Southwest Airlines Co. — Q2 2009 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2009. Unaudited results; amounts below are in millions of dollars except per-share and operating statistics. Southwest cautions that airline results are seasonal and affected by fuel-price and hedge-accounting volatility.
Financial performance
| Metric | Q2 2009 | Q2 2008 | First half 2009 | First half 2008 |
|---|---|---|---|---|
| Operating revenue | $2,616 | $2,869 | $4,972 | $5,399 |
| Operating income | $123 | $205 | $73 | $293 |
| Net income (loss) | $54 | $321 | $(37) | $355 |
| Diluted EPS | $0.07 | $0.44 | $(0.05) | $0.48 |
| Operating margin | 4.7% | 7.1% | 1.5% | 5.4% |
| Operating cash flow | $135 | $2,336 | $420 | $3,300 |
Q2 operating revenue fell 8.8% year over year; passenger revenue declined 8.8%. Passenger yield per revenue passenger mile dropped 8.2%, while load factor improved 1.8 percentage points to 77.0% as capacity declined 3.0%. Q2 operating expenses fell 6.4%, largely on lower fuel costs, but the revenue decline more than offset the savings.
For the first half, revenue declined 7.9% and operating income fell 75.1%. Fuel and oil expense decreased $322 million, but higher wages and maintenance costs partly offset the reduction. Salaries, wages, and benefits increased $60 million; maintenance materials and repairs rose $40 million.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $946 million and short-term investments were $1.252 billion, totaling approximately $2.2 billion, versus $1.803 billion at December 31, 2008.
- Total current assets were $3.094 billion and current liabilities were $3.073 billion. Current maturities of debt were $105 million; long-term debt was $3.278 billion, or $3.383 billion including current maturities.
- Southwest borrowed $332 million under a 10-year, aircraft-secured term loan in May and repaid $400 million drawn under its revolving credit facility and $91 million of credit-line borrowings. The full $600 million revolver was available at quarter-end and expires in August 2010.
- Operating cash flow for the first half was $420 million, versus $3.3 billion a year earlier. The comparison was heavily affected by fuel-derivative collateral: cash collateral received increased $2.435 billion in first-half 2008, while the company had a $185 million collateral outflow in first-half 2009. Investing cash use was $1.014 billion and financing cash provided was $172 million; cash declined $422 million from year-end.
- After quarter-end, Southwest borrowed another $124 million under a 10-year aircraft-secured term loan. Moody’s downgraded its senior unsecured rating to Baa3 on July 22; Fitch lowered it to BBB on July 23. Both ratings remained investment grade, but the company expected somewhat higher prospective borrowing costs.
Material changes, outlook and risks
- Fuel hedging: Management attributed more than 75% of the Q2 net-income decline to different derivative-accounting adjustments versus Q2 2008. Q2 2008 included $361 million of net derivative gains in “Other (gains) losses, net”; Q2 2009 recorded $6 million of net gains from ineffective or non-qualifying fuel derivatives. Southwest reported $750 million of net-of-tax fuel-hedge losses in accumulated other comprehensive loss, with approximately $280 million expected to enter earnings over the following 12 months. Gross estimated fair value of outstanding fuel contracts was a $763 million liability; $425 million of collateral had been posted.
- At June 30, economic hedges covered about 40% of forecast Q3 fuel consumption and 37% for the remainder of 2009 overall. Management estimated Q3 fuel cost at approximately $2.15 per gallon and full-year 2009 below $2.00, including fuel taxes but excluding hedge ineffectiveness and mark-to-market adjustments. It noted that prior fixed hedge losses were expected to make fuel costs higher than unhedged market prices in periods through 2013.
- Demand and capacity: Management cited recession-related weak travel demand, fewer full-fare bookings and increased discounting. Unless demand rebounded significantly, it expected Q3 unit revenue to decline more than Q2’s 6% decline. Southwest planned to fly approximately 5%–6% fewer ASMs in 2009 and expected Q3 capacity to fall approximately 6%–7% year over year. It said it could not predict a profitable Q3, excluding Freedom ’09 and fuel-hedge accounting effects.
- Based on current trends and lower capacity, management expected Q3 unit costs, excluding Freedom ’09 charges, to increase approximately 7% from Q3 2008. Fuel-price volatility, weak demand, labor negotiations, credit-market conditions and access to financing were identified as important risks.
- Cost and fleet actions: The voluntary Freedom ’09 program had 1,404 participants and was expected to cost approximately $70 million, with savings in subsequent years expected eventually to exceed the cost. Southwest expected to end 2009 with 535 aircraft and continued to reallocate capacity to new and existing markets.
- Other notable items: The company completed sale-leasebacks of six aircraft in Q2; the first-half total was eleven aircraft, producing $381 million of cash proceeds. Auction-rate securities totaled $192 million at estimated fair value, including $109 million classified as available-for-sale and $83 million of trading securities; management considered the $11 million fair-value decline temporary. It disclosed aviation-safety-related class actions and a shareholder derivative suit, but did not expect ongoing legal matters or identified IRS adjustments to have a material adverse effect.
- Management reported disclosure controls were effective as of June 30, 2009. A new fuel-derivative management and valuation system was implemented in Q2; management said related financial-reporting controls were effective at period-end.
Important facts for investors to verify
- How fuel-hedge settlements, collateral requirements and the $750 million deferred hedge loss affect future earnings, fuel costs and liquidity.
- Whether weak passenger demand and lower yields persist, and whether the Q3 revenue and cost outlook is achieved.
- The sustainability of operating cash generation, including the impact of working-capital and derivative-collateral movements.
- Debt maturities, aircraft-secured borrowing, revolver renewal or replacement, and any further credit-rating changes or financing-cost increases.
- The timing and realized cost savings from Freedom ’09, as well as aircraft delivery, retirement and capacity plans.
- Liquidity and valuation developments for auction-rate securities and the status or outcome of disclosed legal proceedings.