Security Fee Hits Southwest

The airline complains about an unexpected TSA assessment.
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Updated from 7:03 a.m. EST

Southwest Airlines

(LUV) - Get Report

posted stronger fourth-quarter earnings and said it's optimistic about the first quarter because of continuing declines in competing airlines' capacity.

However, the air carrier missed Wall Street's profit target after an unexpected security fee assessment.

CEO Gary Kelly told analysts Wednesday that he expects a continuation in the fourth quarter's capacity declines. "We're showing that fourth-quarter domestic capacity is down by 4% to 5 % in many regions, and we're benefiting from that," he said. "At least for now, it's going the right way."

Kelly said the factors driving the fourth-quarter profit gains included a pickup in shorthaul traffic in California and Texas, as well as in Philadelphia and Baltimore, where competitors have either increased fares or reduced capacity. Additionally, Southwest has "taken some modest fare increases in the face of a better economy driving better business travel," he said.

The Dallas-based low-cost carrier made $86 million, or 10 cents a share, in the quarter ended Dec. 31, up from the year-ago profit of $56 million, or 7 cents a share. Excluding derivatives-related gains and losses, the latest-quarter profit was 12 cents a share, a penny shy of the Thomson First Call analyst consensus estimate. Revenue rose 20% from a year ago to $1.99 billion.

Southwest noted that the latest quarter's numbers were pulled down by $24 million, before profit sharing and income taxes, in additional federal airport security expenses that the Transportation Security Administration assessed retroactively to 2005. The TSA's determination was made this month.

"We believe the methodology used by the TSA is fundamentally flawed, and we fully intend to contest it," said CFO Laura Wright.

The company said fourth-quarter earnings rose 40% from a year ago despite the assessment and a 39% increase in hedged fuel costs per gallon. Southwest said unit revenue rose 11.7% and yields climbed 4.2 percentage points, while the fourth-quarter load factor, reflecting the proportion of seats filled, hit a record 69.6%.

Southwest also said it expects to see good first-quarter trends but added that it might not match the fourth quarter's unit-revenue expansion pace.

"Based on current strong traffic and revenue trends, we expect January's load factor and unit revenues to exceed year-ago levels," the company said. "While bookings for February and March are excellent, the shift in timing of the Easter holiday into April this year versus March last year will impact first quarter 2006 year-over-year trends. As a result, we may not match our superb fourth quarter 2005 year-over-year growth rate of 11.7% in first quarter 2006."

Kelly said he nevertheless anticipates 15% revenue growth this year as Southwest continues to expand at key airports including Chicago Midway, Philadelphia International and Denver International, where the airline began flying Jan. 3. Southwest will increase capacity by 8% this year as it takes delivery of 33 Boeing 737-700 jets.

Asked whether he thinks the proposed new carrier Virgin America -- in which flight aficionado Richard Branson is a minority investor -- is making a mistake by starting service this year, Kelly said that "to undertake an airline at $67 crude oil is just an enormous risk. ... If you look at the results for the fourth quarter, you will find that we are (possibly) the only airline to make a profit. For me, that about sums it up for a new airline."