Southwest Airlines Co. — FY2013 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2013; it is an annual report, not a standalone fourth-quarter filing. Southwest and AirTran operated 680 aircraft and served 96 destinations. The networks were connected for single-itinerary travel, with full operational integration targeted by the end of 2014. AirTran results are included from its May 2, 2011 acquisition date, which affects comparisons with earlier periods.
Financial performance
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Operating revenue | $17.699 billion | $17.088 billion | +3.6% |
| Operating income | $1.278 billion | $623 million | +105.1% |
| Net income | $754 million | $421 million | +79.1% |
| Diluted EPS | $1.05 | $0.56 | +87.5% |
| Operating cash flow | $2.477 billion | $2.064 billion | +20.0% |
- Passenger revenue rose 3.9%, to $16.721 billion, principally from higher fares and a 1.7% increase in capacity. Passenger yield increased 2.4%; load factor eased to 80.1% from 80.3%.
- Operating expenses declined 0.3%, to $16.421 billion, while capacity grew 1.7%. Reported operating margin was approximately 7.2%, versus 3.6% in 2012; net margin was approximately 4.3%, versus 2.5%.
- Fuel and oil expense fell 5.8%, to $5.763 billion; average economic fuel cost was $3.12 per gallon versus $3.28. Salaries, wages, and benefits increased 6.0%, to $5.035 billion, and represented about 31% of operating expenses.
- At year-end, cash and cash equivalents were $1.355 billion and short-term investments were $1.797 billion. Total debt, including current maturities, was $2.842 billion; stockholders’ equity was $7.336 billion. The company reported $3.2 billion of unrestricted cash and short-term investments and a fully available $1 billion revolving facility.
- Capital expenditures, net, were $1.447 billion. Cash dividends paid were $71 million and share repurchases were $540 million. The company generated $242 million of net cash increase during the year.
- Fourth-quarter revenue was $4.428 billion, operating income $386 million, and net income $212 million, compared with $4.173 billion, $91 million, and $78 million, respectively, in fourth-quarter 2012.
Material changes versus prior period
- GAAP net income increased 79.1%; management attributed the improvement mainly to higher passenger revenue and lower fuel costs. Non-GAAP net income was $805 million versus $417 million, but these measures exclude fuel-hedge effects and special items and are not GAAP.
- Operating expenses per available seat mile declined 1.9% as reported, helped by lower fuel and acquisition/integration expense. Excluding fuel and special items, unit costs increased 2.3%, mainly due to labor costs.
- AirTran acquisition and integration costs declined to $86 million from $183 million. The company estimated approximately $400 million of net, pretax AirTran synergies in 2013, excluding those costs.
- Operating cash flow rose to $2.477 billion. Net debt repayments were $313 million, while the company continued substantial shareholder returns.
Outlook, risks and unusual items
- Management expected 2014 available seat miles to be approximately in line with 2013, first-quarter unit revenue to increase year over year, and first-quarter unit costs excluding fuel, special items, and profitsharing to rise 4%–5% year over year; January winter storms were expected to contribute about two percentage points.
- Management targeted a 15% annual pretax return on invested capital; reported 2013 pretax ROIC, on its adjusted non-GAAP basis, was 13.1%, up from 7.2% in 2012.
- Southwest planned to complete AirTran integration and convert its remaining service to Southwest by the end of 2014. It planned new Southwest service to several Caribbean destinations from July 2014 and additional Mexico and Dominican Republic service by year-end. These plans depended on operational execution, approvals, systems, and airport facilities.
- Fuel remained the largest operating cost and accounted for 35% of 2013 operating expenses. WTI-based derivatives ceased qualifying for hedge accounting prospectively in the second half of 2013; fair-value changes thereafter flowed through earnings, potentially increasing reported volatility. Fuel prices and hedge outcomes remain uncertain.
- Approximately 83% of employees were union-represented, and numerous Southwest labor groups were in negotiations. Management identified labor costs and potential labor disruption as risks.
- Debt maturities were approximately $546 million in 2014. The company also expected to repay certain 717 aircraft notes early on April 1, 2014, incurring an estimated $5 million penalty.
- Contractual obligations totaled $20.417 billion, including $11.911 billion of aircraft purchase commitments and $4.588 billion of operating lease commitments. The company had recorded $410 million of AirTran integration costs through year-end and expected total costs not to exceed $550 million.
- Material execution and exposure items include the costly multi-year reservation-system replacement, international expansion and airport construction, dependence on Boeing and key suppliers, and a pending AirTran antitrust class action. Management said ordinary-course legal proceedings were not expected to have a material adverse effect; the antitrust case remained unresolved.
- The AirTran acquisition generated $970 million of goodwill; the 2013 annual impairment test found no impairment, but future impairment remains possible. The financial statement and internal-control audits received unqualified opinions.
Important facts for investors to verify
- Whether fare and yield improvement can offset labor, airport, and other nonfuel cost increases, particularly as 2014 unit-cost guidance develops.
- Fuel-hedge coverage, cash settlements, collateral exposure, and the earnings impact of WTI derivatives no longer qualifying for hedge accounting.
- Progress, remaining costs, and realized benefits from AirTran integration, including the timing and sustainability of the stated synergy estimate.
- Funding and execution of aircraft orders, airport projects, and reservation-system changes, alongside the $546 million 2014 debt maturities and lease commitments.
- Outcomes of labor negotiations and the pending antitrust litigation, as well as any changes in 2014 capacity, service-conversion, and international-launch plans.