Gary Kelly Speaks at Goldman Sachs

[chase]

Gary Kelly addressed the Goldman Sachs Investors conference today & had some interesting comments. I’ve tried to paraphrase some of the facts...trying to type & listen at the same time...not easy for the likes of me.



ATA Codeshare Info

· only about 10% of SWA flights are codeshare eligible...this will increase with PHX opening up in April as 2nd codeshare city after MDW

· About $80M invested in ATA at this point & revenues are projected to be around $100m for the year (11 months)...not a bad return on the money & it could grow

· MDW had 145 flights at end of ‘04...will be at 192, just below LAS & PHX by 3Q’05

· $100m mentioned above is combination of codeshare revenue & revenue generated by additional 6 gates

· MDW was underutilized since the airport completion project was completed last year....the new gates & growth have allowed SWA to take advantage of this great airport & hopes to do more in the future

· Chicago has much more potential for greater revenue...less LCC competition there since ATA has cut back flights, this helps with pricing & works to SWA’s advantage

· Pricing leverage is low on east coast (more on that later), much better in MDW

· Goal for code sharing agreement...get money back...we’ve loaned them $40M in straight cash, SWA wants to get money back as quickly as possible...once ATA emerges from BC SWA is obligated to purchase $30M of convertible stock ($1 a share) which will hopefully be sold for a profit when the stock begins to be traded again...this will generate more profit for SWA...GK made it clear, the operations are very different, a takeover is not the intent...too many differences...I have heard him say this personally during an interview & he appears to be sincere about it

· Attaboy to Technology Department....0% codeshare software, technology prior to Tgiving announcement with ATA...all built within 3.5 months to have an up & running system that is working well generating money...great job!!!!

Ancillary Income streams

· US Postal contract unlike other carriers is generating good income for SWA....CFO & GK are exploring ways to increase this along with increasing the cargo side of the house to generate more revenue

· Hotels, cars, cruises, credit cards are generating additional revenue but GK doesn’t want to lose focus on what SWA is....the leading low cost carrier in the industry

New aircraft vs. older aircraft

· Rapid addition of aircraft would have to be used aircraft...always a possibility...prefer -700s to -300s but not many in the market...if opportunities present themselves SWA will make a move

· Boeing can’t increase the delivery schedule right now

· Fuel hedging doesn’t appear to be an issue that woudl preclude SWA from expanding...GK kind of addressed it but it sounded like they would be willing to pay more for fuel if they got more airplanes since they would feel the increased capacity would offset the higher fuel costs

Fuel Hedges

· Provides insulation from $50+ barrel of oil prices...85% hedge for rest of year at $26 barrel....additional fuel costs for the remaining 15% will cause an increased in projected fuel costs for ‘05 to $200m

· Hedges provide SWA the time to adjust to current economiccycle & respond to fluctuations in the supply side of the industry, i.e. # of seats...hedges extend through '09 at various %'s...they aren't going away anytime soon but they do increase in price in the out years giving less flexibility but still some insurance

· GK expects to have higher fuel prices from now on....everyone, including SWA is going to have to adjust....ways to save money & be more efficient are going to be paramount

Revenue

· It’s all about revenue...if it doesn’t generate revenue then SWA doesn’t need to be doing it...inflight entertainment...it doesn’t generate revenue & would in fact increase costs, thereby damaging revenues....not being considered at this time

· Technology is just beginning to kick in to save SWA money...fewer employees in areas that don’t involve customer service...GK says we’ll never automate customer service, that is why call centers will remain the way they are & not be outsourced to computers...people want to talk to people

(continued)

 

[chase]

continued....

· Kiosks...SWA is lagging behind in this area slightly but rapidly catching up...40-45% of check ins are done with no contact with humans...15-20% are done at kiosks at the airport, the remaining 20-25% is done online at Southwest.com....65% of ticket sales are done online...next step is for bag tags to be printed at kiosks or in a manner that will allow for quicker checkin w/bags...saves time & people...however, SWA folks will always be around to help & solve problems when technology fails or circumstances require it



Pricing Issues

· East coast is hotbed for competition with LCC...Indy Air a particular point of contention with huge increases in the IAD, BWI market area...bottom line, too many seats chasing too few folks, most obvious on East coast

· Myth #1...SWA has the ultimate pricing hammer....they raise prices, everyone raises prices & problem is solved...GK says NO!!!! True pricing power only comes when the demand strips capacity & it isn’t even close...having a sold out play with one seat left to sell is pricing power....having load factors of 70% at SWA & various levels at other carriers still shows there are many seats to be had out there.....folks go to the lowest price carrier & the first time a legacy carrier didn’t match SWA’s or any other LCC for that matter & could claim the title of “low cost leader” the end would be in sight for SWA in GK’s mind...he doesn’t want to relinquish this title

· my notes directly as I listened to GK’s comments about pricing “

Incremental increases would seem to make sense to help revenue, why doesn’t SWA doesn’t do more of these to help the revenue picture….GK says this question is asked for 34 years…it is an artform, not a science…trying to generate more revenue, not less….going into markets, reducing fares generate more revenue & not less….we have unlimited power to raise fares…a false premise….if you can’t get a seat then you have pricing power….if you have a seat that is available for anyone to get from pt a to pt b, pricing maybe an issue but it isn’t the only issue….computer has allowed the customer to look for the lowest fare….the structure of pricing in the airline industry is flawed….lots of different fare structures but what folks really want is the lowest price, period….very few fares are sold at the high end….SWA may have “some pricing power” but it is elusive & can go away overnight if SWA moves the price too high…..supply exceeds demand right now & therefore there is little pricing power……until supply side issue is fixed, pricing power is illusive & non-existant.

Miscellaneous Comments

· “Airline” show doesn’t generate any income directly....lots of good PR, with loads of positive comments & few negatives...3rd season...one of A&E’s most successful shows...moved from 10PM slot to 8PM slot

· Asked why investors continue to pour $$$M into legacy carriers that are money losers...GK didn’t wish to theorize why but said SWA must be ready to capitalize if things don’t work out...that can only happen if SWA handles this opportunity carefully...expanding into the right markets will the key & being nimble, even when you have 32K employees & 420+ airplanes....the best example of this was the ATA opportunity...without a good balance sheet & good reviews from Wall St this opportunity couldn’t have been taken advantage of....also one of the reasons why it was approved so quickly....an obviously financial viable company helping a struggling company & infusing it with not just money but ideas & leadership

· Next labor negotiations don’t expect to see GK in the negotiation booth like Parker...this isn’t his forte & he knows it....the new department in Southwest that is dedicated toward improving communications & building working relationships between the company & employee groups will be one of the key players in all future negotiations....Colleen oversees this department along with others...he expects his employees to be fairly compensated under the current environment.

· GK spends 1 day a week away from the office out in the system listening & learning about the various operations...his way of staying in touch & always learning from his best assets, the employees
______________
(continued)

 

[chase]

Commentary from an FO

Very enlightening interview....handled very well by GK with straightforward answers. Southwest will not be able to sit back & wait for things to get better....it appears as always the leadership wants to play offense & not defense & certainly GK has done that since he has come on board as CEO. Fuel hedges are providing the time & money to keep the company in the black but with the help of all employee groups GK firmly believes the company can return to the days of higher revenue which will result in a higher stock price, something all shareholders want....this can be done even with high fuel prices IF capacity is decreased in my opinion...revenues can remain in the black but not at the levels needed to meet GK’s goal with BK legacy carriers allowed to operate under rules that other carriers can’t....add to that additional money from 3rd party investors the landscape is troubling but not so much for SWA as it is for Delta, AA, CAL & NWA since they will be more adversely impacted by these reduced costs by BK carriers than SWA....fuel hedging is protecting us no doubt but no such tool is available for the tumble toward dissolution of pension plans & pay scales at the aforementioned non-BK carriers....this year or next, those pensions & payrolls will look much different which will add to the competition that SWA will face.....a challenge I believe SWA is up for.....



Congrats again to the April 6 class & to the folks getting the call for the 20 April class (I think there is one still scheduled for then)



Anecdotal story from a DAL CA today....several days ago a new FO who had spent 19 years at another carrier went into ops & shook everyone’s hand & personally thanked them all, in his own words, “I’ve had more fun in the 2 weeks of flying on the line than I had in my 19 years....you guys are great!!! Thanks so much!!” ....as one new hire told me after his IOE....he said he had a 4 day & not once did he have to sit & wait for a gate to open up or wait until someone would pull the gate to the aircraft...he couldn’t remember the last time that had happened at his previous airline...he said he even saw someone “running to get the jet chocked & parked....I never saw that in my previous life”....SWA isn’t perfect & certainly we have some apples out there who think this place is going to the dogs but to most, it ain’t half bad...thanks to the enthusiasm of all the new hires & for coming to SWA...pass that spirit on to others!!!

 

[canyonblue]

or wait until someone would pull the gate to the aircraft...he couldn’t remember the last time that had happened at his previous airline...

I agree Chase. In 3 years I have only waited one time for the agent to pull the jetway up to the plane, and that was because of a miscommunication between agents. Great teamwork here.

 

[Rez O. Lewshun]

SWA is a machine....

 

[SWA tech]

Getting it done with team work thats the SWA way

 

[DH2WN]

You guys are killing me!! I can't wait until class.

Great stuff Chase.

 

[chase]

Further explanations of hedging by GK & CFO

Found on FT.com

Soaring oil bills force airlines into cost control
By Caroline Daniel
Published: March 24 2005 02:00 | Last updated: March 24 2005 02:00

Most of the biggest names of the US airline industry are facing another year ofheavy losses, job cuts and, in some cases, bankruptcy proceedings. But Gary Kelly asks: "What's to stay up at night about other than just to be so excited about my life?"

//
"A friend asked me, how do you like your job and do you worry about $55 crude oil, and I just don't think there is anything to be gained by worrying about it," the chief executive of Southwest Airlines says.

With crude prices near nominal records and in the week that Gerard Arpey, chief executive of American Airlines, warned that its fuel costs could hit $5bn - $1.4bn higher than 2004 - Mr Kelly's nonchalance seems peculiar.

But the different attitudes reflect very different philosophies towards fuel bills - traditionally an airline's second biggest cost after labour.

While Southwest has hedges covering 85 per cent of its fuel needs for this year, at $26 a barrel, American has hedges in place for just 15 per cent of its needs for the first quarter, priced at $40, falling to only 5 per cent for the rest of 2005.

The fallout is clear: Southwest should remain profitable this year, while American faces a fourth year of losses.

While airlines have focused attention on controlling labour costs, fuel hedging has not been considered a core competence. When fuel was cheap, this did not matter much. Now, that is no longer the case.

As oil prices began their recent rise, legacy airlines adopted the herd mentality: as long as rivals were unhedged, they could be too. "In early 2004 there was a view that fuel prices were too high and were all going down, so they all listened to their investment bankers and saved money by avoiding hedging," said one airline analyst.

Southwest struck out from the herd. Laura Wright, finance director, says the airline was hit by a sudden rise in crude prices in 1999, when it was unhedged: "We wanted to be more disciplined. It was not about predicting what would happen to prices, it was just cost control."

The aim was to predict costs up to two years out, so it lined up hedges for 65 per cent of its 2006 needs at $32 a barrel; for 2009, it has hedges for 25 per cent at $29 a barrel. "We view it as risk management," she says.

Southwest was aided by its robust balance sheet and credit rating, which enabled it to find counter-parties willing to agree deals further into the future.

American used to have a methodical approach. But after signing new labour contracts in April 2003, James Beer, finance director, recalls: "We were still concerned about tipping into bankruptcy. There was a real push to generate cash from whatever we could find. We unwound the hedges that were in the money and achieved that objective."

That left American largely unhedged. "It is hard to get re-established when you have an ever increasing slope. [Fuel] prices have looked very high. You have to add the cost of executing hedges when you are a non-investment grade credit, and balance the desire to return to robust hedging against the reality of a large amount of cash flowing out," Mr Beer says.

American is not alone in prioritising cash. Delta and Continental have no hedges for 2005. United and US Airways, limited by bankruptcy, have minimal hedges. Northwest has hedges for just 6 per cent of its fuel for this year.

There are three consequences. First, more cost cuts to avert more bankruptcies. Merrill Lynch last week forecast that if US crude averages $51 a barrel this year, US airlines will bleed another $5bn, which is clearly unsustainable.

Second, fare rises are inevitable. With so many airlines vulnerable to fuel there is finally a concerted effort to pass these costs on to consumers. This week most airlines agreed the third $5 fare rise in a month, which have added up to $40 to a round-trip domestic ticket.

Finally, airlines are slowly rethinking their hedging philosophies. Tim Walker, assistant treasurer at America West, says: "We are taking small bites of the apple more often. We have been more active since March 2004, and done 25 hedging transactions. Prices may be at historic highs, but we had to be active."

 

[FlyBoeingJets]

As oil prices began their recent rise, legacy airlines adopted the herd mentality: as long as rivals were unhedged, they could be too. "In early 2004 there was a view that fuel prices were too high and were all going down, so they all listened to their investment bankers and saved money by avoiding hedging," said one airline analyst.

Southwest struck out from the herd. Laura Wright, finance director, says the airline was hit by a sudden rise in crude prices in 1999, when it was unhedged: "We wanted to be more disciplined. It was not about predicting what would happen to prices, it was just cost control."

Very well said. Allocating millions? of dollars for a program that might not produce $1 of return is a tough decision. It would be easy to find other ways to spend that money. If oil had stayed low the legacies would have been the heroes. As far as that being a "herd mentality", I don't know. The execs got advice on hedging and made a decision. Unfortunately they took the risky instead of risk averse route. Planning for the long-term is not easy or even popular. Shareholders, board members, and especially labor unions often lose interest in such things. If airline management can get their focus off their compensation packages they can do great things.

Did the legendary Bob Crandall at AMR ever fuel hedge???