LUV

Business Context and Reporting Period

Company: Southwest Airlines Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2000
Business Overview: Southwest Airlines operates as a low-cost carrier. During the quarter, the company expanded its fleet by 28 aircraft (a 9.8% increase) and increased capacity, resulting in a load factor of 66.8%. The company also announced new service routes to Albany, New York, effective May 7, 2000.

Key Financial Metrics

Note: Net income and EPS figures for Q1 2000 include a cumulative effect of a change in accounting principle of $22.1 million (net of tax).

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 15.5% year-over-year, driven by a 16.0% increase in passenger revenue. This was fueled by an 11.3% increase in revenue passengers and a 17.5% increase in Revenue Passenger Miles (RPMs).
• Fuel Costs: Fuel and oil expenses surged 130% to $197.1 million. The average cost per gallon rose 108.5% to $0.82 from $0.39 in the prior year, significantly impacting operating expenses per Available Seat Mile (ASM).
• Operating Expenses: Total operating expenses increased 19.6% to $1.087 billion. However, excluding fuel, operating expenses per ASM decreased 5.3% due to productivity gains and lower maintenance costs on older aircraft.
• Accounting Change: The company adopted Staff Accounting Bulletin 101 (SAB 101), changing revenue recognition for frequent flyer credits. This resulted in a one-time cumulative adjustment reducing net income by $22.1 million.
• Stock Repurchases: The company repurchased $101.4 million of common stock in Q1 2000, compared to no repurchases in Q1 1999.

Guidance, Outlook, and Risks

• Outlook: Management expects unit costs to be adversely affected by higher fuel prices in Q2 2000 compared to Q2 1999. However, excluding fuel, unit costs are expected to decrease. Load factors and bookings for April, May, and June appear consistent with or better than prior year periods.
• Fuel Hedging: As of April 20, 2000, the company had hedged the majority of its fuel requirements for the remainder of 2000. Despite hedging, the company anticipates significantly higher average net jet fuel costs for Q2 2000.
• Supply Chain Risks: A 40-day strike by the Society of Professional Engineering Employees in Aerospace (ending late March 2000) caused delays in new aircraft deliveries from Boeing, impacting charter business and fleet expansion timing.
• Liquidity: The company holds $542.6 million in cash and has an undrawn revolving credit line of up to $475 million. It has significant contractual commitments for aircraft acquisitions totaling approximately $1.867 billion through 2004.
• Legal Contingency: The company is involved in a tax dispute with the IRS regarding deductions for aircraft maintenance costs for the years 1989-1991. Management does not expect a materially adverse effect on financial position.

Investor Verification Checklist

• Fuel Price Sensitivity: Verify the impact of the 108.5% increase in fuel costs on future margins, given the company's expectation of continued high fuel prices in Q2.
• Accounting Change Impact: Confirm the long-term effect of the SAB 101 adoption on revenue recognition and comparability of future earnings.
• Capital Expenditures: Review the $1.867 billion in fixed aircraft commitments and the company's ability to fund these via cash flow, debt, or equity without straining liquidity.
• Stock Repurchase Program: Assess the remaining authorization and strategy for the share repurchase program, which cost $191.9 million over the trailing 12 months.
• Operational Efficiency: Monitor the trend of operating expenses per ASM excluding fuel to ensure productivity gains continue to offset inflationary pressures in other areas.