SOUTHWEST AIRLINES CO quarterly report, Q3 FY2023

Southwest Airlines Co. — Q3 2023 Form 10-Q

Reporting period: Three and nine months ended September 30, 2023. Southwest operates scheduled passenger air transportation in the United States and near-international markets. Figures are in U.S. dollars; financial statement amounts are in millions unless noted.

Financial performance and liquidity

Metric	Q3 2023	Q3 2022	Nine months 2023	Nine months 2022
Operating revenue	$6,525	$6,220	$19,268	$17,642
Operating income	$117	$395	$628	$1,402
Net income	$193	$277	$717	$759
Diluted earnings per share	$0.31	$0.44	$1.15	$1.21
Operating cash flow	$616	$234	$2,739	$3,211

Q3 operating margin was approximately 1.8%, compared with 6.4% a year earlier; nine-month margin was approximately 3.3%, versus 7.9% (calculated from reported figures). Q3 revenue reached a company record, but operating income fell 70% and net income fell 30% year over year. Nine-month operating income declined 55%, while net income declined 6%.

Q3 passenger revenue rose 5.3% to $5.912 billion. Capacity (available seat miles) increased 12.5%, while load factor fell 4.7 percentage points to 80.7%; passenger revenue per available seat mile declined 6.4%.
Q3 operating expenses increased 10.0% to $6.408 billion. Higher labor and maintenance costs outweighed lower fuel expense. Salaries, wages and benefits increased 17.5%; maintenance materials and repairs rose 59.8%. Fuel expense declined 10.6%.
Q3 economic fuel cost was $2.78 per gallon, including approximately $94 million of hedge cash settlement gains. The comparable 2022 cost was $3.34 per gallon.
At September 30, cash and cash equivalents were $9.497 billion and short-term investments were $2.236 billion, or $11.733 billion combined. Current assets of $14.631 billion exceeded current liabilities of $12.112 billion.
Long-term debt, including current maturities, was approximately $8.014 billion; operating lease liabilities were additional. Stockholders’ equity was $11.054 billion. The company had no borrowings under its $1.0 billion revolving credit facility.
Nine-month capital expenditures were $2.812 billion. Southwest paid $428 million in dividends during the period; share repurchases remain suspended.

Material changes and unusual items

Labor costs were a major pressure: results included a $96 million Q3 and $180 million year-to-date increase in estimated Flight Attendant contract ratification bonus expense, following a tentative agreement reached in October. The company also accrues market wage increases for workgroups with open labor contracts.
The December 2022 operational disruption had an estimated $380 million pre-tax impact on first-quarter 2023 results, including lost booking momentum and recovery costs. The filing states there were no material operating-revenue or expense impacts after Q1. It separately identifies approximately $55 million of disruption-related expenses in Q1.
Q3 2022 and nine-month 2022 results included $76 million and $192 million, respectively, of losses on debt extinguishment; there were no corresponding 2023 charges. Higher interest income in 2023 partly offset operating weakness.
Fuel derivative contracts had a net fair value asset of $487 million at September 30. The company reported approximately $77 million of net unrealized fuel-hedge gains in accumulated other comprehensive income expected to be recognized in earnings over the following 12 months.

Outlook and management commentary

Q4 2023 guidance: Revenue per available seat mile expected to decline 9%–11% year over year; capacity expected to increase approximately 21%. Economic fuel cost forecast at $2.90–$3.00 per gallon. CASM-X (unit operating costs excluding fuel, special items and profitsharing) expected to decline 16%–19%.
Full-year 2023 guidance: Capacity growth of 14%–15%; economic fuel cost of $2.85–$2.95 per gallon; CASM-X down 1%–2%; capital spending approximately $3.5 billion; effective tax rate approximately 23%; and year-end fleet of approximately 814 aircraft.
2024 capacity plans: Q1 capacity growth expected at approximately 10%–12%, revised down from prior guidance of 14%–16%; full-year growth expected at 6%–8%. Management cited network optimization, operational excellence, productivity and a return toward historical margins as priorities. Q4 demand was described as stable, with healthy leisure demand and stable business travel; management anticipated record Q4 operating revenue and passenger levels.
The company said Q4 unit-revenue pressure reflects capacity growth outpacing demand, investment in development markets and schedules not ideally matched to current business-travel trends. It expects network adjustments to address these issues.
The August amendment to the revolving credit facility extended its maturity to August 2028, released collateral and removed the minimum liquidity covenant, while adding a coverage-ratio covenant and revising other terms.

Risks, contingencies and commitments

The Department of Transportation notified Southwest on October 27, 2023 that it determined the company failed to provide adequate customer assistance, timely flight-status notifications and proper, prompt refunds related to the December 2022 disruption, and that a civil penalty is warranted. The company could not estimate a possible loss range in the filing.
Other matters include a USERRA class action involving paid short-term military leave, securities and shareholder derivative litigation relating to the 2022 disruption and technology systems, and customer litigation concerning the 737 MAX. The company says it intends to defend these matters; adverse outcomes could be material, although management does not expect current proceedings individually or collectively to materially affect financial condition, results or cash flow.
Labor negotiations remain a risk: TWU 555 members rejected a tentative agreement, and pilot negotiations continue. The TWU 556 Flight Attendant tentative agreement was subject to a Q4 ratification vote.
Southwest is exposed to fuel-price volatility and the possibility that hedges do not adequately protect it; hedge value depends on market prices, contract terms and counterparty performance. Boeing delivery and FAA certification timing, supply-chain issues, severe weather, operational reliability, labor availability and broader economic conditions are also risks.
Following an October 25, 2023 Boeing agreement, firm aircraft-order capital commitments were $133 million for the remainder of 2023, $2.1 billion in 2024 and additional scheduled commitments thereafter. The -7 delivery schedule depends on FAA certification. The agreement extended the order book through 2031.

Important facts for investors to verify

Whether Q4 revenue and capacity guidance is achieved, and whether capacity growth and network changes improve load factor and unit revenue.
Actual labor-contract outcomes and the continuing effect of wage rates, bonuses and other labor costs on unit expenses.
The final DOT penalty or other costs tied to the December 2022 disruption, and the development of related litigation.
Aircraft delivery and -7 certification timing, capital spending, and the company’s ability to execute operational and network improvements.
Fuel prices, hedge settlements and the distinction between GAAP results and management’s non-GAAP “economic” measures.