Southwest Airlines Q3 Tops Estimates Amid Lower Fuel Prices 

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The FINANCIAL — Southwest Airlines Co. on October 22 reported its third quarter 2015 results: 

Record third quarter net income, excluding special items, of $623 million, or $.94 per diluted share. This represented a $241 million increase from third quarter 2014 and exceeded the Thomson Reuters First Call mean estimate of $.92 per diluted share.

Record third quarter GAAP2 net income of $584 million, or $.88 per diluted share, compared with third quarter 2014 GAAP net income of $329 million.

Record quarterly GAAP operating income of $1.2 billion. Excluding special items, record third quarter operating income of $1.0 billion, resulting in an operating margin3 of 20.3 percent.

Returned $549 million to Shareholders through dividends and share repurchases during third quarter 2015, and $1.4 billion during the first nine months of 2015.

Return on invested capital, before taxes and excluding special items (ROIC)1, for the 12 months ended September 30, 2015, of 31.1 percent, compared with 19.0 percent for the 12 months ended September 30, 2014.

Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, “We are very pleased to report outstanding third quarter 2015 results marked by a 63.1 percent year-over-year increase in net income, excluding special items. Our record third quarter operating income, excluding special items, of $1.0 billion produced a strong 20.3 percent operating margin, which is a 680 basis point improvement from the year-ago period. The significant margin expansion was driven largely by lower fuel prices. Our results also benefited from a continued focus on cost control and solid overall revenue performance, including a significant contribution from our Rapid Rewards program. Customer demand for our low fares was evident with an all-time quarterly record load factor of 85.4 percent for third quarter 2015. That’s what low fares without ‘gotcha’s’, which we call TransfarencySM, will do for you. My thanks to our superb Employees for producing our tenth consecutive quarter of record profits and my congratulations to them on their record $484 million profitsharing accrual, thus far this year.

“We are pleased with our third quarter 2015 unit revenue (RASM) performance, considering the longer average stage length, higher average seats per trip (gauge), and softer yield environment. Third quarter 2015 operating revenues grew 10.8 percent to a record $5.3 billion on a year-over-year increase in available seat miles of 7.6 percent. Our third quarter 2015 operating revenues reflected a benefit of approximately $300 million from our July 2015 amended agreement with Chase Bank USA, N.A. (Chase), including a required change in accounting treatment. This benefit includes a one-time non-cash increase to operating revenues of $172 million, which was recorded as a special revenue adjustment. Total operating revenues, excluding this special item4, increased 7.2 percent to $5.1 billion, and decreased slightly on a unit basis, both as compared with third quarter 2014. Based on favorable booking and revenue trends thus far in October, and including the ongoing benefit to operating revenues from our amended Chase agreement (estimated to be approximately $130 million for fourth quarter 2015), we are currently expecting an increase to fourth quarter 2015 unit revenue of approximately one percent, year-over-year.

“Our favorable third quarter 2015 cost trends and outlook for fourth quarter 2015 costs reflect significantly lower jet fuel prices and ongoing fleet modernization benefits. Our third quarter 2015 economic fuel costs1 declined nearly $300 million, year-over-year. Based on our existing fuel derivative contracts and market prices as of October 19, 2015, we currently expect full year 2015 economic fuel costs to decline approximately $1.3 billion, year-over-year.

“We are very pleased with the strength of our network, especially considering our uncharacteristically high percentage of markets under development. Our new Dallas markets, in particular, continue to perform exceptionally well, including the eight new markets launched in August 2015. We reached an exciting milestone in our international expansion last week with the opening of a new five-gate concourse, along with a Federal Inspection Station for Customs and Border Protection, at Houston’s William P. Hobby Airport. We began service between Houston Hobby and San Jose, Costa Rica; Cancun, Mexico City, Puerto Vallarta, and San Jose del Cabo/Los Cabos, Mexico; and our inaugural service to our 96th city, Belize City, Belize. In addition, we are offering seasonal Saturday service to San Juan, Puerto Rico, and Oranjestad, Aruba. Next month, we will begin service from Houston to Montego Bay, Jamaica, and our inaugural service to Liberia, Costa Rica, subject to foreign government approval. That will bring us to ten nonstop destinations across Latin America and the Caribbean for Southwest Customers out of Houston Hobby.

“In addition to producing strong margins and record earnings, our investment grade balance sheet, liquidity, and cash flow remain strong. Our cash and short-term investments were $3.1 billion at the end of third quarter 2015. Thus far this year, we have generated free cash flow1 of $1.6 billion. We have returned $1.4 billion to Shareholders through the payment of $180 million in dividends and the repurchase of $1.2 billion in common stock so far this year, reflecting our ongoing commitment to enhance long-term value for our Shareholders.”

Financial Results

The Company’s third quarter 2015 total operating revenues were a record $5.3 billion, a 10.8 percent increase compared with third quarter 2014, largely driven by third quarter 2015 passenger revenues of $4.7 billion. In addition, as described in more detail below, the Company recorded a special revenue adjustment during third quarter 2015 of $172 million related to its amended agreement with Chase. Other revenues for third quarter 2015 increased 102.1 percent year-over-year, largely due to the amended agreement with Chase and the resulting change in accounting methodology.

The Company executed an amended co-branded credit card agreement with Chase during third quarter 2015, through which the Company sells loyalty points and other items to Chase. For accounting purposes, the amended agreement materially modified the previously existing agreement between Chase and the Company and is subject to Accounting Standards Update 2009-13, “Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force” (ASU 2009-13). Under the transition provisions of ASU 2009-13, the existing deferred revenue liability at the date of the amended agreement was reduced to reflect the estimated selling price of the undelivered element (air transportation) of the contract. As a result, the Company recorded a one-time non-cash adjustment of $172 million that increased revenue, which was classified as a special item and excluded from the Company’s third quarter 2015 reported RASM. In addition, the combined impact of the amended agreement and the effect of the resulting change in accounting methodology benefited third quarter 2015 total operating revenues by approximately $130 million, the impact of which was included in third quarter 2015 RASM. This $130 million benefit reflects a $170 million increase to other revenues offset by a $40 million reduction to passenger revenues. An estimated fourth quarter total operating revenue benefit of approximately $130 million is included in the Company’s current outlook for a fourth quarter 2015 RASM increase of approximately one percent, year-over-year.

Total operating expenses in third quarter 2015 decreased 2.2 percent to $4.1 billion, compared with third quarter 2014. During third quarter 2015, the Company expensed $140 million (before profitsharing expense and taxes) related to the proposed ratification bonuses included in the tentative collective-bargaining agreement recently reached with the Company’s Pilots, which is a special item. Excluding special items in both periods, total operating expenses in third quarter 2015 decreased 1.3 percent to $4.1 billion, compared with third quarter 2014.

Third quarter 2015 economic fuel costs were $2.20 per gallon, including $.50 per gallon in unfavorable cash settlements from fuel derivative contracts, compared with $2.94 per gallon in third quarter 2014, including $.05 per gallon in favorable cash settlements from fuel derivative contracts. Based on the Company’s existing fuel derivative contracts and market prices as of October 19, 2015, fourth quarter 2015 economic fuel costs are estimated to be in the $2.05 to $2.10 per gallon range, as compared with fourth quarter 2014’s $2.62 per gallon. As of October 19, 2015, the fair market value of the Company’s fuel derivative contracts was a net liability of approximately $1.2 billion for the fuel hedge portfolio through 2018, including a $116 million net liability related to the remainder of 2015, according to Southwest Airlines.

Excluding fuel and oil expense and special items in both periods, third quarter 2015 operating costs increased 8.4 percent from third quarter 2014, partially due to the third quarter 2015 profitsharing expense of $177 million, compared with $100 million in third quarter 2014. Excluding fuel and oil expense, special items, and profitsharing expense, third quarter 2015 operating costs increased 5.9 percent from third quarter 2014, and decreased 1.6 percent on a unit basis. Based on current trends and excluding fuel and oil expense, special items, and profitsharing expense, the Company currently expects fourth quarter 2015 unit costs to be comparable to fourth quarter 2014. This fourth quarter cost outlook includes the estimated impact of the tentative collective-bargaining agreement recently reached with the Company’s Pilots.

Operating income in third quarter 2015 was a record $1.2 billion, compared with $614 million in third quarter 2014. Excluding special items, operating income was a third quarter record $1.0 billion in third quarter 2015, compared with $649 million in third quarter 2014.

Other expenses in third quarter 2015 were $292 million, compared with $89 million in third quarter 2014. The $203 million increase primarily resulted from $272 million in other losses recognized in third quarter 2015, compared with $66 million in third quarter 2014. In both periods, these losses included ineffectiveness and unrealized mark-to-market amounts associated with a portion of the Company’s fuel hedge portfolio, which are special items. Excluding these special items, third quarter 2015 had $33 million in other losses, compared with $16 million in third quarter 2014, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. Fourth quarter 2015 premium costs related to fuel derivative contracts are currently estimated to be in the $40 million to $45 million range, compared with $13 million in fourth quarter 2014. Net interest expense in third quarter 2015 was $20 million, compared with $23 million in third quarter 2014.

Third quarter 2015 net income was $584 million, or $.88 per diluted share, which included $39 million (net) of unfavorable special items, compared with third quarter 2014 net income of $329 million, or $.48 per diluted share, which included $53 million (net) of unfavorable special items. Excluding special items, third quarter 2015 net income was $623 million, or $.94 per diluted share, compared with third quarter 2014 net income, excluding special items, of $382 million, or $.55 per diluted share.

For the nine months ended September 30, 2015, total operating revenues increased 6.2 percent to $14.8 billion, while total operating expenses decreased 5.0 percent to $11.8 billion, resulting in operating income of $3.1 billion, compared with $1.6 billion for the same period last year. Excluding special items, operating income was $3.0 billion for the nine months ended September 30, 2015, compared with $1.7 billion for the nine months ended September 30, 2014.

Net income for the nine months ended September 30, 2015, was $1.6 billion, or $2.45 per diluted share, compared with $946 million, or $1.36 per diluted share, for the same period last year. Excluding special items, net income for the nine months ended September 30, 2015 was $1.8 billion, or $2.63 per diluted share, compared with $993 million, or $1.42 per diluted share, for the same period last year.

Balance Sheet and Cash Flows

As of September 30, 2015, the Company had approximately $3.1 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. Net cash provided by operations during third quarter 2015 was $836 million, capital expenditures were $230 million, and assets constructed for others, net of reimbursements, were $23 million, resulting in free cash flow of $583 million. The Company repaid $79 million in debt and capital lease obligations during third quarter 2015, and intends to repay approximately $40 million in debt and capital lease obligations during the remainder of 2015. The Company funded its ProfitSharing Plan during second quarter 2015 associated with its 2014 results. In past years, the Company’s annual profitsharing contribution was funded during third quarter, including $228 million funded in third quarter 2014.

During third quarter 2015, the Company returned $549 million to its Shareholders through the payment of $49 million in dividends and the repurchase of $500 million in common stock. Under the existing $1.5 billion share repurchase program, the Company repurchased $500 million in common stock during third quarter 2015 pursuant to an accelerated share repurchase program launched during the quarter (third quarter 2015 ASR program), and received approximately 9.7 million shares, representing an estimated 75 percent of the shares expected to be repurchased. The Company expects to complete the third quarter 2015 ASR program by the end of this month. For the nine months ended September 30, 2015, free cash flow was a strong $1.6 billion which enabled the Company to return $1.4 billion to Shareholders through the payment of $180 million in dividends and the repurchase of $1.2 billion in common stock. The Company has $700 million remaining under its existing $1.5 billion share repurchase program.

Fleet and Capacity

During third quarter 2015, the Company received three pre-owned Boeing 737-700s to end the quarter with 692 aircraft. The Company continues to manage to approximately 700 aircraft at year-end 2015 and continues to expect to grow its fleet approximately two percent, year-over-year, in 2016. Additional information regarding the Company’s aircraft delivery schedule is included in the accompanying tables. The Company’s capacity plans remain unchanged with expected available seat mile growth of approximately seven percent this year, and an estimated five to six percent in 2016, both year-over-year.

Awards and Recognitions

Named one of Best Companies for Work-Life Balance by Forbes

Named a Top 50 Employer by Workforce Diversity for Engineering & IT Professionals Magazine

Ranked among Best Airline Rewards Programs by U.S. News & World Report

Outsmart Magazine’s Best Airline

 

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