Southwest Airlines Co. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This annual filing also reports fourth-quarter results; it is not a standalone quarterly filing. Southwest operated 750 Boeing 737 aircraft and served 99 destinations across the United States and near-international markets.
Financial performance
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Operating revenue | $21.965 billion | $21.146 billion | +3.9% |
| Operating income | $3.206 billion | $3.407 billion | -5.9% |
| Net income | $2.465 billion | $3.357 billion | -26.6% |
| Diluted EPS | $4.29 | $5.57 | -23.0% |
| Operating cash flow | $4.893 billion | $3.929 billion | +24.5% |
- GAAP operating margin was approximately 14.6%, versus 16.1% in 2017. GAAP net income declined principally because 2017 included a noncash $1.3 billion tax benefit from the Tax Cuts and Jobs Act. Excluding special items and fuel-hedge accounting effects, 2018 net income was $2.435 billion, up 15.1%, and diluted EPS was $4.24, up 20.8%.
- Revenue growth reflected passenger revenue up 3.5%, supported by capacity growth of 3.9% and strong demand. Operating unit revenue was flat year over year; load factor edged down to 83.4% from 83.9%.
- Operating expenses increased 5.8%, faster than capacity. Fuel expense rose 13.2% to $4.616 billion; average economic fuel cost was $2.20 per gallon, up from $2.06. Salaries, wages, and benefits were $7.649 billion, about 41% of operating expenses.
- Capital expenditures were $1.922 billion. Cash and cash equivalents were $1.854 billion and short-term investments $1.835 billion at year-end. The company reported $3.396 billion of debt and capital leases before current maturities and discounts; the balance sheet showed $606 million of current debt maturities and $2.771 billion of long-term debt, net of current maturities.
- Stockholders’ equity was $9.853 billion and total assets were $26.243 billion. Southwest had an unused $1 billion revolving credit facility and investment-grade ratings. It reported a customary working-capital deficit, largely associated with advance ticket sales and loyalty obligations.
- For Q4 2018, revenue was $5.704 billion, operating income $820 million, net income $654 million, and diluted EPS $1.17. Q4 2017 net income of $1.747 billion and diluted EPS of $2.94 included the tax-law remeasurement benefit.
Material changes and capital allocation
- Passenger revenue increased $692 million; other revenue rose 10.3%, primarily from co-branded credit-card activity. A May 2018 fare sale following the Flight 1380 accident reduced estimated passenger revenue by approximately $130 million.
- Southwest generated its 46th consecutive profitable year. It returned $2.3 billion to shareholders in 2018: $2.0 billion in share repurchases and $332 million in dividends. The annual dividend per share increased to $0.605 from $0.475.
- The company adopted new revenue, retirement-cost presentation, and hedge-accounting standards in 2018; prior periods were recast where applicable. The revenue standard notably changed loyalty-program accounting and increased the reported loyalty liability. At year-end, loyalty liabilities were approximately $3.0 billion.
- Southwest planned to adopt the new lease standard on January 1, 2019. It estimated approximately $1.4 billion of operating-lease right-of-use assets and liabilities would be added, alongside removal of about $1.5 billion of assets constructed for others and related construction obligations; management did not expect a significant impact on results or cash flows.
Outlook, risks, and contingencies
- Management planned 2019 available-seat-mile growth of no more than 5%, with Q1 growth of 3.5%–4%. Based on booking trends at the filing date, it estimated Q1 operating unit revenue growth of 4%–5%, assuming no further significant government-shutdown impact. It expected Q1 unit costs, excluding fuel and profit sharing, to increase approximately 6%; the full-year 2019 effective tax rate was projected at approximately 23.5%.
- Southwest intended to begin Hawaii service in 2019, subject to government approvals, including FAA ETOPS certification. The application process had been delayed by the government shutdown. The company also planned 2019 capital expenditures of approximately $1.9 billion and expected its fleet to reach about 775 aircraft by year-end.
- Key operating risks include volatile fuel prices, intense fare and capacity competition, labor-cost pressure, and reliance on Boeing as its sole aircraft supplier. Approximately 83% of employees were union-represented; several large workgroups were negotiating contracts. Weather disruptions caused about 2,200 cancellations in Q3 2018.
- Other risks include operational or cybersecurity system interruptions, regulatory and airport constraints, and execution of international expansion and Hawaii service. The April 2018 Flight 1380 engine failure caused a customer fatality; management identified the related fare-sale revenue impact, while this summary does not assess the accident’s ultimate financial or legal consequences.
- A proposed U.S. class settlement of capacity-related antitrust claims involved a $15 million payment and cooperation; final approval was scheduled for March 2019. Southwest denied wrongdoing. The filing also describes a DOJ capacity inquiry and Canadian litigation. Management did not expect currently ongoing legal proceedings or identified IRS adjustments to materially affect financial condition, results, or cash flow.
- Contractual obligations totaled $16.797 billion, including $10.208 billion of aircraft purchase commitments. The company had guaranteed certain airport-project financing obligations, including $416 million of outstanding Dallas Love Field bonds; airport project timing could affect liquidity.
Important facts for investors to verify
- Compare GAAP and non-GAAP earnings carefully: 2017 GAAP results include a large, nonrecurring tax benefit, while management’s adjusted measures exclude specified items and hedge effects.
- Track jet-fuel prices, hedge coverage and settlements, and the assumptions behind estimated economic fuel costs; a one-cent-per-gallon fuel-price change was estimated to affect 2019 expense by about $22 million before hedging.
- Monitor Hawaii ETOPS approval, launch timing, route economics, and the expected capacity and cost growth against management’s outlook.
- Assess labor negotiations and wage trends, along with the ability to manage rising costs amid competitive fare pressure.
- Review aircraft purchase commitments, liquidity and capital returns, the 2019 lease-accounting transition, and developments in the Flight 1380 matter and pending legal proceedings.