Business Context and Reporting Period
Company: Southwest Airlines Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 1999
Business Overview: Southwest Airlines operates as a low-cost carrier. During the reporting period, the company expanded its fleet to 294 aircraft and its workforce to 26,818 employees. The company initiated new service to Raleigh-Durham, North Carolina, and announced future service to Hartford, Connecticut. A three-for-two stock split was executed in July 1999, with all historical per-share data restated accordingly.
Key Financial Metrics
| Metric (in thousands) | Six Months Ended June 30, 1999 | Six Months Ended June 30, 1998 |
|---|---|---|
| Total Operating Revenues | $2,296,003 | $2,021,494 |
| Operating Income | $420,948 | $320,241 |
| Net Income | $253,604 | $203,401 |
| Diluted Earnings Per Share | $0.47 | $0.38 |
| Cash and Cash Equivalents (End of Period) | $487,635 | $567,173 |
| Net Cash Provided by Operating Activities | $673,138 | $508,424 |
| Total Debt (Current + Long-term) | $624,929 | N/A (Derived from Balance Sheet) |
| Operating Expenses per ASM | 7.40 cents | 7.40 cents |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated operating revenues increased 13.6% year-over-year for the six-month period, driven primarily by a 13.2% increase in passenger revenues. This was fueled by an 8.3% increase in revenue passengers carried and a 15.8% increase in revenue passenger miles (RPMs).
- Profitability: Net income rose 24.7% to $253.6 million. Operating income increased 31.4% to $420.9 million.
- Operational Efficiency: Load factor improved by 3.3 percentage points to 69.1% for the six-month period, as RPM growth (15.8%) outpaced available seat miles (ASM) growth (10.3%).
- Cost Dynamics:
- Fuel: Fuel costs per ASM decreased 14.0% due to lower average jet fuel prices and hedging gains. The average cost of jet fuel was $0.4192 per gallon in 1999 versus $0.4762 in 1998.
- Labor: Salaries, wages, and benefits per ASM increased 2.6% due to higher effective wage rates and health care costs.
- Maintenance: Maintenance costs per ASM increased 7.8% due to outsourcing heavy maintenance and higher engine overhaul costs for 737-200 aircraft.
- Capital Expenditures: Net purchases of property and equipment totaled $568.8 million for the six months, primarily for the acquisition of 24 new 737-700 aircraft and used aircraft.
Guidance, Outlook, and Risks
- Outlook: Management reported strong load factors and revenue trends continuing into July 1999 (75.6% load factor). Bookings for August and September were described as strong. The company expects modest increases in non-fuel unit costs for the third quarter of 1999.
- Capital Commitments: The company has significant contractual commitments for aircraft acquisitions totaling approximately $2.288 billion through 2004. As of July 31, 1999, 15 737-700s were scheduled for delivery in the remainder of 1999.
- Liquidity: The company maintains $487.6 million in cash and a $475 million revolving credit line (undrawn). It also has shelf registrations for $318.8 million in public debt.
- Year 2000 (Y2K) Readiness:
- The company anticipates total Y2K compliance costs of approximately $16 million, with $13.9 million already spent.
- Vital and critical internal systems are expected to be Y2K ready by year-end. Flight safety systems are deemed ready.
- Risk: While management does not expect a material adverse effect, the worst-case scenario involves delays or cancellations of a small percentage of flights in early 2000 due to third-party or airport issues.
- Legal Proceedings: The company is involved in a tax dispute with the IRS regarding aircraft inspection and maintenance deductions for 1989-1991. Management does not believe the outcome will have a materially adverse effect.
Investor Verification Checklist
- Fleet Expansion vs. Cash Flow: Verify the ability to fund $2.288 billion in aircraft commitments using current cash reserves ($487.6M) and operating cash flow ($673.1M for six months) without excessive leverage.
- Fuel Hedging Effectiveness: Confirm the sustainability of fuel cost savings given the volatility in jet fuel prices and the extent of hedging coverage for future quarters (22% of Q3 requirements hedged as of August 9, 1999).
- Maintenance Cost Trends: Monitor the impact of outsourcing heavy maintenance and 737-200 engine overhauls on future unit costs, as these are expected to remain elevated in Q3 1999.
- Y2K Contingency Plans: Assess the robustness of contingency plans regarding third-party vendors and airport infrastructure, as these are outside the company's direct control.
- Load Factor Sustainability: Evaluate whether the 3.3 percentage point increase in load factor can be maintained as capacity (ASMs) continues to grow with new aircraft deliveries.