Southwest reports a first quarter profit

Southwest Airlines Boeing 737-7H4 WL N461WN (msn 32465) FLL (Bruce Drum). Image: 105014.

Southwest Airlines Company today reported its first quarter 2019 results:

  • First quarter net income and earnings per diluted share of $387 million and $.70, respectively
  • First quarter record operating revenues of $5.1 billion
  • Operating margin1 of 9.8 percent, and net margin2 of 7.5 percent
  • Operating cash flow of $1.1 billion, and free cash flow3 of $945 million
  • Returned $678 million to Shareholders through share repurchases and dividends
  • Return on invested capital (ROIC)3 pre-tax of 23.3 percent for the 12 months ended March 31, 2019, or 18.1 percent on an after-tax basis

Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, “Our first quarter 2019 net income was solid despite unexpected headwinds significantly impacting our performance. I am especially proud of our nearly 60,000 Employees for the commendable job under operationally difficult circumstances. Our People were tasked with minimizing disruptions for our Customers due to more than 10,000 flight cancellations arising from the grounding of the Boeing 737 MAX 8 aircraft (MAX), unscheduled maintenance disruptions in connection with efforts to reach a Tentative Agreement (TA) with the Aircraft Mechanics Fraternal Association (AMFA), and severe winter weather. We estimate the impact of these flight cancellations, combined with the impact of the U.S. government shutdown and softness in leisure revenue trends, reduced our first quarter 2019 net income by approximately $150 million. While our strong momentum coming into the year slowed, we drove record revenues, strong margins and cash flows, a healthy profitsharing accrual for our Employees, and significant returns for our Shareholders. All notable first quarter achievements, and testaments to our resilient brand and low-cost business model.

“First quarter 2019 unit revenue growth of 2.7 percent was our best year-over-year performance in 18 consecutive quarters, and benefited from revenue management capabilities implemented in 2018, as well as another stellar performance from our award-winning Rapid Rewards® loyalty program. Looking ahead, we are expecting an even stronger year-over-year unit revenue performance in second quarter 2019.

“Currently, the timeline is uncertain for the MAX aircraft return to service. In the meantime, we have proactively adjusted our published flight schedules for the next several months and removed all MAX flights through August 5th. Our goal is to stabilize and protect the integrity of our flight schedule, while providing dependability and reliability for Customers booking their summer travel. The MAX aircraft represents less than 5 percent of all daily flights, and the vast majority of our Customers’ itineraries have been unaffected by the MAX groundings. Following a rescission of the Federal Aviation Administration (FAA) order to ground the MAX, we will return the aircraft to service once we are confident that we are in compliance with all necessary FAA directives and all necessary Pilot training has been completed. Safety is our top priority, and that commitment will never be compromised.

“The flight cancellations in first quarter 2019, and the resulting lower available seat mile (ASM, or capacity) growth, year-over-year, created significant pressure on our first quarter unit costs. Flight cancellations are expected to drive unit cost pressure for the duration of the MAX groundings.

“While we are adjusting our 2019 plans for the MAX groundings, our long-term financial goals remain unchanged: maintain a strong balance sheet, investment-grade credit ratings, and ample liquidity; generate robust operating and free cash flows; grow earnings, margins, and capital returns; and maintain healthy Shareholder returns.

“We were thrilled to launch service to Hawaii on March 17th, with an inaugural flight from Oakland to Honolulu on Oahu followed by an inaugural flight from Oakland to Kahului on Maui on April 7th. Bay Area Customers were excited finally to have access to Southwest’s low fares to Hawaii. The warm welcome we received from communities across Hawaii was tremendous. We are scheduled to begin service from San Jose to Honolulu on May 5th, and to Maui on May 26th. Our interisland service is scheduled to begin on April 28th, with service between Honolulu and Maui, and between Honolulu and Kona on the island of Hawaii on May 12th. More service is planned for the previously announced gateways of San Diego and Sacramento, and for Lihue on Kauai. We are very pleased with our Hawaii performance, thus far, and expect Hawaii to be the key expansion focus in 2019 and 2020.”

Revenue Results and Outlook
The Company’s first quarter 2019 total operating revenues increased 4.1 percent, year-over-year, to a first quarter record $5.1 billion. First quarter 2019 operating revenue per ASM (RASM, or unit revenues) increased 2.7 percent, driven largely by a passenger revenue yield increase of 2.6 percent, offset slightly by a load factor decline of one-half point, year-over-year, to 81.0 percent. The Company experienced several unexpected events during first quarter 2019 that contributed to a negative revenue impact of more than $200 million, including the MAX groundings, unscheduled maintenance disruptions in connection with efforts to reach a TA with AMFA, severe winter weather, the U.S. government shutdown, and softer leisure revenue trends. The negative impact of these events to first quarter 2019 year-over-year RASM was approximately two points.

Presently, leisure passenger booking and yield trends have improved since first quarter, and close-in bookings and corporate travel remain strong. Based on current bookings and revenue trends, the Company expects second quarter 2019 RASM to increase in the 5.5 to 7.5 percent range, compared with second quarter 2018. The Company’s outlook for second quarter 2019 includes an estimated one-point year-over-year benefit from its revenue management enhancements implemented in 2018, as well as an estimated three-point year-over-year tailwind—approximately one point is related to the Company’s second quarter 2018 suboptimal schedule from the 2017 accelerated retirement of its 737-300 (Classic) fleet, and approximately two points are due to the revenue effects from the Flight 1380 accident in April 2018. Further, second quarter 2019 year-over-year RASM is expected to benefit by approximately one-half point due to the timing shift of Easter to second quarter 2019, and by approximately one point due to lower second quarter 2019 capacity as a result of the MAX groundings.

Cost Performance and Outlook
First quarter 2019 total operating expenses increased 7.3 percent, year-over-year, to $4.6 billion. Total operating expenses per ASM (CASM, or unit costs) increased 5.9 percent, as compared with first quarter 2018. Excluding special items3, first quarter 2019 total operating expenses increased 6.5 percent to $4.6 billion, or 5.1 percent on a unit basis, year-over-year.

First quarter 2019 economic fuel costs3 were $2.05 per gallon and included $.06 per gallon in premium expense and $.03 per gallon in favorable cash settlements from fuel derivative contracts, compared with $2.09 per gallon in first quarter 2018, which included $.07 per gallon in premium expense and $.05 per gallon in favorable cash settlements from fuel derivative contracts. First quarter 2019 ASMs per gallon, or fuel efficiency, improved 0.5 percent, year-over-year. The Company estimates second quarter 2019 fuel efficiency to be flat to down 1 percent, year-over-year, due to the removal of the Company’s most fuel-efficient aircraft from its schedule as a result of the MAX groundings.

Based on the Company’s existing fuel derivative contracts and market prices as of April 18, 2019, second quarter 2019 economic fuel costs are estimated to be in the range of $2.10 to $2.20 per gallon4, including $.05 per gallon in premium expense and an estimated $.08 per gallon in favorable cash settlements from fuel derivative contracts, compared with $2.21 per gallon in second quarter 2018, which included $.06 per gallon in premium expense and $.08 per gallon in favorable cash settlements from fuel derivative contracts. As of April 18, 2019, the fair market value of the Company’s fuel derivative contracts for the remainder of 2019 was an asset of approximately $102 million, and the fair market value of the hedge portfolio settling in 2020 and beyond was an asset of approximately $192 million. Additional information regarding the Company’s fuel derivative contracts is included in the accompanying tables.

Excluding fuel and oil expense and special items, first quarter 2019 operating expenses increased 8.8 percent, as compared with first quarter 2018. First quarter 2019 profitsharing expense was $88 million, as compared with $102 million in first quarter 2018. Excluding fuel and oil expense, profitsharing expense, and special items, first quarter 2019 operating expenses increased 9.5 percent, or 8.1 percent on a unit basis, year-over-year. This increase primarily was due to the Company’s underutilization of its fleet in first quarter 2019 as a result of the delay in starting service to Hawaii, and the resulting one-time start-up costs; higher depreciation and ownership costs; the timing of maintenance events and technology investments; the flight cancellations; and the impact of the TA reached with AMFA, which resulted in an annual 2019 increase of approximately $42 million in salaries, wages, and benefits, with an approximate $30 million impact to first quarter 2019. The Company’s first quarter 2019 unit costs, excluding fuel and oil expense and profitsharing expense, were lower than its latest guidance by approximately two points, primarily due to better than expected Employee productivity and healthcare trends, as well as shifting of certain advertising and airport costs from first quarter into future periods in 2019.

Based on current cost trends and flight schedule adjustments through August 5th, the Company estimates second quarter 2019 CASM, excluding fuel and oil expense and profitsharing expense, to increase in the 10.5 to 12.5 percent range, compared with second quarter 2018. The year-over-year increase is driven largely by the Company’s underutilization of its fleet in second quarter 2019 due to the delay in starting service to Hawaii, one-time Hawaiistart-up costs, and flight cancellations due to the MAX groundings. The Company’s operating costs are largely fixed once flight schedules are published; therefore, the volume of flight cancellations in second quarter 2019 due to the MAX groundings is expected to result in an estimated five-point year-over-year headwind to second quarter 2019 CASM, excluding fuel and oil expense and profitsharing expense. Other primary drivers of the second quarter 2019 estimated unit cost increase are higher airport costs; higher depreciation and ownership costs; the timing of maintenance events and technology investments; and shifting of expenses from first quarter into second quarter 2019.

Based on current cost trends and flight schedule adjustments through August 5th, the Company now estimates annual 2019 CASM, excluding fuel and oil expense and profitsharing expense, to increase in the range of 5.5 to 6.5 percent, year-over-year, compared with 2018’s 8.53 cents, which excludes fuel and oil expense, profitsharing expense, and special items. This increase includes an estimated two-point year-over-year headwind due to lower annual 2019 capacity as a result of the MAX groundings, and an estimated one-half point year-over-year headwind due to incremental costs related to the TA with AMFA.

First Quarter Results
First quarter 2019 net income was $387 million, or $.70 per diluted share, compared with first quarter 2018 net income of $463 million, or $.79 per diluted share. Excluding special items, first quarter 2019 net income was also $387 million, or $.70 per diluted share, compared with first quarter 2018 net income of $438 million, or $.75 per diluted share, and compared with First Call first quarter 2019 consensus estimate of $.61 per diluted share.

Other expenses in first quarter 2019 were $1 million, compared with $14 million in first quarter 2018. The $13 millionyear-over-year decrease was primarily due to higher interest income in first quarter 2019.

The Company continues to estimate its annual 2019 effective tax rate to be approximately 23.5 percent.

Liquidity and Capital Deployment
As of March 31, 2019, the Company had approximately $3.9 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. During first quarter 2019, Fitch Ratings upgraded the Company’s senior unsecured debt to “A-” with an outlook of “Stable.”

Effective as of January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases, codified in Accounting Standards Codification 842. All amounts for first quarter 2019 reflect the adoption of this ASU, while all periods prior to 2019 remain in accordance with prior accounting requirements. The most significant impact of the ASU was on the Company’s unaudited Condensed Consolidated Balance Sheet, through the addition of approximately $1.5 billion of Operating lease right-of-use assets and corresponding operating lease liabilities, in addition to the elimination of approximately $1.7 billion of Assets constructed for others and $1.6 billion of related Construction obligations. The impact to the Company’s unaudited Condensed Consolidated Statement of Income and the unaudited Condensed Consolidated Statement of Cash Flows was not material.

Net cash provided by operations during first quarter 2019 was $1.1 billion, capital expenditures were $160 million, and free cash flow was $945 million. The Company repaid $99 million in debt and finance lease obligations during first quarter 2019, and expects to repay approximately $491 million in debt and finance lease obligations during the remainder of 2019.

During first quarter 2019, the Company returned $678 million to its Shareholders through the repurchase of $500 million of common stock and the payment of $178 million in dividends. The Company repurchased 9.4 million shares of common stock pursuant to a $500 million accelerated share repurchase program launched during first quarter and completed in April. As of March 31, 2019, the Company had $850 million remaining under its current share repurchase authorization.

Based on aircraft commitments as of March 31, 2019, and assuming no prolonged grounding of the MAX aircraft that could impact the Company’s aircraft capital spending, the Company continues to estimate its 2019 capital expenditures to be in the range of $1.9 to $2.0 billion.

Fleet and Capacity
The Company ended first quarter 2019 with 753 aircraft in its fleet. This reflects the first quarter delivery of three leased 737 MAX 8 aircraft. All 34 of the Company’s 737 MAX 8 aircraft were grounded as of March 13, 2019, to comply with an FAA emergency order issued for all U.S. airlines to ground all 737 MAX aircraft. While the Company continues to expect to end 2019 with approximately 775 aircraft in its fleet based on the current aircraft delivery schedule and net of expected 737-700 retirements, prolonged grounding of the MAX aircraft could impact the Company’s delivery and retirement schedule.

Based on flight schedule adjustments through August 5th, and subject to the duration of the MAX groundings, the Company now expects its second quarter 2019 ASMs to decrease in the 2 to 3 percent range, and annual 2019 ASMs to increase in the 2 to 3 percent range, both year-over-year.

Top Copyright Photo: Southwest Airlines Boeing 737-7H4 WL N461WN (msn 32465) FLL (Bruce Drum). Image: 105014.

Southwest Airlines aircraft slide show:

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