Southwest Airlines Results

Southwest Reports Third Quarter Profit

Record third quarter net income of $615 million

Southwest Airlines

 Southwest Airlines Co. (NYSE: LUV) yesterday reported its third quarter 2018 results:

  • Record third quarter net income of $615 million
  • Net income of $614 million, excluding special items1
  • Record third quarter earnings per diluted share of $1.08
  • Operating income of $798 million, or $796 million, excluding special items
  • Operating margin2 of 14.3 percent, and net margin3 of 11.0 percent
  • Operating cash flow of $1.3 billion, and free cash flow1 of $817 million
  • Returned $591 million to Shareholders through a combination of share repurchases and dividends
  • Return on invested capital (ROIC)1 pre-tax of 23.4 percent for the 12 months ended September 30, 2018, or 18.1 percent on an after-tax basis

Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, "I want to congratulate our Employees on an excellent third quarter 2018 performance, resulting in record third quarter earnings per diluted share. The significant increase in our third quarter 2018 earnings per diluted share was driven by record third quarter operating revenues, lower federal income taxes, and a 4.8 percent year-over-year reduction in share count. Despite higher jet fuel prices and other cost pressures, we grew our third quarter 2018 net margin, year-over-year, which is a notable accomplishment.

"I am grateful to our People for their hard work and resilience, as we continue to consistently deliver stellar margins and returns. With these results, we accrued an additional $135 million in profitsharing for the benefit of our Employees and provided $591 million of share buybacks and dividends for our Shareholders.

"As we finish the year, our revenue momentum has continued into fourth quarter 2018, thus far. Unit revenue trends are stable and have recovered nicely from first half 2018. We are particularly pleased with the performance of our new revenue management tools. With our new reservation system in place since last year, we have more capabilities and are well-positioned to drive revenue growth. We expect $80 million to $90 million of year-over-year improvement in fourth quarter 2018 pre-tax results from these enhanced capabilities, which is in line with our annual 2018 pre-tax goal of $200 million.

"On the cost side, our third quarter 2018 unit cost performance was in line with our expectations. Our fuel hedge portfolio mitigated a significant portion of market jet fuel price increases, and we are pleased with the fuel hedge in place for both fourth quarter 2018 and annual 2019. Based on current trends, we continue to expect modest year-over-year inflation in our annual 2018 unit costs, excluding fuel and oil expense and profitsharing expense.

"Based on our second half 2018 revenue trends, we are well-positioned for year-over-year unit revenue growth in 2019, with easier year-over-year comparisons in first half. We also will continue to experience year-over-year unit cost inflation in 2019, excluding fuel and oil expense and profitsharing expense, of at least three percent, as we continue investing in and deploying new operations, technology, and airport infrastructure to support future growth. With the 2017 retirement of our Boeing 737-300 Classic fleet, launch of the 737 MAX, and implementation of our new reservation system, we continue with our efforts to modernize our fleet, optimize our network, and pursue additional revenue opportunities. Given our healthy revenue outlook, and despite expected cost increases, our 2019 goal is to expand margins year-over-year. We are refocusing our efforts to control costs and drive efficiency, and, as ever, we remain steadfast in our efforts to produce industry-leading margins and superior returns in excess of our cost of capital.

"For next year, Hawaii is our expansion focus, and we continue to expect 2019 available seat miles (ASMs, or capacity) to increase no more than five percent, year-over-year."

Revenue Results and Outlook

The Company's third quarter 2018 total operating revenues increased 5.1 percent, year-over-year, to a third quarter record $5.6 billion. Third quarter 2018 operating revenue per ASM (RASM, or unit revenues) increased 1.2 percent, year-over-year, driven largely by a passenger revenue yield increase of 2.3 percent, year-over-year, offset slightly by a load factor decline of 0.9 points, year-over-year, to 83.9 percent. Third quarter 2018 RASM also included an approximate one-half point year-over-year positive impact as a result of approximately 2,200 flight cancellations in third quarter 2018, due to thunderstorms and weather-related disruptions (the "weather cancellations").

Based on current bookings and yield trends, the Company expects fourth quarter 2018 RASM to increase in the one to two percent range, compared with fourth quarter 2017 RASM of 13.88 cents, as recast in accordance with Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (or the "New Revenue Standard"). The Company adopted the New Revenue Standard effective January 1, 2018, and utilized the full retrospective method of adoption allowed by the standard. As such, results for the three and nine months ended September 30, 2017, have been recast under the new standard in order to be comparable with current period results in the accompanying unaudited Condensed Consolidated Statement of Income. The Company's third quarter 2018 year-over-year RASM increase included an approximate one point headwind from the change in the Rapid Rewards revenue recognition method as a result of the Company's adoption of the New Revenue Standard. The Company continues to expect an immaterial impact to its fourth quarter and annual 2018 year-over-year RASM trends as a result of the New Revenue Standard.

Cost Performance and Outlook

Third quarter 2018 total operating expenses increased 7.2 percent, year-over-year, to $4.8 billion. Total operating expenses per ASM (CASM, or unit costs) increased 3.1 percent, as compared with third quarter 2017. Excluding special items in both periods, third quarter 2018 total operating expenses increased 8.1 percent to $4.8 billion, or 4.1 percent on a unit basis, year-over-year.

Effective January 1, 2018, the Company early adopted ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. The new standard eliminated ineffectiveness for all derivatives designated in a hedge for accounting purposes, as well as changed the Company's classification of premium expense associated with fuel hedges from Other (gains) and losses, net, to Fuel and oil expense within the unaudited Condensed Consolidated Statement of Income. As such, the classification of premium expense for the three and nine months ended September 30, 2017, has been recast under the new standard to be comparable with current period results.

Third quarter 2018 economic fuel costs1 were $2.25 per gallon and included $.06 per gallon in premium expense and $.10 per gallon in favorable cash settlements from fuel derivative contracts, compared with $2.07 per gallon in third quarter 2017, as recast, which included $.06 per gallon in premium expense and $.31 per gallon in unfavorable cash settlements from fuel derivative contracts. Third quarter 2018 ASMs per gallon, or fuel efficiency, improved 1.1 percent year-over-year, driven primarily by the retirement of the Classic fleet and the addition of more fuel-efficient 737-800 and 737 MAX 8 aircraft.

Based on the Company's existing fuel derivative contracts and market prices as of October 19, 2018, fourth quarter 2018 economic fuel costs are estimated to be in the range of $2.30 to $2.35 per gallon4, including $.07 per gallon in premium expense and an estimated $.14 per gallon in favorable cash settlements from fuel derivative contracts, compared with $2.16 per gallon in fourth quarter 2017, as recast, which included $.07 per gallon in premium expense and $.19 per gallon in unfavorable cash settlements from fuel derivative contracts. As of October 19, 2018, the fair market value of the Company's fuel derivative contracts settling in fourth quarter 2018 was an asset of approximately $82 million, and the fair market value of the hedge portfolio settling in 2019 and beyond was an asset of approximately $521 million.

Based on the Company's existing fuel derivative contracts and market prices as of October 19, 2018, annual 2019 economic fuel costs are estimated to be in the range of $2.35 to $2.40 per gallon4, including $.04 per gallon in premium expense and an estimated $.08 per gallon in favorable cash settlements from fuel derivative contracts. 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, third quarter 2018 operating expenses increased 7.0 percent, as compared with third quarter 2017. Third quarter 2018 profitsharing expense was $135 million, as compared with $127 million in third quarter 2017. Excluding fuel and oil expense, profitsharing expense, and special items, third quarter 2018 operating expenses also increased 7.0 percent, or 3.0 percent on a unit basis, year-over-year. This increase was due primarily to shifting of spending from first half 2018 into third quarter 2018, higher maintenance and advertising expenses, and a nearly one-point year-over-year negative impact as a result of the third quarter 2018 weather cancellations.

Based on current cost trends, the Company estimates fourth quarter 2018 CASM, excluding fuel and oil expense and profitsharing expense, to be flat to up one percent, compared with fourth quarter 2017's 8.82 cents, as recast, which excluded fuel and oil expense, profitsharing expense, and special items. The Company continues to estimate annual 2018 CASM, excluding fuel and oil expense and profitsharing expense, to be flat to up one percent, compared with annual 2017's 8.47 cents, as recast, which excluded fuel and oil expense, profitsharing expense, and special items.

Third Quarter Results

Third quarter 2018 net income was a third quarter record $615 million, or a record third quarter $1.08 per diluted share, compared with third quarter 2017 net income of $528 million, or $.88 per diluted share. Excluding special items, third quarter 2018 net income was $614 million, or a third quarter record $1.08 per diluted share, compared with third quarter 2017 net income of $554 million, or $.93 per diluted share, and compared with First Call third quarter 2018 consensus estimate of $1.06 per diluted share.

The Company estimates its effective tax rate to be approximately 23 percent for annual 2018. For annual 2019, the Company estimates its effective tax rate to be approximately 23.5 percent.

Liquidity and Capital Deployment

As of September 30, 2018, the Company had approximately $3.8 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 2018 was $1.3 billion, capital expenditures were $454 million, and free cash flow was $817 million. The Company repaid $98 million in debt and capital lease obligations during third quarter 2018, and expects to repay approximately $87 million in debt and capital lease obligations during fourth quarter 2018.

During third quarter 2018, the Company returned $591 million to its Shareholders through the repurchase of $500 million in common stock and the payment of $91 million in dividends. The Company repurchased 8.2 million shares of common stock pursuant to a $500 million accelerated share repurchase program (ASR) launched during third quarter 2018 and completed earlier this month. The Company's third quarter ASR completed the remaining $350 million of its previous $2.0 billion share repurchase program that had been authorized by its Board of Directors in May 2017, and initiated the $2.0 billion share repurchase program authorized by its Board of Directors in May 2018. The Company has $1.85 billion remaining under its current authorization.

For the nine months ended September 30, 2018, net cash provided by operations was approximately $3.9 billion. Capital expenditures, including net proceeds from assets constructed for others, were approximately $1.3 billion, and free cash flow was $2.6 billion. This enabled the Company to return approximately $1.8 billion to Shareholders through the repurchase of $1.5 billion in common stock and the payment of $332 million in dividends.

The Company continues to estimate its annual 2018 capital expenditures to be in the $2.0 to $2.1 billion range. For annual 2019, capital expenditures are expected to be similar to 2018 levels.

Fleet and Capacity

The Company ended third quarter 2018 with 742 aircraft in its fleet. This reflects the third quarter delivery of five new 737-800s and seven new 737 MAX 8s. The Company continues to expect to end 2018 with 751 aircraft in its fleet based on the current aircraft delivery schedule. Additional information regarding the Company's aircraft delivery schedule is included in the accompanying tables.

The Company now expects its annual 2018 year-over-year ASM growth to be approximately four percent, slightly lower than previously expected, due primarily to the third quarter 2018 weather cancellations. The Company now expects fourth quarter 2018 year-over-year ASM growth to be in the 6.0 to 6.5 percent range.

Awards and Recognitions

  • Ranked #2 on the list of Top-Rated Workplaces in 2018 by Indeed
  • Ranked among the Best Airline Rewards Programs by U.S. News & World Report
  • Named a Best Employer for Women 2018 by Forbes
  • Among Forbes's list of America's Best Employers for New Graduates 2018
  • Named the Best Airline for Family Travel by The Points Guy

Southwest Airlines Co.

Condensed Consolidated Statement of Income

(in millions, except per share amounts)

(unaudited)

Three months ended

Nine months ended

September 30,

September 30,

2017

2017

2018

As

Recast

Percent

Change

2018

As

Recast

Percent

Change

OPERATING REVENUES:

Passenger

$

5,194

$

4,944

5.1

$

15,137

$

14,869

1.8

Freight

43

42

2.4

130

128

1.6

Other

338

317

6.6

994

891

11.6

     Total operating revenues

5,575

5,303

5.1

16,261

15,888

2.3

OPERATING EXPENSES:

Salaries, wages, and benefits

1,912

1,791

6.8

5,659

5,385

5.1

Fuel and oil

1,205

1,037

16.2

3,425

3,016

13.6

Maintenance materials and repairs

283

263

7.6

814

758

7.4

Landing fees and airport rentals

337

324

4.0

1,011

969

4.3

Depreciation and amortization

301

302

(0.3)

870

939

(7.3)

Other operating expenses

739

741

(0.3)

2,096

2,154

(2.7)

     Total operating expenses

4,777

4,458

7.2

13,875

13,221

4.9

OPERATING INCOME

798

845

(5.6)

2,386

2,667

(10.5)

OTHER EXPENSES (INCOME):

Interest expense

33

28

17.9

99

84

17.9

Capitalized interest

(9)

(15)

(40.0)

(29)

(38)

(23.7)

Interest income

(20)

(9)

122.2

(47)

(24)

95.8

Other (gains) losses, net

8

9

(11.1)

16

115

(86.1)

     Total other expenses (income)

12

13

(7.7)

39

137

(71.5)

INCOME BEFORE INCOME TAXES

786

832

(5.5)

2,347

2,530

(7.2)

PROVISION FOR INCOME TAXES

171

304

(43.8)

536

920

(41.7)

NET INCOME

$

615

$

528

16.5

$

1,811

$

1,610

12.5

NET INCOME PER SHARE:

Basic

$

1.08

$

0.88

22.7

$

3.13

$

2.66

17.7

Diluted

$

1.08

$

0.88

22.7

$

3.13

$

2.66

17.7

WEIGHTED AVERAGE SHARES OUTSTANDING:

Basic

569

597

(4.7)

578

605

(4.5)

Diluted

569

598

(4.8)

579

606

(4.5)

Southwest Airlines Co.

Reconciliation of Reported Amounts to Non-GAAP Items (excluding special items)

(See Note Regarding Use of Non-GAAP Financial Measures)

(in millions, except per share amounts)(unaudited)

Three months ended

Nine months ended

September 30,

September 30,

2017

2017

2018

As

Recast

Percent

Change

2018

As

Recast

Percent

Change

Fuel and oil expense, unhedged

$

1,225

$

886

$

3,459

$

2,568

Add: Premium cost of fuel contracts

34

34

101

102

Add (Deduct): Fuel hedge (gains) losses included in Fuel and oil expense, net

(54)

117

(135)

346

Fuel and oil expense, as reported

$

1,205

$

1,037

$

3,425

$

3,016

Add: Net impact from fuel contracts (a)

2

46

14

129

Fuel and oil expense, excluding special items (economic)

$

1,207

$

1,083

11.4

$

3,439

$

3,145

9.3

Total operating expenses, as reported

$

4,777

$

4,458

$

13,875

$

13,221

Add: Net impact from fuel contracts (a)

2

46

14

129

Deduct: Lease termination expense

(20)

(33)

Deduct: Aircraft grounding charge

(63)

(63)

Add: Gain on sale of grounded aircraft

25

Total operating expenses, excluding special items

$

4,779

$

4,421

8.1

$

13,914

$

13,254

5.0

Deduct: Fuel and oil expense, excluding special items (economic)

(1,207)

(1,083)

(3,439)

(3,145)

Operating expenses, excluding Fuel and oil expense and special items

$

3,572

$

3,338

7.0

$

10,475

$

10,109

3.6

Deduct: Profitsharing expense

(135)

(127)

(403)

(428)

Operating expenses, excluding profitsharing, Fuel and oil expense, and special items

$

3,437

$

3,211

7.0

$

10,072

$

9,681

4.0

Operating income, as reported

$

798

$

845

$

2,386

$

2,667

Deduct: Net impact from fuel contracts (a)

(2)

(46)

(14)

(129)

Add: Lease termination expense

20

33

Add: Aircraft grounding charge

63

63

Deduct: Gain on sale of grounded aircraft

(25)

Operating income, excluding special items

$

796

$

882

(9.8)

$

2,347

$

2,634

(10.9)

Other (gains) losses, net, as reported

$

8

$

9

$

16

$

115

Deduct: Net impact from fuel contracts (a)

(4)

(109)

Other (gains) losses, net, excluding special items

$

8

$

5

60.0

$

16

$

6

166.7

Net income, as reported

$

615

$

528

$

1,811

$

1,610

Deduct: Net impact from fuel contracts (a)

(2)

(42)

(14)

(20)

Add: Lease termination expense

20

33

Add: Aircraft grounding charge

63

63

Deduct: Gain on sale of grounded aircraft

(25)

Add (Deduct): Net income tax impact of special items (b)

1

(15)

9

(28)

Net income, excluding special items

$

614

$

554

10.8

$

1,781

$

1,658

7.4

Net income per share, diluted, as reported

$

1.08

$

0.88

$

3.13

$

2.66

Deduct: Impact from fuel contracts

(0.07)

(0.02)

(0.03)

Add (Deduct): Impact of special items

0.14

(0.04)

0.16

Add (Deduct): Net income tax impact of special items (b)

(0.02)

0.01

(0.05)

Net income per share, diluted, excluding special items

$

1.08

$

0.93

16.1

$

3.08

$

2.74

12.4

(a) See Reconciliation of Impact from Fuel Contracts.

(b) Tax amounts for each individual special item are calculated at the Company's effective rate for the applicable period and totaled in this line item.

Southwest Airlines Co.

Reconciliation of Impact from Fuel Contracts

(See Note Regarding Use of Non-GAAP Financial Measures)

(in millions)

(unaudited)

Three months ended

Nine months ended

September 30,

September 30,

2018

2017

2018

2017

Fuel and oil expense

Reclassification between Fuel and oil and Other (gains) losses, net,

  associated with current period settled contracts

$

$

(1)

$

$

14

Contracts settling in the current period, but for which the impact has been recognized

  in a prior period (a)

2

47

14

115

Impact from fuel contracts to Fuel and oil expense

$

2

$

46

$

14

$

129

Operating Income

Reclassification between Fuel and oil and Other (gains) losses, net,

  associated with current period settled contracts

$

$

1

$

$

(14)

Contracts settling in the current period, but for which the impact has been recognized

  in a prior period (a)

(2)

(47)

(14)

(115)

Impact from fuel contracts to Operating Income

$

(2)

$

(46)

$

(14)

$

(129)

Other (gains) losses, net

Mark-to-market impact from fuel contracts settling in future periods

$

$

3

$

$

(66)

Ineffectiveness from fuel hedges settling in future periods

(8)

(29)

Reclassification between Fuel and oil and Other (gains) losses, net,

  associated with current period settled contracts

1

(14)

Impact from fuel contracts to Other (gains) losses, net

$

$

(4)

$

$

(109)

Net Income

Mark-to-market impact from fuel contracts settling in future periods

$

$

(3)

$

$

66

Ineffectiveness from fuel hedges settling in future periods

8

29

Other net impact of fuel contracts settling in the current or a prior

  period (excluding reclassifications)

(2)

(47)

(14)

(115)

Impact from fuel contracts to Net Income (b)

$

(2)

$

(42)

$

(14)

$

(20)

(a) As a result of prior hedge ineffectiveness and/or contracts marked-to-market through the income statement.

(b) Before income tax impact of unrealized items.

Southwest Airlines Co.

Comparative Consolidated Operating Statistics

(unaudited)

Certain operating statistics for the three and nine months ended September 30, 2017 have been recast as a result of the Company's January 1, 2018 adoption of ASU No. 2014-09, Revenue from Contracts with Customers, ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, and ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities.

Three months ended

Nine months ended

September 30,

September 30,

2018

2017

Change

2018

2017

Change

Revenue passengers carried

33,860,286

33,029,537

2.5%

100,458,039

96,561,189

4.0%

Enplaned passengers

41,424,418

40,232,993

3.0%

121,898,393

117,248,334

4.0%

Revenue passenger miles (RPMs) (000s) (a)

34,024,307

33,128,227

2.7%

99,606,339

96,851,582

2.8%

Available seat miles (ASMs) (000s) (b)

40,569,507

39,053,164

3.9%

119,428,256

115,924,258

3.0%

Load factor (c)

83.9%

84.8%

(0.9) pts.

83.4%

83.5%

(0.1) pts.

Average length of passenger haul (miles)

1,005

1,003

0.2%

992

1,003

(1.1)%

Average aircraft stage length (miles)

760

756

0.5%

758

760

(0.3)%

Trips flown

347,555

341,086

1.9%

1,027,699

1,010,703

1.7%

Seats flown (d)

52,328,973

50,850,348

2.9%

154,746,141

150,258,237

3.0%

Seats per trip (e)

150.56

149.08

1.0%

150.58

148.67

1.3%

Average passenger fare

$

153.40

$

149.68

2.5%

$

150.68

$

153.98

(2.1)%

Passenger revenue yield per RPM (cents) (f)

15.27

14.92

2.3%

15.20

15.35

(1.0)%

RASM (cents) (g)

13.74

13.58

1.2%

13.62

13.71

(0.7)%

PRASM (cents) (h)

12.80

12.66

1.1%

12.67

12.83

(1.2)%

CASM (cents) (i)

11.77

11.42

3.1%

11.62

11.40

1.9%

CASM, excluding Fuel and oil expense (cents)

8.81

8.76

0.6%

8.75

8.80

(0.6)%

CASM, excluding special items (cents)

11.78

11.32

4.1%

11.65

11.43

1.9%

CASM, excluding Fuel and oil expense and special items (cents)

8.81

8.55

3.0%

8.77

8.72

0.6%

CASM, excluding Fuel and oil expense, special items, and profitsharing

    expense (cents)

8.47

8.22

3.0%

8.43

8.35

1.0%

Fuel costs per gallon, including fuel tax (unhedged)

$

2.28

$

1.69

34.9%

$

2.20

$

1.66

32.5%

Fuel costs per gallon, including fuel tax

$

2.24

$

1.98

13.1%

$

2.18

$

1.95

11.8%

Fuel costs per gallon, including fuel tax (economic)

$

2.25

$

2.07

8.7%

$

2.19

$

2.03

7.9%

Fuel consumed, in gallons (millions)

535

521

2.7%

1,567

1,544

1.5%

Active fulltime equivalent Employees

58,559

55,671

5.2%

58,559

55,671

5.2%

Aircraft at end of period

742

687

8.0%

742

687

8.0%

(a) A revenue passenger mile is one paying passenger flown one mile. Also referred to as "traffic," which is a measure of demand for a given period.

(b) An available seat mile is one seat (empty or full) flown one mile. Also referred to as "capacity," which is a measure of the space available to carry passengers in a given period.

(c) Revenue passenger miles divided by available seat miles.

(d) Seats flown is calculated using total number of seats available by aircraft type multiplied by the total trips flown by the same aircraft type during a particular period.

(e) Seats per trip is calculated using seats flown divided by trips flown. Also referred to as "gauge."

(f) Calculated as passenger revenue divided by revenue passenger miles. Also referred to as "yield," this is the average cost paid by a paying passenger to fly one mile, which is a measure of revenue production and fares.

(g) RASM (unit revenue) - Operating revenue yield per ASM, calculated as operating revenue divided by available seat miles. Also referred to as "operating unit revenues," this is a measure of operating revenue production based on the total available seat miles flown during a particular period.

(h) PRASM (Passenger unit revenue) - Passenger revenue yield per ASM, calculated as passenger revenue divided by available seat miles. Also referred to as "passenger unit revenues," this is a measure of passenger revenue production based on the total available seat miles flown during a particular period.

(i) CASM (unit costs) - Operating expenses per ASM, calculated as operating expenses divided by available seat miles. Also referred to as "unit costs" or "cost per available seat mile," this is the average cost to fly an aircraft seat (empty or full) one mile, which is a measure of cost efficiencies.

Southwest Airlines Co.

Non-GAAP Return on Invested Capital (ROIC)

(See Note Regarding Use of Non-GAAP Financial Measures, and see note below)

(in millions)

(unaudited)

Twelve months

ended

Twelve months

ended

September 30, 2018

September 30, 2017

Operating income, as reported

$

3,127

$

3,475

Net impact from fuel contracts

(41)

(211)

Lease termination expense

37

Aircraft grounding charge

63

Gain on sale of grounded aircraft

(25)

Operating income, non-GAAP

$

3,061

$

3,364

Net adjustment for aircraft leases (a)

100

112

Adjusted operating income, non-GAAP (A)

$

3,161

$

3,476

Non-GAAP tax rate (B)

22.8%

(d)

36.1%

(e)

Net operating profit after-tax, NOPAT (A* (1-B) = C)

$

2,439

$

2,220

Debt, including capital leases (b)

$

3,461

$

3,184

Equity (b)

9,513

7,744

Net present value of aircraft operating leases (b)

624

837

Average invested capital

$

13,598

$

11,765

Equity adjustment for hedge accounting (c)

(98)

426

Adjusted average invested capital (D)

$

13,500

$

12,191

Non-GAAP ROIC, pre-tax (A/D)

23.4%

28.5%

Non-GAAP ROIC, after-tax (C/D)

18.1%

18.2%

As of January 1, 2018, the Company adopted three Accounting Standard Updates ("ASUs"), ASU 2014-09, Revenue from Contracts with Customers, ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, and ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. As a result certain prior period results have been recast due to the transition methods applied. See the Company's Current Report on Form 8-K furnished to the Securities and Exchange Commission on March 20, 2018, as well as subsequent filings, for further information.

(a) Net adjustment related to presumption that all aircraft in fleet are owned (i.e., the impact of eliminating aircraft rent expense and replacing with estimated depreciation expense for those same aircraft). The Company makes this adjustment to enhance comparability to other entities that have different capital structures by utilizing alternative financing decisions.

(b) Calculated as an average of the five most recent quarter end balances or remaining obligations. The Net present value of aircraft operating leases represents the assumption that all aircraft in the Company's fleet are owned, as it reflects the remaining contractual commitments discounted at the Company's estimated incremental borrowing rate as of the time each individual lease was signed.

(c) The Equity adjustment for hedge accounting in the denominator adjusts for the cumulative impacts, in Accumulated other comprehensive income and Retained earnings, of gains and/or losses associated with hedge accounting related to fuel hedge derivatives that will settle in future periods. The current period impact of these gains and/or losses is reflected in the Net impact from fuel contracts in the numerator.

(d) As the twelve month rolling tax rate no longer approximates an annual tax rate due to the significant impact the Tax Cuts and Jobs Act legislation enacted in December 2017 had on corporate tax rates, the Company is utilizing the 2018 year-to-date tax rate for 2018 ROIC, after-tax. The 2018 year-to-date GAAP tax rate was 22.8 percent, and the Non-GAAP tax rate for the period was also 22.8 percent. Utilizing the Company's tax rate based on Operating income, non-GAAP for the twelve months ended September 30, 2018, of 25.7 percent, Non-GAAP ROIC, after tax, would have been 17.4 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information. For full year 2018, the Company estimates its effective tax rate to be approximately 23 percent.

(e) The GAAP twelve month rolling tax rate as of September 30, 2017, was 36.1 percent, and the twelve month rolling Non-GAAP tax rate was also 36.1 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information.

Southwest Airlines Co.

Condensed Consolidated Balance Sheet

(in millions)

(unaudited)

December 31, 2017

September 30, 2018

As Recast

ASSETS

Current assets:

     Cash and cash equivalents

$

2,104

$

1,495

     Short-term investments

1,716

1,778

     Accounts and other receivables

784

662

     Inventories of parts and supplies, at cost

483

420

     Prepaid expenses and other current assets

514

460

          Total current assets

5,601

4,815

Property and equipment, at cost:

     Flight equipment

21,409

21,368

     Ground property and equipment

4,769

4,399

     Deposits on flight equipment purchase contracts

820

919

     Assets constructed for others

1,718

1,543

28,716

28,229

     Less allowance for depreciation and amortization

9,437

9,690

19,279

18,539

Goodwill

970

970

Other assets

1,032

786

$

26,882

$

25,110

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

     Accounts payable

$

1,224

$

1,320

     Accrued liabilities

1,517

1,700

     Air traffic liability

4,756

3,495

     Current maturities of long-term debt

346

348

          Total current liabilities

7,843

6,863

Long-term debt less current maturities

3,100

3,320

Air traffic liability - loyalty noncurrent

827

1,070

Deferred income taxes

2,553

2,119

Construction obligation

1,658

1,390

Other noncurrent liabilities

748

707

Stockholders' equity:

     Common stock

808

808

     Capital in excess of par value

1,485

1,451

     Retained earnings

15,402

13,832

     Accumulated other comprehensive income

412

12

     Treasury stock, at cost

(7,954)

(6,462)

          Total stockholders' equity

10,153

9,641

$

26,882

$

25,110

Southwest Airlines Co.

Condensed Consolidated Statement of Cash Flows

(in millions)

(unaudited)

Three months ended

September 30,

Nine months ended

September 30,

2017

2017

2018

As Recast

2018

As Recast

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income

$

615

$

528

$

1,811

$

1,610

Adjustments to reconcile net income to cash provided by (used in) operating activities:

Depreciation and amortization

301

302

870

939

Aircraft grounding charge

63

63

Unrealized/realized (gain) loss on fuel derivative instruments, net

(2)

(42)

(13)

(20)

Deferred income taxes

104

98

308

219

Changes in certain assets and liabilities:

Accounts and other receivables

(13)

(109)

(23)

Other assets

(30)

(64)

(243)

(264)

Accounts payable and accrued liabilities

161

87

80

(157)

Air traffic liability

52

(119)

1,018

802

Cash collateral received from derivative counterparties

10

151

150

286

Other, net

73

(8)

32

(89)

Net cash provided by operating activities

1,271

996

3,904

3,366

CASH FLOWS FROM INVESTING ACTIVITIES:

Capital expenditures

(454)

(638)

(1,384)

(1,603)

Assets constructed for others

(8)

(17)

(49)

(113)

Purchases of short-term investments

(678)

(531)

(1,607)

(1,653)

Proceeds from sales of short-term and other investments

531

566

1,665

1,696

Other, net

5

5

Net cash used in investing activities

(604)

(620)

(1,370)

(1,673)

CASH FLOWS FROM FINANCING ACTIVITIES:

Proceeds from Employee stock plans

9

7

26

22

Reimbursement for assets constructed for others

8

17

165

113

Payments of long-term debt and capital lease obligations

(98)

(106)

(255)

(534)

Payments of cash dividends

(91)

(75)

(332)

(274)

Repayment of construction obligation

(8)

(2)

(22)

(7)

Repurchase of common stock

(500)

(300)

(1,500)

(1,250)

Other, net

3

6

(7)

17

Net cash used in financing activities

(677)

(453)

(1,925)

(1,913)

NET CHANGE IN CASH AND CASH EQUIVALENTS

(10)

(77)

609

(220)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

2,114

1,537

1,495

1,680

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

2,104

$

1,460

$

2,104

$

1,460

Southwest Airlines Co.

Fuel Derivative Contracts

As of October 19, 2018

Estimated economic fuel price per gallon, including

taxes and fuel hedging premiums (c)(d)

Average Brent Crude Oil price

per barrel

Fourth Quarter 2018

$70

$2.15 - $2.20

$75

$2.25 - $2.30

Current Market (a)

$2.30 - $2.35

$85

Approximately $2.40

$90

Approximately $2.45

Estimated fuel hedging

premium expense per gallon (b)

$.07

Period

Maximum percent of estimated fuel consumption covered by fuel derivative contracts at varying WTI/Brent Crude

Oil, Heating Oil, and Gulf Coast Jet Fuel-equivalent price levels

2018

80%

2019

63%

2020

38%

2021

20%

2022

less than 5%

(a) Brent crude oil average market prices as of October 19, 2018, was approximately $80 per barrel for fourth quarter 2018.

(b) In accordance with the Company's early adoption of Accounting Standards Update No. 2017-12, Targeted Improvements to Accounting for Hedging Activities, the Company began reporting premium expense within Fuel and oil expense as of January 1, 2018.

(c) Based on the Company's existing fuel derivative contracts and market prices as of October 19, 2018, fourth quarter 2018 GAAP and economic fuel costs are estimated to be in the $2.30 to $2.35 per gallon range, including fuel hedging premium expense of approximately $34 million, or $.07 per gallon, and an estimated $.14 per gallon in favorable cash settlements from fuel derivative contracts. See Note Regarding Use of Non-GAAP Financial Measures.

(d) The fuel price per gallon sensitivities provided assume the relationship between Brent crude oil and refined products based on market prices as of October 19, 2018.

Southwest Airlines Co.

737 Delivery Schedule

As of September 30, 2018

The Boeing Company

-800

Firm

Orders

MAX 7

Firm

Orders

MAX 8

Firm

Orders

MAX 8

Options

Additional

 -700s

Additional

MAX 8s

Total

2018

26

19

1

46

(b)

2019

7

20

7

34

2020

35

35

2021

44

44

2022

27

14

41

2023

12

22

23

57

2024

11

30

23

64

2025

40

36

76

2026

19

19

26

30

237

(a)

115

1

7

416

(a) The Company has flexibility to substitute 737 MAX 7 in lieu of 737 MAX 8 aircraft beginning in 2019.

(b) Includes 26 737-800s, 1 737-700, and 10 737 MAX 8s delivered as of September 30, 2018.

 



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