Southwest Airlines Co. — FY2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; filed February 7, 2011. The filing also reports fourth-quarter results. Southwest operated a point-to-point domestic airline with 548 Boeing 737 aircraft serving 69 cities in 35 states at year-end.
Financial performance and position
| Metric | FY2010 | FY2009 |
|---|---|---|
| Operating revenue | $12.104 billion | $10.350 billion |
| Operating income | $988 million | $262 million |
| Net income | $459 million | $99 million |
| Diluted EPS | $0.61 | $0.13 |
| Operating margin | 8.2% | 2.5% |
| Operating cash flow | $1.561 billion | $985 million |
- Revenue grew 16.9%; operating expenses increased 10.2%. Passenger revenue rose 16.1%, reflecting higher fares and a 3.3-point increase in load factor to a company-record 79.3%.
- Operating costs were $11.116 billion. Fuel and oil expense was $3.620 billion, or 32.6% of operating expenses; average fuel cost rose to $2.51 per gallon from $2.12. Operating expense per available seat mile increased 9.7% to 11.29 cents.
- FY2010 non-GAAP net income was $550 million, or $0.74 diluted EPS, versus $143 million and $0.19 in 2009. These company-defined measures adjust for fuel-hedge accounting effects and special items and are not GAAP results.
- Fourth-quarter 2010 revenue was $3.114 billion, operating income $216 million, net income $131 million, and diluted EPS $0.18; fourth-quarter 2009 figures were $2.712 billion, $167 million, $116 million, and $0.16, respectively.
- Year-end cash and cash equivalents were $1.261 billion and short-term investments $2.277 billion, totaling $3.538 billion. Current assets were $4.279 billion against current liabilities of $3.305 billion. Long-term debt less current maturities was $2.875 billion, with $505 million in current maturities. Stockholders’ equity was $6.237 billion.
- Capital expenditures for property and equipment were $493 million. Cash flow from operations was partly supported by a $265 million net inflow from fuel-hedge collateral movements; cash paid to enter new fuel derivatives was $359 million.
Material changes versus prior period
- Net income increased $360 million year over year as revenue recovery, improved fares and load factors, and capacity restraint more than offset higher costs, particularly fuel.
- Passenger yield increased 10.8%; passenger revenue per revenue passenger mile rose to 14.72 cents from 13.29 cents. Available seat miles increased less than 1%, while revenue passenger miles rose 4.8%.
- Fuel costs rose 18.9% in dollars, and labor and airport costs also increased. Operating expense per ASM excluding fuel and special items rose to 7.61 cents from 7.13 cents.
- Operating cash flow improved from $985 million to $1.561 billion. The company ended the year with $3.538 billion of cash and short-term investments, up from $2.593 billion.
- The company began accruing for partially earned frequent-flyer awards in 2010, retrospectively adjusting the 2009 balance sheet; management said the change did not materially affect 2010 earnings or cash flows.
Outlook, risks and unusual items
- Management described the 2011 outlook as solid absent increased fuel-price volatility or slowing travel demand. It forecast 2011 available seat miles to increase approximately 5%–6% versus 2010, while not intending significant overall fleet growth apart from the proposed AirTran acquisition. January 2011 passenger unit revenue was estimated to be up 8%–9% year over year.
- As of January 18, 2011, estimated economic fuel cost for first-quarter 2011 was approximately $2.80 per gallon. Fuel hedges covered varying portions of estimated consumption through 2014; management cautioned that hedging can increase costs relative to unhedged market prices in some periods and create earnings volatility.
- Southwest had agreed to acquire AirTran, subject to AirTran shareholder approval and regulatory clearances, with closing anticipated in second-quarter 2011. The company projected more than $400 million of annual net synergies by 2013 and approximately $500 million of one-time acquisition and integration costs; these were expectations, not achieved results. Integration, labor alignment, aircraft and systems complexity, regulatory approval, litigation, and assumed AirTran debt were identified risks.
- Fuel-hedge accounting materially affected reported results: Southwest recorded $426 million of fuel-hedging losses in 2010 across fuel expense and other gains/losses. The filing emphasizes that GAAP and company-defined economic/non-GAAP results differ.
- Other notable items included $7 million of 2010 pretax AirTran-related costs and a $9 million increase in depreciation expense from lowering residual-value estimates for older 737-300 and 737-500 aircraft. The latter had no reported EPS impact.
- Material exposures include fuel-price swings, labor costs and negotiations, airport cost inflation, regulatory and security requirements, dependence on Boeing and a single engine supplier, and possible collateral demands under fuel-hedge agreements. The company also guaranteed principal and interest on $310 million of Dallas Love Field modernization bonds; the project was expected to cost approximately $519 million.
- Several lawsuits challenged the AirTran merger. A conditional settlement memorandum covered two cases, subject to court approval and other conditions; other merger approvals and conditions remained outstanding at the filing date.
Most important facts for investors to verify
- Whether the AirTran transaction received approvals, closed on schedule, and delivered the projected synergies without integration costs materially exceeding estimates.
- Actual fuel prices, hedge settlements, collateral requirements, and the difference between GAAP earnings and management’s non-GAAP measures.
- Whether revenue and load-factor momentum persisted while fuel, labor, and airport costs increased.
- Cash available after aircraft commitments, debt maturities, AirTran cash consideration and integration spending; also review lease commitments and the Love Field guarantee.
- Progress on labor negotiations, the reservations-system replacement, and the new Rapid Rewards program, including their costs and revenue effects.
- Any material developments in merger litigation, regulatory conditions, or other contingencies. The filing reports an unqualified audit opinion and effective internal controls over financial reporting as of December 31, 2010.