Business Context and Reporting Period
Company: Southwest Airlines Co.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2003
Southwest Airlines is a major domestic carrier providing predominantly shorthaul, high-frequency, point-to-point, low-fare service. As of year-end 2003, the company operated a fleet of 388 Boeing 737 aircraft serving 59 airports in 30 states. Southwest achieved the distinction of being the largest carrier in the United States based on originating domestic passengers boarded and scheduled domestic departures for the period of May through August 2003. The company maintained its streak of consecutive annual profits for the 31st year and consecutive quarterly profits for the 51st period.
Key Financial Metrics
| Metric | 2003 | 2002 |
|---|---|---|
| Operating Revenues | $5,937 million | $5,522 million |
| Operating Income | $483 million | $418 million |
| Net Income | $442 million | $241 million |
| Diluted EPS | $0.54 | $0.30 |
| Operating Cash Flow | $1,336 million | $520 million |
| Total Assets | $9,878 million | $8,954 million |
| Long-term Debt | $1,332 million | $1,553 million |
| Stockholders' Equity | $5,052 million | $4,422 million |
| Cash and Equivalents | $1,865 million | $1,815 million |
Operational Data: Revenue passenger miles (RPMs) increased 5.6% to 47.9 billion. Load factor improved to 66.8% from 65.9%. Average passenger fare was $87.42. Fuel cost per gallon averaged $0.72 (net of hedging gains).
Material Changes vs. Prior Period
- Profitability Surge: Net income increased 83.4% to $442 million. However, this figure includes a $271 million government grant from the Emergency Wartime Supplemental Appropriations Act. Excluding government grants, net income was $298 million, representing a 38.0% increase over the prior year's adjusted net income of $216 million.
- Revenue Growth: Operating revenues rose 7.5%, driven primarily by a 5.6% increase in RPMs and a 1.7% increase in passenger yields due to less heavy fare discounting.
- Expense Management: Operating expenses increased 6.8%. Unit costs (expenses per ASM) rose 2.6% primarily due to higher salaries, profitsharing, and jet fuel prices. However, agency commissions decreased 12.5% as the company shifted sales to its website and eliminated travel agent commissions effective December 15, 2003.
- Fleet Expansion: The fleet grew by 13 net aircraft (17 new 737-700s added, 4 older 737-200s retired), resulting in a 4.2% capacity increase.
Guidance, Outlook, and Risks
Management Commentary & Outlook:
- 2004 Capacity: Available seat mile (ASM) capacity is expected to grow 7-8% in 2004 with a net addition of 29 aircraft.
- Cost Strategy: The company aims to keep unit costs flat in 2004 compared to 2003. Cost savings are expected from eliminating travel agent commissions (~$40 million) and consolidating reservations centers (~$20 million in one-time costs with future annual savings).
- Fuel Hedging: The company has hedged over 80% of its anticipated 2004 fuel consumption, effectively capping prices at approximately $24 per barrel. First-quarter 2004 fuel costs are forecasted between 75 and 80 cents per gallon.
- Stock Repurchase: In January 2004, the Board authorized a $300 million stock repurchase program.
Risks and Contingencies:
- Government Grants: The company relies on federal war-risk insurance coverage, which was extended through August 2004. Uncertainty remains regarding the availability and cost of commercial insurance post-extension.
- Regulatory Environment: The Wright Amendment restricts service from Dallas Love Field to points outside Texas and neighboring states, limiting expansion options in that hub.
- Accounting Changes: A proposed Draft SOP regarding aircraft maintenance (D checks) could require expensing these costs as incurred starting in 2005, potentially impacting future earnings.
- Market Conditions: Recovery of business travel demand remains uncertain, and unit revenues remain below pre-September 11, 2001 levels.
Investor Verification Checklist
- Adjusted Earnings: Verify the company's "non-GAAP" adjusted net income of $298 million (excluding $144 million net of tax from government grants) to assess core operational performance.
- Fuel Hedge Effectiveness: Monitor the realization of the $251 million net asset value in fuel hedge contracts and the impact of rising crude oil prices on the 20% of 2004 fuel requirements that remain unhedged.
- Reservations Center Consolidation: Track the execution of the $20 million restructuring charge in Q1 2004 and the realization of projected long-term savings.
- Debt Maturities: Review the $206 million in current maturities of long-term debt due in 2004 and the company's plan to issue new debt or use cash to refinance.
- Wright Amendment Status: Monitor legislative developments regarding the Wright Amendment, as its modification could significantly alter the company's route network and cost structure.