Southwest Airlines Co. 10-Q Summary (Period Ended September 30, 2010)
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2010, and the nine months ended September 30, 2010. Southwest Airlines Co. is a large accelerated filer operating as a low-cost carrier. A significant development during the period was the announcement on September 26, 2010, of a merger agreement to acquire AirTran Holdings, Inc., subject to regulatory and shareholder approval.
Key Financial Metrics
| Metric (in millions) | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total Operating Revenues | $3,192 | $2,666 | $8,990 | $7,638 |
| Operating Income | $355 | $22 | $772 | $95 |
| Net Income | $205 | $(16) | $328 | $(16) |
| Diluted EPS | $0.27 | $(0.02) | $0.44 | $(0.02) |
| Operating Cash Flow | $385 | $72 | $1,292 | $493 |
| Cash & Short-Term Investments | $3,379 | $2,593 | $3,379 | $2,593 |
| Total Debt (Current + Long-Term) | $3,463 | $3,515 | $3,463 | $3,515 |
Note: Cash and Short-Term Investments calculated as sum of Cash ($1,031M) and Short-term investments ($2,348M) as of Sept 30, 2010.
Material Changes vs. Prior Period
- Revenue Growth: Operating revenues increased 19.7% in Q3 2010 compared to Q3 2009, driven primarily by a 13.4% increase in passenger yield (average fare) and a 1.3 percentage point increase in load factor to 80.9%.
- Profitability: The company returned to profitability, reporting a net income of $205 million in Q3 2010 versus a net loss of $16 million in Q3 2009. This improvement is attributed to better revenue performance and the absence of the $66 million "Freedom '09" early retirement charge recorded in the prior year.
- Cost Increases: Operating expenses rose 7.3% in Q3 2010. Fuel costs per gallon increased 8.8% to $2.47. Salaries, wages, and benefits increased due to higher profitsharing expenses linked to improved economic earnings.
- Accounting Changes: The company reduced the estimated residual values of its owned 737-300 and 737-500 aircraft fleet, resulting in an additional $4 million depreciation expense in Q3 2010.
Guidance, Outlook, and Risks
- Merger Outlook: Southwest expects to close the AirTran acquisition in the first half of 2011. The transaction is projected to yield net annual synergies exceeding $400 million by 2013 and be accretive to earnings in the first year post-close.
- Fuel Hedging: As of September 30, 2010, the company had fuel derivatives covering approximately 46% of Q3 consumption. For Q4 2010, coverage is approximately 40% of estimated consumption. Management estimates economic fuel costs for Q4 2010 will range between $2.45 and $2.50 per gallon.
- Capacity: The company expects to end 2010 with 546 aircraft. Q4 2010 capacity (ASMs) is expected to be approximately 5% higher than Q4 2009.
- Risks: Key risks include the failure to obtain regulatory approval for the AirTran merger, integration challenges, and volatility in jet fuel prices. Several class-action lawsuits have been filed by AirTran shareholders challenging the merger terms, though Southwest believes they are without merit.
- Love Field Modernization: The company is managing a major reconstruction project at Dallas Love Field, with completion scheduled for late 2014. The company has spent $70 million of its own funds eligible for reimbursement via bond issuance expected in Q4 2010.
Investor Verification Checklist
- Merger Approval Status: Verify the progress of AirTran shareholder votes and Department of Justice antitrust clearance.
- Fuel Hedge Exposure: Review the specific price levels and volumes of the fuel derivative portfolio to assess sensitivity to rising oil prices in 2011.
- Integration Costs: Monitor disclosures regarding the $300 million to $500 million in one-time acquisition and integration costs.
- Legal Proceedings: Track the status of the class-action lawsuits filed by AirTran shareholders regarding the merger consideration.
- Love Field Bond Issuance: Confirm the successful issuance of the $520 million tax-exempt bonds in Q4 2010 to reimburse the company for project expenditures.