The cost of Southwest’s near-disaster: Not much…

September 6, 2011

Scruffy looking 737-3H4

On April 1, Southwest Airlines (LUV) Flight 812 suffered a 5-foot rupture in its fuselage, causing the cabin to depressurize rapidly and forcing the pilot into an emergency landing shortly after takeoff from Phoenix. Southwest canceled 624 flights over three days, found (and fixed) flaws in five other aircraft and the FAA ordered additional inspections for other airlines as well. The flying public was, to put it mildly, more than a little shaken, at least temporarily.

And the cost for Southwest Airlines? About $5 million. Except, no, wait — all those canceled flights also meant the company saved a bunch of fuel, which offset its other costs. So make that about $2 million. Or, to put it another way, the incident was immaterial to Southwest’s financial condition and results of operations. Moreover,

“management concluded that there were no known facts or circumstances related to the incident that were reasonably likely to have a material impact on the Company’s future financial condition and results of operations.”

In other words, from a financial and a disclosure perspective, the whole incident was a non-event. We only know this, in fact, because someone at the Securities and Exchange Commission wondered why Southwest never even mentioned the incident in the quarterly report it filed on April 25.

That someone was apparently SEC branch chief Lyn Shenk, or someone on his staff, who sent the initial inquiry to Southwest, in the form of an SEC comment letter on April 28 [PDF], and we tip our hat to him. The SEC has caught a lot of flak lately, but this is one example of someone at the SEC asking about something missing from the filings. And as we know firsthand, it’s often a lot harder to find what’s not there than what’s staring you in the face.

On one level, Southwest makes a good case (in its May 11 response to the initial SEC letter) that the event was a non-event, as far as operations go: The canceled flights represented just 7% of Southwest’s total for the three-day period, and “approximately two-tenths of one percent of the Company’s expected second quarter 2011 flight schedule.” Most affected passengers were put on other Southwest flights (though we imagine not without at least a little inconvenience).

“Although the incident has received media attention, its financial impact on the Company has been no more significant than the immaterial impact of ordinary course events such as weather-related events. Therefore, the Company concluded that it did not have a Form 10-Q disclosure obligation based on the known financial impact at the time of filing.”

Southwest also notes that its 10-Q filing came only after the National Transportation Safety Board had already said the company’s maintenance and inspection schedules were up to date, and after the company concluded it was an isolated incident.

“In addition, the Company saw no evidence that the incident had negatively affected customer demand. Therefore, the Company concluded that there were no known facts or circumstances related to the incident that were reasonably likely to have a material impact on the Company’s future financial condition and results of operations.”

Finally, according to Southwest, evidence points to a manufacturing issue for the specific aircraft, “rather than a design issue with respect to the aircraft type as a whole or any inspection deficiencies on the part of the Company.” There may still be insurance ramifications — talks were apparently under way with the airline’s insurance carrier in May — but if Southwest decides to repair the plane, its costs would be capped at $1 million under its insurance contracts.

“If the Company were to make the decision to not repair the aircraft, its financial liability would also be immaterial, due to the combination of the insurance coverage in place and the fair value of the reusable major components, considered in conjunction with the existing net book value of the aircraft.”

So. No harm, no foul? That’s how it would seem — the SEC closed its review of the filing on June 15 [PDF], apparently without further ado.

We understand the reasoning in each of the specifics. And yet, looking at the big picture, it seems surprising that an event on that scale — that got that kind of attention and caused that much consternation among regulators, passengers and others — turns out to be a complete non-event for the airline involved.

Image source: JL Johnson via Flickr

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