Southwest Airlines Co. — 2012 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2012. The filing also reports fourth-quarter results. Southwest operated alongside AirTran, acquired in May 2011; therefore, 2012 includes a full year of AirTran results, compared with approximately eight months in 2011.
Business context
Southwest principally operated a point-to-point network, while AirTran largely used a hub-and-spoke model. Together, the airlines served 97 destinations and operated 694 aircraft at year-end. The company’s strategy centered on AirTran integration, fleet modernization, revenue initiatives, and adding international capabilities.
Financial and operating performance
| Metric | 2012 | 2011 |
|---|---|---|
| Operating revenue | $17.088 billion | $15.658 billion |
| Operating income | $623 million | $693 million |
| Operating margin | 3.6% | 4.4% |
| Net income | $421 million | $178 million |
| Diluted earnings per share | $0.56 | $0.23 |
| Operating cash flow | $2.064 billion | $1.356 billion |
| Capital expenditures, net | $1.348 billion | $968 million |
| Year-end cash and short-term investments | $2.970 billion | $3.144 billion |
| Long-term debt, excluding current maturities | $2.883 billion | $3.107 billion |
- Revenue rose 9.1%; management attributed most of the increase to including a full year of AirTran. Excluding AirTran in both years, revenue increased 5.5%, mainly on higher passenger yields.
- Operating expenses increased 10.0%, faster than revenue. Operating income declined 10.1%; reported operating margin fell to 3.6% from 4.4%. On the company’s non-GAAP basis, operating income was $838 million, approximately flat year over year.
- Reported net income increased sharply, but comparisons were affected by fuel-hedge accounting and special charges. Non-GAAP net income was $417 million versus $330 million, up 26.4%.
- Fuel and oil expense was $6.120 billion, 37.2% of operating expenses; average fuel cost was $3.30 per gallon versus $3.19. Unit operating costs rose 3.5%; non-GAAP unit costs excluding fuel and special items rose 4.2%.
- Fourth-quarter revenue was $4.173 billion, operating income $91 million, and net income $78 million, compared with $4.108 billion, $147 million, and $152 million, respectively, in fourth-quarter 2011.
- Investing cash outflow was $833 million and financing cash outflow was $947 million. The company repaid $578 million of debt and capital-lease obligations and repurchased about $400 million of stock during 2012.
- Current assets were $4.227 billion and current liabilities $4.650 billion. The company also had an undrawn $800 million revolving credit facility, investment-grade credit ratings, and approximately $6.8 billion of unencumbered aircraft book value.
Material changes and unusual items
- The company recorded $183 million of AirTran acquisition and integration expense in 2012, compared with $134 million in 2011. Management expected total acquisition and integration costs not to exceed $550 million.
- A $137 million third-quarter charge related to transitioning AirTran’s 88 Boeing 717 aircraft to Delta was included in acquisition and integration costs. Deliveries to Delta were expected to begin in August 2013.
- Fuel-hedging activity produced a net $28 million gain across fuel expense and other gains/losses in 2012, compared with a net $259 million loss in 2011. These accounting effects materially influenced reported results.
- Changes to retirement assumptions and residual values for older 737-300/500 aircraft increased 2012 depreciation expense by approximately $46 million in total; the residual-value change was expected to add about $58 million to 2013 expense.
- Air traffic liability increased to $2.170 billion from $1.836 billion. It includes advance ticket sales and frequent-flyer-related obligations.
Outlook, risks and contingencies
- Management expected 2013 capacity, measured by available seat miles, to increase approximately 2%, with the fleet kept relatively flat. It forecast net pre-tax AirTran synergies of approximately $400 million in 2013, excluding integration costs.
- Management expected a solid year-over-year increase in first-quarter 2013 passenger unit revenue. It forecast first-quarter unit costs excluding fuel, profitsharing, and special items to rise 5%–6% year over year. The projected 2013 full-year effective tax rate was approximately 38%–40%.
- Key strategic plans included continued AirTran network and workforce integration; new revenue-management and reservation systems; international service capability; and delivery of new aircraft. The company planned to begin Southwest service to San Juan in April 2013 and expected its international reservation system to be substantially complete in 2014.
- Fuel prices remain a major risk: a one-cent-per-gallon change was estimated to affect 2013 fuel expense by about $18 million before hedging. Hedge coverage was limited for 2013, and hedge ineffectiveness, counterparty exposure, and collateral needs could affect results and liquidity.
- Labor costs and negotiations are material risks: approximately 83% of employees were union-represented, and several major Southwest agreements were in negotiation or became amendable in 2013.
- Other significant risks include execution of AirTran integration and expected synergies, technology and reservation-system implementation, intense competition and economic uncertainty, aircraft-supplier concentration, and possible regulatory, security, weather, or operational disruptions.
- AirTran remained a defendant in antitrust litigation concerning baggage fees and pricing. Plaintiffs had abandoned the capacity-reduction claim, but remaining claims and class certification were unresolved; the company said outcomes could not be predicted with certainty.
- Contractual obligations totaled $20.683 billion, including $12.075 billion of aircraft purchase commitments and $4.393 billion of net operating-lease commitments. The company guaranteed debt service for Dallas Love Field modernization; the project was then expected to cost about $519 million.
Most important facts for investors to verify
- Whether reported earnings growth translates into durable operating improvement, given lower operating income and the impact of fuel-hedge accounting and special charges.
- Actual AirTran synergies achieved against management’s approximately $400 million 2013 target, net of integration costs.
- Fuel prices, hedge coverage and settlements, and any related collateral or counterparty demands.
- Progress on labor agreements, fleet transitions, and planned cost increases, including the 717 transfer and older-aircraft retirements.
- Delivery and financial performance of the new reservation and revenue-management systems, and the timing and economics of international expansion.
- Developments in the AirTran antitrust litigation, Dallas Love Field commitments, and aircraft purchase and lease obligations.