Welcome to the Southwest Airlines Fourth Quarter and Annual 2015 Conference Call. My name is Tom, and I will be moderating today’s conference. This call is being recorded and a replay will be available on southwest.com in the Investor Relations section. At this time, I’d like to turn the call over to Ms. Marcy Brand, Senior Director of Investor Relations. Please go ahead ma’am.

Thank you, Tom and good morning everyone. And welcome to today’s call to discuss fourth quarter 2015 results. Joining me on the call today, we have Gary Kelly, Chairman, President, and CEO; Tammy Romo, Executive Vice President and CFO, Bob Jordan, Executive Vice President and Chief Commercial Officer, Mike Van de Ven, Executive Vice President and Chief Operating Officer. Please note today’s call will include forward-looking statements and because these statements are based on the company’s current intent, expectations and projections. They are not guarantees of future performance, and a variety of factors could cause actual results to differ materially. As this call will include references to non-GAAP results excluding special items, please reference this morning’s press release in the Investor Relations section of southwest.com for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. At this time, I’d like to go ahead and turn the call over to Gary for opening remarks.

Thank you, Marcy and thanks everybody for joining us today for our year-end 2015 earnings call. This was another superb and critical year for Southwest, and I am very grateful to all of our people for their hard work. I want to especially thank them for these terrific results. Tammy is going to take us through the quarter, but I want to offer up, not a comprehensive overview, but at least a few highlights. Of course this was by far our best year of earnings in our entire history, and that includes a record return on invested capital of 32.7%. We no doubt benefited from 29% lower economic jet fuel prices. Obviously that was a major component of our earnings. But so were record load factors, and revenues were up also very solid 5.6%. It was a strategic year for us in that we had secular growth opportunities at Dallas arising from the refuel of Wright Amendment and of course that has been a phenomenal success. We’ve also had secular growth opportunities out of Washington Reagan and LaGuardia that is arising from the acquisition of slots. It was also a year that follow at the end of 2014, the completion of the AirTran, our acquisition and integration. a lot of new markets resulted from that. And then of course it was also a year where we had a unique opportunity in which to build in international terminal and launch international flights out of Houston Hobby. That was for the first time since 1969 by the way. All of that added up to capacity growth of 7.2%, and then of course we were delighted that traffic was stronger than that. It grew 8.8%. And as a backdrop the economy for last year was solid travel demand was solid and of course…

All right, thank you Gary and welcome everyone. We're very pleased to report a standard year of record performance in 2015, representing our 43 consecutive year of profit. Our annual earnings, excluding special items were a record $2.4 billion or $3.52 per diluted share, which was an increase of 75% year-over-year. Our fourth quarter performance was also record setting, and represented 11 consecutive quarter of profit. Fourth quarter net income excluding special items increased 46% year-over-year to $591 million or $0.90 per share, which was in line with consensus. Operating income excluding special items was a record $992 million, which produced a 5-point improvement in operating margin of 19.9%, which is the best fourth quarter margin we've seen since 1978, and it's also worth nothing like last quarter with and without the benefit substantially large rail prices, our earnings and margins improved year-over-year. And the record that really stands out is free cash return on invested capital, excluding special items of 32.7%. I would like congratulate all of our outstanding employees on these fantastically built and like Gary thrilled we can reward our employees with a record breaking profit sharing $620 million for 2015. Our total operating revenues in the fourth quarter were a record $5 billion, up 7.5% year-over-year on a capacity increase of 8.4%. Passenger revenues were also a record $4.6 billion. Demand for our low fares remained very strong throughout the quarter, resulting in more than 11% growth in traffic, and an all-time fourth quarter record high load factor. A softer yield environment resulted in a 7% decline in passenger revenue yields and an $8 decrease in our average fares. Our fourth quarter operating revenues included a $125 million net benefit from the amended Chase contract and the required accounting treatment, and this $125 million benefit was…

Thank you. And will now open our analyst portion of today's call. [Operator Instructions]. Thank you for waiting. We'll begin our first question from Jamie Baker with JP Morgan.

I'm hoping to ask 2.5 questions here. The half-question Tammy, you noted also as a TA -- two TAs out right now, they guided this morning and the impact assuming ratification. Are you willing do the same in terms of what that would mean for the XL [ph] cabin guide you just gave?

No Jamie, just out of respect, the process of -- we'll update that as we progress here.

Sure understood. So why don't we move on to Gary here, and another question on labor. Given your history of profitability, it's no surprise that your 737 wage rates came to represent the peak for U.S. Airlines easily over the last decade. But as the competitor wage bar begin to rise above yours currently, is it inevitable the Southwest pass to establish a peak with every successful contract; or put differently, is your business model predicated on maintaining above market pay scales, or was that just a byproduct of how poorly the competition was at one point?

Well, I am going to try to give you -- I am going to try to answer your question and I want to try to be diplomatic and respectful of the negotiations process here. But I would just say our business model Jamie, is great service and low cost. And we -- every single employee at Southwest Airlines signs up for that, and of course we all need to continue to work hard every day to deliver on those two things. So that is our business model, not. There has never been a promise to be the highest paying airline in the industry. And so to the extent that we're able to do that because we produced great results, I think that is terrific. But all of that needs to obviously be negotiated with our labor groups and that's what happens, and that's the way that works. I think the overriding objective for us is to continue to have a healthy company meaning that we are safe and that we're financially strong. And in order to do that we've got continue to offer great service and our objective is to the low cost producer and live up to the low fare brand promise that we have.

And as a follow up to that last point you've made and I guess this echoes the discussion that you and I had at the Wings Club. You've never faced a larger percentage of competitive capacity that have lower costs than your own than you currently do. In fact, last time you faced a formidable competitor with a superior cost structure, as near as I could tell, you brought them. So I'm wondering how growth at Spirit and Frontier, given their cost structures alters how you think about your own business going forward?

Let me just affirm virtually everything you said. The only edit I would make is that actually when we acquired Air Tran, their costs were not lower than ours interestingly enough, at least by my analysis.

Fair enough.

But clearly there are carriers today whose costs are lower. On that point you and I certainly agree. And first of all, I think that is inventible that overtime that an industry will get more competitive, especially when there is a disrupter as there has been with Southwest Airlines. So it is not shocking at all that we have more intense competition today than in any time in our history. And it is a challenge for our Company and something that I'm very confident that our people will rise up to that challenge. But indeed, it will put an obligation on us to continue to innovate and work very, very hard so that we don’t lose our low fare leadership position in the country. So absolutely, it is different and I think we recognize that the industry is more competitive today than it has been ever. I would quickly add by the way that Southwest has never been stronger. We've never had the route network. We've never had the depth and the breadth of the service that we offer. And we've never had a balance sheet this strong, we've never had earnings this strong. So it's really up to us to continue to make sure that we compete and be the best at service and price.

We’ll take our next question from Duane Pfennigwerth with Evercore ISI.

So the hedge liabilities you called out for '16 and '17, appreciate that detail. I'm just wondering, can that change or is it fully locked in at this point? In other words, if fuel goes higher, does it shrink?

It is if fuel goes higher, it certainly shrinks. I'll start there. And no, it is not entirely locked in. But I think the main takeaway there is that we -- as prices go down, so does our fuel bill as well. So yes, I gave you a pretty good amount of detail there on our hedge as I walk through our -- my comments there. So I think we're positioned very well. We know what we have to manage and I think we're positioned well, if fuel prices go up or if they go down from here.

And then as we think about the capacity that you had in development last year and specifically the Redmond markets, can you help us quantify the benefit you expect, having less of that capacity in development? And if you can help us with sort of the full pie, maybe you could just talk about the markets that you launched in late 2014 that you should've had basically a year of experience with by the fourth quarter, if you saw sort of significant RASM improvement there. And thanks for taking the questions?

Duane, you were fading in and out, but I think we got the gist of your question. Yes, we have -- we can quantify at least from an internal perspective what we think the opportunity is there. I would just start out by acknowledging that that assumes all else as equal and – but, I'm sure that you and everyone else understand that.

Yes, just a couple of comments there to maybe help you out, Duane. We had, again like you said a high number -- high percentage of our markets were under development. You know what those markets are and I'll remind you that the high percentages did include the market that we were converting from AirTran over to Southwest. So the point I'm making there is not all of the markets are created equal. Obviously we reported a lot on Dallas, Love Field and are very pleased with how those markets are progressing. But we wouldn’t expect our international markets as an example to mature at the rate we would say Dallas or even the AirTran markets. So they're all a little bit different, but I can at least help quantify the impact we're expecting here in the first quarter. And if you -- it's probably in terms of -- it's probably at 1 point, I call it -- maybe not even a 1-point impact from development markets. So as we move in to 2016, at least my expectation would be that we'll get some tailwinds from our development markets as those continue to mature.

We'll take our next question from Rajeev Lalwani with Morgan Stanley.

Just two for you guys. The first, I guess with oil coming down so much, and obviously you're going to see that benefit from the fuel numbers you provided. How does that impact how you're thinking about the business either from a revenue or a capacity standpoint, if at all? And then second question was just, you announced the aircraft order today and the acceleration. What drove down -- what changed over the last couple of months. It seems like the opportunity has been out there for some time?

Tammy, I'll take a shot, and if you want to chime in, please do on both of those. I would admit to you all that it is -- the year is off to a very concerning start, when it comes to headlines around the world. It's almost as if we're living in a different dimension here at Southwest, and from what I've heard from some of our competitor reports too. So our business continues to be strong, but I will quickly admit that there are concerning headlines around the world. So then you translate this to oil prices and living in Texas my entire life, this is an oil and gas state, and yes, it is concerning, the impact it will have on companies and debt payments and jobs and so on. There's no question that the United States has benefited from the oil and gas boom that was occurring over the last X number of years since the -- really since the recession. So yes, that's all a concern that no doubt you have. We share that. But at least in terms of seeing any manifestation of that in our business, we just – we don’t see it. Even our oil and gas markets, if you want to call them that, produced very strong results in the fourth quarter. Several of our markets have year-over-year -- our yield pressure if you will. So that's not unique to those markets, but they still produce very, very handsome returns. But yes, it's just something we're going to have to keep our eye on. And I offer that background, just as an acknowledgment that we're just living in a world where we need to continue to be alert and be cautious. I will then follow-on and say that we feel like our plan for 2015 was sound and it turned out to be so. We think that the follow-on plan for 2016 is also sound. It is more conservative then what we had committed ourselves for last year. And as Tammy and I have both reiterated, we’ve not made any change with our capacity outlook. And especially for 2016, we’re still right in the 5% to 6% range, and I think all of us would be prepared that if for whatever reason travel demand weakens, then we would want to address that, and then at least discuss what kind of options we have to react on the down side. But in terms of taking advantage, further advantage of low energy prices and boosting our capacity, we don’t have any plans to do that. Tammy, before we go into the second question, anything you would like to add?

No, I think that was perfect. And in terms of your question on why did we decide to accelerate the Classics. I guess, I just point that to our fleet modernization efforts that when we set our plan, I guess, I just have to say, we’ve been very pleased with the benefits from our fleet modernizations so far, and as we've continued to evaluate, just the operating cost of operating Classic as it dwindles in size. We just really took out our pencils, evaluated it and we were able to come up with a plan that actually is going to enable us to improve our EBIT at very modest capital levels. So I think you know our Southwest well. We prefer a simplified fleet, and even though the Classic fleet is 737, we'd much prefer to operate 700s and 800s. It certainly simplifies a lot of the operations, and also just improves the reliability in terms of just less downtime from a maintenance perspective. So I think we’ll get also get a boost from the productivity of our fleet, which certainly was part of the EBIT contribution that we’re expecting. So all-in-all when we set down and evaluated it, it became pretty compelling to go ahead and accelerate the Classics. So hopefully that helps provide a little color as to what went into the decision making tranches. Gary, did you have anything?

Tammy, only thing I would say about -- it’s always a fair question; why now? Why not earlier? Why not later? And I think it's back to that convergence or confluence of things. First of all, we’re at a fleet number that is manageable to think about accelerating retirement in that way. We have more out of service time with those airplanes for maintenance reasons than we do the rest of our fleet. And Tammy made that point. I just want to reiterate. You'll get a lot more productivity out of a new airplane than what we are currently getting out of these Classics, which means you don’t necessarily even have to have a tail-by-tail replacement, although that is our plan. But they'll be more efficient. The other thing is that Boeing was available to us. Boeing had delivery positions and we were able to strike a deal with them, and in a way that worked for them and was win for them. It was win for us. So that was key. With respect to our people, think about the people who have to touch the airplane, the pilots, flight attendants, mechanics, specially. It’s just far easier for our people to operate the NextGen than it is the Classic. That's just a fact. So this will simplify a lot of things for all three of those work groups and in particular, our pilots. So it’s a good deal. If it works out, it will be better for our customers and all the way around we're just delighted that we have this alternative available and we’re able pull all together to end of the year. But it was an idea and a decision that was aggressively pursued in 2015, in fact in the later part of 2015 and fortunately it all team together.

And just again on the cost obviously. As always, it's just part of our DNA at Southwest. We're very focused on costs and being the low costs producer, and this is just yet another way to help us as we’re managing our cost here over the next several years.

And we’ll take our next question from Hunter Keay with Wolfe Research.

You guys didn’t buy back stock in the quarter for first time in almost five years it looks like. You'd still put money off in the repo and I understand you did the $500 million ARS. But I would have thought you guys would come in and thoughts on after cutting the revenue guide. Did that have anything to do -- not buying the stock have anything to do with posting 800 [ph] million dollars in hedge collateral, or can you give us any kind of colors, the thinking behind sort of putting it on hold for the quarter?

No. It didn’t have anything to do with the fuel hedge collateral, and honestly wouldn't read anything into that at all. We are more focused. As we said this morning we are launching a 500 million accelerated share repurchase and we'll get that launched soon, and then after that we will have 200 remaining on our 1.5, which was approved at our shareholder meeting last night. So we've gone through that authorization pretty darn quick, returning more than a 100% of our free cash flow in 2014 to our shareholders. So I'm very proud of what we did there in 2014 with respect to the share repurchases. So again, actually that included our dividends. So we are -- I don’t think there is anything more to it than that.

That's true. That was already a record amount, and as we've allowed here, we were also beginning to have serious thoughts and conversations with the Boeing company and what -- how that cash flow might flow from that deal. So I think what's material is that we have announced the $500 million today.

Yes. Okay that's just fair. Thank you. And looks like -- when I look at schedule data, I think you guys are trimming over the capacity at Love Field markets into LaGuardia and Regan and moving some of that out west little bit. Does that have anything to do with the operational challenges that you might be encountering at Love Field because of the ongoing legal dispute and obviously the [indiscernible] or feel it but does that have anything to do with that, or is that unrelated and there are other factors, maybe just sort of like market demand based decisions. Any color around what's flowing into that -- if the [indiscernible] is correct.

Yes. You bet, yes sir you bet. No. There is no -- I think our operations folks have done a marvelous job. They are doing what is for us ten turns a day on a gate with well -- in less than full utilization of 18 gates. So the operation actually is doing fine, which simply means that we have --- when we finally get access to all the gates, we will be able to put more flights in there. But you'll note Hunter, that we make changes all over the country, and we don’t make dramatic changes in Dallas, but you've got markets like Seattle that come into mind and Fort Myers, Florida where we make very significant seasonal adjustments. The other things that I mentioned to the media on this very same question this morning is that you know that we have a lot of new flying that's transpired since October 2014. And I went through all that stuff and so has Tammy. So with all of those new way routes, I think we would readily admit to you that in some cases we may have too many flights in some places, we may not have enough flights in places, and so there is always some tuning that continues, and that is all that's going on here at Love Field. So my recollection -- we'll still at a 180 daily departures, which probably cut through everything, and answers your questions best that way. But yes we've got some pluses and minuses in routes, and there's nothing unusual about that.

And will take our next question from Savi Syth with Raymond James.

Just on the unit cost growth, I was just kind of curious, with the higher capacity growth in the first half, I would have thought maybe -- a little surprised by the 2% [indiscernible] growth, and then just wondering -- I know the one-point from the [indiscernible] depreciation. Just wondering the timing -- the timing issues or what was leading to that very high increase in 1Q?

Yes. You are exactly right, Savi. The guidance for the full year is more 1%. So you are exactly right. It's just the timing of when our expenses are falling.

Got it. And then just on the USCC question, they came up before; just wondering Gary, if you have any thoughts here. It seems like the industry was going through a bit of the segmentation. And I know Southwest wants to be kind of the leading low cost, low fare airline. But there is a product differential, and then your kind of performance or be at the product or the service, and merely the things that I was just kind of curious as to what your thought process is? Do you need to be the lowest fare recognizing, that there is a difference in product, and then maybe your thoughts on kind of the customer segmentation, if there is a customer segmentation or if this is truly like a commodity business and you just have to be -- have the lowest fares?

Well. I love your question. Well, everybody's question, but that -- I think that's one that's an interesting one to share. And I'm happy to have an opportunity to address it. We want to be the best service at the lowest price. Period. And describing price, I would agree that we are going to have to do some comparisons between unbundled pricing versus our more bundled approach. All-in, I want Southwest Airlines to be the lowest price. We'll win if we have the best service at the lowest price. And that's been our tradition, that's been our history, that’s what the whole Company is based upon, and that's what our growth plans are fundamentally based upon. I think it is a slippery slope to accept that our costs and our fares can be higher based on service, because as you well know, there is a long list of failures in the airline industry who pursue that exact strategic plan. And it's really a compound. It really not facing up to the challenges of finding more and better ways to compete on cost and on price. So thing I love about Southwest is it's been a Company who has been able to do both. And the other thing that you find I think, which is a slippery slope is companies can change. And while service may not be a great attribute for some of our competitors today, who will go on unnamed, who is to say as they can change that in the future. And so we need to continue to strive to be the best at both, and we need -- while we may not have all the answers at any given point in time, I think that that needs to continue to be our guiding line.

And we have time for one more question. We'll take our last question from Michael Linenberg with Deutsche Bank.

Two quick ones here. When we started the quarter, the guide was for RASM to be up about 1%, and as we moved through much of the quarter, that number was out there. And then, about a month back you took guidance down. And when I think about across the industry, we did see some, some of the carriers come in with weaker than expected at revenues. Some of it was fuel surcharges, some of it was FX, some of it was the Paris attacks. Those are to take some things that I didn’t think impacted you on one hand. Then on the other, we did hear that some airlines just ran a better operation because the winter weather wasn't that bad. So I am curious with your exposure on the energy patch, was that some of it, that you saw some demand weakness in your core energy markets, or is it just a better run operation? What drove that down so much?

Mike, I don't think Tammy would either. I wouldn't blame our energy markets at all, although as I mentioned earlier, I think it is true that the energy markets are seeing some softness in RASM year-over-year, but they're still really healthy. I think the thing that’s -- and Tammy will better insights no doubt, but the thing that stands out to me was Thanksgiving. And we were pretty much tracking along with our forecast for the quarter until then. And if you'll recall our discussion with our November traffic, the pricing environment was not -- I used a word and it was quoted at the time, it was unusual. So the Christmas holiday period was more normal. But regardless, you kind of fast-forward now and Tammy, maybe it might be more helpful to talk about current trends as opposed to what changed, but Mike, that was the main thing that I recall in the fourth quarter, was the yields over the week of thanksgiving holiday travel based on unusual discounting in the industry were lower than what we would have predicted. Anything you want to add there, Tammy?

Yes, Gary I agree. That really was what -- that was primarily what was different from what our forecast was going into the quarter. And by the end of year with the holiday performance in the December, that was actually within our expectations. So as we're just trying to sort through all of that I would just -- our expectation going into the first quarter based on what we've seen so far, and in January is demand seems strong. We're continuing to see strong load factors, but again we're also continuing to see those come in at weaker yields. So at least I guess the way I would characterize at least from what we're seeing so far and our bookings is stabilized.

Mike, the only other thing I would just point out is we had the same question here after -- so Thanksgiving occurred the Paris attacks. And whether there was an effect on bookings with us, with our competitor, I don't know. That's hard to tease out all of that. But the other thing that's going here is if you looking the border GDP results for the fourth quarter, and they weren’t very good. So it's possible that the industry was seeing some softening in demand that led to more aggressive discounting. And it's coupled with the industry also growing faster than GDP. So it wouldn’t be shocking to find that there was a little bit of a rough patch there and just trying to get supply and demand cleared at the right price. So -- but any of that -- beyond that, we're continuing to manage our developing markets. We're continuing to manage our markets in which there are competitive changes in terms of pluses and minuses in activity and overall the demand -- that all -- as we said -- demand, it all adds up to I think a very solid outlook. And I'll just reiterate one more time, that our results are not adjusted for the difference in stage, length and gauge. If you do that, we're turning in positive unit revenue performances in the fourth quarter for the full year 2015, and that would also continue to be our outlook in the first quarter.

It's a good point. And then just on the capacity, I apologize if you threw this out there, Tammy, but I think you gave the full year number five to six, which is obviously unchanged, but normally around this time of the year, you'd get it to us by quarter end. The way it seems, it seems like it would be front end loaded, obviously impacted by the leap day. Do you have kind of rough -- what those rates are by quarter, how we should model it for the year?

Well, she did say 8 to 9 for the first quarter.

Yeah, 8.

It's 8.

9 for the…

It is – I think it was 8.3 in the fourth quarter or so. The high watermark is going to be this quarter and then it will start trending down from there, but I will defer to you on the rest of the quarters, Ms. Romo.

Thank you, Mr. Kelly. Yes, so after this quarter, second quarter is in the 4% to 5% range, yes.

And that concludes the Analyst portion of today's call. Thank you for joining. Ladies and gentlemen, we will now begin our media portion. At this time, I'd like to introduce Ms. Linda Rutherford, Vice President of Communications and Outreach.

Thank you and good afternoon. If you go ahead and queue up, Tom you can give them instructions and we'll get started up on the media Q&A.

[Operator Instructions] Thank you for standing by. We'll take our first question from Jeffrey Dastin with Reuters.

Has Southwest recently exited any pure hedge contracts early for further participation in the fuel price decline? And if so, at what cost?

Yes, I'll be happy to take that. We have reduced our hedges here in 2016. So the answer to that question would be yes. We -- we're just looking at what we had last reported to you in terms of our hedge percentages against the main difference would be in the second half of 2016. so we did reduce our hedges there substantially in light of the declining fuel market. So we went from call it 60% to 70% in the second half of 2016 to probably closer to 30% to 35%.

And a brief follow up to make sure I understood your earlier comments correctly. Is Southwest relying more heavily on call options this year than last?

That would be going forward, and that's correct. And in fact our 2018 position only represents call options. That's exactly right.

So in other words we were already long with a position for '16 and '17 as 2015 unfolded. So Tammy and her team are continuing to work those positions off as best they can, but then any additional hedges that they're doing, they're doing with the call options to answer your question there.

So, the call options are also for 2016 and 2017 in addition to 2018.

Actually anything that we've added, just to be fair to your question, well…

Yes.

The majority of what we've added in 2015 has been call, because all we have is 2018. But yes, I think that would be fair.

[Operator Instructions]. And Ms. Rutherford, there appears to be no further questions at this time. I would like to turn the call back over to you for any additional or closing remarks.

Thank you so much Tom. If anyone in our media community has any follow-up questions, please reach out to us 214-792-4847 or shoot us a question over to www.swamedia.com. Thanks, and have a great afternoon.

That concludes today’s call. Thank you for joining.