Using the information contained in the 10-K, (Financial Statements prepare a one
ID: 2726028 • Letter: U
Question
Using the information contained in the 10-K, (Financial Statements prepare a one page memo evaluating Southwest Airlines. In the memo, be sure to discuss
a) the business environment in which the company operates
b) the company’s profitability and risk
c) any adjustments that are necessary to enhance comparability and usefulness of accounting information while performing the financial analysis
d) a discussion of the company’s growth and future prospects
SOUTHWEST AIRLINES CO.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in millions, except per share amounts)
Year Ended
Year Ended
Year Ended
December 31
December 31,
December 31,
2013
2014
2015
OPERATING REVENUES:
Passenger
16,721$
17,658$
18,299$
Freight
164
175
179
Special revenue adjustment
-
-
172
Other
814
772
1,170
Total operating revenues
17,699
18,605
19,820
OPERATING EXPENSES:
Salaries, wages, and benefits
5,035
5,434
6,383
Fuel and oil
5,763
5,293
3,616
Maintenance materials and repairs
1,080
978
1,005
Aircraft rentals
361
295
238
Landing fees and other rentals
1,103
1,111
1,166
Depreciation and amortization
867
938
1,015
Acquisition and integration
86
126
39
Other operating expenses
2,126
2,205
2,242
Total operating expenses
16,421
16,380
15,704
OPERATING INCOME
1,278
2,225
4,116
OTHER EXPENSES (INCOME):
Interest expense
131
130
121
Capitalized interest
(24)
(23)
(31)
Interest income
(6)
(7)
(9)
Other (gains) losses, net
(32)
309
556
Total other expenses
69
409
637
INCOME BEFORE INCOME TAXES
1,209
1,816
3,479
PROVISION FOR INCOME TAXES
455
680
1,298
NET INCOME
754$
1,136$
2,181$
NET INCOME PER SHARE, BASIC
$ 1.06
$ 1.65
$ 3.30
NET INCOME PER SHARE, DILUTED
$ 1.05
$ 1.64
$ 3.27
WEIGHTED AVERAGE SHARES
Basic
710
687
661
Diluted
718
696
SOUTHWEST AIRLINES CO.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in millions, except per share amounts)
Year Ended
Year Ended
Year Ended
December 31
December 31,
December 31,
2013
2014
2015
OPERATING REVENUES:
Passenger
16,721$
17,658$
18,299$
Freight
164
175
179
Special revenue adjustment
-
-
172
Other
814
772
1,170
Total operating revenues
17,699
18,605
19,820
OPERATING EXPENSES:
Salaries, wages, and benefits
5,035
5,434
6,383
Fuel and oil
5,763
5,293
3,616
Maintenance materials and repairs
1,080
978
1,005
Aircraft rentals
361
295
238
Landing fees and other rentals
1,103
1,111
1,166
Depreciation and amortization
867
938
1,015
Acquisition and integration
86
126
39
Other operating expenses
2,126
2,205
2,242
Total operating expenses
16,421
16,380
15,704
OPERATING INCOME
1,278
2,225
4,116
OTHER EXPENSES (INCOME):
Interest expense
131
130
121
Capitalized interest
(24)
(23)
(31)
Interest income
(6)
(7)
(9)
Other (gains) losses, net
(32)
309
556
Total other expenses
69
409
637
INCOME BEFORE INCOME TAXES
1,209
1,816
3,479
PROVISION FOR INCOME TAXES
455
680
1,298
NET INCOME
754$
1,136$
2,181$
NET INCOME PER SHARE, BASIC
$ 1.06
$ 1.65
$ 3.30
NET INCOME PER SHARE, DILUTED
$ 1.05
$ 1.64
$ 3.27
WEIGHTED AVERAGE SHARES
Basic
710
687
661
Diluted
718
696
Explanation / Answer
Answer
Answer (a) & (b)
The business environment in which the company operates & the company’s profitability and risk
The airline industry has historically been an extremely volatile industry subject to numerous challenges. Among other things, it has been cyclical, energy intensive, labor intensive, capital intensive, technology intensive, highly regulated, heavily taxed, and extremely competitive. The airline industry has also been particularly susceptible to detrimental events such as acts of terrorism, poor weather, and natural disasters. The U.S. airline industry benefited from moderate economic growth during 2015 and was further aided by a significant drop in fuel prices. The U.S. airline industry, including Southwest, has increased available seat miles, and has increased the number of seats per trip through slimline seat retrofits and the use of larger aircraft.
Southwest Airlines Co. operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States and near-international markets. For the 43rd consecutive year, the Company was profitable, earning $2.2 billion in net income. Southwest commenced service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities: Dallas, Houston, and San Antonio. The Company ended 2015 serving 97 destinations in 40 states, the District of Columbia, the Commonwealth of Puerto Rico, and seven near-international countries including Mexico, Jamaica, The Bahamas, Aruba, Dominican Republic, Costa Rica, and Belize. During 2015, the Company added its first three destinations in Central America (San Jose, Costa Rica, Belize City, Belize, and Liberia, Costa Rica) and also commenced Southwest service to a fourth destination in Mexico (Puerto Vallarta). At December 31, 2015, Southwest operated a total of 704 Boeing 737 aircraft. During 2015, the Company also added 20 domestic nonstop destinations from Dallas Love Field. These routes were made possible by the repeal of certain federal flight restrictions at Dallas Love Field in October 2014. At year-end 2015, Southwest offered a total of 180 weekday departures to 50 nonstop destinations from Dallas Love Field. In addition, the Company added eight international nonstop destinations from a newly constructed five-gate international terminal at Houston’s William P. Hobby Airport. Based on the most recent data available from the U.S. Department of Transportation, as of June 30, 2015, Southwest was the largest domestic air carrier in the United States, as measured by the number of domestic originating passengers boarded.
Southwest principally provides point-to-point service, rather than the “hub-and-spoke” service provided by most major U.S. airlines. The hub-and-spoke system concentrates most of an airline’s operations at a limited number of central hub cities and serves most other destinations in the system by providing one-stop or connecting service through a hub. By not concentrating operations through one or more central transfer points, Southwest’s point-to-point route structure has allowed for more direct nonstop routing than hub-and-spoke service. Approximately 74 percent of the Company’s Customers flew nonstop during 2015, and, as of December 31, 2015, Southwest served 637 nonstop city pairs. Southwest’s point-to-point service has also enabled it to provide its markets with frequent, conveniently timed flights and low fares. For example, Southwest currently offers 20 weekday roundtrips from Dallas Love Field to Houston Hobby, 14 weekday roundtrips from Los Angeles International to Oakland, 12 weekday roundtrips from Burbank to Oakland, 11 weekday roundtrips from Phoenix to Las Vegas, and ten weekday roundtrips from San Diego to San Jose. Southwest complements its high-frequency short-haul routes with long-haul nonstop service between markets such as Los Angeles and Nashville, Las Vegas and Orlando, San Diego and Baltimore, and Houston and New York LaGuardia. During 2015, the Company continued to incorporate the Boeing 737-800 into its fleet, which offers significantly more Customer seating capacity than Southwest’s other aircraft. This has enabled the Company to more economically serve long-haul routes, as well as high-demand, slot-controlled and gate-restricted airports, by adding seats for such routes without increasing the number of flights. For 2015, the Company’s average aircraft trip stage length was 750 miles, with an average duration of approximately 2.0 hours, as compared with an average aircraft trip stage length of 721 miles and an average duration of approximately 2.0 hours in 2014. During 2014, the Company also operated AirTran Airways. AirTran’s final passenger service occurred on December 28, 2014, and it has been integrated into Southwest.
Southwest Airlines launched international service in 2014, and ended 2015 with service to 11 international destinations. The Company’s international expansion in 2015 was facilitated by the completion of construction of a new five-gate international terminal at Houston’s William P. Hobby Airport. The new terminal includes an expanded security checkpoint and an upgraded Southwest ticketing area. Approximately $287 million of the Company’s 2015 operating revenues were attributable to foreign operations. The remainder of the Company’s 2015 operating revenues, approximately $19.5 billion, was attributable to domestic operations. Approximately $226 million of the Company’s 2014 operating revenues were attributable to foreign operations (including those attributable to both Southwest and AirTran). The remainder of the Company’s 2014 operating revenues, approximately $18.4 billion, was attributable to domestic operations.
Southwest Airlines Co. (LUV) : (Source : Yahoo Finance)
Financial Highlights
Fiscal Year
Fiscal Year Ends:
31 Dec
Most Recent Quarter (mrq):
31-Mar-2016
Profitability
Profit Margin (ttm):
11.16%
Operating Margin (ttm):
22.22%
Management Effectiveness
Return on Assets (ttm):
12.84%
Return on Equity (ttm):
31.10%
Income Statement
Revenue (ttm):
20.06B
Revenue Per Share (ttm):
30.73
Qtrly Revenue Growth (yoy):
9.30%
Gross Profit (ttm):
13.80B
EBITDA (ttm)6:
5.41B
Net Income Avl to Common (ttm):
2.24B
Diluted EPS (ttm):
3.40
Qtrly Earnings Growth (yoy):
12.80%
Balance Sheet
Total Cash (mrq):
3.58B
Total Cash Per Share (mrq):
5.61
Total Debt (mrq):
3.35B
Total Debt/Equity (mrq):
44.74
Current Ratio (mrq):
0.55
Book Value Per Share (mrq):
11.74
Profitability ratios of the company is comfortable.
Answer c)
Any adjustments that are necessary to enhance comparability and usefulness of accounting information while performing the financial analysis
Adjustments needed for financial analysis is as follows
Balance sheet: We adjust the value of certain items, remove the artificial effects of smoothing permitted by accounting standards, recognize certain off-balance sheet transactions, and change the debt versus equity classification of certain hybrid financial instruments with both debt and equity features.
Income statement: We eliminate the effects of certain smoothing, recognize additional expenses, attribute interest to new debt that we recognize, and segregate the effects of unusual or non-recurring items.
Cash flow statement: We adjust the cash flow statement to be consistent with our adjustments to the balance sheet and income statement. For example, we identify and segregate the cash effects of the unusual transactions and events that we separate on the income statement.
Answer (d)
A discussion of the company’s growth and future prospects
Following the Company’s effective completion of the AirTran integration at the end of 2014, one of the Company’s primary areas of focus was on allowing its expanded network to develop, while also improving the reliability of its operations. Throughout most of 2015, the Company had a significantly higher than normal portion of its network considered under development, due to new service implemented upon converting both international and domestic destinations over from AirTran to Southwest, as well as growth in existing Southwest markets including Dallas, Houston, Washington D.C, and New York. In 2016, the portion of those markets under development will return to a more long-term historical figure based on capacity. Following the integration of AirTran, the Company also made investments in its 2015 flight schedule to improve its overall on-time performance. The Company’s on-time performance during 2015 as reported through November 2015 was approximately 80 percent, which increased approximately 7 points compared to full year 2014.
During 2015, the Company took several steps designed to enhance its existing service in cities across the network or to connect existing cities with new service not previously offered by Southwest, most notably:
The Company began offering daily nonstop flights to 20 new cities from Dallas Love Field, marking the Company’s most robust schedule ever offered at Dallas Love Field, with 180 daily departures to 50 nonstop destinations.
• The Company connected Central America to the Company’s network with the addition of Liberia, Costa Rica; San Jose, Costa Rica; and Belize City, Belize in 2015.
• The Company began service to Puerto Vallarta, Mexico in June 2015.
• During October 2015, the all-new international terminal at Houston Hobby opened and the Company commenced service from Houston Hobby to Mexico (Cancun, Mexico City, Puerto Vallarta, Cabo San Lucas/Los Cabos), Belize City, Belize; San Jose, Costa Rica; Liberia, Costa Rica; and Montego Bay, Jamaica.
During 2015, the Company took delivery of 19 737-800 aircraft from Boeing and 24 pre-owned Boeing 737-700 aircraft from third parties, and retired four Boeing 737 Classic (737-300 and 737-500) aircraft during the year. Following AirTran’s final passenger service on December 28, 2014, the Company removed all remaining Boeing 717-200 aircraft (“B717s”) from service. As of December 31, 2015, 87 of AirTran’s 88 B717 aircraft had been delivered to Delta pursuant to a lease/sublease agreement, and one B717 aircraft was undergoing conversion in preparation for delivery to Delta.
The Company is scheduled to be the launch customer for Boeing’s new, more fuel-efficient 737 MAX 8 aircraft, which is expected to enter service in 2017. The 737 MAX 8 is expected to reduce fuel burn and CO2 emissions approximately 20 percent, compared with the original Next-Generation 737s (737- 300 and 737-500) when they first entered service. Southwest is also scheduled to be the launch customer for the Boeing 737 MAX 7 series aircraft, with deliveries expected to begin in 2019. Currently, the Company has firm orders in place for 170 MAX 8 aircraft and 30 MAX 7 aircraft.
At the end of December 2015, the Company revised its future firm delivery schedule to reflect 33 additional -800s, and the conversion of its remaining 25 -700 firm orders to -800s. In addition, two preowned -700s were added to its delivery schedule. The incremental seat gauge and aircraft will be used to replace the capacity associated with the Company’s year-end decision to further accelerate the retirement of its Classic fleet to no later than mid-2018, as compared to the previous plan of 2021. The Company continues to plan for modest year-over-year fleet growth through 2018 of no more than two percent, on average. The Company also expects an approximate five to six percent increase year-over year in 2016 ASMs. The revised delivery schedule is currently estimated to increase the Company’s firm aircraft capital commitments by $400 million beyond 2015. Replacing the Boeing 737-300s and Boeing 737-500s with more efficient and cost-effective aircraft is expected to provide significant cost savings, along with improving the Customer experience with better ontime performance and WiFi equipped aircraft.
Financial Highlights
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