Southwest Airlines Co. — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; comparisons are against Q1 2009 unless noted. Unaudited interim results; the filing cautions that airline results are seasonal and this quarter is not necessarily indicative of full-year performance. Amounts below are in millions except per-share and operating-statistic data.
Financial results and liquidity
| Metric | Q1 2010 | Q1 2009 / prior date |
|---|---|---|
| Operating revenue | $2,630 | $2,357 |
| Operating income (loss) | $54; 2.1% operating margin | $(50); (2.1)% margin |
| Net income (loss) | $11; $0.01 diluted EPS | $(91); $(0.12) diluted EPS |
| Non-GAAP net income (loss) | $24; $0.03 diluted EPS | $(20); $(0.03) diluted EPS |
| Cash from operations | $373 | $286 |
| Cash and short-term investments | $2,773 at March 31, 2010 | $2,593 at December 31, 2009 |
| Total debt, including current maturities | $3,475 at March 31, 2010 | $3,515 at December 31, 2009 |
| Stockholders’ equity | $5,537 at March 31, 2010 | $5,454 at December 31, 2009 |
Net cash used in investing was $322, including $139 of net property and equipment purchases; net cash used in financing was $55, including $60 of debt and lease-obligation payments and $7 of dividends. Cash and equivalents were $1,110 at quarter-end. A $600 revolving credit facility was undrawn and expires in October 2012. Revenue growth outpaced expense growth: operating revenue rose 11.6%, while operating expenses increased 7.0%. Fuel and oil expense was $821, up from $698; the filing says fuel represented approximately 32% of operating expenses, versus 29% a year earlier.
Material changes and operating performance
- Passenger revenue increased $243, or 10.8%, driven by higher fares and improved load factor. Average fare rose 9.6% to $124.90; load factor increased 6.0 percentage points to 75.9%. Passenger revenue yield per RPM rose 9.1%.
- Available seat miles fell 6.4% as Southwest reduced capacity and trips flown declined 6.2%. Revenue passengers carried rose 1.1%.
- Operating expenses per ASM increased 14.4% to 11.39 cents; excluding fuel, they rose 9.8% to 7.76 cents. Average fuel cost per gallon, including hedging activity and taxes, increased 25.1% to $2.49.
- Southwest returned to GAAP profitability from a prior-year loss. Management attributed the improvement principally to higher passenger yields and load factors, revenue initiatives, and lower capacity. Reported GAAP results also reflect fuel-derivative accounting effects; on the company’s non-GAAP basis, operating income was $102 versus $31 in Q1 2009.
Outlook, risks, and unusual items
- Management expected second-quarter and full-year 2010 ASMs to be approximately flat year over year. It expected Q2 nonfuel unit costs to exceed Q2 2009 but decline from Q1 2010; nonfuel cost pressure was expected to be greater in the first half of 2010.
- Management reported strong load-factor and yield trends continuing into April and estimated first-half April passenger unit revenue was up approximately 19% year over year. If trends continued, it expected significant Q2 unit-revenue improvement. These are forward-looking statements, not guarantees.
- At April 20, Southwest estimated Q2 economic fuel costs, including taxes, at $2.40–$2.45 per gallon. Fuel-hedge coverage and outcomes vary with market prices. The filing noted substantial deferred hedge losses and estimated that Q1-end fuel derivatives had a net pretax liability of approximately $72 after $325 of posted cash collateral. A 50% fall in relevant commodity prices could require an additional $293 of collateral under the company’s stated assumptions.
- Fuel-hedge valuations, ineffectiveness, and hedge-accounting treatment can create material earnings volatility. Q1 included $27 of net gains from mark-to-market adjustments on unsettled fuel contracts, while premium costs for fuel derivatives were $31. The company’s non-GAAP “economic” measures exclude certain noncash hedge-accounting effects and are not GAAP or necessarily comparable with similarly titled measures of other companies.
- Southwest planned seven further 737-700 deliveries during 2010 and expected to end the year with 542 aircraft. Firm aircraft commitments totaled approximately $3.1 billion, with $250 due in the remainder of 2010. The company reported $2.8 billion of cash and short-term investments and said it could also use operating cash flows, borrowing, or leasing.
- Southwest manages the Love Field Modernization Program and had spent $41 on it by March 31, classified as property and equipment. It planned to guarantee principal, any premium, and interest on proposed bonds of up to $520; the filing says bond issuance was anticipated in Q2 2010. Liquidity could be affected by unsuccessful or delayed bond issuance or reimbursement, though management did not then expect a significant financial-position impact.
- A $15 temporary fair-value decline was recorded on auction-rate securities. Of the $159 held, $100 was classified as available for sale and $59 as trading securities; the company had drawn the full $59 credit line associated with the latter and could put those securities back to the counterparty at par in June 2010. The available-for-sale securities remained subject to liquidity and valuation uncertainty.
- Federal supplemental war-risk insurance was scheduled to expire August 31, 2010; failure to extend it could increase insurance costs or limit coverage. Management did not expect ongoing legal proceedings or IRS matters to have a material adverse effect. The filing reported no material change to previously disclosed risk factors.
- Effective January 1, 2010, Southwest began accruing for partially earned frequent-flyer awards. The retrospective December 31, 2009 balance-sheet adjustment reduced retained earnings by $12; management said the change did not materially affect Q1 2010 earnings or cash flows.
Investor verification priorities
- Reconcile reported GAAP results with the company’s non-GAAP results and assess the effect and timing of fuel-hedge settlements, deferred losses, and required collateral.
- Verify subsequent fuel prices, hedge coverage, and actual fuel costs against the Q2 and full-year estimates stated in the filing.
- Track revenue yields, load factors, capacity decisions, and nonfuel unit costs against management’s Q2 and full-year expectations.
- Confirm issuance and financing terms for Love Field bonds, the company’s guarantee exposure, and reimbursement timing.
- Monitor the June 2010 auction-rate-security put and the recoverability and valuation of remaining illiquid securities.
- Assess aircraft spending and debt maturities against liquidity, operating cash generation, and the undrawn credit facility.