Norwegian annual report 2013

CEO's remarks

The 2013 financial year was one characterized by expansion and reorganization. Norwegian is developing from a Scandinavian airline to a global player. This transition requires new thinking in terms of how we do business, with both flexibility and a willingness to change as our key competences.

Amid growth and change, we marked our seventh consecutive year of net profit. However, given the eight per cent reduction in unit cost we had hoped to report better margins. Profit was set back by teething problems with our Dreamliner aircraft, while a warm and sunny Nordic summer reduced bookings in the important months of July and August. Similarly, profits were hampered by capacity investment and increased competitive pressure during the second half of 2013.

Norwegian was named “Best Low Cost Airline in Europe” by SkyTrax and “Low cost airline of the Year” by Air Transport News, a testimony that passengers enjoy a superior product for affordable fares. In total, 20.7 million passengers chose to fly with us, an increase of 3 million over 2012.

All of our markets enjoyed significant overall growth, with 81 new routes on offer. Capacity in terms of seat kilometers increased by 32 per cent, two thirds of which was in the Nordic core market. In the continental European market, growth was attributed to the new UK and Spanish bases. Starting in April, Londoners could choose from 20 new Norwegian routes to the Mediterranean and, in October, Warsaw, Munich, Hamburg, and Cologne became non-stop destinations from our Spanish bases.

The most significant milestone was the launch of the long-awaited flights to North America and Southeast Asia. The first flight departed from Oslo on 30 May bound for New York; Stockholm followed suit the day after. By year-end Norwegian operated flights from Scandinavia to New York, Fort Lauderdale, and Bangkok, and we had begun the sale of tickets to Los Angeles, Orlando, and San Francisco.

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Financial performance

Net profit was NOK 322 million, equivalent to a net profit margin of two per cent. Pre-tax profit came in at NOK 437 million compared to NOK 623 million last year.

Teething problems with the Dreamliner and unusually good weather in the Nordic countries during the important summer months had a combined negative effect on earnings amounting to NOK 374 million.

Revenues were influenced by planned capacity investment across the business and by increased competitive pressure in the Scandinavian market in the second half of 2013. Our primary competitor, with a unit cost more than 70 per cent higher than Norwegian, has priced its tickets at levels not supported by its cost level.

The unit cost (CASK) decreased eight per cent excluding fuel and six per cent including fuel. An even larger proportion of cost-efficient Boeing 737-800s in our fleet, an overall larger scale and a longer-than-average sector length were the primary drivers. A growing share of our operations is based outside the high-salary region that is the Nordic countries, whereby we align our crew costs to the local competition where we fly. Dreamliner operations to Southeast Asia and North America did not make a positive contribution to unit cost during the first year, even when adjusted for the Dreamliners’ teething problems, although this was anticipated due to the initial small-scale nature of the operation as well as its start-up costs


Capacity investment & product

In 2013 capacity growth (ASK) was 32 per cent, making Norwegian one of the fastest growing airlines in the world. A third of this growth can bes attributed to entirely new markets. There was also significant expansion in our existing markets, with ASK growth of 17 per cent in Norway, 23 per cent in Sweden, 29 per cent in Denmark, and 56 per cent in Finland.

Big is not necessarily beautiful. At Norwegian we believe growth must be profitable, whether it be less, equal to, or more than the market average. Dumping the ticket price to attract traffic is done at the push of a button – the hard part is lowering the cost level correspondingly.

Our business model is based on high volume and competitive low fares.  When adding new capacity, particularly in markets where we have a limited prior presence, we actively use our agile cost structure to stimulate volume. Capacity investment in new markets has a temporary softening effect on unit revenue, but low fares are an effective allurement for prompting customers to try what we offer. Hands-on experience for passengers is significantly more effective than a random billboard or TV commercial.

Norwegian’s value proposition is the ability to offer a superior product at a lower cost. We operate one of the youngest aircraft fleets in the world using eco-friendly aircraft with generous legroom, fresh and modern interiors and state-of-the art entertainment systems. About 80 per cent of the aircraft used on our European, Middle Eastern, and North African routes are Wi-Fi equipped. The aircraft used on longer routes to Southeast Asia and North America all have individual Android-based in-flight entertainment systems featuring movies, music, moving maps and even an in-flight electronic snack bar.

Typical business routes are characterized by a high-frequency schedule, with up to 16 daily departures on the busiest routes. Flexible tickets are available on all Norwegian flights; fast track is available at the largest airports and a Direct-to-Gate option makes check-in redundant across Scandinavia and in Finland. Our biggest advantage, however, is the one which is the hardest to imitate – positive and service-minded employees.


Global operations with a global cost structure

Though Scandinavians are statistically among the most frequent travelers in the world, they are in limited supply.

Establishing international bases across Europe enables us to tap into new markets, whether they are provincial markets in the Nordic countries, or entirely new markets such as Mediterranean routes from London Gatwick. These bases also enable Norwegian to compete with the most cost-efficient airlines.  To maintain a competitive edge outside Scandinavia, expansion into new markets must be on a level playing field with incumbent airlines. Recruitment for new bases takes place locally to offer competitive and favorable local terms of employment.

Despite an average salary level twice that of our European counterparts Norwegian has managed to take second place in terms of cost efficiency at primary airports in Europe, through efficient operations, automation, and a state-of-the-art aircraft fleet.

At our European bases, for instance at London Gatwick, Norwegian’s unit cost is substantially lower than the average for the company. The salary levels are aligned with the competition and we operate a uniform fleet of cost-efficient Boeing 737-800s.

Our American and Asian operations follow the same strategy. The New York, Fort Lauderdale, and Bangkok crew bases allow Norwegian to easily reach a large number of European destinations, ensuring access to large catchment areas and high volumes. Norwegian has been crisscrossing Europe without paying attention to borders for almost 12 years; we are now pulling the same strategy across the Atlantic and to the Far East. We fly to several European countries from our overseas destinations, not just one - which is the case for most of our European legacy competitors. By way of example, no other European airline offers more non-stop destinations from New York and Los Angeles than Norwegian.

The combination of employing the best available asset - the Boeing 787 Dreamliner - and operating on even terms with our global competitors has created a solid foundation for our overseas operations. Add to that the infrastructure shared with our already efficient European operations and optimized scheduling due to higher cruise speeds and independence from alliances, which are typically more concerned with short connecting times rather than non-stop services shortcutting hubs altogether, and this makes for a good foundation for profitability.


Battle of the Atlantic

Contrary to common belief, the transatlantic market is tightly controlled by three global alliances that have a combined market share of 87 per cent. The member airlines of each alliance legally cooperate by sharing costs and agreeing on prices.

Our US-bound operations have attracted significant attention from incumbent legacy carriers. No wonder -Norwegian is the first low-cost airline to break the transatlantic oligopoly, offering affordable non-stop fares to the flying public. We offer a high quality low-cost service which bypasses time-consuming and expensive layovers at alliance hubs such as Frankfurt, Charles de Gaulle, Amsterdam, or Copenhagen.

The alliances and trade unions organizing the crews that staff the alliances’ aircraft have used polemical terms and slogans in their PR stunt against Norwegian – e.g. “flag of convenience,” “race to the bottom” and “social dumping” – to suggest that Norwegian’s business model, country of incorporation and hiring practices are inconsistent with “fair wages and working conditions”, “high labor standards” and “safety culture”. The goal of the alliance airlines’ allegations and persistent lobbying is clear: to delay and impede Norwegian’s market entry and to protect their high-fare oligopoly.

Safe operations in the air and on the ground are Norwegian’s paramount priority. Norwegian has been running a safe operation since the incorporation of the Group in 1993 and has not registered any serious accidents or incidents to either passengers or crew involving the operation of aircraft. The Group’s aircraft operations are governed by the rules and regulations set forth by the European Aviation Safety Agency (EASA), irrespective of whether the crews are based in Asia, Europe or America.

We have received attention for using Thai crews on US-bound flights, using a Singaporean agency to employ pilots and using an Irish operating license. Contrary to the belief of our alliance competitors, the set-up is chosen for operational reasons – we operate from several countries and cities to several countries and cities, as opposed to a typical alliance structure with a single hub at one end. Our set-up, which promotes non-stop flights, requires several bases located in large catchment areas such as Bangkok and New York.

This set-up has no cost advantage in terms of salaries. Both our Thai and US crews are being compensated similarly, between USD 34,000 and USD 40,000 per year depending on seniority. That is on par with the median flight attendant salary in the US, currently USD 37,000 according to the US Department of Labor. From the point of view of our Thai crews, Norwegian offers a salary level about ten times higher than the Thai average. Captains and first officers employed through the Singaporean agency receive average gross payments of over USD 100,000 annually, which is well above the average salary level in any country in the world – even Norway.

The operational rationale for both the Singaporean and Irish subsidiaries is discussed in greater detail below.


Corporate Structure

A global operation calls for a different kind of organizational structure and mindset. A key consideration in the restructuring activities undertaken in 2013 was building a structure which maintains Norwegian's flexibility and adaptability despite its growing size and entry into new markets in Europe and across continents. This restructuring has included the establishment of new legal entities, the reorganization and relocation of key personnel together with their decision-making authority, rights and assets to the relevant entities at their respective legal locations.

All aircraft are being transferred from the parent company to a fully-owned asset management company. The asset management company is incorporated under the laws of Ireland and has USD as its functional currency. Ireland is the largest aviation finance cluster in Europe, which makes the country a natural location, given Norwegian's global expansion and large aircraft orders. Ireland is also a full signatory to the Cape Town Convention, which is a prerequisite for optimal financing. The asset management company operates as the lessor of the aircraft, which are leased to the subsidiaries holding AOCs.

Aircraft operations are allocated to separate fully-owned subsidiaries, each holding their own Air Operator Certificate (AOC). While we do get full access to the US using the AOC issued by Norway, we do not have access to most Asian, African and South American destinations from countries other than Norway. Since we aspire to fly to those regions from multiple European countries, we need an EU-AOC which secures traffic rights from all EU-countries. The reason for choosing Ireland over other EU countries is the synergies from co-locating the AOC at the same physical location as the asset management company. 

In line with legal developments in Europe, fully-owned country-specific resource companies are being established. National entities ensure that all employees are offered terms and conditions in line with the social welfare systems and regulations in each individual country.

The background for establishing a Singaporean subsidiary was our original plan to expand more rapidly in Asia. The traffic right limitations of our original Norwegian AOC made us focus on the more liberal transatlantic market. We still believe that the large future traffic patterns will come from Asia, and we expect significant growth in that region in the future. The intention of the Singaporean subsidiary is for it to be a recruitment and employment company for pilots in the region. Singapore was chosen over other Asian countries due to its close business relations with Europe and the USA, its stable political environment, its status as an aviation cluster, its liberal air services agreements, and the fact that the country is English-speaking.

Keeping resource companies and the asset management company separate from the AOC companies means production can easily move from one AOC to another; for instance to better adapt to seasonal demand patterns in different regions or even cyclical demand changes.

Specific activities of the airline's commercial operations have been reorganized and established in separate new entities, including but not limited to Norwegian Holiday and Norwegian Cargo, as well as branding and marketing activities.


Dreamliner

The introduction of the Dreamliner caused more problems than we could reasonably have expected. The first two aircraft were delivered several months late, and when they arrived their dispatch reliability was too low. During the first months of operation, delays were inevitable and passengers flew more often on replacement aircraft than on the Dreamliner. This was not the product we wanted to offer to our passengers.

The manufacturer, Boeing, which is responsible both for building and maintaining our Dreamliners, has put considerable effort into improving the performance of the aircraft. Modifications have been made to avoid snags occurring in the first place, and when they do occur, more spare parts and technicians have been made available to promptly fix any issue.

The performance has improved dramatically since the aircraft first entered service and they are now performing beautifully, which has validated Norwegian’s confidence in the Dreamliner as a true game changer. Passenger comfort is unparalleled, with low noise levels, high humidity and ambient mood lighting, which reduces jet lag. Fuel consumption is even lower than expected, implying that fuel savings per seat is more than 20 per cent compared to the most modern similar-sized aircraft in operation.

The demand for a low-cost alternative to Southeast Asia and North America is clearly illustrated by load factors, which averaged 90 per cent in 2013 – about 5 percentage points higher than we expected. As a consequence of this high demand and confidence in the aircraft type, we have increased the Dreamliner order from eight to 14. The last six we have ordered are a stretch version of the 787-8 we already operate, called the 787-9. It offers greater capacity, longer range and - more importantly - lower unit cost.


Fleet renewal

A continuous fleet renewal effort has become an integral part of our business. By early 2012 Norwegian had placed the largest aircraft order in European history, comprising 222 short-haul aircraft. By year-end 2013 we had a total of 271 undelivered aircraft on firm order: 60 Boeing 737-800, 100 Boeing 737 MAX8, 100 Airbus A320neo and 11 Boeing 787 Dreamliners.

Norwegian’s goal is to operate only the most cost-efficient and environmentally-progressive fleet of aircraft available. This will be achieved by replacing short-haul aircraft after 7-9 years of operation with brand-new aircraft. Our recent orders secure the continuous and long-term supply of both replacement and net growth aircraft. The set-up of the asset management company in Ireland also allows us to lease aircraft to other airlines for shorter or longer periods. This flexible approach helps us to tailor our growth to match demand patterns without being tied to the aircraft delivery schedule, but also without having to dispose of the valuable assets that our new state-of-the art aircraft will be.

In 2013, 14 brand-new 737-800s entered the fleet along with three 787-8 Dreamliners.

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The Environment

New aircraft supercharge our cost efficiency and significantly enhance the passenger experience. However, the greatest beneficiary of our fleet renewal efforts is the environment.

altIn 2013, CO2 emissions per passenger per kilometer were only 87 grams, a two per cent reduction compared to the previous year. Norwegian is one of the most environmentally-friendly airlines in Europe.

The reputation of air travel as an environmental “bad boy” is unmerited. There are few other sectors that can point to such comprehensive advances in energy efficiency. Since 2008 when our fleet renewal effort began, Norwegian’s fuel consumption per seat kilometer has decreased by a staggering 17 per cent. Today, emissions per airline passenger are approaching those per train passenger in many countries.

However, the choice of aircraft is pivotal when it comes to aviation and emissions. The environmentally-progressive Boeing 737-800 significantly enhances Norwegian’s environmental contribution. By comparison, the Boeing 737-600 - also a “Next Generation” aircraft in the same family as the -800 and commonly seen at Scandinavian airports - is nowhere near as environmentally-progressive, as it consumes 35 – 40 per cent more fuel per seat.

In this Annual Report, we have dedicated an entire section to the environmental effects of what we do and how we seek to minimize our environmental footprint. We have added a comprehensive benchmark between aircraft types as well as between alternative modes of transportation.

Aircraft financing

By year-end, Norwegian had 257 undelivered direct-buy short-haul aircraft and two direct-buy long-haul aircraft on order. A total of 43 direct-buy 737-800s and one 787-8 had already been delivered, of which 30 737-800s and one 787-8 were on Norwegian’s own books, financed with export credits. The remaining 13 have been financed using sale-and-leaseback transactions.

In 2013, net interest-bearing debt increased by NOK 549 million while total investments amounted to NOK 2.1 billion. Net cash flow from financing activities was only NOK 0.2 billion; the remainder was financed with cash flow from operations, which amounted to NOK 2.4 billion. In spite of the NOK 2.1 billion investments, the company produced a positive free cash flow and the cash position at year-end was NOK 435 million higher than last year.

Financing activities take place on an ongoing basis for our future deliveries. For 2014, long-term external financing of approximately NOK 1,700 million of the NOK 3,000 million requirement was in place by year-end 2013. The gross debt increase (net of amortization) for 2014 is expected to be in the area of NOK 2,200 million. By year-end, the company had a PDP balance of NOK 2,550 million, of which 94 per cent was paid using own funds.


Going forward

There will also be considerable capacity investment in 2014, particularly during the spring, with a large number of new routes both in the transatlantic and inter-European markets.

We continue to open more bases, both for European and overseas traffic, and with our two new bases in Spain - Barcelona and Madrid - we are well positioned for taking a share of the rapidly-growing leisure markets. Our bases in Fort Lauderdale and New York allow for the efficient operation of our transatlantic route portfolio, reaching a large number of European destinations while avoiding excessive crew layovers.

Heading into autumn, we will retire all of our leased 737-300s and the oldest 737-800, helping us both to reduce unit costs and reduce capacity growth in the seasonally slower months. As we enter 2015, we will have one of the world’s most efficient fleets and an effective base structure covering most of the leisure markets in Western Europe, hopefully allowing us to reap the rewards of our capacity and fleet investments in 2013 and 2014.

Bjørn Kjos // CEO