- Third quarter record net income and earnings per diluted share of $659 million and $1.23, respectively
- Third quarter record operating revenues of $5.6 billion
- Operating margin1 of 14.5 percent, and net margin2 of 11.7 percent
- Operating cash flow of $1.1 billion; free cash flow3 of $716 million; returned $596 million to Shareholders through share repurchases and dividends
- Return on invested capital (ROIC)3 pre-tax of 23.7 percent for the 12 months ended September 30, 2019, or 18.6 percent on an after-tax basis
- Third quarter federal tax benefit of $31 million, or $.05 per diluted share
Gary C. Kelly, Chairman of the Board and Chief Executive Officer, stated, "Our third quarter 2019 record financial performance was notable considering an estimated $210 million reduction in operating income due to the continued grounding of the Boeing 737 MAX 8 aircraft (MAX). Notwithstanding this challenge, we generated record third quarter operating and unit revenues; solid margins; strong cash flows and returns to Shareholders; and a healthy profitsharing accrual for our Employees. I am extremely grateful to our People for their unwavering commitment to the highest levels of Customer Service, and applaud them for one of the best third quarter operational performances in our history.
"We are engaged in ongoing discussions with The Boeing Company (Boeing) regarding compensation for damages related to the MAX groundings. The operating income reduction from the MAX groundings is estimated to be $435 million for the nine months ended September 30, 2019, and we expect the damages to continue to grow into 2020. We have not reached a settlement with Boeing, and no estimated settlement amounts have been included in our third quarter 2019 results.
"Boeing stated yesterday they are targeting regulatory approval of MAX return to service in fourth quarter 2019. Upon a rescission of the Federal Aviation Administration (FAA) order to ground the MAX, we continue to estimate it will take us one to two months to comply with applicable FAA directives, including all necessary Pilot training. As such, the MAX has been removed from our flight schedule through February 8, 2020. The FAA will determine the timing of MAX return to service, and we offer no assurances that current estimations and timelines are correct.
"I am proud of the superb job our People are doing to manage the financial and operational impacts of the MAX-related flight schedule adjustments. Third quarter 2019 unit revenue growth was a strong 4.2 percent, year-over-year, which was in line with our expectations. And, we continue to control costs despite significant year-over-year unit cost pressures resulting from the MAX groundings.
"Looking ahead to fourth quarter 2019, our financial outlook remains stable and solid. Thus far, Customer demand remains strong and the revenue environment remains healthy. Based on these trends and current bookings, we are expecting another positive year-over-year unit revenue performance in fourth quarter 2019, despite the suboptimized flight schedule during the holiday time periods, as a result of the extended MAX groundings. While we expect the MAX groundings will put pressure on fourth quarter 2019 unit costs, we remain diligent in our cost control efforts and currently expect fourth quarter 2019 year-over-year unit cost growth to ease from third quarter 2019's year-over-year unit cost growth, excluding fuel and oil expense and profitsharing expense, of 7.6 percent.
"We recently announced that new service between Sacramento and Honolulu, and between Honolulu and Lihue, will begin in November 2019, accelerated from our previous plan to start in January 2020. New flights from Oakland and San Jose to both Lihue and Kona, and new interisland service between Honolulu and Hilo, and between Kona and Kahului, will begin in January 2020. By March 2020, we plan to offer 12 daily departures from California to Hawaii, and 34 daily departures among the Hawaiian Islands. We are very pleased with the strength of Customer demand for Southwest service in Hawaii, and it will continue to be a focus for growth in 2020.
"Our network is performing extremely well, and we look forward to resuming our growth next year once the MAX is returned safely to service. Although our 2019 and 2020 plans have been affected, our long-term financial goals remain unchanged: maintain a strong balance sheet, investment-grade credit ratings, and ample liquidity; generate robust operating and free cash flows; grow earnings, margins, and capital returns; and maintain healthy Shareholder returns."
Revenue Results and Outlook
The Company's third quarter 2019 total operating revenues increased 1.1 percent, year-over-year, to a third quarter record $5.6 billion, despite the negative impacts as a result of the MAX groundings. Third quarter 2019 operating revenue per available seat mile (RASM, or unit revenues) was a record 14.32 cents, and increased 4.2 percent, driven largely by a passenger revenue yield increase of 4.1 percent, and offset slightly by a load factor decrease of 0.4 points, all year-over-year. Third quarter 2019 RASM benefited year-over-year by approximately two points as a result of lower third quarter 2019 available seat miles (ASMs, or capacity) due to the MAX groundings, as well as an approximate one-point tailwind—with one-half point related to the Company's third quarter 2018 suboptimal schedule from the 2017 accelerated retirement of its 737-300 (Classic) fleet, and one-half point related to the revenue effects from the Flight 1380 accident in April 2018. Third quarter 2019 RASM also benefited year-over-year by an approximate one-half point due to revenue management capabilities implemented in 2018.
Currently, passenger booking and revenue trends remain solid, and the Company expects fourth quarter 2019 RASM to be in the range of flat to up 2 percent, compared with fourth quarter 2018. The Company's outlook for fourth quarter 2019 assumes no year-over-year RASM net benefit due to the MAX groundings, unlike second and third quarter 2019. The estimated year-over-year RASM benefit of two to three points driven by lower fourth quarter 2019 capacity from the MAX groundings is expected to be offset by the negative year-over-year RASM effects from the complexity of adjusting the Company's previously published fourth quarter 2019 flight schedule. The Company's adjustments to remove the MAX aircraft from its fourth quarter 2019 flight schedule provide for a more uniform week-to-week schedule over the peak holiday period relative to fourth quarter 2018, which is needed to maintain schedule feasibility and minimize disruption to Customers and the operation. As a result, there is more year-over-year flying in off-peak periods and—due to a fleet deficit—less flying in peak periods than planned, or optimal.
Cost Performance and Outlook
Third quarter 2019 total operating expenses increased 0.9 percent, year-over-year, to $4.8 billion. Total operating expenses per ASM (CASM, or unit costs) increased 4.0 percent, compared with third quarter 2018. Excluding last year's special items3, third quarter 2019 total operating expenses increased 0.9 percent to $4.8 billion, or 3.9 percent on a unit basis, year-over-year.
Third quarter 2019 economic fuel costs3 were $2.07 per gallon and included $.04 per gallon in premium expense with no cash settlements from fuel derivative contracts, compared with $2.25 per gallon in third quarter 2018, which included $.06 per gallon in premium expense and $.10 per gallon in favorable cash settlements from fuel derivative contracts. Third quarter 2019 ASMs per gallon, or fuel efficiency, decreased 0.9 percent, year-over-year, due to the removal of the Company's most fuel-efficient aircraft from its schedule as a result of the MAX groundings. The Company expects fourth quarter 2019 fuel efficiency to decrease in the range of 1 to 2 percent, year-over-year, as a result of the MAX groundings.
Based on the Company's existing fuel derivative contracts and market prices as of October 18, 2019, fourth quarter 2019 economic fuel costs are estimated to be in the range of $2.05 to $2.15 per gallon4, including $.04 per gallon in premium expense with no cash settlements from fuel derivative contracts, compared with $2.25 per gallon in fourth quarter 2018, which included $.06 per gallon in premium expense and $.06 per gallon in favorable cash settlements from fuel derivative contracts. As of October 18, 2019, the fair market value of the Company's fuel derivative contracts for the remainder of 2019 was an asset of approximately $2 million, and the fair market value of the fuel hedge portfolio settling in 2020 and beyond was an asset of approximately $134 million. Additional information regarding the Company's fuel derivative contracts is included in the accompanying tables.
Excluding fuel and oil expense and special items, third quarter 2019 operating expenses increased 4.4 percent, compared with third quarter 2018. Third quarter 2019 profitsharing expense was $144 million, compared with $135 million in third quarter 2018. Excluding fuel and oil expense, special items, and profitsharing expense, third quarter 2019 operating expenses increased 4.3 percent, or 7.6 percent on a unit basis, year-over-year. Approximately six to seven points of this year-over-year unit cost increase was due to the MAX groundings and the resulting lower third quarter 2019 capacity. The year-over-year increase of 7.6 percent in third quarter 2019 CASM, excluding fuel and oil expense, special items, and profitsharing expense, was better than expected primarily due to favorable airport settlements, lower than expected airport rate increases, and continued cost control.
Based on current cost trends, the Company expects fourth quarter 2019 CASM, excluding fuel and oil expense and profitsharing expense, to increase in the 4 to 6 percent range, compared with fourth quarter 2018. Prior to the MAX groundings, the Company expected fourth quarter 2019 CASM, excluding fuel and oil expense and profitsharing expense, to decrease approximately 2 percent, year-over-year. Approximately six points of the expected incremental year-over-year unit cost increase in fourth quarter 2019 are driven by lower fourth quarter 2019 capacity as a result of the MAX groundings, net of two to three points of year-over-year unit cost benefit driven by more year-over-year flying in off-peak periods as a result of fourth quarter 2019 flight schedule adjustments. Additionally, the Company expects approximately one point of year-over-year unit cost increase in fourth quarter 2019 due to the shifting of maintenance and technology expenses from third quarter into fourth quarter 2019. Once the Company publishes its flight schedule, its operating costs are largely fixed. The Company currently has flights for sale through April 13, 2020, with the MAX removed from its flight schedule through February 8, 2020.
Third Quarter Results
Third quarter 2019 net income was a third quarter record $659 million, or a third quarter record $1.23 per diluted share, compared with third quarter 2018 net income of $615 million, or $1.08 per diluted share, and compared with third quarter 2019 First Call consensus estimate of $1.08 per diluted share.
Other expenses in third quarter 2019 decreased by $12 million, year-over-year, primarily due to higher interest income in third quarter 2019 as a result of higher interest rates and a higher cash balance, combined with lower interest expense as a result of less outstanding debt.
The Company's third quarter 2019 effective tax rate was 19.5 percent, lower than previously expected primarily due to a $31 million federal tax benefit attributable to a recent clarification of certain tax laws regarding bonus depreciation. The Company estimates its fourth quarter 2019 effective tax rate to be approximately 23.0 percent.
Liquidity and Capital Deployment
As of September 30, 2019, the Company had approximately $4.0 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $1.0 billion. Net cash provided by operations during third quarter 2019 was $1.1 billion, capital expenditures were $375 million, and free cash flow was $716 million. The Company repaid approximately $70 million in debt and finance lease obligations during third quarter 2019, and expects to repay approximately $346 million in debt and finance lease obligations during fourth quarter 2019.
During third quarter 2019, the Company returned $596 million to its Shareholders through the repurchase of $500 million of common stock and the payment of $96 million in dividends. The Company repurchased 7.5 million shares of common stock pursuant to a $500 million accelerated share repurchase (ASR) program launched during third quarter 2019, representing an estimated 75 percent of the shares expected to be repurchased under that ASR program. The third quarter ASR program is expected to terminate no later than October 29, 2019. In addition, the Company received an additional 2.0 million shares of common stock in final settlement of its $400 million ASR program launched during second quarter 2019 and completed in August 2019. The Company's third quarter 2019 ASR program completed the remaining $400 million of its previous $2.0 billion share repurchase program that had been authorized by its Board of Directors in May 2018, and initiated $100 million of its $2.0 billion share repurchase program authorized by its Board of Directors in May 2019. The Company has $1.9 billion remaining under its current authorization.
For the nine months ended September 30, 2019, net cash provided by operations was approximately $3.2 billion. Capital expenditures were approximately $766 million, and free cash flow was approximately $2.4 billion. This enabled the Company to return approximately $1.8 billion to Shareholders through the repurchase of $1.45 billion in common stock and the payment of $372 million in dividends.
Due to the delay in MAX deliveries, and based on Boeing's targeted regulatory approval of MAX return to service in fourth quarter 2019, the Company now estimates its annual 2019 capital expenditures to be in the range of $1.1 billion to $1.2 billion, compared with its previous guidance in the range of $1.2 billion to $1.3 billion.
Fleet and Capacity
The Company ended third quarter 2019 with 752 aircraft in its fleet. All 34 of the Company's MAX aircraft were grounded as of March 13, 2019, to comply with the FAA emergency order issued for all U.S. airlines to ground all MAX aircraft. Further, Boeing is not delivering new MAX aircraft and, therefore, not meeting its contractual delivery schedule. Based on Boeing's targeted regulatory approval of MAX return to service in fourth quarter 2019, the Company currently expects to receive seven MAX aircraft deliveries during fourth quarter 2019, with the remaining 34 MAX aircraft originally scheduled for delivery in 2019 shifting into 2020. As previously disclosed, as a result of the MAX groundings, the Company deferred the retirement of seven of its owned 737-700 aircraft to future years. The Company retired one 737-700 aircraft during third quarter 2019, and plans to retire an additional ten 737-700 aircraft during fourth quarter 2019. Additional information regarding the Company's aircraft delivery schedule is included in the accompanying tables.
The Company's third quarter 2019 ASMs decreased 2.9 percent, year-over-year. For fourth quarter 2019, the Company expects ASMs to decrease in the range of 0.5 to 1 percent, year-over-year. The Company now expects annual 2019 ASMs to decrease approximately 1.5 percent, within its previous guidance range of a decrease of 1 to 2 percent, year-over-year.
Regulatory approval of MAX return to service is subject to Boeing's ongoing work with the FAA, who will determine the timing of MAX return to service. Any changes to current estimations could result in additional flight schedule adjustments and reductions beyond February 8, 2020, further delays in aircraft deliveries, and additional financial damages. The Company continues to plan for multiple MAX return to service scenarios.
Awards and Recognitions
- Ranked #3 on the list of Top-Rated Workplaces in 2019 by Indeed
- Ranked among the Best Airline Rewards Programs by U.S. News & World Report
- Named a Best Employer for Women 2019 by Forbes
- Among Forbes' list of America's Best Employers for New Graduates 2019
- Named a Top 100 Internship Program by WayUp
The Company will discuss its third quarter 2019 results on a conference call at 12:30 p.m. Eastern Time today. To listen to a live broadcast of the conference call, please go to http://www.southwestairlinesinvestorrelations.com.
1Operating margin is calculated as operating income divided by operating revenues.
2Net margin is calculated as net income divided by operating revenues.
3See Note Regarding Use of Non-GAAP Financial Measures for additional information on free cash flow, ROIC, and special items. In addition, information regarding special items, ROIC, and economic results is included in the accompanying reconciliation tables.
4Based on the Company's existing fuel derivative contracts and market prices as of October 18, 2019, fourth quarter 2019 fuel costs per gallon on a GAAP and economic basis are both estimated to be in the $2.05 to $2.15 range. See Note Regarding Use of Non-GAAP Financial Measures.