Business Context and Reporting Period
Company: Southwest Airlines Co.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended June 30, 1997
Business Overview: Southwest Airlines operates as a low-cost carrier. During the period, the company expanded its fleet to 252 aircraft and added service to Jacksonville, Florida, and Jackson, Mississippi. The company is currently in negotiations with the Transport Workers Union regarding flight attendant contracts.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended June 30, 1997 |
6 Months Ended June 30, 1997 |
3 Months Ended June 30, 1996 |
6 Months Ended June 30, 1996 |
|---|---|---|---|---|
| Total Operating Revenues | $956,892 | $1,843,987 | $910,308 | $1,682,837 |
| Operating Income | $156,407 | $243,610 | $142,206 | $199,599 |
| Net Income | $93,832 | $144,706 | $85,316 | $118,317 |
| Diluted EPS | $0.62 | $0.96 | $0.56 | $0.77 |
| Cash from Operations | $220,604 | $314,115 | $222,176 | $363,891 |
| Cash and Equivalents (End of Period) | $577,784 | $577,784 | $478,285 | $478,285 |
| Total Debt (Current + Long-term) | $753,874 | $753,874 | N/A | N/A |
Note: Total Debt calculated as Current maturities of long-term debt ($116,947) plus Long-term debt less current maturities ($636,927) as of June 30, 1997.
Material Changes vs. Prior Period
- Revenue Growth: Operating revenues increased 5.1% for the quarter and 9.6% for the six-month period compared to the prior year. Passenger revenues drove this growth, increasing 4.0% (quarter) and 8.9% (six months), supported by higher Revenue Passenger Miles (RPMs) and improved yields.
- Profitability: Net income rose 10.0% for the quarter and 22.3% for the six-month period. Operating income margins improved due to cost efficiencies.
- Operational Efficiency: Operating expenses per Available Seat Mile (ASM) decreased 3.6% for the quarter and 0.7% for the six-month period. Key drivers included lower aircraft engine repair costs, reduced advertising spending, and lower jet fuel prices in the second quarter.
- Load Factor: Load factors declined to 63.9% (quarter) and 63.0% (six months) from 67.0% and 63.8% in the prior year, respectively. This decrease is attributed to an 8.0% increase in capacity (ASMs) outpacing the 3.0% increase in demand (RPMs).
- Capital Expenditures: Net purchases of property and equipment were $296.6 million for the quarter and $412.5 million for the six months, reflecting the purchase of new 737-300 aircraft and progress payments.
Guidance, Outlook, and Risks
- Tax Legislation Impact: The Taxpayer Relief Act of 1997 revised the federal excise tax on domestic tickets. Management estimates this will increase Southwest's tax burden by $30 million to $35 million in 1998. The company is evaluating alternatives to offset this impact.
- Load Factor Outlook: Management does not expect the third-quarter 1997 load factor to match the third quarter of 1996, citing the prior year's heavy promotional activities and the reimposition of the 10% federal excise tax in March 1997.
- Capital Commitments: The company has aggregate funding commitments of approximately $1,757.7 million for scheduled aircraft deliveries through 2001. Funding sources include cash on hand ($577.8 million), internally generated funds, a $475 million revolving credit line, and outstanding shelf registrations for $414.4 million in public debt.
- Legal Contingency: The IRS has proposed adjustments to income tax returns for 1987–1991 regarding aircraft financings. Southwest intends to vigorously protest these adjustments. Management believes the resolution will not have a materially adverse effect on operations.
- Accounting Change: The company will adopt FASB Statement No. 128 (Earnings per Share) for periods ending after December 15, 1997, which will require restating prior periods and excluding the dilutive effect of stock options from basic EPS.
Investor Verification Checklist
- Debt Structure: Verify the terms of the $100 million senior unsecured debentures issued in February 1997 and the utilization of the $475 million revolving credit line.
- Tax Exposure: Monitor the implementation of the new federal excise tax structure and the company's ability to pass costs to consumers or offset the estimated $30–$35 million 1998 burden.
- IRS Dispute: Track the status of the IRS examination regarding 1987–1991 aircraft financing adjustments and any potential litigation costs.
- Union Negotiations: Review progress on the flight attendant contract negotiations with the Transport Workers Union, which became amendable in May 1996.
- Capacity vs. Demand: Assess whether the company can improve load factors as capacity continues to expand with new aircraft deliveries.