Southwest Airlines Company (LUV)

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Southwest Airlines (LUV)

Q3 2012 Earnings Call

October 18, 2012 12:30 pm ET

Executives

Marcy Brand

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

Tammy Romo - Chief Financial Officer and Senior Vice President of Finance

Michael G. Van De Ven - Chief Operating Officer and Executive Vice President

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

Linda B. Rutherford - Vice President of Public Relations & Community Affairs

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

Analysts

Scott Tan - JP Morgan Chase & Co, Research Division

Glenn D. Engel - BofA Merrill Lynch, Research Division

Michael Linenberg - Deutsche Bank AG, Research Division

John D. Godyn - Morgan Stanley, Research Division

Thomas Kim - Goldman Sachs Group Inc., Research Division

Jeffrey A. Kauffman - Sterne Agee & Leach Inc., Research Division

Helane R. Becker - Dahlman Rose & Company, LLC, Research Division

Savanthi Syth - Raymond James & Associates, Inc., Research Division

Raymond Neidl - Maxim Group LLC, Research Division

Kevin Crissey - UBS Investment Bank, Research Division

David E. Fintzen - Barclays Capital, Research Division

Presentation

Operator

Welcome to the Southwest Airlines Third Quarter 2012 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, and welcome to today's call. Joining me on the call today is Gary Kelly, Southwest's 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 COO.

Today's call will begin with opening comments from Gary, followed by Tammy providing a review of our third quarter results and current outlook. We will move to the Q&A portion of the call following Tammy's remarks. And Gary, Tammy, Bob and Mike will be available to take your questions.

As a quick reminder, 2011 year-to-date consolidated results include AirTran beginning May 2, the date of the acquisition. In order to provide what we believe to be a more meaningful year-over-year comparison on today's call, when referring to year-to-date 2012 results compared to 2011, we may provide commentary on a combined basis as defined in this morning's press release.

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 such as combined results and 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 now I'll turn the call over to Gary for opening remarks.

Gary C. Kelly

Thank you, Marcy, and thanks, everyone, for joining us today for our Third Quarter Earnings Call.

Third quarter earnings were $97 million or $0.13 a share, which was slightly ahead of the First Call consensus. We had a lot of activity in the quarter. We made a lot of progress. And clearly I'm not satisfied with our earnings results at these levels, but always pleased to have a profit.

I do want to thank all of our Southwest people for their hard work and their results. Again, we made very solid progress on our strategic initiatives that are underway. We had excellent operations for the quarter and outstanding customer service.

Just several notable events. We completed the 717 lease and sublease deal with Delta. We've converted 9 of the AirTran 737s into Southwest at this point. We opened or converted 5 airports at our 2 Southwest airlines. And at the same time, AirTran shut down operations at 6 airports, and that brings to 16 since a year ago.

We're continuing our 737-700 retrofit of our interiors and we now have 147 of the -700s with 143 seats that have been converted. And in addition to that, of course, the AirTran 9 aircraft that are converted are also in the 143-seat configuration. So that work is continuing and will continue through the first half next year until we get all of the 700s done.

We made significant progress on a host of technology efforts, and several of those are scheduled for implementation next year, which I'm very excited about.

Our third quarter revenues and earnings were -- again, as I said, they were solid but below our plan and below our return target. There were definite signs of demand weakness. And especially in September, that month was down on a unit basis about 2% to 3%. And of course, our results mirrored what was going on with the rest of the industry.

The good news that we reported this morning is that October so far is back on track. Its unit revenues are up about 4%. And sustaining our revenue momentum, of course, is absolutely critical.

So we have 3 or 4 key revenue initiatives that are planned for 2013 to sustain our revenue momentum. First of all is the continued rollout of our seating reconfiguration of the 700s or known as Evolve. Second is the connection of the Southwest and the AirTran networks, which is scheduled for early next year. And really related to that is the ongoing optimization of the combined airlines' networks, and we're doing that with every single schedule that we publish. And then fourthly is the introduction of a new -- at least the first phase of a new revenue management system. But I would say that in addition to those 4 planned activities, we're also evaluating opportunities for additional revenue drivers in 2013.

On the cost front, the investments that are reflected in our operating costs to modernize the fleet, I think, will pay very handsome dividends, but those costs will begin to ease next year. And ultimately, with respect to our operating cost, at least excluding fuel, our goal is to reduce our unit costs from current levels. I don't think that's necessarily likely for the full year 2013, but that is our goal.

And for several reasons, we'll be pursuing aggressive cost control efforts for all of 2013, with the goal of paring at least $100 million from our corporate overhead. There's no real fat at Southwest, but clearly I think there are some opportunities for us to streamline and to focus.

I am very pleased with the performance of our All-New Rapid Rewards program. And of course, it is 1 of our 5 strategic initiatives and the very first one to be delivered. Partner sales alone generated another $50 million in revenues in the third quarter, and we're on pace to do $200 million or more for the year.

In addition, since last year, there's a build in our air traffic liability of over $400 million and those are cash sales that are in effect locked up until the member takes a trip. And that is -- of course, those monies have not flown to revenues yet and that's in addition to the several hundred million dollars that we are counting on in revenues this year from our All-New Rapid Rewards program. But all of those are contributing to very, very strong cash flow at Southwest Airlines.

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