This episode of Red Belly Radio was recorded shortly after 2010 fourth quarter earnings were released. I got to sit down with our Chairman, President, and CEO, Gary Kelly and talk about our profit for the quarter and for the year. We also talk about fuel hedging and about some of the changes coming in 2011 and 2012. Give it a listen.
This Red Belly Radio includes references to non-GAAP results. A reconciliation of Southwest’s non-GAAP results to GAAP results is available on the Investor Relations section of southwest.com.
From Gary Kelly’s Office. No, really! You’re listening to Red Belly Radio!
Steve: Hello and thank you for listening to Red Belly Radio. My name is Steve Heaser. You know, for every quarter, publicly traded companies, like Southwest, have to report their earnings. This is for the company’s shareholders, as well as Wall Street and the general public to know how the company’s doing. And that means that for the fourth quarter of each year, a company also reports annual earnings. Well, for Southwest Airlines, our annual report on earnings was on January 20th and I actually got a few minutes to speak with Gary Kelly to talk about our earnings and what 2011 might be looking like. Here goes…
Steve: Earlier you said that this job is fun when the news is good and not so much when it’s bad. So how’s your day going to go today Gary?
Gary: Oh it’s a great day Steve. You know, actually telling the truth, I love Southwest Airlines every day. Every day is a good day at Southwest Airlines. But in terms of sharing the news, obviously it’s a lot more fun to share good news. 2010 was a great year and we accomplished a lot. It was never ‘in the bank’ that we would have that kind of a year especially on the heels of the terrible recession that we faced in 2008-2009. I’m very proud of our Employees. They worked extremely hard. We’re turning out record load factors and I’m sure our Employees in Operations all know that. But what a wonderful challenge. If you think about the opposite, where we had Customers that were not liking Southwest Airlines, and moving away from us to our competitors, that would be a problem. So, we have a nice problem here which is we have more Customers than we’ve ever had before. That does present some challenges that we need to be realistic about, that we need to address and we need to work together. That’s what our Employee, Warrior Spirits are all about and again, all I can do today is just really praise them all and thank you all. And I’m just very, very proud of these 2010 results. It was a very solid profit, we had $115 million in the fourth quarter, and $550 million for the year, and all those sound like huge numbers and it’s a comfortable profit but we’re only about two-thirds of the way there in terms of hitting our profit goal – really a profit requirement in order to buy airplanes so we have a ways to go but the good news is that we’re making really, really good progress.
Steve: Well how does this compare to other airlines? Is Bags Fly Free really helping?
Gary: Bags Fly Free is a grand-slam homerun and I’m real proud of our current campaign with No Change Fees. I think that that will prove as successful. It is a wonderful way to put our money where our mouth is with our Customers and really set ourselves apart from the rest of the industry. Which shows very poorly in brand rankings, whereas Southwest shows very, very high in something that our People can all be very proud of. We’re winning more Customers because we don’t charge those fees. I would much rather have a whole Customer paying us the whole fare, instead of one lousy bag fee. And that’s exactly what’s happening and that’s one reason why our profits are so good. The rest of the industry is doing a descent job of turning out profits finally, but not with the consistency that Southwest does. And of course we all know that they do that with much lower wage rates. So, where would you rather be, you know, at Southwest, or Brand X? Here we’re proud of what we do and our Employees are rewarded for that and our Customers think very highly of us.
Steve: I tend to think of only one answer for this – and I see it every day when I fill up my car. Is it costing us more to fill up our airplanes?
Gary: Unfortunately it is, you know. And were it not for higher gas prices, I would be really bullish about 2011. We would have a really nice increase in earnings, I think, in 2011 compared to 2010. But the dose of reality is crude oil prices. They’re up 20% at this point versus a year ago, and that makes it really tough. We’ll have a challenging first quarter. We need to be profitable obviously for a whole list of reasons and every year we need to…, you know our Employees want their pay to go up every year, is a way to think about it and the only way to do that successfully over time is for our earnings to go up every year and that’s why it’s important to all Southwest Warriors that we keep our costs low, do all we can to be as fuel efficient as possible and that’s the one cloud overhanging 2011 at this point.
Steve: Are we still hedging much fuel, going forward?
Gary: We are, and when you talk about what we need to do to manage our fuel costs, it’s really a three or a four pronged approach. Number one, is we do need to hedge and put as much price protection in as possible. Hedging is not the total answer, and it’s costly and it carries some risks, so it has to be managed very, very carefully. To just put hedging in perspective though, over the last decade, we’ve saved about $4 billion with hedging, and that literally translates in to our being able to afford purchasing, about 130-140 aircraft. So had we not hedged in other words, you’d see a fleet that was much smaller and far fewer jobs than what we have today, so it kind of puts in perspective the value that hedging brings to the Company. And it blunts the effect, in an immediate sense of a sharp spike in fuel prices, so we do that. We’re about 65% hedged in 2011, and all the way out through 2014. But we also have a lot of fuel conservation efforts underway. We’ll have to have revenue increases to offset that increase cost or else our earnings will go down substantially. So you will see fare increases from time to time as a consequence, a direct consequence of higher gas prices. And then finally over time we’ll need to continue to work together to find ways to get Southwest Airlines more efficient, more reliable, more on time and more productive, and that’s what we’ll need to do.
Steve: Have we ever had quarters, or even a year where hedging made the difference of a profit or loss?
Gary: Oh, absolutely. Many, many quarters in several years over the last decade we would not have been profitable without hedging.
Steve: And we talk about hedging, we’re talking about Jet-A fuel, not crude. Because you watch crude closely.
Gary: We actually do use crude oil as the proxy for jet fuel; mainly because jet fuel is not traded in the financial markets, at least in a cost effective way. Whereas crude oil is traded very widely and there’s a close distillate of crude oil – gasoline being a distillate as an example, but heating oil, home heating oil is actually very close to jet fuel. Jet fuel is a kerosene-like distillate, and so heating oil does trade widely and we also use heating oil as a proxy for jet fuel.
Steve: Gosh, a lot of changes coming this year. It’s only the first couple of weeks into the year and we’ve got Rapid Rewards. I understand we’ve actually ordered some -800 planes, but they’re not coming until 2012. But, a lot of changes coming this year, huh?
Gary: Well, there’s a lot of construction that’s underway in 2011 I think is a way to visualize it. There will be a lot of effort in 2011 to manage our operation on a day-to-day basis. We’ve got challenges presented with more connecting passengers and record load factors and we will need to attend to that and you’ll see a lot of effort applied there. We will roll out our All-New Rapid Rewards Program in about six weeks, March 1st, so that’s very exciting. That will obviously be a lot of effort, a lot of effort’s gone in to building it and now we need to do the hard work and roll it out for our Customers , so that’s very exciting. But in the meantime, we’ll be constructing the capability to operate -800s. There are twenty that are firmly ordered for delivery in 2012, very exciting. I think the -800 will become an important part of our fleet and our future. We’ll also of course be closing I hope, on the AirTran transaction in the second quarter and that will be real work for us in 2011. The integration work of course will be later after we close but that work will be underway. Then finally we’ll begin probably more seriously the work to replace our reservation system which creates capabilities, if nothing else it brings us international capabilities for the future, so that will be very exciting as well.
Steve: Gary, thank you so much for being my guest today.
Gary: You bet’cha Steve – anytime my friend.
Steve: We’ll see you around. Well that does it for this episode. Red Belly Radio is a trademark of the Southwest Airlines Company. This episode is copyrighted 2011. The CEO, the President, and the Chairman of the Board, that’s all Gary if you didn’t pick up on that, has indicated that we have come to the conclusion of this podcast. Please turn off and stow all portable electronic devices.
Important Information for Investors and Stockholders
The communications contained in Red Belly Radio do not constitute an offer to sell or the solicitation of an offer to buy any securities or a solicitation of any vote or approval. The proposed acquisition of AirTran Holdings, Inc. (“AirTran”) by Southwest Airlines Co. (“Southwest”) will be submitted to the stockholders of AirTran for their consideration. In connection therewith, Southwest has filed a registration statement on Form S-4 with the Securities and Exchange Commission (the “SEC”) that includes a proxy statement of AirTran that also constitutes a prospectus of Southwest. Southwest and AirTran also plan to file other documents with the SEC regarding the proposed transaction. SOUTHWEST URGES INVESTORS AND SECURITY HOLDERS OF AIRTRAN TO READ THE PROXY STATEMENT/PROSPECTUS AND ANY OTHER RELEVANT DOCUMENTS FILED WITH THE SEC CAREFULLY AND IN THEIR ENTIRETY AS THEY BECOME AVAILABLE BECAUSE THEY CONTAIN IMPORTANT INFORMATION ABOUT THE PROPOSED TRANSACTION. Investors and security holders may obtain free copies of the proxy statement/prospectus and other documents containing important information about Southwest and AirTran, as such documents are filed with the SEC, through the website maintained by the SEC at http://www.sec.gov/. Copies of the documents filed with the SEC by Southwest are available free of charge on Southwest’s website at http://www.southwest.com/ under the tab “Investor Relations” or by contacting Southwest’s Investor Relations Department at (214) 792-4415. Copies of the documents filed with the SEC by AirTran are available free of charge on AirTran’s website at http://www.airtran.com/ under the tab “Investor Relations” or by contacting AirTran’s Investor Relations Department at (407) 318-5188.
Southwest, AirTran and certain of their respective directors and executive officers may be deemed to be participants in the solicitation of proxies from the stockholders of AirTran in connection with the proposed transaction. Information about the directors and executive officers of Southwest is set forth in its proxy statement for its 2010 annual meeting of shareholders, which was filed with the SEC on April 16, 2010. Information about the directors and executive officers of AirTran is set forth in its proxy statement for its 2010 annual meeting of stockholders, which was filed with the SEC on April 2, 2010. These documents can be obtained free of charge from the sources indicated above. Other information regarding the participants in the proxy solicitation and a description of their direct and indirect interests, by security holdings or otherwise, is contained in the proxy statement/prospectus and other relevant materials filed with the SEC.