Southwest Airlines Co. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing is an annual report; fourth-quarter figures below are included where disclosed. Unless noted otherwise, amounts are in U.S. dollars.
Business context and reporting period
Southwest operates a predominantly domestic, point-to-point airline using an all-Boeing 737 fleet. At year-end it served 97 destinations and operated 704 aircraft. In 2015 it expanded service at Dallas Love Field and launched additional international routes, including service from Houston Hobby’s new international terminal. AirTran’s final passenger service was in December 2014, completing the operational integration.
Financial and operating performance
| Metric | 2015 | 2014 |
|---|---|---|
| Operating revenue | $19.820 billion | $18.605 billion |
| Operating income | $4.116 billion | $2.225 billion |
| Net income | $2.181 billion | $1.136 billion |
| Diluted earnings per share | $3.27 | $1.64 |
| Operating cash flow | $3.238 billion | $2.902 billion |
| Capital expenditures | $2.041 billion | $1.748 billion |
| Load factor | 83.6% | 82.5% |
Fourth-quarter 2015 revenue was $4.977 billion, operating income $1.026 billion, net income $536 million, and diluted EPS $0.82. Fourth-quarter 2014 comparables were $4.628 billion, $621 million, $190 million, and $0.28, respectively. Reported fourth-quarter revenue and EPS included approximately $124 million and $0.10, respectively, from the amended Chase co-branded credit-card agreement and associated accounting change.
Full-year operating margin was approximately 20.8% and net margin approximately 11.0%, calculated from reported results. The company reported record annual net income and operating income. Management’s non-GAAP figures, which exclude specified items and adjust fuel-hedge effects, were operating income of $3.957 billion and net income of $2.355 billion; these measures are supplemental, not GAAP results.
Revenue increased 6.5% year over year, while capacity (ASMs) grew 7.2%. Passenger revenue rose 3.6%, but passenger yield declined 4.7% and passenger revenue per ASM declined 3.4%. Fuel and oil expense fell 31.7% to $3.616 billion as the average economic fuel price declined 29.1% to $2.07 per gallon. Salaries, wages, and benefits rose 17.5%, including record profitsharing expense of $620 million and $334 million accrued for union contract bonuses. Operating expenses per ASM declined 10.6%, largely due to lower fuel costs; excluding fuel and special items, they were approximately flat year over year.
Liquidity, debt, and capital allocation
At December 31, 2015, cash and cash equivalents were $1.583 billion and short-term investments were $1.468 billion, totaling about $3.051 billion. Current assets were $4.024 billion and current liabilities $7.406 billion; current liabilities include substantial air-traffic and accrued liabilities. Total debt and capital leases were $3.198 billion, including $637 million of current maturities. The company had no borrowings under its $1 billion revolving credit facility, which expires in April 2018, and reported compliance with its financial covenant. Stockholders’ equity was $7.358 billion.
Operating cash flow of $3.238 billion funded investment and shareholder returns. The company repurchased approximately $1.180 billion of stock and paid $180 million in dividends during 2015. It issued $500 million of 2.65% senior notes due 2020. Management estimated 2016 capital expenditures of approximately $2.0 billion. Contractual obligations totaled $18.180 billion, including $10.550 billion of aircraft purchase commitments and $3.819 billion of operating lease commitments.
Outlook, material changes, and risks
- Management expected 2016 ASMs to increase approximately 5%–6%, with fleet growth through 2018 planned at no more than 2% annually on average. First-quarter 2016 operating unit revenue was expected to be flat year over year, including an estimated $110 million benefit from the Chase agreement. First-quarter unit costs excluding fuel, special items, and profitsharing were expected to rise approximately 2% year over year.
- The Chase agreement changed revenue allocation and recognition. For 2015, the filing estimates the change increased operating revenue by $427 million and net income by $227 million, including a one-time, non-cash $172 million revenue adjustment. This materially affects comparability with prior periods; management’s non-GAAP presentation excludes specified effects.
- Southwest accelerated retirement of its 737-300 and 737-500 aircraft to no later than mid-2018. The estimate change was immaterial in 2015 but is expected to increase 2016 depreciation and amortization expense by approximately $89 million. Boeing deliveries and revised aircraft orders raise firm aircraft capital commitments.
- Fuel-price exposure remains significant. At year-end, fuel derivatives had a net liability fair value of approximately $1.481 billion; the company had provided $835 million in cash collateral and $250 million in aircraft collateral. Fuel-hedge accounting and commodity correlations can increase earnings volatility. The company was effectively unhedged for first-quarter 2016 at then-current price levels.
- Labor negotiations remain a key cost and execution risk: several large union groups were negotiating, and a tentative agreement with ramp, operations, provisioning, and freight agents was awaiting ratification. The company accrued $334 million of related bonuses in 2015.
- Capacity-related antitrust investigations and class actions were pending in the United States and Canada. The company said it was cooperating with government inquiries and intended to defend the cases; outcomes could not be predicted. Other risks include airline competition and economic sensitivity, operational disruption, technology and cybersecurity exposure, dependence on Boeing and key suppliers, and extensive regulation.
- The company reported investment-grade credit ratings from Moody’s, S&P, and Fitch. It also stated that its auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Separate underlying operating performance from the Chase agreement’s accounting and revenue-recognition effects, particularly when comparing fourth-quarter and full-year results.
- Track passenger yield and unit revenue against capacity growth, and assess whether strong load factors can offset fare pressure.
- Monitor labor contract outcomes, the $334 million bonus accrual, and resulting labor-cost trends.
- Review fuel-hedge settlements, collateral needs, and the exposure implied by the large derivative liability; distinguish market fuel savings from hedge-related accounting effects.
- Assess aircraft retirement, delivery, and capital-spending plans against cash generation, debt maturities, and shareholder distributions.
- Follow the status and potential financial or operational consequences of the antitrust matters and the 2017 reservation-system implementation.