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Southwest Airlines Co. (NYSE:LUV) (the "Company") today reported its second quarter 2016 results:
Record quarterly GAAP1 net income of $820 million, or $1.28 per diluted share, compared with second quarter 2015 GAAP net income of $608 million, or $.90 per diluted share.
Excluding special items2, record quarterly net income of $757 million, or $1.19 per diluted share, compared with second quarter 2015 net income of $691 million, or $1.03 per diluted share. This compared to First Call second quarter 2016 consensus estimate of $1.21 per diluted share.
Record quarterly GAAP operating income of $1.3 billion, resulting in a strong second quarter operating margin3 of 23.7 percent. Excluding special items, second quarter 2016 operating income was also a quarterly record $1.3 billion, resulting in an operating margin2 of 23.5 percent.
Strong second quarter free cash flow2 of $649 million; returned $763 million to Shareholders through a combination of dividends and share repurchases.
Return on invested capital, before taxes and excluding special items (ROIC)2, for the 12 months ended June 30, 2016, of 33.5 percent, compared with 28.2 percent for the 12 months ended June 30, 2015.
Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, "We are pleased to report another quarter of record profits, strong margins, and healthy cash flows. The investments we have made in our business and our network are generating significant returns. As with first quarter 2016, record operating revenues and low fuel prices were the primary drivers of our record second quarter performance. Year-over-year, our second quarter 2016 operating revenue growth outpaced our available seat mile (ASM) growth, producing positive second quarter 2016 operating unit revenue (RASM) growth, despite a very competitive fare environment. Demand for our low fares was strong throughout the quarter with record load factors each month. While solid traffic demand has continued into July, thus far, the fare environment remains challenging, and close-in yields have softened in recent weeks. In addition, year-over-year RASM comparisons in third quarter are more difficult as the amended co-branded credit card agreement with Chase Bank USA, N.A. went into effect in third quarter 2015.
"We continue to make prudent investment decisions and remain steadfast in controlling our total operating costs. Our balance sheet, cash flow, and liquidity are strong, allowing for meaningful returns and rewards for our Employees and Shareholders.
"My congratulations go to our magnificent Employees for this tremendous second quarter performance, which resulted in a record $206 million profitsharing accrual. While year-over-year profit comparisons are more challenging in third quarter, our current revenue and cost outlook suggest another strong operating margin in excess of 18 percent4, excluding special items."
Revenue Results and Outlook4
The Company's total operating revenues were a quarterly record $5.4 billion, driven largely by second quarter 2016 passenger revenues of $4.9 billion. Year-over-year, second quarter 2016 operating revenues grew 5.3 percent, and increased 0.6 percent on a unit basis.
Second quarter 2016 total operating revenues included approximately $135 million associated with the July 2015 amendment of the Company's co-branded credit card agreement with Chase Bank USA, N.A. (Chase) and a resulting required change in accounting methodology. This improved year-over- year RASM performance by 2.6 points. The $135 million net benefit reflects an approximate $200 million increase to other revenues offset by an approximate $65 million reduction to passenger revenues. While the Company expects a similar revenue benefit in third quarter 2016, it will be comparable to the benefit realized in third quarter 2015 due to the July 2015 effective date of the Chase amendment and therefore will not result in the two to three point year-over-year RASM improvement the Company has realized for the past four quarters.
Based on current bookings and yields, the Company expects third quarter 2016 RASM to decline in the three to four percent range, compared with third quarter 2015 RASM (excluding the one-time special revenue adjustment of $172 million recorded in third quarter 2015 as a result of the Chase amendment and a resulting required change in accounting methodology).
Cost Performance and Outlook4
Second quarter 2016 total operating expenses of $4.1 billion increased 2.0 percent, and decreased 2.6 percent on a unit basis, as compared with second quarter 2015. During second quarter 2016, the Company recorded a $21 million impairment charge (before profitsharing and taxes) for the intangible assets associated with its Newark Liberty International Airport slots5 as a result of the Federal Aviation Administration (FAA) announcement in April 2016 that Newark will be designated as a Level 2 schedule-facilitated airport under the International Air Transport Association Worldwide Slot Guidelines effective October 30, 2016. Second quarter 2015 operating expenses included $55 million (before profitsharing and taxes) in expense related to proposed and paid ratification bonuses associated with certain workgroups. Excluding special items, total operating expenses increased 3.9 percent to $4.1 billion, and decreased 0.8 percent on a unit basis, both as compared with second quarter 2015.
Second quarter operating costs benefited from a 10.1 percent decline in fuel and oil expenses. Second quarter 2016 economic fuel costs were $1.81 per gallon, including $0.42 per gallon in unfavorable cash settlements from fuel derivative contracts, compared with $2.02 per gallon in second quarter 2015, including $0.08 per gallon in unfavorable cash settlements from fuel derivative contracts. Based on the Company's existing fuel derivative contracts and market prices as of July 18, 2016, third quarter 2016 economic fuel costs are estimated to be approximately $2.05 per gallon. As of July 18, 2016, the fair market value of the Company's fuel derivative contracts for the second half of 2016 was a net liability of approximately $545 million, and was a net liability of approximately $510 million for the hedge portfolio in 2017 and 2018, combined. Additional information regarding the Company's fuel derivative contracts is included in the accompanying tables.
Excluding fuel and oil expense and special items in both periods, second quarter 2016 operating expenses increased 7.5 percent compared with second quarter 2015. Second quarter 2016 profitsharing expense was $206 million, compared with $182 million in second quarter 2015. Excluding fuel and oil expense, special items, and profitsharing expense, second quarter 2016 operating costs increased 7.1 percent, and increased 2.1 percent on a unit basis, both as compared with second quarter 2015.
Based on current trends and excluding fuel and oil expense, special items, and profitsharing expense, the Company expects its third quarter 2016 and annual 2016 unit costs to increase approximately two percent, and approximately one percent, respectively, as compared with the same year-ago periods, largely due to additional depreciation expense associated with the accelerated retirement of the Company's Classic fleet (Boeing 737-300/-500 aircraft) to no later than third quarter 2017.
Second Quarter Results
Including and excluding special items, second quarter 2016 operating income was a quarterly record $1.3 billion, compared with $1.1 billion in second quarter 2015.
Other income in second quarter 2016 was $28 million, compared with other expenses of $108 million in second quarter 2015. The $136 million increase primarily resulted from $43 million in other gains recognized in second quarter 2016, compared with $88 million in other losses in second quarter 2015. In both periods, these gains and 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 $48 million in second quarter 2016, compared with $19 million in second quarter 2015, primarily attributable to the premium costs associated with the Company's fuel derivative contracts. Third quarter 2016 premium costs related to fuel derivative contracts are currently estimated to be in the $30 million to $35 million range, compared with $33 million in third quarter 2015. Net interest expense in second quarter 2016 was $15 million, compared with $20 million in second quarter 2015.
Second quarter 2016 net income was a quarterly record $820 million, or $1.28 per diluted share, compared with second quarter 2015 net income of $608 million, or $.90 per diluted share. Excluding special items, second quarter net income was a quarterly record $757 million, or $1.19 per diluted share, compared with second quarter 2015 net income of $691 million, or $1.03 per diluted share.
Balance Sheet and Cash Flows
As of June 30, 2016, the Company had approximately $3.4 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. Net cash provided by operations during second quarter 2016 was $1.1 billion, capital expenditures were $462 million, and assets constructed for others, net of reimbursements, were $1 million, resulting in free cash flow of $649 million. The Company repaid $48 million in debt and capital lease obligations during second quarter 2016, and expects to repay approximately $500 million in debt and capital lease obligations during the remainder of 2016. The Company funded a $620 million ProfitSharing contribution as a result of its 2015 results to its ProfitSharing Plan in second quarter 2016.
During second quarter 2016, the Company returned $763 million to its Shareholders through the payment of $63 million in dividends and the repurchase of $700 million in common stock. The Company completed its previous $1.5 billion share repurchase program with the repurchase of $200 million in common stock, or 4.5 million shares, pursuant to an accelerated share repurchase (ASR) program launched and completed during second quarter 2016. On May 18, 2016, the Company's Board of Directors authorized a new $2.0 billion share repurchase program, along with a 33 percent increase in the Company's quarterly dividend. Under this new authorization, the Company repurchased $500 million in common stock, or 12.3 million shares, pursuant to another ASR program launched and completed during second quarter 2016, bringing total shares repurchased during second quarter 2016 to approximately 16.7 million. In addition, during second quarter 2016, the Company received the remaining 2.3 million shares pursuant to its first quarter 2016 $500 million ASR program. The Company intends to repurchase an additional $250 million of Southwest common stock under an ASR program expected to be launched soon (third quarter 2016 ASR program). Subsequent to the launch of the third quarter 2016 ASR program, the Company will have $1.25 billion remaining under its existing $2.0 billion share repurchase program.
For the six months ended June 30, 2016, net cash provided by operations was $2.7 billion, capital expenditures were $900 million, and assets constructed for others, net of reimbursements, were $2 million, resulting in free cash flow of $1.8 billion. This enabled the Company to return approximately $1.4 billion to Shareholders through the payment of $160 million in dividends and the repurchase of $1.2 billion in common stock.
Fleet and Capacity
The Company ended second quarter 2016 with 719 aircraft in its fleet. This reflects the second quarter delivery of 7 new Boeing 737-800s and 6 pre-owned Boeing 737-700s, as well as the retirement of 8 Boeing 737 Classic aircraft. The Company continues to plan to end this year with 723 aircraft. To adjust future deliveries for the accelerated retirement of the Classic fleet, the Company announced a restructured Boeing delivery schedule in June. With the previously announced decision to accelerate the retirement of its Classic fleet to no later than third quarter 2017, the Company no longer anticipates significant retirements between 2018 and 2023. With that in mind, firm deliveries previously scheduled between 2019 and 2022 were deferred to 2023 through 2025 in the restructured order book. This resulted in a meaningful $1.9 billion deferral of capital spending. In addition, the restructured delivery schedule provides significant fleet flexibility to manage long-term growth opportunities. The Company continues to manage to average annual net fleet growth for the three-year period ending 2018 of no more than two percent. Annual ASM growth (capacity) over that time period is expected to peak at this year's five to six percent range. In light of the current revenue environment, the Company continues to evaluate future capacity growth with a focus on growing prudently and profitably. Additional information regarding the Company's aircraft delivery schedule is included in the accompanying tables.
The Southwest network continues to perform well, including the second quarter 2016 inaugural service from its 98th city, Long Beach, California. The Company recently reached some exciting international milestones with the U.S. Department of Transportation (DOT) authorizing the Company to serve two destinations in Cuba, Varadero and Santa Clara, and issuing a tentative decision granting authority for the Company to serve Havana, Cuba from Ft. Lauderdale and Tampa, Florida. The Company has also received DOT authority to provide its first ever international service from Oakland International Airport with daily flights to San Jose del Cabo and Puerto Vallarta, Mexico starting in February 2017. In addition, the Company has requested authority to serve three Mexican beach destinations from Los Angeles International Airport consistent with the pending liberalized bilateral agreement between the two countries which has not yet become effective. The Company eagerly awaits implementation of this agreement which will provide numerous additional opportunities for the Company to add low-fare service and competition in U.S.- Mexico markets.
Awards and Recognitions
Named as one of Corporate Responsibility Magazine's 100 Best Corporate Citizens 2016.
Named to BetterInvesting's Top 100 Company list.
Recognized for 2016 Airline Program of the Year by InsideFlyer for our Rapid Rewards® program.
Among the top airline scores for overall customer satisfaction and for Airline Loyalty/Reward Program Satisfaction in the J.D. Power 2016 North America Airline Satisfaction Study.
Recognized by Newsweek as one of America's Greenest Companies.
Designated a 2016 Most Valuable Employer for Military by CivilianJobs.com.
Tied for #1 on American Customer Satisfaction Index (ACSI) Travel Report 2016.
Named Air Forwarder's Association Domestic Carrier of the Year.
Received the 2015 Express Cargo Standard of Excellence award from Express Delivery and Logistics Association.
Conference Call
The Company will discuss its second quarter 2016 results on a conference call at 12:30 p.m. Eastern Time today. To listen to a live broadcast of the conference call please go to http://investors.southwest.com
1Generally Accepted Accounting Principles in the United States.
2See Note Regarding Use of Non-GAAP Financial Measures for additional information on special items, ROIC, free cash flow, and operating margin. In addition, information regarding special items, ROIC, and economic results is included in the accompanying reconciliation tables.
3Operating margin is calculated as operating income divided by operating revenues.
4Projected results do not reflect the potential impact of special items, or fuel and oil expenses and profitsharing expense, where indicated, and the tax effect of all such items because the Company cannot reliably predict or estimate those items or expenses or their impact to its financial statements. Accordingly, a reconciliation of non- GAAP financial measures to the equivalent GAAP financial measures for projected results is not available without unreasonable effort.
5A "slot" is the right of an air carrier, pursuant to regulations of the FAA, to operate a takeoff or landing at a specific time at certain airports.
Cautionary Statement Regarding Forward-Looking Statements
This news release contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Specific forward- looking statements include, without limitation, statements related to (i) the Company's financial outlook, expectations, strategies, and projected results of operations, including specific factors expected to impact the Company's results of operations; (ii) the Company's expectations related to its management of risk associated with changing jet fuel prices; (iii) the Company's expectations with respect to liquidity (including its plans for the repayment of debt and capital lease obligations) and capital expenditures; (iv) the Company's expectations with respect to its share repurchases and returning value to Shareholders; (v) the Company's fleet and capacity plans, strategies, and expectations and the factors expected to impact such plans, strategies, and expectations; and (vi) the Company's network and growth plans, strategies, and opportunities. These forward-looking statements are based on the Company's current intent, expectations, and projections and are not guarantees of future performance. These statements involve risks, uncertainties, assumptions, and other factors that are difficult to predict and that could cause actual results to vary materially from those expressed in or indicated by them. Factors include, among others, (i) changes in demand for the Company's services and other changes in consumer behavior (including with respect to the Company's co-branded credit card); (ii) the impact of economic conditions, fuel prices, actions of competitors (including without limitation pricing, scheduling, and capacity decisions and consolidation), and other factors beyond the Company's control, on the Company's business decisions, plans, and strategies; (iii) changes in aircraft fuel prices, the impact of hedge accounting, and any changes to the Company's fuel hedging strategies and positions; (iv) the Company's ability to timely and effectively implement, transition, and maintain the necessary information technology systems and infrastructure to support its operations and initiatives; (v) the Company's dependence on third parties, in particular with respect to its fleet and technology plans; (vi) the impact of governmental regulations and other governmental actions related to the Company's operations; (vii) the impact of labor matters on the Company's business decisions, plans, and strategies; (viii) the Company's ability to maintain positive relations with employees and employee representatives and any related pressure on the Company's labor costs; and (ix) other factors, as described in the Company's filings with the Securities and Exchange Commission, including the detailed factors discussed under the heading "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
Investor Contact:
Southwest Airlines Investor Relations 214-792-4415
Media Contact:
Southwest Airlines Media Relations 214-792-4847
swamedia@wnco.com
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in millions, except per share amounts) (unaudited)
Three months ended
June 30,
Six months ended
June 30,
2016
2015
Percent Change
2016
2015
Percent Change
OPERATING REVENUES:
Passenger
$4,905
$4,852
1.1
$9,303
$9,030
3.0
Freight
45
46
(2.2)
87
90
(3.3)
Other
434
213
103.8
820
405
102.5
Total operating revenues
5,384
5,111
5.3
10,210
9,525
7.2
OPERATING EXPENSES:
Salaries, wages, and benefits
1,639
1,607
2.0
3,179
3,026
5.1
Fuel and oil
903
1,005
(10.1)
1,755
1,882
(6.7)
Maintenance materials and repairs
280
240
16.7
543
469
15.8
Aircraft rentals
59
59
—
118
119
(0.8)
Landing fees and other rentals
309
299
3.3
611
584
4.6
Depreciation and amortization
299
250
19.6
588
494
19.0
Acquisition and integration
—
3
n.m.
—
26
n.m.
Other operating expenses
619
563
9.9
1,196
1,060
12.8
Total operating expenses
4,108
4,026
2.0
7,990
7,660
4.3
OPERATING INCOME
1,276
1,085
17.6
2,220
1,865
19.0
OTHER EXPENSES (INCOME):
Interest expense
32
29
10.3
62
62
—
Capitalized interest
(11)
(7)
57.1
(22)
(14)
57.1
Interest income
(6)
(2)
200.0
(11)
(3)
266.7
Other (gains) losses, net
(43)
88
n.m.
71
121
(41.3)
Total other expenses (income)
(28)
108
n.m.
100
166
(39.8)
INCOME BEFORE INCOME TAXES
1,304
977
33.5
2,120
1,699
24.8
PROVISION FOR INCOME TAXES
484
369
31.2
787
638
23.4
NET INCOME
$820
$608
34.9
$1,333
$1,061
25.6
NET INCOME PER SHARE:
Basic
$1.30
$0.91
42.9
$2.09
$1.58
32.3
Diluted
$1.28
$0.90
42.2
$2.07
$1.57
31.8
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic
632
665
(5.0)
637
670
(4.9)
Diluted
639
673
(5.1)
644
678
(5.0)
Southwest Airlines Co.
Reconciliation of Reported Amounts to Non-GAAP Items
(See Note Regarding Use of Non-GAAP Financial Measures)
(in millions, except per share amounts)(unaudited)
Three months ended
June 30,
Six months ended June 30,
2016
2015
Percent Change
2016
2015
Percent Change
Fuel and oil expense, unhedged
$716
$962
$1,293
$1,792
Add: Fuel hedge (gains) losses included in Fuel and oil expense
187
43
462
90
Fuel and oil expense, as reported
$903
$1,005
$1,755
$1,882
Add (Deduct): Net impact from fuel contracts (1)
30
(5)
22
(9)
Fuel and oil expense, non-GAAP (economic)
$933
$1,000
(6.7)
$1,777
$1,873
(5.1)
Total operating expenses, as reported
$4,108
$4,026
$7,990
$7,660
Deduct: Union contract bonuses
—
(55)
—
(55)
Add (Deduct): Net impact from fuel contracts (1)
30
(5)
22
(9)
Deduct: Acquisition and integration costs
—
(3)
—
(26)
Add: Litigation settlement
—
—
—
37
Deduct: Asset impairment
(21)
—
(21)
—
Total operating expenses, non-GAAP
$4,117
$3,963
3.9
$7,991
$7,607
5.0
Deduct: Fuel and oil expense, non-GAAP (economic)
(933)
(1,000)
(1,777)
(1,873)
Operating expenses, non-GAAP, excluding Fuel and oil expense
$3,184
$2,963
7.5
$6,214
$5,734
8.4
Deduct: Profitsharing expense
(206)
(182)
(361)
(308)
Operating expenses, non-GAAP, excluding profitsharing and Fuel and oil expense
$2,978
$2,781
7.1
$5,853
$5,426
7.9
Operating income, as reported
$1,276
$1,085
$2,220
$1,865
Add: Union contract bonuses
—
55
—
55
Add (Deduct): Net impact from fuel contracts (1)
(30)
5
(22)
9
Add: Acquisition and integration costs
—
3
—
26
Deduct: Litigation settlement
—
—
—
(37)
Add: Asset impairment
21
—
21
—
Operating income, non-GAAP
$1,267
$1,148
10.4
$2,219
$1,918
15.7
Other (gains) losses, net, as reported
$(43)
$88
$71
$121
Add (Deduct): Net impact from fuel contracts (1)
91
(69)
11
(76)
Other (gains) losses, net, non-GAAP
$48
$19
152.6
$82
$45
82.2
Net income, as reported
$820
$608
$1,333
$1,061
Add: Union contract bonuses
—
55
—
55
Add (Deduct): Net impact from fuel contracts (1)
(121)
74
(33)
85
Add: Acquisition and integration costs
—
3
—
26
Deduct: Litigation settlement
—
—
—
(37)
Add: Asset impairment
21
—
21
—
Add (Deduct): Net income tax impact of fuel and special items (2)
37
(49)
5
(48)
Net income, non-GAAP
$757
$691
9.6
$1,326
$1,142
16.1
Net income per share, diluted, as reported
$1.28
$0.90
$2.07
$1.57
Add (Deduct): Impact from fuel contracts
(0.19)
0.11
(0.05)
0.13
Add: Impact of special items
0.03
0.09
0.03
0.07
Add (Deduct): Net income tax impact of fuel and special items (2)
0.07
(0.07)
0.01
(0.08)
Net income per share, diluted, non-GAAP
$1.19
$1.03
15.5
$2.06
$1.69
21.9
(1) See Reconciliation of Impact from Fuel Contracts.
(2) Tax amounts for each individual special item are calculated at the Company's effective rate for the applicable period and totaled in this line item.
Southwest Airlines Co.
Reconciliation of Impact from Fuel Contracts
(See Note Regarding Use of Non-GAAP Financial Measures)
(in millions)
(unaudited)
Three months ended
June 30,
Six months ended
June 30,
Fuel and oil expense
2016
2015
2016
2015
Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period settled contracts
$(7)
—
$(7)
—
Contracts settling in the current period, but for which gains and/or (losses) have been recognized in a prior period (1)
37
(5)
29
(9)
Impact from fuel contracts to Fuel and oil expense
$30
$(5)
$22
$(9)
Operating Income
Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period settled contracts
$7
$—
$7
$—
Contracts settling in the current period, but for which gains and/or (losses) have been recognized in a prior period (1)
(37)
5
(29)
9
Impact from fuel contracts to Operating Income
$(30)
$5
$(22)
$9
Other (gains) losses, net
Mark-to-market impact from fuel contracts settling in future periods
$81
$(71)
$5
$(91)
Ineffectiveness from fuel hedges settling in future periods
3
2
(1)
15
Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period settled contracts
7
—
7
—
Impact from fuel contracts to Other (gains) losses, net
$91
$(69)
$11
$(76)
Net Income
Mark-to-market impact from fuel contracts settling in future periods
$(81)
$71
$(5)
$91
Ineffectiveness from fuel hedges settling in future periods
(3)
(2)
1
(15)
Other net impact of fuel contracts settling in the current or a prior period (excluding reclassifications)
(37)
5
(29)
9
Impact from fuel contracts to Net Income (2)
$(121)
$74
$(33)
$85
(1) As a result of prior hedge ineffectiveness and/or contracts marked-to-market through the income statement.
(2) Before income tax impact of unrealized items.
Southwest Airlines Co.
Comparative Consolidated Operating Statistics
(unaudited)
Three months ended
June 30,
Six months ended
June 30,
2016
2015
Change
2016
2015
Change
Revenue passengers carried
32,340,969
30,800,742
5.0%
60,944,448
57,243,738
6.5%
Enplaned passengers
39,479,241
37,670,284
4.8%
74,107,682
69,769,242
6.2%
Revenue passenger miles (RPMs) (000s) (1)
32,707,694
30,858,381
6.0%
61,115,858
56,719,247
7.8%
Available seat miles (ASMs) (000s) (2)
38,225,282
36,476,030
4.8%
73,493,431
68,773,495
6.9%
Load factor (3)
85.6%
84.6%
1.0 pts.
83.2%
82.5%
0.7 pts.
Average length of passenger haul (miles)
1,011
1,002
0.9%
1,003
991
1.2%
Average aircraft stage length (miles)
767
756
1.5%
762
748
1.9%
Trips flown
334,452
326,309
2.5%
648,989
622,879
4.2%
Seats flown (4)
49,112,849
47,612,415
3.2%
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