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Southwest Airlines Reports 44 years of profit

Southwest Airlines Reports 44 years of profit


 Southwest Airlines  today reported its fourth quarter and annual 2016 results:

  • Fourth quarter net income of $522 million, or $.84 per diluted share, compared with fourth quarter 2015 net income of $536 million, or $.82 per diluted share.
  • Excluding special items1, fourth quarter net income of $463 million, or $.75 per diluted share, compared with fourth quarter 2015 net income of $591 million, or $.90 per diluted share. This exceeded the First Call fourth quarter 2016 consensus estimate of $.70 per diluted share.
  • Record annual net income of $2.24 billion, or $3.55 per diluted share, compared with 2015 net income of $2.18 billion, or $3.27 per diluted share.
  • Excluding special items, record annual net income of $2.37 billion, or $3.75 per diluted share, compared with 2015 net income of $2.36 billion, or $3.52 per diluted share.
  • Annual operating income of $3.76 billion, resulting in an operating margin2 of 18.4 percent.
  • Excluding special items, annual operating income of $3.96 billion, resulting in an operating margin3 of 19.4 percent.
  • Record annual operating cash flow of $4.29 billion, and record annual free cash flow1 of $2.25 billion.
  • Returned $1.97 billion to Shareholders in 2016, through a combination of $222 million in dividends and $1.75 billion in share repurchases.
  • Annual return on invested capital (ROIC)1 of 30.0 percent.

Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, “We are delighted to report record annual profits for 2016, our 44th consecutive year of profitability. Our total operating revenues reached a record $20.4 billion, with sustained demand for our legendary low fares and superior Customer Service. Our profit margins were very strong, and our ROIC was a near-record 30.0 percent. Our record profits and balance sheet discipline generated record free cash flow, allowing us to return significant value to our Shareholders. Operationally, our performance was also very solid. We carried a record number of Customers while improving our ontime performance, baggage delivery rate, and net promoter score. My thanks and congratulations to the superb People of Southwest for these outstanding results, which earned them $586 million in profitsharing during 2016.

“We ended the year with a solid fourth quarter 2016 performance. Total operating revenues grew 2.0 percent, year-over-year, to a fourth quarter record $5.1 billion, exceeding our expectations as of the beginning of the fourth quarter. Travel demand and close-in yields improved post-election. In addition, December business travel was stronger than anticipated leading up to the holiday period. Based on current bookings and revenue trends, we estimate first quarter 2017 operating unit revenues will be flat to down one percent, year-over-year. This represents a continued and sequential improvement from the 2.9 percent operating unit revenue year-over-year decline in fourth quarter 2016, which is an encouraging start to the year.

“As expected, our fourth quarter unit costs increased, year-over-year, due to higher fuel costs, pay increases from amended union contracts, and additional depreciation expense associated with the accelerated retirement of our Boeing 737-300 aircraft. While inflationary cost pressures are expected in 2017 due to the union contract pay increases, we are continuing our efforts to drive offsetting cost efficiencies through fleet modernization and ongoing technology investments in our operations.

“During fourth quarter 2016, we began service to Cuba with daily flights to Varadero, Havana, and Santa Clara. We also launched international flights from Los Angeles International Airport (LAX) to Cancun, Puerto Vallarta, and Los Cabos, Mexico. In commencing this LAX service, we were the first U.S. carrier to launch new service between the United States and Mexico under the recently approved Air Transport Agreement. Earlier this month, we filed an application with the U.S. Department of Transportation to serve Owen Roberts International Airport in Grand Cayman4, and announced plans to launch service to Cincinnati/Northern Kentucky International Airport in June 2017.

“We are excited about our strategic technology investments, especially our new reservation system. In December, we began selling domestic itineraries in the new Amadeus platform. We remain on track to move to a single reservation system on May 9, 2017, with significant incremental profits expected to begin in 2018. The first release deployed in December, providing booking capabilities for travel on and after May 9, was virtually flawless. As this is the largest technology project in our history, I commend our People on their tremendous efforts to deliver these critical new capabilities.

“As we close out a year of record results, we begin 2017 with momentum and enthusiasm. We are on track to open a new international terminal in Fort Lauderdale, along with the launch of new service, this June. We are on track to launch the new Boeing 737-8 in the fall. And, we are encouraged by recent revenue trends, as well as the prospects for continued economic growth and moderate fuel prices. We are excited about our current outlook for another strong year with opportunities to win more Customers and reward our People and our Shareholders.”

Notable 2016 accomplishments include:

  • Achieved 44th consecutive year of profitability and $586 million in profitsharing
  • Generated 30.0 percent ROIC
  • Returned $1.97 billion to Shareholders through repurchases of $1.75 billion of common stock (approximately 40 million shares) and payment of $222 million in dividends
  • Retired our last Boeing 737-500 aircraft
  • Achieved an exceptional net promoter score of 69.1 percent
  • Launched daily service from Long Beach Airport (LGB), making LGB our tenth airport within California
  • Launched service to Cuba with daily flights to Varadero, followed by service to Havana, our 100th city served, and Santa Clara
  • Launched international service from Los Angeles International Airport, Fort Lauderdale-Hollywood International Airport, and Tampa International Airport, ending the year with thirteen5 international gateway airports from the 48 contiguous states
  • Ratified collective bargaining agreements with our Flight Crew Training Instructors; Ramp, Operations, Provisioning, and Cargo Agents; Flight Attendants; Pilots; and Aircraft Appearance Technicians
  • Announced new inflight entertainment agreements with Panasonic Avionics Corporation and Global Eagle Entertainment in support of our commitment to enhance the inflight Customer Experience and improve internet connectivity on our flights
  • Received numerous awards and recognitions, including being named to FORTUNE’s list of World’s Most Admired Companies for the 22nd consecutive year; being named Domestic Carrier of the Year by the Airforwarders Association, Best Low Cost Carrier in North America from Premier Traveler for the third consecutive year, and one of CR’s 100 Best Corporate Citizens 2016; recognized by Express Delivery and Logistics Association with the 2015 Express Cargo Standard of Excellence award, as well as Logistic Management Magazine’s 2016 Quest for Quality Award for the 20th consecutive year; recognized by InsideFlyer as 2016 Airline Program of the Year for our Rapid Rewards program and ranked among the top Airline Rewards Programs by U.S. News & World Report; and designated as a 2016 Most Valuable Employer for military by CivilianJobs.com, as well as a Best Employer in Forbes’ 2016 list

Revenue Results and Outlook

The Company’s fourth quarter 2016 total operating revenues were a record $5.1 billion, driven largely by record fourth quarter passenger revenues of $4.6 billion. As compared with fourth quarter 2015, total operating revenues increased 2.0 percent on a 5.0 percent increase in available seat miles, resulting in a 2.9 percent decline in operating unit revenues (RASM). Strong demand for low fares resulted in a fourth quarter record 84.4 percent load factor, and a 3.8 percent year-over-year decline in fourth quarter passenger revenue yield. Based on revenue and booking trends thus far in January, the Company expects its first quarter 2017 RASM to be flat to down one percent, as compared with first quarter 2016.

Annual 2016 total operating revenues increased 3.1 percent, year-over-year, to a record $20.4 billion. Annual operating revenues for 2015 included a one-time special revenue adjustment of $172 million recorded as a result of the July 2015 amendment of the Company’s co-branded credit card agreement with Chase Bank USA, N.A. and a resulting required change in accounting methodology. Excluding this special item, annual 2016 total operating revenues increased 4.0 percent, year-over-year.

Cost Performance and Outlook

Fourth quarter 2016 total operating expenses increased 7.1 percent to $4.2 billion, and increased 2.0 percent on a unit basis, as compared with fourth quarter 2015. Excluding special items in both periods, which primarily related to the Company’s fuel hedge derivative contracts, total operating expenses increased 8.1 percent to $4.3 billion, and increased 2.9 percent on a unit basis, year-over-year.

Fourth quarter 2016 economic fuel costs1 were $2.07 per gallon, including $.50 per gallon in unfavorable cash settlements from fuel derivative contracts, compared with $2.03 per gallon in fourth quarter 2015, including $.52 per gallon in unfavorable cash settlements from fuel derivative contracts. Annual 2016 economic fuel costs per gallon declined 7.2 percent, as compared with 2015. Based on the Company’s existing fuel derivative contracts and market prices as of January 20, 2017, first quarter economic fuel costs are estimated to be in the $1.95 to $2.00 per gallon range6. As of January 20, 2017, the fair market value of the Company’s fuel derivative contracts settling in first quarter 2017 was a net liability of approximately $136 million, and was a net liability of approximately $354 million for those settling over the remainder of 2017 beyond first quarter. In addition, the fair market value of the hedge portfolio settling in 2018 and 2019, combined, was a net asset of $109 million. 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, fourth quarter 2016 operating expenses increased 8.8 percent, as compared with fourth quarter 2015. Fourth quarter 2016 profitsharing expense was $123 million, compared with $136 million in fourth quarter 2015. Excluding fuel and oil expense, special items, and profitsharing expense, fourth quarter 2016 operating expenses increased 9.7 percent from fourth quarter 2015, and increased 4.4 percent on a unit basis, both year-over-year, driven largely by additional depreciation expense associated with the accelerated retirement of the Company’s Boeing 737-300 fleet and the impact of amended union contracts in 2016. The Company currently expects its year-over-year unit cost inflation in 2017 to ease substantially by fourth quarter 2017. This is attributed largely to the wage rate increases that became effective in fourth quarter 2016 from the ratification of the Flight Attendant and Pilot contracts, which became amendable June 2013 and September 2012, respectively. Based on current cost trends and the significant snap-up in wage rates in year one of these new agreements, first quarter 2017 unit costs, excluding fuel and oil expense, special items, and profitsharing expense, are estimated to increase in the six to seven percent range7, year-over-year, while annual 2017 unit costs, excluding fuel and oil expense, special items, and profitsharing expense, are estimated to increase approximately three percent, year-over-year. Wage rate increases from amended union contracts are estimated to drive approximately four points of this first quarter 2017 unit cost outlook, and approximately three points, or substantially all, of this annual 2017 unit cost outlook.

Annual 2016 total operating expenses increased 6.1 percent to $16.7 billion, and increased 0.4 percent on a unit basis, year-over-year. Excluding fuel and oil expense, special items, and profitsharing expense, annual 2016 total operating expenses increased 8.1 percent, and increased 2.3 percent on a unit basis, year-over-year, primarily due to additional depreciation expense associated with the accelerated retirement of the Company’s Boeing 737-300 fleet and the impact of amended union contracts in 2016.

Fourth Quarter and Annual Results

Fourth quarter 2016 operating income was $846 million, compared with $1.0 billion in fourth quarter 2015. Excluding special items, operating income was $768 million, compared with $992 million in fourth quarter 2015.

Other expenses in fourth quarter 2016 were $37 million, compared with $179 million in fourth quarter 2015. This $142 million decrease resulted primarily from $26 million in other losses recognized in fourth quarter 2016, compared with $164 million in other losses recognized in fourth quarter 2015. 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, fourth quarter 2016 had $43 million in other losses, compared with $44 million in fourth quarter 2015, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. First quarter and annual 2017 premium costs related to fuel derivative contracts are currently estimated to be approximately $35 million and $135 million, respectively. Net interest expense in fourth quarter 2016 was $11 million, compared with $15 million in fourth quarter 2015.

Annual 2016 operating income was $3.76 billion, compared with $4.12 billion in 2015. Excluding special items, annual 2016 and 2015 operating income was approximately $3.96 billion in both periods. Annual 2016 net income was a record $2.24 billion, or $3.55 per diluted share, compared with annual 2015 net income of $2.18 billion, or $3.27 per diluted share. Excluding special items, annual 2016 net income was a record $2.37 billion, or $3.75 per diluted share, compared with $2.36 billion, or $3.52 per diluted share in 2015.

Liquidity and Capital Deployment

As of December 31, 2016, the Company had approximately $3.3 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. For 2016, net cash provided by operations was a record $4.29 billion, capital expenditures were $2.04 billion, and assets constructed for others, net of reimbursements, were $2 million, resulting in record free cash flow of $2.25 billion. The Company currently estimates its 2017 capital expenditures will be approximately $2.3 billion. The Company repaid $591 million in debt, convertible notes, and capital lease obligations during 2016, and is currently scheduled to repay approximately $560 million in debt and capital lease obligations during 2017. During fourth quarter 2016, the Company issued $300 million of unsecured notes due in 2026, and entered into a $215 million secured term loan maturing in 2026.

In 2016, the Company returned $1.97 billion to its Shareholders through the payment of $222 million in dividends and the repurchase of approximately 40 million shares in common stock for $1.75 billion. This compares with $1.36 billion returned to Shareholders in 2015. During fourth quarter 2016, the Company received the remaining 1.7 million shares pursuant to the $250 million third quarter 2016 accelerated share repurchase (ASR) program, bringing the total shares repurchased under that ASR program to 6.7 million. The Company also received approximately 4.7 million shares pursuant to the $300 million fourth quarter 2016 ASR program representing an estimated 75 percent of the shares expected to be repurchased under that ASR program. The Company has $950 million remaining under its May 2016 $2.0 billion share repurchase authorization.

Fleet and Capacity

The Company ended 2016 with 723 aircraft in its fleet. This reflects the delivery of 38 new Boeing 737-800s and 23 pre-owned Boeing 737-700s, as well as the retirement of 42 Boeing 737-300/500 aircraft during the year. By the end of third quarter 2017, the Company intends to retire the 87 Boeing 737-300s that remained in its fleet at December 31, 2016, as previously announced. After taking into account scheduled deliveries for new and pre-owned aircraft in 2017, this accelerated retirement schedule is expected to decrease the Company’s fleet to 703 aircraft by year-end 2017. For 2018, the Company’s current firm aircraft commitments would result in 743 aircraft by year-end 2018, including nine Boeing 737-800 options exercised during 2016, and two Boeing 737-800 options exercised in January 2017. The Company increased its available seat miles (capacity) by 5.7 percent in 2016, as compared with 2015, and currently intends to grow its 2017 capacity, year-over-year, by approximately 3.5 percent, with approximately 2.5 points of the increase relating to its domestic growth. Additional information regarding the Company’s aircraft delivery schedule is included in the accompanying tables.

Conference Call

The Company will discuss its fourth quarter and annual 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

www.southwestairlinesinvestorrelations.com.

1See Note Regarding Use of Non-GAAP Financial Measures for additional information on special items, ROIC, and free cash flow. In addition, information regarding special items, ROIC, and economic results is included in the accompanying reconciliation tables.

2Operating margin is calculated as operating income divided by operating revenues.

3Operating margin, excluding special items, is calculated as operating income, excluding special items, divided by operating revenues. See Note Regarding Use of Non-GAAP Financial Measures. In addition, information regarding special items is included in the accompanying reconciliation tables.

4Pending requisite governmental approvals.

5Excludes gateway airports only serving San Juan, Puerto Rico.

6Economic fuel cost projections do not reflect the potential impact of special items because the Company cannot reliably predict or estimate the hedge accounting impact associated with the volatility of the energy markets or the impact to its financial statements in future periods. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort.

7Year-over-year projections do not reflect the potential impact of fuel and oil expense, profitsharing expense, and special items in both years because the Company cannot reliably predict or estimate those items or expenses or their impact to its financial statements in future periods, especially considering the significant volatility of the Fuel and oil expense line item. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort.

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