西南航空 (LUV) 2014 Q2 法說會逐字稿

Good day, and welcome to the Southwest Airlines second-quarter 2014 conference call.

My name is Tom, and I'll 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.

And good morning, everyone.

Welcome to today's call to discuss our second-quarter results.

On the call today 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, President of AirTran Airways; and Ron Ricks, Executive Vice President, and Chief Legal and Regulatory Officer.

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

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

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

And, Gary, now I'll turn it over to you for opening remarks.

Thank you very much, Marcy.

And good morning, everyone, and thanks for joining us for our second-quarter 2014 earnings.

We're very pleased with the second-quarter performance.

I'd like to point out a list of things before Tammy takes us through the financial results.

First of all, I want to thank all of our employees for their hard work, for successfully transforming Southwest Airlines, for these stellar earnings results, and then for the historic year of 2014 that they're managing.

Second, the quarterly results include significant planned benefits from our all new Rapid Rewards program, the AirTran acquisition, and our fleet modernization.

We would not have these results without these initiatives.

Third, the network optimization over the last five years has paid off handsomely, supported, of course, by our strategic initiatives.

But we have significant market strength across our route network.

It is very impressive; it is very encouraging.

And while we have a very large percentage of the network under development -- almost 20% -- unlike a year ago, it's not a significant drag on our performance.

And we've got reason to believe that this segment will mature rapidly.

Fourth, the cost-control efforts, which is essentially our fleet modernization initiative, is working very well, producing fuel efficiency as well as non-fuel efficiencies.

Fifth, we have a number of large, non-routine programs and projects that are being managed.

Several will become final this year: international, the repeal of the Wright amendment, and the completion of the AirTran integration.

Let me just go through each of those very quickly.

First, we finished and launched international, right on schedule.

That is a very key milestone for wrapping up the AirTran integration.

There are probably thousands of people to thank for what has been a flawless effort to get international up and running for Southwest Airlines.

I am very grateful to them all, but in particular our technology department and their leadership on this project.

The repeal of the Wright amendment is now 88 days away.

The schedule is out for sale.

It is a superb schedule.

The airport construction is close to completion.

The airport is also looking superb.

And our marketing and advertising is in full swing, and it is superb.

We've got more surprises planned for the fall.

It will be a joyous celebration after 35 years of restrictions at Dallas Love Field.

And then, finally, we are right on track to move airplanes and people out of AirTran and into Southwest by year end, to convert the remaining airports and routes from AirTran to Southwest by year end, and then retire the AirTran brand and the few remaining Boeing 717s that we'll have by year end.

Of course, that's a lot of work that I just ticked through, and our people are doing a superb job of managing all of that.

Sixth, we are continuing to generate very strong cash flow, allowing us to reduce debt, reduce outstanding shares, and return value to shareholders, with LUV at a lifetime high.

We've got a $1-billion-plus share repurchase authorization to continue returning value to our shareholders, along with our quarterly dividend.

And that was just increased by 50% by our Board at our May meeting.

And then, finally, our third-quarter earnings outlook is strong.

That, of course, is at this point in time.

We'll continue to closely monitor our results and our outlook, the economy and fuel prices, as we now contemplate reasoned and measured available seat mile growth beginning in 2015.

And our immediate priority with growth is, of course, Dallas Love Field, number one; and then, secondly, Washington Reagan.

And that is as we begin to operate and fly the slots that we acquired from American earlier this year for Washington Reagan.

And our focus will be reliable, excellent operations, outstanding customer service, and consistent strong profits, which means a return on invested capital of at least 15%.

And, as planned, we've got tremendous growth opportunities that have been enabled beyond 2014.

And that really is a remarkable change since just 2010.

And all of that is a wonderful thing, but those opportunities will have to be prioritized, and they will have to be pursued in a manner that allows us to achieve our annual goals.

And, again, to repeat those, it is excellent, reliable operations; it is outstanding customer service, and consistent profits at our targeted ROIC of at least 15%.

So, Tammy, with that overview I'd like to turn it over to you.

And congratulations, Ms. Romo, on a wonderful quarter.

Thank you, Gary.

And thanks to everyone for joining us today.

As we reported, our second-quarter 2014 net income, excluding special items, was $495 million, or $0.70 per diluted share, which represents our fifth consecutive quarter of record profitability.

These are very strong results, and we are seeing significant benefits from our strategic initiatives.

Our profits were up 77%, with EPS up 84%, which is a significant year-over-year improvement.

And that was driven by strong revenues, lower fuel prices, and our ongoing cost-control efforts.

Our second-quarter GAAP net income was also a record $465 million.

Our operating income, excluding special items, also set a second-quarter record, and produced a stellar 16.3% operating margin.

And, of course, I'm delighted to say our pre-tax return on invested capital, excluding special items, for the 12 months ended June 30 was 17.1%, which, on an after-tax basis, was 10.7%, well exceeding our weighted average cost of capital.

This is a tremendous accomplishment that required much work and focus by all of our people.

And I congratulate and thank all of our outstanding employees for the strong financial results released this morning.

Our second-quarter revenue performance was very strong, and we broke many records.

Operating revenues increased to a record $5 billion, driven by record passenger revenues of $4.8 billion, which increased 8.5% year over year on relatively flat ASMs.

Strong demand for travel, both business and leisure, resulted in record traffic, passenger yields and load factors.

And, as Gary already said, our strategic initiatives also significantly contributed to our record second-quarter revenues.

I also want to mention that our second-quarter passenger revenues included $47 million related to a change to previously recorded estimates of tickets expected to spoil in the future.

But with or without this additional revenue, passenger unit revenues were very, very strong.

And, as we reported, PRASM grew 9% year over year, and that was supported by unit revenue strength across all regions and lengths of haul.

This was an outstanding performance, especially considering roughly 2-point year-over-year unit revenue headwinds from increased seat gauge and stage length, which, of course, had an even greater unit cost benefit.

As Gary already mentioned, we had close to 20% of our second-quarter ASMs under development, which is significantly higher than historical norms.

And our international and other developing markets, resulting in large part from the AirTran integration, are ramping up nicely, and performing in line with our expectations.

Strong revenue trends have continued thus far in the third quarter.

And based on current bookings and revenue trends, we expect July's PRASM to be up year over year roughly 3% over last July's strong performance.

And bookings for August and September are also good.

So, our revenue outlook for third quarter is quite good.

But keep in mind: Third-quarter year-over-year comparisons will be more challenging due to the strong prior-year trends.

Moving to freight and other revenues, freight revenues grew 2.3% year over year, as we continue to expand cargo service with the integration of our AirTran network.

And we currently expect third-quarter freight revenues to be comparable to second quarter.

And although we had solid gains in our ancillary products, other revenues declined year over year as expected, due to the decrease in fees, of course, as we wind down the AirTran flying.

And other ancillary revenues were also $58 million.

We currently expect other revenues in third quarter to also decline year over year, likely at a greater year-over-year rate than we experienced in second quarter.

And that's simply due to the ongoing conversion of the AirTran network.

Turning to cost, we had a solid performance, with operating cost comparable to second-quarter last year.

And on a unit basis, cost excluding special items increased only 1.2%.

In addition to the cost reductions from our strategic initiatives, we also benefited from lower fuel cost.

Our second-quarter economic fuel price per gallon was $3.02 per gallon, which reflected a $0.05 hedging gain.

And our fleet modernization and other fuel-conservation initiatives improved fuel burn by 1.4% year over year, which reduced our second-quarter fuel cost by approximately $20 million.

Our third-quarter fuel hedge consists of 10%.

It's 10% hedged at varying crude oil prices, and about 25% in Gulf Coast jet varying prices.

Based on market prices as of July 21, and our current hedge position, our third-quarter 2014 economic fuel price is forecast to be in the $2.95 to $3 range.

And our hedging premiums are estimated to be about $15 million in the third quarter.

Excluding special items, and fuel and oil expense, our unit costs were up 3.4%.

A significant portion of this increase was driven by record profit sharing of $127 million.

And when you exclude profit sharing, our unit cost increased just 1.7% year over year.

And this was slightly better than our 2% to 3% guidance on unit cost, primarily due to the shift of certain costs, such as advertising and training, to the second half of the year.

Based on current cost trends, we expect third-quarter unit costs, excluding fuel, special items and profit sharing, to increase year over year, similar to what we saw in the second quarter, which was a 1.7% year-over-year increase.

Turning to our very healthy balance sheet and cash flow, we ended second-quarter 2014 with $4 billion in cash and short-term investments, which included $105 million in collateral held from third parties.

Our free cash flow during the second quarter was a strong $838 million.

And year to date we have generated approximately $1.6 billion.

As a result of our strong free-cash-flow generation, we've returned $652 million to our shareholders through the repurchase of $555 million in stock and a distribution of $97 million in dividends for the first half of this year.

And since August 2011, our buyback authorization at that time, and including our quarterly dividend payments, we've returned a meaningful $1.9 billion to our shareholders.

In the second quarter, we repurchased $240 million in shares, and distributed $42 million in dividend payments, including our June payment, which represented our 151st consecutive quarterly dividend paid to shareholders in our history.

We have $780 million remaining under our $1-billion share repurchase authorization, which was announced in May, along with a 50% increase in our quarterly dividend.

And since the acquisition of AirTran, we've also reduced our debt and capital lease obligations net by a significant $1.5 billion, and intend to repay an additional $440 million in scheduled debt and capital lease payments for the second half of this year.

Our leverage, including off-balance-sheet aircraft leases, was 37% as of the end of June.

Our 2014 capital spending forecast remains at approximately $1.8 billion, with $1 billion to $1.1 billion of that related to firm aircraft spend.

And that brings me to the fleet, and I'll refer you to our press release for our second-quarter activity, but here is a quick recap of our full-year 2014 fleet plans.

We have 33 firm orders for 737-800s from Boeing, and plan to add at least 17 pre-owned 737-700s.

We've removed 41 of the AirTran 717s from service; the remaining 47 will be removed from service by the end of this year.

As of the end of the second quarter, we've transitioned 36 717s to Delta, and currently plan to transition 16 more this year.

In addition, thus far, we've transitioned 24 of the 52 AirTran -700s to Southwest, which leaves 28 -700 aircraft remaining that we plan to transition before the end of this year.

Our fleet plans still include managing to a relatively flat fleet through the end of 2015, with a baseline of roughly 695 aircraft, which, again, was our combined fleet at the time of the AirTran acquisition.

We expect our third-quarter 2014 ASMs to increase year over year approximately 2%, and full-year 2014 ASMs to be up under 1% year over year.

Again, for 2015, we expect our available seat miles to increase year over year, and that's driven by the 2% to 3% increase expected in seats from the updating of our fleet, along with the higher utilization of our fleet post-integration.

2015 ASMs are also expected to grow from a longer stage length on the new flights at Love Field, DCA, LaGuardia, and new international flying from Houston.

As we manage the integration work and removal of the 717s, and as previously guided, we plan to augment the firm orders in pre-owned aircraft beyond what we have disclosed in our press release.

So, really no new news there.

To close, we are delighted with our second-quarter earnings performance, which exceeded our expectations.

Our Southwest Warriors have worked very hard to execute our strategic initiatives and restore our financial performance.

And it's very gratifying to see how well it's all coming together here in 2014.

The benefits relating to the AirTran integration, our fleet modernization efforts, the -800s, and our new Rapid Rewards program are all meeting or exceeding expectations.

And the full replacement of our reservation system is off to a great start.

July 1 was a day of great pride here at Southwest, as we successfully launched international service to Aruba, Montego Bay and Jamaica, with our new international reservation system.

And the network opportunities that we have ahead are very exciting, and we will continue to focus on achieving and sustaining adequate returns on capital.

Our cash flow and balance sheet remain strong.

And we will continue our diligent efforts to provide adequate returns to our valued shareholders.

And, although we still have a few months to go before we can claim victory for full-year 2014, we are very well positioned to meet or exceed our 15% target with the exceptional results produced during the first half of the year.

And with that overview, Tom, we are ready to take questions.

(Operator Instructions)

Michael Linenberg with Deutsche Bank.

Yes, good afternoon, everyone.

Tammy, back on the aircraft, I think you said that you were going to be bringing on 17 used 737s.

Are those 700s or 800s, is that a mix?

It's 700s.

And is that all this year or into next year?

Yes, the 17 that I gave is all this year.

Okay, great.

And, then, when you talked about next year, just to clarify, the seat count is up 2% to 3%, but then you threw in 1 point about longer stage length.

So, if we think about it on a ASM basis it's going to be slightly higher than 2% to 3%?

Is that how we should think of it?

Yes, Mike, we haven't provided our full-year ASM outlook.

However, we will be publishing our first quarter 2015 schedule in the coming weeks, and at that we'll reflect about a 5% ASM growth year over year.

And, Mike, I know you'll remember this, we had 1.5 points of this growth is we're expecting that to be due to, as you'll recall first quarter this year we were impacted by the winter storms.

And, of course, as you would expect with the sunset of the Wright amendment we'll likely have a longer flying out of Love Field and also DCA and likely LaGuardia.

So, I think that accounts for the difference between the 2% to 3% increase in seats versus the 5% ASM growth that we're expecting in our schedule, which will take us through about March.

Again, Mike, the 5% that Tammy is talking about is the estimate for the first quarter.

Yes, very good.

That's helpful.

And then my second question, and this is either for Tammy, you, or even Gary.

When you look at the booking window for customers, business and leisure, historically you've been a lot shorter than the rest of the industry.

I think the rest of the industry, think it's 330 days plus or minus a few.

You've historically been, I don't know, maybe up to 200, 210.

As you move into the newer systems, you move on to the Amadeus Altea system, and as you start flying international where people tend to book those, especially on the leisure front, some of those tickets are booked much further in advance.

A trip to Jamaica or even down the road if you decide to fly to Hawaii, those are bigger decisions and they tend to have longer lead times.

Do we start to see your booking period extend?

Is that in the Offing?

Would that be part of moving onto this new Amadeus system?

Your thoughts on that.

I think there's really two aspects to answering your question.

One is just customer behavior.

You're right -- even if we don't change our 180 day -- and your rule of thumb there is right, it's about six months out.

Even if we don't change that, I suspect that we'll start seeing more bookings out farther on our booking curve.

Secondly, with the new reservation system that we're working on that won't be in place for 2015 -- and we haven't given a timeline for that yet, Tammy, I don't think -- we don't want to change our current reservation system capabilities.

It's not worth it.

So, it will be a year or more before we'll have the capabilities to realistically extend the bookings.

I think there's more to it than just adding the reservation system capability.

That's a long time to put a schedule out.

And, as you know, the rest of the industry goes in and makes changes to it, and we typically have not done that.

So, that would be somewhat of a policy/procedure change that we would need to think through, as well.

So, we agree with everything you said, that as we go longer and go more international that there will probably be more demand for bookings farther out.

And that's something that we'll have the capabilities in the future to choose to do or not.

I don't think we've made a firm commitment one way or the other.

Okay, very good.

Thanks guys.

Hunter Keay with Wolfe Research.

Hi, everybody.

Thank you very much.

How much of your cost advantage do you attribute to having a single fleet type now that you've acquired and are in the process of divesting 717s?

We know that we have a significant advantage just from a single fleet type.

From the 717s, really, the benefit of transitioning from 717s back to a 737 fleet is pretty significant.

Now, of course a lot of that is just driven by just the more fuel-efficient 737 fleet.

So, probably the best gauge I can give you, if your question is on really the 717s versus the 737, are really just the benefits that we provided in our fleet modernization efforts, which is the EBIT, we're expecting that to be in the $500 million range here for this year.

But, clearly, we have a clear advantage relative to the rest of the industry, and certainly a single fleet type is a contributor to that.

Our advantage, as I think you know, Hunter, relative to the legacy carriers, our cost advantage is probably 30% to 35%.

So, I don't have a specific figure to give you here off the top of my head but certainly it is a notable contributor to our low-cost advantage.

Okay, Tammy.

And as you think about obviously longer stage length next year, and the hesitancy to give ASM guidance on known seat count guidance, and as we think about the increased popularity of the Rapid Rewards program, are you getting pressure from some of your better customers to improve the number of redemption markets?

And one of those being Hawaii.

And I know you guys talked about expanding into Hawaii at your Analyst Day.

I think it was a couple years ago, almost, at this point.

But how has that thought process evolved?

And are the 800s coming ETOPS-certified that would enable that to take place next year?

I'm not sure I'm totally following your question.

With the Southwest route network we don't have any restrictions anywhere.

Every seat, every flight, obviously every destination has access online, and then you've got the opportunity to buy seats offline with our Rapid Rewards program.

I think our program's doing fantastic.

By all measures, it is better than the other program.

We've got record levels of membership and all the things that I know you know.

In terms of people being dissatisfied with how they can use their rewards on the Southwest system, no, we don't get that at all.

If we ever do choose to serve Hawaii I'm sure they will be delighted to have that.

But in the meantime we've got some wonderful Southwest destinations which, Hunter, one way or the other they're going to continue to get more attractive as we expand beyond the 48 states.

Mike Van De Ven does have some of the 800s equipped with ETOPS.

We have work to do to fly to Hawaii, which I doubt we'll be able to keep a secret.

So, you'll know when we've made that commitment when we decide that.

And it will take us not years from start to finish but it will take us some time to actually activate that.

Hawaii is one of 50 potential destinations that we now have created.

And it will just have to compete priority-wise with other great opportunities that we have.

I realize your question wasn't specifically about Hawaii.

The only thing that I noticed, Tammy, looking at the utilization of the awards, which was interesting to me, is that the growth we've seen in the award usage over the past five-plus years has actually taken place more in short-haul markets.

And in the old days our program was oriented towards rewarding people for flying short, and then they would use the award to fly long.

Interestingly enough, the growth in utilization is actually more in short-haul markets.

But I don't think we've got any complaints whatsoever at this point with our new program.

It's working very well.

Okay, thanks a lot.

John Godyn with Morgan Stanley.

Hi, thank you for taking my question.

Gary, I just wanted to follow up on the last thing that you just said -- 50 potential destinations out there that you've created.

Can you just walk us through the process here for how you're thinking about growth going forward?

We've heard other low-cost carriers talk about the rising price umbrella creating a lot of new growth opportunities.

I'm just curious big picture how you arrive at that number.

And it certainly sounds like you're now prospecting for new markets.

Again, we've been working on this, John, for years, so there's no surprise with where we are.

I think it is simply counting dots that have simply been created by adding the 737-800 and international capabilities, also propelled by the AirTran acquisition, that makes these potential destinations available to us.

They were not available to us in 2010, was the main point I was trying to illustrate.

We won't go add 50 dots to the route map next year.

The 50, as I'm describing it to you, they are all beyond the 48 states, so there's nothing new.

It's Hawaii, Alaska, Canada, the Caribbean, Mexico, Central America, and the northern part of South America.

Those are all within the performance capabilities of the 737.

And they all at least look sufficiently attractive when it comes to the traffic potential in filling up the 737s.

It's a wonderful place to be, and whether we'll ultimately serve all 50 destinations is not guaranteed or committed to.

It's just the fact that those are opportunities, there's a number of them.

And we'll have to prioritize according to fundamentally what's the next best opportunity for traffic and revenue and profits.

It will be a little complicated by the fact that, in some cases, we'll need to add capabilities to the aircraft, like ETOPS, so that has to be factored in.

Or, in the case of Mexico in particular you have to apply for route authorities, and we'll have to do that on a strategic and tactical basis, as well.

But as I said in my remarks, it's a wonderful thing, and it's just nice to be able to have a number of opportunities to choose from.

Got it.

That's helpful.

I had understood it as 50 in general, but it sounds like you're specifically talking about international opportunities because of the change in capability.

And that's just the way our domestic route map has developed.

After the AirTran acquisition, we added 17 more domestic destinations to the Southwest route map.

As you look at the route map we cover the top 50, with one exception.

We know and you know that our opportunities to add dots or destinations in the 48 states is rather limited.

So, absolutely the opportunities to grow in terms of destinations is beyond the 48 states.

Now let me quickly clarify that there are numerous opportunities to grow within the 48 states among the destinations that we currently serve, connecting dots, additional frequencies.

Wright amendment or rather Dallas Love Field and Washington Reagan being two prominent and easy examples there.

But additional thoughts will be beyond the 48 states, most likely.

That's very helpful.

And that's a good segue into my second question, which is, I understand the difficulty in talking about ASM growth rates overall when you have so many different moving parts in international growth, and so on and so forth.

But domestically over the next few years what's the right framework for thinking about capacity growth or your willingness to add capacity growth?

I think it's to be determined.

I think that we have a real high-class problem, which is we have far more places that we would like to serve than we'll have airplanes.

And we'll make those judgments tactically based on, again, the inputs that I've described to you.

But one would assume that if we have mature markets that have growth opportunities, that that would probably compete for a top priority spot.

But, again, there's no reason for us to make that commitment at this point.

And we'll just have to manage this in a very measured way year to year, with the annual objectives in mind of running a great operation offering outstanding customer service, and hitting our return on invested capital target.

And those are going to be the guide posts in determining how we grow and how fast we grow.

And do you think about that ROIC target for growth differently for international versus domestic, given just different risks?

Yes.

In other words, every opportunity is going to have to meet the 15% threshold.

And if the risks are higher, then that will have to be factored in.

Great, thanks a lot for the color.

Helane Becker with Cowen & Co.

Thanks very much, Operator.

Hi, everybody.

Thank you for the time.

Just on the 717 transition, what will salaries and training costs look like after this year, maybe percent change or what percent is this year related to the training and so on to move those pilots from the 717s to the 737s?

Hi, Helane.

Yes, I think it's really after this year, I think we may have some training costs that dribble into next year, but it shouldn't be all that significant.

And in terms of just the step up in the wage rates as we bring our AirTran employees, convert them over to Southwest employees, really all that's remaining there are, of course, the crews.

But that's all been factored into the guidance that we've given you.

So, really, all of the employees are already Southwest employees with the exception of the pilots and flight attendants that we need over on the AirTran side until we bring that flying over to Southwest.

Helane, I probably won't add anything to what Tammy's already said, but just for a little color -- and this is a huge shout out to all of our folks in our training departments, flight operations and then all the rest of our operating groups -- they are doing a phenomenal job.

We have record training events occurring in 2014.

So, in other words, in the first-half costs that you already have seen, we have an unusually large amount of training under way.

And that will continue through the balance of this year.

And I agree with Tammy, by the time you get into 2015, we'll be back more to normal.

Although I think, Mike, there's probably some front end, maybe two months of 2015 where we will have heavy training events.

But the other point to make here is that you have a lot of aircraft and a lot of employees, quote, out of service in 2014 and we're still producing strong results.

Those airplanes effectively come back into service next year as they get through the conversion.

And then our employees, as they get through all the big gulp of training that's taking place in 2014, they will be more productive next year, as well.

You'll have a higher percentage of employees at the Southwest pay scale next year, so that will create some inflation.

And I'll defer to Tammy on that.

And, Helane, the only other point I just wanted to make on the training, if you're working on your model there, just as a reminder those training costs are included in the integration costs.

And, as we said in the earnings release, we're expecting that total cost to be about $515 million.

Training is just one component of that, of course.

So, that's where the training costs at least are showing up.

Okay.

So the 8% numbers we're looking at in salaries is a true number and doesn't have any of those events in it?

That is correct.

It does include, as we're converting the AirTran employees over to Southwest, it includes that step up.

But it does not include the training costs.

Those are included in the integration cost.

Okay.

And then just my follow-up question on an unrelated item.

I think you said you opened the schedule and are starting to take bookings for the Wright amendment flying, with 88 days to go.

Early days yet, I know, but can you give us some color on how that's booking and what you're seeing in terms of picking up passengers that may have been avoiding you, not going on a one-stop basis over some of your other cities?

They look very normal, they look very solid.

And that's just within the context that the outlook looks real strong.

So, it all looks good.

I think Tammy mentioned in her comments just the second-quarter performance of the, quote, Wright right amendment markets.

And we saw a very strong increase already.

And I suppose a lot of it's just the awareness that's been created about the restrictions coming down and the publishing of the new schedule.

But, yes, I think we had a 21% increase in the Wright amendment revenue, oriented around Dallas, obviously, in second quarter.

But, yes, those markets all look good.

There's 15 new non-stop destinations that will launch in October 13 to early November.

And we can't wait.

Great, okay.

Thanks very much, guys.

Duane Pheffingworth from Evercore.

Hi, thanks.

Just continuing on Helane's question there, but specific to fleet, if you think about lower utilization, transitioning aircraft to Delta, and from AirTran to Southwest, can you quantify what the headwind to CASM is this year as it relates to fleet transition and lower utilization?

Hey, Duane.

I'm just thinking here with you.

We would be impacted some on the utilization.

I don't know that I can pinpoint a specific number for you as we move forward.

But we should see, as we get all of the flying over to Southwest, obviously, an improvement in the utilization, which is also driving some of the ASM improvement or the ASM increase that I mentioned for the first quarter.

I'm just trying to think through and reconcile with you what that number might be.

It just feels like it's probably a material component of your CASM growth, which may not recur, right?

Yes, to your point, we definitely have opportunities as we look ahead to 2015 to be more efficient with our fleet.

And, as you can imagine, with the conversion of all the markets in 2014, just from a staffing perspective, as well, we're clearly not as efficient as we could be going forward, as well, once we have just more stability our network.

We haven't given unit cost guidance for next year, but as you can see, this year we're certainly benefiting from the increased gauge.

And I would expect in 2015 that we would also get some benefit from just the overall improvement in utilization.

But we're still working through our plan and our schedule and all of the details for next year.

And we'll give you better guidance on that as we get a little bit later in the year and have a little more certainty on our schedule for 2015.

Okay, thanks.

And then one for Gary.

When you hit this target, which we have been pointing to for years, and you finally realized it this year, what do you do?

Do you raise it?

What happens when you hit a longstanding aspirational target?

I think, Duane, we do what I said we're going to do, which is we're going to take up every year and have a goal to run an excellent, reliable operation, provide outstanding customer service, and have a business and a plan that continues to have consistent profitability, achieving at least a 15% pre-tax return on invested capital.

We've got opportunities to grow the network, both domestically and internationally, as we've described.

And we'll want to manage that growth very carefully so that we sustain all three of those performance levels.

But we want our return on invested capital to continue to be at least 15%, with 15% as the floor.

Okay, thank you.

Joe DeNardi with Stifel Nicolaus.

Good afternoon.

Tammy, maybe going back to the Rapid Rewards program in the context of how successful you view that being for you guys, can you just talk a little bit about the growth and the Frequent Flier liability there.

It's growing at a rate a little bit faster than your peers.

Is the plan to manage that a little bit more aggressively in the future or are you okay with the growth you're seeing?

We're constantly evaluating our Rapid Rewards program.

And just as a reminder, we did recently increase the coefficient for using Rapid Rewards flights.

So, that's at least keeping the usage in line with what our more recent trends have been.

But, as Gary stated earlier, we've been extremely happy with the Rapid Rewards program.

And the second quarter impact related to our Rapid Rewards program is probably roughly $95 million on a year-over-year basis, $95,000.

So, we're seeing probably a 40% to 50% increase in our revenue year over year.

So, we're delighted with how that's performing.

But to your point, we've obviously got to keep an eye on the liability.

We're monitoring the usage but the overall economics we're very happy with.

Okay, thanks.

Jamie Baker with JPMorgan.

Good afternoon, everybody.

A quick clarification on labor.

The cost guidance doesn't contain any accruals, correct, Tammy?

That is correct.

Okay.

And more broadly speaking, and I'm not asking you to negotiate in public here, I'm just curious if there's been any change in the tone of negotiations in light of your very impressive recent results.

Negotiations continue.

We've got negotiations in a number of work groups.

And the pace and, understandably, the texture of those negotiations is different by work group.

It obviously puts the Company in a position where it can afford to do certain things.

But the main thing that we need to do is to preserve Southwest Airlines' low-fair brand and low-cost position competitively.

And it doesn't change the need to do that.

Our competition is stronger today than it has been in a long time.

That hasn't changed, Jamie, and therefore it's a great rallying cry for all of our people to work together to beat all of our competitors.

And that work continues.

Sure, okay.

I appreciate that.

And, secondly, I know you don't guide on fuel efficiency, but with [identification], 717s going out, 730s coming in, longer stage lengths, I personally could use an assist.

For 2015, would you expect ASMs per gallon to exceed 74, or is something in the 73 range more likely?

I'll let Tammy think about that while I just make one quick comment here.

And, Jamie, I think we can do that now.

We have tried to, or at least our investor relations effort here has tried to, give you some guidance with the fleet modernization benefits -- which I think, Tammy, are largely fuel efficiency.

That's correct.

So, you do have that.

But you're right, it hasn't equated precisely to the consumption number.

But, yes, we're already realizing significant benefits from the fleet modernization/fuel efficiency.

Of course the fleet modernization, with an upgauging benefit, as an example, as you well know, has benefits beyond just fuel burn.

But, anyway, do you have anything?

Yes, and I would definitely agree with that conclusion.

You've punched nicely north of 72 as of the fourth quarter of last year.

I think, directionally, you're in the ballpark, Jamie.

I had a 73 in mind.

But I think we'll continue to see improvement as we go, for all of the obvious reasons, as we continue to replace the 717s and the classic aircraft with more fuel-efficient airplanes.

We haven't given a number yet for next year but I wouldn't be surprised to see it exceed 74.

Okay.

I appreciate that, Tammy and Gary.

Thank you very much.

Thomas Kim, Goldman Sachs.

Good afternoon.

Thanks very much.

I know your credit rating is very important to you, and obviously having a strong balance sheet makes a lot of sense.

I'm just wondering whether you think your balance sheet is bordering too conservative at this stage, with cash and short-term investments hovering north of about 20% of consensus revenue estimates for the year.

Maintaining a healthy balance sheet, obviously, has always been a top priority for Southwest.

And we really do have a lot -- it's really a balancing act -- and we have a lot of guide posts.

Of course, one of our goals for this year that we've stated is, we have an investment grade balance sheet, we would like to notch that up.

And, so, that's obviously one consideration.

But as Gary said earlier, we have a lot of high-class problems or questions on our hands.

So, really, our overall goal is to enhance shareholder value.

I think we'll need to balance our capital expenditures against our desire to continue to enhance capital through shareholder deployment.

And I think the other guide post I would just point you to is, our cash balance is $4 billion.

Our target is probably closer to $2.5 billion.

But keep in mind, too, there's some seasonality in that cash balance.

And we do have, as I mentioned earlier, we've got over $400 million in debt due later this year.

Of course with the peak second quarter we've got higher cash balances.

And seasonally that's typically the case, so that's just another factor.

We're looking ahead at what our needs are, and with the overall goal in mind to enhance shareholder value through either deploying capital back to our shareholders and, also, as Gary mentioned, we want to continue to grow the airline.

Just trying to be real quick with you here, if I just take your question literally -- is it too conservative -- I would say no, it's not too conservative.

Is it too aggressive?

-- No.

Is it at the exact right spot?

I don't know that I'm ready to answer that quite yet.

So we continue to work -- as you know, the rating agencies don't just look at leverage.

In fact, interestingly enough, they don't look at leverage much at all.

And that's the way we normally casually talk about it.

So, there's other things they look at, and we'll want to continue to work with them in an effort to try to improve the credit rating.

I think that that would be better than being so close to junk.

On the other hand, if trends continue for several years, like they have been for the last couple, the balance sheet is going to continue to show less and less leverage.

And, yes, it is possible that it gets to a point where we think that it's, quote, too conservative.

But I don't feel that we're there right now.

And, like Tammy said, I think that's a high-class problem and something ultimately can be managed.

The only other thing that I think needs to be mentioned here is that we've lived through a brutal decade where every balance sheet in the industry was stressed, and most went bankrupt.

You just can't extrapolate 2014 into infinity.

We do want to make sure that we error on the side financially of being conservative, and being very well-prepared for the unpredictable.

And the unpredictables happened a lot to us in 43 years.

But, again, that's not to say we're worried.

We're not.

We're feeling very confident and very good and very pleased with this quarter, and very pleased with our outlook.

I definitely appreciate all of that.

If I could just ask a separate question, Gary.

On your international expansion, can you help us understand your thought process behind building depth versus breadth in your network?

And then a separate question related to the international side, obviously we appreciate that your fleet will have much longer range.

But I'm curious as to how your unit cost advantage or competitiveness changes when you start competing against your network peers that are going to be flying a larger gauge fleet.

Excellent questions, and questions that, again, I'd put in that high-class problem category.

We're going to have to choose.

And I suppose that the choices from one decision point to the next will probably have different priorities.

Things will just change.

We want to do both.

We certainly want to increase the diversity and the breadth of our route system.

But we have opportunities that we haven't seen in quite some time to also improve the depth in a lot of our markets.

And those are the exact conversations and debates that our commercial experts are having right now.

I'd rather not tip our hand as to exactly what we might do.

But, again, just to put it in perspective for everyone, international right now is 1% of Southwest's route system.

So, it is a very small component.

And it's going to be small for a long time.

So, I think that may very well help direct us in the future as to how we think about additional flights from one schedule to the next.

But 50 dots on the route map obviously is a great opportunity to increase the breadth.

And, again, all this has to fit in with hitting our return requirements.

I think, by definition, increasing the depth, one would think, would be less risk as opposed to increasing the size of the route network.

So, all that will have to be factored in, as well.

We've got a great opportunity to grow, grow the earnings, and continue as we grow the capital base along with the growth and earnings to hit our 15% minimum target.

It's very exciting and we've got opportunities to do both.

So, that's, again, a very high-quality problem.

I appreciate it's late in the call.

Do you care to comment on just the last question about unit cost competitiveness over the longer haul?

I'm sorry.

I didn't skip it on purpose.

I'd forgotten you'd asked the question.

As you go longer, it gives us less ability to bring our strength, which is efficiency in turning airplanes.

It makes it a little bit harder to bring that competitively to the market.

That will have to be factored in.

I don't know that we are well prepared for, quote, ultra long-haul flying.

But we feel we have a very solid cost advantage with the 737 and the route network that we're envisioning to, again, North America and the northern part of South America.

So, I think that that holds true, at least with the analysis that we've done.

And that's been the case over a number of years.

We want to continue to be low-cost producer and work hard to achieve that position and then maintain it.

And certainly we want to be known as the low-fare brand and we're going to work hard to sustain that, as well.

Thanks very much, Gary.

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

Thank you, Tom.

And thanks again to everyone for joining our call today.

As always, I'll be available this afternoon if you have any additional questions.

Thanks again.

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 Culture and Communications.

Great, thank you.

Tom.

And we would like to welcome all the members of the news media who might have questions for Tammy and Gary.

I think Tom is going to give instructions and we'll get that started.

(Operator Instructions)

Mike Sasso with Bloomberg News.

Hi, good afternoon.

I noticed that you announced earlier that you were going to purchase 17 pre-owned 737s.

I noticed I was on a call earlier with the United folks and they announced a new strategy for them to buy used.

And certainly Delta is well-known for pursuing that strategy.

I wonder if you could just talk about used planes as a strategy and what's going on with that.

Sure.

Again, for us, it's not new either.

I think we used a pre-owned market historically for more tactical growth opportunities.

And we were very active in the 1990s, in particular, going out into the used market, finding good airplanes.

And had the capability of quickly converting them to the Southwest livery and putting them into revenue service.

When the market is available, that is a very good strategy.

And, in particular, it works well for us right now.

So, what is unique for Southwest is we're an all 737 carrier.

We are the launch customer for the 737 Max, which is coming online in 2017.

All indications are it will be a vastly superior aircraft from an economic perspective.

If our Chief Operating Officer had his druthers, he would rather be getting those airplanes new right now as opposed to the current generation.

A wonderful way to bridge the gap is to go into the used market rather than buying the current generation new from Boeing, understanding that we'll be using them for a shorter period of time.

But that just means that we'll get the 737 Max that much faster, again compared to buying an airplane here in 2014 and keeping it for 30 years.

That all works great, and that's a great strategy, but the airplanes have to be available.

And it just so happens that there are a lot of 737-700s on the used markets at attractive prices that are available.

If they are not, then I'm sure we wouldn't continue to pursue that strategy.

So, everything has to come together.

We love the 737-700, which is the NG product.

That's what Mike is picking up.

The economics are fantastic.

So, I think that works very well,

So, it's not necessarily a new strategy for us.

The circumstances are different this time that cause us to pursue that.

It definitely helps us manage our capital spending at a time where we would like to not only replace retiring equipment but also begin to pick up a few units to grow.

So, all the way around, I think it's a great strategy and something that's working very well for us.

Just a quick follow-up.

You said there were a lot of 737-700s on the market.

Why is that right now?

Mike, do you want to speak to that?

Yes.

Mike, it's just a function of them rolling off of lessors' order leasing books.

They typically lease the airplane out anywhere from 8, 10, 12, even up to 20 years.

And they roll into the marketplace, and we just have a bow wave of them rolling into the marketplace over the next couple of years.

And we're the largest 737-700 operator in the world.

And it's an airplane that we really like.

And it could be that other airlines are pursuing other aircraft types.

It's often hard to know.

But we like that airplane and, for whatever reason, there's a lot of them.

And that was Mike Van De Ven, our COO, by the way, that was answering that question.

And just one thing to add -- the lessors love to lease to Southwest Airlines because we do have a very strong balance sheet.

Yes.

You heard the question earlier about our credit rating.

And Tammy makes an outstanding point, which we are a preferred customer for anybody who wants to get paid.

That is correct.

Doug Cameron with the Wall Street Journal.

Caught me by surprise.

I was late in the queue.

Didn't think I'd get one.

This is one for Gary or maybe Ron.

Going back to the international expansion, guys, I see you've been active in some DOT dockets with regard to potential Mexico flights.

Which makes me think, I wonder if any of the international expansion in that region is dependent on any regulatory changes, be it new bilaterals, or whether there is plentiful opportunities for you with the status quo as far as current air service agreements are concerned.

Ron Ricks, our EVP and Chief Regulatory and Legal Officer, will step up to the microphone here.

I think the only new development there that might merit some attention is that the United States and Mexico are discussing a new bilateral.

And what we're hearing is that, for the first time in quite some time -- by the way, I don't think the treaty between the two countries has been renegotiated since the early 1960s.

So, the first time since then, Mexico is interested in liberalizing that treaty.

Liberalizing, in this context, meaning more opportunities for more flights by US carriers.

That is a goal that we support.

And it's something we are urging the United States government to pursue in the negotiations in hopes that we can achieve a new bilateral sooner rather than later, which means expanded opportunities for us.

And I know there are only two or three designations now, Ron.

You're confident you could get one of those, if and when you decide to fly from Hobby Air, any other points?

If I understand your question, there are a number of routes that we're interested in pursuing over the short term, and there are opportunities.

But the point of the new bilateral negotiations is to expand that list more, so that we could have more opportunity.

But I think, regardless of whether there's a new treaty or not, to Gary's earlier commentary, there are plenty of opportunities for us.

Again, a high-class problem.

There are lots of places we can go, so we don't think we'll be route restricted, if that's a concern.

But, on the other hand, Mexico is a very attractive place for us to fly, our existing route structure and the demographics of the United States today.

And if there are more opportunities in Mexico, then I'm sure Mr. Andrew Watterson and his team and our network planning group would be happy to pursue them.

And, Doug, the other thing, Ron is acknowledging, we're acknowledging, that there may be some city-pair routes that we can't get the route authority to fly.

We know that.

But the thing that is different about Southwest Airlines is we have dozens of cities that we have point-to-point networks that originate from.

So, we have routes into Mexico right now from Orange County, California; Austin, Texas; San Antonio, Texas, as an example.

Houston may not be open to us to certain Mexican cities but I'll bet we can find other spots on the Southwest system that are.

But, in any event, we have 50 potential beyond 48 state destinations.

And if we can't go one place, we'll have ample opportunities to go somewhere else.

And as a practical matter, we simply cannot satisfy all the growth opportunities at the same time anyway.

So it will help prioritize if we're restricted,

But, clearly, we're in support -- and Ron made this clear -- we're in support of liberalizing the bilateral agreement between the United States and Mexico.

And that will bring more competition, that will lower fares, it will be better for consumers.

So it's not just about us selfishly.

It's really what's good for consumers.

Great, thanks.

I've been watching the docket.

Thanks, guys.

David Konig with the Associated Press.

Hi, folks.

I will make it easy, an easy one here.

Gary, I see that the release does talk about a 3% PRASM gain expected in July over last July.

Anything else you can say about demand in the third quarter in bookings?

And part of that is how soon do you expect it's going to be until everybody starts dumping a bunch of extra capacity into the system?

I think the capacity -- just to go backwards with your question -- I think the supply side of this is generally a longer cycle.

So, if you just looked at us, if we wanted to add more flights next month, we couldn't do it.

That's a fairly long lead time that's required to acquire equipment, hire and train employees, et cetera.

So, right now, the demand is very strong and it is balanced very nicely with the supply of seats.

We are going to manage our growth very carefully so that we don't upset that balance for Southwest Airlines.

What the rest of the industry does, of course, I can't speak to.

I think, David, the bigger risk personally is the economy and fuel prices.

With all of the turmoil there is in the Middle East, things could change quite rapidly and I'm much more concerned about that.

The demand side of things, if you will, continuing to be stable and strong as opposed to a radical change in the supply side any time soon.

Okay, thanks.

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

Great.

Thank you so much for your interest today.

We know there's lots of news going on in the industry, so thank you for tuning in to us.

If you have any additional questions, our communications team, that number is 214-792-4847.

Thank you so much.

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

Thank you for joining.