Southwest Airlines Company (Southwest Airlines and AirTran Airways) (Dallas) today reported its third quarter 2014 results:

Record third quarter net income, excluding special items1, of $382 million, or $.55 per diluted share, compared to third quarter 2013 net income, excluding special items, of $241 million, or $.34 per diluted share. This represented a 61.8 percent increase from third quarter 2013, and exceeded the First Call consensus estimate of $.53 per diluted share.

Record third quarter net income of $329 million, or $.48 per diluted share, which included $53 million (net) of unfavorable special items, compared to third quarter 2013 net income of $259 million, or $.37 per diluted share, which included $18 million (net) of favorable special items.

Record third quarter operating income of $614 million. Excluding special items, record third quarter operating income of $649 million.
Returned $241 million to Shareholders through dividends and share repurchases.

Return on invested capital1, before taxes and excluding special items (ROIC), for the twelve months ended September 30, 2014, of 19.0 percent, as compared to 10.6 percent for the twelve months ended September 30, 2013.

Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, “We are very pleased to report another record quarterly profit performance, which resulted in a $100 million third quarter 2014 profitsharing expense for our Employees. Excluding special items, third quarter 2014 net income was $382 million, or $.55 per diluted share, and operating income was $649 million, resulting in a 13.5 percent operating margin2. The 386 basis point year-over-year improvement in operating margin, excluding special items, was driven by strong revenues, lower jet fuel prices, and a solid cost performance.

“Total operating revenues were $4.8 billion, which was a 5.6 percent increase from a year ago, despite a four percent decline in trips and two percent fewer seats flown3, as we work through the transition of AirTran aircraft. Our traffic and revenue trends were strong throughout the third quarter, generating a 4.5 percent year-over-year increase in unit revenues, despite a large percentage of our route system in development or conversion as we continued to transition AirTran flying to Southwest. Our third quarter 2014 revenue strength was driven by record load factors and a strong performance in our Rapid Rewards frequent flyer program. Thus far, revenue momentum has continued into October 2014, with favorable load factor and unit revenue trends. Current bookings for November and December are also good.

“Our third quarter 2014 cost performance benefited from lower jet fuel prices and our fleet modernization efforts. With these trends continuing, we are poised for another solid cost performance for fourth quarter 2014. Based on current cost trends, and excluding fuel and oil expense, profitsharing, and special items, we expect full year 2014 unit costs to increase approximately two percent compared to last year.

“Our third quarter 2014 financial performance was very gratifying, and I commend our outstanding Employees of Southwest Airlines for their unending dedication to providing reliable, low cost operations with our legendary, friendly Customer Service. As an industry leader of low fares and low costs, we are very pleased with the transformative and successful execution of our strategic initiatives that contributed significantly to our 19.0 percent ROIC for the twelve months ended September 30, 2014. Our Employees are the very best in the airline industry, and we were thrilled to unveil a bold, new visual expression of our brand in September. Our Heart aircraft livery, airport experience, and logo marries our past to our present and commemorates the transformation of Southwest in 2014. It is dedicated with much gratitude to our People.

“We are also thrilled with the July 1, 2014, launch of Southwest international service. During third quarter, we began service to Oranjestad, Aruba; Montego Bay, Jamaica; Nassau/Paradise Island in the Bahamas; and San Jose del Cabo/Los Cabos and Cancun, Mexico, all markets previously served by AirTran Airways. Next month, we will initiate Southwest service to Punta Cana, Dominican Republic, and Mexico City, which will complete the conversion of international service from AirTran to Southwest. Also during third quarter, we announced that our first destination in Central America will be Juan Santamaria International Airport in San Jose, Costa Rica. The inauguration of this service is expected to be on March 7, 2015, subject to government approval.

“October 13, 2014, was a momentous day for Southwest Airlines. After 34 years, we are finally free from the Wright Amendment restrictions4, and have proudly launched our initial nonstop offerings from Dallas Love Field to seven popular destinations, with ten more nonstop destinations, previously announced, on the horizon.

“In addition to our strong third quarter 2014 earnings performance, our balance sheet, liquidity, and cash flows support our commitment to maintain our financial strength so that we can continue to take great care of our Employees, Customers and Shareholders. At the end of third quarter 2014, we had $3.6 billion in cash and short-term investments. For the nine months ended September 30, 2014, net cash provided by operations was $2.7 billion, and capital expenditures were $1.3 billion, resulting in strong free cash flow1 of $1.4 billion. We have further strengthened our balance sheet and repaid $517 million in debt and capital lease obligations, thus far in 2014, including $167 million in debt and capital lease obligations repaid during the nine months ended September 30, 2014, and $350 million repaid on October 1st. Thus far this year, we have returned $893 million to Shareholders through the payment of $138 million in dividends and the repurchase of $755 million in common stock.”

Financial Results and Outlook

The Company’s third quarter 2014 total operating revenues increased 5.6 percent, while operating unit revenues increased 4.5 percent, on a 1.1 percent increase in available seat miles, all as compared to third quarter 2013. Third quarter 2014 passenger revenues were $4.6 billion, which was an increase of 4.9 percent on a unit basis, as compared to third quarter 2013.

Total operating expenses in third quarter 2014 increased 0.7 percent to $4.2 billion, as compared to third quarter 2013. Third quarter 2014 profitsharing expense was $100 million, compared to $69 million in third quarter 2013. The Company incurred costs (before profitsharing and taxes) associated with the acquisition and integration of AirTran, which are special items, of $23 million during third quarter 2014, compared to $28 million in third quarter 2013. Cumulative costs associated with the acquisition and integration of AirTran, as of September 30, 2014, totaled $488 million (before profitsharing and taxes). The Company expects total acquisition and integration costs to be approximately $550 million (before profitsharing and taxes). Excluding special items in both periods, total operating expenses in third quarter 2014 increased 1.1 percent to $4.2 billion, as compared to third quarter 2013.

Third quarter 2014 economic fuel costs were $2.94 per gallon, including $.05 per gallon in favorable cash settlements from fuel derivative contracts, compared to $3.06 per gallon in third quarter 2013, including $.01 per gallon in favorable cash settlements from fuel derivative contracts. Based on the Company’s fuel derivative contracts and market prices as of October 17, 2014, fourth quarter 2014 economic fuel costs are expected to be in the $2.70 to $2.75 per gallon range, compared to fourth quarter 2013’s $3.05 per gallon. As of October 17, 2014, the fair market value of the Company’s hedge portfolio through 2018 was a net liability of $236 million. Additional information regarding the Company’s fuel derivative contracts is included in the accompanying tables.

Excluding fuel and oil expense, profitsharing, and special items in both periods, third quarter 2014 operating costs increased 2.6 percent from third quarter 2013, and increased 1.5 percent on a unit basis.

Operating income in third quarter 2014 was $614 million, compared to $390 million in third quarter 2013. Excluding special items, operating income was $649 million in third quarter 2014, compared to $439 million in the same period last year, a 47.8 percent increase year-over-year.

Other expenses in third quarter 2014 were $89 million, compared to other income of $29 million in third quarter 2013. The $118 million swing primarily resulted from $66 million in other losses recognized in third quarter 2014, compared to $59 million in other gains recognized in third quarter 2013. In both periods, these gains/losses included ineffectiveness and unrealized mark-to-market amounts associated with a portion of the Company’s fuel hedging portfolio, which are special items. Excluding these special items, third quarter 2014 had $16 million in other losses, compared to $19 million in third quarter 2013, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. Fourth quarter 2014 premium costs related to fuel derivative contracts are currently estimated to be $13 million, compared to $22 million in fourth quarter 2013. Net interest expense in third quarter 2014 was $23 million, compared to $30 million in third quarter 2013.

For the nine months ended September 30, 2014, total operating revenues increased 5.3 percent to $14.0 billion, and total operating expenses were $12.4 billion, resulting in operating income of $1.6 billion, compared to $893 million in operating income for the same period last year. Excluding special items, operating income was $1.7 billion for the nine months ended September 30, 2014, compared to $1.0 billion for the same period last year. Net income for the nine months ended September 30, 2014, was $946 million, or $1.36 per diluted share, compared to $542 million, or $.75 per diluted share, for the same period last year. Excluding special items, net income for the nine months ended September 30, 2014, was $993 million, or $1.42 per diluted share, compared to $569 million, or $.79 per diluted share, for the same period last year.

Balance Sheet and Cash Flows

As of September 30, 2014, the Company had $3.6 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. Net cash provided by operations during third quarter 2014 was $240 million, and capital expenditures were $433 million. The Company repaid $48 million in debt and capital lease obligations during third quarter 2014, and intends to repay an additional $395 million in debt and capital lease obligations during fourth quarter 2014, including $350 million repaid on October 1, 2014.

During third quarter 2014, the Company returned $241 million to its Shareholders through the payment of $41 million in dividends and the repurchase of $200 million in common stock, or 5.0 million shares, pursuant to an accelerated share repurchase (ASR) program executed during the quarter. This ASR program was completed in early October, and the Company then received an additional 1.1 million shares, bringing the total shares repurchased under the third quarter 2014 ASR program to 6.1 million. During third quarter, the Company also received the remaining 1.4 million shares pursuant to the second quarter 2014 $200 million ASR program, bringing the total shares repurchased under that ASR program to 7.4 million. Thus far in 2014, the Company has returned $893 million to its Shareholders through $138 million in dividends, and the repurchase of $755 million in common stock, or 29.2 million shares. The Company has $580 million remaining under its existing $1 billion share repurchase authorization.

Fleet

During third quarter 2014, the Company’s fleet increased by two to 685 aircraft at period end. This reflects the third quarter 2014 delivery of 11 new Boeing 737-800s and two pre-owned Boeing 737-700s, as well as the retirement of one Boeing 737-500. In addition, the Company removed ten Boeing 717-200s from service during third quarter 2014 in preparation for transition out of the fleet.

Boeing 737 Delivery Schedule:

Copyright Photo: Eddie Maloney/AirlinersGallery.com. Boeing 737-7H4 N909WN (msn 32458) arrives at Las Vegas.

Southwest Airlines Aircraft Slide Show: 

AirTran Airways Aircraft Slide Show: