Southwest Airlines Company (LUV) — Q1 2015 Earnings Call Transcript

Thank you very much, Matt, and thanks everybody for joining us for our first quarter earnings call. It was a great first quarter. I want to start by congratulating our Southwest employees for these exceptional results. Southwest is doing well because of their hard work, perseverance, and outstanding customer service. I'm delighted to report that each employee earned their share of a total $125 million profit sharing related to our first quarter profits, which is far greater than any prior first quarter in our history. Of course, lower fuel prices were a big part of the first quarter story. Our economic fuel price per gallon was down 35% to $2 a gallon year-over-year, and that alone contributed over $450 million in fuel cost savings. Fifteen percent of every fuel savings dollar goes to our employees. So again, a very, very big thank you to our Southwest family. But besides lower fuel prices, there's a lot more to the story, and a lot to be pleased with. Our unit revenues were flat while our core unit cost, excluding fuel, special items, and profit sharing, were down 3.6%. Even if fuel prices had remained constant, our earnings would have been up roughly 80%. We're beginning to more fully realize the benefit of our strategic initiatives and that is the AirTran merger, the 737-800, our fleet modernization efforts, and our renewed frequent flyer plan. We are also seeing more fully the benefits from our aggressive route schedule optimization over the last five years. These results are really strong despite our renewed low-cost capacity growth, but the unusually high percentage of routes that are in development. That's primarily a function of AirTran integration, but we also have strategically added capacity to Dallas Love Field, Washington Reagan, and New York LaGuardia. Given all that, we are intentionally growing new markets, which are mostly newer international, at a slow and measured pace. We want to carefully manage our future capacity growth, continue our revenue momentum, and hit our return on capital targets and reward shareholders. So our focus for the near term will be on the basics: operational reliability, hospitable customer service, manageable capacity growth, and healthy shareholder returns. Our top event for this year is the completion of construction of the Houston International Terminal and the launch of international flights in October of this year to six nonstop Latin American destinations. This year, we have a larger than normal increase in flying as we increase the utilization of our roughly 700 aircraft fleet from a low 88% to a more normal 93% by year’s end, and that is aircraft that are scheduled to be in service out of our total fleet. Now that's the equivalent of about 40 airplanes from January to December. Next year, we'll be back to a more normal fleet growth of approximately 2%. Of course, next year we’ll also get the full-year benefit of this year's increase and return to our normal historical utilization rates. The cost penalty of underutilizing the fleet essentially disappears by year-end. I'm very pleased with the performance of our strategic initiatives; I'm very pleased with our current performance; I'm very excited about our future plans; and I hope that lower, stable energy prices are here to stay. But all in all, a fantastic quarter. And with that, I will turn it over to Tammy Romo, our CFO, to take us through all this good news.

Thanks, Gary, and thanks to everyone for joining us. We are absolutely thrilled to report on our tremendous first quarter results today. Net income excluding special items was a first-quarter record, $451 million or $0.66 per share, which was by far the best first quarter in our history. It was only $34 million shy of being an all-time quarterly record and even surpass our annual 2012 and 2013 profits, which is just a tremendous performance. First quarter GAAP net income was slightly higher at $453 million. Our strong first quarter results were driven by another quarter of record revenues, substantially lower fuel prices, and our continued focus on our non-fuel costs, particularly our fleet modernization efforts. Our operating income ex-special items was also a first quarter record at $770 million, and we expanded our operating margin by more than 1000 basis points to 17.4%. Our pretax return on invested capital, excluding special items for the 12 months ended March 31st, was an exceptional 25.6% or 16.1% on an after-tax basis. So, congratulations to all our wonderful employees for these exceptional first quarter results, which mark our eighth quarter of consecutive record profitability. Turning to revenues, we were very pleased to report another record performance there as well. Our first quarter operating revenues increased 6% year-over-year to $4.4 billion, driven largely by record passenger revenues of $4.2 billion. Overall, we are very pleased with the revenue strength across our networks, especially considering 22% of our network was under development, which is substantial. We continue to be pleased with the performance of our new Dallas; Washington Reagan; and LaGuardia services, and international also continues to do well and meet or exceed our expectations. Our Rapid Rewards program continues to contribute significantly, with nearly $100 million incremental revenue year-over-year in the first quarter. We are very pleased with the performance of our frequent flyer program and continue to seek opportunities to drive additional returns from it as well. On a unit basis, our total operating revenues grew in line with our 6% increase year-over-year in capacity as we guided, which resulted in a first-quarter record passenger unit revenue performance. While our revenue yields declined just slightly, our strong demand for low fares resulted in record traffic and load factors on 1% fewer trips year-over-year. Our unit revenue performance was outstanding, especially when you consider the roughly 4% increase in stage length and 2.6% increase in seats per trip, both compared to first quarter last year, which combined was estimated to impact unit revenues by two to three points, which of course was more than offset by a favorable benefit to a unit cost. We had a significant portion of our first quarter capacity under development with more than half of markets converted from AirTran. Thus far in April, we’re pleased with the continuation of solid revenue and booking trends, which are trending in line with normal sequential trends. Based on these trends, we expect strong passenger revenue growth in April and approximately 6% to 7% year-over-year ASM growth. We currently expect April PRASM, passenger revenue per available seat mile, to decline 2% year-over-year. Keep in mind, year-over-year unit revenue comparisons for the second quarter will be more challenging than third due to the 7% versus 6% year-over-year ASM growth, with second quarter stage length estimated to increase a little over 4% and gauge to increase over 2%, both year-over-year. As a reminder, we have significant spoilage adjustments in the second quarter of 2014, when normalized across, resulted in year-over-year PRASM trends, 9% for April; 10% for May last year; and up 8% for June. We are also pleased with our freight and other revenue. Our award-winning cargo team was recently recognized by Air Cargo World for the sixth consecutive year. They produced a double-digit increase in freight revenues in the first quarter. We currently expect second quarter 2015 freight revenues to increase slightly from Q1 2015. Other revenues declined slightly year-over-year from the elimination of AirTran fees with the integration completed in December last year. This was largely offset by a strong performance in certain ancillary revenues such as EarlyBird Check-In and A1 through A15 upgraded boarding positions sold at a gate. Our EarlyBird revenues increased 25% year-over-year to $68 million, and other ancillary revenues were approximately $40 million. We expect second quarter 2015 other revenues to increase from first quarter levels but decline year-over-year. Our first quarter unit cost excluding special items decreased 12.4% on a year-over-year basis, largely due to lower fuel prices as well as ongoing cost control efforts. Our first quarter economic jet fuel price per gallon declined 35% year-over-year to $2, which resulted in over $450 million in fuel savings in just the first quarter. Based on our hedge position and market prices as of last Thursday, we expect our second quarter fuel price per gallon to also be approximately $2, which is significantly below second quarter 2014’s $3.02. We currently estimate full-year 2015 year-over-year fuel cost savings to approach $1.4 billion, based on current market prices. Excluding special items in fuel, our unit costs were comparable to first quarter last year, and this does include over a 100% increase in profit sharing and 401(k) savings plan expenses, just over $200 million compared with $99 million in first quarter last year. Excluding profit sharing and special items, our non-fuel unit costs decreased 3.6% year-over-year, reflecting the benefit of our fleet modernization. Maintenance unit costs, in particular, declined 30% year-over-year, primarily due to the retirement of the 717 fleet. Based on our current cost trends, we expect second quarter 2015 unit costs, excluding fuel, special items, and profit sharing, to decrease year-over-year in the 1% to 2% range compared with second quarter 2014. For full-year 2015, unit costs, excluding fuel, special items, and profit sharing, are estimated to decrease approximately 2% year-over-year, which is slightly better than our previous guidance. We ended the quarter with $3.4 billion in cash and short-term investments, and we also have our $1 billion revolving credit line fully available. We continue to generate tremendous free cash flows, which allows us to make prudent investments in the business while returning value to our shareholders. Our first quarter operating cash flows grew 30% year-over-year to $1.45 billion, which exceeded our CapEx of $573 million and assets constructed for others, a net of reimbursement of $20 million to result in first quarter free cash flow of $859 million. We returned $381 million to our shareholders during the first quarter through $300 million in share repurchases and $81 million in dividend payments. We have $80 million remaining under our $1 billion share repurchase authorization, which we intend to complete next month. We also repaid $51 million in debt and capital lease obligations during the first quarter, and we intend to repay an additional $133 million during the remainder of 2015. Our balance sheet is strong, with leverage including off-balance sheet aircraft leases up 34% as of the end of the quarter. We remain the only investment-grade U.S. airline by all three credit agencies. For 2015, we continue to expect our cap spending to fall in the $1.7 billion to $1.8 billion range, excluding our assets constructed for others, which is estimated to be in the $50 million to $100 million range net. We continue to carefully manage our invested capital, which we've reduced by $1.3 billion since 2012. Overall, we remain very pleased with the consistent strength of our balance sheet and strong cash flow generation, which allows us to maintain a balanced approach to cap deployment, which includes the ability to return significant value back to our shareholders, employees, and customers alike. And that brings me to a quick recap of our first quarter 2015 fleet activity. We ended the quarter with 679 aircraft in our fleet. We took delivery of seven dash 800s from Boeing and eight pre-owned dash 700s, and we retired one dash 500. We have transitioned 63 717s to Delta, which brings us to 25 remaining that we will be transitioned to Delta by the end of this year. All 52 AirTran dash 700s are converted to the Southwest livery, with the last five completed during the first quarter. We continue to manage to a baseline of roughly 700 aircraft by the end of this year, and we expect our second quarter 2015 ASMs to increase year-over-year approximately 7%. Our full-year 2015 capacity growth remains on pace to also increase 7% year-over-year, again largely on Dallas, with a smaller portion on Washington Reagan, LaGuardia, and international. The response to our new markets has been very gratifying, and our development markets continue to perform at or ahead of expectation. Also, keep in mind, there will be a carryover impact of our 2015 ASM growth into 2016. The full-year effect of 2015's expansion is estimated to increase 2016 ASMs by 5% year-over-year. We expect any further 2016 growth above that to be modest. We expect our 2016 year-over-year fleet growth to be approximately 2%. In conclusion, I'd like to once again thank our 47,000 employees for their tremendous efforts and congratulating them on exceptional first quarter performance, which is a strong start to what is shaping up to be just a spectacular year. Our revenue and booking trends remain strong thus far into the second quarter, and our cost performance was solid. We are continuing to benefit from substantially lower year-over-year jet fuel prices, and our ongoing cost control efforts are also delivering results. We have a low-cost structure and we will continue our rigorous efforts to improve efficiency. We have a strong financial foundation and strong cash flow, and we remain focused on prudent capital allocation. We are reinvesting in our business with the focus on generating strong returns, and we have continued our aggressive management of our invested capital through share repurchases and cash dividends. Coming off a record 2014, we’re delighted with the strong start to this year. Based on current trends, we expect another record profit performance in the second quarter. And with that overview, Matt, we’re ready to take questions.

Gary, thanks for the color on the 2016 capacity. How should we think about the mix between domestic and international as we assume a mid-single-digit growth rate next year? Would it be roughly half and half, or how should we think about that?

I believe Tammy will help clarify anything I miss here. There’s a carryover effect from our year-over-year growth in 2016, which is influenced by the increased flying activity we had in 2015. For example, we’re not adding any new flights in Washington Reagan this year that I can recall, yet since those changes occurred in the latter half of 2014, Reagan is contributing significantly to our growth rate in 2015. This kind of impact will continue into 2016. Focusing on the new flying we plan to introduce in 2016, it will be roughly evenly divided between domestic and international. We will be adding flights in Houston later this year. I also anticipate that next year we’ll see about one additional international flight on top of the full-year impact from what we add to Houston this year. Overall, it'll be a modest low single-digit increase, with some additional domestic flights planned for next year. However, we are expecting only modest incremental growth in 2016 beyond the current rate established in 2015.

And then Tammy, one for you, when we think about the down 2% unit revenue guidance for April, are the headwinds that you called out, the tough compare stage and gauge and spoilage. Are those the extent of the headwinds or are you seeing fare compression, increases in competitive capacity, as some other carriers have mentioned, that are pressuring unit revenues as well?

Julie, I would say that our pressure on unit revenues is exactly what you said is largely driven from stage and gauge, and of course just a large percentage of our network under development. So that we always have some movement in competitive capacity, but the majority of that pressure is driven from just longer haul flying and increased gauge.

Obviously the timing of Easter is always a little tricky in these trends and comps. So, we've taken all that into account. If you will just compare, I think just our trend looking at comparing second quarter to first quarter, the trend looks very normal. That is, again, taking into account the holiday timing. But we feel like everything is looking good and as Tammy has been very clear in pointing out, we have a lot of developing markets that we are staying on top of and carefully managing. Our hope, of course, is that those continue to improve over time. I can’t guarantee that, but we are very pleased with the developing markets' progress that we’ve seen so far.

Directionally, how do you expect May and June to trend relative to April on a year-on-year basis?

We provided guidance, and I've already mentioned that in terms of year-on-year comparisons, April was up about 9%, May was up around 10%, and June was slightly lower at about 8%. So, there isn't much variation across the months when compared to last year.

I'm not sure, if Bob Jordan is on the line or this is a question for Gary. But as we think about IT, how much is IT holding you guys back from implementing things that you think your customers want? Whether that's an unbundled, more of an unbundled product or not, or maybe things that help optimize returns without feeling you're taking something away from your customers. If I could maybe get you to sort of think about it on a scale of 1 to 10 right now in terms of where you are in the investment horizon as it relates to specifically IT, I'd love to hear your thoughts on that.

Hunter, Bob, he’s here. So, certainly want Bob and Mike may want to chime in as well. But we’re all impatient and have opportunities that are before us that we would love to be able to capitalize on. We have operational improvements that we’re very desirous of and we’ve got customer experience improvement. So, it really covers all three categories, financial; service; and operations. I think what is exciting is we know that we’ve got opportunities to continue to invest that will generate very handsome returns. I am a little reluctant to put a number on it. I’ll defer to Bob and Mike to see if there is something they want to share there, but the headline of course is a new reservation system, which comes with enhanced capabilities that really address all three of those objectives. We have been forthcoming that we think that’s worth a lot of money; some things fall into revenue management techniques which we for competitive reasons we leave that as a rather vague headline. But I think we’re very happy with our product; I think we’re happy with our customer experience; I don’t see that there is anything that is dramatic, it's being held back from what we’re doing. I will fully admit that a new revenue reservation system will come with capabilities that will explore whether it's code sharing or whether it's assigning seats and things like that. But we’re not at this point committed to making any of those kinds of changes yet either. So, I feel like we’re doing really good. And clearly what I hope to communicate here is absolutely we know there are returns on investment as we continue to invest in IT.

I believe the situation remains the same; there is always more technology work to accomplish than can be completed in a year. If it were possible to instantly achieve everything, there are tasks we would prioritize right away. However, we have a solid program with well-planned implementations from 2015 to 2017, the most significant of which is the new reservation platform. Additionally, major initiatives currently making substantial contributions include fleet modernization, network optimization, advancing our markets, and the significant impact of the Rapid Rewards program. None of these efforts are being delayed by IT. The elements making a real difference are primarily driven by Rapid Rewards, and we do not face any hindrances due to inadequate IT investment; in fact, most of those challenges are behind us. As Gary noted, we have significant developments on the horizon that will be particularly beneficial as we implement the new reservation system. This will include more comprehensive fare rules, enhanced access to ancillary services, and ongoing improvements in O&D revenue management, much of which is already underway. Looking ahead, we have projects that will deliver value over the next three to five years as we continue to adopt new technologies. I am optimistic about our current position, especially regarding the elements that are driving progress and are independent of IT at this time.

Thank you, Bob. And a question again for Gary here is you guys have made comments in the last couple of years about keeping your growth roughly in line with GDP. But 7% this year, even if you look at that on a seat basis, we'll say it's up four and then next year you're going to have probably be a little bit above GDP as well. So, I understand you guys are earning your cost of capital and things are going real well for you, but why is the growth at Love Field and Reagan incremental? And why is it not replacing underperforming routes, which would make your growth opportunities still exciting in new markets and whatnot, but it would make the overall growth rate maybe a little bit less disruptive from an overall capacity growth perspective? Where is that growth that goes away in the event that fuel goes back up again?

I believe we haven't altered our overall growth strategy in the past six months. The fluctuation in fuel prices hasn’t significantly affected our plans. To put it another way, we are planning for the future while assuming higher fuel costs, which I believe is a prudent approach. It would be unwise to order a large number of airplanes only to discover that fuel prices rise unexpectedly. First, we need to estimate future traffic growth, and the best indicator we have for that is GDP. Currently, we are experiencing growth that exceeds GDP because we have worked hard over the past five years to create significant opportunities, and we are now looking to capitalize on them. Additionally, we have a fleet of 700 airplanes and do not aim to reduce the size of the airline. In reality, our airline has not been fully utilizing its fleet for several years. Now, we have excellent opportunities to enhance our unit cost efficiency and profitably increase our flight operations. In the first quarter, we increased our seat capacity by about 1.6%, while our origin and destination traffic rose by 5.7%. As long as we can continue to match or exceed our seat growth, that’s the key factor. If we find ourselves unable to do so, we can adjust accordingly. The additional fleet growth we are planning for next year is relatively modest. My expectation is that the growth peak will occur this year, beginning to decline next year and decreasing again in 2017. We want to clarify why we are focusing more on growth this year, as it seems we will return to more typical growth patterns in the coming years.

Just on the used aircraft side, and the dash 700s that you've been adding, can you just refresh our memory a little bit about how many you're adding this year, how the retirement schedule has changed, and really how you think about the economics of used aircraft versus new aircraft right now?

If you look at our order book with Boeing for 2015, we have 19 firm and 17 dash 700s in the pre-owned market, and we’re managing that 700 fleet count. As you know, we have 88 717s that we’re replacing from AirTran. We’re using a combination of new aircraft and those from the pre-owned market. At this point, the economics on the pre-owned side have allowed us to augment orders from Boeing to meet our aircraft needs. Looking ahead, we will continue to pursue what makes sense to drive the best overall economics. We are still working through our fleet plans. For 2016, we have 31 firm orders with Boeing, along with four pre-owned aircraft from Boeing. We are using a combination of both to meet our needs in 2015 while seeking the best economics for Southwest.

Just a follow-up there, if you had to guess which one would change for 2016, the 31 firm or the four pre-owned, it seems like the four probably would move higher if things stay about where they are?

The pre-owned market, we have plenty of opportunity there to supplement our needs. So I think that's a reasonable assumption.

We have a significant number of potential retirements coming up next year, and we have some flexibility regarding the timing of these retirements. Over the past year, we've emphasized that we possess more fleet flexibility now than ever before. Our goal is to optimize both financial and operational performance, utilizing the alternatives available within our fleet options.

And then just for my second question on the other revenue line, I think you guided to about a 9% decline in the first quarter and it came in roughly down 1% and just wonder if you could give us more detail, maybe we're getting beyond some of the loss of the AirTran fees that you’re not going to lose going forward. Why wouldn't other revenue be kind of more firm relative to the trend that we've seen over the last couple of years?

Yes, I think that in our first quarter, our ancillary revenues were strong and offset the losses we experienced from the fees lost due to AirTran. We were really pleased with those trends. Therefore, I agree with you; I believe we can expect those trends to continue to strengthen.

Gary, a question on consolidation; I'm trying to find a common denominator behind the deals that you've done or tried to do in the past. So you've got Muse, Frontier, and I guess maybe we could include ATA; those were all struggling competitors. Morris struck me at the time as mostly about aircraft. And I don't know, AirTran might fall between those two examples; that was likely influenced by what was going on at the industry level. You may have different opinions. What I'm getting at is what would influence your decision to turn to M&A again; would you consider during an airline bull market or should we assume that Southwest's interest is only likely to be peaked if there is a competitor with its back against the wall?

I agree with your historical analysis, Jamie. Hypothetically speaking, in a situation where our organic growth opportunities are constrained due to cost pressures, uncertainties, or geographical limitations, it would be wise for any company to explore alternative growth options, with mergers and acquisitions being one viable strategy. This was certainly the case for us with the AirTran acquisition, which helped revitalize our organic growth initiatives. The strategic appeal of AirTran was also its geographical advantages, allowing us to enhance our 48-state route map, which has proven to be very successful. Additionally, it provided us with valuable experience in international markets, helping us to formulate future plans. This scenario illustrates the past interest in M&A that could also apply in the future. However, what's different now compared to 2010 is that we have more growth opportunities available than ever before. Therefore, while M&A could potentially distract us from our current growth efforts, it would need to be justified, as it is not a priority given our ambitions with the current system.

I have a follow-up question about the profit-sharing topic. Your formula seems simple and has likely remained unchanged longer than your competitors. I'm trying to recall the last time there were any updates; perhaps you can clarify that for me. What was that?

It was 1989.

Okay, all right, helpful; so, clearly unchanged the longest. Looking forward though, is profit sharing a topic where you consider what the market is doing or does it fall more into that kind of Southwest marching to its own drum type category, like other facets of your business model?

Well, it has to factor in what the external realities are. So whether it's healthcare, whether it's retirement, whether it's salaries and wages, everything has to be informed to some degree by the market.

I just wanted to follow up on one thing on the 2016 growth that I'm not clear on. So, is the 2% of fleet growth, is that incremental to the 5% of annualized growth that's coming from annualizing what you're introducing this year? And then also just kind of curious, as you look to next year, is the split between seat and stage going to be similar to what you saw this year?

In response to your first question, Savi, yes; we're discussing a fleet of 700 airplanes, so a 2% increase would equate to 14 planes. We're looking at a net increase in the teens, although, as Tammy has mentioned, there are various factors at play. This year, we will retire all of the 717s; those are in addition to the numbers we share in our financial reports. Additionally, there are roughly 25 airplanes that I still consider part of the fleet, even though they are in the process of being retired. However, that is not how we report it to you. Regardless, we expect to have more airplanes in 2016. I spoke long enough that I overlooked your second question.

The mix between stage length and fees.

Mix, well that depends. What is in the press release today are from 700s. We haven’t taken any 700 delivery from Boeing since 2011. So, we’re in the midst of making that choice. If we switch that choice to 800s; well then obviously the gauge will continue to grow somewhat. I don’t think it would be, Tammy, at the same rate that we’ve been seeing it grow. This year, you’ve got a pretty big swap out of 717s either for 700s or 800s, depending on how you want to match all that up. But you’ve got a pretty significant gauge effect in 2015, so it should be less in 2016 if we convert those to 800s. What is on the press release for the pre-owned are 700s for next year. We might pick up some pre-owned 800s, but we’ve really been looking to replace our 300s with 700s. The stage length piece of it, again will be somewhat, obviously dependent upon where we go, but the odds are that we’ll continue to add longer than average trips. You’ll get the full-year effect of launching international service to Houston. The Houston service is going to be longer haul by definition to Latin America. So, yes, I think the stage continues to grow; the gauge continues to grow, but probably at a lesser rate than what you're experiencing right now.

And for my second question, I wonder if you could talk a little bit more on how Dallas is progressing? And one question I had was, I mean I know you've mentioned in the past that you're seeing 90% load factors there, and I'm wondering, does that signal that maybe you're leaving some revenue on the table by having such high load factors?

Well, they are coming down, so Tammy you want to take that?

Sure, yes, we’re still seeing fantastic load factors out of Dallas, and they are above system average load factors. And what we have said before is we have some markets hitting 90%. So yes, we’re very pleased with our Dallas performance; it continues to be very strong with very, very substantial increases in traffic year-over-year.

Tammy, I know in the past, you mentioned maybe that's the market that matures faster. How is that progressing versus other markets that you've entered into?

Well, I think if you look at our new markets, I mean normally you would expect those can take years to two, three, sometimes even more years, but certainly at least what the results we’re seeing thus far with our new markets suggest that yes, we’ll have some of our markets that would progress at a faster than normal rate. Certainly, Dallas will hopefully fall into that category. We’re monitoring all that very closely, but so far as we said, our new markets are meeting or exceeding our expectation. Some will mature very quickly, and there will probably be some that take a little bit longer, but in the aggregate, we’re very pleased that the rate in which those are progressing.

Dallas is experiencing rapid development, which is somewhat unusual. While some city pairs in new markets appear more typical, they are not the majority. This morning, a reporter asked me about Dallas due to its significant success, which we anticipated. In fact, we were taken aback by some experts claiming that the Southwest effect had diminished. However, it has proven to be a great success, despite having a 20 gate capacity. The demand clearly exceeds that limit. We are very satisfied with the service and the new airport. There's still work to be done, but it certainly stands out as an exception in terms of new growth.

And Savi, just in terms of as you are thinking ahead as well. Historically, the development markets have been, I would say, 4% to 5% of the system. That is close to where we would expect to trend by 2016. We will have a heavy percentage of our markets; it will trend down here from the first quarter; I would guess it would be around 11% by the end of the year, and then it would be more in line as we get into next year, which is a more normal percentage of development markets.

This connects to Hunter's question; one might ask why we would have such a significant portion in developing markets. Part of this is related to integrating AirTran. However, we also had confidence that Dallas would perform well. In other words, while 22% is a considerable share in development, the quality and performance of those markets are certainly better than what one would typically expect from a developing market overall.

Yes, Savi, I will share one other bit of information just again. It really is a testament to how well our markets are performing. If you adjust for stage length, I guess just looking at unit revenues that drag on our first-quarter results is under 1 point. So again, just very strong performance.

Tammy, you had about a $500 million benefit on the cash flow statement in 2014 from deferred taxes. I guess I was thinking we might see some of that start to reverse here. Can you just give some color around what drove that? Is that related to new aircraft deliveries and accelerated depreciation for tax purposes, or is it something else? What happens to that number in 2015?

The key factor influencing our preferred taxes is the accelerated depreciation associated with our aircraft deliveries. Unless there is an additional extension of the bonus depreciation, which we are optimistic about, we utilized it this year; these extensions are typically on a yearly basis. If there is an extension, we anticipate that our cash tax rate will align more closely with our book taxes, primarily driven by the bonus depreciation.

And then just on your comment regarding, I think you said prudent capital allocation; just trying to get some sense of maybe if you could give some more color on what that means? Because I think based on my numbers here, I've got you covering your fixed charges by about 12 times or something at this point, and just wondering if it kind of beyond the $130 million number that you said you still have for this year in terms of debt paydown, is that kind of aided this point? Or is there further debt paydown to go over the next couple of years? And how are you thinking about the potential to perhaps re-lever a little bit before interest rates might go back up?

We do have a large bullet payments coming due in 2016 and 2017, about $300 million in each year. So yes, that certainly will factor in. Our balance sheet is in great shape; in terms of the guidepost, we definitely want a strong balance sheet. We want to maintain our investment-grade quality. Certainly, we would want to manage our debt levels to ensure we’re maintaining our balance sheet strength. Outside of that, we continue to aggressively manage our capital spending as you can see with our cap spending guidance that we have for the year. That will continue to be a focus here as we move forward. Additionally, the lever we have beyond that is our share repurchases and our dividends. I think our past results here speak to the fact that we want to continue to return value to our shareholders.

So, on the two debt maturities that you mentioned in 2016 and 2017, is the current view that you would cash settle those or that you would try to term them out?

I would expect that we'd do some level of financing here over the next year or so, but again we want to maintain fairly modest debt levels like we have today.

Yes, but nothing early; we wouldn't try to take on additional debt beyond what we've already done.

Yes, to Gary's point, we've looked at that and we've already done what it makes sense to do.

The GBTA revised down its outlook for business travel spend this year, so my question really is on that. So first, the Rapid Rewards program has, of course, evolved pretty dramatically over the past five years. And I'm wondering if how you measure the demand segment has evolved, and then secondly, what have you seen year-to-date, and what are you seeing looking ahead?

So, Dan, you were kind of faint there, so you just talking about business travel?

Right.

I can't really say that there's been a change in business travel personally. It's difficult to get a clear perspective. We try to gather insights through various methods, and there's a noticeable difference among them, but overall it seems stable. Our Rapid Rewards program has been a great success, and Tammy can provide specific figures, but overall, things are looking good. When examining our overall results, it's clear that our route network has been very active and we continue to achieve strong outcomes. We're paying close attention to our exposure in the oil sector, and everything appears to be fine. Overall, the situation seems positive. We have a significant presence in leisure travel, especially with our near international expansion in Latin America, which leans heavily towards leisure. You may see some changes in our mix because of that, but we aren't observing a decline in our business travel at consistent levels.

The only thing I’d add to that, Gary, is that we're very pleased with our corporate sales. Those outpaced our capacity and we're up almost double-digit. I agree with you, our business mix is still roughly a third of our passengers. Considering the mix of developing markets and everything that we have going on in our network, we're really pleased with the trends.

The frequent flyer, you didn't specifically ask it this way, but just as further empirical evidence for I guess your question, the utilization of our frequent flyer program and utilization of frequent flyer program card, credit card just continues to outperform our expectations, year-on-year. I'm just delighted with that program change, the execution, customer reaction, and the financial results that we have, it's just gone really, really well.

And I guess, you know, just following up on that and I'm going back a bit in time here, but at Southwest Investor Day last November, the view was that revenue could grow inline with capacity this year. As we stand here today, Southwest has added some additional capacity, and second quarter aside, I'm wondering if you still feel that revenue for the year can still grow in line with the capacity adds or has the world changed.

Yes, I’d be happy to comment on that one. Our goal certainly hasn't changed, that's not guidance of course, but at least starting out here this year we feel really good about the trends. Of course, we're starting out with flat unit revenue. I acknowledge we have added since Investor Day though, and I would point out that we have ticked up our capacity just a bit, mainly for the two additional gates that we picked up at Love Field. So, our capacity's up about a percentage point. So, admittedly, that puts a little more pressure on us to achieve that for the year. We’ll just have to see how all that plays out, but obviously what we're trying to do at the end of the day is manage to continue to strengthen our earnings and in our margins.

We’re off to a good start. We considered this from various angles and want to remind everyone that if you account for stage length and gauge changes in the first quarter, there's an almost 3% effect. A lot of the answer to your question will depend on how much stage and gauge changes we ultimately see, as everyone is looking at static unit numbers. Adjusted, I believe we will see growth in unit revenues, which is how I view it. Regarding Dallas Love Field, I’m unsure about the year-over-year stage length change, but it’s important to consider given the significant changes in flight distances. We’re doing well in the first quarter; we are right on track with capacity, and I’m very proud of our team for achieving this. They face a challenging comparison in the second quarter. It’s still early to give you a definitive direction on that. We acknowledge that’s the goal, and we will strive to meet it. So far, so good.

Good commentary, thanks. I wonder if I could squeeze one more in. Southwest has highlighted 60% as an average percent of free cash flow return to shareholders, again at its Investor Day. As we look ahead, I'm just wondering if that's still a good level to think about, again as we look ahead here.

Did you say 60? I didn’t hear what your question was?

Yes, correct. So, at the Investor Day, Southwest…

I think what we said was more than 50, but yes, I mean really no big difference, no big change in our philosophy since Investor Day.

You guys had done a lot of work on the Evolve seating in the new aircraft and the reconfiguration and so on. And then with the new aircraft, I saw that you're going with a completely new redesigned seat. Is that because the Evolve seat didn't measure up to expectations or is this more cost-effective seat? How should we think about this new seat?

I think it is the latter. The Evolve seat is great. We did not have B/E Aerospace seat; it was not on the market when we were looking for seats earlier. I think Mike Van De Ven found a better seat. Mike, do you want to talk about the advantages of going to the new seat?

Yes. The seat has been redesigned based on advancements in seat technology over the past four or five years. The frames of the seats fit closer to the airplane walls, which provides approximately half an inch more width. This adjustment results in about an inch and a half reduction in distance from the walls. Additionally, this design change creates extra legroom. All the seats are also wider, making it an improvement in seat technology. It offers better economics, increased comfort, and more personal space, making the switch an obvious choice.

And you're launching this seat, right, Mike?

Yes, we're launching the seat, and we’ll start rolling out on the fleet in mid-2016.

Just another opportunity to offer something new and improved.

I have a question for you regarding your aircraft order and the large customer for the MAXes. Have you considered selling any of your delivery positions given the current low fuel costs?

Mike, would you like to speak to that?

No, we haven’t thought about selling any of our delivery positions. In fact, we’d like to have maybe not more positions, but getting them sooner as we have them in our order book. We’re very excited about the airplane. It gives us of course none of the fuel burn, but it gives us greater range; it gives us better performance with the airplane, and I think it's going to give us more route flexibility than we have today.

Good day, Matt, and welcome to the members of the media who are on our call today. We’re going to go ahead and get geared up to take some of your questions. So, Matt if you could give them some instructions on how to queue up, we’ll get started.

Let me start out with asking a left field question. You've got Delta saying it needs continued space to do five flights a day and you've got the lawsuit going on in the District of Columbia. What is your degree of confidence that you'll be able to operate the 180 flights as of whatever it is, August 9 and not have to accommodate Delta? And what will you do if you have to accommodate Delta?

Well, we’re confident that we can execute on our flight schedule; we would not have published it otherwise. We’ll just leave accommodation up to the owner of the airport, the City of Dallas. We’ll be fully utilizing our 18 gates that we have worked really hard over a long period of time to get up and running. Obviously, they’re very successful flights, and customers are benefiting from more competition and lower fares. So, we’re very, very pleased with where we are and looking forward to adding flights in August.

Does that assume or not assume Delta is wiggling into your gates?

We will be very busy in fully utilizing our 18 gates.

If I could ask a follow-up question, your FTEs increased nearly 2,000 year-over-year. Where did that come from? Are you just staffing up at airports? Is there some transfer of part-times to FTEs or contract employees to FTEs? Where did such a large increase come from?

Terry, the increase we are seeing is largely straightforward; there are no significant shifts happening, it's operational. While we have some corporate increases related to projects, the majority of the rise is due to flight attendants, especially for the larger aircraft, the 800s, which need four flight attendants instead of three like the other types. We have noticed a great surge in traffic and passengers. Our ground operations at airports are also experiencing staffing increases. We want to ensure that our employees can effectively serve our customers without having to rely heavily on overtime, which also gives us opportunities to further invest in our operations and customer service. These two factors are primarily driving our headcount increases.

I was wondering if you could talk a little bit more in terms of Love Field. You've talked about how successful it's been, but can you break out is that more business travelers that you're seeing or is that leisure? Do you have any color you can give about the mix of passengers that you're seeing as you've increased flights at Love Field?

Off the cuff, I don't know that I can have a lot. We obviously have some traditional business markets like New York and Washington that we’ve added. I would at least guess off the top of my head that we’re seeing a larger mix of business travelers there. But Andrea, I think it's just a natural mix of people flying for business and pleasure. Our rule of thumb historically has been that the short-haul flights were more dominated by people traveling on business. So, I think these longer-haul flights that we’re having probably have a more normal mix of roughly 40% business plus or minus and the balance being leisure would be my guess, but I don't know. Tammy, I don't know if you have any more specific insight there?

No, I don't have specific numbers to give you. But yes, I would agree…

I know the flights are full. That I know.

I could just give you maybe a little more color just on Dallas. We added a number of new markets on April the 8th, and they were added with a much shorter booking window; we announced them later. Even those markets and those 13 new flights are full. A lot of those are running over 90% load factors, just like the overall Dallas mix, again with a much shorter booking window. Dallas in total is running a higher local mix, so attracting the local Dallas customer, so fewer connections. So that really answers your business leisure question, which I think and what Gary, I think is probably more average given the longer-haul. But it demonstrates another point, just the strengthened Dallas that we’re seeing with every new flight that we add.

Might Southwest accelerate the addition of international destinations, so leisure travelers can take advantage of the stronger U.S. dollar, and more generally, has the strong U.S. dollar changed your international strategy at all?

As usual, Southwest is different. The short answer to your question is no, I don't see us changing our plans at least right now; over time, we will continue to adjust our plans. All of our sales are in U.S. dollars, so we’re not facing challenges related to foreign currency due to the stronger dollar. It may affect international demand, but we don't have foreign currency challenges. We are also flying to near-international destinations, including Mexico and the Caribbean; we just launched service to Costa Rica. I believe these areas are less impacted by the issues you've mentioned. We're adding service to cities where customers are familiar with us. Most of the traffic on these international flights consists of U.S. citizens who are already our customers, so we’re providing them with more options. It's somewhat easier for us to enter these new markets compared to starting service in a new country where we rely on travelers from that country being aware of us and booking with Southwest, which is a much larger challenge. Finally, we're new at this. We want to expand our international presence at a measured pace for operational learning and to continue supporting our other ongoing expansions. This includes converting former AirTran markets to Southwest, which often means new Southwest service; launching a lot of new services from Dallas Love Field; and utilizing the slots we acquired from American Airlines. That’s already a lot to manage. We are enhancing our core growth with some additional international flying. We’ve been very pleased with the progress so far, but we plan to proceed cautiously and have no intention of changing our plans at this point.

Thank you. And if I also may ask separately, is Southwest looking to add to its fuel hedge book now?

I believe we will always seek opportunities to enhance our hedging program. Essentially, it's an insurance program. With prices having decreased, we have another chance to secure improved insurance coverage compared to what we previously had. However, I should note that the cost of insurance has risen since we've already made a purchase; now we need to unwind that and make another buy. That said, this is precisely what Tammy and her team are considering. I'll let Tammy share any updates on the program; I think we are mostly aligned with what has been communicated in the press release.

That's right, Gary.

Matt, I just wanted to share based on feedback I've gotten from Linda this morning that there was some confusion perhaps that I created earlier with my comment about assigned seating. I was simply offering up an example of the kinds of new capabilities that we’ll get with new technology just as color commentary. We’ve looked at assigned seating very carefully before and dismissed that. We could have built that capability on our own. I was simply pointing out that we’ll have that in the future; it would make it easy for us to relook at that at some point in the future, but we have absolutely no thought, no plans, and no desire to assign seats whatsoever. And with that I will turn it back over to Ms. Rutherford now.

Thank you, Gary. The communications group is standing by if you all have any follow-up questions. The number to reach us is 214-792-4847, or you can certainly send an inquiry to SWA Media at wunco.com. Thanks so much everyone.