Southwest Airlines Co. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Financial statement amounts are in millions, except per-share data and operating statistics. Comparisons are with the corresponding 2009 periods.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Operating revenue | $3,168 | $2,616 | $5,798 | $4,972 |
| Operating income | $363 | $123 | $417 | $73 |
| Net income | $112 | $91 | $123 | Breakeven |
| Diluted EPS | $0.15 | $0.12 | $0.17 | — |
| Operating cash flow | $540 | $135 | $913 | $420 |
- Q2 revenue increased 21.1%; passenger revenue rose 20.4%. Operating income increased $240 million. Approximate operating margin rose to 11.5% from 4.7%.
- First-half revenue increased 16.6%; approximate operating margin was 7.2% versus 1.5%. GAAP first-half net income was $123 million, compared with breakeven a year earlier.
- Company-reported non-GAAP net income, which adjusts for fuel-derivative accounting effects, was $216 million in Q2 ($0.29 diluted EPS) and $239 million for the first half. These are supplemental, non-GAAP measures.
- Fuel and oil expense rose $207 million in Q2 and $331 million in the first half. Average fuel cost including taxes and hedge effects increased 28.2% to $2.50 per gallon in Q2 and 26.4% to $2.49 in the first half. Q2 operating expenses increased 12.5%; expenses per available seat mile (ASM) rose 12.8%, or 6.4% excluding fuel.
- Passenger yield increased 17.3% and load factor improved 2.3 percentage points to 79.3% in Q2. First-half load factor rose 4.1 points to 77.7%. Q2 ASMs were down 0.3% year over year.
Balance sheet, liquidity, and cash flow
- At June 30, cash and cash equivalents were $989 million and short-term investments were $2.135 billion, totaling $3.124 billion. Total current assets were $3.971 billion and current liabilities $3.338 billion.
- Long-term debt, including current maturities, was $3.447 billion, compared with $3.515 billion at December 31, 2009. The company had no borrowings under its $600 million revolving credit facility; it expires in October 2012.
- First-half investing cash outflow was $932 million, including $298 million of net property and equipment purchases; financing cash outflow was $106 million. Cash and cash equivalents declined $125 million from year-end to $989 million.
- Operating cash flow benefited from a $442 million increase in air traffic liability and depreciation and amortization, while the company spent a net $422 million on fuel-hedging options for future periods. Short-term investments increased during the first half.
Material changes, outlook, and risks
- Revenue recovery reflected higher fares and load factors, capacity and schedule adjustments, marketing and revenue-management initiatives, and newer offerings. Management said full-fare traffic remained below historical levels, despite continued year-over-year improvement.
- Management expected strong year-over-year unit-revenue growth in Q3, while noting tougher comparisons after the recovery that began in Q3 2009. Q3 ASMs were forecast 2%–3% above Q3 2009; full-year 2010 ASMs were expected to be approximately flat year over year, with 546 aircraft planned in the active fleet at year-end.
- Management estimated Q3 economic fuel cost, including taxes, at approximately $2.40 per gallon using market information as of July 26, 2010. Fuel-hedge coverage varied by market price; management also cautioned that some hedges would not provide coverage at current prices. Hedging, hedge-accounting qualification, and fuel-price volatility materially affected reported earnings.
- Q2 included $146 million of net other expense, primarily reflecting fuel-derivative mark-to-market and ineffectiveness losses; the comparable 2009 quarter had $23 million of net other income. The company recorded an $18 million TSA security-fee refund in Q2. Full-year 2010 tax rate was projected at 38%–40%.
- Fuel derivatives had a reported net fair-value liability of $365 million, and the company had posted $195 million of cash collateral. In a stated scenario where relevant market prices fell by one-third from June 30 levels, it estimated an additional $552 million of collateral could be required.
- The Love Field modernization project was expected to begin major construction in the second half of 2010. The company had spent $53 million on eligible early costs, expected bonds of up to $520 million subject to market conditions, and would guarantee bond principal and interest. Final accounting treatment was not yet determined; timing or unsuccessful issuance could affect liquidity.
- Other noted uncertainties include fuel prices, economic and travel demand, competition, and government-provided war-risk insurance then scheduled to expire August 31, 2010. Management expected an extension but warned that failure to extend could raise insurance costs or limit coverage. The company also implemented the first phase of a new ERP system, materially changing internal controls; management reported disclosure controls effective and added monitoring controls.
Important facts for investors to verify
- Whether revenue, yield, and load-factor improvements continued after Q2, particularly as year-over-year comparisons became more difficult.
- Fuel-hedge fair values, cash settlements, hedge-accounting effects, and collateral requirements; GAAP and company-defined non-GAAP results differ materially.
- Progress and financing terms for the Love Field project, including the bond issuance, guarantee exposure, reimbursement timing, and final accounting treatment.
- Execution of fleet, capacity, and cost plans, and the effect of the ERP implementation on financial reporting controls.