Southwest Airlines Co. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Southwest operates scheduled passenger service in the United States and near-international markets. Comparisons are against 2020, when the COVID-19 pandemic severely reduced air travel; 2020 therefore provides a disrupted baseline.
Financial performance and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Operating revenue | $4.679 billion | $1.793 billion | $10.739 billion | $7.035 billion |
| Operating income (loss), GAAP | $733 million | ($1.411 billion) | $1.526 billion | ($2.648 billion) |
| Net income (loss), GAAP | $446 million | ($1.157 billion) | $909 million | ($2.166 billion) |
| Diluted EPS, GAAP | $0.73 | ($1.96) | $1.49 | ($3.89) |
| Operating income (loss), excluding special items (non-GAAP) | ($59 million) | ($1.577 billion) | ($1.490 billion) | ($3.841 billion) |
| Net income (loss), excluding special items (non-GAAP) | ($135 million) | ($1.173 billion) | ($1.356 billion) | ($2.751 billion) |
| Diluted EPS, excluding special items (non-GAAP) | ($0.23) | ($1.99) | ($2.29) | ($4.95) |
GAAP operating margin was approximately 15.7% in Q3 2021, compared with a loss in Q3 2020. That reported profit included $763 million of U.S. Treasury payroll-support grant allocations, recorded as a reduction of expense. Excluding special items, Southwest remained loss-making. The filing reports Q3 operating expenses per available seat mile (ASM) of 10.18 cents, down 15.9% year over year; fuel costs rose materially.
- Revenue and demand: Q3 passenger revenue was $4.227 billion, versus $1.454 billion. Capacity (ASMs) rose 46.4%; load factor improved to 80.7% from 44.9%. Passenger revenue reached 83% of Q3 2019 levels, and passengers carried reached 87% of 2019 levels. The Delta variant weakened close-in bookings and contributed to elevated cancellations.
- Cash flow: Q3 operating cash flow was negative $575 million, compared with negative $1.050 billion a year earlier. Nine-month operating cash flow was positive $2.075 billion, versus negative $531 million. The 2021 year-to-date figure included $2.7 billion of payroll-support grants and a $1.1 billion increase in air traffic liability. Nine-month capital expenditures were $325 million.
- Liquidity: At September 30, cash and cash equivalents were $12.980 billion and short-term investments were $3.024 billion, or approximately $16.0 billion combined. Current assets were $18.554 billion and current liabilities $9.135 billion. Southwest reported no borrowings under its $1.0 billion revolving credit facility and compliance with its $1.5 billion minimum-liquidity covenant.
- Debt: Current maturities of long-term debt were $225 million and long-term debt was $11.013 billion, totaling $11.238 billion. The company repurchased $80 million principal of convertible notes for $121 million cash during Q3, recording a $12 million extinguishment loss.
- Other balance-sheet items: Air traffic liability was $8.236 billion, up from $7.133 billion at year-end 2020. It includes advance ticket sales, customer travel funds and loyalty obligations. Shareholders’ equity was $10.250 billion.
Material changes versus the prior comparable period
- Revenue and operating results rebounded sharply from pandemic-depressed Q3 2020 levels, primarily as domestic leisure travel improved. Q3 2021 revenue was still below 2019 levels.
- Higher flying activity increased variable expenses, while higher jet fuel prices were a significant cost pressure: Q3 fuel and oil expense rose 161.2% year over year, and fuel cost per gallon including tax rose to $2.01 from $1.18.
- Government payroll assistance materially affected reported costs and GAAP earnings. Year-to-date 2021 included $2.7 billion of grant allocations, compared with $2.3 billion in the first nine months of 2020.
- Southwest’s nine-month air traffic liability increased, reflecting stronger ticket sales and deferred passenger and loyalty revenue. The company estimated that $1.4 billion of customer travel funds in that liability had a September 7, 2022 expiration date.
Outlook, risks and unusual items
- Q4 outlook: Management did not expect the company to be profitable in Q4 2021. It estimated Q4 operating revenue would be down 15%–25% versus Q4 2019, load factor of 80%–85%, and ASMs down approximately 8% versus Q4 2019. Excluding fuel, special items and profitsharing, Q4 unit costs were expected to increase 8%–12% versus Q4 2019, reflecting labor and airport-cost inflation, staffing investments and lower productivity.
- Near-term demand: Management estimated Delta-related demand weakness reduced August and September 2021 operating revenue by approximately $100 million and $200 million, respectively, and could reduce Q4 revenue by approximately $100 million. October guidance was unchanged despite estimated impacts from Delta-related weakness and operational cancellations; management said improving demand trends offset these headwinds. Managed business revenue in September remained 73% below September 2019.
- Operations and staffing: Earlier October 2021 operational challenges led to flight cancellations and customer refunds and goodwill costs. The filing identifies hiring and retaining qualified employees, wage inflation, and potential effects of federal vaccination requirements on employees and vendors as risks. Southwest was targeting approximately 5,000 new hires by year-end.
- Fuel and fleet: Fuel-price volatility and the effectiveness, valuation and accounting treatment of fuel hedges could affect results. Southwest had fuel derivative contracts with a reported fair value asset of $681 million. Boeing MAX-7 certification and delivery timing remained dependent on FAA approvals; the company also had substantial aircraft commitments and options.
- Government support and shareholder returns: Payroll-support programs provided grants and loans; related restrictions barred share repurchases and dividends through September 30, 2022, and limited executive compensation through April 1, 2023. Share repurchases remained suspended.
- Unusual accounting items: The filing records a $140 million net reversal of Extended ETO accruals in the first nine months of 2021, an $88 million correction of previously underaccrued payroll tax credits, and a $60 million correction of prior-period investment gains. Management stated these corrections were not material to prior-period statements and were not expected to be material to full-year 2021 statements.
- Contingencies: Litigation includes claims concerning the Boeing 737 MAX and alleged airline capacity coordination, as well as securities and derivative actions. A court certified four classes in a MAX-related case; the company and Boeing received permission to appeal the certification. Management said it did not expect current legal proceedings or IRS adjustments to have a material adverse effect, but outcomes remain uncertain.
Most important facts for investors to verify
- How much of reported profitability and operating cash generation depends on government grants, tax credits, and changes in customer advance-ticket balances.
- Whether revenue, load factor and business travel recover toward 2019 levels, and whether the Q4 revenue and cost estimates were achieved.
- Whether staffing constraints, wage inflation and operational reliability affect capacity, cancellations, customer refunds or costs.
- How fuel prices and hedge settlements affect cash fuel costs, and whether hedge coverage provides the expected protection.
- Debt repayment needs, aircraft purchase commitments, and the effect of payroll-support restrictions on dividends and repurchases.
- Developments in Boeing MAX certification and delivery schedules, vaccination-related workforce risks, and material litigation proceedings.