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Executives

Gary Kelly – Chairman, President & CEO

Laura Wright – SVP of Finance & CFO

Analysts

Hunter Keay – Stifel Nicolaus

Bill Greene – Morgan Stanley

Jamie Baker – JPMorgan

Dan McKenzie – Hudson Securities

Helane Becker – Jesup & Lamont

Will Randow – Citi

Duane Pfennigwerth – Raymond James

Southwest Airlines Co. (LUV) Q1 2010 Earnings Call Transcript April 22, 2010 12:30 PM ET

Operator

Welcome to the Southwest Airlines first quarter 2010 conference call. Today's call is being recorded. We have on the call today Gary Kelly, Southwest's Chairman, President and Chief Executive Officer and Laura Wright, the company's Senior Vice President of Finance and Chief Financial Officer.

Before we get started, please be advised that this 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 non-GAAP results; therefore, please see our earnings press release in the Investor Relations section of our website at Southwest.com for further information regarding our forward-looking statements and for a reconciliation of our non-GAAP results to our GAAP results.

At this time, I would like to turn the conference over to Gary Kelly for opening remarks. Please go ahead, sir.

Gary Kelly

Thank you, Robert. Thanks everyone for joining us this morning. We are delighted with our first quarter results. We had net income excluding special items of $24 million or $0.03 a share which was in line with our analyst estimates. With very high energy prices and weak demand quarter seasonally, it's just very tough to make a profit in the first quarter or so, just to have a profit I think is a very significant accomplishment.

I've already been asked to today how did our people do it. I think its very straight forward. We did it with industry leading low cost. We've done it with industry leading revenue performances and then finally with our great people. We have another outstanding quarter in terms of our customer service performance, another quarter of excellent operations and I'm very, very proud of our people.

It's been a significant transformation effort for them, a lot of change to manage and so again to have these kinds of results is just a huge tribute to our people. We have continued to aggressively turn our revenues with revenue management techniques, changes to our fair structure and also with our network planning that had a very nice benefit in the first quarter and course that will continue indefinitely.

Capacity was down 6.4% in the first quarter, and as a consequence our load factor was up. We had a record 75.9% first quarter load factor that was up six points, but also bucking the normal trend, our yields were also and normally when we see traffic rise and load factors arrives if that the expense of yields. Our yields were up 9.1%, which again is really helping to drive our revenue performance, just outstanding all the way around.

We set a number of records. We had an all time record quarterly unit revenue performance. If you look back compared to 2007, our unit revenues are up over 25%, and of course 19.3% just compared to the last year's recessionary performance. Second quarter that's far the trends are strengthening still; we have very strong bookings in place for April, May, June.

We are looking forward to opening up Panama City in May and I've been especially pleased with the strength of the bookings in that market because we just don't have any history because there is little air service in Panama City. We have a very unique partnership St. Joe Company.

It's just again a testament to the strong Southwest network and also the brand that we enjoy. The other real highlight I think to report on, and the real star in the quarter was Denver. We thanked our people there. Over and over, our Denver performance is pretty incredible. Our RASM was up in that market over 20%.

Our traffic is up over 20% and we're adding capacity at the same time. So just one example of how we are driving revenues at Southwest, but with that very quick overview and my thanks again to all of our people and all the great work they have done, Laura Wright, our Chief Financial Officer is going to take us through the details of the quarter.

Laura Wright

Thank you, Gary and good morning everyone. To begin with I'd like to echo Gary's comments and state that we are really pleased to report a first quarter profit. Our first quarter GAAP net income was $11 million or a penny per diluted share excluding special and non-GAAP charges totally a net of $13 million relating to mark-to-market and other items associated with FAS 133.

Our first quarter net income was $24 million or $0.03 per diluted share. That compares to a net loss of $20 million or $0.03 loss per diluted share in first quarter of '09 and these group results were in line with Wall Street main estimate at $0.03. Our improved first quarter results were driven by remarkably strong revenue performance.

Our passenger revenues were up over $240 million or 10.8%, and our other revenues were up $30 million or 40% despite capacity reduction of 6.4% during the quarter. Air traffic continued to grow again this quarter by 1.6% again despite of 6.4% reduction capacity. We continued to believe we are gaining market share with our steadfast commitment to our Bags Fly Free campaign and overall finance still primarily on the leisure side remained strong as evidenced by our record monthly load factors in each month of the quarter.

Our passenger revenue yields turned positive on a year-over-year basis during the quarter for the first time since January of 2009 resulting in a 9.1% increase compared to the first quarter of last year. This yield improvement strengthened throughout the quarter with January essentially flat, February up 9% to 10% and March yields up 16% to 17%.

As a result of the year-over-year important in both our load factor and our passenger yields, which is a combination we really like and we had an 18.4% year-over-year improvement in our first quarter passenger unit revenues. As reported in our monthly traffic releases, the year-over-year improvements in our passenger unit revenues also improved throughout the quarter.

We began to see some signs of improvement in our business demand in March. Our full fare mix in the first quarter was 20% up slightly from the first quarter of last year and up two points from the fourth quarter of 2009. However, for the month of March our full fare mix was up 3% versus March of '09. although our year-over-year comparisons became easier starting in February, the mix improvement particularly in our short-haul markets indicate were beginning to see some recovery in business travel demand.

Despite this increase in trends, we have not recovered the previous estimated levels that we saw pre-2009 that none the less, the trends are perfectly moving in the right direction. Demand for our Business Select product was strong in the quarter. Our Business Select revenue was $21 million. That's up from $18 million in both the first and fourth quarters of last year and we carried 15% more Business Select passengers in the first quarter of this year.

Our Wright amendment revenues were $47 million in the first quarter of 2010, a nice improvement from the $38 million from a year ago period and we again we continue to see significant benefit from our capacity test our network realignment and our revenue management effort, which combines contributed 100s of millions in revenues in the first quarter.

Overall, we're very encouraged by the recent passenger revenue trend, and so the first half of April, our month-to-date passenger RASM is estimated to have increased in the 19% range compared to the same period for April of last year. And as Gary noted, our bookings thus far for May and June also look strong.

Based on our revenue and bookings trend thus far, we're currently expecting another significant year-over-year improvement in our second quarter passenger unit revenues. Our freight revenues were in line with the first quarter of last year as a reduction in our capacity was offset by higher average rate.

Our other revenues increased 40% from the first quarter of last year's to $105 million, and that was primarily due to new revenue and this was never launched in the summer and fall of 2009. Our Early Bird revenues were approximately $17 million for the first quarter, that's up from $13 million in the fourth quarter of last year and we generated about $10 million in revenues on our pet carrier on the Company's minor service charge and access heavy bag in the fourth quarter combined.

We expect the similar year-over-year performance in our freight and other revenues in the second quarter as experienced in the first quarter. Turning to our cost performance, our first quarter operating expenses excluding special items increased 8.7% compared to the first quarter of last year due to largely to higher energy prices.

Our economic fuel cost including fuel taxes increased 33% to $2.34 per gallon in the first quarter, which was in line with what we anticipated. Based on the current forward curve, our crude prices are expected to increase with the back at this year forecasted close to $90 a barrel and heading at those levels are higher beyond 2010.

With the goal to minimize the impact of volatile energy prices, we continue to aggressively manage our fuel hedge portfolio using a combination of caller, call options and call spread. We provided our hedge positions for the remainder of 2010 including the second quarter in our press release this morning that to break that down at this further for the second quarter were effectively 44% hedged at prices settling up to $100 per barrel.

We are also about 17% hedged in the second quarter if price is settled in the $100 to $120 per barrel and about 35% hedge if price above $120 per barrel. Premium cost associated with our second quarter fuel hedge which are recorded below the line and other gains and losses are estimated to be in the $30 million range. For the second half of this year, we are approximately 75% hedge and crude prices up to $100 per barrel. The coverage dropped to 50% and prices settled in the $100 to $120 per barrel range and it increases to 75% to prices averaged above $120 per barrel.

Our premium cost for the second half of this year are estimated to be up about $70 million. Based on the April 20th market price which was around $85 a barrel for the second quarter, we estimate that our second quarter 2010 fuel cost including taxes, but excluding premiums will be in the $2.40 and $2.45 per gallon range.

This estimate includes a $0.04 per gallon hedge penalty. To provide you with some sensitivity with respect to our second quarter 2010 fuel hedge position and the corresponding fuel cost per gallon, at second quarter prices dropped from current levels in average $75 a barrel for the quarter, our estimated hedging penalty increases to $0.17 per gallon. However, second quarter average prices rise from current levels and average around $95 per barrel for the quarter. We would expect to have $0.07 per gallon hedging gain.

With respect to our fuel hedging strategy, we have not changed our fundamental philosophy that we must protect the enterprise against catastrophic energy prices. And as opportunities unfold in this market that will allow us to layer in protection in a cost effective, we are well placed to react.

Looking at the full-year of 2010, the volatility that we are experiencing is quite difficult to provide revised full-year guidance. However, based on the current forward prices, and our current hedge portfolio, our best estimate at 2010 fuel price and the $2.45 per gallon range and that's equates to about $0.06 per gallon, penalty of the current market prices for full-year 2010.

As of two days ago, the total net liability of our concurrent fuel hedge portfolio was about $260 million. Turning to non-fuel cost, our first quarter operating expenses excluding fuel in special items increased to 2.7% compared to the first quarter of 2009 or 9.8% on a unit basis driven primarily by the 6.4% year-over-year reduction in our capacity.

Increased profit sharing and revenue-related charges, which are primarily charged from discounts accounted for approximately one point of the 9.8% CASM ex-fuel increase. Weather cancellations accounted for 1 to 2 points of a 8.9% year-over-year non-fuel cost unit cost increase and if you exclude the weather impact, our non-fuel unit cost performance was slightly better than we expected, primarily due to lower than expected maintenance expense.

However, continued inflationary cost pressure most notably in our airport cost, non-labor or cost to strengthen our efforts to maximize our productivity gains. Based on these existing cost pressures, we currently expect our second quarter 2010 unit cost excluding fuel-related taxes to significantly increase from second quarter 2009's $0.0691, but to decline from the first quarter 2010's $0.0776.

For full-year 2010, our year-over-year unit cost pressure should ease somewhat in the back half of the year compared to the first half as a result of very modest capacity additions in the third and fourth quarter. With respect to airport costs, our first quarter landing fees and other rental unit cost increased 21.7% year-over-year to $0.0084, primarily due to airport rate increases and fewer favorable airport audit adjustments this year.

Based on the continued rate inflation at various airports, we expect our second quarter 2010 airport unit cost to increase from second quarter 2009's $0.070 that declined slightly from our first quarter 2010's $0.0084. Our first quarter salaries, wages and benefits increased 10.4% to $0.0382 over the first quarter of last year.

Higher wage rates in capacity reduction significantly contributed to the fourth quarter year-over-year increase. The weather disruptions related cancellations also increased our salaries, wages and benefits starting the quarter. During the second quarter of 2010, we currently expect a similar year-over-year increase from second quarter 2009 to $0.0338.

Our maintenance unit costs came in better than expected at $0.73, a decrease of 3.9% from the first quarter of last year, primarily due to fewer than expected airplane events and lower engine expense with less flying due to the weather cancellation. We currently expect our second quarter 2010 maintenance unit costs to be in line with second quarter 2009's, $0.0074.

Our first quarter other operating expenses for ASM increased 9.6% year-over-year to $0.0148, primarily due to reduced capacity and an increased in our revenue-related cost. We expect a similar year-over-year increase in second quarter 2010 better operating expense and the cost.

Turning to the balance sheet, we ended the quarter with $2.8 billion in unrestricted cash in short-term investment and we currently have core unrestricted cash in short-term investments of approximately $3 billion and our $600 million credit facility remains fully and done and available.

Our leverage including aircraft leases is in the low 40% range. Starting the quarter, we generated $373 million of cash flow from operations with first quarter capital expenditure of $139 million. For the full-year 2010, we continue to expect our capital spending to be in the $600 million, $700 million range.

With respect to our fleet, we ended the first quarter with 541 aircraft. During the quarter, we received three new airplanes from Boeing and we returned one as 737-300 on lease. Our fleeting capacity plans are unchanged with our full-year available mile capacity. We expected to be roughly flat with 2009 and as I mentioned earlier our year-over-year capacity declines awaited the first of the year with our largest quarterly capacity decline behind us in the first quarter.

For the second quarter, we expect our available seat mile capacity to be relatively flat or slightly better from last year's second quarter and our third and fourth quarters would both be up in the 2% to 3% range. We included an update in Boeing delivery schedule in the accompanying tables to the press release that was issued this morning and Robert with that Gary and I are now ready to take questions.

Question-and-Answer session

Operator

(Operator Instructions) Our first question comes from Hunter Keay of Stifel Nicolaus.

Hunter Keay – Stifel Nicolaus

Thanks very much. A question for you guys. Would you consider a merger partner – an out of bankruptcy merger partner that in all areas was attractive at face value like bolting on a new geography, say 737 fleet, flop a buy in, good economics, but there was push back from the acquiree's labor groups? Would that hold up you guys from pursuing something that would be accretive?

Gary Kelly

No and I'm just taking your question literally. I don't think it would hold us from pursuing it but there is a difference between pursuit and actually striking a deal. It's really tough to talk about these things in theory or hypothetically but we have a great company. We've got a great culture. We've got a great brand and I believe we have tremendous growth opportunities that could come in the form of organic growth like we have enjoyed most of our history but clearly we need to be open minded and see if there's a way that we could accelerate our growth and strengthen the company for the future by being open to a merger. There is nothing new Hunter in that view. I think that's always been our view and we have acquired two airlines in our history. So I think there is evidence of that philosophy baked into our history.

Hunter Keay – Stifel Nicolaus

Okay, great. Thanks, Gary. And how far along were you guys on the IT side with the WestJet co-chair and with that termination is there another IT initiative that maybe moves up in the queue in terms of priorities?

Gary Kelly

Well, we are – that work was suspended in 2009. So that's not new news. With the work that was spooled back up in the fall we jointly agreed with our two co-chair partners how we would approach that in terms of a work effort and timelines and deliverables in 2010. So with that revised work plan that was developed last year we're on track on that. The work that we have in front of us was intended to serve both countries, both Canada and Mexico. So I think in that respect in other words, our work continues uninterrupted by the termination with Canada.

The other thing to mention is that it's always been our desire to have a limited number of co-chair partners and part of it is more tactical in terms of where we go internationally with co-chair partners than strategic. So the point being that we felt like two partners was the right number to try to manage simultaneously.

Right now we're down to one and I think we're happy with that. If we can find another co-chair partner to an attractive market that fits in with our work plan over the next 12 to 24 months I think we would be open to that. But it's not anything that we're actively pursuing at this point. I think we're happy to concentrate on Mexico and Volaris, who is a terrific partner to work with thus far.

Hunter Keay – Stifel Nicolaus

Okay, very good. Thank you very much for the time.

Operator

Our next question comes from Bill Greene of Morgan Stanley.

Bill Greene – Morgan Stanley

Yes, hey there. Good afternoon. Gary, I'm wondering if we can think about something. One of your low-cost competitors has started breaking out fuel costs from the ticket price, sort of in effect creating a full surcharge concept for domestic tickets and it seems to me that could be a powerful tool for Southwest, given how low your ex-fuel unit costs are. But it's also got an unbundling aspect to it, which I sense you think is not a good thing. So how do we think about the idea of offering a lower fare, plus a fuel cost? Is that ever a good idea? How do you think about that kind of idea?

Gary Kelly

Bill as you were asking your question I was just thinking that through. I will admit to you that we haven't seriously considered that kind of a presentation and of course the DOT has rules on how one can advertise and present fair information. I'm looking at Laura here. I'm sure that there is complexity involved also in a way that one chooses to try to publish those kinds of things in various systems.

But passing on some of the, whether its easy or hard for us to do those kinds of things, one of the things that I'm concerned about as we evolve the Southwest Airlines brand here is complexity and we want to be transparent with our customers. We want them to be able to trust the Southwest brand, to be able to count on Southwest to deliver on promises and it just seems to me that the more you break that down, the more complex you make it and the more apt you are to surprise customers.

Nobody likes to show-up and at the last minute be stuck with an additional charge. But you asked a good question and it's something that I think we could probably give a little bit more thought to but I would admit to you, it's nothing that we have considered doing. I think Laura wants to comment.

Laura Wright

I think the DOT rules really do not allow us to advertise separately. So they're specific on what is an add on line PFCs and TSA charges but we couldn't market it and show it on the internet as a surcharge under the rules that exist today.

Gary Kelly

She makes a very good point which I should have clarified. Answering your question all assumes that we publish it and market it in a way that meets the DOT rules which at least one of our competitors right now, there are lines and lines and lines of small print that are required in order to comply with the adequate representation of the fares.

So, again that just really violates everything that we're trying to do at Southwest which is to keep it simple, keep it low, give good value to our customers and I think especially with the economy the way it is I just think our folks are delivering beautifully against that charge.

Bill Greene – Morgan Stanley

Okay. No, that's a good answer. So if I think about Southwest and your competitive position now there has obviously been a lot of talk in the press about M&A and all the sort of stuff but what do you think Southwest's biggest competitive challenge is? It's not so much the macro. I just mean what do you sort of think about on the competitive landscape and kind of keeps you up at night if you will?

Gary Kelly

Well, you redirect me if I'm on the wrong track here Bill but we have I think very solid principals that we think about in terms of our strategy and our vision and what we want to be really the best at, at Southwest Airlines. So that's where my mind goes when you ask that question.

We want to – we are in a mode where we want to win more customers and fortunately we're delivering against that very powerful goal. We've seen a very significant shift to Southwest Airlines over the last 24 months, probably for a variety of reasons but we feel like we're really delivering against that.

Within that, I think competitively, what would keep me up at night is we don't want to lose our competitive advantage with customers. We don't want to lose the low fare position in their mind. We don't want to lose our operational excellence and lose bags and be late. So, we really focus on the fundamentals at Southwest.

Alternatively, while we want to continue to invest in the customer experience, I consider that to be investing in the basics. So I don't think you're going to see us chase the last customer by spending money foolishly to add frills and amenities that most customers just don't appreciate.

So, I don't think that takes us to an extreme. All that said, you've got to have good people who care about each other and who care about serving customers. So to maintain our competitive advantage I think more than anything we've just got to maintain our very strong culture.

Bill Greene – Morgan Stanley

All right. Thank you for the time.

Operator

Your next question comes from Jamie Baker of JPMorgan.

Jamie Baker – JPMorgan

Hey good afternoon everybody. Gary, profitability can be somewhat intoxicating. In the past its led airlines to do some – I don't know, some odd things. You've overseen the first reduction in supply in Southwest's history. I think the margin results speak for themselves. I suppose the question going forward is whether from here, you are more interested in margin or in market share? You did after all talk about growth opportunities. Any thoughts on this?

Gary Kelly

Very fair question. I think we are very, very focused on profitability and in a way that is prosperous. We haven't met our return on capital in a decade and that's just not acceptable to us. So I think we all know why and we all know what the history has been but we are working as fast as we can to restore those proper margins.

As you know, it's not like throwing darts and we're going to make judgments about our outlook, about the future. It's hard to predict when a volcano is going to erupt and fortunately that doesn't affect Southwest Airlines but it is a very tough business and we won't get it perfect.

But I mentioned that in light of not really providing an excuse but just also factoring in that we're going to need to be – we're going to need to err on the side of caution here unless we have a really compelling opportunity back to Hunter's question and until we're comfortable that we're getting our profit targets it makes no sense to grow the fleet.

Now I don't want you to take that too literally. We may add five airplanes next year. But in terms of getting back to annual growth of 20 units a year, I just don't see that that is in the cards for us unless we're hitting our returns. We do have a belief though. We're going to be in 69 destinations next month with Panama City and we believe we can do a lot more than that and we're retooling Southwest so that international destinations ultimately simply become a tactical decision instead of a strategy and we'll get there at some point.

But we do want to grow and I think we've got some very powerful evidence, especially over the last year that adding new cities actually helps our unit revenue production. So again you're seeing record revenue numbers, fourth quarter, first quarter with four brand new cities but we're able to do that of course by culling less effective markets in lieu of these markets. So yes we want to grow and we're hopeful that we can but we're not going to do it if we're not hitting our profit target.

Jamie Baker – JPMorgan

Got it. Well, I appreciate the color on that. And just a follow-up for Laura. Looking at the RASM comps, they seem to get easier in May and June relative to April. I realize you don't want to comment on May RASM but is there anything structural, anything that occurred last year, new root activities, something that I'm forgetting about that would otherwise prevent May RASM from being even better than April RASM, assuming that demand trends just kind of stay where they are?

Laura Wright

I'm assuming your thinking – I can't think of anything really structural. Certainly you've just got to look at what our capacity was during last year between those months and what our capacity is in this year between those months as well as what's going on with what our competitors are doing in our markets. But structurally there wasn't anything that I can (inaudible) if you can think of anything Gary?

Gary Kelly

I agree with Laura. I can't think of anything either. But I tell you what, the way I've tried to evaluate our performance is, it is so good. Your talking about 20% plus or minus unit revenue growth which now appears to be pretty consistent for a string of months, at least we hope going forward and I don't know how one can know, is last years number that we're using as the reference point, is it perfect? Is it right?

There's just so many variables at play here. If we can sustain something close to 20% for a while, I am very, very pleased with that. And of course it encourages us to take a few risks and try some new things which is where new learnings come along and one can afford to do that.

So we're doing a lot as you know with the schedule and with revenue management. Some of those things may not work from time to time and sometimes it takes us a while to evaluate that but long story short, I think that the point I was trying to make with my opening remarks Jamie is that as best we can distil a variety of questions about trends, we think that our trends in the second quarter look stronger than the trends that we have behind us in the first quarter and exactly how the arithmetic works out eventually, obviously what remains to be seen.

Laura Wright

I think just one other point that I think we just have to see. When we look at January and we looked at March and this is kind of what we experienced after 9/11. The really peak travel months, these have the potential to outperform some of it and so those are things that we're watching as well and I think we'll just have to see as more time to get more evidence. So….

Gary Kelly

It's just all the good things you know. When we have more demand, that just gives us more pricing power and that was pretty evident there and I'd completely agree with Laura. So April, May are more shoulder months. So think they're going to be a little softer than March and June but again net, net just very, very strong trends. We're happy.

Jamie Baker – JPMorgan

Well, you don't hear it from me very often but good quarter. Thanks a lot.

Gary Kelly

Thank you, Jamie. It means a lot.

Operator

Our next question comes from Dan McKenzie of Hudson Securities.

Dan McKenzie – Hudson Securities

Hey guys. Southwest is doing a great job of offsetting higher costs, with an assortment of revenue initiatives obviously. But for investors that look longer term, I'm wondering what kind of opportunity there is for Southwest to meaningfully lower costs, as you sit and look at your cost structure today.

Gary Kelly

Well, it's hard work and we're obviously having a lot of success with our revenue initiatives and we felt like strategically again if you go back to 2005 and 2006 when we were spending a lot of time thinking about what we wanted to be next, that's where we felt like we had the greatest opportunity.

You have a very efficient airline. You have very productive employees turning out outstanding operations. So when you look across that spectrum, there is just not a lot broken. Our employees do enjoy very good compensation packages but they've earned them and so as we go forward we're going to be looking for continuous improvement to eliminate waste and to eliminate inefficiencies. You see that every single quarter.

So, our headcount for aircraft was down yet again in the first quarter. So I think ones expectations needs to be realistic and I think you should expect that we're going to work very hard to continue to keep our costs under control. But I don't see the same kind of upside potential there that we, as compared to what we have on the revenue side.

Dan McKenzie – Hudson Securities

Understood. Okay. And I guess, my second question is at what point is Southwest capacity constrained with incremental growth at Denver, Milwaukee, and Minneapolis?

Gary Kelly

Capacity constrained in the sense of facilities or aircraft or help me with you're….

Dan McKenzie – Hudson Securities

Yes, exactly with facilities and I guess with respect to aircraft as well because that also ties into the capacity part of the equation.

Gary Kelly

Well I don't think there is any near term issue with Milwaukee. First of all we started out Milwaukee I think with a dozen daily departures and we intend that we're going to sit there for a little while and certainly that's my feeling today. We don't have any plans at least I'm ready to share that we want to grow at Milwaukee from where we are.

Now Denver has been entirely different. It's been a very high growth market. We anticipated that it would be, although it's far exceeded our expectations and I think we're in great shape in terms of the ground facilities in Denver. If need be, there is, at least in the footprint of the airport, there is the ability to build out more space at terminal C which is the one that we operate in. But I think we're up to 15 gates there. We'll be at 144 daily departures in August and I think all that works just fine.

So long story short, not concerned about facilities there. We were facilities constrained in Philadelphia for a long. We have addressed that, feel real good about that but at least in the near term the focus area for us in that respect is Denver. We have got some growth opportunities in St Louis; we have got plenty of facilities there to expand.

So for a change we don't have facility constraints is the issue for Southwest. In most places it's really the opposite whether it's plenty of facilities available.

Dan McKenzie – Hudson Securities

I see. Okay. Thanks a lot. I appreciate that.

Operator

Our next question comes from Helane Becker of Jesup & Lamont.

Helane Becker – Jesup & Lamont

Good afternoon, everybody. Thanks very much for taking my question. Thank you also, Laura, for answering my Wright Amendment question. You anticipated that.

Laura Wright

I told you they are just for you.

Helane Becker – Jesup & Lamont

I know, right? Thank you. Just on St Louis, Gary, I was just kind of wondering, American has pulled back so much, and I guess that has happened over the last couple of weeks. So, you might not be able to quite answer this yet but I notice they are replacing a lot of mainline with a lot of regional jets and I have to think your 737s would be a far more attractive plane than their R-jets. Can you look out to your bookings in that market and see if the share is shifting and speak to them at all?

Gary Kelly

It's one of our, I did highlight Denver with my opening remarks which sort of implies that Denver is the only city showing 20% plus RASM improvement and St Louis is in there too. They have a very strong year-over-year performance. I think we are today roughly 73 daily departures and we are going to go up to 83. I do think that there is upside potential with St Louis. I hope that our network planners are been too conservative there but we don't know. American was carrying a tremendous amount of flow traffic through St Louis. So, it's not a one to one ratio here in other words, if they drop one flight it's not worth one flights worth of additions to us because we are obviously interested in local traffic.

But nonetheless, we have seen very strong share shifts; we have seen a strong RASM performance. We have got some needs to add some new non-stops for us out of St Louis and all of that is out there and published and it's definitely a good growth story for us.

Helane Becker – Jesup & Lamont

That's good. Because that was very helpful. And then on – you mentioned Panama City, which I think is going to be a very interesting airport for you because I don't think there's any airport in the Panhandle right now. I think you have to drive quite a distance. Can you sort of look at your bookings for May and beyond in that market as it opens and ascertain whether you are pulling passenger's away from Tampa or other markets that you might be serving so that the growth might be less than you would anticipate?

Gary Kelly

Well, this one is -- this is fund exercise for Southwest because we have been in an environment where we didn't want to take significant risk. Opening up Panama City for an airline would be significant risk. Now that we have – so we mitigated that with our relationship with the St. Joe Company. So we are very, very excited about this opportunity. We think it's going to do very well. We think we will do well, we think we can do good for the community. One of the problems we are trying to provide air service to the Panhandle or Northwest Florida is that actually there is a handful of airports.

Now we are not going to compete against Tampa. So, that part of your question I think you can easily eliminate that we won't. Its 100s of miles from TAMP around the cost but you have Mobile, Alabama, Pensacola, Florida, Fort Walton Beach and then finally Panama City in the east. So, the traffic that does fly is distributed among four airports and what we hope to do obviously is provide superior service now at Panama City.

Brand new airport has virtually no air service today and that was our struggle is how we can get comfortable with no history that we can generate traffic there. But Southwest brand is strong, our network is strong. We have got four non-stop markets with two daily departures each. The bookings look very, very good, It implies that we will have very solid load factors once we get up and running and I have told everyone at Southwest I am just stunned because there was just now way to know but it looks like its going to be a great success and we are very anxious to get started and as you it will be a brand new airport.

We don't know where the bookings are coming from and my recollection is from Dave" Ridley, our Senior VP of Marketing that they are about 15 million visitors a year by automobile and so part of the game here is to get them out of their minivans and SVUs on the Southwest flights and we don't need very many of them to fill eight flights up. So, it looks like our strategy is going to work well.

Helane Becker – Jesup & Lamont

Okay. Great. Thank you very much for that color. I just have one other question, I think Dan McKenzie actually might have asked a variation of this. Would you consider a joint venture with another airline in a market if it made economic sense to you? Like in other words like in Milwaukee, where there's three airlines serving the market, probably not making very much, if any, money and if two airlines maybe got together, it would make more economic sense. Would you consider doing something like a JV?

Gary Kelly

Well, I think we are open to doing a codeshare and that is a form of a joint venture. We are – we have said that we don't want very many codeshare partners and our strategy has been to primarily well to solely focus on codeshare partners to fly to places that we don't want to go. So, international markets again fit that profile better for us right now. Although we may want to fly international one of these days too. So, we don't have any domestic codeshare partners, and I am – that's not withstanding our agreement that we have with our pilots. We don't have any codeshare partners and we don't really desire to have any codeshare partners in the U.S. because we think we can serve U.S. markets better than a codeshare partner.

Helane Becker – Jesup & Lamont

Great.

Gary Kelly

I wanted to answer but I think again just to put it in perspective we are opened to codeshare partners beyond the 48 contiguous states in theory and right now we obviously just have one and right now we are happy with that. We want to get our Mexican codeshare up and running.

Helane Becker – Jesup & Lamont

Got it. Okay. Thank you very much for all of your help. I appreciate it.

Gary Kelly

Thank you for all your questions.

Operator

Our next question comes from Will Randow with Citi.

Will Randow – Citi

Hey, thanks guys. Great quarter.

Gary Kelly

Thanks, Will.

Will Randow – Citi

In terms of your April RASM comparison and it looked pretty tough compared to the industry and with your impressive month to-date RASM growth, implying about 19% growth, just look at the multi-year comparisons relative to '09. I mean that would reflect 19% growth in April which is a couple of points higher than the first quarter on a versus 2008 basis, and implied by a 25% year-over-year RASM growth for the second quarter. Is my – is there something funny with my math, or is that kind of how it shakes out?

Laura Wright

Well, we haven't given any specific RASM guidance for May and June, what was really was reported was at April. Mid-month April we were at year-over-year about 15% and versus last year. I think I can't remember somebody asked a question earlier about April, I think it was Jamie. In June, certainly the last year in the comp kind of got worse throughout the quarter but that point with him was there is still a lot of other pieces moving around in terms of capacity changes and peak versus non-peak period.

Will Randow – Citi

Is your capacity materially different throughout the month and within the quarter?

Laura Wright

In May or June, let me look at that. Second quarter capacity is up from the first quarter. You haven't pretty very.

Gary Kelly

Yeah, it looks like we are continuing somewhat with the first quarter trend. Will be down some in April of roughly flat in May and up a little bit in June but I don't know, I wasn't following your argument on how you got to 25%.

Will Randow – Citi

I guess if you look at the comparison versus '08. You guys are up 19% in March at this level and if you can just kind of run that multi-year comparison you will get to like a 30% which is like huge number for the following month.

Gary Kelly

I think the only thing that I was trying to point out earlier is that sometimes when in predicating, the strength is there. The revenue growth is very powerful; we can see what's contributing. We have new products that we have introduced over the last 36, 24, 12 month. They are working etcetera, etcetera, so but I think the point I was trying to make that when you try to pin the growth to a relative period. It implies that all of those reference periods are peer and they never are and there is just so many things changing that we are just not hung up on whether we do up 20 or up 18, or up 22 we are just managing at its best as we can.

So, I am not uncomfortable with you saying its 25% personally but there is no way I can attest to that forecast.

Will Randow – Citi

And then if I'm not mistaken, I think your capacity guidance may have moved up or maybe it's just rounding errors in terms of the second quarter. I think you guys are talking about down 1% last January. Can you refresh us on your expectations by quarter for 2010?

Laura Wright

It's all rounding. We haven't made any changes let to ever to our capacity plans for the year from what we have talked in January. Second quarter is going to be down slightly flat to down slightly and full year is I think we have said down maybe about 1% last it was – I think the 2nd January and I think you should think of it as flat to slightly down for the full year but no change at all in our aircraft or scheduled plans.

Will Randow – Citi

And lastly, if I could just squeeze one last one real quickly. In terms of your unit cost ex-fuel guidance, how should we think about the level of year-over-year change through the quarters? Does it kind of go down to relatively flat when we hit the fourth quarter? Maybe you are showing a similar pace of change in the second quarter relative to the first quarter?

Laura Wright

Well, it definitely improves each quarter of the year and lot of that isn't the changes in the capacity would not be thinking of it as flat by the end of the fourth quarter. As we talked about we do have inflationary cost pressure in our airport that's not going to go away in the third and fourth quarter and we expect that we will continue to have some year-over-year cost pressures in the back half of the year on the salaries, wages and benefit and just again was very low growth. The other areas that I noted in the first quarter that we had about a point increase in CASM just due to profit churning chart self discount but certainly if we can continue to see our revenues grow at these rates and our profits improve, we are going to have a good CASM penalty associated with those two categories.

Will Randow – Citi

Thank you very much guys

Operator

We do have time for one more question at this time and our last question will come from Duane Pfennigwerth of Raymond James.

Duane Pfennigwerth – Raymond James

Hi, thanks. Regarding your 2011 hedge position, 60%, if you look at your hedges on a combined basis. So, the new hedges and your existing hedges that you locked in some losses on, at what price is that 60% in the money? At what price do you start to pay below market?

Laura Wright

Yeah, if you look at this we are talking about 2011?

Duane Pfennigwerth – Raymond James

Yes.

Laura Wright

Okay. If we get -- when you combine the new hedges and the old hedges at about a 90 mid-90 dollar level in 2011, we are basically no gain or no loss from the two hedge positions that we have.

Duane Pfennigwerth – Raymond James

Okay. That's great. And then just regarding RASM, understand we don't want to speak to specific levels of growth beyond the near term. But, you were cutting your capacity in the second half of last year, and I don't know if it was just that or maybe a change in philosophy around revenue management, but you have these big year-to-year load factor increases in the second half of '09. And I wonder as you think about the second half of this year comping against those big year to year increases in load, will it be more difficult to push yield only? Or how should we think about that dynamic in terms of RASM growth as we comp against those big load factor increases last year?

Gary Kelly

Well, I think that's a very fair and great question and we are not – we got great momentum and we are delighted with that. So we want to keep our revenues gains that we have earned that we have worked really hard to get it to this point. That gains if you fast forward to 2011 what kind of gain should we expect there. I don't think we can answer that question yet. Now our goal is to continue to grind out some gains it will be harder to accomplish a six point load factor increase in the first quarter of 2011.

So I think we can concede all of that, so we will need to look to some other tools revenue management is far from done and they will continue to do some aggressive pruning with their techniques and they have got an entire system of replacement effort that is our plan for the next couple of years.

The other big thing of course is coming is a rapid reward system replacement and we really believe that, that's going to bring with it a significant revenue contribution that we are not currently getting. So, I think the mechanical answer to your question is we will continue to look for new sources of revenue along the way and those I think can be most readily identified from our frequent flyer program and Southwest.com techniques and then we are going to want to continue to perfect and the grow the things that we have already introduced. So, a quick example business select, its doing $80 million, $90 million a year we think here in 2010. Early bird like amount, they are brand new products.

The awareness among our customers is amazingly low. So its sort of begs the question of what is the potential of those kinds of products. Again you go back to our marketing challenge. We have a number of virtues that we would love to sell to our customers and we have the great position of having a strong with which ones do we sell. So, banks by free has worked famously now for us and but again well that has been somewhat at the expense of trying to push some of the other features that we really want to push but a good question, I don't think we have unlimited potential with their load factor. On the other hand I don't think we are done and we will certainly as a goal desire to boast our loads again next year but it will be a combination of basic things, load factors, revenue management techniques, some modest fare increases and we will continue to pursue the introduction of new product. So, three things.

Duane Pfennigwerth – Raymond James

Thanks very much.

Laura Wright

Thanks, Duane.

Operator

At this time, I would like to turn the call back over to our moderators for any additional or closing remarks.

Laura Wright

Thank you everyone for joining us today. We appreciate your support. If you have any follow up questions the Investors Relations team will be standing by and everybody have great day and week. Thank you.

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Source: Southwest Airlines Co. Q1 2010 Earnings Call Transcript
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