Southwest Airlines Co. (NYSE:LUV) (the “Company”) today reported its fourth quarter and annual 2014 results:
- Record fourth quarter net income, excluding special items1, of $404 million, or $.59 per diluted share, compared with fourth quarter 2013 net income, excluding special items, of $236 million, or $.33 per diluted share. This exceeded the First Call consensus estimate of $.55 per diluted share.
- Fourth quarter net income of $190 million, or $.28 per diluted share, which included $214 million (net) of unfavorable special items, compared with net income of $212 million, or $.30 per diluted share, in fourth quarter 2013, which included $24 million (net) of unfavorable special items.
- Record annual net income, excluding special items, of $1.4 billion, or $2.01 per diluted share, compared with 2013 net income, excluding special items, of $805 million, or $1.12 per diluted share.
- Record annual net income of $1.1 billion, or $1.64 per diluted share, which included $261 million (net) of unfavorable special items, compared with net income of $754 million, or $1.05per diluted share, in 2013, which included $51 million (net) of unfavorable special items.
- Return on invested capital, before taxes and excluding special items (ROIC)1, of 21.2 percent for 2014, as compared with 13.1 percent for 2013.
Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, “We are extremely proud to report record annual 2014 net income, excluding special items, of $1.4 billion, or $2.01 per diluted share. Our 2014 total operating revenues were strong, increasing 5.1 percent to a record $18.6 billion. Our 2014 operating cost performance was also solid, with costs declining, year-over-year. Our ROIC for 2014 was 21.2 percent. This remarkable achievement would not have been possible without the hard work, perseverance, and determination of our Southwest People, and I commend them for these exceptional results, which earned them a record $355 million in profitsharing for 2014, up 56 percent from the previous record in 2013. Our strategic plan has come together successfully, and we have realized significant contributions from the AirTran integration, fleet modernization efforts, and the continued growth of our Rapid Rewards program.
“Our balance sheet and liquidity remain strong, with cash and short-term investments of $3.0 billion at the end of 2014. We generated strong free cash flow1 of $1.1 billion in 2014, allowing us to repurchase $955 million of Southwest common stock, pay $139 million to Shareholders in dividends, and reduce debt and capital lease obligations by $261 million, net, during the year.
“We concluded 2014 with record fourth quarter profits, excluding special items, of $404 million, or $.59 per diluted share. Total operating revenues were a fourth quarter record $4.6 billion. On a year-over-year basis, our fourth quarter 2014 revenue per available seat mile increased 2.0 percent, which is outstanding considering the 2.4 percent increase in available seat miles(ASMs); the 2.6 percent increase in stage length; the 2.4 percent increase in seats per trip2 (gauge); and the large percentage of our capacity under development. Customer demand remained strong, resulting in a record fourth quarter 2014 load factor of 82.0 percent, up 1.6 points from fourth quarter 2013. We are pleased with our passenger unit revenue and booking trends thus far in January, considering the continuing impact of increasing ASMs, stage length, and gauge, and the large percentage of our capacity under development. Based on these trends, we currently expect our first quarter 2015 passenger revenues to grow in line with the expected six percent increase in first quarter 2015 ASMs, both on a year-over-year basis.
“Our fourth quarter 2014 unit costs, excluding special items, were down 3.8 percent year-over-year, primarily as a result of significantly lower fuel prices. Our first quarter 2015 cost outlook is also favorable. With the collapse in fuel prices since September 2014, fuel prices have declined nearly 50 percent. Based on our existing fuel derivative contracts and market prices as ofJanuary 16, 2015, we estimate our first quarter 2015 economic fuel costs to be approximately $1.90 per gallon, which would result in approximately half a billion dollars in year-over-year fuel cost savings for first quarter alone. Excluding fuel and oil expense, special items, and profitsharing, we currently expect first quarter and full year 2015’s unit costs to decline in the one to two percent range, compared with the same year-ago periods, driven largely by our capacity growth and ongoing fleet modernization initiatives.
“December 28, 2014, marked the sunset of the AirTran brand. Overall, the AirTran acquisition resulted in net pre-tax synergies (excluding acquisition and integration expenses) of approximately $500 million in 2014, exceeding our $400 million target.
“We launched international service on Southwest Airlines to seven destinations in five countries in 2014, which will grow to seven countries with our plans to begin service to San Jose, Costa Rica; Puerto Vallarta, Mexico; and Belize City, Belize, in 2015, pending government approvals. We have been very pleased with the overall performance of our markets under development, most notably Dallas Love Field, New York LaGuardia, and Reagan National.
“Without question, 2014 was a monumental year for Southwest Airlines with many notable achievements. My gratitude goes out to our outstanding Employees for their tremendous efforts and the successful execution of our strategic initiatives, which allowed us to achieve our financial goals and expand our service internationally. As we enter 2015, we are well positioned financially and excited about our growth opportunities ahead. We remain steadfast in our unwavering commitment to preserve our financial strength, provide job security for our Employees, protect our low fare brand, and deliver adequate returns to our Shareholders. We live up to that commitment by offering friendly, reliable, and low cost air travel, and by expanding our network in a sensible manner.”
Notable 2014 accomplishments for Southwest Airlines include:
- Achieved 42nd consecutive year of profitability, with record profits
- Achieved 21.2 percent ROIC, beyond our minimum 15 percent target
- Earned a record $355 million in profitsharing, a 56 percent increase from 2013
- Recognized as the top 2014 stock price performer of the S&P 500 with a 125 percent increase in 2014
- Returned $1.1 billion to Shareholders through repurchases of $955 million of common stock (33 million shares) and payment of $139 million in dividends
- Reduced long-term debt and capital lease obligations by $261 million, net of debt issuance
- Completed the integration of AirTran’s network and Employees into Southwest, achieving net pre-tax synergies of approximately $500 million in 2014 (excluding acquisition and integration expenses)
- Continued to grow our Rapid Rewards program
- Continued modernizing our fleet with new Boeing 737-800s and pre-owned Boeing 737-700s, while retiring Classic 737s and AirTran 717-200s
- Deployed our international reservation system and launched Southwest’s inaugural international service to Aruba, The Bahamas, Montego Bay, Cancun, Los Cabos, Mexico City, andPunta Cana
- Announced service to San Jose, Costa Rica; Puerto Vallarta, Mexico; and Belize City, Belize for 2015, pending government approvals
- Announced the selection of Amadeus’ Altea reservations solution to replace the legacy domestic reservation system used by Southwest
- Nearly tripled the flights we offer at Reagan National, and launched new service to New York LaGuardia
- Launched nonstop service from the newly renovated Dallas Love Field to 17 destinations following the October 13, 2014, lifting of the Wright Amendment restrictions3; including San Francisco and Oakland which started in January 2015
- Unveiled a bold, new visual expression of our brand; the Heart livery, airport experience, and logo marries our past to our present and commemorates the transformation of Southwest
- Opened our new Training and Operations Support center in Dallas
- Received numerous awards and recognitions, including being named to FORTUNE’s 2014 list of World’s Most Admired Companies for the 20th consecutive year; being named Airline of the Year by Air Transport World, Domestic Carrier of the Year by the Airforwarders Association, Best Low Cost Carrier in North America from Premier Traveler-Best of 2014, and one of the Civic 50 by Points of Light and Bloomberg LP; recognized for one of the top airline frequent flyer programs in U.S. News & World Report’s 2014 rankings of the Best Airline Rewards Programs; and recognized as one of the Top 100 Military Friendly Employers® by Victory Media, publisher of G.I. Jobs and Military Spouse and one of FORTUNE’s 2014 Businessperson of the Year
- For the 18th consecutive year, received the 2014 Quest for Quality Award, awarded by Logistics Management Magazine to Southwest Airlines Cargo
Financial Results and Outlook
The Company’s fourth quarter 2014 total operating revenues increased 4.5 percent to $4.6 billion, while operating unit revenues increased 2.0 percent, on a 2.4 percent increase in available seat miles, all as compared with fourth quarter 2013. The growth in operating revenues was largely driven by strong fourth quarter 2014 passenger revenues.
Fourth quarter 2014 passenger revenues were $4.4 billion, which was an increase of 2.6 percent on a unit basis. As a result of continued monitoring of Member redemption activity and behavior under the new Rapid Rewards program launched in March 2011, the Company has increased the amount of spoilage expected for points sold to business partners. This change in estimate, which was recorded on a prospective basis, increased passenger revenues by approximately $55 million, and increased net income by $.04 per share, for fourth quarter 2014 and for the year ended December 31, 2014. The higher spoilage rate is expected to continue in 2015; however, the precise revenue impact will not be determinable until the actual number of point redemptions for the period is known. Based on current trends, the Company expects its first quarter 2015 passenger revenues to grow in line with the increase in its first quarter 2015 available seat mile capacity, both on a year-over-year basis.
Total operating expenses in fourth quarter 2014 decreased 0.9 percent to $4.0 billion, as compared with fourth quarter 2013. Fourth quarter 2014 profitsharing expense was $100 million, compared with $66 million in fourth quarter 2013. The Company incurred costs (before profitsharing and taxes) associated with the acquisition and integration of AirTran, which are special items, of $48 million during fourth quarter 2014, compared with $19 million in fourth quarter 2013. Excluding special items in both periods, total operating expenses were $3.9 billion in fourth quarter 2014, compared with $4.0 billion in fourth quarter 2013.
Fourth quarter 2014 economic fuel costs were $2.62 per gallon, including $.03 per gallon in unfavorable cash settlements from fuel derivative contracts, compared with $3.05 per gallon in fourth quarter 2013, including $.03 per gallon in favorable cash settlements from fuel derivative contracts. Based on the Company’s fuel derivative contracts and market prices as of January 16, 2015, first quarter 2015 economic fuel costs are expected to be approximately $1.90 per gallon, which is nearly 40 percent lower than first quarter 2014’s economic fuel costs of $3.08 per gallon. As of January 16, 2015, the fair market value of the Company’s fuel derivative contracts for 2015 was a net liability of $234 million, and an approximate $1.1 billion net liability for the hedge portfolio through 2018. 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, fourth quarter 2014 operating costs increased 3.6 percent from fourth quarter 2013, and increased 1.2 percent on a unit basis, primarily due to higher labor, depreciation, and advertising costs. Based on current capacity plans and cost trends, the Company expects its first quarter 2015 unit costs, excluding fuel and oil expense, profitsharing, and special items, to decrease in the one to two percent range, compared with first quarter 2014’s 8.50 cents.
Operating income in fourth quarter 2014 was a fourth quarter record $621 million, compared with $386 million in fourth quarter 2013, resulting in a 13.4 percent operating margin4. Excluding special items, operating income was a fourth quarter record $679 million in fourth quarter 2014, compared with $418 million in fourth quarter 2013, a 62.4 percent increase year-over-year.
Other expenses in fourth quarter 2014 were $319 million, compared with $52 million in fourth quarter 2013. This $267 million increase primarily resulted from $293 million in other losses recognized in fourth quarter 2014, compared with $27 million in other losses recognized in fourth quarter 2013. In both periods, these losses included ineffectiveness and unrealized mark-to-market losses associated with a portion of the Company’s fuel hedging portfolio, which are special items. Excluding these special items, fourth quarter 2014 had $11 million in other losses, compared with $21 million in fourth quarter 2013, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. First quarter 2015 premium costs related to fuel derivative contracts are currently estimated to be in the $25 million to $30 million range, compared with $17 million in first quarter 2014. Net interest expense in fourth quarter 2014 was$26 million, compared with $25 million in fourth quarter 2013.
For 2014, total operating revenues increased 5.1 percent to $18.6 billion, and total operating expenses were $16.4 billion, resulting in record operating income of $2.2 billion, compared with$1.3 billion in operating income for 2013. For 2014, special charges (before profitsharing and taxes) associated with the acquisition and integration of AirTran were $126 million. Cumulative costs associated with the acquisition and integration of AirTran, as of December 31, 2014, totaled $536 million (before profitsharing and taxes). The Company expects total acquisition and integration costs to be approximately $550 million (before profitsharing and taxes) upon completing the transition of AirTran 717-200s out of the fleet in 2015. Excluding special items, operating income was a record $2.4 billion for 2014, compared with $1.4 billion for 2013.
Balance Sheet and Cash Flows
As of January 21, 2015, the Company had approximately $3.1 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. Net cash provided by operations during fourth quarter 2014 was $203 million, and capital expenditures were $467 million. For 2014, net cash provided by operations was $2.90 billion, capital expenditures were$1.75 billion, and assets constructed for others, net of reimbursements, were $53 million, resulting in free cash flow of approximately $1.1 billion. The Company currently estimates its 2015 capital expenditures will be in the $1.6 billion to $1.7 billion range. The Company repaid $561 million in debt and capital lease obligations during 2014, and is currently scheduled to repay approximately $180 million in debt and capital lease obligations during 2015.
During fourth quarter 2014, pursuant to an accelerated share repurchase (ASR) program executed during the quarter, the Company returned $200 million to its Shareholders through the repurchase of 3.8 million shares of common stock, representing an estimated 75 percent of the shares the Company expects to purchase under the ASR program. The specific number of shares that the Company ultimately will repurchase under the ASR program will be determined generally based on a discount to the volume-weighted average price per share of the Company’s common stock during a calculation period to be completed during first quarter 2015. At settlement, under certain circumstances, the third party financial institution may be required to deliver additional shares of common stock to the Company, or under certain circumstances, the Company may be required to deliver shares of its common stock or may elect to make a cash payment to the third party financial institution. During fourth quarter 2014, the Company also received the remaining 1.1 million shares pursuant to the third quarter 2014 $200 million ASR program, bringing the total shares repurchased under that ASR program to 6.1 million. In 2014, the Company returned $1.1 billion to its Shareholders through $139 million in dividends, and the repurchase of $955 million in common stock, or 33 million shares. The Company has $380 million remaining under its existing $1 billion share repurchase authorization.
During 2014, the Company’s fleet decreased by 16 to 665 aircraft at the end of 2014. This reflects the delivery of 33 new Boeing 737-800s and 22 pre-owned Boeing 737-700s, as well as the retirement of five Boeing 737 Classic aircraft. This also reflects the remaining 66 AirTran 717-200s being removed from service during 2014. As of the end of 2014, the Company had converted 47 of the 52 AirTran 737-700s to the Southwest livery with Evolve configuration with the remaining five in conversion. For 2015, the Company continues to manage to a baseline of roughly 700 aircraft and an approximate six percent year-over-year increase in ASMs. Additional information regarding the company’s aircraft delivery schedule is included in the accompanying tables.