to begin the conversion of aircraft and airports and employees from AirTran into Southwest Airlines.

That all implies that we'll have big schedule changes occurring within the AirTran unit throughout the year.

Many of those, again, are already published, out through August.

Of course, we're launching the 737-800 in the first quarter of this year.

That's a very big deal for Southwest Airlines, and brings with it quite a bit of change.

We announced two days ago that we have the New Southwest Experience, the new in-flight cabin experience upgrade that we are planning for the 700s.

We'll begin to see the impact from the new Boeing agreement that we came to agreement on, in December.

You'll see those financial effects flowing through the year.

We plan to pay down more debt, and that's on top of 2011's debt pay down, all post acquisition.

So a lot of things are occurring in 2012, and again, I feel like our folks are very much up to the task.

In addition to those things in the background, we'll continue construction of technology, and in particular, to make sure that Southwest Airlines has the capabilities to fly international over the next couple years.

We'll bring in 33 new airplanes.

We're going to retire 40.

So you'll actually see a decline in the fleet from where we stand today through the end of the year.

Again, that's probably more mechanical than anything else.

We grew the fleet a little bit in 2011.

We're pretty much ending up in 2012 where we had initially targeted because we did push some retirements from 2011 to 2012.

So again, I wouldn't read anything into that, other than mechanically that's just the way the retirements match up to the acquisition of new aircraft.

As we said in the release, we've got $1.3 billion of capital spending planned.

That, I believe, is unchanged from what you all have heard from us before.

No external financings are planned.

We're clearly managing for free cash flow, and very much continuing to focus on driving shareholder value.

We have a $500 million share repurchase authorization, and of that, we have $225 million remaining.

I'm very pleased with our liquidity -- $275 million, sorry, I can't read my own writing -- that is $275 million remaining.

Very pleased with our liquidity of $3.5 billion, plus our untapped revolver of $800 million.

Very pleased with our balance sheet leverage and how it is rapidly declining.

And again, just I'm very pleased overall with our 2011 performance, and the momentum we have coming into 2012.

So with that hopefully very quick overview, let me just turn it over to Laura Wright, our CFO.

Thank you, Gary, and good morning, everyone, or afternoon to some of you.

Our fourth-quarter GAAP net income was $152 million or $0.20 per diluted share.

Excluding special items, we reported earnings of $66 million or $0.09 per diluted share, including the anti-dilutive effect of our convertible debt.

As Gary noted, this exceeded our First Call consensus estimate by $0.01.

Special items during the quarter consisted primarily of $107 million net related to non-cash hedging gains, and $21 million net of taxes for AirTran integration expenses, primarily related to consulting fees and our cancellation of XM Radio.

Our full-year 2011 GAAP net income was $178 million or $0.23 per share.

And excluding special items, our 2011 net income was $330 million or $0.43 per diluted share.

Our pretax return on invested capital for 2011 was approximately 7%.

And I agree with Gary, 2011 was a big year for Southwest, and I would also like to thank all of the employees at Southwest and AirTran for their hard work and their many accomplishments in 2011 that enabled us to announce the results that we are telling you about today.

On the revenue front, we had a strong fourth-quarter revenue performance.

We set a number of fourth quarter revenue records, those included operating revenues, passenger revenues, passenger yield, passenger unit revenues, and total unit revenues.

Our operating revenues were $4.1 billion, and our passenger revenues were $3.9 billion, which was a $915 million increase or 31%, up from last year's $2.9 billion Southwest-only results.

About two-thirds of the passenger revenue growth was attributable to AirTran.

And the remaining one-third, or $300 million, was organic growth at Southwest.

On a combined basis, our passenger unit revenues grew 8.2% in the quarter versus last year, and our total unit revenues were up 7%.

Our October combined PRASM was up close to 7%.

November combined PRASM was up close to 10%, and our December combined PRASM was up 6% to 7%, as previously reported.

During the fourth quarter, we corrected the income statement allocation as certain of our revenues from the sale of Frequent Flier points associated with our Chase credit card agreement.

The reallocation didn't change our total revenues or bottom line, but was simply a shift of revenues from the Other revenue category to passenger revenues.

This re-class totaled $46 million for January through September.

However, there was an additional $13 million that we re-classed for October/November, subsequent to our reporting our monthly PRASM results.

On a monthly basis, the re-class has about a 0.5 point or less benefit to PRASM.

Our December PRASM that we reported already reflected the reallocation at the time we reported our traffic.

During the fourth quarter, our yields were up 8.5% on a combined basis.

And our yields at AirTran outperformed Southwest in the fourth quarter; they were up almost 17% year-over-year.

We've made significant improvements in the AirTran revenue management structure already, even before optimizing the network, which begins this year, and before connecting the networks later this year, both of which will also bring significant revenue potential.

Our average fares on a combined basis were up 10% as a result of eight fare increases we've taken since the fourth quarter of last year.

Despite the increased fares, our load factors have continued to be strong, with an 80.5% fourth quarter combined load factor.

That was down 0.2 points from last year's record fourth quarter load factor.

Our mix of full-fare passengers in the quarter at Southwest was 17%.

The number of Southwest full-fare passengers were down about 1% in the fourth quarter versus our third quarter, and that is significantly better than the average sequential drop in fourth quarter full-fare passengers versus third quarter.

Looking at several measures, all indications are that our corporate travel trends are stable.

There's also evidence that over time many business passengers are purchasing travel in other fare categories impacting our full-fare mix versus historical trends.

Our business select fare product had another strong performance, with $22 million in revenues for the quarter.

Our Wright Amendment revenues were $56 million in the quarter, and $240 million for the full year, up from $217 million in 2010.

And based on the revenue and the strong booking trends thus far in January, we expect our January passenger unit revenues to increase year-over-year 7% to 8% on a combined basis.

February is currently on a similar pace, as the year-over-year pace as January, but we do expect to have more difficult year-over-year comparisons in March due to the timing of Easter.

Our fourth-quarter freight revenues were $36 million; that was up 13% over last year.

And our fourth quarter Other revenues were $212 million, which decreased $24 million as compared to the fourth-quarter 2010 combined results.

Our fourth quarter early bird revenues increased $7 million to $36 million.

And the full-year early bird revenues were $142 million, far surpassing the $100 million annual target that we set when we launched the product.

We currently expect our first-quarter 2012 freight and Other revenues to be comparable to our fourth-quarter 2011 freight and Other revenues.

Turning to fuel, again, the year-over-year decline in our fourth-quarter earnings excluding special items was largely driven by higher energy prices.

Our fourth-quarter economic fuel cost per gallon including hedges and taxes was $3.29, a 34% increase over the prior year.

Our unhedged fuel price per gallon was $3.17.

The increase in our fuel expense in the fourth quarter due to the 34% increase in fuel price per gallon was approximately $380 million in the fourth quarter, and for the full year, the increase in fuel bill due to the higher prices was $1.6 billion.

Our fourth-quarter premium expenses related to fuel hedging, which are recorded below the line in Other gains and losses, were $14 million in the quarter, and that compared to $44 million a year ago.

The market value of our hedge portfolio at December 31 was a liability of $44 million.

That compared to a liability at September 30 of $660 million.

And as of January 17, the value of that hedge portfolio is an asset of approximately $100 million.

Looking forward on fuel, we utilized a similar strategy for the first half of 2012 hedges as we did in the fourth quarter of 2011, where we've reduced our floor exposure, we've reduced our premiums, and also reduced our hedge protection.

As a result of these actions, for the first half of 2012, we have minimal protection, but in the second half of 2012 we've got meaningful protection for WTI prices in excess of $100.

In turn, we were able to reduce our current premium spend for 2012 to $48 million.

That compares to $114 million spent in 2011, and $162 million in 2010 on a combined basis.

In the first quarter of 2012, our hedge premiums are approximately $6 million, and the hedge premiums in the second quarter are approximately $5 million.

Based on the market prices as of January 13, and our existing hedge portfolio, we currently expect our first-quarter 2012 economic fuel price per gallon to be in the $3.35 per gallon range.

This includes an approximate $0.12 per gallon hedging loss.

Our full-year 2012 fuel cost estimate, again, based on the January 13 forward curve, is $3.30 per gallon.

And the full year unhedged fuel cost estimate is $3.22 per gallon.

Our hedge positions in 2013 and 2014 provide significant upside protection.

Although at today's backward-dated prices, the market value of our positions is modest, these hedges provide meaningful protection to us if prices increase to the $105 and above level.

As we move away from our years with 2008 losses, we have 2013, our last year of a legacy hedge, we intend to keep our annual fuel hedge premiums below $100 million, and build a portfolio that provides catastrophic protection upon appropriate market conditions.

Turning to our non-fuel costs, on a combined basis our fourth quarter operating expenses excluding fuel and special items increased 2.7% versus last year.

And on a unit basis, they increased 0.5%.

This was better than our 2% guidance, primarily due to lower maintenance costs and lower advertising spend in the fourth quarter.

For 2012, we currently anticipate a modest unit cost increase excluding fuel, profit sharing, and revenue-related costs on a combined basis, primarily due to salaries, wages and benefits, maintenance and airport costs.

However, our 2012 CASM will also be impacted by a couple of items related to our fleet replacement initiative.

First, the refresh of our 737-700 interiors, which we're calling Evolve -- the cost of that retrofit will be expensed versus capitalized.

And we currently expect $40 million to hit maintenance expense in 2012, and $20 million to hit our maintenance cost line in 2013.

Second, with our decision to accelerate the retirement of our 737 Classic fleet, we've shortened their expected useful lives, which has increased our Classic depreciation expense in 2012 by about $50 million.

We're very excited about the series of fleet announcements that we've made over the past couple of months.

Certainly this week's announcement regarding our decision to retrofit our 737-700 fleet with a new customer and environmental friendly interior, along with six extra seats, is the final step of the much larger fleet initiative.

Collectively, the combination of the new 737-800 with the Sky Interior, the Evolve retrofit on our 700 fleet, the acceleration of our 737 Classic retirements with NG and MAX replacements delivers a handsome financial return, allowing us to reduce our operating costs and also produce more revenues.

We reduced the fuel burn by 6% to 7% by replacing our Classic aircraft with the NG, and by 17% to 18% with the MAX.

As our Classic fleet has aged, the annual maintenance cost has increased due to a higher level of inspections.

And the average annual structural maintenance expense for our oldest Classics is around $2 million per aircraft, annually.

Additionally, the newer airplanes will reduce the out-of-service time, and increase our aircraft productivity.

All-in, the financial impact of our fleet modernization program easily exceeds our 15% return on investment criteria, accounting for the capital cost for replacement and the financial costs associated with shortening the Classic life.

We anticipate the combination of fleet initiatives will conservatively produce a mid to high single-digit CASM improvement upon completion of the Evolve retrofit program, and upon having about 100 -800s in our fleet.

The revenue potential for the Evolve program is conservatively in the $200 million annual range, and the 800s with 28% more seats also provides the opportunity for hundreds of millions of additional revenue.

And we currently have 78 of the 800s on firm order, delivering between 2012 and 2014.

For 2012, we expect the contribution to earnings before tax from these collective fleet programs to be about $70 million, taking into account the $40 million maintenance charge for the retrofit, and the accelerated depreciation, the contribution to 2013 EBT is expected to exceed $300 million, again, accounting for the additional maintenance expense.

And by 2014, when the Evolve retrofit is complete, and we have a substantial number of the 800s in our fleet, the expected EBT contribution is in excess of $500 million.

For 2012, we're also expecting a significant decline in our non-operating expenses, with our interest expense expected to be down almost $60 million on a combined basis due to the retirement of $1 billion of debt since the AirTran acquisition.

Additionally, we're expecting a significant decline in our hedging premium expense versus 2011, again, with our 2012 premiums at $48 million versus $114 million in 2011.

We remain on track to realize the $400 million of net synergies related to the AirTran acquisition in 2013.

Net revenue gains remain the primary contributor.

However, now that we're eight months into the acquisition, we currently expect that our cost synergies in the aggregate and on an annual basis will exceed the expected cost to synergies from increased labor costs.

The estimated labor cost to synergy in total is approximately $150 million, and that is expected to be phased in between 2012 and 2015.

For 2012, we're currently forecasting net synergies in the $200 million range, with the net revenues two-thirds of the contribution, and net costs the remaining one-third.

In 2011, the net synergies realized were approximately $80 million, split evenly between revenues and costs.

The revenue gains were from revenue management actions on pricing and inventory management, and the cost savings were in corporate overhead, maintenance contracts, renegotiated financing contracts in insurance, and general procurement.

We ended 2011 with $3.1 billion of core unrestricted cash and short-term investments, net of fuel hedge collateral deposits provided to counterparties of $226 million.

During 2011, we generated $1.4 billion of cash flow from operations, with $400 million of free cash flow.

We repaid $638 million of debt during 2011, and as a result, our leverage including off-balance-sheet leases is approximately 47%, down from just over 50% after acquiring AirTran in May.

Our 2011 CapEx was $968 million.

This included approximately $40 million of capitalized costs that were related to the acquisition and integration of AirTran.

I wanted to quickly point out the increase on our balance sheet in our air traffic liability account.

There is a $257 million increase that relates directly to our all-new Rapid Rewards program.

The cash sales from points sold to our business partners during the full year increased $250 million versus 2010.

And the vast majority of this revenue is deferred, thereby increasing our air traffic liability, and this will be recognized into passenger revenues as flights occur in the future.

For the fourth quarter alone, our cash partner sales increased over $100 million, again, showing that this new program is producing very strong results.

As of yesterday, our cash had grown to $3.5 billion, and we continue to have an $800 million line of credit fully available and undrawn.

Gary pointed out cap spending for 2012 unchanged at $1.3 billion, and debt maturities of $560 million planned for 2012.

Let me quickly finish with a fleet and capacity overview.

During the fourth quarter, we took delivery of three -700 aircraft from Boeing, and we retired four of our 300s, two of which were on leases, ending the year with 698 airplanes.

In 2012, we will take 33 airplanes, all 800s, five of which will be leased from a third party.

The first of our 800 deliveries are scheduled for March.

We have two, and the remainder are pretty evenly spread throughout the year.

With the 40 retirements planned for 2012, we will end the year with a fleet of 691 airplanes, and we still expect that our 2012 combined available seat mile capacity will be relatively flat with our 2011 combined capacity.

In the first quarter of 2012, our combined capacity is going to be up about 1% versus last year.

That's mainly attributable to an extra day in the quarter with this being a Leap Year.

In the second quarter, our capacity is expected to be down 1% to 2%.

These forecasts that we're providing today include our current forecast, which includes the impact of the AirTran aircraft transitions that are going to begin in the next few months.

It also includes the addition of the larger gauge -800 airplanes, and the additional seats from the recently announced Evolve interior on our 700 fleet.

Our schedule currently published through August 10 does not reflect the additional seats of Evolve and the 800s.

And with that, I will turn it over to Bob Jordan for an integration update on AirTran.

Well, thank you, Laura, and thanks, everyone, for joining us on the call today.

I am very happy to report that overall our AirTran integration is proceeding on track, as planned, and is on time.

I want to begin by thanking everybody at both Southwest and AirTran for their hard work and dedication to the integration.

They have kept their eye on the ball by running one of the best operations in the industry, while staying focused on the integration plan.

In fact, 2011 was AirTran's best operational year ever, with on-time performance for the year at AirTran of 84.8%.

And in December, which is typically a very tough month with winter weather, AirTran's on-time performance was 91.9%, which is the best December ever, beating the previous December by nearly 10 points.

There was an equally strong performance in mishandled bags and complaints, so I'm just absolutely pleased with the people of AirTran for these results.

On the integration front, optimizing our joint network continues to be a significant focus, with scheduled publication lead times.

Most of that doesn't really show up until 2012, but by improving overlap markets and repurposing less profitable flying now, we are creating the opportunities to improve our network returns.

And some examples include our announcement during the fourth quarter of new 2012 AirTran service to Mexico City and Cabo San Lucas.

And AirTran -- I'm sorry, Southwest entry into Atlanta that begins next month with 15 daily flights, ramping up to 18 daily flights by the Summer.

In total, based on our joint schedules currently published through August 12, we will serve 103 cities in our combined networks, providing significant revenue potential when we have the capacity and capability in place to connect the networks in 2012.

We have completed 22 of 31 shared city transitions, co-locating our operations side-by-side.

In a number of these shared cities, we have also in-sourced below-the-wing operations to Southwest ramp personnel.

We've harmonized our passenger services vendors; we've harmonized our de-ice programs.

We've merged maintenance facilities in Orlando and Baltimore during the fourth quarter, and construction of the Atlanta cargo facility has been completed and is scheduled to open in conjunction with our service start-up there on February 12.

We began to harmonize policies and procedures in the fourth quarter, including things like sporting equipment and select fees for UMs and pets, for example.

We've also harmonized our large scale maintenance contracts, for example, GE and Honeywell, and those have resulted in substantial cost synergies, as Laura has already covered.

On the labor front, our pilots ratified their seniority list integration agreement in November.

Our flight attendants, mechanics, and flight instructors have reached tentative SLI agreements that have been sent to membership for ratification votes.

And these are just absolutely huge accomplishments, and I want to commend our people for their focus and their ownership of this key step of getting the SLI proposal out for a vote.

As you all know, seniority list integration is absolutely a crucial part of our integration plan, and it's wonderful that we can move forward with this without arbitration.

We are also very excited to be on track with the integration just overall, especially the receipt of our Single Operating Certificate, which we are still expecting in March of this year.

And overall, we enter 2012 well positioned to begin the real heavy lifting of aircraft and station conversions, larger network moves, many of which are already in upcoming schedules.

Overall, as well, I'm just very pleased with AirTran's financial performance, as Laura mentioned.

AirTran's marketing, revenue management, and network planning activities have been managed by Southwest since early last Fall, and through a combination of modest network changes, the utilization of Southwest revenue management tools and techniques, we are seeing substantial year-over-year RASM increases at AirTran each month, and the acquisition was modestly accretive to our 2011 results, as we had planned.

Finally, I would like to close with a historic milestone that's been reached just this week in our integration efforts.

The very first group of AirTran employees officially joined the Southwest family, and I, for one, am extremely excited with this integration milestone.

It just moves us one step closer to the day that we all become one airline.

Just on a final note, I had the pleasure of spending yesterday in Atlanta just working the terminal there, talking to a lot of our AirTran folks, and I can assure you that the AirTran employees remain as enthusiastic and optimistic about joining Southwest Airlines as they have from the very beginning, and that's just a absolutely wonderful thing.

And with that, Tom, I would like to open up the call to questions.

(Operator Instructions) Bob McAdoo, Avondale Partners.

Just a couple of quick ones.

When we think about this flat capacity for 2012, in the context of adding six seats to airplanes and whatever, when you say flat, is that flat in ASM, so therefore the plane miles is dropping?

Is it flat in plane miles, therefore seat miles are increasing?

How should we think about the word flat, given the changes that are going on in the fleet?

Yes, so Bob, when we say flat capacity we're talking about available seat miles on a year-over-year basis.

So, certainly we have more seats.

They're being phased in, but we have airplanes being integrated going through conversion at AirTran.

We have, and as we noted, we're actually going to be down -- down net for the year.

So, that's flat ASMs.

Okay.

And then the second thing is you talk about the non-fuel costs being up in this quarter and in this year.

How much of that is -- is what I guess you would call kind of normal inflation kind of things versus the fact that you'll have by the end of the year some AirTran airplanes that are converted, and I think we have all talked about how the AirTran system when it's converted will have higher costs and higher RASM.

How much of it will be tied to the growth of -- I mean, the conversion of AirTran airplanes by the end of the year or how many AirTran airplanes would actually be potentially even converted by the end of the year.

How far along will that process be?

I'll answer the first question, then we can answer the second.

So, if you look at our 2012 plan, the impact of AirTran, I noted we have net synergies from a revenue and a cost.

So, this is good guys, bad guys, net's about $200 million.

Net-net, AirTran integration is not creating the cost inflation that we talked about.

It's primarily from inflation in our salaries, wages and benefits, which is contractual rate increases and step increases.

We also are expecting some inflationary increases on the airport costs this year and maintenance.

Those are really the three big drivers, but it's not being caused by the AirTran integration.

Second question was the integration -- Bob, you want to talk about the integration of the airplanes for 2012?

Well, we currently have the plan of -- the aircraft integration and modifications start, assuming again that we achieve SOC in March as planned, those will start in late March, early April.

The current plan is to begin and complete about 13 of those next year, so put those back in through -- this year, put those back into the Southwest network, about 13 of the 737s.

So, from a capacity impact, those will be retrofitted with the new Evolve interiors, so we'll move from 137 to 143.

But on a capacity basis it's a very modest impact.

Those 13 aircraft moving from 137 to 143 have a very, very, very modest impact on a capacity change.

Ray Neidl, Maxim Group.

I was looking at your program for the stock buyback.

Is that because -- I know you've got strong cash flow but are you required to do that for the employee compensation, the stock that you give to them and will that be permanent?

Is that something you're going to keep up for the employees?

Then regarding the debt buyback program, again, you have strong cash flow but are you doing that basically -- why would you -- buying back cheap debt?

Are you doing that basically because you're trying to keep your investment grade rating?

And you're not comfortable with your balance sheet even though your debt to capitalization ratio is low.

The first question, which was the share buyback, it is not related to any of our employee stock program.

No requirement, that was just a decision that our Board made as we've done in the past, based on excess cash and trying to enhance our shareholder return.

So, second question was the --

The debt buyback.

Oh, the debt buyback.

So, those were really --

They're not really buybacks.

Not buybacks.

We didn't go out in the market.

They were debt maturities.

Certainly there was debt associated with AirTran that was called upon the acquisition that's included in there, but when we acquired AirTran we were very clear that they had much more leverage and more debt than Southwest.

I think from day one, we announced our intent to, over the first couple years reduce the combined leverage after acquisition, so we're just completing that plan.

Okay, that sounds logical.

Just as a follow-up, a different direction.

With AMR going into bankruptcy, do you see any possible opportunities going into DFW?

No.

Okay.

That was quick and simple.

Bill Greene, Morgan Stanley.

Gary, a little over a month ago, maybe two months ago now, you did put out a memo to the employees, just noting the huge changes the industry's gone through and sort of talked about the challenges that, that might have for Southwest.

As I was thinking about that, when I think about your cost structure, what I get challenged by is, obviously not much you can do in the long-term on fuel.

Your employees and your planes seem pretty productive.

So I was sort of struck by the notion that maybe it suggests that we've got to kind of reassess compensation expectations.

But maybe you can talk through a little bit of the logic of what you see happening there, what your hopes were to achieve with this.

Well, first of all, it was just, as you well know, it was the truth.

It was really a reaction to the events across town, of course, but also a misunderstanding of whether it is an opportunity for Southwest or whether it presents more challenge.

And so I was simply trying to address that.

The fact is that our pay rates are higher now than anybody else in the industry by quite some margin.

We make that up, obviously, by increased productivity.

So, we need to sustain that.

And to the extent that we have become less productive in areas, which has happened, things change over time, Bill, and we do have opportunities.

We need to re-energize ourselves.

And then certainly to the extent that we still have waste that hasn't been wrung out in the Company, we want to go and attack that.

But I'd just challenge the premise that there's no opportunities left to improve productivity or improve our efficiencies, or to eliminate waste, because there are.

And we can't ever be satisfied with that.

Now, we've got some fundamental opportunities from a -- if you want to think about it, as a policy perspective -- to improve our productivity.

We can refresh our fleet and certainly replace less efficient, less reliable aircraft with more efficient, more reliable aircraft and that was a fundamental component of the fleet strategy that we announced roughly a week or so later.

So it puts -- I think that puts that into context.

We're certainly going to pursue those kinds of opportunities.

In terms of scheduling airplanes on a daily basis, we've done a lot over the last couple years to trim schedules, but there is available aircraft time if we can be more innovative and clever in finding ways to successfully market that time, especially late in the evening.

So, we have those kinds of the basic opportunities, as well.

Okay.

One of the things that comes up a lot, obviously, is now that American's in, maybe we should revisit some of this consolidation stuff.

You've seen in the press some suppositions that some of your peers are looking at that.

What's the appetite at Southwest for further M&A?

Obviously you've got to get through the AirTran acquisition, but once that's done how do you think about what your long-term comfort with further acquisitions is?

Well, I don't think we're comfortable in speculating what we might or might not do in terms of any kind of a deal.

I think we would certainly admit that we have a strategy.

It's an energetic one.

We have a lot of work planned certainly for not only 2012 but 2013, 2014 and 2015.

We'll only want to commit to work that we feel like we can do in a high quality way and in a successful way.

Any time you contemplate a merger, obviously that is a huge undertaking and we're really busy with not only that but with other things that we have.

I would fully admit, and not certainly wouldn't want to try to be cute about this, a hub and spoke legacy carrier that has multiple aircraft type, it's not obvious how that would fit for a Company like a Southwest Airlines.

You know that.

We know that.

I think what we will clearly do, and what we've admitted that we would do is, we will pay close attention to any things that do become available, whether it's a simple route or whether it's other assets.

We'll be on our toes to move on those if there're some good opportunities.

But I can't give you a straight answer as to whether or not we would be seriously entertaining other M&A activity.

Sorry, just one clarification.

Are you saying your hands are sort of tied right now or too full to pursue anything or you could, you have the bandwidth left if something became available to look at it?

I'm not answering that.

I think that we -- if you asked us if we were busy, I would say yes.

That there's a lot going on and we will always want to do that well and it would clearly be a factor in us contemplating adding anything else to our corporate to-do list.

But I didn't answer the question as to whether or not I thought we had the bandwidth for it and I -- that -- priorities can be revisited and so I'm not comfortable speculating on what we might or might not do in that regard.

Hunter Keay, Wolfe Trahan.

Gary, about six months ago you said you hit the point where you think you pushed fares as much as you could to be productive.

But since then, obviously the fare environment has gotten a lot better.

And you've matched quite a few recent industry increases, I think, including one last week.

And you added some capacity.

How does demand trends today stack up to what you were seeing then when you said you thought you pushed fares high enough?

Is it better?

Is it about the same?

Is it worse?

Is visibility better?

Any kind of color on that would be great.

Hunter, I think six months ago -- if Laura and I put ourselves back in the August time period, talking about our second-quarter results and the current trends, we were a little confused at that point in time with what we were seeing demand-wise.

I think, since then we've clarified with our third- and fourth-quarter results that demand has actually continued to be quite strong.

So, we had a little mid-year chop for whatever reason there but third and fourth has just been very steady, very stable, very strong and that's what we're seeing so far here in January.

It's a very good environment.

The macro environment, everything we read every day feels better than it did there when we were having the debt crisis, and I think everybody was spooked by a number of things that were going on there.

So, absolutely, things feel much more stable, much more consistent.

Laura's already reported here this morning or this afternoon that we're looking at 7% to 8% unit revenue gains yet again here in January.

So, I'm feeling pretty good.

Okay.

That's great.

Thanks, Gary.

And I wanted to just ask a quick one on the other revenue line.

I realize there were some restatements, I should say, some re-classifications of revenue.

But I think even factoring that in, I think you guys were expecting -- if I'm not mistaken, mid to high single digit growth, but it came down about 10%.

What drove that above and beyond the re-classification?

And is it possible that maybe we're starting to see some of that bag fee revenue dyssynergy start to pop up there?

How should we think about modeling that going into next year?

Hunter, it was -- really, the difference from the guidance that we gave you was re-classifications.

It was a re-classification we talked about and it was also higher deferral percentages on our business partner income, which are actually up more than we expected.

We're just deferring more of it into ATL.

But we did not see any dyssynergies in the numbers for the bag fees that you're talking about.

So, it's really related to the accounting for the business partner income.

Jamie Baker, JPMorgan.

Gary, I'm still trying to reconcile the generally bullish demand tone of this call with the fact that you have blocked several industry fare increases in recent months.

This isn't a question about future pricing.

I'm just trying to get a handle on what you've seen in the last two or three months.

As Hunter pointed out, you did take a long haul increase, but you've resisted attempts to move up fares in sub 1,500-mile markets.

How do we reconcile that fact with what you're saying and would it be wrong to read into this that shorter-haul demand might be under some pressure relative to longer haul?

Well, it's probably a similar answer to what I gave to Bill.

I won't talk about pricing tactics, either in the rear view mirror or going forward.

We want to be the low fare leader.

We're very pleased with our no hidden fees positioning.

I think that's worked very, very well for us.

And then it's down to managing market by market and most markets have fairly significant competitive situations underway.

So -- but otherwise, I'm not comfortable giving any particular insight.

I would say that the -- with the exception of the middle of the year, we've had a very strong revenue performance and a very strong revenue environment.

We are, in 2012, about to begin managing quite a bit of churn in the AirTran/Southwest route systems.

We're trying to pay very close attention to that.

Overall, macro-wise, we're feeling pretty good about the economy and our own performance.

I think what we've all been -- don't lose sight of the fact that what Laura was reporting about the AirTran unit, and that the AirTran yields as a unit are up almost 20% at times.

So, these are just facts that I'm illustrating that, while we didn't take a fare increase, we got a much higher yielding result through other techniques.

So on balance, as I've said, I'm very pleased with the fourth-quarter revenue performance, very pleased with the customer satisfaction.

We are managing very carefully this introduction of a brand-new Frequent Flier program which I think here at this point in time is going exceptionally well.

All of those things are factors in the way we think about pricing at a macro level.

But overall, again, the trends are good and obviously we're -- I'm hoping that translates into a strong revenue performance here in 2012.

Well, as a follow-up to that, Gary, since we don't have the DOT data ourselves yet to answer this question, historically AirTran yields across the spectrum of stage length have been lower than yours.

They made up for it with bag fees and with higher loads.

In terms of sort of equalizing the yield performance between the two units you cite that AirTran's up 20%.

What's the current differential, if you're aware of one, between Southwest pricing and AirTran pricing?

I don't think that there is or was a fundamental difference in the pricing structures.

Now, clearly there are some differences.

If one sits down and studies it market by market, and we don't have -- of course, we don't have complete overlap either with our systems.

But I don't think you'll find a particularly different price fare structure, Jamie.

Again, this is all public information.

Right, right.

What is admittedly different between the two companies is the mix, mix of business in leisure, mix of connections and non-connections, mix of full fare discount, that is very different.

And without using fare increases, we've been able to change that revenue management approach within AirTran, as we have already shared, and that's what's driving the unit revenue growth at AirTran.

But it's not a fare structure, per se.

Got it.

All right I appreciate that insight, that's actually --

It's how we -- Laura's saying it's execution, so it's how we are utilizing that fare structure, we've been able to make some improvements.

I think to Southwest -- I doubt that it's the Southwest brand, per se, but it is sort of the Southwest approach and Southwest philosophies that are realizing some gains right now.

Yes, obviously a lot of different ways to skin the revenue cat.

So, definitely appreciate that.

Thanks for the color.

Helane Becker, Dahlman Rose.

So, two questions.

One is are you preparing for any, or accruing for any wage rate increases for labor as the employees ratify their single lifts?

Well, I think the answer is no.

There's no retro --

I don't -- because as I'm thinking out loud, I'm looking at Bob and Laura here.

That implies there's a retroactive rate change and we don't do that.

So we've done that in the past but that is not -- that's not currently in the works unless I'm just forgetting something.

But in terms of the cost guidance in our budgeting that we give you, we have expected -- we built into our forecast a timing of when we expect some of those equalizations to occur.

So, it's in our guidance but not in the accruals.

I think prospectively.

Yes, I think the big difference is where you know, for example the pilots, and then where we have a contract out or a proposal out for ratification, you know what's planned and so we have those raises and the timing of those raises in the forecast.

But there is no catch-up retro, at least as far as I remember, or any group that has either ratified, or is in the works, or any group that we -- or any plan for any group that we need to move through SLI in the future.

So there's nothing to accrue.

But Helane, just to make sure we're all three understanding your question, we have -- the pilots, we have the deal.

So, we know exactly what pilots move to what pay rates and when.

As Laura mentioned in her remarks, we're phasing AirTran's integration into Southwest, and therefore, those labor rate changes are also phasing into Southwest between now and when we're done, which will be roughly 2014.

If that --

Right.

Those are all forward-looking, so there's nothing to, quote, accrue in that sense.

Okay.

But the numbers that Laura's giving us for cost guidance, it includes what you just said, the integration and the phase-ins, right?

Correct.

So, I'm understanding that?

Yes.

Okay.

Perfect.

And then my second question is with respect to the additional seats on the aircraft, is there any way -- I know capacity's going to be flat, and so on.

But is there any way to say what the ASM impact is from just adding those seats?

Sure.

Sort of net of retirements.

I don't know what it is off the top of my head, but we can figure that out.

We can get it to you.

It's -- we can give you a full run rate when they're all in.

Then as you know, they're phasing in, so you get -- you don't get the full impact in year one.

So, we're -- if you give us a minute, we'll see if we can get you that number.

Otherwise, we'll just shoot it to you.

But -- and this somewhat ties into Bob McAdoo's question.

The available seat mile forecast is almost literally flat in 2012 compared to 2011 for the full year.

Right.

The trips, though, are down and they're down probably 3% plus.

Okay.

So it's everything that we've been discussing.

You get more seats per departure and you may get a little bit longer distance being flown on average as well.

But, it's really the additional seats that's making up that gap in trips and the aircraft fleet itself will be down seven units as we -- again, as we discussed -- by the end of the year.

Okay.

Looking here, it looks like it's about for the move to the Evolve interior for the aircraft that will be converted in 2012, it looks like it's about a 0.5 point-ish impact on capacity.

Okay.

That is so perfect.

Thank you so much for your help.

Have a nice day.

Dan McKenzie, Rodman & Renshaw.

A couple of questions here.

Southwest has done a lot of network restructuring and implemented a number of revenue initiatives over the past years but margins still remain pretty frustrated by the high fuel prices.

So I'm wondering, how willing would you be to take even more aggressive steps including shrinking the airline further to hit targeted returns?

I guess implicit in the question is, do you feel at least internally that based on the capacity plans that you have, that you can hit the targeted returns that you've outlined in the past?

Well, yes, I think it's -- I think I would agree with what I think you just said as a latter point.

I think in the end, I think any management worth its salt has to do what it's got to do and we're all obligated, we have a duty to manage our shareholder value here and to hit our returns on investment.

So there's some art in agreeing on what that target ought to be, but I think everyone generally agrees with our target of 15% on a pretax basis.

So we're determined to do that, Number One.

Number Two, I don't believe that the right way to achieve that is to shrink the fleet.

Mainly because we have so many opportunities.

If we don't like the way our assets are deployed today, we have a lot of opportunities to deploy them in a different way.

And I think that, that would -- strategically it would be a mistake.

It's very painful to down-size.

There is a cost associated from a goodwill perspective with customers, with employees, with downsizing, and so companies do that.

Some companies are forced to do that.

It's a tool that we have, if we find that we need it.

I think it is my least favorite tool.

The nice thing for us is that we're only in 72 cities right now and we are creating more capabilities to be able to serve even more markets very effectively.

So that's -- that is our plan and again, as you know, our orientation is to fix our fuel cost issue and our profitability challenge and then grow the airline, and do it in that way.

But, if we have to shrink, we have to shrink but that's certainly not in the cards right now, Dan.

Understood.

And then I guess going back to some of the market commentary, if I could focus on just one part of the country.

Atlanta stands out as the 11th largest city in the country but ranks first for capacity.

And nearby Charlotte ranks as the Number One growth market in the United States for capacity versus just four years ago.

So, relative to the rest of the country capacity at two nearby airports has not been particularly restructured versus just about every other larger market in the country.

I guess given that, I'm wondering what you can share about how that impacts your view of your fifth largest market or at least that part of the country.

Well, I'm not sure that I have anything new to add to the discussion.

We feel like -- and so does AirTran -- we feel like we can add value to the Atlanta discussion.

We can win customers in Atlanta.

We can take existing Southwest customers to Atlanta.

We can certainly significantly restructure the AirTran schedule and take advantage of the Southwest network, and that's what we're focused on doing.

We've had great success with that approach, especially here in Denver over the last five years, and we're the low cost guy.

We're the low fare leader.

We're going to -- we'll be something different in the market.

I think the market is embracing that and we're certainly excited with what we heard so far.

Charlotte, I don't have a whole lot to offer.

There is a presence there by AirTran, which means by definition that we'll give it a good, hard look and we have not announced what our plans are one way or the other with Charlotte yet.

So it's a little premature for me to address that.

But Atlanta, we've been very open.

You can't really acquire AirTran without having some idea about what you're going to do in Atlanta.

We've shared that and we're about to get started.

(Operator Instructions) Duane Pfennigwerth, Evercore Partners.

Wondering if you can talk about your overlap with American on a markets basis?

Well, we can.

What percent of your network overlaps with American capacity?

It's sort of a direct and indirect question.

If you look at it on an indirect basis, a lot.

There is a lot of overlap in Dallas.

There's a lot of overlap in Chicago, even though it's not the same airport.

We have a lot of overlap with them in California.

They have a large presence in New York.

So we don't, but those are the big hitters.

I guess South Florida, as well.

So there's plenty of overlap.

There's plenty of opportunities to gain some share if they shrink.

They have made dramatic changes to their route structure over the last 20 years and Southwest has picked up a whole lot of business.

So, you know what is under way at Dallas Love Field.

We're completely reconstructing the terminal.

The Wright Amendment, of course, restrictions drop in 2014, which will allow for a more fair competition out of the north Texas area too.

So, there's some things happening there.

But I don't have a ready percentage.

I don't know if you remember --

I do.

Duane, if you look at the direct and indirect, where you count Dallas and Chicago as common markets, we -- it's about a 35% overlap with our capacity.

Okay.

Thanks.

That's helpful.

And then just do you have total capacity trends in your markets and then competing capacity trends in the fourth quarter and into the first quarter here?

I do have that.

Let me get it real quick.

Okay.

So, if we look at first quarter, the total seats in our direct markets are expected to be down about 3%.

If you look at direct and indirect, it's the same number, down 3%.

That compares to fourth quarter where competitors seats were down 2.6% in our direct markets and down 2.3% when you include indirect.

So, a slightly better comparison in 1Q versus 4Q.

Great.

Thanks for that detail.

At this time, ladies and gentlemen, I'd like to turn the call back over to Ms.

Brand for any additional or closing remarks.

Thanks, Tom and thanks everyone for joining us.

Of course as always if you have any follow-up questions Ryan and I are available and hope everyone has a great day.

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

I'd like to first introduce Ms Ginger Hardage, Senior Vice President of Culture and Communications.

Great, thank you, Tom.

We know that everyone's ready to now ask questions of Bob, Gary and Laura.

So, if you wouldn't mind just giving us the routine on how they queue up for calls and we'll get that portion started right now.

(Operator Instructions) Mary Schlangenstein, Bloomberg News.

I had just a couple of quick questions.

Laura, I wanted to ask you, I think you talked about an annual hedging spend limit.

Was that right or did I misunderstand that?

Yes, what I mentioned was, prospectively as we get to what we call clean sheet years, it's our goal to have annual hedging premiums under $100 million.

Great.

And the second question was -- Gary, when you were talking about increasing productivity and eliminating waste, and you mentioned potentially looking at some later flights in the day, is there any potential that you guys would start doing some stuff overnight or were you just talking about maybe more flights towards the end of your current day?

Let me let Bob answer that one.

Well Mary, over the last few years as we've pruned out the unproductive flying in the schedule, a lot of that is really early in the day and really late in the day kind of flying for the most part.

We have flights, you've heard this before -- that we just weren't covering our fuel costs, for example.

As we've really worked the network and as hopefully, we get some economic improvement here in 2012, it does look like there's a chance to begin to stretch the day back out just a bit, add some flying towards the end of the day and the beginning that we may have pruned out over time.

I'm not talking about going back to 2007 or 2008, but it does look like we've got opportunities to stretch the day back out just a bit.

The second thing, you asked about the overnight or red-eye flying, one of the things that AirTran -- that we can learn from AirTran is they actually did a fair amount of red-eye flying.

Some of that, actually pretty profitable.

So, the schedules that are in place out through August of this year, we have actually maintained a lot of that red-eye flying in the AirTran schedule and are considering some of that for the combined schedules as we move forward.

It's nothing dramatic.

We're talking about 10 to 15 flights, not 50 or 75.

But I don't think we've concluded it, so I would not rule out some modest red-eye flying added to the mix.

But again, it's a fairly small number of flights and it would make a pretty small dent in our overall utilization and capacity.

Okay.

And when you talk about just adding some back a little bit later in the day that you had pruned back, so are you talking about flights that generally wind up around 10 o'clock?

Oh no, we're talking about --

Later than that?

-- flights that are generally earlier than that.

This is sort of -- and again, it's market by market but a lot of this, we've actually pulled out 8 o'clock, 8.30, 9 o'clock flights that just weren't enough in the heart of the day so it really is market by market.

But you look at your markets that are strong, that can support additional frequencies and the planes are used up in the middle of the day so their frequency would have to be added later, maybe 8 o'clock versus 5 o'clock.

So we just go market by market.

But we are looking at some modest add-backs.

Kelly Yamanouchi, The Atlanta Journal Constitution.

I'm wondering for your Southwest service launch here in Atlanta, how are bookings looking?

What are the load factors like in your mix of premium versus discount passengers for the Southwest branded service here?

Well, the former we can give you a little insight on.

The latter, we -- you can't.

I'll at least speak to that.

The bookings look normal.

And we, with all new markets, we monitor them very closely and we use reference markets to get some idea and it's pretty typical for a new city.

We have some that are ahead of what you would think, some that are behind what you would think, but overall it looks fine.

At this stage with advanced bookings, these are all going to be leisure customers for the most part.

They could be business customers who are willing to commit to advanced purchase restrictions, but you can't really get any kind of a read based on the booking as to what the purpose of the trip is.

So, we don't know.

But they're all discount tickets right now.

I see.

The only other thing Kelly, I would mention to you that when we start a month, we probably have 0.5 of the bookings in place for the whole system for that month.

So a lot has to happen the week of travel and it appears to me that Atlanta's not going to be any different in that regard.

The only other thing I would say is that just the nature of the itineraries that are being booked, we tend to be a point-to-point or a nonstop airline, and the bookings suggest that as well.

So, it looks very normal for a Southwest city opening.

Great.

And then wondering what kind of competitive response you've seen from Delta and whether that's better or worse than you expected.

Well, they're one of the largest airlines in the world and with their Number One market that they serve.

And so I would expect them to be vigorous competitors, and we thrive on competition.

(Operator Instructions) David Koenig, the Associated Press.

You've talked about first quarter demand but I didn't hear you break it out between leisure and business travel demand.

I know it's early.

Is there anything you could say there even about the first 18, 19 days of the month?

David, we didn't speak to that.

But just talking about what we've seen so far, business travel looks very stable.

I don't see it going up or down in terms of the fourth quarter performance.

It does feel like we are still lagging 2007, so pre-recession levels with respect to business travel.

As we've been saying, it has a very healthy performance.

The traffic demand looked really good.

A lot of the changes that we've made seemed to be working well and in particular the All-New Rapid Rewards program.

So all indications are that business travel is holding up quite nicely.

But I don't think we can give you any more insight than that about January.

I would be surprised based on the overall trends to see any fundamental change in that in January, but I think the honest answer is, we don't really have any insight into that yet.

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

Great.

Well, thank you all so much for calling in today.

If you think of additional questions as your stories develop, you know that we stand by and we'll be ready to get those answers for you.

That number is 214-792-4847.

Thank you so much for being on the call today and hope everyone has a great day.

This does conclude today's conference call.

Thank you for joining.