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Southwest Airlines (NYSE:LUV)

Q4 2012 Earnings Call

January 24, 2013 11:30 am 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

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

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

Analysts

Michael Linenberg - Deutsche Bank AG, Research Division

Hunter K. Keay - Wolfe Trahan & Co.

David E. Fintzen - Barclays Capital, Research Division

James D. Parker - Raymond James & Associates, Inc., Research Division

Duane Pfennigwerth - Evercore Partners Inc., Research Division

John D. Godyn - Morgan Stanley, Research Division

Jamie N. Baker - JP Morgan Chase & Co, Research Division

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

Kevin Crissey - UBS Investment Bank, Research Division

Operator

Welcome to the Southwest Airlines Fourth Quarter 2012 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, 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, 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; Mike Van De Ven, Executive Vice President and COO; and Ron Ricks, Executive Vice President and Chief Legal and Regulatory Officer.

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

As a quick reminder, 2011 full year 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 full year 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 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.

And with that, Gary, I will turn it over to you.

Gary C. Kelly

Thank you, Marcy, and thanks, everyone, for joining us. Welcome. We're very pleased to share our fourth quarter earnings results, obviously pleased to report increased earnings for the year 2012, a solid profit in fourth quarter, slightly ahead of expectations and flat compared to 1 year ago, excluding items.

Our operational performance and our customer service delivery were both exceptional in 2012. Our cash flow from operations, if you exclude all the hedging collateral changes, was an all-time record for Southwest Airlines at $2.1 billion for 2012.

And it was an exceptional year for our shareholders, as we were able to repurchase 46 million shares for $400 million, reducing our shares outstanding almost 6%. We also increased the quarterly dividend by 122% in May of last year.

We were also able to pay down $1.2 billion in debt since the May 2011 AirTran acquisition, with the balance sheet leverages declining and very, very strong.

Real story in 2012 was the progress that we made on our strategic initiatives. There are 5 of those: all-new Rapid Rewards, AirTran, the introduction of the 737-800 into our fleet, overall fleet modernization and then our reservation system replacement.

There were significant accomplishments in 2012. There were significant effort and investment, both from a capital and an operating perspective, that were expended on these strategic initiatives.

I'm not satisfied, of course, with 2012's absolute earnings, but it was still a remarkable year given the amount of construction work that is -- that was under way. And our people are transforming Southwest, and in the meantime, they are running a great airline.

Business, for us, has been good. Yields are up. We've had some traffic effect, but load factors remain near record levels.

The timing of Christmas and New Year's put the month of December behind trend and the month of January ahead of trend. But all in all, fourth quarter and first quarter bookings and revenue trends look very solid, at least at this point.

Broadly speaking, while we see a lot of encouraging signs in the broader economy, we're monitoring demand closely for signs of any weakening by consumers resulting from the increased income taxes. But at this point, we're not seeing any signs of any weakness; at least it's buffered by a pretty benign industry capacity forecast. And our forecast is showing that the industry will be down capacity-wise domestically in the 1% to 2% range in the first quarter.

So thinking about 2013, we want to preserve our strong culture, brand and customer service levels; we want to maintain our operational excellence; and we want to regain our financial prosperity. We have a plan to boost revenues this year by $1.1 billion over 2012 levels. We also have efforts underway to increase our aircraft efficiency and utilization and also increase our fuel efficiency on a unit basis.

2012 cost pressures that we were -- that we've been seeing in maintenance, for example, and depreciation, those will begin to ease in 2013. And of course, we're going to be very focused on managing our invested capital. And in particular, our capital spending plan for 2013 will be down from 2012 levels.

But the #1 deliverable for 2013, without a doubt, is the connection of the Southwest and AirTran route networks. That will put us in a position to follow up aggressively to optimize the combined networks as if it were 1. And we have a number of markets that are not performing to our satisfaction, and we will begin to address those gradually throughout 2013. And of course, that is one of our leading drivers in our plans to boost our 2013 revenues by $1.1 billion. And of course, that is what will position us to hit our 15% return on invested capital requirement.

So with that very quick overview, I'd like to turn it over at this point to Tammy Romo, our CFO. And before I do that, I would just like to thank all of our Southwest family one more time for a tremendous 2012. So Tammy, over to you.

Tammy Romo

Thank you, Gary, and good morning, everyone. 2012 was a big year of progress for Southwest, as Gary noted. And I would also like to extend my gratitude to all of our Southwest warriors for their hard work and many accomplishments in 2012 that enabled us to report our 40th consecutive year of profits, which really is a remarkable accomplishment in our industry.

Our full year 2012 GAAP net income was $421 million, or $0.56 per diluted share. And if you back out the special items, our 2012 net income was $417 million, or $0.56 per diluted share, which was up 30% versus our 2011 EPS.

We ended the year with a solid fourth quarter performance. Our fourth quarter 2012 net income x special items was $65 million, or $0.09 per diluted share, which exceeded First Call Consensus by $0.01.

Despite challenging year-over-year comps from the December holiday mismatch, Hurricane Sandy and last year's ticket tax benefit, our fourth quarter revenues were strong. Our operating revenues were a record $4.2 billion, driven by record passenger revenues and an impressive growth in cargo revenues. Passenger revenues were a record $3.9 billion. Passenger revenue yield, passenger unit revenues and operating unit revenues were all fourth quarter record.

Also, I want to point out, we changed the income statement classification of certain revenues from purchase points in our frequent flyer program in the fourth quarter. The reclass didn't change our total revenues, our bottom line, but was simply a shift of revenues from other revenues to passenger revenues. And these points are largely redeemed for Southwest flights. The reclass totaled $27 million for the first 9 months of 2012, and our fourth quarter 2012 results reflect $11 million related to this reclass. For purposes of your models, the impact on a monthly basis was immaterial versus what we reported to you in our monthly traffic releases.

On a unit basis, passenger revenues grew 2.3% year-over-year, led by strong October PRASM of close to 6%, followed by a solid November, especially considering the challenging year-over-year comparison.

December was impacted by Christmas return traffic, as Gary mentioned, falling in January. But overall, we had solid holiday traffic over the 2-week periods spanning December and January.

Passenger revenue yield increased 3.4% year-over-year. We implemented 4 systemwide fare increases. And while they had a positive impact to unit revenues, the benefit from recent fare increases has been less than what we've historically realized. And this is a testament to the challenging yield environment and just underscored -- underscores the nice traction our commercial team is making in this difficult environment and in the midst of integrating the Southwest and AirTran network.

We are seeing encouraging signs in our business travel trends. Our mix of close-in passengers for fourth quarter was in line with the third quarter mix of 20%. While our mix was relatively unchanged from third quarter, revenue performance was encouraging.

We continue to be pleased with the strong revenue contribution from our ancillary products and initiatives. Our Business Select revenues were approximately $23 million, a fourth quarter record performance. We recognized another $50 million in incremental passenger revenues from our Rapid Rewards program, bringing this year's total incremental revenue recognized from our new program to $180 million. As we've ramped up our all new Rapid Rewards program, results have been tremendous.

Wright Amendment revenues were also tremendous, increasing 18% year-over-year to $67 million in fourth quarter and with full year 2012 totaling $276 million.

We continue to be very pleased with the revenue contribution from the incremental 800 and Evolve seating. The fourth quarter benefited by over $50 million from the incremental seats and full year 2012 in excess of $100 million.

Overall, our EBIT contribution from fleet modernization was on track with our forecasted $70 million, and we continue to anticipate a $300 million EBIT contribution in 2013.

Traffic and revenue trends thus far in January suggest passenger unit revenues will be up in the 2% to 3% range compared to January of last year.

On Monday this week, we began selling available A1 through A15 boarding positions to customers 45 minutes prior to departure for $40 per flight. This new option is not a replacement for our Business Select Fare or Earlybird Check-In, but simply a creative way to generate revenue on premium boarding positions that are going unused. We tested the new boarding option in San Diego just -- for just over a month, and the customer response was very exciting. While still very early on, the results thus far from this week's launch have been encouraging.

Turning to fourth quarter freight and other revenue performance. Our freight revenues grew nearly 17%, driven by increased shipments as a results of better domestic economic conditions than fourth quarter last year. We currently expect first quarter freight revenues to be comparable to fourth quarter -- our fourth quarter 2012 performance.

Other revenues declined year-over-year in fourth quarter, largely due to the decrease in ancillary revenue from a reduction in AirTran capacity. We currently expect first quarter other revenues to be comparable to first quarter last year.

EarlyBird revenues in fourth quarter was $39 million and for the full year, $161 million, far exceeding our original expectations. We also recognized $70 million in fourth quarter from other seats.

As previously announced, EarlyBird charge will increase from $10 per one-way ticket to $12.50 per one-way ticket effective in March 2013. Beginning next month, fees charge for certain check baggage will also increase. In addition, we plan to tighten the flexibility associated with our least expensive and most restrictive tickets later this year by implementing a no-show fee for customers that do not call ahead to cancel their ticket prior to the originally scheduled flight time. All of these new 2013 revenue streams are expected to contribute an estimated $100 million incremental revenue.

Turning to fuel. Our fourth quarter 2012 economic fuel price per gallon, including fuel taxes, was $3.32 per gallon, which was in line with our most recent expectations and significantly less than our initial guidance of $3.45 per gallon at the beginning of the quarter.

Our hedging premiums, which are included below the line, and other expenses, were $3 million versus $14 million in the prior year. As always, we provided a fuel hedge sensitivity table for your reference in this morning's release. As all of our 2013 fuel hedge positions are based in Brent, you will notice the chart reflects Brent average crude oil scenarios rather than WTI historically presented in this chart.

Based on market prices as of January 18 and our minimal hedge position, our first quarter 2013 economic fuel price is forecasted to be approximately $3.30 per gallon, including a $0.05 locked in loss. As a reminder, after first quarter 2013, we no longer have any exposure to locked in losses from our 2008 legacy hedge portfolio. Our net premium cost for first quarter will be approximately $5 million.

The increase in our fourth quarter unit cost, excluding fuel, profit sharing and special items, was in line with our guidance. As expected, investment in our fleet initiatives contributed about 1.5 to our fourth quarter cost inflation. The remainder of the fourth quarter year-over-year cost inflation related to labor rate and health cost increases.

We currently expect first quarter unit cost, excluding fuel, special items and profit sharing, to increase year-over-year in the 5% to 6% range. However, we expect year-over-year cost pressures, excluding fuel, profit sharing and special items, as Gary mentioned earlier, to ease dramatically in 2013, especially in the back half, as we complete our Evolve retrofits and begin to realize more of our fleet modernization benefits.

On the nonoperating cost side, our net interest expense declined year-over-year from lower debt. We expect first quarter 2013 net interest expense to be comparable to fourth quarter.

We ended 2013 with $3 billion in cash and short-term investments. And as Gary already covered, our cash flow from operations was very strong at $2.1 billion and free cash flow for the year was over $700 million. With our share repurchases and increased dividends, we returned $422 million to our shareholders. We repurchased $400 million of stock in 2012 or approximately 46 million shares, and that totals $625 million or 73 million shares under our $1 billion authorization.

We made $578 million of debt repayments in 2012, which included the prepayment of approximately $19 million in December related to a high interest aircraft secured loan that we assumed as part of the AirTran acquisition.

Our leverage, including off balance sheet aircraft leases, continued to decline, and it was 41% at year-end.

For 2013, we expect another year of healthy free cash flow. Our 2012 cap spending forecast remains in the $1.1 billion to $1.2 billion range, and our 2013 scheduled debt maturities are expected to be in that $200 million range, which includes our intent to make a $20 million prem payment on another high interest aircraft secured loan from AirTran later this month.

Overall, I am very pleased with our financial position, as we remain investment-grade with strong liquidity, modest debt and a focus on preserving our financial strength and enhancing shareholder value.

Just to give you a quick recap of our 2013 fleet and capacity plan. For 2013, we have 20 firm orders for 737-800s and we expect to transfer 16 717s to Delta. When combined with our Classic retirement schedule, we expect our fleet to be down slightly this year.

We expect our 2013 ASM capacity to increase modestly in the 2% range year-over-year. And of course, this capacity increase is driven by incremental seats from the addition of the 800s and the 6 extra seats from our Evolve retrofits. However, on a trip basis, we'll be down in the 2% to 3% range year-over-year.

For first quarter 2013, we expect capacity to be flat over -- versus 1 year ago. And for second quarter 2013, we expect our available seat miles to increase in the 2% to 3% range year-over-year.

Overall, just very pleased with our 2012 results. Our people have done a just wonderful job navigating through a year full of tremendous accomplishments. Looking at the first quarter, January revenue trends thus far are encouraging, as well as bookings for the remainder of the quarter. We have significant revenue opportunities this year, bolstered by our strategic initiatives in our new revenue stream.

We continue to work diligently to control our cost, and we expect second half 2013 unit cost tailwinds year-over-year as we complete our Evolve retrofits and we begin realizing more cost benefits from our fleet modernization initiative.

We are starting the year with excitement and confidence in our 2013 plan that calls for reaching a 15% ROIC this year.

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

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Michael Linenberg with Deutsche Bank.

Michael Linenberg - Deutsche Bank AG, Research Division

Just 2 questions here. You talk about some of the ancillary revenue opportunities, and I saw the press release out not too long ago that the Row 44 product, I think it's in 300 or 400 of your airplanes. What's -- how is that doing thus far? What's the uptake? What's the opportunity there? How should we think about it?

Gary C. Kelly

Well, I think considering that the installation time has been pretty lengthy and we haven't had a majority of the aircraft that were installed. As a consequence, we didn't have any marketing awareness or merchandising of that feature behind it in any meaningful way. Considering that, that's about where we are here, Mike, in 2012, I think it's done fine. The reliability of the product was not where we wanted it to be in prior years. It's now running -- last statistics I saw were 98%, which is not quite good enough, but it's not too bad, considering the leading edge technology that it really offers. So we did, last year, Tammy, I think we did $5 million or so in revenue from the product. Obviously, we're looking for a lot more than that. The take rates are -- escape me at the moment, but I want to say that, clearly, long-haul has a better take rate than the short-haul does. It's a little bit behind our expectations. But again, I would attribute a lot of that to comments that I've already made. What is very exciting that we put in the press release, and again, our marketing folks are going to get behind the product this year and start promoting it much more heavily, is we do have a live television feature. It is really good. They're going to increase the offerings with that. And we'll also be in a position where we can offer some video-on-demand. And that's just, of course, in addition to the straight up Internet access. So I think it has a lot of potential. I don't think that history is going to be a guide. And I'm kind of anxious to see what happens here this year. But with -- Bob, so in terms of your $1.1 billion revenue plan, it's not a material element of that.

Robert E. Jordan

It's not.

Gary C. Kelly

So I think that's just pure upside for us.

Michael Linenberg - Deutsche Bank AG, Research Division

Okay, good. Just my second question, and Gary, this is for you as well. When I look at some of the DOT stats on part-time versus full-time employees, one thing that sort of stands out, and again, this may be how they crunch the numbers, Southwest seems to be -- seems to have a lot less part-time than most other carriers. And you've seen a lot of the major carriers, some of these has been through the restructurings that they've gone through. They do have a lot more variable cost element to their business. They brought on a lot more part-time employees. And my sense is that, that's going to become -- there may be more of a drive toward that direction, given the change in health care costs and minimum thresholds that people need to work in order to be fully covered versus sort of pay on their own. Is it because Southwest is historically been much more highly unionized than the average carrier? Has that prevented you from pursuing a lot more part-time type opportunities? Or what's behind that number? And again, I'm assuming that the DOT sort of treats everybody on an apples-to-apples comparison in how they count this data.

Gary C. Kelly

Mike, we -- just trying to cut right to the bottom line here, we are more unionized than probably any other U.S. airline. But I don't think the original -- the essence of it initially was because we're unionized. Now it is a factor in union contracts, so we don't have the unilateral ability in all of our union contracts to have unlimited numbers or percentages of part-time. So let me at least acknowledge that, that is a constraint. What is different today compared to even 20 years ago, much less 40 years ago, is the world has changed and the need for flexibility, I think, more than trying to avoid health care cost, it's the need for flexibility that's really driving this, where we don't have an even flight schedule throughout the day. And now we're trying to get into markets like Key West, Florida, which has 2 daily departures. So clearly, you can't have full-time headcount complements there. We do have a fewer -- we have a lighter schedule on Saturday, as an example, and obviously, we don't need as many staff on a day that we have fewer flights. And I think the future really is trying to get the flight schedule matched up better to customer demand, and that will -- that clearly creates a need for more flexibility in the future than what we had in the past. So for whatever reason the world has changed, perhaps we didn't need as much flexibility 30 or 40 years ago, clearly, today, we do. Fuel prices are probably the big game changer there. And it is definitely something that we will need to do in the future to be successful. We'll need more part-time workers in our workforce.

Operator

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

Hunter K. Keay - Wolfe Trahan & Co.

Gary, is it possible for you guys to introduce checked bag fees without damaging the Southwest brand?

Gary C. Kelly

Well, customers hate bag fees, Hunter. So I think that by definition, there would be an impact to the brand.

Hunter K. Keay - Wolfe Trahan & Co.

Okay. Yes, okay. And I guess, as we think about -- this is kind of a -- just a question about your frequent flyer accounting. As your load factors have been driving up over the last couple of years, is there a thought to maybe changing the frequent flyer accounting from incremental cost to deferred revenue? And if so, what kind of impact should we expect on the financial statements if you were to make that change?

Gary C. Kelly

Tammy, do you want to answer that?

Tammy Romo

Yes. At this point, we're not contemplating any change in our frequent flyer accounting program.

Operator

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

David E. Fintzen - Barclays Capital, Research Division

Just as we look through the quarter, there's obviously potential to get deeper into the quarter, there's a lot of things moving around on the RASM side. I'm just curious how sort of 2 factors plan to how we should think about the comp progression. One is, I mean, it looks like you're running a schedule that's much more March heavy than it's been in the past. So you have a nice -- you have a more of an uptick in ASMs in March. And then the second thing is you've got the codeshares pulling in. I'm just wondering, how do we balance those 2 things? I mean, should we be thinking about a March RASM comp that's more impacted by the capacity and not enough time with codesharing? Just any help there would be great.

Gary C. Kelly

Well, I think that, that is a fair question. I think it's a little bit premature to suggest that we're going to have a challenge in March. I think the best -- it's seasonal, so I think the best thing we have going for us with a little more capacity in March is just the fact that, that's when demand really begins to surge. You are correct, at least in my opinion, in assuming that there won't be a whole lot of codeshare traffic realized in the month of March. We really don't have all of that optimized until the 1st of April. So March will miss that. As we look at the broader economic trends, it seems to support the current, the sort of the fourth quarter unit revenue growth rate. Tammy shared with you what we've seen so far in January. And as long as the economy doesn't take a hit from the increase in income taxes, which really [ph] doesn't -- there's no sign of that yet. I'm not overly concerned about March. Tammy, I don't know if you want to add anything.

Tammy Romo

Yes. The only thing I would add to that is just a reminder that March does have the benefit of early Easter versus April in 2012. And then just as you think through the sequential trends, January, of course, benefited from the shift on holiday traffic, so when you look at sequential trends from January to February, that would -- you just want to think through that as you compare that to average. That's in -- I think, when you look at how Easter falls, if you look at historical trends where Easter was in March, I don't think there's really anything, at least at this point, that we're expecting that would be unusual and as you try to trend this throughout the first quarter. And then as you pointed out, codeshare, certainly, that benefit would be more in April.

David E. Fintzen - Barclays Capital, Research Division

Okay. And then, just even thinking a little longer term on codeshare. I mean, when you think back to the ATA codeshare, and I know it's in much smaller scale. But you obviously have a booking curve that's got to get into place. But was there also any signs of sort of a spool up above and beyond that? Or is that once you sort of turn on the codeshare, work through the booking curves, you kind of get your fair share, so to speak? Or is it consumers have to take some time to learn that it's out there?

Gary C. Kelly

You're testing our collective memories prior to the summer of '08. But it's pretty instant. You publish these itineraries. And that's where the brand comes in so strong as -- if you have people that come to southwest.com looking for itineraries, they don't know what dots we connect. And so, it's pretty immediate. Because that's the only way you're going to get it. In other words, we're -- you won't have billboards out there promoting these new itineraries, so the only way people are going to find it is by coming to southwest.com. So I think it ought to ramp up pretty quickly. But again, we're -- we don't have any way to -- there's no empirical forecast that we can share. It's just based on our judgment and just the logic that you're applying. And certainly, that was our experience with ATA.

Operator

And we'll take our next question from Jim Parker with Raymond James.

James D. Parker - Raymond James & Associates, Inc., Research Division

Is it correct that your AirTran synergies are in line with your expectations?

Tammy Romo

Yes. They are tracking right in line thus far.

James D. Parker - Raymond James & Associates, Inc., Research Division

Okay. It would be a little inconsistent, I guess, with what we're seeing in Atlanta because you have taken down flights rather dramatically. And I -- my question would be, how is Atlanta as a focus point performing, and what is your game plan? Because in the beginning, we were concerned that it would take a -- it would have a very negative impact on Delta, and now it appears actually it's pretty good for Delta. So what is -- are you realizing the synergies in Atlanta that you anticipated, and what's the game plan for Atlanta?

Gary C. Kelly

Well, I don't know that I can apply the synergies to a location, Tammy, as I'm thinking out loud here. The -- and Jim, the other thing that I am reacting to is the "taking down the capacity." So I think, we're about, in terms of total flights between Southwest and AirTran, on a combined basis, we're about where we were when we bought AirTran. The problem with Atlanta right now -- the problem with the AirTran flight schedule right now is that it is suboptimized. So we closed 14 airports in 2012. At the same time, we've begun to introduce flying at Southwest with the thought that it will eventually all convert from AirTran into Southwest Airlines. So there is no doubt that it's suboptimized. By extension, because the majority of AirTran flying goes through Atlanta, Atlanta is suboptimized. So I don't think there's any -- there's no secret about that. I think despite all of that, we're still on track realizing synergies. Understanding, Jim, again, I think Tammy and her team have been very clear on this, the synergies so far in '11 and '12 are really cost driven, not revenue driven. So '13, once we connect the networks and then begin this optimization effort, this is the year where Bob and his team are going to be bringing a lot of revenue synergies to the table.

Tammy Romo

Yes, Jim, you'll start to see that flip a little bit here in 2013. So as we continue to bring AirTran employees over to Southwest, you'll see the -- we'll have more cost to synergies. But of course, the thought here and the plan here is that those would be more than offset as we begin connecting the network. So clearly, the revenue synergies will come on much more significantly once we codeshare and have the ability to optimize our Atlanta flying.

Robert E. Jordan

Yes, David (sic) [James]. This is Bob. I would just add a couple of things. There are real positive signs in Atlanta, like the gains we've seen at local passengers. It really is, as Gary said, the inability to just optimize the networks because we don't have the connectivity. So where we have been able to, for example, manage the capacity in overlap markets, we've seen really good results. A lot of that we just cannot do until we have the connectivity. And so you're just running a suboptimized AirTran network in Atlanta. The flight schedule, I think, we're -- as Gary said, we're right on top of about where we are. We might be down 10 to a dozen flights from a year, 18 months ago, but it's -- a lot of that relates to the number of aircraft that have been converted out of AirTran already to pull -- and we've had to pull the schedule down there. But where we've had a lot of optimization techniques and changes are going to come with the connectivity, that will be starting here in the next couple of weeks and continue to the first quarter. And I'm just very optimistic about what that will do for our revenue performance once we can really optimize the combined network.

Gary C. Kelly

Jim, again, and hopefully, we're not over explaining here, but we haven't done anything in Atlanta, I think, is sort of the bottom line. Except to begin the process of unhubbing it. And so I think all of the cities that we closed were tied in to Atlanta. So we're just -- this is the year where we really get to work on building Atlanta. And the nice thing is we've had just such a wonderful reception in the community. So we're very pleased with the reaction to the Southwest brand. And I think we are in a -- from our perspective, we're just getting started in 2011. And to be at this point, I think is very exciting for us. So we got a big year coming up, though, for Atlanta, no question.

Operator

And we'll take our next question from Duane Pfennigwerth with Evercore Partners.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Regarding your full year CASM guidance, any update, maybe I missed it here, to the sort of 1% growth rate that you've -- I think you put forth at Investor Day.

Tammy Romo

No update. That is still our guidance.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Okay. And then can you just tell me what that assumes regarding new labor agreements and how you'd handicap a new pilot agreement this year?

Tammy Romo

It is based on our current contract.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

And how would you handicap the odds of a new pilot agreement this year?

Gary C. Kelly

Well, I -- that's nothing that I can predict. So we are in negotiations with more groups than our pilots, of course. And we will have more groups coming online this year. So we'll have a lot of labor discussions underway. They're all productive. And of course, we have the benefit that we've always enjoyed here, which is a very strong culture. And I think our employees are very interested in maintaining our low-cost leadership and growing Southwest Airlines. I think everyone understands, we have to hit our prosperity targets. So we're -- I think we're very encouraged about the support that we see on that front from our labor groups.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

I appreciate that detail, Gary. And then just with respect to the sort of priority boarding at the gate. Can you talk about, on average, how many of those A1 through A15 boarding slots are typically open at departure? Or are you now blocking those off going forward?

Gary C. Kelly

Well, let me give it -- I'll let Tammy do a little math in her head here while I'm at least framing this up. So I think you understand well. But for everyone's benefit, we have a new boarding process in 2007. We bring out a new product called Business Select. And that has more than just priority boarding as features with it, and it costs more money. In 2009, we brought out EarlyBird, which allows for a $10 fee that will soon be $12.50, automatic check in and also more of a priority in the boarding process. What we were missing was a feature or a product at the airport. And so this is filling that gap. We do 6% or 7% of our boardings, I think, by Business Select, probably more than double that by EarlyBird. So I don't think it will sell that many of this product. There are plenty of the A1 to A15 boarding positions. If you kind of back in with the math -- I just can't do that in my head. But I wouldn't suggest that you all assume that we'll be selling 10 of these per departure. I don't think it's anything like that. And Bob, your assumptions are much, much more modest.

Robert E. Jordan

Yes. The assumptions that were baked into the revenue plan that we shared with you at the Analyst Day were very modest. And so we're talking about selling 1 or less than 1 per flight. Because again, as Gary said, it just fills the gap in terms of something that's available at the gate. Now we ran a test for about a month in San Diego. And the test was very positive. It was positive both in terms of the feedback from our customers and our employees. We heard a lot of "wow, this is the best thing you've ever done" kind of feedback from both sides. And on the take rate, we actually had a take rate in that test, which was not publicized, which exceeded our expectations, so, by a little bit. So I'm very encouraged about the product in total. It launched on Monday. So we have just a little bit of data so far. I wouldn't draw many conclusions from that, but I'm very encouraged about number one, the fact that the product does fill a gap that our customers want. And number two, that will hit the financial targets that we embedded in our plan for 2013 around that product.

Tammy Romo

Yes. And just in terms of the potential benefit and what we have baked in to the plan. As you will recall, it's part of the $100 million guidance we have for all of our new 2013 ancillary revenue initiatives. But just for this product, it's potentially in the tens of millions. So we feel really good about it so far based on the early results.

Gary C. Kelly

And again, Duane, we can wrap this up for you. I'm sure we've given you more than you want. But the -- just to frame it up, Business Select, our target was $100 million a year, and we're real close to that in 2012. EarlyBird is more robust. So it's not $200 million, but it's getting closer to that. So this is far more modest than either Business Select or EarlyBird, we think. If it's better than that, I think that will be fine, too.

Operator

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

John D. Godyn - Morgan Stanley, Research Division

Gary, just a follow-up on the bag fees concept. Years ago, when you introduced the no-bag-fees policy, you used to talk about how much you benefited on the PRASM side through a load factor growth and even some yield strength by not charging the fees. I'm not sure if you can quantify that benefit today. But if you were to pursue bag fees, wouldn't it follow that we'd see significant pressure on either yields or loads that could more than offset the benefits of the fees? Or has something changed about that framework today?

Gary C. Kelly

Oh, no. I think you're exactly right. And of course, the longer -- the more the time goes by, the more chance we have to research this and experiment. But our judgment at the time was that we would be revenue positive by virtue of the fact that we would get more customers, and that would outweigh the direct fee revenue. In the intervening years from -- -- that was lost in '09. In the intervening years, our market share, adjusting for capacity changes, has been up as much as 2 percentage points at times. So yes, we've consistently shared that the best estimate that we had was about $1 billion increase annually from these market share gains, which we attribute much of that to our baggage policy. What marketing has begun to do more scientifically here in 2012 is much more specific research. Because now customers know. I mean, they know what we do. They know what others do. And so you can introduce a series of questions. And in doing that, interestingly enough, it supports the argument that we've been making that it would cost us, and it would cost us something close to $1 billion. Now who knows if that is true until you try to do that. But in any event, that is our judgment. And we don't have any plans to charge for bags at this time.

John D. Godyn - Morgan Stanley, Research Division

Great, that's really helpful. And just some of your competitors have suggested that continued rationalization in the industry is going to raise returns at the legacy airlines, mostly in the domestic market as opposed to international. When you think about what that might mean for Southwest, if it's true, would that be an opportunity to ride sort of the rising tide of improving domestic returns? Or is that more of an opportunity to bring back this sort of virtuous cycle of taking advantage of markets where competitors are earning too much by growing market share and then using that growth to keep cost low and reinforce your advantage there? How do you think about that?

Gary C. Kelly

Well, I think our overarching goal is safety and financial prosperity. And it is just through that mechanism that we can take care of our people, take care of our customers, take care of our shareholders. So it has to be with the goal in mind that we're going to hit our 15% return on invested capital target. Clearly, if you think about the big 3 factors on us, externally, it's the economy, fuel prices and competition. So if competition eases in markets, that's just going to make it more attractive for us and certainly could facilitate us hitting our 15% return.

John D. Godyn - Morgan Stanley, Research Division

Okay. But it's fair to say that until you've hit those -- until you hit that return target, we probably wouldn't see this -- more of this bringing back the virtuous cycle kind of angle? Is that a fair concept?

Gary C. Kelly

I'm not sure I agree with your virtuous cycle terminology.

John D. Godyn - Morgan Stanley, Research Division

What I'm getting at is just more accelerating capacity growth.

Gary C. Kelly

Well, the world is just not that black and white. So the answer to your question in the sense that yes, that is our overarching goal is to achieve financial prosperity, which is specifically defined as 15% returns. So that will be -- we've got to have a belief that we're on a path to do that or we shouldn't be taking any actions to the contrary of that. Whether or not we're going to be more aggressive at a point in time or less aggressive with capacity, I'm not taking that off the table. I mean, that's one of our biggest competitive advantages, it's our low cost, our superior customer service. And you simply weaken a company by retreating. So we'll definitely want to continue to be aggressive but mindful of the fact that we need to hit our 15% return.

Operator

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

Jamie N. Baker - JP Morgan Chase & Co, Research Division

If I was to walk into the headquarters and survey Southwest employees as to which department wields more clout, the finance department or the marketing department, what do you think the answer would be? And the reason I'm asking here is when I think about your accounts, trends and raising fares or first bag fees, these do seem like good marketing ideas. But as an analyst, I'm conflicted in terms of the financial impact. So I'm just kind of wondering, which department carries a bigger stick, for lack of a better term?

Gary C. Kelly

Well, that's like asking what's more important, your brain or your liver. You can't live without either one. So they're all important and they all really carry equal importance. And that's why I said I think the highest priority that we have at the company is to be safe and to be financially strong. So those are -- they're not mutually exclusive.

Jamie N. Baker - JP Morgan Chase & Co, Research Division

Let me go at it about a slightly different way. Let's say your revenue management team, hypothetically, you see strength across the board in all markets and decides that demand could support higher fares. How does that process play out? What happens next? Do they walk into your office, Gary? Do they walk to the marketing department to get approval? Do they have a unilateral power to execute an increase on their own? I'm not asking you to comment on future pricing. I'm just curious when you've raise fares in the past, how does the process internally play out?

Gary C. Kelly

Well, I think, I'm the old CFO. But the -- there are companies that are famous in the country for having the finance department control the company. No, our commercial organization is led by Bob Jordan, and he is empowered to execute his plan.

Robert E. Jordan

No. We'll tell you, of course, when we have -- when we're working on new ideas, the A1 to A15, for example. We always have that vetted by our financial team. We are a team. We work together. But yes, the -- particularly on the commercial side, things are moving every single day, and we have to make a lot of judgments hour by hour as they come at us.

Tammy Romo

Jamie, we all sit very close to each other and we talk all the time. So we are -- we vet everything and we work very, very closely together.

Gary C. Kelly

I mean, the nice -- and I'm not sure exactly where you're angling, Jamie. So we may not be addressing the essence of your question. But the nice thing about this group is that they are a team. And they don't even think the way that you're asking the question. So it's -- we all share the same -- you will get the same answer from every person here when you talk about what we stand for, where we want the company to go, how -- what we're going to do to get there. It is a very tight team and we work extremely well together, and that's how we're going to win.

Operator

And we'll take our next question from Helane Becker with Dahlman Rose.

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

When I look at your revenues over the last, say, 3 or 4 years, the real revenue increase that you've seen recently has been as a result of the AirTran merger. So could you talk a little bit about how you get to the next level? How you get the next -- well, you talked about your goal for the next $1.1 billion. But how do you go beyond that? Or is that it?

Gary C. Kelly

Well, maybe a contrast is helpful in answering the question. If I think about where we are compared to the competition, we're not dependent solely on fare increases from here. We have a number of opportunities to optimize the acquisition that we've been spending quite a bit of time talking about this morning. We have opportunities to enhance our revenue management. We're going to be bringing forward new technology with a reservation system, which has tremendous revenue-generating capabilities along with that. And we don't serve beyond the 48 states in any meaningful way. So we have opportunities to grow our loyalty, to grow the number of customers that we have and also to, obviously, grow the number of destinations that we serve. So we have enormous opportunities to grow revenues. It just has to be done in a way that also grows profits and at the right return level, so very different than our competitors. And we'll always have the ability to expand beyond North America later. But really, everything that we're talking about is within the reach of the 737 as well. So it's a very efficient way for us to expand.

Robert E. Jordan

Helane, the other way -- just to make the point, if you just look at what we've laid out for 2013, what we talked about at Analyst Day, for example, the addition of the O&D revenue management, the network changes to harvest aircraft out of block and turn these ancillary revenue ideas, continued increase on All-New Rapid Rewards, the addition of the seats to the Evolve and 800s, those are adding in 2013 on the order of $700 million to the revenue plan. So that is completely outside of the AirTran acquisition, for the most part. So I think if you just look at the plan for 2013, I think it proves that the -- the fact that there's a lot of opportunity.

Gary C. Kelly

And I guess just the last point to try to make here is, and I think it relates to several of the previous questions, that we are a brand. And it is firmly affixed in people's mind, and that is a good thing. But we are a low-fare, low-cost brand. And so in answering your question and others', what we are -- what we're determined to do is maintain that low-cost leadership so that we can maintain our low-fare leadership, and then it makes these things possible. If we're going to change our brand, then I think it changes the answer to your question entirely because I don't think we do have opportunities to grow revenues in a meaningful way, if we're going to become a high-cost, high-fare carrier. So it all has to start with who are you and what do you want to be. And I think so long as we're low cost and low fare, we have significant opportunities to grow revenues.

Operator

And we have time for one final question today, it is from Kevin Crissey with UBS.

Kevin Crissey - UBS Investment Bank, Research Division

If I just take your return on invested capital table and just simply do the math to get to 15%, if we double your operating income and don't change the invested capital base, you come out of it like 14.4%. So you need to do a little bit more than that. If we think about the mix between the denominator and the numerator, how much should we expect of it to be coming from the improved operating income versus the reduction in the invested capital, considering that your invested capital calculation is a 5 quarter average, it looks like?

Tammy Romo

Well, I think we have already shared with you, I've been pretty -- well, actually in great detail what our numerator, at least our planned numerator would be for the -- for ROIC calculation. So obviously, just mathematically, the rest would have to come from the invested capital base.

Operator

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

Marcy Brand

Thank you, Tom, and thanks everyone from the analyst community for joining us today. Everyone, have a great day. Of course, if you have any additional questions, we are available this afternoon.

Operator

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 Communications and Strategic Outreach.

Linda B. Rutherford

Hi, Tom. Thank you, and good morning. Everyone. If the media folks would queue up, then we will begin to take your questions. So Tom, if you could let them know how to do that.

Operator

[Operator Instructions] And we'll begin with our first question from Terry Maxon with The Dallas Morning News.

Terry Maxon

I'll have my usual parochial question. The -- your first gates at Dallas Love Field's new terminal open, I believe, in April for you, about 12 gates.

Gary C. Kelly

Yes, sir.

Terry Maxon

In that interim, 18 months between the time that you can fly nonstop anywhere out of Dallas Love Field, how do you intend to use those 12 gates? Will you use them more intensely than you had at the -- at your old concourse and there's a period where you'll be using gates in both of them? Do you intend to step up your activity in the short term with the new gates? Will it allow you to do so?

Gary C. Kelly

I think, Terry, the way to think about 2013 is it's pretty much a continuation of what you've been seeing. So I don't think we'll have any major changes just because of the opening of the new airport. As we get closer, it's really more of a question about what are we going to do next year. And we're in the, I would say, early stages of debating what our options are there. A lot of it will have to do with, obviously, trade-offs throughout the rest of our system. But the -- and Ron Ricks is here. So I'll let him jump in. But we've opened the ticket counter space on November 1, as you well know. The concourse is on schedule to open. I believe it's 11 gates first, Ron, and there's a 12th that's added very quickly. I think there's some ramp or tarmac work that has to be completed. And we'll move the vast majority, the super majority of our flights over to the new terminals. So we're very excited about that. But that's just going to pick up Southwest as you know it today and move it over to some brand-spanking-new facilities.

Operator

We'll take our next question from David Koenig with the Associated Press.

David Koenig

Gary, yesterday, Scott Kirby talked about the high load factors, and said they're offering a precursor to higher fares. He wasn't talking specifically, I don't think, about his airline. I wondered if you agree. And also whether further industry consolidation might increase momentum for higher fares?

Gary C. Kelly

Well, I think that the fares, at least from our perspective, are a function of cost. And we are finally in 2012 and 2013 getting adjusted to record energy prices. So to have crude oil in $112 a barrel and us talking about hitting our prosperity, a financial target is a pretty remarkable thing of -- for those of us who fought the battle here for the last decade to overcome fuel prices. So that's the main driver. As a practical matter, if the market can't absorb those charges, well then, you're kind of left with an unsuccessful business. So clearly, supply and demand and -- are key factors in any economic equation. And then of course, it ultimately is at what price. So if supplies stay the same and demand improves, clearly, there's an opportunity for pricing to strengthen. Load factors are one indication of that. But because we have such disparate travel habits between business travelers and consumers, that's not always a good indicator. But load factors, absolutely across the industry, are at record high levels. That does indicate, I think, pretty good health of the industry, certainly in relative terms to the prior years. And as I reported earlier, the industry, at least in the markets that we serve, is not growing capacity. So if the economy continues to improve and demand continues to improve, that would be a good healthy environment for everyone.

David Koenig

And then the consolidation part of that, would more consolidation increase that momentum?

Gary C. Kelly

It just depends on what is done in consolidation. If consolidation is 1 plus 1 is less than 2, then that means you're taking supply down. And yes, I think that, that would strengthen pricing, if that's what happens.

Operator

And we'll take our next question from Andy Compart with Aviation Week.

Andrew Compart

Gary, you said at the beginning of the analyst call that there are a number of markets not performing to Southwest's satisfaction, and you'd begin to address those gradually during this year.

Gary C. Kelly

Yes, sir.

Andrew Compart

If you can elaborate on how you plan to address them? Are these markets that you're going to pull out of to change the pattern of service, change the frequencies? What's your thinking there?

Gary C. Kelly

Andy, I think it's all of the above. And in some cases, it may just be moving the flight times around a bit. One of the things that Mike Van de Ven and Bob Jordan are working jointly together on is to get more of our flights concentrated between 8 a.m. and, say, 7 p.m. And so there are -- if we can improve the efficiency of the aircraft scheduling during the day, there are opportunities to get more flights in that premium part of the day. So you -- we have obvious things like that, that we could do. But it could be that short-haul markets are a perfect example, Andy, where 10 years ago, we had far more frequencies in short-haul markets because there were far more travelers in those markets. So we've trimmed out frequencies, and I'm sure we'll continue to do some of that here in 2013. I hope what we have less of is eliminating nonstop service between city pairs. But again, in this environment where costs have gone up, fares have gone up and travel demand has gone down in certain markets, that is a possibility, too. But for the most part, it will be, and Bob mentioned this earlier, it's a matter of trying to improve the efficiency of the airline schedule and have better market timings for our flights.

Operator

And we have time for one final question today. It does come from Ghim-Lay Yeo with Flight Global.

Ghim-Lay Yeo

I just have 2 quick questions. The first is about the retirement of 737 Classic. I think it was Tammy who mentioned earlier on that you'll be retiring some aircraft this year. Are you able to elaborate on that, please? And I have a second question that's to clarify about your comments about Atlanta. You said that 2013 is going to be a big year for the airport. So does that mean you're looking at adding capacity back in the -- into the airport for the year ahead?

Tammy Romo

Yes. In terms of Classic retirements for 2013, we're expecting to retire about 13. But again, as I mentioned in my comments, just from an overall fleet perspective, we are expecting to maybe be down just slightly in terms of a number of aircraft.

Gary C. Kelly

And with respect to Atlanta, Bob, would you like to speak to that?

Robert E. Jordan

Oh, yes, sure. On Atlanta, it's really not a change in the number of flight, it's a change in the flight schedule, so, particularly post the codeshare implementation. We can really begin to optimize the combined AirTran and Southwest schedules, which of course, most of that flows through Atlanta. So you'll see, what I would call pretty substantial changes in the actual schedule. But not -- I would say not substantial changes in the number of flights in Atlanta between the 2 carriers.

Operator

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

Linda B. Rutherford

Thanks, Tom, and thank you all for joining us this morning. As always, members of our media, if you have any follow-up questions, you can reach us at (214) 792-4847 or through our media site at www.swamedia.com. Thanks so much.

Operator

This does conclude today's call. Thank you for joining.

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