Southwest Airlines' CEO Discusses Q3 2011 Results - Earnings Call Transcript

Southwest Airlines (LUV)

Q3 2011 Earnings Call

October 20, 2011 12:30 pm ET

Executives

Ginger Hardage - Senior Vice President of Corporate Communications

Marcy Brand -

Laura H. Wright - Chief Financial Officer, Chief Accounting Officer and Senior Vice President of Finance

Robert E. Jordan - Chief Commercial Officer, Executive Vice President and President of Airtran Airways

Gary C. Kelly - Chairman, Chief Executive Officer, President and Member of Executive Committee

Analysts

William J. Greene - Morgan Stanley, Research Division

Kevin Crissey - UBS Investment Bank, Research Division

Terry Maxon

Garrett L. Chase - Barclays Capital, Research Division

Andrew Compart

Bob McAdoo - Avondale Partners, LLC, Research Division

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Kelly Yamanouchi - Denver Post

Glenn D. Engel - BofA Merrill Lynch, Research Division

Lori Ranson - Air Transport Intelligence

David Koenig - Associated Press

Michael Linenberg - Merrill Lynch

Presentation

Operator

Good day, and welcome to the Southwest Airlines' Third Quarter 2011 Conference Call. My name is Tom, and I will be moderating today's call. This call is being recorded, and a replay will be available on southwest.com in the Investor Relations section. At this time, I'd like to turn the call over to Ms. Marcy Brand, Director of Investor Relations. Please go ahead, ma'am.

Marcy Brand

Thank you, Tom. Good morning, everyone. Welcome to our third quarter 2011 conference call. Joining me on the call today is Gary Kelly, Southwest Chairman, President and Chief Executive Officer; Bob Jordan, Executive Vice President and Chief Commercial Officer and President of AirTran Airways; and Laura Wright, Senior Vice President, Finance and Chief Financial Officer.

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

This morning's release includes Southwest's third quarter 2011 consolidated results, which include AirTran's results for the full quarter. Southwest year-to-date 2011 consolidated results include AirTran's results since the May 2 acquisition date. Prior-year results do not include AirTran. However, in order to provide what we believe to be a more meaningful year-over-year comparison on today's call, we will also be discussing specified results on a combined basis.

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

In addition, outlook commentary will be provided on a combined basis as compared to combined prior-year results, unless otherwise noted. We provided supplemental financial information on a combined basis for year-to-date 2011 and for prior-year results in this morning's press release, along with related reconciliations.

Before we get started, 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.

This call will also include references to results, excluding special items or non-GAAP results. 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 now I'll turn the call over to Gary for opening remarks.

Gary C. Kelly

Well, thank you very much, Marcy, and thanks, everyone, for joining us this morning. We had $122 million third quarter profit, excluding special items. That's $0.15 a share, $0.01 better than the Wall Street estimates. And of course, that's very satisfactory. However, the results are 37% below last year's third quarter, and that's not satisfactory. But I am very proud of our people. The challenges to earnings are cost related, and especially fuel cost, they were up 33.8% on a per gallon basis compared to last year. And were it not for that, our earnings would've been outstanding, excluding items.

Our people deserve a lot of praise because we had a stellar revenue performance. We had record load factors, record yields, record revenues. We had All-New Rapid Rewards program that was a very significant contributor, and we also had much improved operations performance.

All of that was accompanied by very strong customer satisfaction ratings. Of course, our GAAP results include a markdown on a minor portion of our fuel hedge portfolio, and that's because of the swoon that occurred in energy prices following the U.S. government debt crisis in August.

Since the end of the quarter, by the way, prices have increased, and that markdown has essentially reversed itself. So the accounting is complex. It is overly complex. In my opinion, it's confusing. So we, along with Wall Street, count all of our portfolio when the hedges actually settle.

So speaking of hedging, we have reduced our hedging portfolio over the next several months to, I would call, actively manage what we believe will be a lower-price environment. We have significant hedges in place for second half 2012 all the way through 2014 and somewhat into 2015. And that, of course, is to protect against a surge in prices. In our view, the fundamentals suggest that there is significant upside price risk from where we are today. All of that assumes no slowdown in growth here in the United States and especially in Asia.

I would like to highlight just a couple of things for the third quarter just to make sure that you are aware. First of all, we had a very strong revenue performance. We saw no weakening in overall demand. And I think perhaps more importantly, we saw no softening in business travel. So we've had very stable business travel trends since the spring.

We had a very strong performance of our only Rapid Rewards program, and it's the second full quarter results. And across the board, we saw very strong metrics. Our membership numbers were up significantly, up almost 50% compared to last year. The flight activity from our more mature members was up, more than system activity. We saw the premium in fares paid by Rapid Rewards members increase. We saw the number of members applying for credit cards increase. The credit card activity increase. Other related partner revenue growth was up more than expected. And then we had a very, very healthy amount of revenue associated with the sale of points, mainly for future revenue recognition. But very, very pleased with the results of the program. We think that we've got the best program in the industry. And certainly, believe it's a bold move but a big improvement over our Rapid Rewards program of the past.

Secondly, we had significant progress with the AirTran integration. Planning continues. And importantly, a lot of work has been completed in terms of reaching labor agreements with our pilots. So the Southwest pilots and the AirTran pilots each have votes underway. We're working with the FAA, of course, to achieve a single operating certificate. A lot of technology construction is underway. A lot of preparation is in place to begin our aircraft conversion in the first half of next year. And we also have been preparing our flight schedules in terms of optimizing Southwest and AirTran flying activity and also preparing to connect the 2 and convert airports next year.

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