Southwest Airlines Co. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Southwest operates a major domestic airline and was continuing to integrate AirTran. Unless stated otherwise, amounts are in U.S. dollars.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Operating revenue | $4.166 billion | $4.084 billion |
| Operating income / margin | $215 million / 5.2% | $70 million / 1.7% |
| Net income / net margin | $152 million / 3.6% | $59 million / 1.4% |
| Diluted earnings per share | $0.22 | $0.08 |
| Operating cash flow | $1.119 billion | $983 million |
| Capital expenditures | $407 million | $534 million |
- GAAP operating expenses were $3.951 billion, down 1.6%; fuel and oil expense fell 9.8% to $1.314 billion. Lower fuel prices and fleet modernization were principal factors. Salary, wage and benefit expense rose 7.8%, partly due to contractual wage increases, storm-related overtime, medical costs and higher profitsharing.
- Passenger revenue rose 2.5% to $3.933 billion. Load factor increased 2.2 percentage points to 79.3%; average fare rose 3.1%. Available seat miles (capacity) declined 1.1%.
- Cash and cash equivalents were $1.741 billion at quarter-end, and short-term investments were $1.757 billion, totaling $3.498 billion. Total debt, including current maturities, was approximately $2.814 billion. A $1 billion revolving credit facility was undrawn; the company reported covenant compliance.
- Cash from operations was supported by a $761 million increase in air traffic liability, reflecting bookings for future travel and frequent-flyer point sales, among other factors. Investing activities used $358 million; financing activities used $375 million, including $315 million of share repurchases and $56 million of dividends. Cash increased $386 million during the quarter.
- Quarterly dividend declared was $0.04 per share, versus $0.01 a year earlier. Weighted-average diluted shares declined to 707 million from 727 million.
Material changes and operating developments
- Reported operating income increased to $215 million from $70 million; net income rose to $152 million from $59 million. Management also reported non-GAAP operating income of $242 million and non-GAAP net income of $126 million, excluding specified fuel-hedge impacts and special items. These company-defined measures are not GAAP and may not be comparable with other companies’ measures.
- Winter storms caused more than 7,500 flight cancellations. Management estimated a $45 million revenue reduction and a $5 million net operating-cost impact, or approximately $50 million lower operating income.
- Trips flown declined 5.9%, while revenue passenger miles rose 1.7%; the company attributed higher passenger revenue primarily to improved yields, average fares and length of haul, with stronger load factor partly reflecting lower capacity.
- Southwest began selling seats on its first scheduled international flights, planned to begin July 1, 2014, and expected to complete the AirTran network, fleet and systems integration by December 31, 2014. It had incurred approximately $428 million of AirTran integration costs and expected total costs not to exceed $550 million.
- Southwest acquired 54 additional Washington Reagan National Airport slots and planned additional service at Reagan, LaGuardia and Dallas Love Field. The company did not expect overall fleet growth in 2014 and expected second-quarter and full-year ASMs to be flat year over year.
Outlook, risks and contingencies
- Management expected another solid year-over-year increase in operating unit revenues for Q2, based on April revenue trends and bookings. It expected Q2 freight revenue to increase and other revenue to decline further year over year.
- Management forecast Q2 unit costs, excluding fuel, special items and profitsharing, to increase 2%–3% year over year. It expected a full-year 2014 effective tax rate of approximately 38%.
- Fuel derivatives covered 54% of Q1 fuel consumption; as of March 31, coverage was up to 34% of remaining estimated 2014 consumption, depending on market prices. WTI-based derivatives no longer qualified for prospective hedge accounting, making fair-value movements flow through earnings and increasing volatility. The company cautioned that hedges may not fully protect against jet-fuel price changes and could make hedged fuel cost exceed unhedged market prices in some periods.
- Fuel derivatives were a net asset with a reported fair value of $218 million before collateral effects. Management estimated that a 25% decline in relevant commodity prices could require additional collateral of $301 million in cash, $221 million in aircraft and $105 million in letters of credit, while lower prices would also reduce fuel costs. These are sensitivities, not forecasts.
- Major construction-related matters include the Love Field modernization project: $452 million of construction costs and a $450 million construction obligation were recorded at quarter-end. Southwest also guaranteed principal and interest on $456 million of Love Field modernization bonds. Other airport projects include Houston Hobby and planned work at Fort Lauderdale and Los Angeles; some construction cash flows are offset by airport or county funding and reimbursement arrangements.
- A putative class-action antitrust case involving AirTran and Delta remained pending; claims include alleged conspiracy over baggage fees and capacity/pricing. Management said ongoing legal proceedings and IRS matters were not expected to have a material adverse effect. The filing reported no material change to previously disclosed risk factors.
- Management identified risks including AirTran integration and IT execution, demand and competition, fuel prices and hedge effectiveness, aircraft plans, regulation and the timing and prioritization of strategic spending. Disclosure controls were assessed as effective, with no reported material change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue strength, fares and load factor persist after the unusually disruptive winter-weather quarter, and whether planned flat capacity supports further unit-revenue gains.
- How fuel prices, hedge settlements, WTI hedge-accounting treatment and potential collateral requirements affect earnings and liquidity.
- Whether costs excluding fuel, special items and profitsharing remain within management’s 2%–3% Q2 increase outlook, given wage, benefit and other operating-cost pressures.
- Progress and remaining cost of AirTran integration, including the planned year-end 2014 completion and the estimate of up to $550 million in total costs.
- Capital commitments and execution for aircraft deliveries, airport projects and Love Field bond guarantees, alongside ongoing dividends and repurchases.
- Developments in the antitrust litigation and any change to management’s assessment of legal or other contingencies.