Southwest Airlines Co. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Southwest operates scheduled passenger air service in the United States and near-international markets. Results were heavily affected by the COVID-19 pandemic and are not necessarily indicative of future periods.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Operating revenue | $1.793B | $5.639B | $7.035B | $16.698B |
| Operating income (loss) | $(1.411)B | $819M | $(2.648)B | $2.292B |
| Net income (loss) | $(1.157)B | $659M | $(2.166)B | $1.787B |
| Diluted EPS | $(1.96) | $1.23 | $(3.89) | $3.29 |
| Cash from (used in) operating activities | $(1.050)B | $1.091B | $(531)M | $3.163B |
- Q3 revenue fell 68.2% year over year; passenger revenue fell 72.2%. Nine-month revenue was down 57.9%.
- Q3 available seat miles declined 32.8%, while load factor fell to 44.9% from 83.5%. Average fare declined 19.8% to $125.07.
- Q3 operating expenses fell 33.5%, less than the capacity reduction. Operating expenses per available seat mile declined 1.1%; excluding fuel, profitsharing and special items, they rose 23.4%.
- Q3 fuel expense declined 65.2%, reflecting lower fuel prices and consumption. Average economic fuel cost was $1.23 per gallon, down 40.6%.
- Q3 interest expense increased to $111M from $30M, primarily due to higher debt. Nine-month interest expense rose 161.1% to $235M.
- Management-reported non-GAAP Q3 operating loss was $1.577B and net loss was $1.173B; nine-month non-GAAP operating and net losses were $3.841B and $2.751B. These measures exclude specified special items and are not GAAP results.
Liquidity, debt and capital
- At September 30, cash and cash equivalents were $12.109B and short-term investments were $2.453B, totaling $14.562B in cash and short-term investments. Current assets were $16.133B versus current liabilities of $7.804B.
- Long-term debt, including current maturities, was approximately $10.855B, compared with $2.665B at December 31, 2019. The company raised $13.6B through financing transactions during the first nine months, including debt and equity offerings, Treasury support and aircraft-secured borrowings; it repaid temporary credit-facility borrowings.
- Financing provided $10.199B of net cash in the first nine months. Investing used $107M; capital expenditures were $425M. The company also received $815M from aircraft sale-leasebacks, $428M in supplier proceeds, and $428M from Boeing related to the 737 MAX grounding.
- Unrestricted cash and short-term investments plus available revolving credit totaled $14.6B in liquidity; the $1B revolving facility had no amounts outstanding. The company reported compliance with its $2.5B minimum liquidity covenant.
- Credit ratings were downgraded in March and April 2020, though the company remained investment grade. Share repurchases and dividends were suspended under CARES Act restrictions.
Material developments, outlook and risks
- Pandemic and demand: Demand and bookings remained severely depressed. Q3 revenue passengers fell 65.3% and passenger revenue miles fell 63.9%. The company cited modest improvement in close-in leisure demand in August and September and into October, but significant uncertainty remained.
- Near-term outlook: Management estimated Q4 capacity would decline about 40% year over year, with December capacity down 40%–45%. October and November revenue was projected down 65%–70% and 60%–65%, respectively. Q4 operating expenses, excluding fuel, special items and prior-year profitsharing, were expected to decline 20%–25% year over year. Q4 average core cash burn was estimated at about $11M per day; October at about $12M per day. These are management estimates, not guarantees.
- Workforce programs: About 4,200 employees elected voluntary separation and approximately 11,000 were participating in Extended Emergency Time Off. Accrued program costs totaled $1.207B at quarter-end; Q3 included $1.1B of program charges, partially offset by payroll support. Management estimated savings of about $400M in Q4 2020 and $1.1B in 2021. Potential total program costs could reach approximately $1.7B, with some estimated future costs not accrued.
- Government support: Southwest received $3.4B under the CARES Act Payroll Support Program, including approximately $2.4B in grants and a $976M Treasury loan, plus warrants for up to 2.7M shares. CARES Act restrictions include limits on dividends and buybacks through September 30, 2021, and restrictions on employee pay and service obligations. Management urged an extension of federal payroll support; absent an extension, it was pursuing temporary pay concessions and said furloughs could be a last resort in early 2021.
- 737 MAX: All 34 MAX aircraft in the fleet remained grounded, and Boeing deliveries were suspended. Southwest said MAX aircraft likely would remain out of published schedules until at least Q2 2021, subject to FAA approval, training and other requirements. The company and Boeing had an interim agreement limiting MAX deliveries through 2021 to no more than 48, versus higher existing contractual figures.
- Unusual items and estimates: Q2 sale-leasebacks of 20 aircraft generated $222M in gains and $815M in proceeds, while increasing future operating lease obligations. Fuel hedge de-designations and interest-rate swap mark-to-market losses added earnings volatility. No goodwill or intangible impairment was recorded, but management will continue monitoring impairment assumptions.
- Other risks and contingencies: Risks include prolonged or renewed pandemic effects, weak demand, access to capital and higher borrowing costs, fuel-hedge volatility and counterparty exposure, labor negotiations, MAX delays and aircraft commitments, and supplier disruption. The company disclosed ongoing consumer, securities and derivative litigation; management did not expect existing legal matters or IRS adjustments to have a material adverse effect. It guaranteed airport-related obligations, including $289M for the LAX Terminal 1.5 project and $407M of Dallas Love Field bond principal.
Most important facts for investors to verify
- Whether passenger demand, bookings, revenue, load factors and daily cash burn track management’s Q4 estimates.
- How long pandemic-related restrictions and weak business and leisure travel persist, and whether further federal support is enacted.
- Cash consumption, available liquidity, debt maturities, refinancing access, rating changes and compliance with credit-facility covenants.
- Actual costs and savings from voluntary separation and leave programs, including whether employees return early or further accruals are needed.
- FAA approval, MAX return-to-service timing, Boeing compensation and the final aircraft delivery and capital-spending schedule.
- Future changes in travel-credit redemption and spoilage estimates, fuel-hedge accounting and valuation, and potential impairment assessments.