Southwest Airlines Reports Record Net Income of $273 Million

Southwest Airlines

Southwest Airlines today reported its second quarter 2012 results. Second quarter 2012 net income was $228 million, or $.30 per diluted share, which included $45 million (net) of unfavorable special items. This compared to net income of $161 million, or $.21 per diluted share, in second quarter 2011, which included favorable special items totaling $40 million (net).

Excluding special items, second quarter 2012 net income was a record $273 million, or $.36 per diluted share, compared to $121 million, or $.15 per diluted share, in second quarter 2011. This compared favorably to Thomson’s First Call mean estimate of $.33 per diluted share. Operating income for second quarter 2012 was $460 million, compared to $207 million in second quarter 2011.

Excluding special items, operating income was a record $485 million for second quarter 2012, compared to $276 million for the same period last year. Additional information regarding special items is included in this release and in the accompanying reconciliation tables.

Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, “We are very pleased to report second quarter net income, excluding special items, that more than doubled second quarter last year. Record revenues driven by steady growth were sufficient to overcome high jet fuel prices and produce a record operating income of $485 million, and a record net income of $273 million, both excluding special items. These results would not have been possible without the successful implementation of our strategic initiatives by our People. They have done, and continue to do, a magnificent job.

“We continue to make great progress integrating AirTran into Southwest. We received approval by the Federal Aviation Administration for our Single Operating Certificate in March 2012. Since then, we’ve converted five AirTran aircraft to the Southwest paint and interior configuration, and have begun transitioning AirTran airport facilities to Southwest, with Seattle and Des Moines scheduled to be completed this quarter. The majority of our unions have reached agreements regarding seniority integration, and we are making progress with the remaining agreements. We produced approximately $80 million in net, pre-tax synergies in first half 2012, and we continue to target net, pre-tax synergies of $400 million in 2013 (excluding acquisition and integration expenses).

“We have significant efforts underway to strategically optimize and modernize our fleet. Last December, we announced a firm order for 150 Boeing 737 MAX airplanes, and 58 additional 737NG aircraft, bringing our total firm orders with The Boeing Company to 350 for 2012 through 2022. In January, we announced that we will retrofit the 737-700 fleet with an updated cabin interior. Evolve: The New Southwest Experience provides a new environmentally friendly cabin experience designed to enhance Customer comfort and improve fleet efficiency. The new sleek interior design also provides the opportunity to increase the number of seats onboard from 137 to 143. In May, we moved 30 Boeing 737 scheduled deliveries for 2013 and 2014 to 2017 and 2018. Earlier this month, we reached an agreement with Delta Air Lines, Inc. and Boeing Capital Corp. to lease or sublease all 88 of AirTran’s Boeing 717 aircraft to Delta, beginning August 2013. For now, our goal is to keep our fleet relatively flat, based on the current aircraft delivery schedule with Boeing, the B717 retirement schedule established with the Delta deal, and our adjusted retirement schedule for the 737 Classics. Given that we don’t plan to grow the fleet until we hit our financial targets, deferring 30 new aircraft deliveries will reduce our 2012 to 2014 capital spending by approximately $1 billion. Replacing B717s with B737s is expected to significantly benefit our financial results as the B737 trip costs approximate the B717′s, but with 20-26 more seats. All told, our various fleet initiatives are estimated to contribute, pre-tax, more than $300 million in 2013, more than $500 million in 2014, and in excess of $700 million in 2015.

“We continue to aggressively optimize our combined networks. AirTran began new international service in the second quarter to Cancun, Mexico City, and Cabo San Lucas. Southwest launched new service between Austin-Bergstrom International Airport and Ronald Reagan Washington National Airport (DCA) earlier this month and, in early August, Southwest will add two daily roundtrips from DCA to St. Louis, Missouri. Our 2012 available seat miles will be comparable to 2011 combined available seat miles, despite our plan to end this year with six fewer aircraft than 2011. For 2013, we expect our fleet to remain comparable to 2012, and we are planning for modest year-over-year available seat mile growth, attributable to additional seats from 737-800 deliveries, the Evolve retrofit, and the replacement of B717s with B737s.”

Financial Results and Outlook

AirTran Airways, Inc. became a wholly-owned subsidiary of the Company on May 2, 2011. Results discussed in this release and provided in the accompanying unaudited Condensed Consolidated Financial Statements and Comparative Consolidated Operating Statistics include the results of operations and cash flows for AirTran beginning May 2, 2011, including the impact of purchase accounting. Periods presented prior to the acquisition date do not include AirTran’s results. However, the Company believes the analysis of specified financial results on a “combined basis” provides more meaningful year-over-year comparability. Financial information presented on a “combined basis” is the sum of the historical financial results of the Company and AirTran for periods prior to the acquisition date, but includes the impact of purchase accounting beginning May 2, 2011. Supplemental financial information presented on a “combined basis” and the accompanying reconciliations are included in this release.

The Company’s total operating revenues in second quarter 2012 increased 11.6 percent to $4.6 billion, compared to $4.1 billion in second quarter 2011, and increased 4.7 percent year-over-year compared to $4.4 billion, on a combined basis. Operating unit revenues increased 6.0 percent from second quarter 2011, on a combined basis. Based on traffic and revenue trends thus far, the Company currently expects another solid year-over-year increase in operating unit revenues in third quarter 2012.

Total second quarter 2012 operating expenses were $4.2 billion, compared to $3.9 billion in second quarter 2011, and were comparable to second quarter last year on a combined basis. Excluding special items in both periods, second quarter 2012 unit costs increased 1.7 percent from second quarter 2011 combined unit costs.

Second quarter 2012 economic fuel costs were $3.22 per gallon, including $.04 per gallon in unfavorable cash settlements for fuel derivative contracts, compared to $3.28 per gallon in second quarter 2011, including $.03 per gallon in favorable cash settlements. Based on market prices as of July 17, 2012, the Company expects third quarter 2012 economic fuel costs to be in the $3.05 to $3.10 per gallon range, including fuel taxes and $.03 per gallon in unfavorable cash settlements for fuel derivative contracts. Third quarter 2012 premium costs, recorded in Other (gains) losses, are currently estimated to be approximately $17 million, compared to premium costs of $36 million in third quarter 2011. As of July 17, 2012, the fair market value of the Company’s hedge portfolio through 2016 was a net liability of approximately $30 million, compared to a $184 million net asset at March 31, 2012. Additional information regarding the Company’s fuel derivative contracts is included in the accompanying tables.

Excluding fuel and special items in both periods, second quarter 2012 unit costs increased 4.3 percent from second quarter 2011′s combined 7.41 cents. Based on current cost trends, the Company expects another year-over-year increase in its third quarter 2012 unit costs, compared to third quarter 2011′s unit costs of 7.38 cents, excluding fuel and special items in both periods.

Operating income for second quarter 2012 was $460 million, compared to $207 million in second quarter 2011. Excluding special items in both periods, operating income was $485 million for second quarter 2012, compared to $276 million in second quarter 2011, and compared to $295 million in second quarter last year, on a combined basis. The Company incurred $11 million in special charges (before taxes) associated with the acquisition and integration of AirTran during second quarter 2012, representing a cumulative total of $165 million in acquisition and integration costs, as of June 30, 2012. The Company expects total acquisition and integration costs will be approximately $550 million.

Other expenses for second quarter 2012 were $92 million, compared to $68 million of other income in second quarter 2011. This $160 million swing primarily resulted from $62 million in other losses recognized in second quarter 2012, compared to $113 million in other gains recognized in second quarter 2011. In both periods, these gains and losses, which are special items, primarily resulted from unrealized mark to market gains/losses associated with a portion of the Company’s fuel hedging portfolio. Excluding these special items, other losses were $14 million in second quarter 2012, compared to $27 million in second quarter 2011, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts. Second quarter 2012 premium costs were $12 million, compared to $26 million in second quarter 2011. Net interest expense declined to $30 million in second quarter 2012, compared to $45 million in second quarter 2011, primarily as a result of the Company’s repayment of its $400 million notes in December 2011 and the redemption of its $385 million notes in March 2012.

Total operating revenues for the six months ended June 30, 2012 increased 18.9 percent year-over-year to $8.6 billion, while total operating expenses increased 17.5 percent year-over-year to $8.1 billion, resulting in operating income in first half 2012 of $481 million, versus $321 million in first half 2011. Excluding special items in both periods, operating income was $495 million for first half 2012, compared to $387 million for the same period last year. Excluding special items and on a combined basis, total operating revenues for the six months ended June 30, 2012 increased 5.2 percent year-over-year, while total operating expenses increased 4.1 percent year-over-year, resulting in combined operating income in first half 2012 of $495 million, versus $382 million in first half 2011.

Net income for first half 2012 was $327 million, or $.43 per diluted share, compared to $166 million, or $.22 per diluted share, for the same period last year. Excluding special items, net income for first half 2012 was $255 million, or $.33 per diluted share, compared to $142 million, or $.19 per diluted share, for the same period last year.

The Company’s return on invested capital (before taxes and excluding special items) was approximately 8 percent for the twelve months ended June 30, 2012. Additional information regarding pre-tax return on invested capital is included in the accompanying reconciliation tables.

Net cash provided by operations for second quarter 2012 was $145 million, and capital expenditures were $416 million. On May 16, 2012, the Company’s Board of Directors increased the Company’s previous $500 million share repurchase authorization to $1 billion. As of June 30, 2012, the Company had repurchased approximately 59 million shares of common stock for approximately $500 million, since the initial $500 million authorization by the Board of Directors on August 5, 2011. As of July 18th, the Company had approximately $3.7 billion in cash and short-term investments, and a fully available unsecured revolving credit line of $800 million.

Net cash provided by operations for first half 2012 was $1.4 billion, and capital expenditures were $543 million, resulting in free cash flow* in excess of $800 million. The Company repaid $469 million in debt during first half 2012, and is scheduled to repay approximately $90 million in debt for the remainder of 2012.

Southwest Airlines