Southwest Airlines Co. 2013 Annual Report To
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SOUTHWEST AIRLINES CO. 2013 ANNUAL REPORT TO SHAREHOLDERS To our Shareholders: Our goals for 2013 were ambitious. We wanted to stay on track with our five Strategic Initiatives described below. We wanted to maintain our strong Brand, unique Culture, and award-winning Customer Service. We wanted to sustain our strong ontime performance and baggage handling. Finally, we wanted to improve our cost performance, achieve our profit requirement, and return value to our Shareholders. Just like in 2011 and 2012, an enormous amount was accomplished in 2013. As a result, we produced stellar results. Our 2013 net income was a record $754 million, or $1.05 per diluted share, including special items (primarily noncash, mark-to-market, and other items required for a portion of the Company’s fuel hedge portfolio, as well as costs associated with the acquisition and integration of AirTran). Excluding special items1, our 2013 profits were also a record, increasing 93 percent year-over-year to $805 million, or $1.12 per diluted share. Our annual pre-tax return on invested capital, excluding special items (ROIC), was 13.1 percent, nearly doubling 2012’s performance. Total operating revenues were a record $17.7 billion, boosted by strong yields and an 80.1 percent load factor. Through the combination of stable fuel prices and rigorous cost control efforts, we met our goal to improve our cost performance. Despite a roller coaster economy, we achieved record earnings; and, while just short of our 15 percent ROIC target, we produced the best ROIC since 2000. Our stock price rose 84 percent in 2013 and reached an all-time high, split-adjusted, closing price of $23.98 a share on March 17 of this year. I applaud the outstanding People of Southwest and AirTran for these strong results, which earned them a record $228 million contribution to the ProfitSharing Plan for the year 2013. We preserved our financial strength and returned value to our Shareholders, as planned. As of December 31, 2013, our cash and short-term investments were a strong $3.2 billion, with a fully-available $1 billion bank line-of-credit. In May 2013, our Board of Directors authorized an increase in our previous share repurchase authorization to $1.5 billion, and quadrupled our quarterly dividend. These actions, coupled with the generation of a healthy $1.03 billion in free cash flow2 during 2013, enabled us to return $611 million to Shareholders through repurchases of $540 million of common stock (38 million shares) and distribution of $71 million in dividends. We repaid $313 million in debt and capital lease obligations during 2013. As a result, our debt- to-total capital ratio (including aircraft leases) declined to approximately 38 percent at yearend. All told, our invested capital base was reduced by approximately $1 billion during 2013. We remain the only investment grade-rated U.S. airline. 1 Additional information regarding non-GAAP financial measures is included in the accompanying Form 10-K for the fiscal year ended December 31, 2013. 2 Free cash flow is calculated as operating cash flows of $2.48 billion less capital expenditures of $1.45 billion. While we did not achieve our ontime performance and baggage handling goals in 2013, we did not lose focus on providing best-in-class Customer Service, once again, leading the domestic airline industry in Customer Satisfaction in 20133. Southwest received numerous other awards and recognitions during 2013, including Best Domestic Airline for Customer Service by Executive Travel Magazine’s Leading Edge Awards, Brand of the Year in the Value Airline Category by the Harris Poll, and the top ranking by InsideFlyer Magazine for Best Customer Service and Best Loyalty Credit Card. We are now in the fourth year of a bold five-year strategic plan that began in 2011. We believe our five Strategic Initiatives are transformative with the potential to drive more revenue, reduce unit costs, and make Southwest more competitive. The world has changed dramatically since 2000. Our competitors took draconian measures, including massive layoffs and pay cuts, to adjust to today’s economic realities and have been given new life through the use of federal bankruptcy laws. Thanks to the hard work and extraordinary efforts of our Southwest Warriors, Southwest has adjusted through incredible Teamwork and unwavering resolve to execute our strategic plan. We have survived the onslaught of challenges to remain profitable for 41 consecutive years, remain the nation’s largest airline in terms of domestic originating passengers boarded4, and operate the largest Boeing fleet in the world. The transformation hasn’t been easy, but it was necessary, and we made significant and successful progress in 2013: AirTran Integration: We achieved approximately $400 million in annual net pre-tax synergies in 2013 (excluding acquisition and integration expenses), as planned. Since 2011, we have converted 17 of the 52 AirTran Boeing 737-700s to the Southwest Evolve configuration, and the remaining are scheduled to be converted this year. During 2013, we converted 12 AirTran stations to Southwest operations, and by yearend, introduced Southwest service in all remaining domestic AirTran markets. We continued to optimize the combined Southwest and AirTran networks, enabled by connecting the networks in April 2013. With our international reservation system launched in January 2014, we remain on track to convert AirTran’s seven international markets, along with its remaining domestic markets, by the end of this year. As planned, this will allow us to complete the AirTran integration and retire the brand by the end of 2014. Fleet Modernization: We completed the 143-seat Evolve retrofit of 372 Boeing 737-700 aircraft and 78 Boeing 737-300 aircraft in the Southwest fleet. All Southwest -700s and -800s are now equipped with Row 44 technology, enabling access to satellite-based WiFi, and we became the first and only carrier to offer gate-to-gate connectivity. We also launched free live TV through 2014, compliments of DISH; movies and television on demand; a new WiFi portal; and an iMessaging feature for iOS users. We transitioned 13 of the 88 AirTran Boeing 717- 200s to Delta, and we replaced the flying with Boeing 737 aircraft, which are larger gauge and cost approximately the same amount to fly on a per-trip basis as the smaller Boeing 717 aircraft. The remaining Boeing 717s are scheduled to be removed from the AirTran network by the end of 2014 and transitioned to Delta through 2015. In order to manage our fleet needs as 3 From the 2013 yearend DOT Air Travel Consumer Report issued February 2014. Top ranking is for Southwest Airlines only. 4 As measured by the number of originating domestic passengers boarded and based on data available from the U.S. Department of Transportation (DOT), as of September 30, 2013. we transition the Boeing 717 fleet to Delta and retire Classic Boeing 737 aircraft, we revised our future Boeing delivery schedule and augmented our Boeing deliveries with pre-owned aircraft. We also announced that Southwest will be the launch customer for the Boeing 737 MAX 7 series, with deliveries beginning in 2019, following the expected delivery of the Boeing 737 MAX 8 beginning in 2017. We believe the Boeing 737 MAX will have the lowest operating unit costs in the single-aisle segment and provide benefits with an engine/airframe combination that is uniquely designed to optimize operating performance. With intentional focus on careful capital management, our restructured delivery schedule deferred $1 billion in aircraft capital spending over the next five years to beyond 2018. Boeing 737-800s: We ended 2013 with 52 Boeing 737-800s in our fleet, and have 52 more on order for 2014 and 2015, combined. We have 170 Boeing 737 MAX 8 scheduled for delivery in 2017 through 2024. With 20 percent more seating capacity, we can operate the -800 at a lower unit cost than the -700, and better serve longhaul and capacity-constrained, high-demand markets, as well as potential new longhaul markets to Mexico, the Caribbean, Central America, northern South America, Canada, Alaska, and Hawaii. Overall, our fleet modernization efforts and the addition of -800s to our fleet contributed approximately $300 million to our 2013 profit before taxes. International Capabilities and New Reservation System: We launched our inaugural Southwest service outside the continental United States in April 2013 to San Juan, Puerto Rico. In January 2014, we deployed our international reservation system and began selling Southwest’s first international service to Aruba, The Bahamas, and Jamaica, scheduled to fly July 1, 2014. By the end of this year, we intend to convert AirTran service from Cancun, Los Cabos, and Mexico City, Mexico, and Punta Cana, Dominican Republic, to the Southwest route network. We broke ground on the five-gate international terminal at Houston’s William P. Hobby Airport, planned to open in late 2015. And, we have future plans to bring Southwest near-international service to Fort Lauderdale-Hollywood International Airport with the airport’s design and construction of a new five-gate Concourse A with an international processing facility. Over the next several years, we intend to replace our existing reservation systems with a comprehensive system that would provide the ability for Southwest to serve international destinations and allow for other Customer Service, revenue management, and schedule production capabilities. Rapid Rewards® Frequent Flyer Program: To date, the program has exceeded our expectations with respect to growth in Rapid Rewards Memberships, Member flight activity, Southwest’s co-branded Chase® Visa credit card holders, points sold to business partners, and points purchased by program Members. Customers are now able to transfer their loyalty rewards between Southwest’s Rapid Rewards and AirTran’s A+ Rewards frequent flyer programs, providing Members the benefit of the combined network for redemption.