The FINANCIAL — Southwest Airlines Co. on April 27 reported its first quarter 2017 results:
Net income of $351 million, diluted earnings per share of $.57, operating income of $658 million, and operating margin1 of 13.5 percent
Excluding special items2, net income of $372 million, diluted earnings per share of $.61, operating income of $626 million, and operating margin3 of 12.8 percent
First quarter record operating cash flow of $1.6 billion and first quarter record free cash flow2 of $1.2 billion
Returned $673 million to Shareholders through a combination of dividends and share repurchases
Return on invested capital (ROIC)2 for 12 months ended March 31, 2017, of 27.7 percent
Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, “We are pleased to report strong first quarter 2017 profits and margins, especially considering the passenger revenue yield environment and higher fuel prices. Our balance sheet, liquidity, and cash flows also remained strong, enabling another quarter of substantial returns and rewards for our Employees and Shareholders.
“Total operating revenues were a first quarter record $4.9 billion. We carried a record number of passengers for any first quarter on 2.3 percent more trips, year-over-year. As expected, first quarter operating unit revenues (RASM) declined, year-over-year, due largely to the competitive fare environment and shift in Easter travel demand. Year-over-year RASM trends in April have turned positive, even excluding an approximate $10 million Easter benefit. Based on current bookings and revenue trends, we expect second quarter 2017 RASM to increase in the one to two percent range, year-over-year, which is notable considering our year-ago RASM growth and industry outperformance.
“Our first quarter unit cost inflation was driven primarily by higher fuel costs and pay increases from amended union contracts. Costs associated with our operational initiatives and the upcoming implementation of our new reservation system also contributed to our first quarter cost pressures. Our cost inflation is expected to abate dramatically in second half 2017 to end this year with fourth quarter unit costs in line with year-ago levels, excluding fuel and oil, special items, and profitsharing4. Our annual 2017 unit costs, excluding fuel and oil, special items, and profitsharing, are estimated to increase approximately three percent, year-over-year4, unchanged from prior expectations.
“We continue to fine tune our network and introduce new markets that strengthen our network, as well as support our revenue and profitability targets. Earlier this week, we launched service from San Diego International Airport (SAN) to San Jose del Cabo/Los Cabos, Mexico, making SAN our fourth gateway city in The Golden State to operate international flights. As the airline that carries the most passengers every day to, from, and within California5, we are further strengthening our West Coast presence with new Sacramento service beginning in August 2017. This June, we will consolidate our Ohio operations and launch service to Cincinnati/Northern Kentucky International Airport. We will also launch service to Grand Cayman with the opening of the new five-gate international concourse at Ft. Lauderdale- Hollywood International Airport (FLL). As we continue to seek opportunities to take Southwest Customers to exciting new international destinations, we are thrilled to announce that we have filed an application with the U.S. Department of Transportation for authority to serve Providenciales, Turks & Caicos, from FLL beginning in fourth quarter 2017, subject to requisite governmental approvals6.
“Our Employees delivered another solid operational performance, and I commend them for persevering through the challenging weather conditions during the quarter. No doubt, their legendary Southwest Hospitality contributed to our strong first quarter net promoter score of 71.4 percent. Our Employees are the best in the industry, and their commitment to achieve our Vision to be the world’s most loved, most flown, and most profitable airline is unwavering.
“We are off to a great start this year, and we are excited about our future. We continue to strengthen our network, and our plan to grow 2017 available seat miles approximately 3.5 percent, year-over-year, remains unchanged. We are on track to launch our new reservation system next month. Our current revenue trends reinforce our goal to deliver year-over-year RASM growth this year, and we remain intensely focused on controlling costs. With our encouraging outlook and continued expectation for healthy margins and cash flows, we remain steadfast in our commitment to return significant value to our Employees, Customers, and Shareholders.”
Revenue Results and Outlook
The Company’s total operating revenues increased 1.2 percent, year-over-year, to a first quarter record $4.9 billion, driven largely by first quarter record passenger revenues of $4.4 billion. On a unit basis, operating revenues declined 2.8 percent, year-over-year, which was in line with the Company’s expectations. Demand for Southwest’s low fares remained strong and the fare environment remained competitive, resulting in a 2.6 percent decline in passenger revenue yield. Based on current bookings and improved yield trends, the Company expects positive year-over-year RASM in second quarter 2017.
Cost Performance and Outlook
First quarter 2017 total operating expenses increased 8.8 percent to $4.2 billion, and increased 4.5 percent on a unit basis, as compared with first quarter 2016. Excluding special items in both periods, which primarily related to the Company’s fuel hedge derivative contracts, total operating expenses increased 9.9 percent to $4.3 billion, and increased 5.6 percent on a unit basis, year-over- year. First quarter 2017 economic fuel costs2 were $1.96 per gallon, including $0.29 per gallon in unfavorable cash settlements from fuel derivative contracts, compared with $1.78 per gallon in first quarter 2016, including $0.56 per gallon in unfavorable cash settlements from fuel derivative contracts. Based on the Company’s existing fuel derivative contracts and market prices as of April 21, 2017, second quarter 2017 economic fuel costs are estimated to be in the $1.95 to $2.00 per gallon range7. As of April 21, 2017, the fair market value of the Company’s fuel derivative contracts settling during the second half of 2017 was a net liability of approximately $290 million. In addition, the fair market value of the hedge portfolio settling in 2018 and 2019, combined, was a net asset of approximately $110 million.
Excluding fuel and oil expense and special items in both periods, first quarter 2017 operating expenses increased 8.8 percent, as compared with first quarter 2016. First quarter 2017 profitsharing expense was $99 million, compared with $155 million in first quarter 2016. Excluding fuel and oil expense, special items, and profitsharing expense, first quarter 2017 operating expenses increased 11.3 percent, and 6.9 percent on a unit basis, year-over-year. As expected, approximately four points of this unit cost increase was due to the significant snap up in wage rates in year one of new Flight Attendant and Pilot contracts that became effective in fourth quarter 2016. In addition, costs associated with the preparation for the upcoming implementation of the Company’s new reservation system contributed to the first quarter 2017 year-over-year cost increase. Based on current cost trends, the Company estimates second quarter 2017 unit costs, excluding fuel and oil expense, special items, and profitsharing expense, will increase approximately six percent, year-over-year4. The Company expects its cost inflation to ease substantially by fourth quarter 2017 due to tailwinds associated with the retirement of its Boeing 737-300 (Classic) fleet by the end of third quarter, the implementation of its new reservation system next month, and the lapse of the step-up in wage rates from labor agreements ratified in 2016, according to Southwest Airlines.
First Quarter Results
First quarter 2017 operating income was $658 million, compared with $944 million in first quarter 2016. Excluding special items, first quarter 2017 operating income was $626 million, compared with $952 million in first quarter 2016.
Other expenses in first quarter 2017 were $105 million, compared with $128 million in first quarter 2016. The $23 million decrease resulted primarily from $94 million in other losses recognized in first quarter 2017, compared with $114 million in first quarter 2016. 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, other losses were $29 million in first quarter 2017, compared with $34 million in first quarter 2016, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. Second quarter 2017 premium costs related to fuel derivative contracts are currently estimated to be approximately $35 million, compared with $48 million in second quarter 2016. Net interest expense in first quarter 2017 was $11 million, compared with $14 million in first quarter 2016.
First quarter 2017 net income was $351 million, or $0.57 per diluted share, compared with first quarter 2016 net income of $513 million, or $.79 per diluted share. Excluding special items, first quarter 2017 net income was $372 million, or $.61 per diluted share, compared with first quarter 2016 net income of $569 million, or $.88 per diluted share, and compared with First Call first quarter 2017 consensus estimate of $.63 per diluted share.
Liquidity and Capital Deployment
As of March 31, 2017, the Company had approximately $3.5 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. Net cash provided by operations during first quarter 2017 was a first quarter record $1.6 billion, capital expenditures were $414 million, and free cash flow was a first quarter record $1.2 billion. The Company repaid $369 million in debt and capital lease obligations during first quarter 2017, and expects to repay approximately $190 million in debt and capital lease obligations during the remainder of 2017.
During first quarter 2017, the Company returned $673 million to its Shareholders through the payment of $123 million in dividends and the repurchase of 9.8 million shares in common stock for $550 million. The Company received 8.8 million shares pursuant to a $500 million accelerated share repurchase (ASR) program launched and completed during first quarter 2017, and the remaining shares were repurchased through $50 million in open market transactions. During first quarter 2017, the Company also received the remaining 1.2 million shares pursuant to the $300 million fourth quarter 2016 ASR program, bringing the total shares repurchased under that ASR program to 6.0 million. The Company has $400 million remaining under its May 2016 $2.0 billion share repurchase authorization.
Fleet and Capacity
The Company ended first quarter 2017 with 727 aircraft in its fleet. This reflects the first quarter 2017 delivery of nine new Boeing 737-800s and three pre-owned Boeing 737-700s, as well as the retirement of eight Classic aircraft. As previously announced, the Company intends to retire the 79 Classic aircraft that remained in its fleet at March 31, 2017, by the end of third quarter 2017. The Company’s fleet and capacity plans remain unchanged for 2017. Total aircraft, net of all Classic retirements, is expected to decline to 703 by year-end, and available seat mile (ASM) growth, year-over-year, is expected to be approximately 3.5 percent. For 2018, the Company’s current firm aircraft commitments and remaining options would result in 750 aircraft by year-end. While the Company has not finalized its 2018 capacity plans, it continues to expect year-over-year ASM growth to be less than its 2016 year-over-year ASM growth of 5.7 percent. Additional information regarding the Company’s aircraft delivery schedule is included in the accompanying tables.
Awards and Recognitions
Named to FORTUNE’s list of World’s Most Admired Companies for the 23rd consecutive year. Southwest was ranked as the #8 Most Admired Company, and is the only commercial airline to make the Top Ten
Ranked #1 in the U.S. Department of Transportation Customer Satisfaction ranking for 2016
Received the 2016 Express Cargo Standard of Excellence award from Express Delivery and Logistics Association
Ranked #1 Airline to work for in the U.S. for 2017-2018 by Airline Boarding
Received the Air Cargo Excellence Platinum Award by Air Cargo World magazine, making this the 13th consecutive year Southwest Airlines Cargo® has been honored in the annual Air Cargo Excellence Survey
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