Southwest Airlines Co. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are against Q1 2014 unless noted. Southwest operates a major domestic airline and completed AirTran’s final passenger service in December 2014.
Financial and operating performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Operating revenue | $4.414 billion | $4.166 billion | +6.0% |
| Operating income | $780 million | $215 million | +262.8% |
| Operating margin | 17.7% | 5.2% | Improved |
| Net income | $453 million | $152 million | +198.0% |
| Diluted EPS | $0.66 | $0.22 | +200.0% |
| Operating cash flow | $1.452 billion | $1.119 billion | +29.8% |
| Capital expenditures | $573 million | $395 million | Increased |
- Passenger revenue rose 6.2% to $4.178 billion. Passengers carried increased 5.5%, capacity (ASMs) 6.0%, and load factor 0.8 percentage points to 80.1%; passenger yield declined 0.7%.
- Fuel and oil expense fell 33.3% to $877 million as economic fuel cost per gallon declined 35.1% to $2.00. Fuel hedging generated a $47 million loss in fuel expense, versus an $18 million gain in Q1 2014.
- Reported operating expenses declined 8.0% to $3.634 billion despite 6.0% capacity growth. Salaries and benefits rose 11.3%, largely due to higher profitsharing; lower fuel costs and a $37 million litigation settlement also affected results.
- Non-GAAP operating income was $770 million and non-GAAP net income was $451 million. These measures exclude specified fuel-hedge effects and special items; they are not GAAP measures.
- Cash and cash equivalents were $2.025 billion and short-term investments $1.413 billion at quarter-end. Total debt, including current maturities, was approximately $2.687 billion. The company also had a fully available $1 billion revolving facility and reported covenant compliance with no borrowings.
- Shareholders’ equity was $6.902 billion. The company paid $81 million in dividends and repurchased $300 million of stock during the quarter. Net cash increased $743 million to $2.025 billion.
Material changes and unusual items
- Net income and operating income reached Q1 records, principally reflecting sharply lower fuel costs, revenue growth, and capacity expansion. Pre-tax ROIC for the trailing twelve months was 25.6%, versus 14.2% a year earlier; ROIC is a company-defined non-GAAP measure.
- A revised estimate of Rapid Rewards point breakage, effective October 2014, increased Q1 passenger revenue by approximately $43 million and net income by $23 million, or $0.03 per basic and diluted share. The company expected the higher estimated breakage rate to continue through 2015.
- A $37 million litigation settlement was recorded as a benefit to operating expenses. AirTran integration costs were $23 million, compared with $18 million in Q1 2014; management anticipated smaller continuing costs, mainly related to B717 conversion and subleasing.
- Southwest had no economic fuel hedge for estimated remaining 2015 consumption at then-current prices. Fuel derivative fair value was a net liability of approximately $1.1 billion; $743 million of net-of-tax losses were deferred in AOCI for future recognition. Estimated premium costs were $110–$120 million for full-year 2015.
- Operating cash flow benefited from a $717 million increase in air traffic liability, primarily bookings for future travel and frequent-flyer point sales; it should not be viewed as equivalent to recurring earnings cash generation.
Outlook, risks, and contingencies
- Management planned approximately 7% year-over-year ASM growth for 2015 and expected Q2 ASM growth of approximately 7%. It forecast April 2015 passenger unit revenue to decline approximately 2% year over year, while noting strong April revenue and booking trends and a difficult comparison with Q2 2014.
- Management expected Q2 unit costs, excluding fuel, profitsharing, and special items, to decline approximately 1%–2% year over year. It projected a 2015 effective tax rate of 37%–38%.
- Network expansion included new Dallas Love Field destinations and planned Houston Hobby international service, subject to approvals. The company expected 21 additional aircraft deliveries in the remainder of 2015 and had substantial aircraft purchase commitments, including $538 million remaining for 2015.
- Fuel-price and hedge-accounting volatility remain significant. WTI-based derivatives no longer qualified for hedge accounting prospectively, and their fair-value changes flow through earnings. At March 31, the company had posted $283 million cash, $302 million aircraft collateral, and $75 million letters of credit to fuel-derivative counterparties.
- Airport development commitments include projects at Fort Lauderdale, Houston Hobby, Los Angeles, and Dallas Love Field. Southwest guaranteed obligations related to airport project financing, including the LAX credit facility and Dallas Love Field bonds.
- An antitrust class-action case involving AirTran and Delta remained pending; class certification and other motions were unresolved. Management did not expect ongoing legal matters or IRS examinations to have a material adverse effect. The filing reported no material change in previously disclosed risk factors.
Key facts for investors to verify
- How much of earnings improvement is sustainable as fuel prices, fuel-hedge settlements, and deferred AOCI losses change?
- Whether the $43 million frequent-flyer breakage estimate benefit persists and how actual point redemption experience compares with the model.
- Whether revenue and unit-cost trends meet management’s outlook amid capacity growth and tougher comparisons.
- Cash generation after aircraft and airport investment, aircraft commitments, share repurchases, and dividends.
- Fuel-derivative collateral requirements and exposure to counterparties, plus progress and costs for airport projects and the pending antitrust case.