Southwest Airlines Co. (NYSE: LUV) (the "Company") today reported its fourth quarter and annual 2017 results:
Record fourth quarter net income and earnings per diluted share of $1.9 billion and $3.18, respectively
Excluding special items1, fourth quarter net income of $459 million, or $.77 per diluted share
Record annual net income and earnings per diluted share of $3.5 billion and $5.79, respectively
Excluding special items1, annual net income of $2.1 billion, or $3.50 per diluted share
Annual operating income of $3.5 billion, resulting in an operating margin2 of 16.6 percent, or 16.3 percent, excluding special items3
Annual operating cash flow of $3.9 billion, and annual free cash flow1 of $1.8 billion
Returned approximately $1.9 billion to Shareholders through a combination of $274 million in dividends and $1.6 billion in share repurchases
Annual return on invested capital (ROIC)1 of 25.9 percent
Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, "Our strong fourth quarter earnings performance capped another year of extraordinary achievements, including 45 straight years of profitability. Last week, for the 24th consecutive year, Southwest was named to FORTUNE's 2018 list of World's Most Admired Companies. I want to thank our People for their exceptional results and congratulate them on this outstanding honor.
"Our strong profits, cash flow, and financial position enabled us to deploy capital wisely and sustain high returns on invested capital. We made significant progress modernizing our fleet, investing in technology and facilities, and returning value in excess of our free cash flow1 to Shareholders. We celebrated several notable milestones during 2017, including the implementation of our new reservation system; the retirement of our Boeing 737-300 Classic fleet; the launch of the new Boeing 737 MAX 8; the launch of service to Cincinnati, Grand Cayman, and Turks & Caicos; and the announcement of our commitment to serve Hawaii. Our Employees delivered another outstanding year of operational Reliability and Hospitality, including the best baggage delivery rates in our history. These achievements are significant, especially considering the backdrop of unprecedented natural disasters and the competitive industry environment. As ever, the Warrior Spirits and fortitude of our People resulted in an outstanding overall 2017 performance, which earned them $543 million in profitsharing during 2017.
"We applaud Congress and the President for the tax reform legislation passed on December 22, 2017. We celebrated the passage of tax reform with our Employees through a $1,000 per person cash bonus paid on January 8, 2018. We also announced an incremental donation to charitable causes and an additional investment in our fleet to support future growth opportunities and fleet modernization. The tax reform is very meaningful to Southwest Airlines, reducing our 2017 deferred tax liability by $1.4 billion. Based on our current outlook, the reduction in the statutory federal rate will result in hundreds of millions in tax savings, which will significantly boost our earnings in 2018.
"As we look to realize ongoing benefits of modernizing our fleet and optimizing our route network, we are enthusiastic about our ability to leverage our strengths and scale to meet Customer demand. We are pleased with the progress made thus far to obtain authorization from the Federal Aviation Administration for Extended Operations (ETOPS) to operate between the mainland and the Hawaiian Islands later this year. In addition, as a complement to our more than forty flights a day to 15 cities nonstop from Seattle-Tacoma International Airport, today we announce our commitment to launch up to five daily flights4 at a new commercial aircraft facility at Paine Field in Everett, Washington, scheduled to be completed later this year.
"We begin 2018 focused on our goal to expand margins and profits, excluding special items1. Our balance sheet and liquidity remain strong, with manageable debt service and capital spending this year. Our 2018 growth plans effectively replace Classics retired last year and further strengthen our robust route network. Based on the current outlook and our commercial initiatives and objectives, our goal remains to achieve positive unit revenue growth in 2018, year-over-year. We continue to expect our new reservation system to produce incremental improvements in pre-tax results of approximately $200 million in 2018, primarily from enhanced revenue management capabilities. We remain focused on improving our productivity and reliability and reducing our year-over-year operating costs per available seat mile, excluding fuel and oil expense, profitsharing expense, and special items1, in 2018. Overall, our strong financial performance, solid outlook, healthy balance sheet, and significantly lower federal income taxes, provide the cash flow to continue to reward our Employees, keep our costs and fares low for our Customers, reinvest in our business, return value to our Shareholders, and support our communities."
Notable 2017 accomplishments for the Company include:
Achieved 45th consecutive year of profitability
Employees earned $543 million in profitsharing
Strengthened its investment-grade credit rating with an upgrade to A3 with Moody's Investors Service and an upgrade to BBB+ with Standard & Poor's
Deployed the largest technology initiative in its history with the achievement of a new reservation system
Completed the early retirement of the remaining Boeing 737-300 Classic aircraft
Introduced the Boeing 737 MAX 8 into its fleet
Revised its Boeing delivery schedule to support future growth opportunities and continued fleet modernization
Opened the newly revitalized and enhanced Terminal 1 at Fort Lauderdale-Hollywood International Airport to support expanded international flying from South Florida
Consolidated its Ohio operations and launched service at Cincinnati/Northern Kentucky International Airport
Launched service to Grand Cayman and Turks & Caicos Islands, ending the year with service to 14 international destinations in 10 countries
Launched international service from Oakland International Airport, San Diego International Airport, Nashville International Airport, and St. Louis Lambert International Airport, ending the year with 16 international gateway airports from the 48 contiguous states
Announced plans to begin selling tickets in 2018 for service to Hawaii
Ratified a collective bargaining agreement with the Facilities Maintenance Technicians
Received numerous awards and recognitions, including being ranked #1 in the U.S. Department of Transportation Customer Satisfaction ranking for 2016; named Domestic Carrier of the Year by the Airforwarders Association for the 8th consecutive year; ranked the highest Low-Cost Carrier in the J.D. Power 2017 North America Airline Satisfaction Study; named one of Corporate Responsibility's 100 Best Corporate Citizens 2017; recognized by Express Delivery and Logistics Association with the 2016 Express Cargo Standard of Excellence award; received Readers' Pick for Best Frequent Flyer Program (U.S.) for its Rapid Rewards® Program by SmarterTravel; ranked among the Best Airline Rewards Programs by U.S. News & World Report; named one of Glassdoor's Best Places to Work for the 9th consecutive year; named Program of the Year for its Rapid Rewards Program and recognized for providing the Best Loyalty Credit Card, the Best Airline Redemption Ability, and for the 5th consecutive year, the Best Customer Service by the Freddie Awards; and designated as a 2017 Most Valuable Employer for military by Recruit Military, as well as a Best Employer in Forbes' 2017 list
Revenue Results and Outlook
The Company's fourth quarter 2017 total operating revenues were a fourth quarter record $5.3 billion, driven largely by record fourth quarter passenger revenues of $4.7 billion. As compared with fourth quarter 2016, total operating revenues increased 3.9 percent on a 2.0 percent increase in available seat miles, resulting in a 1.9 percent increase in operating unit revenues (RASM). Strong passenger demand resulted in a fourth quarter record 85.0 percent load factor, while fourth quarter passenger revenue yield decreased 0.1 percent, year-over-year. Passenger bookings and revenues for first quarter 2018, thus far, are solid. Based on these trends and the current outlook, the Company expects first quarter 2018 RASM to increase in the one to two percent range, as compared with first quarter 2017.
Beginning January 1, 2018, the Company expects to adopt Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, and plans to utilize the full retrospective method of adoption allowed by the standard. The Company is in the process of completing its analysis of information necessary to recast prior period results, in order to provide comparative results in all periods presented. As such, the Company's current forward-looking guidance for 2018 revenue trends excludes any impact associated with the adoption of ASU No. 2014-09.
Annual 2017 total operating revenues increased 3.7 percent, year-over-year, to a record $21.2 billion due to strong passenger demand for low fares, resulting in a 0.1 percent increase in RASM.
Cost Performance and Outlook
Fourth quarter 2017 total operating expenses increased 6.4 percent to $4.5 billion, and increased 4.3 percent on a unit basis, as compared with fourth quarter 2016. Excluding special items1 in both periods, which primarily related to the Company's fuel hedge derivative contracts, fourth quarter 2017 total operating expenses increased 5.1 percent to $4.5 billion, and increased 3.0 percent on a unit basis, year-over-year.
Fourth quarter 2017 economic fuel costs1 were $2.09 per gallon, including $.19 per gallon in unfavorable cash settlements from fuel derivative contracts, compared with $2.07 per gallon in fourth quarter 2016, including $.50 per gallon in unfavorable cash settlements from fuel derivative contracts. Annual 2017 economic fuel costs1 of $2.00 per gallon increased 4.2 percent, as compared with 2016.
Beginning January 1, 2018, in accordance with the Company's planned early adoption of ASU No. 2017-12, Targeting Improvements to Accounting for Hedging Activities, the Company will report fuel hedging premium expense within Fuel and oil expense rather than within Other (gains) and losses, net, on the Income Statement. Based on the Company's existing fuel derivative contracts and market prices as of January 19, 2018, first quarter 2018 economic fuel costs1 are estimated to be in the $2.10 to $2.15 per gallon range5. This compares with both first quarter 2017's economic fuel cost1 of $2.03 per gallon, which will be recast from $1.96 per gallon, as reported, and fourth quarter 2017's economic fuel cost1 of $2.16 per gallon, which will be recast from $2.09 per gallon, as reported. Fuel hedging premium expense of approximately $34 million, or $.07 per gallon, is included in the first quarter 2018 estimated guidance range and also in the recast per-gallon prices for first and fourth quarters, 2017.
The Company's annual 2018 economic fuel costs1 are currently estimated to be in the $2.10 to $2.15 per gallon range5, which is an approximate two percent increase from 2017's annual economic fuel costs1 per gallon, including approximately $135 million, or $.06 per gallon, of fuel hedging premium expense in both years. The Company estimates an improvement in 2018 available seat miles per gallon, or fuel efficiency, in the two to three percent range, year-over-year, driven primarily by the retirement of the Boeing 737-300 Classic aircraft and the addition of the more fuel-efficient Boeing 737 MAX 8 aircraft.
As of January 19, 2018, the fair market value of the Company's fuel derivative contracts settling in first quarter 2018 was a net asset of approximately $31 million, and a net asset of approximately $102 million for those settling over the remainder of 2018. In addition, the fair market value of the hedge portfolio settling in 2019 and beyond was a net asset of approximately $169 million. Additional information regarding the Company's fuel derivative contracts is included in the accompanying tables.
Excluding fuel and oil expense and special items1 in both periods, fourth quarter 2017 operating expenses increased 6.2 percent, as compared with fourth quarter 2016. Fourth quarter 2017 profitsharing expense was $115 million, compared with $123 million in fourth quarter 2016. Excluding fuel and oil expense, profitsharing expense, and special items1, fourth quarter 2017 operating expenses increased 6.7 percent, and increased 4.6 percent on a unit basis, both year-over-year. These increases were driven primarily by increases in salaries, wages, and benefits including the tax reform Employee bonus of approximately $70 million, a litigation settlement, a shift in advertising spend from third quarter 2017, incremental costs associated with technology investments including ETOPS authorization in preparation for Hawaii, and an incremental charitable contribution following the passage of tax reform. Based on current cost trends, first quarter 2018 unit costs, excluding fuel and oil expense, profitsharing expense, and special items1, are estimated to increase in the range of 0.5 to 1.5 percent6, year-over-year.
Annual 2017 total operating expenses increased 5.9 percent to $17.7 billion, and increased 2.3 percent on a unit basis, year-over-year. Excluding fuel and oil expense, profitsharing expense, and special items1, annual 2017 total operating expenses increased 8.7 percent, and increased 4.9 percent on a unit basis, both year-over-year, primarily due to increases in salaries, wages, and benefits, and airport landing fees and rentals. Based on current cost trends, annual 2018 unit costs, excluding fuel and oil expense, profitsharing expense, and special items1, are estimated to be in the range of flat to down one percent6, year-over-year.
Fourth Quarter and Annual Results
Fourth quarter 2017 operating income was $773 million, compared with $846 million in fourth quarter 2016. Excluding special items1, fourth quarter 2017 operating income was $746 million, compared with $768 million in fourth quarter 2016.
Other expenses in fourth quarter 2017 were $36 million, compared with $37 million in fourth quarter 2016, which included other losses recognized of $28 million and $26 million, respectively. In both periods, these losses included ineffectiveness and unrealized mark-to-market amounts associated with a portion of the Company's fuel hedge portfolio, which are treated as special items. Excluding these special items1, fourth quarter 2017 had $31 million in other losses, compared with $43 million in fourth quarter 2016, primarily attributable to fuel hedging premium expenses associated with the Company's fuel derivative contracts. Net interest expense in fourth quarter 2017 was $8 million, compared with $11 million in fourth quarter 2016.
Fourth quarter 2017 net income was a quarterly record $1.9 billion, or a quarterly record $3.18 per diluted share, compared with fourth quarter 2016 net income of $522 million, or $.84 per diluted share. Fourth quarter 2017 net income was positively impacted by a $1.4 billion tax benefit due to 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. This non-cash tax benefit effectively reduces the Company's deferred tax liability on its Balance Sheet as of December 31, 2017. Excluding this and other special items1, fourth quarter 2017 net income was $459 million, or $.77 per diluted share, compared with fourth quarter 2016 net income of $463 million, or $.75 per diluted share, and the First Call fourth quarter 2017 consensus estimate of $.76 per diluted share.
Annual 2017 operating income was $3.5 billion, compared with $3.8 billion in 2016. Excluding special items1, annual 2017 operating income was $3.5 billion, compared with $4.0 billion in 2016. Annual 2017 net income was a record $3.5 billion, or a record $5.79 per diluted share, compared with annual 2016 net income of $2.2 billion, or $3.55 per diluted share. Excluding special items1, annual 2017 net income was $2.1 billion, or $3.50 per diluted share, compared with $2.4 billion, or $3.75 per diluted share in 2016. The Company's annual 2017 effective tax rate was (7.3) percent. Excluding the impact of the fourth quarter 2017 $1.4 billion tax benefit due to tax reform legislation, and other special items1, annual 2017 effective tax rate was approximately 36 percent. For full year 2018, the Company estimates its effective tax rate to be in the 23 to 23.5 percent range, as a result of a lower corporate tax rate, and including the estimated impact of state taxes.
Liquidity and Capital Deployment
As of December 31, 2017, the Company had approximately $3.3 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1 billion. For 2017, net cash provided by operations was $3.9 billion, and capital expenditures were $2.1 billion, resulting in free cash flow1 of $1.8 billion. Annual 2017 capital expenditures were lower than expected primarily due to approximately $115 million of capital investments that shifted from 2017 into 2018. The Company currently estimates its 2018 capital expenditures will be approximately $1.9 billion. The Company repaid $592 million in debt and capital lease obligations during 2017, and is currently scheduled to repay approximately $337 million in debt and capital lease obligations during 2018. During fourth quarter 2017, the Company issued $300 million of unsecured notes due in 2022 and $300 million of unsecured notes due in 2027.
In 2017, the Company returned approximately $1.9 billion to its Shareholders through the payment of $274 million in dividends and the repurchase of approximately 26.7 million shares of common stock for $1.6 billion. During fourth quarter 2017, the Company returned $350 million to its Shareholders through the repurchase of common stock. The Company repurchased $250 million in common stock pursuant to an Accelerated Share Repurchase (ASR) program launched during fourth quarter 2017 and received approximately 3.32 million shares, representing an estimated 75 percent of the shares expected to be repurchased under that ASR program. Additionally, the Company repurchased approximately 1.63 million shares during fourth quarter 2017 through $100 million in open market transactions. During fourth quarter 2017, the Company also received approximately 1.21 million shares, which remained pursuant to a $300 million third quarter 2017 ASR program. The Company has $1.35 billion remaining under its May 2017 share repurchase authorization.
Fleet and Capacity
The Company ended 2017 with 706 aircraft in its fleet. This reflects the delivery of 39 new Boeing 737-800 aircraft, 13 new Boeing 737 MAX 8 aircraft, and 18 pre-owned Boeing 737-700 aircraft, as well as the retirement of 87 Boeing 737-300 Classic aircraft during the year. In December 2017, the Company revised its future firm order delivery schedule with Boeing to support future growth opportunities and fleet modernization, at favorable economics. The Company exercised 40 737 MAX 8 options for 15 firm orders in 2019 and 25 firm orders in 2020. The Company deferred 23 737 MAX 7 firm orders from 2019 through 2021 to 12 firm orders in 2023 and 11 firm orders in 2024. The Company also accelerated 23 737 MAX 8 firm orders from 2023 to 2024 to an additional 21 firm orders in 2021 and 2 firm orders in 2022. For 2018, the Company continues to expect to end the year with 750 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 increased its available seat miles by 3.6 percent in 2017, as compared with 2016. The Company expects its 2018 available seat mile year-over-year growth to be in the low five percent range, with first half 2018 year-over-year growth in the low three percent range and second half 2018 year-over-year growth in the low seven percent range. The second half 2018 year-over-year growth rate is significantly impacted by the 2017 retirement of Boeing 737-300 Classic aircraft and the approximately 5,000 flight cancellations due to natural disasters in third quarter 2017.