Southwest Airlines Co. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Unaudited results; dollar amounts in millions unless noted. Southwest continued integrating AirTran and modernizing its fleet.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Operating revenue | $4,643 | $4,616 | $8,727 | $8,606 |
| Operating income | $433 | $460 | $503 | $481 |
| Net income | $224 | $228 | $283 | $327 |
| Diluted EPS | $0.31 | $0.30 | $0.39 | $0.43 |
| Operating margin | 9.3% | 10.0% | 5.8% | 5.6% |
| Net margin | 4.8% | 4.9% | 3.2% | 3.8% |
| Operating cash flow | $778 | $145 | $1,760 | $1,370 |
Q2 revenue rose 0.6%; passenger revenue increased $33 million, while freight rose $1 million and other revenue declined $7 million. Q2 operating expenses increased 1.3% to $4,210 million, despite a 3.0% increase in capacity. Reported fuel expense fell $88 million year over year, while salaries, wages and benefits rose $76 million and landing fees and other rentals rose $32 million.
Cash and cash equivalents were $1,489 million and short-term investments $1,904 million at June 30, for $3,393 million in combined cash and short-term investments. Total debt, including current maturities, was $2,934 million, down from $3,154 million at December 31, 2012. The company had a $1 billion unsecured revolving credit facility, no borrowings under it, and was in covenant compliance. Current assets of $4,864 million were below current liabilities of $5,779 million; air traffic liability accounted for $3,077 million of current liabilities.
Changes versus prior period
- Q2 GAAP operating income fell 5.9% and net income fell 1.8%; diluted EPS increased from $0.30 to $0.31, partly reflecting fewer average shares outstanding.
- For the first half, GAAP operating income increased 4.6%, but net income declined 13.5%. Results were affected by fuel-derivative accounting; other gains and losses were $1 million of expense in H1 2013 versus $109 million of income in H1 2012.
- Management’s non-GAAP results, which exclude specified fuel-hedge effects and acquisition/integration items, showed Q2 net income of $274 million versus $273 million, and H1 net income of $328 million versus $255 million. These measures are supplemental, not GAAP substitutes.
- Q2 capacity (ASMs) rose 3.0%, while load factor eased 0.3 percentage points to 81.6%; passenger yield declined 1.9% and operating revenue per ASM declined 2.4%. The average economic fuel cost fell 5.0% to $3.06 per gallon.
Outlook, management commentary and risks
- Management expected 2013 ASMs to increase approximately 2% year over year and planned 2014 capacity to remain in line with 2013. It did not intend to grow the overall fleet in 2013; nine additional 737-800 deliveries were expected in the second half.
- Management reported approximately $95 million of AirTran net synergies in Q2 and continued to target approximately $400 million in total annualized net synergies by year-end 2013. Full AirTran integration was targeted by the end of 2014; Atlanta operations were to transition to a point-to-point model in fall 2013.
- Management described third-quarter revenue trends as encouraging, with July unit revenues above the prior year and bookings viewed as solid. It expected third-quarter freight and other revenues to decline year over year. Third-quarter unit costs excluding fuel, special items and profitsharing were expected to rise slightly; non-fuel salaries per ASM were expected to be comparable with Q2, and airport costs per ASM were expected to increase year over year.
- Fuel hedges covered approximately 93% of estimated remaining 2013 consumption as of June 30. Outstanding fuel derivatives had a $92 million net fair-value liability before collateral. Management cautioned that hedges may not track jet fuel prices fully; a 25% decline in relevant commodity prices could require substantial additional collateral, although lower fuel prices would also benefit operations. Some deferred hedge losses were expected to enter earnings as fuel was consumed.
- The company expected no more than $550 million of AirTran acquisition and integration costs in total; $363 million had been recorded through June 30. It expected current liquidity and operating cash generation to fund remaining costs.
- Southwest guaranteed principal and interest on $456 million of bonds issued for the Dallas Love Field modernization project; construction costs recorded as an asset and corresponding liability totaled $404 million. Two aircraft maintenance contracts had stated termination penalties totaling approximately $106 million, but termination had not occurred.
- An antitrust class-action case involving AirTran and Delta remained pending; management did not expect ongoing legal matters or IRS adjustments to materially adversely affect financial condition, results or cash flow. The filing reported no material change to previously disclosed risk factors.
Key facts for investors to verify
- Reconcile GAAP and non-GAAP results, especially fuel-hedge mark-to-market effects and continuing AirTran integration costs.
- Assess whether AirTran synergies, integration milestones and planned capacity discipline are achieved, and whether revenue trends recover from Q2 unit-revenue declines.
- Monitor non-fuel unit-cost inflation, including labor and airport charges, against fleet-modernization and fuel-efficiency benefits.
- Review fuel-hedge coverage, future settlements, counterparty exposure and potential collateral needs alongside fuel-price movements.
- Track cash generation and its composition: first-half operating cash flow included a $907 million increase in air traffic liability and a $282 million cash-flow benefit from higher accounts payable and accrued liabilities.
- Monitor aircraft purchase commitments, Dallas Love Field obligations, the pending antitrust litigation and any developments in the stated aircraft-contract termination penalties.