西南航空 (LUV) 2014 Q1 法說會逐字稿

Welcome to the Southwest Airlines first quarter 2014 conference call.

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

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

At this time, I'd like to turn the call over to Ms. Marcy Brand, Senior Director of Investor Relations.

Please go ahead, ma'am.

Thank you, Tom.

Good morning, everyone, and welcome to today's call to discuss our first quarter results.

Joining me on the call is Gary Kelly, our Chairman, President, and CEO; Tammy Romo, Senior Vice President, Finance and CFO; Bob Jordan, Executive Vice President and Chief Commercial Officer, and President of AirTran Airways; and Mike Van de Ven, Executive Vice President and Chief Operating Officer.

We will begin with opening remarks from Gary followed by Tammy providing a review of our results and our current outlook.

We will move to the Q&A portion of the call following Tammy's remarks.

Please be advised that today's 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.

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

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

Thank you, Marcy, and good morning, everyone, and thank you for joining us.

Our first quarter results, $126 million, were excellent.

I'm very pleased.

I'm very happy for all of our Southwest people.

They have worked very hard to get us to this point and I am delighted to see them rewarded for their efforts.

Demand was very strong and very steady and resilient, you might say, considering the extreme weather and all the flight cancellations.

But I'm very grateful to our customers for hanging in there with us, as well.

The bad weather definitely cost us, but we still managed to stay on plan.

Fuel prices continued to be stable, with some help from our fuel hedging program, and currently we expect fuel price stability to continue with modest hedging protection, at least for 2014 at about 20% coverage.

I'm very pleased with the progress on our five strategic initiatives.

Starting at the top, all new Rapid Rewards is, of course, up and running and very smoothly.

And, in my opinion, our folks are delivering the best frequent flyer plan in the business and it is exceeding our expectations.

Next is the 737-800, we're now up to 54 units in the fleet.

It's delivering high load factors, very strong revenues, and, of course, lower unit costs, so very pleased with that initiative.

Third is the rest of our fleet modernization.

It's very much on track.

The Evolve seating retrofits were completed last year, and those aircraft are also delivering the added revenues at a lower unit cost.

The AirTran 717 retirements are underway, gradually being replaced by 737s in Southwest.

This too significantly boosts revenue per trip for the -- really the same, if not lower cost per trip.

And then finally, we're continuing the accelerated retirement of the 737 classics.

All combined, these fleet activities are providing a boost to our fuel efficiency gains, as well.

Next, we completed the first phase of our reservation system replacement with the on-time launch of our new international reservation system.

That was done on January 27.

And even more satisfactory, it's performed flawlessly.

And finally, the last year of the AirTran integration is right on track.

Aircraft are being transitioned out of AirTran and effectively into Southwest.

Flight crews and dispatchers are transferring into Southwest at the same rate.

Published flights are rapidly coming down in the AirTran brand and coming up in Southwest Airlines.

The commercial aspect of the integration will be done by year end, and we'll have some wind down activities that will spill into 2015, but all those should be invisible to customers.

We'll launch more flights from LaGuardia, Reagan, and Love Field as planned.

LaGuardia and Reagan slots, of course, are resulting from the AA divestitures, and then Love Field expansion is due to the repeal of the Wright amendment.

And then next year, we'll launch more international flights out of our new international terminal that's under construction at Houston Hobby.

So a lot of things going on in 2014 and they're clicking right along.

We're working on our 2015 plans.

We have a desire to grow modestly next year based on the results that we expect for 2014.

We're on track to achieve our return on invested capital target for 2014, and, of course, as usual that assumes no change in economic, fuel price, or cost trends.

But assuming we keep the fleet flat next year, our roughly 695 aircraft, given the large number of out-of-service airplanes that are coming back into service in 2015, in addition to the up-gauging effect of trading out 717s for 737s, as well as adding 737-800s, that would increase our seat capacity next year in the 2% to 3% range.

But until we report otherwise, you should continue to assume a flat fleet for 2015 and that will allow for meaningful growth.

Our balance sheet is in superb shape.

It should strengthen this year as we continue to produce strong cash flow and pay down debt.

At the same time, we've continued to reward our shareholders with share repurchases and increased dividends, and our liquidity is exceptionally strong supporting these balance sheet moves.

So in short, a great quarter, and especially considering the weather, the integration drags that continue, and the high percentage of developing markets.

So I'm very, very pleased to be here with you all this morning, and now I want to turn it over to Tammy Romo, our CFO.

All right, thank you, Gary, and thanks to everyone for joining us today.

I'll begin with a quick summary of our overall results and then I'll jump into the revenue and cost trends.

As Gary said, our first quarter net income, excluding special items, was a record $126 million, which was $0.18 per diluted share, and that exceeded First Call consensus of $0.16.

This was a significant improvement over our first quarter last year's $53 million, which was driven by improved performance each month of the quarter, especially March, which was a record profit performance.

Our first quarter GAAP net income was also a record at $152 million.

Operating income, excluding special items, also set a first quarter record of $242 million, which was a stellar performance, especially considering the estimated $50 million reduction resulting from the winter storms.

Our pre-tax return on invested capital, excluding special items, for the 12 months ended first quarter was 14.2%, which on an after-tax basis was 8.9%, which exceeded our average cost of capital.

These are superb results and I am grateful to our Southwest and AirTran warriors for their outstanding efforts, especially during this year's challenging weather.

We are close to our 15% pre-tax ROIC goal and we plan to hit it this year, although, of course, it's always difficult to predict the economy and fuel prices, but we will continue to exert every effort to hit it.

Our record first quarter operating revenues increased 2% year-over-year to $4.2 billion on a 1% decrease year-over-year in ASMs.

Solid load factors across all haul links and healthy contributions from our revenue products contributed to our very strong first quarter revenues.

In addition, our strategic initiatives remain on track and continue to contribute significantly to our profitability.

Both operating and passenger unit revenues were record first quarter performances.

Our first quarter business travel trends were also strong with double-digit increases in corporate sales.

Our passenger unit revenues grew 3.5% year-over-year, which included about 1 point benefit from significant winter storm cancellations that reduced revenues by about $45 million but on 1.7% fewer ASMs.

January and February PRASM were each up over 5% followed by a 1% increase year-over-year in March PRASM.

This was an outstanding performance, especially considering 2 point year-over-year unit revenue headwind from increased seat gauge and (technical difficulty), which, of course, has a greater unit cost benefit.

In addition, nearly 20% of our first quarter ASMs were under development.

Our revenue strength has continued thus far into April, of course, benefiting from the Easter and Passover holiday shift, and based on current bookings and revenue trends thus far, we expect April PRASM to be up year-over-year in the 6% to 7% range.

Keep in mind, April also benefits from easier year-over-year comps compared to May and June.

Bookings for May and June are also currently solid.

And just one other consideration.

The July 4 holiday that falls on a Friday versus Thursday last year, which could impact June travel.

Let's turn to freight and other revenues, and our freight revenues grew 2.6% year-over-year as we continue to expand our award-winning cargo service with the integration of our AirTran network.

And other revenues declined year-over-year, as expected, largely due to the decrease in ancillary AirTran fees from a reduction in AirTran capacity, all as planned.

Ancillary revenues on Southwest, however, did experience strength which was driven by EarlyBird and our A1 through A15 select boarding, as well as pet fees.

We currently expect second quarter other revenues to also decline year-over-year, likely at a greater rate than experienced in first quarter, again, due to the ongoing conversion of the AirTran network.

I'll turn to fuel now.

Our first quarter 2014 economic fuel price per gallon including fuel taxes was $3.08 per gallon, which was in line with our expectations, and this was 6% below first quarter last year's $3.29 per gallon and that was largely driven by favorable swing in jet [juice.] We also had a $0.06 hedging gain for the quarter and Brent also declined year-over-year, but that was partially offset by an increase in crack spread.

Our first quarter results also benefited from better fuel efficiency as a result of our fleet modernization and other fuel conservation efforts.

Our first quarter fuel burn improved by about 1% year-over-year and that also reduced our fuel cost by roughly $15 million.

In our ongoing commitment to the environment, we recently operated our first flight utilizing our Boeing 737-800 equipped with our scimitar winglets, and we are expecting annual fuel savings of approximately 5% to 5.5% per aircraft.

Our hedging premiums, including below the line in other expenses, were $17 million in first quarter and we are currently expecting a similar amount in the second quarter.

Our second quarter fuel consumption is -- we've got a modest hedge in place of about 15%, and that's at varying crude oil positions.

And based on our market prices, and this is as of April 21, and our current hedge position, our current second quarter 2014 economic fuel price is forecasted to be comparable to second quarter last year's $3.06 per gallon.

Excluding fuel, profit sharing and special items, our first quarter unit costs increased about 3.5% year-over-year, and approximately 3 points of that year-over-year unit increase related to winter storms during the first quarter.

This better than expected cost performance was primarily due to favorable airport settlements that were not anticipated, and our operating costs also benefited from lower advertising and technology spend for the quarter that have been reallocated to later in the year.

So based on current cost trends, we expect second quarter unit costs, excluding fuel, special items and profit sharing to increase year-over-year in the 2% to 3% range.

And for the full year 2014, we are also expecting a 2% to 3% year-over-year increase in our unit cost excluding fuel, special items and profit sharing.

Turning to the balance sheet and cash flow.

We ended first quarter 2014 with $3.5 billion in cash and short-term investments which included $10 million in collateral held from third parties.

We had very healthy free cash flow for the first quarter.

It was $712 million, which supported our ability to return $371 million to our shareholders through repurchasing of $315 million of stock and distributing $56 million in dividends.

The repurchase of shares included a $200 million accelerated stock repurchase program that was executed on February 24 at which time we received 7 million shares, representing 75% of what we anticipated receiving under the program.

The program will be completed by May 9, at which time, if needed, we'll settle in either cash or shares.

We have $20 million remaining under our $1.5 billion share repurchase authorization which we intend to complete this quarter.

Since the initial buyback authorization in August 2011, and including our quarterly dividend payments, we've returned a meaningful $1.6 billion to our shareholders, which demonstrates our long-term standing commitment to return value to our shareholders.

We made $46 million of debt payments during the first quarter and as a reminder, we have approximately $500 million in debt and capital lease scheduled payments for the remainder of the year.

Our leverage, including off-balance sheet aircraft leases, was 38% as of March 31.

Our 2014 capital spending forecast is approximately $1.8 billion, and that does include the cost of the DCA slots.

And about $1 billion to $1.1 billion of our total CapEx relates to firm aircraft spend.

With this manageable level of capital spend, our cash flow outlook remains strong.

And we also remain steadfast in our commitment to manage invested capital which we've reduced by $1.1 billion since 2012.

Our balance sheet is investment grade and it is always a priority for us to keep that strong.

Before I close, I will spend just a few minutes on our fleet.

As you saw in the press release, we provided the detail in the text of the press release, but to recap, our full year 2014 fleet plans, we have 33 firm orders for Dash 800s from Boeing and plan to add at least 14 pre-owned Dash 700s.

We removed 22 717s from service in 2013, and the remaining 66 717s will be removed from service by the end of the year, even though there will be some transitioning to Delta in 2015.

As of the end of the first quarter, we have transitioned 24 717s to Delta.

In addition, thus far we have transitioned 21 of the 52 AirTran Dash 700s to Southwest, which leaves 31 Dash 700 aircraft remaining that we plan to transition before the end of this year.

And as Gary mentioned, we have significant amount of activity we are managing this year as we wind down the AirTran brand and phase out the AirTran 717 fleet.

But at a high level, we've been managing to a relatively flat fleet through the end of 2015, give or take a few aircraft, with a baseline of roughly 695 aircraft which was our combined fleet at the time of the AirTran acquisition.

Our flight schedule is currently published through October 31 of this year, and we will hold to our plan to maintain flat year-over-year ASMs for 2014.

We haven't set our fleet, our capacity plans for 2015.

So while it's premature to give an ASM forecast for 2015,year-over-year growth in seats will be 2% to 3%, and this, of course, will have significant unit cost benefit as we anticipated.

And, of course, we've got exciting growth opportunities ahead such as Love Field and Houston Hobby International flying in 2015.

Our commercial team has done an excellent job to date of optimizing our network and our operations team is doing a superb job managing a significant amount of conversion activity.

In summary, we have not set our 2015 plans, but we have options to flex capacity up or down as needed, and our classic retirement plan was built to provide flexibility, and we can also augment our fleet needs through the pre-owned market.

As we manage the integration work and removal of the 717s, we will augment the firm orders in pre-owned aircraft.

We may augment that beyond what we had disclosed in our press release, but, again, all with the intention to manage to a flat fleet of 695 aircraft.

All of this has been contemplated in our CapEx guidance of $1.8 billion for 2014, and our 2015 CapEx is expected to fall below 2014, with a flat fleet of 695 aircraft in mind.

We have very exciting network opportunities and we will manage with a continued focus on achieving and sustaining adequate returns on capital.

In closing, we had a very strong first quarter 2014 performance and second quarter trends support continued momentum.

Our strategic plan is coming together very nicely, and we're recognizing substantial benefits from our initiatives and investments.

We continue to have a disciplined growth strategy with flat year-over-year ASM capacity in 2014, and at least 2% to 3% seat growth in 2015.

We expect healthy free cash flows this year with manageable CapEx and debt obligations in 2014 and 2015, and we have an investment grade balance sheet.

We continue to return significant value to our shareholders through share repurchases, dividends and healthy earnings, and our 15% ROIC goal remains unchanged.

We are close to the goal and, as I said earlier, we will continue to exert ourselves to hit that.

And so with that, Tom, we're ready to take questions.

Thank you.

(Operator Instructions)

(music playing) Thank you for waiting.

We'll now begin with our first question from Michael Linenberg with Deutsche Bank.

Yes, hey, Tammy, I think you had talked about most of the AirTran [res], I think Gary had mentioned, by year end that the commercial side will have been wound down.

What's the carrying cost?

Like, I can go onto the website and there's an AirTran website and I can call up and presumably I'm speaking with an AirTran res employee, even though they are a Southwest employee.

What's that additional carrying cost that essentially goes away?

Is it $30 million, $40 million a year?

What's the number?

How do we think about that?

Just to make sure I'm tracking your question, Mike, you're asking what kind of inefficiencies do we have as we wind down the AirTran brand?

Yes, the cost of just supporting a separate brand.

I don't know if there's still any billboards left, but the signage, there's obviously to maintain it, there's got to be some cost associated with it that presumably will go away.

Yes, no, there's -- I agree with you.

We certainly -- there are some inefficiencies as we maintain two brands, and just the fact that we just from a scheduling perspective and a crewing perspective, especially given that we don't have a stable -- we've been managing our schedule through this integration, I agree with you, there should be some opportunities for improvement next year.

We'll start to work on our plan here for 2015 very soon, but I would anticipate that there would be some efficiencies that we'll be able to gain next year.

We haven't put a figure to it yet but, yes, we'll certainly work to wring out any efficiencies that we can.

And, of course, our unit costs will also benefit from the up-gauging in our fleet modernization efforts, as well.

Mike, the only thing that I would add to that really perfect answer is that most of the obvious stuff is gone.

So in other words, the way you were describing it, I don't think there are any material inefficiencies there by having a dual brand because our marketing folks are managing to one marketing budget.

So you might say that the AirTran brand -- in other words, it's possible that the AirTran brand could be a bit under supported, but in any event, I think there are definitely inefficiencies in the scheduling of two separate fleets that Tammy was referring to, and those, I think, we've at least described qualitatively, but I don't think we have put a number to that yet.

But most of the obvious stuff is gone.

We don't have two headquarters.

We don't have two -- we don't have anything like two headquarters departments operating.

It is all consolidated into Southwest.

So it's really the inefficiency of having two operating companies, I think, is where the big opportunity here.

Mike, I'll give you one example of an inefficiency.

Just as we're going through the transition with the implementation of a new reservation system as an example.

Right now we are maintaining three reservation systems, and, of course, with the goal to ultimately get to one.

So we do have some of those inefficiencies that we'll continue to work through.

So it's those types of ideas that we'll need to (technical difficulty) are opportunities that we'll need to continue to work as we plan for 2015 and even into 2016.

Okay.

Great.

Then just my second question, you talked about the higher CapEx number due to the purchase of the slots.

Have you called out what that number is, what you paid for the slots?

And then, sort of along those lines, I know that you're interested, obviously, in the Dallas Love Field gates.

Are there other American/US Airways gates around their system that you'd be interested in or is it just Love Field?

Well, I'll let Tammy speak to the slots.

I believe that's confidential, so we have not disclosed that.

Okay.

But the Love Field gates are, obviously -- there's only two of them, so it's a rather modest opportunity there, but in any event at this point we don't have any other interest.

Okay.

Mike, and the slots are confidential and we have not disclosed that.

Okay.

Very good then.

Thank you.

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

Hey, good afternoon, guys.

Just on the seat growth in 2015, I know it's still very early stages, but I was wondering how much of that might be domestic versus international?

Well, international, Savi, is so small.

It's only 1% of our total capacity right now.

The international opportunity that I highlighted that you're aware of out Houston Hobby is fourth quarter.

So it's not going to have a material capacity impact on 2015.

Bob, thinking out loud, I think the vast majority is going to be domestic and probably oriented towards -- what we've already announced is our plans to expand at Dallas Love Field, so all of that will be domestic.

So it will be heavily weighted towards domestic.

Yes, I would agree.

It's really Dallas, and it's really the investment in the DCA slot flying and the LaGuardia slot flying that carries them into 2015.

And, as Gary said, our international business is a very small percent of the total already.

So even Houston on that for part of the year, it's a small percent of a small percent.

It's really the domestic.

Let me just repeat again that we're only published through October.

So these aren't committed plans that Bob and I are sharing with you.

That's just our -- assuming that the fleet is flat and assuming you see that kind of seat growth, that is what I would assume the split would be with those markets.

But we could decide, just to be fair to your question, we could decide between now and whenever we publish the second half schedule that we want to put more capacity next year internationally.

To me, that's what is assumed with that flat fleet.

Understood.

And then, just the National flights that you're switching from AirTran to Southwest, I know AirTran has some ancillary like baggage fees and all those fees.

Are you able to capture that through higher fares on these international flights, or is maybe introducing bag fees on just international something would you consider?

I think the answer to your first question is yes.

You just look at the continued unit revenue growth and that includes bringing down the AirTran brand and bringing those flights up at Southwest.

And there is no thought to confusing the brand by offering bag fees on certain flights like international, no.

All right.

Just if I might squeeze one last one related to this, just so 1% of ASMs today, how much and how fast could that increase, do you think, over the next few years, (technical difficulty) [international]?

Well, again, I think it's premature.

First of all, we want to grow but we're cautious.

The first priority here is to hit and then sustain our return on capital, so I think that's really premature.

But I think it's going to continue to be a relatively modest component of the Southwest route system for the near future, for over the next several years.

All right.

Great.

That's very helpful.

Thank you so much.

We'll take our next question from Glenn Engel with Bank of America.

Good afternoon.

Two questions on labor.

Hey, Gary.

Hey, Tammy.

One is, when I looked at the departures they were (technical difficulty) [down] 5.9% in the quarter yet headcount was down only 1.4%.

Why aren't we seeing -- it seems like your productivity, at least on a departure basis, got worse.

And then, two, can you go over the profit sharing calculation and how we should do that going forward and whether current integration charges are now starting to flow through the profit sharing line?

Yes, Glenn.

I think on just your question on trips relative to headcount, we, obviously, had a lot of inefficiency just due to -- I would attribute that largely to the weather.

On the profit sharing, again, our profit sharing was $29 million for the quarter, and that was reduced by $6 million related to acquisition and integration costs, half of which were incurred in first quarter 2014 and the other half related to integration costs incurred from April 2011 through December 23, which was in accordance with our profit sharing plan.

The integration costs for that deferral period totaled about $385 million.

And that will result, and this is probably what you need, Glenn, that will result in $58 million of lower profit sharing expense to be recorded January 2014 through December 2018, and $3 million of which lowered first quarter 2014 profit sharing expense.

And additional integration costs, do those now impact profit sharing or are those also --?

Those just flow right through like you normally would.

We're past our cut-off period, so, yes, those would just flow through the profit sharing calculation as normal.

Glenn, on your headcount productivity question, the other thing, and, of course, I know you know all this, but you can't just use trips as the only proxy for the headcount.

So the available seat miles are probably a better proxy for the flight crews.

And then the trips are also getting -- some of them are getting more flight attendants per trip, as an example.

So there's a -- while, yes, the trips are down, and that does provide some relief for some work groups, it is certainly not all.

Thank you.

And we'll take our next question from Hunter Keay with Wolfe Research.

Hey, thank you.

So, Tammy, about a year ago you said you guys were going to tighten some flexibility around some of your most restricted fares and you said it was going to be done later in 2013.

I'm kind of curious to know what you did, what you found out, and if it was successful or not, and if there's anything you can do going forward on that?

Yes, Hunter.

What we did recently is we did tighten restrictions on our want-to-get-away fares.

That's just essentially -- it's just a no-show, I would consider that really more of a no-show penalty, and it's essentially if you don't call and cancel your flight, those funds would be forfeited.

Okay.

You were specifically referring to the no-show policy?

That's correct.

That's exactly what I was referring to.

Thank you.

And can we talk about sort of the relationship between advertising expense and distribution strategy?

You guys spend about $200-plus million a year on advertising, which is a lot, and I understand that because you need people to go to southwest.com to buy your tickets.

But have you thought about that in the context of maybe putting some more of your inventory on online travel agencies that would give you more exposure that way, and maybe alleviate some of the expense on the advertising side that you would have to get in peoples' minds to go to southwest.com.

If they just go to Expedia and see your fare there maybe you could spend a little bit less on advertising while sort of tweaking the distribution strategy a little bit.

Any thoughts on the relationship between those two?

Hunter, I guess I'll comment and then see if Gary or Bob have anything to add.

But in terms of, usually the onlines as you know, those are usually customers looking for discount fares and we have no issue with that on southwest.com.

We drive a lot of customers to southwest.com because they know that they can rely on us for low fares.

And just another, I think, interesting fact too is that once we started distributing AirTran fares on southwest.com, we quickly became their largest distribution channel.

So we're always looking at advertising and always looking for ways to spend those dollars more efficiently and we'll, obviously, continue to do that going forward.

But at this point, we don't have any major changes contemplated for our distribution strategy.

Yes, Hunter, this is Bob.

I'll add a couple more things.

Obviously, AirTran uses the OTAs, and to Tammy's point, we've seen no issue converting AirTran markets, flights, and customers to southwest.com.

In fact, those markets are converting and maturing at a rate that's better than a typical new market for Southwest.

So I really believe in our distribution strategy.

The other thing, really on the advertising, when you comp us to others you've got to think about total distribution cost.

So what you've got to add back are they're paying for DDS fees and bookings.

There's all kinds of costs that you have to look at in total as distribution in addition to just advertising.

And every time we look at that across all of our competitors we are in the lowest, whether you look at that on a per passenger basis or a per revenue generated basis.

So I'm very comfortable with where our costs are, if you look at total distribution costs which would include advertising.

But as Tammy said, we're always watching our advertising cost.

As an example, we're managing the combined AirTran and Southwest brand basically at the same level of advertising cost that was Southwest only prior.

So we're constantly looking for efficiencies there.

Yes, and we certainly have realized that, to Bob's point, but all that's been factored into the synergy numbers that we provided for AirTran.

That's interesting.

Okay.

Thank you very much.

And we'll take our next question from John Godyn with Morgan Stanley.

Hey, thank you for taking my question.

Gary, and Tammy, definitely appreciate the additional color on seat count growth next year.

Of course, some of that is sort of one-time in nature.

I'm curious if the team is willing to speak to a long-term ASM growth rate?

If we envision a world where you're hitting your 15% ROIC target, what would be like a steady-state Southwest growth rate?

Well, I think it's premature to say.

I think that's really not so much a strategic question as it is tactical.

This is a very tactical business and especially when it comes to growth and growth opportunities.

I think number one is you have to have a strong balance sheet.

Number two, you have to have confidence that your earnings will provide adequate returns, and then you have to be confident that you know how to manage growth.

So we've been a growth Company for most of our history, and I do feel like the Company has a lot of institutional knowledge about how to identify new markets and about how long it takes to develop them, and about how much should be exposed at any given point in time.

The other factor, of course, over a longer period of time that is key to your question is what are fuel prices going to be.

And then, secondly, what are our overall costs going to be, because that will mean everything about generating more passengers and traffic and share for Southwest Airlines.

So under the assumption that we continue to be, if not the low cost producer, darn near close to it, and maintain our low fare brand, and fuel prices remain stable over the next decade, I think we have significant opportunities to grow the fleet from here.

I wouldn't say that that's 10% per annum.

I think that that was, for this industry, and for our Company unwise.

So something in the low-single-digits makes sense in terms of a planning horizon.

But you are right to point out, John, that here in the meantime when you go from 2012 to 2013 to 2014 to 2015, there's a lot of noise from year-to-year.

And so once we get clear of 2015, that's something we'll be focused on and we'll want to manage our growth very carefully, and, again, with an eye towards keeping the balance sheet strong and hitting our return on capital.

That was very thorough.

Thank you.

The good part about the noise as you mentioned, Gary, in your prepared remarks is that it's going to improve the cost structure.

When we think about all the moving parts in 2015, and we think about sort of the seat utilization kind of popping back on the up-gauging from the dash 800s and the change in mix there, as well as perhaps even going back to Mike's question earlier on some of these AirTran expenses going away, it seems natural to think that we should see a deceleration meaningfully in the CASM, ex-fuel growth, perhaps even a flat to down trend given all these numbers.

I'm not sure if I've got the moving parts right.

Maybe I'm missing some risks outside of labor.

If you could just help me think through that directionally, that would be helpful?

Well, and, Tammy, you chime in, too.

John, you've been very thorough, as well, in your analysis.

That is all intuitive.

We have the same view that you do.

We've not finalized our plan yet and, therefore, we're just not ready to provide any guidance.

But if you think about the swap from the 717 to the 737, just to repeat what I said in my remarks, the costs are essentially the same.

They may even be lower to operate the same number of airplanes, yet you're getting 26 more seats on every single departure.

So when we talk about growth for Southwest next year, I'm not going to argue to you that it's free because it is true that we could choose to have fewer airplanes if we don't believe that we can generate that much traffic.

But you're right, the growth that we're talking about in the near term should come at a very modest cost relative to a normal view of a fully-allocated unit of growth.

So that certainly factors in somewhat to our thinking, but the bottom line is, we need to be comfortable that we can generate traffic to absorb the increase in seats that we are planning for next year.

So if we end up at growing seats 2.5% next year, then we need to be comfortable that we'll grow our traffic by 2.5%.

If we don't, then I don't think that we should be pursuing it.

Very helpful.

Thank you.

And we'll take our next question from Joe DeNardi with Stifel.

Hey, good afternoon.

So I guess my understanding, part of the reason you're keeping capacity flat this year is to facilitate ROIC improvement.

So does that imply simply that growing capacity is a negative for ROIC?

No, but I think it's just common sense that tells you that if your base business is not achieving your return target, why would you increase the base?

I think it's just that simple.

As a practical matter, the other thing that we keep reminding you and everyone about is the that there's just a lot of work going on.

So the aircraft movements out of Southwest/AirTran and into Southwest are going to be record numbers.

And then more Mike Van de Ven and our operating departments that creates record numbers of training events for employees.

So it's a lot of activity to manage.

If you then said now I want to grow by X-number of aircraft on top of that, I just think that that is unwise on its face.

So for several reasons we want to maintain relatively flat capacity in 2014.

But the main reason is, we haven't hit our 15% target yet.

I think we need to do that first and then make a judgment about whether that's sustainable with growth.

Okay.

Yes, that's helpful.

On the flexibility you have in terms of capacity for 2015, should I think about the driver there in terms of up or down, is that really going to be a function of the demand and pricing trends that you're seeing, or should I think of it more as you guys using that as a means of managing CASM growth?

I think it's demand.

Yes, clearly, what we're trying to do is optimize the network to match customer demand and I think our commercial team is doing a great job with the network and as evidenced by our first quarter results.

And, again, that's what I was trying to say earlier, which is if we're going to increase seats, we need to be comfortable that we will also increase customers.

It helps mitigate the risk to know that the growth is going to come online at a very attractive cost.

But that's not the reason to grow.

The reason to grow is because we believe we can increase the traffic and the revenues, and then it would, again, come hopefully at a very attractive cost to provide that service.

Okay.

Thank you.

We'll take our next question from Thomas Kim with Goldman Sachs.

Thanks.

Tammy, could I just ask you with regard to some cost items, can you provide a little more color on the maintenance side, because I think you had mentioned that there was a little bit of delay or deferral in Q1, should we assume that gets pushed into Q2, and if you could quantify that to some extent we would appreciate it?

Yes, our maintenance cost that we did have, they came in a little bit lower than expected for first quarter, just due to shifting, but all of that's been incorporated into the guidance that we gave you, so it's not material.

Okay.

And then just a minor point, but I'm curious as to what drove the 5% increase in other OpEx?

Part of that is weather.

If you look at our increase, the 3.5% CASM increase, unit cost increase excluding profit sharing and special items, most of that was attributable to weather for the quarter.

And we also had some shifting in our technology spend.

So some of that will get shifted out throughout the rest of the year, but, again, that's been incorporated into our 2% to 3% increase for the full year in that guidance.

Okay.

Thanks a lot.

We'll take our next question from David Fintzen with Barclays.

Hey, good afternoon, everyone.

Gary, can you remind me, we've been talking a lot about the 15% return target.

Can you remind me why it's 15%?

It's something that I just remember as long as I've been around, and I suspect it came in the 1990s when 15% probably meant something much bigger than it does today.

What I mean by that is 15% now as a return target, not dissimilar from your other large competitors and, frankly, it's lower than really the growth-oriented carriers.

When you start thinking about growth and return targets shouldn't that target really be much higher?

I don't have a problem in debating where the target should be.

I think it also depends on how fast one grows.

So if we don't grow, I think that the target probably should go up.

If we do grow, the main thing is, are we creating shareholder value or not.

And so it's a matter of art as to how much of a premium over our weighted average cost of capital we need to be earning.

You look at -- and, of course, you're expert at this -- so you look at broader indices or broader performance across industries, which we do, and feel like the 15% is an adequate return.

But that's something that we, obviously, would continue to consider and talk with our major shareholders about.

And so the other thing -- and you know the industry well -- that I would remind you is that there are very few -- there are no -- there are no airlines who have hit a 15% return on invested capital over a cycle except for Southwest Airlines.

And that is what we did in the 1970s.

That's what we did in the 1980s, that's what we did in the 1990s.

So that history alone would tell you that it is not a layup to hit that.

But in any event, Tammy already said that that's our target and the target has not changed.

Does that mean that it will forever be 15%?

No.

I don't think -- I wouldn't say it that way.

But certainly for 2014, we worked very hard for a decade to get to this point and are not going to be ashamed to turn in that kind of performance if that is the way it turns out.

Okay.

No, that helps.

That's helpful.

It just helps to kind of put the -- frame the debate around the fleet growth.

That's very helpful.

The other question, the question I actually intended to ask was, can you help us think a little about aircraft utilization, and maybe even broader, asset utilization kind of going forward?

Historically, you've run kind of [split] the assets.

It's a little more tactical business now in terms of keeping schedules in the meat of the day, the meat of the year, so-to-speak.

When we're thinking about aircraft utilization over time, should we be assuming that you don't go back to where maybe Southwest ran five, six, seven years ago?

Well, David, again, you know us well.

And you know this business very well.

The utilization, just as a quick refresher, has varied a little bit since we bought AirTran.

So AirTran as a unit has never been, I would say, efficiently scheduled.

So we've had a little bit of slop in there, and then, of course, we've had a lot of aircraft out of service in 2013 and now in 2014 going through various conversions, either Evolve seats or now converting airplanes out to Delta or converting them into Southwest, all the things that you know about.

So at least we can say that we are underutilized right now, and that the utilization will improve once we get clear of this integration work in 2015, and especially 2016.

So that we can agree to.

As to will the airlines schedule the way that it did before 2008 or 2009 where we had a lot of early morning flights, a lot of late evening flights, I don't think so.

And, again, I think we just all have to be open to the fact that things might change, but unless the demand reappears at that time of the day, and it is efficient to schedule an airplane on a marginal cost basis, I don't see that that flying will come back.

But you've got $100 crude oil, $110 crude oil today, compared to a time where it was $10 to $20 a barrel which made it more viable to operate flights on the shoulders with less than 50% load factors.

And that's just not the case today.

So as long as that case remains, then absolutely you'll see the flights scheduled in the meat of the day, and, Bob, we're probably at the highest percentage ever, aren't we, about 88%, 89%, 90% scheduled between 7 AM to 7 PM?

We are.

For five years now, we've cut those early and late flights, really just based on demand.

It's a flight-by-flight, market-by-market exercise.

And, yes, we've got more flights than ever where the demand is in the day.

So I think it's a great thing from a financial and flight performance perspective.

Yes, I would expect that -- I wouldn't expect that trend cutting early and late to continue at the pace it has over the past five years, so I think we're more stable now, but I don't see us going back.

For us, we've got opportunities to consider red eye flying and things like that, and that is something that Bob and Mike are thinking about, but we don't have any plans to make any material change in the way we're scheduling the fleet for any reason for that matter.

But that would be the one exception, perhaps, to the shoulder flying comments.

Okay.

No, that's all very helpful.

I appreciate the comments.

Thanks.

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

Hey, good afternoon, everybody.

Just a quick clarification for Tammy on non-passenger demand.

Did you say other revenue would decline[year-on-year a bit more than in Q1 or freight, mail and other?

It doesn't make a huge difference but I wanted to clarify.

I said other.

That's just, obviously, as we're moving AirTran flying over to Southwest that would be the ancillary revenues, and so we'll see -- that's just simply the remainder of the ancillary charges going away as we of move them over to the AirTran brand.

Got it.

And then -- oh, I'm sorry, were you adding something else?

Jamie, I was just going to clarify that at least on the freight side, since we haven't talked about freight, we are adding more and more markets.

Since AirTran did not previously carry freight, so I think we have decent opportunities to grow the freight revenue category.

But the other category that you asked about, that Tammy mentioned, yes, that will continue to decline.

Got it.

Got it.

And then, Gary, a question on the progress with the pilots.

The challenge that I'm facing is that your existing contract already appears to be among the industry's more, if not most, efficient.

And I certainly understand that the pilots like to see wages increase.

That makes perfectly good sense.

What's less clear is what management's [ask] might look like in terms of improved economics.

It's not like you need scope (technical difficulty) RJs or anything like that.

I know you don't want to negotiate in public, but are there any competitor contracts that you could point to and at least say, hey, airline X over there has some really interesting flexibility in the pilot contracts, something like that?

Well, Jamie, you're right, we are efficient.

But we have things that are tangible today that are under discussion that would give Southwest more flexibility and make Southwest more efficient.

So as good as we are, there are always things that can change, and as a matter of fact, there are absolutely some examples with competitors and, if you will permit me, I won't share who those are.

(Laughter)

In any event, absolutely there's always opportunities with every work group, always, to find ways to improve, and the nice thing is we're doing well.

We've got good news.

There are definitely some things that we can do for our people going forward, as well, and keep of Southwest strong and build (technical difficulty) well for all of our employees and that's a wonderful place to be.

Okay.

Excellent.

Thank you very much, Gary.

Thanks, Tammy.

Thank you.

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

Thank you, Tom.

And as always, if there are any follow-on questions, please feel free to call.

We appreciate you all joining today and have a great day.

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

I'd like to first introduce Ms. Linda Rutherford, Vice President of Communication and Outreach.

Thanks, Tom.

For the media folks on the call, if you've got a question, go ahead and, Tom, let them know how they can queue up for that.

Yes, ma'am.

(Operator Instructions)

(music playing) And thank you for waiting.

We will now begin with our first question from Terry Maxon with the Dallas Morning News.

Good afternoon.

Hi.

As you are probably aware, Virgin America has scheduled an event tomorrow to announce something about their Dallas operations.

Have you got a sense that the competition for those gates have been settled?

Have you gotten any word whether Virgin America is getting them or that you're out of the competition for them?

Terry, we are waiting patiently to see what the next step is in the process.

So as far as I am aware, we are still in the running for consideration.

Delta wants the city of Dallas to take control of the gates and make them common use gates.

Is that an acceptable alternative to Southwest, or do you believe one way or the other one airline should definitely get them?

Well, I think that sort of gets into the contractual aspect of the lease and nothing that I really want to comment on.

So I can understand why somebody would argue for that, but it's going to be up to the city of Dallas and its lease with American and their sublease rights to determine how to apply this.

So I'd rather not comment on that.

Thank you.

And we'll take our next question from Andrea Ahles with Fort Worth Star-Telegram.

Hi, good afternoon.

Terry asked part of my question which was about the Love Field gates, but I was wondering if you could also talk about how has demand (inaudible) [been for the new flights] since you released the schedule, have you had a lot of interest from people on the Love Field flights and what you might be doing there?

Are you considering other cities you might be adding in 2015 if you get those gates or if, as you sort of tinker with your schedule going forward at Love Field?

Well, Love Field is, of course, it's going to happen, so we've already pre-announced that we'll be selling more flights to more destinations sometime soon.

So we're not taking bookings yet, Andrea, as I think you know, on the 15 new nonstop destinations that we've announced.

That's a stay tuned.

I think Tammy mentioned already that our business out of Love Field is up significantly.

It's up double-digit this year even without the new flights yet.

So I don't know that we can quite explain that, other than just a great service that our Southwest warriors offer every day.

But, yes, our business at Love Field is good and we're looking forward to launching the new service here later this year.

Do you know when you're going to make those (inaudible) flights available for purchase?

I do know.

When would that be?

Linda, have we disclosed that yet?

We have not yet said that.

We haven't said that yet, so stay tuned.

All right, thank you, Gary.

And we have time for one more question.

We'll take our last question from Aaron Karp with Air Transport World.

Yes, you talked about how you think the international flying will be a relatively modest component for the next few years.

How much of a revenue enhancement do you think international will be near term, and are you looking at it primarily as a long-term growth opportunity?

Well, yes, over the long term I think it's a large opportunity.

We're thinking about it as North America.

I would throw in Hawaii and Alaska, just because it is so different than flying in the 48 states into that whole growth opportunity.

We serve 96 cities today with Southwest and AirTran, and have a potential to add 50 new destinations over some period of time, and that would be several hundreds worth of airplanes worth of flying.

So it's a very material opportunity, and as I mentioned earlier, growing the airline is in many ways tactical.

We've made the strategic investment to create the capability at Southwest to fly beyond the borders and to fly longer distances.

So that strategic decision is made and is in place.

Then where we decide to go within that geographic footprint, that will depend on a lot of factors.

But in any event, I would absolutely expect the 1% would grow as a percentage of our total.

At what rate, I'm not willing to predict yet.

Bob, I don't know if you have a number off the top of your head what the potential is.

I don't think it's going to be half of our business.

It's not going to be anything like that.

I'd be surprised if it was 25% of our business.

But it could probably be in the 10%, 15% range, don't you think?

Yes, I think so.

The domestic market is, obviously, much more mature.

The international markets that we're looking at, there's still a lot of room for development.

More room for competition, lot of higher fares.

Obviously, those would connect very well to our very mature domestic network, our very wide domestic network.

So I think there's a lot of opportunity there.

But it's a lot of opportunity on a relatively small base compared to the total.

So, yes, I would expect -- to Gary's numbers, sort of the high-single-digits, low-double-digits is where I feel like we could grow to.

But again, that growth rate, the growth potential on the current base is much larger simply because the base is so small today.

And, again, this all assumes 737 service, the geographic footprint is all of North America including the Caribbean, and actually the northern reaches of South America.

So it's a very exciting opportunity, 200 airplanes.

I didn't do the math in my head, but that would be about, not quite a third (technical difficulty) [increase] in the fleet.

So it's longer haul flying which takes longer and it is higher revenue.

So maybe our 10% to 15% estimate is low.

But we need to walk before we run here and we're excited and ready to get started.

Thank you.

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

Thank you, Tom.

If anybody has any follow-up, our members of the media can reach out to the folks in the communications department and have a wonderful afternoon.

Ladies and gentlemen, this does conclude today's conference.

We appreciate your participation.