Southwest Airlines Co. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. The filing is unaudited. Q1 2012 includes AirTran results, acquired May 2, 2011; Q1 2011 does not, so reported year-over-year comparisons are not fully comparable.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Operating revenue | $3,991 | $3,103 |
| Operating income | $22 | $114 |
| Net income | $98 | $5 |
| Diluted EPS | $0.13 | $0.01 |
| Operating cash flow | $1,225 | $965 |
| Capital expenditure payments, net | $127 | $57 |
- Reported operating margin was approximately 0.6% versus 3.7% a year earlier; net margin was approximately 2.5% versus 0.2%.
- Revenue rose 28.6% overall, largely from AirTran. Excluding AirTran’s post-acquisition results, revenue increased $210 million, or 6.8%; passenger revenue rose 6.6% on that basis.
- Operating expenses increased 32.8% overall. Operating expenses per available seat mile (ASM) rose 6.2%, while non-GAAP unit costs excluding fuel and special items increased 1.0%.
- Fuel and oil expense was $1,510 million, versus $1,038 million. Economic fuel cost was $3.44 per gallon, up 16.2% year over year. The company said fare increases did not fully offset higher fuel costs.
- Net income included a $170 million net gain in “Other (gains) losses,” primarily reflecting fuel-derivative mark-to-market effects. The company’s non-GAAP measure showed a $18 million net loss, or $(0.02) diluted EPS, versus non-GAAP net income of $20 million, or $0.03, in Q1 2011. These non-GAAP figures are company-defined and not substitutes for GAAP results.
- Cash and cash equivalents were $1,558 million at quarter-end; short-term investments were $2,226 million. Management reported unrestricted cash and short-term investments of $3.8 billion, plus an available $800 million unsecured revolving credit facility expiring in April 2016.
- Current assets were $5,120 million and current liabilities $5,047 million. Debt, including current maturities, totaled $3,307 million at March 31, compared with $3,751 million at December 31, 2011. The company repaid $431 million of debt and capital lease obligations during the quarter, including redemption of $385 million of 6.5% notes.
- Operating cash flow included a $720 million increase in air traffic liability from bookings for future travel, as well as increases in payables and accrued liabilities and cash flows from fuel-derivative activity. Financing cash use was $484 million, including debt payments, $50 million of share repurchases, and $7 million of dividends.
Material changes and operating trends
- Capacity rose 25.0% and revenue passenger miles 23.4%, reflecting the expanded combined operation. Load factor declined 1.0 percentage point to 77.3%; average fare increased 4.9% to $146.44.
- Fuel expense was the principal pressure on operating performance. Consolidated operating expenses per ASM rose 6.2%; management attributed more than 92% of that increase to fuel.
- AirTran contributed $678 million of revenue and an $11 million net loss in Q1 2012. Acquisition and integration costs were $13 million in the quarter.
- Comprehensive income was $265 million versus $346 million in Q1 2011, reflecting changes in other comprehensive income, including fuel-derivative valuations.
Outlook, management commentary, and risks
- Management expected total net pre-tax AirTran synergies of $400 million annually in 2013, excluding acquisition and integration expenses. It estimated total AirTran integration and acquisition costs of approximately $500 million and cautioned that costs and timing could vary.
- The company planned no overall fleet growth in 2012, with 33 Boeing 737-800 deliveries expected and approximately 40 older 737-300/500 aircraft to be retired. It expected 2012 ASMs to approximate the combined Southwest and AirTran 2011 level. Its aircraft delivery commitments with Boeing totaled $12.829 billion.
- Management said April passenger unit-revenue growth was exceeding March’s year-over-year increase of 5%, and remaining Q2 bookings and revenue trends were solid. It expected Q2 freight revenue moderately above Q2 2011; consolidated other revenue slightly below combined Q2 2011. The company projected full-year 2012 effective tax of approximately 38%–40%.
- As of April 16, 2012, management described Q2 2012 fuel-hedge coverage as minimal at current estimated consumption. It warned hedge effectiveness could be impaired by widening differences between WTI crude and jet fuel prices; hedge-accounting volatility also affects reported earnings. A modeled one-third decline in relevant commodity prices could require an additional $527 million cash collateral and $94 million in aircraft collateral, though lower fuel prices would also benefit operations.
- The company guaranteed principal and interest payments on $310 million of bonds issued for the Dallas Love Field modernization project; another bond tranche was expected in Q2 or Q3 2012. Project spending was expected to total approximately $519 million, with completion scheduled for the second half of 2014.
- Risks include fuel-price volatility and hedge mismatch, AirTran integration and synergy execution, IT and reservation-system implementation, labor relations, economic and competitive conditions, and aircraft commitments. Management reported disclosure controls were effective at March 31, 2012; internal-control integration work following the AirTran acquisition continued.
- Pending legal matters included an AirTran shareholder action seeking attorneys’ fees and an antitrust class action concerning baggage fees, capacity, and pricing. Management did not expect ongoing legal proceedings or IRS matters to have a material adverse effect, but the filing described unresolved litigation and discovery.
Most important facts for investors to verify
- How much of GAAP net income and earnings volatility came from fuel-derivative fair-value changes, and how the company-defined non-GAAP and economic measures reconcile to cash fuel costs.
- Whether fare and unit-revenue trends can offset fuel inflation without further weakening load factor or demand.
- Progress toward AirTran integration, the $400 million 2013 synergy target, and the estimated $500 million integration-cost total.
- Liquidity and collateral exposure under adverse fuel-market moves, alongside scheduled aircraft spending and other contractual commitments.
- Developments in the antitrust and shareholder litigation, Love Field bond guarantees, and labor and systems-integration milestones.