Southwest Airlines Co. (NYSE: LUV) — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual report; fourth-quarter figures are noted separately where available. Southwest operated 747 Boeing 737 aircraft and served 101 destinations. Its business was materially affected by the FAA grounding of its 34 Boeing 737 MAX aircraft beginning March 13, 2019.
Financial performance
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Operating revenue | $22.428 billion | $21.965 billion | +2.1% |
| Operating income | $2.957 billion | $3.206 billion | -7.8% |
| Net income | $2.300 billion | $2.465 billion | -6.7% |
| Diluted EPS | $4.27 | $4.29 | -0.5% |
| Operating margin | 13.2% | 14.6% | -1.4 percentage points |
| Operating cash flow | $3.987 billion | $4.893 billion | -18.5% |
| Capital expenditures | $1.027 billion | $1.922 billion | Lower, primarily reflecting delayed aircraft deliveries |
Passenger revenue increased 1.6% to $20.776 billion; other revenue rose 10.9% to $1.480 billion, led by co-branded card activity. Passenger yield rose 3.1%, load factor was 83.5% versus 83.4%, and capacity (ASMs) declined 1.6%. Operating expenses increased 3.8% to $19.471 billion; expenses per ASM rose 5.5%, while unit costs excluding fuel, special items, and profitsharing rose 7.7%. Lower fuel prices helped: fuel expense fell 5.8% to $4.347 billion, and average fuel cost declined to $2.09 per gallon from $2.20. Salaries, wages, and benefits rose 8.4% to $8.293 billion.
Fourth quarter: Revenue was $5.729 billion versus $5.704 billion in 2018; operating income was $665 million versus $820 million; net income was $514 million versus $654 million. A discretionary $124 million pre-tax profitsharing award reduced fourth-quarter net income by approximately $97 million, or $0.18 per diluted share.
Financial position and capital allocation
- At year-end, cash and cash equivalents were $2.548 billion and short-term investments were $1.524 billion, totaling approximately $4.1 billion in unrestricted cash and short-term investments.
- Total debt, including current maturities and finance leases, was $2.678 billion. Stockholders’ equity was $9.832 billion. Management reported total debt to total assets of 10.3%.
- A $1.0 billion unsecured revolving credit facility, expiring August 2022, was undrawn; Southwest was in compliance with its financial covenant. Investment-grade ratings were Fitch A-, Moody’s A3, and S&P BBB+.
- Southwest returned $2.4 billion to shareholders in 2019: $2.0 billion through share repurchases and $372 million in dividends. The annual dividend per share was $0.700, up from $0.605.
- Contractual obligations totaled $15.545 billion, including $9.972 billion of aircraft purchase commitments. The company reported a working-capital deficit, which it attributes largely to advance ticket sales and other air traffic liabilities.
Material changes and operating developments
- Management estimated the MAX grounding reduced 2019 operating income by $828 million. The grounding also delayed aircraft deliveries and reduced capacity; fixed costs could not be reduced in line with canceled flights.
- Southwest reached a confidential Boeing compensation agreement intended to cover a substantial portion of estimated 2019 MAX-related damages. Proceeds were generally recorded as reductions to the cost basis of existing and future MAX aircraft, not as 2019 earnings. The company received $400 million of supplier proceeds in 2019.
- Unscheduled maintenance disruptions and the U.S. government shutdown also weighed on 2019 results, particularly in the first quarter. Fourth-quarter weather disruptions caused approximately 2,100 canceled flights.
- Southwest began Hawaii service in 2019, expanded its network, and exited Mexico City and Newark. It reported 47 consecutive years of profitability.
- The company adopted the new lease accounting standard in 2019, recognizing operating lease right-of-use assets and liabilities; management said the effect on results and cash flows was not significant.
Outlook, risks, and contingencies
As of the filing date, Southwest had removed MAX aircraft from its schedule through June 6, 2020, and expected further schedule adjustments were possible. It forecast first-quarter 2020 ASMs down 1.5%–2.5% year over year and could not provide full-year 2020 ASM guidance because MAX return timing was uncertain. It expected first-quarter RASM growth of 3.5%–5.5%, while unit costs excluding fuel and profitsharing were expected to rise 6.0%–8.0%. Management’s outlook did not assume additional Boeing compensation for 2020 MAX-related damages.
- Key risks include an extended MAX grounding or delivery delay, dependence on Boeing as the sole aircraft manufacturer, fuel-price volatility and hedge exposure, labor costs and ongoing contract negotiations, intense fare competition, and operational or technology disruptions.
- Fuel derivatives had a fair-value asset of $110 million at year-end. Hedging, collateral requirements, counterparty performance, and possible loss of hedge accounting could affect liquidity and earnings volatility.
- Pending litigation includes a putative class action alleging concealment of MAX defects; Southwest denies wrongdoing and is defending the case. A separate antitrust settlement involving Southwest for $15 million received final approval in 2019, with an objector appeal process still noted in the filing. Management did not expect ordinary-course legal proceedings or IRS adjustments to materially affect results.
- Other exposures include airport-project guarantees, including a $176 million guaranteed obligation related to the LAX Terminal 1.5 project, and a guarantee supporting $407 million of outstanding Dallas Love Field bonds. Management did not expect these projects to materially affect financial position.
- The auditor issued unqualified opinions on the financial statements and internal control. Critical audit matters were loyalty-point spoilage estimates and valuation of fuel derivatives.
Most important facts for investors to verify
- Whether and when the FAA authorizes MAX return to service, and the resulting schedule, delivery, cost, and capacity impacts.
- The terms, cash timing, and accounting treatment of Boeing compensation, including any compensation for 2020 damages.
- Whether operating-cost inflation, labor negotiations, and reduced capacity continue to pressure margins and cash generation.
- Liquidity and capital allocation after aircraft deliveries resume, including aircraft commitments, repurchases, dividends, and debt maturities.
- Developments in the MAX-related litigation, fuel-hedge valuation and collateral exposure, and significant loyalty-program assumptions.