SOUTHWEST AIRLINES CO quarterly report, Q2 FY2020

Southwest Airlines Co. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. Southwest operates scheduled passenger airline service in the United States and near-international markets. Results were severely affected by the COVID-19 pandemic and are not necessarily indicative of future periods.

Financial performance and liquidity

Amounts in U.S. dollars unless stated otherwise.

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Operating revenue	$1.008 billion	$5.909 billion	$5.242 billion	$11.059 billion
Operating income (loss)	$(1.127) billion	$968 million	$(1.237) billion	$1.473 billion
Net income (loss)	$(915) million	$741 million	$(1.009) billion	$1.128 billion
Diluted earnings (loss) per share	$(1.63)	$1.37	$(1.87)	$2.06
Operating cash flow	$897 million	$966 million	$520 million	$2.071 billion

• Q2 revenue fell 82.9% year over year; passenger revenue declined 87.2%. For the first half, revenue decreased 52.6% and passenger revenue fell 55.5%.
• Q2 load factor was 31.4%, down 55.0 percentage points; capacity (ASMs) fell 55.3%. Passenger yield decreased 21.1%, and operating revenue per ASM (RASM) fell 61.9% to 5.63 cents.
• Q2 reported operating expenses fell 56.8%, but the reported total included a $784 million net credit from payroll support and voluntary-separation accounting. Cost per ASM was 11.94 cents, down 3.4%; excluding fuel, profitsharing, and special items, it was 16.12 cents versus 9.09 cents.
• Q2 net loss excluding special items was $1.501 billion; adjusted operating loss was $2.154 billion. These non-GAAP measures exclude, among other items, payroll support, aircraft sale-leaseback gains, and certain derivative effects.
• At June 30, cash and cash equivalents were $12.351 billion and short-term investments were $2.106 billion, totaling approximately $14.5 billion. Current assets were $15.872 billion versus current liabilities of $9.361 billion.
• Debt, including current maturities, was approximately $9.6 billion, compared with approximately $2.7 billion at December 31, 2019. The company raised substantial debt and equity financing during the first half; it states it raised $17.3 billion net of fees since the beginning of 2020.
• Six-month operating cash flow was supported by a $1.368 billion increase in air traffic liability, including advance sales and unused customer travel funds. Those liabilities totaled $6.879 billion at June 30; approximately 28% represented customer travel funds available for future redemption.

Material changes and significant items

• COVID-19 drove major flight reductions, cancellations, and demand deterioration. In April, load factor was 7.8%; it improved to 29.9% in May and 49.5% in June. Q2 passengers carried fell 85.0% year over year.
• The company recorded $1.1 billion of payroll support as a reduction of Q2 operating expenses and accrued $307 million for accepted voluntary-separation benefits. Sale-leasebacks of 20 aircraft generated $222 million in gains and $815 million in proceeds; the transactions also increased future operating lease obligations.
• Q2 financing included a $2.3 billion common-stock offering and $2.3 billion of convertible notes, alongside additional unsecured notes and aircraft-secured borrowing. The company repaid its $3.7 billion term-loan facility and $1.0 billion revolving-credit borrowing during the quarter.
• Share repurchases and dividends were suspended under CARES Act-related restrictions. The company had repurchased $451 million of shares and paid $188 million in dividends during the first half, before these restrictions took effect.
• The 737 MAX remained grounded. Southwest had 34 MAX aircraft grounded and nearly 100 aircraft in storage overall. MAX aircraft were excluded from the published schedule through mid-December 2020; the company cautioned that return-to-service timing and delivery plans could change.

Outlook, risks, and contingencies

• Management estimated July year-over-year revenue would decline 70%–75%, with load factor of 40%–45%; August revenue was estimated to decline 70%–80%, with load factor of 30%–40%. These were estimates made at filing time, amid softer bookings and increased cancellations.
• Planned Q3 capacity was down 20%–30% year over year; Q4 capacity was expected to be down approximately 25%. Q3 operating expenses excluding fuel, special items, and profitsharing were projected to decline 10%–20% year over year.
• Average daily core cash burn was $23 million in Q2, with an alternative calculation that includes working-capital changes of approximately $14 million. July core cash burn was estimated at $18 million per day; Q3 was expected to be around the Q2 level. The company said the calculation methodology varies across airlines.
• The company expected approximately $3.3 billion of Payroll Support Program funding, including a $2.3 billion grant and loan support. Approximately $957 million received remained to be allocated to eligible Q3 costs at June 30; the final $326 million installment was expected in late July. CARES Act restrictions include limits on dividends and buybacks through September 30, 2021, and restrictions on involuntary furloughs through September 30, 2020.
• About 16,900 employees elected voluntary separation or extended time off programs. Management estimated Q3 charges of approximately $540 million for additional separation benefits and more than $800 million for extended emergency time off, subject to final approval. Programs were expected to reduce salaries, wages, and benefits by more than $400 million in Q4 2020 and $1 billion in 2021.
• Southwest signed a non-binding letter of intent with Treasury regarding a potential secured loan of approximately $2.8 billion; it had not decided whether to participate. Credit ratings were downgraded by Moody’s, S&P, and Fitch in March and April.
• Other risks include the duration and recurrence of the pandemic, travel demand and restrictions, access to capital, fuel prices and hedge accounting volatility, Boeing/FAA MAX timing and aircraft deliveries, and supplier and workforce disruption. The company assessed goodwill and indefinite-lived intangibles and recorded no impairment as of June 30.
• Legal matters include airline-capacity antitrust litigation, MAX-related customer litigation, securities class-action litigation, and a derivative action concerning alleged safety disclosures. Management said it did not expect the outcomes of ongoing proceedings or IRS matters to have a material adverse effect.

Investor verification priorities

• Track passenger bookings, cancellations, load factors, revenue trends, and actual capacity against management’s July–Q4 estimates.
• Reconcile liquidity and cash burn, including the impact of customer refunds, unused travel funds, deferred payroll support, and working-capital movements.
• Verify the timing and accounting for remaining payroll support, voluntary-separation and extended-time-off charges, and expected cost savings.
• Monitor debt balances, interest expense, credit ratings, covenant compliance, and any decision on the proposed Treasury secured loan.
• Confirm 737 MAX regulatory return-to-service timing, aircraft deliveries, and related fleet and capital-spending commitments.
• Assess the sustainability of reported results after excluding payroll grants, sale-leaseback gains, and derivative-related items; review the non-GAAP reconciliations and assumptions.