LUV

Southwest Airlines Co. 10-Q Summary (Q1 2009)

Business Context and Reporting Period

This filing covers the quarterly period ended March 31, 2009. Southwest Airlines Co. reported a net loss for the quarter, primarily driven by a decline in domestic air travel demand due to the U.S. recession. The company reduced capacity by 4.1% year-over-year but faced significant fare discounting, resulting in lower yields. Management announced a voluntary early retirement program ("Freedom '09") and plans to reduce fleet capacity by approximately 5% in 2009.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Operating revenues decreased 6.8% ($173 million) due to a 4.1% reduction in capacity (Available Seat Miles) and a 2.8% decrease in passenger yield. The timing of the Easter holiday (March 2008 vs. April 2009) also negatively impacted year-over-year comparisons.
• Operating Loss: The company shifted from an operating income of $88 million in Q1 2008 to an operating loss of $50 million in Q1 2009.
• Expense Dynamics: Total operating expenses decreased slightly by 1.4% ($35 million). While fuel costs dropped $102 million due to lower market prices, this was partially offset by a $36 million increase in salaries/wages (due to contract ratifications) and a $41 million increase in maintenance costs (due to new engine repair agreements for 737-700s).
• Hedging Impact: Despite lower physical fuel prices, the company recorded $146 million in hedging losses in Q1 2009, compared to $291 million in hedging gains in Q1 2008. This resulted in a net fuel cost per gallon that was only 6.6% lower than the prior year.

Guidance, Outlook, and Risks

• Capacity Strategy: Southwest plans to end 2009 with 535 aircraft (a net reduction of two) and fly approximately 5% fewer ASMs than in 2008. Q2 2009 capacity is expected to decrease ~3% year-over-year.
• Cost Reduction: The "Freedom '09" voluntary early retirement program was announced to reduce headcount. Capital spending for 2009 and 2010 was reduced by approximately $1.4 billion compared to 2008 plans.
• Fuel Hedging Risk: The company holds significant fuel derivative contracts with a net liability of approximately $931 million (excluding $300 million cash collateral). Due to "sold" instruments and undesignated hedges, the company expects to pay above-market fuel prices for future periods (estimated $0.15–$0.19 per gallon premium through 2013).
• Liquidity: Cash and short-term investments totaled $2.1 billion as of March 31, 2009. The company has a $600 million revolving credit facility with $200 million remaining available.
• Legal Contingencies: Settled an FAA fine for $7.5 million (paid in installments). Facing shareholder derivative suits and class actions related to a 2008 airworthiness incident, though management does not expect a material adverse effect.

Investor Verification Checklist

• Fuel Hedge Liability: Verify the impact of the $931 million net fuel derivative liability on future earnings, specifically the expected above-market fuel costs through 2013.
• Yield Trends: Monitor Q2 2009 passenger revenue yields, as management expects continued declines despite higher load factors.
• Cost Control: Assess the effectiveness of the "Freedom '09" retirement program and new labor contracts in curbing the 9.1% year-over-year increase in salary expenses per ASM.
• Auction Rate Securities: Review the status of $192 million in Level 3 auction rate securities, which are subject to liquidity risks and fair value adjustments.
• Collateral Requirements: Confirm that the company's investment-grade credit rating remains intact to avoid triggering additional cash collateral postings on fuel hedges.