Southwest Airlines Co. — Q1 2020 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2020, compared with Q1 2019. Southwest operates scheduled passenger air service in the United States and near-international markets. COVID-19 sharply reduced travel demand from late February; the 737 MAX fleet also remained grounded.
Financial and operating performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Operating revenue | $4.234 billion | $5.149 billion | Down 17.8% |
| Operating income (loss) | $(110) million | $505 million | Turned to loss |
| Net income (loss) | $(94) million | $387 million | Turned to loss |
| Diluted earnings (loss) per share | $(0.18) | $0.70 | Turned to loss |
| Operating margin | (2.6)% | 9.8% | Calculated from reported figures |
| Net margin | (2.2)% | 7.5% | Calculated from reported figures |
| Operating cash flow | $(377) million | $1.105 billion | Down $1.482 billion |
Passenger revenue fell 19.0% to $3.845 billion. Passenger traffic (revenue passenger miles) declined 22.0%, capacity declined 6.7%, and load factor fell 13.3 percentage points to 67.7%. Average fare rose 2.5% and passenger yield per mile rose 4.0%, but did not offset lower volume. Operating expenses declined 6.5% to $4.344 billion; expenses per available seat mile increased 0.2%, while excluding fuel and profitsharing they rose 5.1%.
Fuel expense decreased 14.3% to $870 million, with average fuel cost down 7.3% to $1.90 per gallon. The income tax benefit was $50 million; the 34.3% effective tax rate reflected anticipated carryback refunds from projected 2020 losses. Q1 net loss included a $24 million unrealized interest-rate-swap loss and $2 million of fuel-derivative losses; excluding special items, the company reported a $77 million net loss and diluted loss per share of $0.15.
Liquidity, debt and cash flows
At March 31, cash and cash equivalents were $3.940 billion and short-term investments were $1.605 billion, totaling $5.545 billion, versus $4.072 billion at year-end 2019. Current assets were $7.028 billion and current liabilities $10.241 billion, a working capital deficit of $3.213 billion, largely reflecting air traffic liabilities. Total debt, including current maturities, was approximately $5.083 billion, versus $2.665 billion at December 31, 2019. Debt excludes operating lease liabilities.
Financing cash inflows included $1.0 billion drawn on a 364-day term loan, $1.0 billion drawn on the revolving facility, and $500 million of 2030 notes. Financing activities provided $1.774 billion overall. Investing activities used $5 million, including $224 million of capital expenditures and $300 million of Boeing proceeds. The company paid $188 million in dividends and repurchased $451 million of stock in Q1; it subsequently suspended both activities. By April 24, cash and short-term investments had risen to approximately $9.3 billion, including additional borrowings and other liquidity actions.
Material changes and management outlook
Management attributed the sharp deterioration in Q1 results to COVID-19 cancellations and collapsing bookings in March. March load factor was 46.6%, versus 85.7% a year earlier, and approximately 20% in the second half of March. Customer refunds and credits increased; travel funds redeemable for future trips represented about one-third of air traffic liabilities at March 31, versus about 13% at year-end 2019. The company extended eligible travel-fund expiration dates to September 7, 2022.
For April and May, management estimated operating revenue would fall 90%–95% year over year in each month. It estimated April capacity down about 60% and load factor about 6%; for May, capacity down 60%–70% and load factor 5%–10%. The company could not reasonably estimate trends beyond May. It estimated average daily cash burn of $30 million–$35 million in Q2, excluding cash sales, refunds, financing proceeds and payroll support. It expected continued unit-cost pressure from reduced capacity and the MAX grounding.
Subsequent to quarter-end, Southwest agreed to approximately $3.3 billion of CARES Act payroll support: about $2.3 billion in grants and a $948 million unsecured term loan, together with warrants for up to 2.6 million shares. It received approximately $1.6 billion of the support on April 21. The support carries restrictions, including no common-stock repurchases or dividends through September 30, 2021, employee pay and furlough constraints, executive-compensation limits, and possible DOT service requirements. The company also drew further amounts under its 364-day facility after quarter-end; approximately $3.68 billion was outstanding as of the filing date.
Risks, contingencies and unusual items
- COVID-19 duration, travel restrictions, weak demand, refunds, fixed operating costs and access to capital create substantial operating and liquidity uncertainty. Management said its available plans were probable to mitigate liquidity risk, but acknowledged conditions could worsen.
- The 34 Boeing 737 MAX aircraft remained grounded; return-to-service timing depended on FAA approval, and the company expected the grounding to continue through its published schedule to October 30, 2020, while cautioning that timing was uncertain. Approximately 350 aircraft were in long-term storage or temporary parking during the pandemic.
- Southwest secured aircraft for amended credit facilities, which include a $2.5 billion minimum liquidity covenant and, after March 31, 2021, a financial coverage covenant. It reported compliance with the liquidity covenant at March 31. Credit ratings were downgraded by Moody’s, S&P and Fitch during March and April, though Southwest described its ratings as investment grade.
- The company identified no impairment charge for goodwill, indefinite-lived intangibles or amortizable assets as of March 31, but said assumptions were uncertain and would be monitored.
- Fuel hedges were affected by the demand collapse, including an estimated over-hedged Q2 position and hedge de-designations. Lower fuel prices, market volatility and hedge-accounting changes may cause further earnings volatility.
- Contingencies include a $212 million remaining guarantee related to the Los Angeles Terminal 1.5 project and $407 million of Dallas Love Field bond principal guaranteed by the company. Management did not expect ongoing litigation or IRS matters to have a material adverse effect; disclosed cases include MAX-related claims and a securities class action.
Important facts for investors to verify
- Whether passenger demand, bookings, load factor and revenue recover beyond the April–May estimates, and how quickly daily cash burn declines.
- Actual liquidity after subsequent borrowing, CARES Act receipts, refunds, operating outflows and facility requirements; also review debt maturities and collateral pledged.
- Final CARES Act support terms, grant and loan accounting, warrant dilution, and the impact of restrictions on dividends, repurchases, staffing and operations.
- FAA and Boeing developments affecting MAX return-to-service, aircraft deliveries, compensation and Southwest’s fleet and capacity plans.
- Changes in travel-credit redemption and spoilage assumptions, fuel-hedge valuations and settlements, and any future impairment conclusions.
- Developments in disclosed legal proceedings and guarantees, and whether ratings or credit-facility covenants change.