SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file No. 1-7259
Southwest Airlines Co.
(Exact name of registrant as specified in its charter)
TEXAS 74-1563240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
P.O. Box 36611, Dallas, Texas 75235-1611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 792-4000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock outstanding as of the close of business on
July 18, 2003:
782,931,936
<Page>
SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
<Table>
<Caption>
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in millions)
(unaudited)
June 30, 2003 December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents $2,204 $1,815
Accounts and other receivables 128 175
Inventories of parts and supplies, at cost 87 86
Fuel hedge contracts 111 113
Prepaid expenses and other current assets 51 43
Total current assets 2,581 2,232
Property and equipment, at cost:
Flight equipment 8,211 8,025
Ground property and equipment 1,075 1,042
Deposits on flight equipment purchase contracts 665 389
9,951 9,456
Less allowance for depreciation and amortization 3,001 2,810
6,950 6,646
Other assets 107 76
$9,638 $8,954
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $341 $362
Accrued liabilities 599 529
Air traffic liability 575 412
Income taxes payable 11 -
Current maturities of long-term debt 132 131
Total current liabilities 1,658 1,434
Long-term debt less current maturities 1,539 1,553
Deferred income taxes 1,388 1,227
Deferred gains from sale and leaseback of aircraft 176 184
Other deferred liabilities 140 134
Stockholders' equity:
Common stock 782 777
Capital in excess of par value 163 136
Retained earnings 3,718 3,455
Accumulated other comprehensive income 74 54
Total stockholders' equity 4,737 4,422
$9,638 $8,954
<FN>
<F1>
See accompanying notes.
</FN>
</Table>
<Page>
<Table>
<Caption>
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
OPERATING REVENUES:
Passenger $1,465 $1,425 $2,771 $2,640
Freight 25 22 47 43
Other 25 26 48 47
Total operating revenues 1,515 1,473 2,866 2,730
OPERATING EXPENSES:
Salaries, wages, and benefits 587 501 1,103 963
Fuel and oil 194 189 402 359
Maintenance materials and
repairs 104 101 210 198
Agency commissions 13 15 25 29
Aircraft rentals 46 47 91 94
Landing fees and other rentals 91 88 181 171
Depreciation 95 86 188 171
Other operating expenses 245 257 480 507
Total operating expenses 1,375 1,284 2,680 2,492
OPERATING INCOME 140 189 186 238
OTHER EXPENSES (INCOME):
Interest expense 23 27 49 53
Capitalized interest (8) (5) (15) (9)
Interest income (7) (9) (12) (19)
Other (gains) losses, net (265) 7 (272) 9
Total other expenses (income) (257) 20 (250) 34
INCOME BEFORE INCOME TAXES 397 169 436 204
PROVISION FOR INCOME TAXES 151 67 166 81
NET INCOME $246 $102 $270 $123
NET INCOME PER SHARE:
Basic $.32 $.13 $.35 $.16
Diluted $.30 $.13 $.33 $.15
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 780 772 779 771
Diluted 820 809 814 810
<FN>
<F1>
See accompanying notes.
</FN>
</Table>
<Page>
<Table>
<Caption>
Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $246 $102 $270 $123
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation 95 86 188 171
Deferred income taxes 136 62 148 76
Amortization of deferred gains on sale and
leaseback of aircraft (4) (4) (8) (8)
Amortization of scheduled airframe
inspections & repairs 12 11 24 22
Changes in certain assets and liabilities:
Accounts and other receivables 31 4 47 (58)
Other current assets (7) (11) (8) 6
Accounts payable and accrued liabilities 59 77 52 (9)
Air traffic liability 40 (30) 163 81
Income taxes payable 11 - 11 -
Other 19 (4) 18 (18)
Net cash provided by operating activities 638 293 905 386
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (325) (144) (518) (253)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt - - - 385
Proceeds from trust arrangement - 60 - 119
Proceeds from Employee stock plans 20 11 32 31
Payments of long-term debt and
capital lease obligations (14) (50) (20) (55)
Payment of trust arrangement - (161) - (284)
Payment of revolving credit facility - - - (475)
Payments of cash dividends (4) (4) (11) (11)
Other, net - (1) 1 (5)
Net cash provided by (used in)
financing activities 2 (145) 2 (295)
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 315 4 389 (162)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 1,889 2,114 1,815 2,280
CASH AND CASH EQUIVALENTS AT END OF PERIOD $2,204 $2,118 $2,204 $2,118
CASH PAYMENTS FOR:
Interest, net of amount capitalized $15 $21 $37 $38
Income taxes $4 $2 $4 $2
<FN>
<F1>
See accompanying notes.
</FN>
</Table>
<Page>
Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Southwest Airlines Co. (Company or Southwest) have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. The unaudited condensed consolidated
financial statements for the interim periods ended June 30, 2003 and 2002
include all adjustments (which include only normal recurring adjustments) which
are, in the opinion of management, necessary for a fair presentation of the
results for the interim periods. The Condensed Consolidated Balance Sheet as
of December 31, 2002 has been derived from the Company's audited financial
statements as of that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. Operating results for the three and six months ended
June 30, 2003 are not necessarily indicative of the results that may be
expected for the year ended December 31, 2003. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Southwest Airlines Co. Annual Report on Form 10-K for the year ended
December 31, 2002.
2. STOCK-BASED EMPLOYEE COMPENSATION
The Company has stock-based compensation plans covering the majority of its
Employee groups, including plans adopted via collective bargaining, a plan
covering the Company's Board of Directors, and plans related to employment
contracts with certain Executive Officers of the Company. The Company accounts
for stock-based compensation utilizing the intrinsic value method in accordance
with the provisions of Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees" and related Interpretations.
Accordingly, no compensation expense is recognized for fixed option plans
because the exercise prices of Employee stock options equal or exceed the
market prices of the underlying stock on the dates of grant.
The following table represents the effect on net income and earnings per share
if the Company had applied the fair value based method and recognition
provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," to stock-based Employee compensation
(in millions, except per share amounts):
<Page>
<Table>
<Caption>
Three months Six months
ended June 30, ended June 30,
2003 2002 2003 2002
Net income, as reported $246 $102 $270 $123
Add: Stock-based Employee compensation
expense included in reported income,
net of related tax effects - - - -
Deduct: Total stock-based Employee
compensation expense determined under
fair value based methods for all
awards, net of related tax effects (14) (8) (31) (16)
Pro forma net income $232 $94 $239 $107
Net income per share
Basic, as reported $.32 $.13 $.35 $.16
Basic, pro forma $.30 $.12 $.31 $.14
Diluted, as reported $.30 $.13 $.33 $.15
Diluted, pro forma $.29 $.12 $.30 $.13
</Table>
As required, the pro forma disclosures above include options granted since
January 1, 1995. Consequently, the effects of applying SFAS 123 for providing
pro forma disclosures may not be representative of the effects on reported net
income for future years until all options outstanding are included in the pro
forma disclosures. For purposes of pro forma disclosures, the estimated
fair value of stock-based compensation plans and other options is amortized to
expense primarily over the vesting period.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." SFAS No. 148 amends the transition
and disclosure provisions of SFAS No. 123. The Company is currently evaluating
SFAS No. 148 to determine if it will adopt SFAS No. 123 to account for Employee
stock options using the fair value method and, if so, when to begin transition
to that method. If the Company had adopted the prospective transition method
prescribed by SFAS 148 on January 1, 2003, compensation expense for the three
and six months ended June 30, 2003 of $4 million and $15 million, respectively,
would have been recorded. After related profitsharing and income tax effects,
this would have reduced net income by $2 million and $8 million, respectively.
Net income per share, diluted, for second quarter 2003 would not have been
affected. Net income per share, diluted, for the six months ended June 30,
2003, would have been reduced by $.01 per share.
3. DIVIDENDS
During the three month periods ended June 30, 2003 and March 31, 2003,
dividends of $.0045 per share were declared on the 780 million shares and 778
million shares of common stock then outstanding, respectively. During the
three month periods ended June 30, 2002 and March 31, 2002, dividends of $.0045
per share were declared on the 772 million shares and 771 million shares of
common stock then outstanding, respectively.
<Page>
4. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net income
per share (in millions except per share amounts):
<Table>
<Caption>
Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
NUMERATOR:
Net income available to
common stockholders $246 $102 $270 $123
DENOMINATOR:
Weighted-average shares
outstanding, basic 780 772 779 771
Dilutive effect of Employee stock
Options 40 37 35 39
Adjusted weighted-average shares
outstanding, diluted 820 809 814 810
NET INCOME PER SHARE:
Basic $.32 $.13 $.35 $.16
Diluted $.30 $.13 $.33 $.15
</Table>
5. FINANCIAL DERIVATIVE INSTRUMENTS
Airline operators are inherently dependent upon energy to operate and,
therefore, are impacted by changes in jet fuel prices. Jet fuel and oil
consumed in the three months ended June 30, 2003 and 2002 represented
approximately 14.1 percent and 14.7 percent of Southwest's operating expenses,
respectively. The Company endeavors to acquire jet fuel at the lowest possible
prices. Because jet fuel is not traded on an organized futures exchange,
liquidity for jet fuel hedging is limited. However, the Company has found that
both crude oil and heating oil contracts are effective commodities for hedging
jet fuel. The Company utilizes financial derivative instruments as hedges to
decrease its exposure to jet fuel price increases. The Company does not
purchase or hold any derivative financial instruments for trading purposes.
The Company utilizes financial derivative instruments for both short-term and
long-term time frames when it appears the Company can take advantage of market
conditions. The Company was hedged for 100 percent of its first quarter 2003
and second quarter 2003 fuel consumption. For third quarter 2003, the Company
has fuel hedges in place for 87 percent of its expected fuel consumption with a
combination of derivative instruments that effectively cap prices under $24 per
barrel. As of June 30, 2003, the Company also had agreements in place to hedge
87 percent of its fourth quarter 2003 total anticipated jet fuel requirements
with a combination of derivative instruments that effectively cap prices under
$24 per barrel, approximately 80 percent of its anticipated 2004 requirements
at approximately $23 per barrel, and approximately 45 percent of its
anticipated 2005 requirements at approximately $23 per barrel. As of June 30,
2003, the majority of the Company's remaining 2003 hedges are effectively
<Page>
heating oil-based positions in the form of option contracts. The majority of
the remaining hedge positions are crude oil-based option contracts.
The Company accounts for its fuel hedge derivative instruments as cash flow
hedges, as defined, in Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended (SFAS
133). All changes in fair value that are considered to be effective, as
defined, are recorded in "Accumulated other comprehensive income" until the
underlying jet fuel is consumed. The fair value of the Company's financial
derivative instruments at June 30, 2003, was a net asset of approximately $178
million. The current portion of this net asset, approximately $111 million, is
classified as "Fuel hedge contracts" and the noncurrent portion, approximately
$67 million, is classified in "Other assets" in the Condensed Consolidated
Balance Sheet. The fair value of the derivative instruments, depending on the
type of instrument, was determined by the use of present value methods or
standard option value models with assumptions about commodity prices based on
those observed in underlying markets.
During the three months ended June 30, 2003 and 2002, the Company recognized
$36 million and $7 million in gains in "Fuel and oil" expense, respectively,
from hedging activities. During the three months ended June 30, 2002, the
Company also recognized approximately $3 million of net expense in "Other
(gains)losses, net," related to the ineffectiveness of its hedges. The Company
recognized approximately $6 million of net expense related to amounts excluded
from the Company's measurements of hedge effectiveness, in "Other (gains)
losses, net" during both second quarter 2003 and second quarter 2002.
As of June 30, 2003, the Company had approximately $76 million in unrealized
gains, net of tax, in "Accumulated other comprehensive income" related to fuel
hedges. Included in this total are approximately $49 million in net unrealized
gains that are expected to be realized in earnings during the twelve months
following June 30, 2003.
During second quarter 2003, the Company entered into interest rate swap
agreements relating to its $385 million 6.5% senior unsecured notes due March
1, 2012 and $375 million 5.496% Class A-2 pass-through certificates due
November 1,2006. Under the first interest rate swap agreement, the Company
pays the London InterBank Offered Rate (LIBOR) plus a margin every six months
and receives 6.5% every six months on a notional amount of $385 million until
March 1, 2012. Under the second agreement, the Company pays LIBOR plus a
margin every six months and receives 5.496% every six months on a notional
amount of $375 million until November 1, 2006.
The Company's interest rate swap agreements qualify as fair value hedges, as
defined by SFAS 133. The fair value of the interest rate swap agreements,
which are adjusted regularly, are recorded in the Condensed Consolidated
Balance Sheet as necessary, with a corresponding adjustment to the carrying
value of the long-term debt. The fair value of the interest rate swap
agreements, excluding accrued interest, at June 30, 2003 was approximately
$7 million. This amount is recorded in "Other assets" in the Condensed
Consolidated Balance Sheet. In accordance with fair value hedging, the
Company also recorded a $7 million increase to the carrying value of
long-term debt.
<Page>
6. COMPREHENSIVE INCOME
Comprehensive income included changes in the fair value of certain financial
derivative instruments, which qualify for hedge accounting, and unrealized
gains and losses on certain investments. Comprehensive income totaled $261
million and $290 million for the three and six months ended June 30, 2003,
respectively. Comprehensive income totaled $106 million and $186 million for
the three and six months ended June 30, 2002, respectively. The differences
between net income and comprehensive income for each of these periods was as
follows (in millions):
<Table>
<Caption>
Three months ended June 30,
2003 2002
Net income $246 $102
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $9 and $3 13 4
Other, net of deferred taxes of $1 and $0 2 -
Total other comprehensive income 15 4
Comprehensive income $261 $106
Six months ended June 30,
2003 2002
Net income $270 $123
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $13 and $41 20 63
Other, net of deferred taxes of $0 and $0 - -
Total other comprehensive income 20 63
Comprehensive income $290 $186
</Table>
A rollforward of the amounts included in "Accumulated other comprehensive
income," net of taxes, is shown below (in millions):
<Table>
<Caption>
Accumulated
Fuel other
Hedge comprehensive
Derivatives Other income (loss)
Balance at December 31, 2002 $56 ($2) $54
2003 changes in value 74 - 74
Reclassification to earnings (54) - (54)
Balance at June 30, 2003 $76 ($2) $74
</Table>
7. REVOLVING CREDIT FACILITY
The Company is a party to two unsecured revolving credit facilities from which
it can borrow up to $575 million from a group of banks. One of the facilities,
for half of the total amount, was renewed for an additional year during April
<Page>
2003. This facility now expires in April 2004. The other facility, for half
of the amount, expires in April 2005. At the Company's option, interest on the
facilities can be calculated on one of several different bases. For most
borrowings, Southwest would anticipate choosing a floating rate based upon
LIBOR. If fully drawn, the spread over LIBOR would be 75 basis points for both
facilities given Southwest's credit rating at June 30, 2003.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45).
FIN 45 requires that a liability for the fair value of an obligation for
guarantees issued or modified after December 31, 2002 be recorded in the
financial statements of the guarantor. Guarantees pre-existing before the
implementation of FIN 45 are required to be disclosed in financial statements
issued after December 15, 2002. While the Company has various guarantees
included in contracts in the normal course of business, primarily in the form
of indemnities, these guarantees would only result in immaterial increases in
future costs, and do not represent significant commitments or contingent
liabilities of the indebtedness of others.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46) which requires the consolidation of
variable interest entities, as defined. FIN 46 is applicable to variable
interest entities created after January 31, 2003. Variable interest entities
created prior to February 1, 2003, must be consolidated effective July 1, 2003.
Disclosures are required currently if the Company expects to consolidate any
variable interest entities. The Company does not currently believe that any
material entities will be consolidated with Southwest as a result of FIN 46.
9. EMERGENCY WARTIME SUPPLEMENTAL APPROPRIATIONS ACT
On April 16, 2003, the Emergency Wartime Supplemental Appropriations Act
(Wartime Act) was signed into law. Among other items, the legislation includes
a $2.3 billion government grant for airlines. Southwest received $271 million
as its proportional share of the grant during second quarter 2003. This amount
is included in "Other (gains) losses" in the accompanying income statement for
the three and six months ended June 30, 2003.
<Page>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Comparative Consolidated Operating Statistics
Relevant Southwest comparative operating statistics for the three and six
months ended June 30, 2003 and 2002 are as follows:
<Table>
<Caption>
Three months ended June 30,
2003 2002 Change
Revenue passengers carried 17,063,496 16,772,419 1.7%
Revenue passenger miles (RPMs) (000s) 12,550,665 11,998,867 4.6%
Available seat miles (ASMs) (000s) 17,893,765 17,172,875 4.2%
Load factor 70.1% 69.9% .2 pts.
Average length of passenger haul (miles) 736 715 2.9%
Trips flown 237,518 236,830 0.3%
Average passenger fare $85.87 $84.98 1.0%
Passenger revenue yield per RPM (cents) 11.67 11.88 (1.8)%
Operating revenue yield per ASM (cents) 8.47 8.58 (1.3)%
Operating expenses per ASM (cents) 7.68 7.48 2.7%
Operating expenses per ASM,
excluding fuel (cents) 6.60 6.38 3.4%
Fuel costs per gallon,
excluding fuel tax (cents) 67.4 67.4 -
Fuel consumed, in gallons (millions) 286 280 2.1%
Number of Employees at period-end 32,902 33,149 (0.7)%
Size of fleet at period-end 379 366 3.6%
Six months ended June 30,
2003 2002 Change
Revenue passengers carried 32,141,033 31,235,701 2.9%
Revenue passenger miles (RPMs) (000s) 23,446,366 22,391,457 4.7%
Available seat miles (ASMs) (000s) 35,292,897 33,692,832 4.7%
Load factor 66.4% 66.5% (.1) pts.
Average length of passenger haul (miles) 729 717 1.7%
Trips flown 470,605 468,025 0.6%
Average passenger fare $86.23 $84.52 2.0%
Passenger revenue yield per RPM (cents) 11.82 11.79 0.3%
Operating revenue yield per ASM (cents) 8.12 8.10 0.2%
Operating expenses per ASM (cents) 7.59 7.40 2.6%
Operating expenses per ASM,
excluding fuel (cents) 6.45 6.33 1.9%
Fuel costs per gallon,
excluding fuel tax (cents) 71.0 65.4 8.6%
Fuel consumed, in gallons (millions) 563 548 2.7%
Number of Employees at period-end 32,902 33,149 (0.7)%
Size of fleet at period-end 379 366 3.6%
</Table>
<Page>
Material Changes in Results of Operations
Summary
The Company's second quarter began with the onset of the United States
war with Iraq and a continued languid airline revenue and economic environment.
The Company saw a disruption in revenue and booking trends up to and during the
war. In mid-June, traffic and revenue trends began to improve and traffic
levels for July and August are expected to be strong. The Company also
continued its efforts to control costs, maintain high productivity levels, and
offer outstanding Customer Service. The Company's second quarter 2003 earnings
performance represented its 49th consecutive quarterly profit.
Consolidated net income for second quarter 2003 was $246 million ($.30
per share, diluted), compared to second quarter 2002 net income of $102 million
($.13 per share, diluted). As disclosed in Note 9 to the unaudited condensed
consolidated financial statements, results for second quarter 2003 include a
$271 million government grant from the Wartime Act. The Company believes that
excluding the impact of this special item will enhance comparative analysis of
results. The government grant received during second quarter 2003, which was
related to the war with Iraq, was not indicative of the Company's operating
performance for that period, nor should it be considered in developing trend
analysis for future periods, including third quarter 2003. The following table
reconciles results reported for the three and six months ended June 30, 2003,
compared to the prior year, with results excluding the impact of the government
grant received in second quarter 2003:
<Table>
<Caption>
Three months ended Six months ended
June 30, June 30,
(In millions, except per share amounts) 2003 2002 2003 2002
Operating expenses, as reported $1,375 $1,284 $2,680 $2,492
Profitsharing impact of government grant (41) - (41) -
Operating expenses, excluding impact of
government grant $1,334 $1,284 $2,639 $2,492
Operating income, as reported $140 $189 $186 $238
Profitsharing impact of government grant 41 - 41 -
Operating income, excluding impact of
government grant $181 $189 $227 $238
Net income, as reported $246 $102 $270 $123
Government grant, net of income taxes
and profitsharing (143) - (143) -
Net income, excluding government grant $103 $102 $127 $123
Net income per share, diluted, as reported $.30 $.13 $.33 $.15
Government grant, net of income taxes
and profitsharing (.17) - (.17) -
Net income per share, diluted, excluding
government grant $.13 $.13 $.16 $.15
</Table>
<Page>
Excluding the government grant from second quarter 2003 results, net
income was $103 million, slightly higher than second quarter 2002, even though
the prior year results included $36 million in additional passenger revenue
from a reduction in estimated future refunds and exchanges included in "Air
traffic liability." The $36 million adjustment was necessary due to a change
in Customer travel patterns and a higher than usual mix of low-fare
nonrefundable ticket sales following the September 11, 2001 terrorist attacks.
For first half 2003, net income was $127 million, also slightly higher than net
income for the comparable period of 2002, which also included the $36 million
adjustment to passenger revenue.
Second quarter 2003 operating income was $140 million compared to
operating income of $189 million in 2002, a decrease of 25.9 percent, primarily
due to the profitsharing impact in 2003 of the $271 million government grant.
Second quarter 2003 operating income, excluding the government grant, was $181
million, 4.2 percent below the prior year. The decrease was due to the second
quarter 2002 $36 million adjustment to passenger revenue. For first half 2003,
operating income was $227 million, slightly below operating income of $238
million for the comparable period of 2002, also due to the prior year $36
million adjustment to passenger revenue.
Although the Company continues to experience significantly higher costs
for aviation insurance and airport security compared to pre-September 11, 2001,
thus far, Southwest has been able to mitigate a portion of such increases
through lower agency commissions, the Company's fuel hedging program, and other
cost reduction efforts implemented following the terrorist attacks. Based on
the Company's current revenue and cost outlook and, barring any unforeseen
event, the Company expects third quarter 2003 earnings to exceed third quarter
2002 earnings of $75 million, which included $48 million (pretax), in "Other
gains" from the Company's final payment received from the Air Transportation
Safety and System Stabilization Act.
Comparison of three months ended June 30, 2003 to three months ended June 30,
2002
Revenues
Consolidated operating revenues increased by $42 million, or 2.9 percent,
primarily due to a $40 million, or 2.8 percent increase in passenger revenues.
The increase in passenger revenues was primarily due to a 4.6 percent increase
in revenue passenger miles (RPMs) flown. The year-over-year increase in
revenue was lower than it would have been due to the second quarter 2002
inclusion of $36 million in additional passenger revenue from a reduction in
estimated refunds and exchanges included in "Air traffic liability."
Second quarter 2003 capacity, as measured by available seat miles (ASMs),
increased 4.2 percent compared to second quarter 2002. The capacity increase
resulted from the addition of 13 aircraft (net of one retirement) from June
2002 through June 2003. The second quarter 2003 load factor was 70.1 percent,
an increase of .2 points compared to 2002. The Company also experienced a 1.7
percent increase in revenue passengers carried compared to second quarter 2002.
Second quarter 2003 passenger yield per RPM decreased 1.8 percent to
11.67 cents from 11.88 cents in second quarter 2002 due to the prior year $36
million in additional passenger revenue from a reduction in estimated refunds
and exchanges. Operating revenue yield per ASM decreased 1.3 percent to 8.47
<Page>
cents compared to second quarter 2002, also due to the prior year passenger
revenue adjustment. However, average passenger fare increased 1.0 percent to
$85.87 despite the prior year passenger revenue adjustment, primarily due to
moderate fare increases taken by the Company.
Thus far, traffic and load factors for July, and bookings for the
remainder of July and August are strong due to high demand for vacation travel.
Thus far in third quarter 2003, unit revenues are exceeding year ago levels.
The outlook for the economy remains uncertain, however, and the Company remains
concerned about travel post-Labor Day.
Consolidated freight revenues increased by $3 million, or 13.6 percent,
primarily due to increases in freight and cargo revenues from both moderate
rate increases taken by the Company and an increase in the number of shipments.
For third quarter 2003, the Company may experience a year-over-year decrease in
consolidated freight revenues compared to third quarter 2002 primarily
due to lower mail revenues as the U.S. Postal Service may shift some mail
shipments to other freight and commercial carriers. Other revenues decreased
slightly in second quarter 2003 as a 36.5 percent decline in charter revenue
was mostly offset by a 21.5 percent increase in commissions earned from
programs the Company sponsors with certain business partners, such as the
Company sponsored First USA Visa card.
Operating expenses
To a large extent, changes in operating expenses for airlines are driven
by changes in capacity, or ASMs. The following presents Southwest's operating
expenses per ASM for the three months ended June 30, 2003 and 2002 followed by
explanations of changes on a per ASM basis:
<Table>
<Caption>
Three months ended June 30, Per ASM Percent
2003 2002 Change Change
Salaries, wages, and benefits 3.28 2.92 .36 12.3
Fuel and oil 1.08 1.10 (.02) (1.8)
Maintenance materials
and repairs .58 .59 (.01) (1.7)
Agency commissions .07 .09 (.02) (22.2)
Aircraft rentals .26 .27 (.01) (3.7)
Landing fees and other rentals .51 .51 - -
Depreciation .53 .50 .03 6.0
Other operating expenses 1.37 1.50 (.13) (8.7)
Total 7.68 7.48 .20 2.7
</Table>
Operating expenses per ASM were 7.68 cents, a 2.7 percent increase
compared to 7.48 cents for second quarter 2002. This increase was primarily
due to higher profitsharing expense (reflected in salaries, wages, and
benefits) from the increase in earnings available for profitsharing compared to
second quarter 2002, primarily due to the $271 million government grant. Based
on recent trends, the Company currently expects third quarter 2003 unit costs
to exceed third quarter 2002 primarily due to higher wages and health benefit
costs.
<Page>
Salaries, wages, and benefits expense per ASM increased 12.3 percent.
Approximately 65 percent of the increase was due to a $41 million increase in
profitsharing, which related to the $271 million government grant. The
remaining 35 percent of the increase was primarily due to higher wages from
higher average wage rates.
Fuel and oil expense per ASM decreased 1.8 percent primarily due to a
decrease in the Company's fuel burn rate per ASM flown. Although the Company
flew 4.2 percent more available seat miles than second quarter 2002, fuel
consumption was up only 2.2 percent. The average fuel cost per gallon in
second quarter 2003 was 67.4 cents, the same as second quarter 2002, including
the effects of hedging activities. For third quarter 2003, the Company has
fuel hedges in place for 87 percent of its expected fuel consumption with a
combination of derivative instruments that effectively cap prices under $24
per barrel. The majority of the Company's near term hedge positions are in the
form of option contracts. See Note 5 to the unaudited condensed consolidated
financial statements for further discussion of the Company's hedging
activities.
Maintenance materials and repairs per ASM decreased 1.7 percent primarily
due to the increase in ASMs exceeding the dollar increase in maintenance
materials and repairs. The Company expects third quarter 2003 maintenance
materials and repairs per ASM to be higher than third quarter 2002 expense due
to a year-over-year increase in contract rates for outsourced engine
maintenance.
Agency commissions per ASM decreased 22.2 percent primarily due to a
decline in commissionable revenues. The percentage of commissionable revenues
decreased from approximately 20 percent in second quarter 2002 to approximately
16 percent in second quarter 2003. Approximately 53 percent of revenues in
second quarter 2003 were derived through the Company's web site at
www.southwest.com versus 46 percent of revenues in second quarter 2002. Based
on recent trends, the Company currently expects commissionable revenues to
remain in the 16 percent range in third quarter 2003.
Aircraft rentals per ASM decreased 3.7 percent compared to second quarter
2002 primarily due to the increase in ASMs relative to the number of leased
aircraft. Although ASMs increased 4.2 percent, the number of leased aircraft
declined by one, as a result of a retirement in second quarter 2003. All of
the aircraft acquired in 2002 and 2003 are owned by the Company. Approximately
23.5 percent of the Company's aircraft fleet was under operating lease at June
30, 2003, compared to 24.6 percent at June 30, 2002.
Landing fees and other rentals per ASM was flat compared to second
Quarter 2002 as a 3.7 percent increase in other rentals per ASM was offset by a
4.2 percent decrease in landing fees per ASM. The increase in other rentals
expense per ASM was primarily due to the Company's expansion of gate and
counter space at several airports. The decrease in landing fees expense per
ASM was primarily due to an increase in the average stage length per trip
flown, or miles flown per aircraft trip. The Company flew 4.2 percent more
ASMs, but the number of trips flown remained relatively flat compared to 2002.
Depreciation expense per ASM increased 6.0 percent primarily due to an
increase in owned aircraft. All 14 of the aircraft put into service by the
Company over the past twelve months are owned by the Company. This, along with
the retirement of one leased aircraft, has increased the Company's percentage
<Page>
of aircraft owned or on capital lease to 76.5 percent at June 30, 2003 from
75.4 percent at June 30, 2002.
Other operating expenses per ASM decreased 8.7 percent primarily due to a
decrease in aviation insurance costs. Following the terrorist attacks,
commercial aviation insurers dramatically increased the premiums and reduced
the amount of war-risk coverage available to commercial carriers. The federal
government stepped in to provide supplemental third-party war-risk insurance
coverage to commercial carriers for renewable 60-days periods, at substantially
lower premiums than prevailing commercial rates and for levels of coverage not
available in the commercial market. In November 2002, Congress passed the
Homeland Security Act of 2002, which mandated the federal government provide
third party, passenger, and hull war-risk insurance coverage to commercial
carriers through August 31, 2003, and which permits such coverage to be
extended by the government through December 31, 2003. The Emergency Wartime
Supplemental Appropriations Act (see Note 9 to the unaudited condensed
consolidated financial statements) extends the government's mandate to provide
war-risk insurance until August 31, 2004 and permits such coverage to be
extended until December 31, 2004. As a result of more coverage from government
insurance programs and a more stable aviation insurance market, the Company was
able to negotiate lower 2003 aviation insurance premiums than 2002. However,
aviation insurance remains substantially higher than before September 11, 2001.
The Company currently expects a year-over-year decrease in other operating
expenses per ASM for third quarter 2003, primarily from lower aviation insurance
costs.
Other
Interest expense decreased by $4 million, or 14.8 percent, primarily due
to lower effective interest rates. Two interest-rate swaps were executed by
the Company in second quarter 2003 to convert a portion of its fixed-rate debt
to a lower floating rate. The Company entered into interest rate swap
agreements relating to its $385 million 6.5% senior unsecured notes due
March 1, 2012 and $375 million 5.496% Class A-2 pass-through certificates due
November 1, 2006. See Note 5 to the unaudited condensed consolidated financial
statements for more information on the Company's hedging activities.
Capitalized interest increased by $3 million, or 60.0 percent, primarily
due to an increase in progress payment balances for future aircraft deliveries.
Interest income decreased by $2 million, or 22.2 percent, primarily due
to a decrease in rates earned on investments.
Second quarter 2003 "Other (gains) losses, net" primarily consist of a
$271 million government grant from the Wartime Act. See Note 9 to the
unaudited condensed consolidated financial statements for more information on
this grant. Also included in second quarter 2003 "Other (gains) losses, net"
are amounts recorded in accordance with SFAS 133. See Note 5 to the unaudited
condensed consolidated financial statements for more information on the
Company's hedging activities. The Company recognized $6 million of expense
related to amounts excluded from the Company's measurements of hedge
effectiveness. In second quarter 2002, the Company recognized approximately $6
million of expense related to amounts excluded from the Company's measurements
of hedge effectiveness and $3 million in expense related to the ineffectiveness
of its hedges.
<Page>
Comparison of six months ended June 30, 2003 to six months ended June 30, 2002
Revenues
Consolidated operating revenues increased by $136 million, or 5.0
percent, primarily due to a $131 million, or 5.0 percent increase in passenger
revenues. The increase in passenger revenues was primarily due to a 4.7
percent increase in revenue passenger miles (RPMs) flown.
First half 2003 capacity, as measured by available seat miles (ASMs),
increased 4.7 percent compared to 2002. The capacity increase resulted from
the net addition of 13 aircraft (net of one retirement) from June 2002 through
June 2003. The 2003 load factor was 66.4 percent, approximately the same as
2002. The Company also experienced a 2.9 percent increase in revenue
passengers carried compared to 2002.
First half 2003 passenger yield per RPM increased slightly to 11.82 cents
from 11.79 cents in 2002. Operating revenue yield per ASM increased slightly
to 8.12 cents from 8.10 cents in 2002, primarily due to a higher average
passenger fare. Average passenger fare increased 2.0 percent to $86.23
despite the prior year $36 million passenger revenue adjustment, primarily due
to moderate fare increases taken by the Company.
Consolidated freight revenues increased by $4 million, or 9.3 percent due
to an increase in freight and cargo revenues, primarily from moderate rate
increases taken by the Company. Other revenues were slightly higher in first
half 2003 as a 26.6 percent increase in commissions earned from programs the
Company sponsors with certain business partners, such as the Company
sponsored First USA Visa card, was mostly offset by a decline in charter
revenues.
Operating expenses
To a large extent, changes in operating expenses for airlines are driven
by changes in capacity, or ASMs. The following presents Southwest's operating
expenses per ASM for the six months ended June 30, 2003 and 2002 followed by
explanations of changes on a per ASM basis:
<Table>
<Caption>
Six months ended June 30, Per ASM Percent
2003 2002 Change Change
Salaries, wages, and benefits 3.13 2.86 .27 9.4
Fuel and oil 1.14 1.06 .08 7.5
Maintenance materials
and repairs .60 .59 .01 1.7
Agency commissions .07 .09 (.02) (22.2)
Aircraft rentals .26 .28 (.02) (7.1)
Landing fees and other rentals .51 .51 - -
Depreciation .53 .51 .02 3.9
Other operating expenses 1.35 1.50 (.15) (10.0)
Total 7.59 7.40 .19 2.6
</Table>
<Page>
Operating expenses per ASM were 7.59 cents, a 2.6 percent increase
compared to 7.40 cents for 2002. The overall increase was primarily due to
higher salaries, wages and benefits from higher average wage rates and higher
profitsharing expense from the government grant.
Salaries, wages, and benefits expense per ASM increased 9.4 percent.
Approximately half of the increase was due higher average wage rates compared
to 2002. The other half of the increase was due to an increase in
profitsharing from the increase in earnings available for profitsharing,
primarily from the $271 million government grant, and an increase in health
care costs.
Fuel and oil expense per ASM increased 7.5 percent primarily due to an
increase in average fuel cost per gallon. The average fuel cost per gallon in
first half 2003 was 71.0 cents, an 8.6 percent increase compared to 65.4 cents
per gallon in 2002, including the effects of hedging activities. See Note 5 to
the unaudited condensed consolidated financial statements for further
discussion of the Company's hedging activities.
Maintenance materials and repairs per ASM increased 1.7 percent primarily
due to an increase in contract rates per hour flown for outsourced engine
maintenance. The Company outsources its engine maintenance work for 737-300
and 737-500 aircraft and expense is based on the number of hours flown for
those aircraft and the rate charged per hour flown. This increase was
partially offset by a decrease in the number of outsourced heavy maintenance
events for airframes.
Agency commissions per ASM decreased 22.2 percent primarily due to a
decline in commissionable revenues. The percentage of commissionable revenues
decreased from approximately 21 percent in first half 2002 to approximately 17
percent in 2003. Approximately 52 percent of revenues in first half 2003 were
derived through the Company's web site at www.southwest.com versus 46 percent
of revenues in 2002.
Aircraft rentals per ASM decreased 7.1 percent compared to 2002 primarily
due to the increase in ASMs relative to the number of leased aircraft.
Although ASMs increased 4.7 percent, the number of leased aircraft declined by
one, as a result of a retirement in 2003. All of the aircraft acquired in 2002
and 2003 are owned by the Company. Approximately 23.5 percent of the Company's
aircraft fleet was under operating lease at June 30, 2003, compared to 24.6
percent at June 30, 2002.
Landing fees and other rentals per ASM was flat compared to 2002 as a 3.7
percent increase in other rentals per ASM was offset by a decrease in landing
fees per ASM. The increase in other rentals expense per ASM was primarily due
to the Company's expansion of gate and counter space at several airports. The
decrease in landing fees expense per ASM primarily was due to first half 2003
credits from airports' audits of prior periods. The amount of credits received
in first half 2003 was more than the credits received in the same prior year
period.
<Page>
Depreciation expense per ASM increased 3.9 percent primarily due to an
increase in owned aircraft. All 14 of the aircraft put into service by the
Company over the past twelve months have been purchased. This, along with the
retirement of one leased aircraft, has increased the Company's percentage of
aircraft owned or on capital lease to 76.5 percent at June 30, 2003 from 75.4
percent at June 30, 2002.
Other operating expenses per ASM decreased 10.0 percent primarily due to
a decrease in aviation insurance costs. As a result of more coverage from
government insurance programs and a more stable aviation insurance market, the
Company was able to negotiate lower 2003 aviation insurance premiums than 2002.
However, aviation insurance premiums remain substantially higher than before
September 11, 2001.
Other
Interest expense decreased by $4 million, or 7.5 percent, primarily due
to lower effective interest rates. Two interest-rate swaps were executed by
the Company in second quarter 2003 to convert a portion of its fixed-rate debt
to a lower floating rate. The Company entered into interest rate swap
agreements relating to its $385 million 6.5% senior unsecured notes due
March 1, 2012 and $375 million 5.496% Class A-2 pass-through certificates due
November 1, 2006. See Note 5 to the unaudited condensed consolidated financial
Statements for more information on the Company's hedging activities.
Capitalized interest increased by $6 million, or 66.7 percent, primarily
due to an increase in progress payment balances for future aircraft deliveries.
Interest income decreased by $7 million, or 36.8 percent, primarily due
to a decrease in rates earned on investments.
First half 2003 "Other (gains) losses, net" primarily consist of a $271
million government grant from the Wartime Act. See Note 9 to the unaudited
condensed consolidated financial statements for more information on this
reimbursement. Also included in first half 2003 "Other (gains) losses, net"
are amounts recorded in accordance with SFAS 133. See Note 5 to the unaudited
condensed consolidated financial statements for more information on the
Company's hedging activities. The Company recognized $13 million of expense
related to amounts excluded from the Company's measurements of hedge
effectiveness and $14 million in income related to the ineffectiveness of its
hedges. In 2002, the Company recognized approximately $12 million of expense
related to amounts excluded from the Company's measurements of hedge
effectiveness and $2 million in income related to the ineffectiveness of its
hedges.
Liquidity and Capital Resources
Net cash provided by operating activities was $905 million for the six
months ended June 30, 2003, compared to $386 million in the same prior year
period. The increase was primarily due to higher net income in 2003, largely
attributable to the $271 million government grant. Net cash provided by
operating activities was $1,038 million for the 12 months ended June 30, 2003.
Cash generated from operating activities for the 12 months ended June 30, 2003
was primarily used to finance capital expenditures.
<Page>
Cash flows used in investing activities in first half 2003 totaled $518
million compared to $253 million in 2002. Investing activities in both years
consisted primarily of payments for new 737-700 aircraft delivered to the
Company and progress payments for future aircraft deliveries. Cash flows used
in investing activities for the 12 months ended June 30, 2003 totaled $868
million.
Net cash from financing activities in first half 2003 was $2 million
compared to $295 million, net, used in financing activities in 2002. Cash used
in financing activities during first half 2002 was primarily for the repayment
of the Company's $475 million revolving credit facility that the Company drew
down in September 2001 and for the repayment of a special purpose trust
through which the Company had financed the purchase of 19 new aircraft during
2001 and 2002. The trust was dissolved prior to December 31, 2002. These
investing activities were partially offset by cash generated from the issuance
of $385 million in unsecured notes in March 2002.
Contractual Obligations and Contingent Liabilities and Commitments
Southwest has contractual obligations and commitments primarily with
regards to future purchases of aircraft, payment of debt, and lease
arrangements. Following the receipt of three new 737-700 aircraft from Boeing
in the second quarter 2003 and two in first quarter 2003, the Company has 12
remaining 737-700 aircraft deliveries for 2003. Also, during second quarter
2003, the Company exercised its remaining options for 2004, exercised six 2005
options for accelerated delivery in 2004, and accelerated the firm delivery of
two 2005 aircraft to 2004. This change brings the Company's total firm orders
to 42 for 2004. The following table details the Company's current firm orders,
options, and purchase rights through 2012.
<Table>
<Caption>
Current Schedule
Firm Options*
2003** 17 -
2004 42 -
2005 22 12
2006 22 16
2007 25 29
2008 6 45
2009-2012 - 177
Total 134 279
*Includes purchase rights
**Includes five aircraft delivered in first half 2003
</Table>
<Page>
The following table details information on the 379 aircraft in the
Company's fleet as of June 30, 2003:
<Table>
<Caption>
Average Number Number Number
737 Type Seats Age (Yrs) of Aircraft Owned Leased
-200 122 20.8 26 24 2
-300 137 12.1 194 110 84
-500 122 12.2 25 16 9
-700 137 3.1 134 133 1
TOTALS 9.5 379 283 96
</Table>
The Company has the option, which must be exercised two years prior to
the contractual delivery date, to substitute -600s or -800s for the -700s.
Aggregate funding needed for firm commitments, as of June 30, 2003, is
approximately $3.4 billion, subject to adjustments for inflation, due as
follows: $417 million in 2003, $1.1 billion in 2004, $684 million in 2005,
$645 million in 2006, $523 million in 2007, and $95 million thereafter.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at June 30, 2003 of $2.2 billion
and internally generated funds. The Company has two available unsecured
revolving credit facilities from which it can borrow up to $575 million from a
group of banks. One of the facilities, for half of the total amount, was
renewed for an additional year during April 2003. This facility now expires in
April 2004. The other facility, for half of the amount, expires in April 2005.
The Company will also consider various borrowing or leasing options to maximize
earnings and supplement cash requirements.
The Company currently has outstanding shelf registrations for the
issuance of up to $1.0 billion in public debt securities and pass through
certificates, which it may utilize for aircraft financings in the future.
Forward looking statements
Some statements in this Form 10-Q (or otherwise made by the Company or on
the Company's behalf from time to time in other reports, filings with the
Securities and Exchange Commission, news releases, conferences, World Wide Web
postings or otherwise) which are not historical facts may be "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking
statements include statements about Southwest's estimates, expectations,
beliefs, intentions or strategies for the future, and the assumptions
underlying these forward-looking statements. Southwest uses the words
"anticipates," "believes," "estimates," "expects," "intends," "forecasts",
"may," "will," "should" and similar expressions to identify these
forward-looking statements. Forward-looking statements involve risks and
uncertainties that could cause actual results to differ materially from
historical experience or the Company's present expectations. Factors that could
cause these differences include, but are not limited to:
- Items directly linked to the September 11, 2001 terrorist attacks, such as
the adverse impact of new airline and airport security directives on the
<Page>
Company's costs and Customer demand for travel, changes in the
Transportation Security Administration's scope for managing U.S.
airport security, the availability and cost of war-risk and other aviation
insurance, including the federal government's provision of third party
war-risk coverage, and the possibility of further terrorist attacks or
additional incidents that could cause the public to question the
safety and/or efficiency of air travel.
- War or other military actions by the U.S. or others.
- Competitive factors, such as fare sales and capacity decisions by the
Company and its competitors, changes in competitors' flight schedules,
mergers and acquisitions, codesharing programs, and airline bankruptcies.
- General economic conditions, which could adversely affect the demand for
travel in general and consumer ticket purchasing habits, as well as
decisions by major freight Customers on how they allocate freight
deliveries among different types of carriers.
- Factors that could affect the Company's ability to control its costs, such
as the results of Employee labor contract negotiations, Employee hiring
and retention rates, costs for health care, the largely unpredictable
prices of jet fuel, crude oil, and heating oil, the continued
effectiveness of the Company's fuel hedges, changes in the Company's
overall fuel hedging strategy, capacity decisions by the Company and its
competitors, unscheduled required aircraft airframe or engine repairs and
regulatory requirements, changes in commission policy, availability of
capital markets, and future financing decisions made by the Company.
- Disruptions to operations due to adverse weather conditions and air
traffic control-related constraints.
Caution should be taken not to place undue reliance on the Company's
forward-looking statements, which represent the Company's views only as of the
date this report is filed. The Company undertakes no obligation to update
publicly or revise any forward-looking statement, whether as a result of new
information, future events or otherwise.
<Page>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 7A. Quantitative and Qualitative Disclosures About Market Risk
in the Company's Annual Report on Form 10-K for the year ended December 31,
2002 and Note 4 to the unaudited condensed consolidated financial statements.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to
ensure that it is able to collect the information it is required to disclose in
the reports it files with the Securities and Exchange Commission (SEC), and to
process, summarize and disclose this information within the time periods
specified in the rules of the SEC. Based on an evaluation of the Company's
disclosure controls and procedures as of the end of the period covered by this
report conducted by the Company's management, with the participation of the
Chief Executive and Chief Financial Officers, the Chief Executive and Chief
Financial Officers believe that these controls and procedures are effective to
ensure that the Company is able to collect, process and disclose the
information it is required to disclose in the reports it files with the SEC
within the required time periods.
Internal Control over Financial Reporting. During the period covered by
this report, there have been no changes in the Company's internal control over
financial reporting that have materially affected or are reasonably likely to
materially affect the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to various legal proceedings and claims arising in
the ordinary course of business, including, but not limited to, examinations by
the Internal Revenue Service (IRS). The IRS regularly examines the Company's
federal income tax returns and, in the course of which, proposes adjustments to
the Company's federal income tax liability reported on such returns. It is the
Company's practice to vigorously contest those proposed adjustments that it
deems lacking of merit.
The Company's management does not expect that the outcome in any of its
currently ongoing legal proceedings or the outcome of any proposed adjustments
presented to date by the IRS, individually or collectively, will have a
material adverse effect on the Company's financial condition, results of
operations or cash flow.
<Page>
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
During the second quarter of 2003, Herbert D. Kelleher exercised
unregistered options to purchase Southwest Airlines Co. Common Stock as
follows:
Number of Shares Option Date of Date of
Purchased Price Exercise Option Grant
51,947 $1.00 June 16, 2003 January 1, 1992
54,630 $2.24 June 16, 2003 January 1, 1992
287,173 $1.00 June 16, 2003 January 1, 1996
506,250 $4.64 June 16, 2003 January 1, 1996
The issuance of the above shares to Mr. Kelleher was exempt from the
registration provisions of the Securities Act of 1933, as amended (the
"Act"), by reason of the provision of Section 4(2) of the Act because,
among other things, of the limited number of participants in such
transactions and the agreement and representation of Mr. Kelleher that
he was acquiring such securities for investment and not with a view to
distribution thereof. The certificates representing the shares issued
to Mr. Kelleher contain a legend to the effect that such shares are not
registered under the Act and may not be transferred except pursuant to
a registration statement that has become effective under the Act or to
an exemption from such registration. The issuance of such shares was
not underwritten.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders was held in Dallas, Texas on
Wednesday, May 14, 2003. The following matters were voted on at the meeting:
(i) The following nominees were elected to the Company's Board of Directors
to hold office for a term expiring in 2004: Herbert D. Kelleher: 475,891,455
shares voted for and 145,427,997 shares withheld; Rollin W. King: 529,654,941
shares voted for and 86,124,789 shares withheld; June M. Morris: 464,861,397
shares voted for and 156,458,055 shares withheld. There were no broker non-
votes on this matter.
The following nominees were elected to the Company's Board of Directors to hold
office for a term expiring in 2006: William H. Cunningham: 481,283,710 shares
voted for and 140,035,742 shares withheld; Nancy B. Loefler: 595,327,252
shares voted for and 25,992,200 shares withheld; Louis E. Caldera: 600,025,769
shares voted for and 21,293,683 shares withheld. There were no broker
non-votes on this matter.
<Page>
Additionally, the following current directors of the Company continued to serve
as directors as of the Annual Meeting: Colleen C. Barrett, C. Webb Crockett,
William P. Hobby, Travis C. Johnson, John T. Montford, and James F. Parker.
(ii) A shareholder proposal related to shareholder right to vote on the
Company's shareholder rights plan was considered. A total of 349,986,828
shares were voted for the proposal, 188,729,885 shares were voted against the
proposal and 3,741,301 shares abstained from voting. There were 78,861,438
broker non-votes on this matter.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
10.1 Amendment No. 3 to Southwest Airlines Co. Profit Sharing Plan
10.2 Amendment No. 3 to Southwest Airlines Co. 401(k) Plan
10.3 2003 Non-Qualified Stock Option Plan
10.4 Amendment No. 1 to 2000 Aircraft Appearance Technicians Non-
Qualified Stock Option Plan
10.5 Amendment No. 1 to 2000 Stock Clerks Non-Qualified Stock
Option Plan
10.6 Amendment No. 1 to 2000 Flight Simulator Technicians Non-
Qualified Stock Option Plan
10.7 First Amendment to 364-Day Competitive Advance and Revolving
Credit Facility Agreement among Southwest Airlines Co., the
banks party thereto, and JPMorgan Chase Bank, as Administrative
Agent, dated as of April 22, 2003
10.8 Supplemental Agreements Nos. 25, 26, 27, 28 and 29 to Purchase
Agreement No. 1810, dated January 19, 1994 between The Boeing
Company and Southwest
Pursuant to 17 CFR 240.24b-2, confidential information has been omitted
and has been filed separately with the Securities and Exchange
Commission pursuant to a Confidential Treatment Application filed with
the Commission.
99.1 Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
99.2 Certifications Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
On July 21, 2003, Southwest filed a current report on Form 8-K to furnish
the Company's public announcement of its second quarter 2003 earnings.
<Page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOUTHWEST AIRLINES CO.
July 22, 2003 By /s/ Gary C. Kelly
Gary C. Kelly
Executive Vice President-
Chief Financial Officer
(Principal Financial and
Accounting Officer)
<Page>
EXHIBIT INDEX
Exhibit No. Description
Exhibit 10.1 - Amendment No. 3 to Southwest Airlines Co. Profit
Sharing Plan.
Exhibit 10.2 - Amendment No. 3 to Southwest Airlines Co. 401(k) Plan.
Exhibit 10.3 - 2003 Non-Qualified Stock Option Plan.
Exhibit 10.4 - Amendment No. 1 to 2000 Aircraft Appearance Technicians
Non-Qualified Stock Option Plan.
Exhibit 10.5 - Amendment No. 1 to 2000 Stock Clerks Non-Qualified
Stock Option Plan.
Exhibit 10.6 - Amendment No. 1 to 2000 Flight Simulator Technicians
Non-Qualified Stock Option Plan.
Exhibit 10.7 - First Amendment to 364-Day Competitive Advance and
Revolving Credit Facility Agreement among Southwest
Airlines Co., the banks party thereto, and JPMorgan
Chase Bank, as Administrative Agent, dated as of April
22, 2003.
Exhibit 10.8 - Supplemental Agreements Nos. 25, 26, 27, 28 and 29 to
Purchase Agreement No. 1810, dated January 19, 1994
between The Boeing Company and Southwest.
Pursuant to 17 CFR 240.24b-2, confidential information
has been omitted and has been filed separately with the
Securities and Exchange Commission pursuant to a
Confidential Treatment Application filed with the
Commission.
Exhibit 99.1 - Certifications Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 99.2 - Certifications Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002