Southwest Airlines Co. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing also reports unaudited fourth-quarter results. Southwest acquired AirTran on May 2, 2011; consolidated 2011 results include AirTran only from the acquisition date, so annual comparisons are not like-for-like.
Business context
Southwest operates a predominantly domestic, point-to-point airline. Following the AirTran acquisition, the combined fleet comprised 698 aircraft at year-end, including Boeing 737s and 717s. Southwest served 72 cities in 37 states; AirTran also served selected international destinations. Southwest reported its 39th consecutive profitable year.
Financial performance
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Operating revenue | $15.658 billion | $12.104 billion |
| Operating income | $693 million | $988 million |
| Net income | $178 million | $459 million |
| Diluted EPS | $0.23 | $0.61 |
| Operating margin | 4.4% | 8.2% |
| Net margin | 1.1% | 3.8% |
| Operating cash flow | $1.385 billion | $1.561 billion |
Annual revenue rose 29.4%, largely reflecting AirTran’s inclusion. Excluding post-acquisition AirTran results, revenue increased 12.8% from 2010. AirTran contributed $2.0 billion in revenue and a $23 million net loss for the included period. Southwest’s load factor reached a record 80.9%, compared with 79.3% in 2010; passenger yield rose to 15.10 cents per revenue passenger mile from 14.72 cents.
Fuel was the main profitability pressure: expense was $5.644 billion, up 55.9%, and represented about 37.7% of operating expenses. Average fuel cost was $3.19 per gallon versus $2.51. Operating expenses rose 34.6%, faster than revenue. Non-GAAP operating income was $839 million and non-GAAP net income was $330 million; these company-defined measures exclude specified fuel-hedge accounting effects and special items, including $134 million of acquisition/integration expense and a $17 million RNP-related impairment charge.
Fourth quarter: Revenue was $4.108 billion versus $3.114 billion in Q4 2010; operating income was $147 million versus $216 million; net income was $152 million versus $131 million. Operating and net margins were approximately 3.6% and 3.7%, respectively, compared with 6.9% and 4.2% in Q4 2010. AirTran is included in 2011 quarterly results from May onward.
Balance sheet, liquidity and cash flow
- Year-end cash and cash equivalents were $829 million and short-term investments were $2.315 billion, totaling about $3.144 billion in available cash and short-term investments.
- Total assets were $18.068 billion; stockholders’ equity was $6.877 billion. Debt and capital lease obligations were $3.777 billion before current maturities and debt discounts; $644 million was classified as current maturities.
- Operating cash flow of $1.385 billion was below 2010’s $1.561 billion. Investing cash use was $1.051 billion and financing cash use was $766 million. Financing uses included $540 million of debt and lease repayments, $225 million of share repurchases, and $81 million paid to convertible note holders.
- The company had an undrawn $800 million unsecured revolver expiring in 2016 and stated it was in compliance with its financial covenant. It reported investment-grade ratings and approximately $6.2 billion of unencumbered aircraft book value.
- Contractual obligations totaled $23.197 billion, including $12.622 billion of aircraft purchase commitments and $5.583 billion of operating lease commitments. The company also had $230 million of outstanding letters of credit.
Material changes versus the prior period
- Net income fell 61.2% and operating income fell 29.9% year over year; management attributed the primary decline to higher fuel costs, alongside acquisition/integration costs and fuel-hedge accounting impacts.
- AirTran expanded the network, assets, workforce, and debt. The acquisition’s total transaction value, including acquired debt and capitalized aircraft operating leases, was approximately $3.2 billion. Southwest recorded $970 million of goodwill.
- Annual capacity increased 22.5% on a consolidated basis, partly due to AirTran; revenue passenger miles rose to 97.6 billion from 78.0 billion. Southwest-only capacity increased 5.5%.
- Repurchases resumed in 2011: approximately 27.5 million shares for $225 million during the year, within a $500 million authorization. Dividends remained $0.018 per share for the year.
Outlook, commentary and risks
- Management expected AirTran integration to take several years, with estimated net annual synergies exceeding $400 million in 2013, excluding integration costs. Integration and closing costs were estimated at approximately $500 million through 2014; $134 million was incurred in 2011.
- For 2012, the company planned to keep overall fleet size broadly flat, with ASMs approximately matching combined 2011 levels; it expected 33 Boeing 737-800 deliveries and retirement of about 40 older 737-300/500 aircraft. Management cited strong January 2012 passenger unit revenue trends, up approximately 7% year over year on a combined comparison.
- Fuel exposure remains substantial. At January 2012, management said first-half 2012 hedge coverage was minimal; hedge coverage increased for later periods. Fuel derivatives can be ineffective or create earnings volatility, and the company reported $226 million of cash collateral posted to fuel counterparties at year-end.
- Key risks include fuel-price volatility, economic weakness and fare pressure, airline competition, labor costs and negotiations, execution and expense risks from AirTran integration, information-system disruption, aircraft/supplier concentration, regulation and potential taxes, and credit-rating or collateral triggers.
- AirTran remained a defendant in class antitrust litigation concerning baggage fees and alleged capacity/pricing coordination; the filing states outcomes cannot be predicted. Ordinary-course legal matters were not expected by management to materially affect results. Goodwill impairment testing found no impairment in 2011, but future impairment remains possible.
- Management expected first-quarter 2012 consolidated unit costs, excluding fuel, profitsharing and special items, to rise versus combined first-quarter 2011 levels. It projected a 2012 full-year effective tax rate of approximately 38%–40% on a non-GAAP basis.
Important facts for investors to verify
- Separate underlying Southwest performance from AirTran’s partial-year contribution when assessing growth and margins.
- Track realized fuel costs, hedge coverage, hedge ineffectiveness, deferred hedge losses, and collateral requirements.
- Test progress against AirTran integration milestones, the $400 million-plus synergy target, and the estimated $500 million integration-cost total.
- Review 2012 capacity, aircraft deliveries and retirements, and the effect of fleet changes on unit costs and capital needs.
- Monitor labor negotiations, the antitrust case, and the company’s debt maturities and large aircraft and lease commitments.