Southwest Airlines Reports Fourth Quarter And Annual Profit; 46th Consecutive Year Of Profitability

Southwest Airlines Co. (NYSE: LUV) (the "Company") today reported its fourth quarter and annual 2018 results:

Fourth quarter net income and earnings per diluted share of $654 million and $1.17, respectively, compared with fourth quarter 2017 record net income and record earnings per diluted share of $1.7 billion and $2.94, respectively
Excluding special items1, record fourth quarter net income and record earnings per diluted share of $654 million and $1.17, respectively
Annual net income and earnings per diluted share of $2.5 billion and $4.29, respectively, compared with annual 2017 record net income and record earnings per diluted share of $3.4 billion and $5.57, respectively
Excluding special items, record annual net income and record earnings per diluted share of $2.4 billion and $4.24, respectively
Annual operating income of $3.2 billion, resulting in an operating margin2 of 14.6 percent, or 14.4 percent, excluding special items3
Annual record operating cash flow of $4.9 billion, and record free cash flow1 of $3.1 billion
Returned approximately $2.3 billion to Shareholders in 2018 through a combination of $2.0 billion in share repurchases and $332 million in dividends
Annual return on invested capital (ROIC)1 pre-tax of 23.6 percent, or 18.4 percent on an after-tax basis
Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, "2018 was an incredible year of resilience and achievement. Our Employees persevered through significant challenges, delivering our 46th consecutive year of profitability with strong margins, record cash flows, and $544 million in profitsharing. We finished the year strong, with record fourth quarter net income and earnings per diluted share, excluding special items. This was driven by strong yields, record revenues, and a solid cost performance. Earlier this week, Southwest was again named to FORTUNE's 2019 list of World's Most Admired Companies. I am especially grateful for our People and their unwavering devotion to Southwest Airlines. My thanks and my congratulations to them on these outstanding results despite a very challenging environment.

"We celebrated notable milestones during 2018, including approximately $205 million of pre-tax profits from revenue management enhancements implemented in 2018. These enhancements are expected to drive year-over-year revenue growth in 2019, particularly during the first half of the year. Our Rapid Rewards program revenues continued to grow, as did revenues from our ancillary products. Tax savings from the 2017 tax reform legislation contributed hundreds of millions toward our earnings and record operating cash flow in 2018, and we continued to invest in our People and our Company, while providing $2.3 billion in returns to our Shareholders during 2018.

"Our financial goals for 2019 are to grow profits and earnings per share, expand margins, improve returns on invested capital, and maintain an investment-grade balance sheet. I am pleased with our revenue momentum, particularly with our unit revenue growth expectations for the first half of the year. Our 2019 non-fuel cost outlook has improved, compared with our earlier projections. We have a priority to improve our cost performance and maintain solid cost control beyond 2019. As we have historically, our goal beyond 2019 is to keep annual unit cost growth, excluding fuel and oil expense and profitsharing expense, below two percent.

"Based on current revenue trends, our cost outlook, and energy futures, we are currently expecting a strong first quarter 2019 financial performance. We are well-positioned to generate stellar annual after-tax returns on capital in 2019, barring any unforeseen events. Our outlook is bright thanks to the never-ending commitment of our superb People to deliver low fares and great service.

"Hawaii remains our expansion focus for 2019, and we are in the final phase of obtaining authorization from the Federal Aviation Administration (FAA) for Extended Operations (ETOPS) to operate between California and the Hawaiian Islands. Our remaining work is currently suspended until the government reopens and the FAA is allowed to resume normal certification activities. We are well-prepared to perform the next steps in the ETOPS application process. We are anxious for the government to resolve this shutdown so we can bring low fares and a boost to Hawaii's travel and tourism industry.

"We continue to expect 2019 available seat miles (ASMs, or capacity) to increase no more than five percent, year-over-year. As we continue to optimize our flight schedules, we announce today our decision to cease operations at Benito Juárez Mexico City International Airport on March 30, 2019, and reallocate these resources to better opportunities within our existing route network.

"This year began with an immeasurable loss to the Southwest Family. We mourn the passing of our founder, friend, and hero, Herb Kelleher. He instilled in us the esprit de corps of our Company, and he fought for Southwest for more than 50 years, transforming our industry and ultimately providing the nation with the freedom to fly. Herb is well-known around the world as a legendary businessman, but his legacy is People, including his beloved Southwest Family. We will continue to honor Herb by protecting, preserving, nurturing, and growing his beloved Southwest Airlines."

Notable 2018 accomplishments for the Company include:

Achieved 46th consecutive year of profitability
Employees earned $544 million in profitsharing
Revised Boeing delivery schedule to support continued fleet modernization
Announced intent to begin service to four Hawaiian airports in 2019: Daniel K. Inouye International Airport in Honolulu, Kahului Airport on Maui, Lihue Airport on Kauai, and Ellison Onizuka Kona International Airport at Keahole; from Oakland Metropolitan Airport, San Diego International Airport, Mineta San Jose International Airport, and Sacramento International Airport
Entered into an agreement with Alaska Airlines to lease 12 slots at New York's LaGuardia Airport and 8 slots at Washington Reagan National Airport
Began providing cargo service to select international destinations
Launched international service from Indianapolis International Airport, Sacramento International Airport, Mineta San Jose International Airport, Columbus International Airport, New Orleans International Airport, Pittsburgh International Airport, and Raleigh-Durham International Airport, ending the year with 23 active gateway airports (including seasonal) from the 48 contiguous states
Received numerous awards and recognitions, including:
Named to FORTUNE's list of World's Most Admired Companies. Southwest was ranked as the No. 8 Most Admired Company, and was the only commercial airline to make the Top 10.
Ranked No. 1 in the U.S. Department of Transportation Customer Satisfaction ranking for 2017
Named Domestic Carrier of the Year by the Airforwarders Association for the 9th consecutive year
Ranked highest Low-Cost Carrier for customer satisfaction for the 2nd year in a row in the J.D. Power 2018 North America Satisfaction Study™
Named one of Corporate Responsibility Magazine's 100 Best Corporate Citizens 2018
Ranked among the Best Airline Rewards Programs by U.S. News & World Report
Named to Glassdoor's Best Places to Work list for the 10th consecutive year
Named Program of the Year for Rapid Rewards® Program and recognized for providing the Best Loyalty Credit Card; the Best Airline Redemption Ability; the Best Elite Program; the Best Promotion; and for the 6th consecutive year, the Best Customer Service by the Freddie Awards
Designated a 2019 Military Friendly Company by Victory Media
Recognized as a Best Employer in Forbes' 2018 list
Revenue Results and Outlook
The Company's fourth quarter 2018 total operating revenues increased 8.5 percent, year-over-year, to a fourth quarter record $5.7 billion. Fourth quarter 2018 operating revenue per ASM (RASM, or unit revenues) increased 1.8 percent, year-over-year, driven largely by a passenger revenue yield increase of 3.7 percent, year-over-year, offset by a load factor decline of 1.5 points, year-over-year, to 83.5 percent. The Company experienced stable passenger demand and strength in passenger yields, including close-in yields, throughout fourth quarter 2018.

Passenger demand is healthy across the booking curve, and current yield trends, including close-in bookings and corporate travel, remain strong. Thus far in January, the negative revenue impact from the ongoing government shutdown is estimated to be $10 million to $15 million. Based on these trends, and assuming no further significant impact on bookings from the ongoing government shutdown, the Company currently estimates first quarter 2019 RASM to increase in the four to five percent range, compared with first quarter 2018. The Company's outlook for first quarter 2019 RASM includes an estimated 1.5 point year-over-year benefit from its revenue management enhancements implemented in 2018, as well as an estimated 1.5 point year-over-year tailwind due to several items: its first quarter 2018 sub-optimal schedule from the accelerated retirement of its Boeing 737-300 (Classic) fleet; the prior year competitive fare environment; and the March 2018 Spring Break holiday shift impact. These expected year-over-year benefits to first quarter 2019 RASM are offset slightly by an estimated $40 million negative revenue impact in first quarter 2019 due to the timing shift of Easter to second quarter 2019.

Annual 2018 total operating revenues increased 3.9 percent, year-over-year, to a record $22.0 billion, primarily due to the successful deployment of several revenue management enhancements enabled by the Company's new reservation system, an improved fare environment in second half 2018, and strong passenger demand for low fares.

Cost Performance and Outlook
Fourth quarter 2018 total operating expenses increased 8.1 percent, year-over-year, to $4.9 billion. Total operating expenses per ASM (CASM, or unit costs) increased 1.5 percent, as compared with fourth quarter 2017, primarily due to higher jet fuel prices in 2018. Excluding special items in both periods, fourth quarter 2018 total operating expenses increased 7.5 percent to $4.9 billion, or 0.9 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 twelve months ended December 31, 2017, has been recast under the new standard to be comparable with current period results.

Fourth quarter 2018 economic fuel costs1 were $2.25 per gallon and included $.06 per gallon in premium expense and $.06 per gallon in favorable cash settlements from fuel derivative contracts, compared with $2.16 per gallon in fourth quarter 2017, which included $.07 per gallon in premium expense and $.19 per gallon in unfavorable cash settlements from fuel derivative contracts. Annual 2018 economic fuel costs of $2.20 per gallon increased 6.8 percent, as compared with 2017. Annual 2018 ASMs per gallon, or fuel efficiency, improved 1.5 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. The Company estimates an improvement in 2019 fuel efficiency in the one to two percent range, year-over-year, due to continued fleet modernization efforts.

Based on the Company's existing fuel derivative contracts and market prices as of January 18, 2019, first quarter 2019 economic fuel costs are estimated to be in the range of $2.00 to $2.05 per gallon4, including $.06 per gallon in premium expense and an estimated $.02 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. In addition, the Company expects annual 2019 economic fuel costs to be in the range of $2.00 to $2.10 per gallon4, including $.04 per gallon in premium expense and an estimated $.01 per gallon in favorable cash settlements from fuel derivative contracts. As of January 18, 2019, the fair market value of the Company's fuel derivative contracts settling in first quarter 2019 was an asset of approximately $12 million, and an asset of approximately $73 million for those settling over the remainder of 2019. In addition, the fair market value of the fuel hedge portfolio settling in 2020 and beyond was an asset of approximately $145 million. 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, fourth quarter 2018 operating expenses increased 6.7 percent, as compared with fourth quarter 2017. Fourth quarter 2018 profitsharing expense was $141 million, as compared with $115 million in fourth quarter 2017. Excluding fuel and oil expense, profitsharing expense, and special items, fourth quarter 2018 operating expenses increased 6.2 percent, and decreased 0.2 percent on a unit basis, both year-over-year.

Based on current cost trends, the Company estimates first quarter 2019 unit costs, excluding fuel and oil expense and profitsharing expense, to increase approximately six percent, compared with first quarter 2018's 8.65 cents, which excludes fuel and oil expense, profitsharing expense, and special items. The year-over-year increase is driven largely by the Company's underutilization of its fleet in first half 2019 due to the delay in its impending service to Hawaii, and the resulting one-time start-up costs; higher airport costs; higher depreciation and ownership costs; and the timing of maintenance events and technology investments.

Annual 2018 total operating expenses increased 5.8 percent to $18.8 billion, and increased 1.8 percent on a unit basis, year-over-year. Excluding fuel and oil expense, profitsharing expense, and special items, annual 2018 total operating expenses increased 4.6 percent, and increased 0.7 percent on a unit basis, both year-over-year.

Based on current cost trends, the Company estimates annual 2019 unit costs, excluding fuel and oil expense and profitsharing expense, to increase in the range of 3 to 3.5 percent, compared with annual 2018's 8.53 cents, which excludes fuel and oil expense, profitsharing expense, and special items. The Company expects year-over-year inflation in 2019 unit costs, excluding fuel and oil expense and profitsharing expense, due primarily to approximately 1.5 points in salaries, wages, and benefits from staffing needs, wage rate increases, and health care inflation; approximately one point from higher airport costs; and an approximate one-half point from maintenance costs. The Company expects its 2019 year-over-year unit cost inflation, excluding fuel and oil expense and profitsharing expense, to be weighted in first half 2019, and expects its second half 2019 unit costs, excluding fuel and oil expense and profitsharing expense, to be roughly flat, year-over-year.

Fourth Quarter and Annual Results
Fourth quarter 2018 net income was $654 million, or $1.17 per diluted share, compared with a quarterly record fourth quarter 2017 net income of $1.7 billion, or a quarterly record $2.94 per diluted share. Fourth quarter 2017 net income was positively impacted by a $1.3 billion tax benefit due to federal tax reform legislation, which was recorded as a result of the difference in tax rates in effect when income tax expense was accrued, as compared with the rates expected to be in effect when the income taxes will be paid. Excluding special items, fourth quarter 2018 net income was a fourth quarter record $654 million, or a fourth quarter record $1.17 per diluted share, compared with fourth quarter 2017 net income of $458 million, or $0.77 per diluted share, and compared with the fourth quarter 2018 First Call consensus estimate of $1.07 per diluted share.

Annual 2018 net income was $2.5 billion, or $4.29 per diluted share, compared with a record annual 2017 net income of $3.4 billion, or a record $5.57 per diluted share. Excluding special items, annual 2018 net income was a record $2.4 billion, or a record $4.24 per diluted share, compared with $2.1 billion, or $3.51 per diluted share in 2017. The Company's annual 2018 effective tax rate was 22.1 percent, which was lower than the Company's expectations due primarily to the realization of tax credits during fourth quarter 2018. The Company continues to estimate its annual 2019 effective tax rate to be approximately 23.5 percent.

Liquidity and Capital Deployment
As of December 31, 2018, the Company had approximately $3.7 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1.0 billion. Net cash provided by operations in 2018 was a record $4.9 billion. Capital expenditures in 2018, including net proceeds from assets constructed for others, were $1.8 billion, and free cash flow was a record $3.1 billion. The Company currently estimates its 2019 capital expenditures will be in the $1.9 billion to $2 billion range. The Company repaid $342 million in debt and capital lease obligations during 2018, and expects to repay approximately $590 million in debt and capital lease obligations during 2019.

In 2018, the Company returned $2.3 billion to its Shareholders through the repurchase of 36.5 million shares of common stock for $2.0 billion and the payment of $332 million in dividends. The Company repurchased 9.8 million shares of common stock pursuant to a $500 million accelerated share repurchase program launched and completed during fourth quarter 2018. The Company has $1.35 billion remaining under its current share repurchase authorization.

Fleet and Capacity
The Company ended 2018 with 750 aircraft in its fleet. This reflects the delivery of 26 new 737-800s, 18 new 737 MAX 8s, and 1 pre-owned 737-700 during the year. The Company currently expects to add approximately 25 aircraft in 2019 and end the year with approximately 775 in its fleet based on the current aircraft delivery schedule and net of expected 737-700 retirements. Additional information regarding the Company's aircraft delivery schedule is included in the accompanying tables.

The Company increased its available seat miles by 3.9 percent in 2018, as compared with 2017. The Company expects its 2019 year-over-year capacity to increase no more than five percent. First quarter 2019 year-over-year capacity growth is expected to be in the 3.5 to 4 percent range.