Southwest Airlines Co. 10-Q Summary
Business Context and Reporting Period
This filing is a Quarterly Report (Form 10-Q) for Southwest Airlines Co. for the period ended March 31, 2007. The company reported its 64th consecutive quarterly profit. As of April 18, 2007, there were 780,832,895 shares of Common Stock outstanding.
Key Financial Metrics
| Metric | Q1 2007 | Q1 2006 |
|---|---|---|
| Operating Revenues | $2,198 million | $2,019 million |
| Operating Expenses | $2,114 million | $1,921 million |
| Operating Income | $84 million | $98 million |
| Net Income | $93 million | $61 million |
| Diluted EPS | $0.12 | $0.07 |
| Operating Cash Flow | $617 million | $751 million |
| Cash & Equivalents (End) | $1,618 million | $2,600 million |
| Total Debt (Current + Long-term) | $1,679 million | $1,689 million |
Unit Metrics: Revenue Passenger Miles (RPMs) increased 5.4% to 16.1 billion. Load factor decreased 1.2 points to 68.0%. Cost per Available Seat Mile (CASM) increased 2.6% to 8.93 cents (excluding fuel, CASM increased 1.7%).
Material Changes vs. Prior Period
- Net Income Surge: Net income rose 52.5% year-over-year, primarily driven by a $83 million gain recorded in "Other (gains) losses" related to the ineffectiveness and mark-to-market adjustments of fuel derivative contracts. This contrasts with a $13 million gain in Q1 2006.
- Operating Income Decline: Operating income fell 14.3% to $84 million. This decrease occurred because operating expenses grew 10.0% while revenues grew 8.9%.
- Revenue Drivers: Passenger revenue increased 9.0% due to a 7.2% capacity increase (adding 38 aircraft) and a 3.4% improvement in RPM yield. However, the load factor dropped to 68.0% from 69.2% due to weather, economic slowing, and higher fares.
- Expense Pressures: Fuel cost per gallon increased 5.3% to $1.59 despite hedging, due to a less favorable hedge position compared to the prior year. Maintenance costs rose significantly (23.4% per ASM) due to increased airframe inspections on a maturing fleet.
Guidance, Outlook, and Risks
- Q2 2007 Outlook: Management expects capacity to grow approximately 9% versus Q2 2006. However, they anticipate a lower load factor than the record 78.0% achieved in Q2 2006 and do not expect to match the prior year's unit revenue performance. Fuel costs are expected to remain capped near $1.70 per gallon due to hedging.
- Fuel Hedging: The company is protected for over 90% of its 2007 fuel needs at an average crude oil equivalent of ~$50/barrel. The fair value of fuel derivatives stands at a net asset of $1.4 billion.
- Capital Allocation: The company completed a $400 million stock repurchase program in Q1 2007 and initiated a new $300 million program in March 2007. They have firm orders for 117 Boeing 737-700 aircraft with aggregate funding needs of approximately $2.9 billion.
- Risks: Key risks include volatility in jet fuel prices, the potential expiration of government-provided war-risk insurance in December 2007, and the impact of hedge ineffectiveness on earnings volatility.
Investor Verification Checklist
- Hedge Accounting Impact: Verify the sustainability of the $83 million non-operating gain from fuel derivatives and its effect on future earnings volatility.
- Maintenance Costs: Monitor if the 23.4% increase in maintenance costs per ASM is a temporary trend due to fleet maturing or a structural increase.
- Load Factor Trends: Assess if the decline in load factor (68.0%) is a seasonal anomaly or indicative of broader demand weakness.
- Liquidity Position: Confirm the impact of the $885 million in cash collateral deposits held for fuel hedges on available liquidity.
- Stock Repurchases: Track the execution of the new $300 million share repurchase program authorized in March 2007.