Southwest Airlines Company (Dallas) today reported its second quarter 2013 results.  Second quarter 2013 net income was $224 million, or $.31 per diluted share, which included $50 million (net) of unfavorable special items.  This compared to net income of $228 million, or $.30 per diluted share, in second quarter 2012, which included $45 million (net) of unfavorable special items.  Excluding special items, second quarter 2013 net income was a record $274 million, or $.38 per diluted share, compared to $273 million, or $.36 per diluted share, in second quarter 2012.  This was in line with the First Call consensus estimate of $.38 per diluted share.  Additional information regarding special items is included in this release and in the accompanying reconciliation tables.

Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, “We are  pleased to report record quarterly earnings of $274 million (excluding special items).  This performance benefited from all-time high operating revenues and lower fuel prices.  In addition, our focus on managing costs resulted in modest year-over-year cost inflation despite significant investments in fleet modernization and other strategic initiatives.  I commend our hard-working and dedicated Employees for their efforts to achieve these excellent results, while simultaneously executing on our strategic initiatives.

“While the lingering effects of government sequestration and higher taxes continued to be a drag on air travel demand, second quarter 2013 revenues and passenger traffic still reached record levels.  In addition, we are in the midst of integrating AirTran, launching new city-pairs, and optimizing the combined networks.  We maintained strong load factors and ended the quarter with a record June load factor of 85.0 percent, which is notable considering the increasing mix of larger gauge 737-800s and Evolve -700s.  Although the 2.4 percent year-over-year decline in second quarter unit revenues was below plan¹, results improved throughout the quarter. Third quarter 2013 revenue trends are encouraging, thus far.  To date, July unit revenues are approximately three percent above last year’s July, benefiting from Southwest and AirTran network connections and our gradual combined network optimization.  Current bookings for the remainder of the third quarter also look solid.

“We remain on track with our plan to fully integrate AirTran into Southwest Airlines by the end of 2014.  We are on schedule to complete the conversion of AirTran’s Boeing 737-700s to the Southwest livery and deploy the Southwest international reservation system next year.  During second quarter, we transitioned one -700, bringing total aircraft conversions to 12 since the acquisition.  Seven more -700 conversions are planned for this year, with the remaining 33 planned for next year in conjunction with the conversion of AirTran’s eight international markets.  We will be transitioning AirTran’s 88 Boeing 717-200s out of the fleet, beginning next month.

“Connecting the Southwest and AirTran networks was a key milestone this quarter.  As of April 14, Customers can now fly across our combined 97 destinations on a single itinerary.  Our ability to optimize the combined networks and operations is enhanced significantly with connecting capabilities as we continue to transition AirTran markets to the Southwest network.  Earlier this week, we extended our 2014 flight schedule through early March and announced new Southwest service between Hartsfield-Jackson Atlanta International Airport and Ronald Reagan Washington National Airport, beginning in February, which will augment AirTran’s five daily nonstop flights.  During second quarter 2013, Southwest launched new service to Charlotte, North Carolina; Flint, Michigan; Portland, Maine; Rochester, New York; and Wichita, Kansas, which were all AirTran cities.  We also began operating Southwest’s first scheduled service outside of the continental United States, with daily service to San Juan, Puerto Rico, beginning April 14^th.  By the end of 2013, we will have a Southwest presence in all AirTran domestic cities retained following the acquisition.  While much of the converted capacity represents new city-pairs, we expect these new routes to develop rapidly.  Our Cargo business also benefited from connecting the networks, coincident with the April 14^th launch of cargo on AirTran under the Southwest brand.

“We are excited about our future network opportunities as we add international capabilities and continue the development of our domestic route network.  We were thrilled to be awarded the slot exemption from the U.S. Department of Transportation to begin service between Houston Hobby and Ronald Reagan Washington National Airport next month.  The introduction of this daily Southwest service will complete a triad of nonstop service options between Hobby and the Boston, New York, and Washington, D.C. metro areas.

“We continue to make progress on our fleet modernization efforts.  During second quarter, we added three new Boeing 737-800s into service and retired two Boeing 737-300s.  We also removed the first AirTran 717 from active service during the quarter in preparation for its transition out of the fleet next month.  As of June 30, 2013, all Southwest Boeing 737-700s and 14 Boeing 737-300s have been retrofitted with the Evolve interior, and we plan to retrofit 64 additional -300s in the second half of this year.  In May, we announced revisions to our future aircraft delivery schedule, including the launch of the Boeing 737 MAX 7 in 2019, with three objectives in mind:  efficiently and aggressively manage our invested capital, shift the mix of new aircraft deliveries to the MAX, and replace Boeing 717s and Boeing 737s being retired over the next three years with more economical aircraft.  This includes augmenting our Boeing orders with the acquisition of pre-owned aircraft.  In line with our plan, available seat miles (capacity) for 2013 are estimated to increase two percent year-over-year as a result of larger gauge aircraft.  For 2014, we currently plan to keep our capacity in line with 2013 as we continue to optimize our network and execute our strategic plan.

“Our fleet modernization and other fuel conservation efforts resulted in a 4.1 percent improvement in second quarter available seat miles per gallon.  Second quarter economic fuel costs declined significantly to $3.06 per gallon, as expected, compared to second quarter 2012’s $3.22 per gallon.  Based on our fuel derivative contracts and market prices as of July 22, third quarter 2013 economic fuel costs are expected to be in the $3.05 to $3.10 per gallon range, which is below third quarter 2012’s $3.16 per gallon.

“Our second quarter unit costs, excluding fuel, special items, and profitsharing, increased 1.7 percent, compared to second quarter last year.  Based on current trends and benefits from our fleet modernization efforts, we expect our third quarter 2013 unit costs, excluding fuel, special items, and profitsharing, to increase slightly from third quarter 2012’s 7.72 cents.

“Our balance sheet and liquidity remain strong with approximately $3.7 billion in cash and short-term investments, as of yesterday, and a $1 billion fully available revolving credit facility.  Our second quarter cash flow from operations was $778 million, and capital expenditures were $193 million, resulting in $585 million in free cash flow².  Our strong cash flow generation and record second quarter profits (excluding special items) reinforce the Board’s authorizations in May 2013 to increase our stock repurchase program from $1 billion to $1.5 billion, along with quadrupling our quarterly dividend to an estimated 1.2 percent annual yield (based on yesterday’s closing stock price of $13.76).  During second quarter 2013, we returned approximately $279 million to our Shareholders through the payment of $28 million in dividends and the repurchase of approximately $251 million, or approximately 18 million shares, under an accelerated stock repurchase program completed in June.  Since August 2011, we have repurchased approximately $975 million, or approximately 100 million shares, under our total $1.5 billion share repurchase authorization.”

Financial Results

The Company’s second quarter 2013 total operating revenues increased 0.6 percent to $4.6 billion, while operating unit revenues decreased 2.4 percent, on a 3.0 percent increase in available seat miles, and approximately four percent increase in average seats per trip, all as compared to second quarter 2012.  Total operating expenses in second quarter 2013 increased 1.3 percent to $4.2 billion, as compared to second quarter 2012.  The Company incurred costs (before taxes) associated with the acquisition and integration of AirTran, which are special items, of $26 million during second quarter 2013, compared to $11 million in second quarter 2012.  Cumulative costs associated with the acquisition and integration of AirTran, as of June 30, 2013, totaled $363 million (before profitsharing and taxes).  The Company expects total acquisition and integration costs to be no more than $550 million (before profitsharing and taxes).  Excluding special items in both periods, total operating expenses in second quarter 2013 were $4.2 billion, compared to $4.1 billion in second quarter 2012.

Second quarter 2013 economic fuel costs were $3.06 per gallon, including $.05 per gallon in unfavorable cash settlements for fuel derivative contracts, compared to $3.22 per gallon in second quarter 2012, including $.04 per gallon in unfavorable cash settlements for fuel derivative contracts.  The Company has derivative contracts in place for approximately 80 and 85 percent of its estimated fuel consumption in the third and fourth quarters of 2013, respectively.  As of July 22^nd, the fair market value of the Company’s hedge portfolio through 2017 was a net asset of approximately $102 million.  Additional information regarding the Company’s fuel derivative contracts is included in the accompanying tables.

Excluding fuel, special items, and profitsharing in both periods, second quarter 2013 operating costs increased 0.7 percent from second quarter 2012, and 1.7 percent on a unit basis.

Operating income for second quarter 2013 was $433 million, compared to $460 million in second quarter 2012.  Excluding special items, operating income was $479 million for second quarter 2013, compared to $485 million in the same period last year.

Other expenses for second quarter 2013 were $70 million, compared to $92 million in second quarter 2012.  This $22 million decrease primarily resulted from $47 million in other losses recognized in second quarter 2013, compared to $62 million in second quarter 2012.  In both periods, these losses primarily resulted from unrealized mark-to-market gains/losses associated with a portion of the Company’s fuel hedging portfolio, which are special items.  Excluding these special items, other losses were $12 million in second quarter 2013, compared to $14 million in second quarter 2012, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. Third quarter 2013 premium costs related to fuel derivative contracts are currently estimated to be approximately $22 million, compared to $15 million in third quarter 2012.  Net interest expense declined to $23 million in second quarter 2013, compared to $30 million in second quarter 2012, primarily due to the repayment of AirTran aircraft financing facilities during the first quarter of 2013.

For the six months ended June 30, 2013, total operating revenues increased 1.4 percent to $8.7 billion, while total operating expenses increased 1.2 percent to $8.2 billion, resulting in operating income of $503 million, compared to $481 million for the same period last year.  Excluding special items, operating income was $591 million for first half 2013, compared to $495 million for first half 2012.

Net income for first half 2013 was $283 million, or $.39 per diluted share, compared to $327 million, or $.43 per diluted share, for the same period last year.  Excluding special items, net income for first half 2013 was $328 million, or a record $.45 per diluted share, compared to $255 million, or $.33 per diluted share, for the same period last year.

The Company’s return on invested capital (before taxes and excluding special items) was approximately nine percent for the twelve months ended June 30, 2013.  Additional information regarding pre-tax return on invested capital is included in the accompanying reconciliation tables.

For the six months ended June 30, 2013, net cash provided by operations was $1.8 billion, and capital expenditures were $727 million, resulting in free cash flow² in excess of $1 billion.  The Company repaid $216 million in debt and capital lease obligations during first half 2013, and intends to repay approximately $100 million more in debt and capital lease obligations during the remainder of the year.

Copyright Photo: Brian McDonough/AirlinersGallery.com. A beautiful banking shot of Boeing 737-8H4 WL N8322X (msn 36997) completing the River Approach into Washington’s Reagan National Airport (please click on the photo for the full-size view).

Southwest Airlines: