Southwest Airlines 2010 Annual Report Download - page 24

As discussed above under “Company Operations – Impact of Fuel Costs,” the Company has historically
entered into fuel derivative contracts to protect against rising fuel costs; however, because energy prices can
fluctuate significantly in a relatively short amount of time, the Company must also continually monitor and
adjust its fuel hedge portfolio and strategies to address fuel price volatility. These types of adjustments in the
Company’s overall fuel hedging strategy, as well as the ability of the commodities used in fuel hedging
(principally crude oil, heating oil, and unleaded gasoline) to qualify for special hedge accounting, have
historically significantly affected, and are likely to continue to affect, the Company’s results of operations. There
can be no assurance that the Company will be able to continue to cost-effectively hedge against increases in fuel
prices. The Company’s fuel hedging arrangements and the impact of hedge accounting on the Company’s results
of operations are discussed in more detail under “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and in Note 10 to the Consolidated Financial Statements.
The airline industry is particularly sensitive to changes in economic conditions; a return of unfavorable
economic conditions or an increase in economic uncertainty could negatively affect the Company’s results
of operations.
The airline industry is particularly sensitive to changes in economic conditions, which affect Customer
travel patterns and related revenues. For example, during 2008 and most of 2009, the Company’s results of
operations were negatively affected when unfavorable U.S. economic conditions drove changes in travel patterns
and resulted in reduced spending for both leisure and business travel. For some consumers, leisure travel was an
expendable discretionary expense, and short-haul travelers had the option to replace air travel with surface travel.
Businesses were able to forego air travel by using communication alternatives such as videoconferencing and the
Internet or were more likely to purchase less expensive tickets to reduce costs, which can result in a decrease in
average revenue per seat. Unfavorable economic conditions also hampered the ability of airlines to raise fares to
counteract increased fuel, labor, and other costs. Although U.S. economic conditions improved during 2010,
some uncertainty has remained. A return to unfavorable economic conditions, or even an increase in economic
uncertainty, could again negatively affect the Company’s results of operations and could cause the Company to
adjust its business strategies.
The Company’s low cost structure is one of its primary competitive advantages, and many factors could
affect the Company’s ability to control its costs.
The Company’s low cost structure has historically been one of its primary competitive advantages, as it has
enabled the Company to offer low fares, drive traffic volume, and grow market share. The Company’s low cost
structure has become increasingly important as the Company has controlled capacity growth. While the Company
has in the past been able to cover increasing costs through growth, the combination of capacity control and
increasing costs has contributed to an increase in the Company’s costs per available seat mile. The Company has
limited control, however, over increases in many of its costs. For example, the Company has limited control over
costs associated with fuel, labor, aircraft airframe and engine repairs, and regulatory compliance. Jet fuel and oil
constituted approximately 33 percent of the Company’s operating expenses during 2010, and the cost of fuel is
subject to the external factors discussed in the first Risk Factor above. Salaries, wages, and benefits constituted
approximately 33 percent of the Company’s operating expenses during 2010. The Company’s ability to control
labor costs is limited by the terms of its collective bargaining agreements, and increased labor costs have
impacted the Company’s low cost competitive position. As discussed further under “Management’s Discussion
and Analysis of Financial Condition and Results of Operations,” the Company’s unionized workforce, which
makes up the majority of its Employees, have had pay scale increases as a result of increased seniority and
contractual rate increases. In addition, as discussed under “Business-Regulation,” the airline industry is heavily
regulated, and the Company’s regulatory compliance costs are subject to potentially significant increases from
time to time based on actions by the regulatory agencies. Furthermore, when other airlines reduce their capacity,
airports costs are then allocated among a fewer number of total flights, which has resulted in increased landing
fees and other costs for the Company. The Company is also reliant upon third party vendors and service
providers, and its low cost advantage is also dependent in part on its ability to obtain and maintain commercially
reasonable terms with those parties.
18