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, 2004 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 14, 2004:
790,181,982
<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, 2004 December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents $1,768 $1,865
Accounts and other receivables 222 132
Inventories of parts and supplies,
at cost 108 93
Fuel hedge contracts 315 164
Prepaid expenses and other
current assets 58 59
Total current assets 2,471 2,313
Property and equipment, at cost:
Flight equipment 9,242 8,646
Ground property and equipment 1,142 1,117
Deposits on flight equipment
purchase contracts 886 787
11,270 10,550
Less allowance for depreciation 3,198 3,107
8,072 7,443
Other assets 270 122
$10,813 $9,878
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $464 $405
Accrued liabilities 870 650
Air traffic liability 658 462
Current maturities of long-term debt 317 206
Total current liabilities 2,309 1,723
Long-term debt less current maturities 1,239 1,332
Deferred income taxes 1,649 1,420
Deferred gains from sale and
leaseback of aircraft 160 168
Other deferred liabilities 202 183
Stockholders' equity:
Common stock 790 789
Capital in excess of par value 263 258
Retained earnings 3,979 3,883
Accumulated other
comprehensive income 287 122
Treasury stock, at cost (65) -
Total stockholders' equity 5,254 5,052
$10,813 $9,878
</Table>
<Page>
<Table>
<Caption>
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
OPERATING REVENUES:
Passenger $1,654 $1,465 3,082 $2,771
Freight 28 25 54 47
Other 34 25 64 48
Total operating revenues 1,716 1,515 3,200 2,866
OPERATING EXPENSES:
Salaries, wages,
and benefits 622 587 1,212 1,103
Fuel and oil 246 194 476 402
Maintenance materials
and repairs 124 104 238 210
Agency commissions - 13 2 25
Aircraft rentals 44 46 89 91
Landing fees and
other rentals 99 91 202 181
Depreciation and amortization 107 95 209 188
Other operating expenses 277 245 529 480
Total operating expenses 1,519 1,375 2,957 2,680
OPERATING INCOME 197 140 243 186
OTHER EXPENSES (INCOME):
Interest expense 22 23 40 49
Capitalized interest (10) (8) (20) (15)
Interest income (5) (7) (9) (12)
Other (gains) losses, net 11 (265) 12 (272)
Total other
expenses (income) 18 (257) 23 (250)
INCOME BEFORE INCOME TAXES 179 397 220 436
PROVISION FOR INCOME TAXES 66 151 81 166
NET INCOME $113 $246 $139 $270
NET INCOME PER SHARE:
Basic $ .14 $ .32 $ .18 $ .35
Diluted $ .14 $ .30 $ .17 $ .33
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 784 780 785 779
Diluted 817 820 817 814
</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,
2004 2003 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $113 $246 $139 $270
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization 107 95 209 188
Deferred income taxes 66 136 81 148
Amortization of deferred gains
on sale and leaseback of aircraft (4) (4) (8) (8)
Amortization of scheduled airframe
inspections & repairs 13 12 27 24
Changes in certain assets and
liabilities:
Accounts and other receivables (4) 31 (50) 47
Other current assets 3 (7) (11) (8)
Accounts payable and
accrued liabilities 160 59 282 52
Air traffic liability (42) 40 197 163
Income taxes payable - 11 - 11
Other 18 19 (19) 18
Net cash provided by
operating activities 430 638 847 905
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment, net (511) (325) (870) (518)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt 29 - 58 -
Proceeds from Employee stock plans 27 20 40 32
Payments of long-term debt and
capital lease obligations (13) (14) (21) (20)
Payments of cash dividends (4) (4) (11) (11)
Repurchase of common stock (11) - (136) -
Other, net (3) - (4) 1
Net cash provided by (used in)
financing activities 25 2 (74) 2
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (56) 315 (97) 389
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 1,824 1,889 1,865 1,815
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $1,768 $2,204 $1,768 $2,204
CASH PAYMENTS FOR:
Interest, net of amount capitalized $4 $15 $17 $37
Income taxes $2 $4 $2 $4
</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, 2004 and 2003, include all adjustments, which are, in
the opinion of management, necessary for a fair presentation of the results
for the interim periods. This includes all normal and recurring adjustments,
and other accounting entries as described herein. The Condensed
Consolidated Balance Sheet as of December 31, 2003, 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. Financial results
for the Company, and airlines in general, are seasonal in nature.
Historically, the Company's second and third fiscal quarters have been more
profitable than its first and fourth fiscal quarters. Operating results for
the three and six months ended June 30, 2004, are not necessarily indicative
of the results that may be expected for the year ended December 31, 2004.
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, 2003.
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):
<Table>
<Caption>
Three months Six months
ended June 30, ended June 30,
2004 2003 2004 2003
Net income, as reported $113 $246 $139 $270
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 (10) (14) (22) (31)
Pro forma net income $103 $232 $117 $239
Net income per share
Basic, as reported $.14 $.32 $.18 $.35
Basic, pro forma $.13 $.30 $.15 $.31
Diluted, as reported $.14 $.30 $.17 $.33
Diluted, pro forma $.13 $.29 $.15 $.30
</Table>
3. DIVIDENDS
During the three month periods ended March 31, 2004, and June 30, 2004,
dividends of $.0045 per share were declared on the 784 million and 785
million shares of common stock then outstanding, respectively. During the
three month periods ended March 31, 2003, and June 30, 2003, dividends of
$.0045 per share were declared on the 778 million and 780 million shares of
common stock then outstanding, respectively.
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,
2004 2003 2004 2003
NUMERATOR:
Net income available to
common stockholders $113 $246 $139 $270
DENOMINATOR:
Weighted-average shares
outstanding, basic 784 780 785 779
Dilutive effect of Employee stock
Options 33 40 32 35
Adjusted weighted-average shares
outstanding, diluted 817 820 817 814
NET INCOME PER SHARE:
Basic $.14 $.32 $.18 $.35
Diluted $.14 $.30 $.17 $.33
</Table>
<Page>
5. FINANCIAL DERIVATIVE INSTRUMENTS
Fuel Contracts - 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 month periods ended June 30, 2004 and 2003,
represented approximately 16.2 percent and 14.1 percent, respectively, of
Southwest's operating expenses for those periods. 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 currently has a mixture of purchased call
options, collar structures, and fixed price swap agreements in place to hedge
over 80 percent of its remaining 2004 total anticipated jet fuel requirements
that effectively cap crude oil-equivalent prices under $24 per barrel. The
Company is also 80 percent hedged for 2005 with prices capped at approximately
$25 per barrel, and approximately 45 percent hedged for 2006 with prices capped
at approximately $28 per barrel. As of June 30, 2004, the majority of the
Company's remaining 2004 hedges are effectively heating oil-based. Beyond 2004,
the majority of the hedge positions are crude oil-based.
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, 2004, was a net asset of
approximately $548 million. The current portion of this net asset,
approximately $315 million, is classified as "Fuel hedge contracts" and the
noncurrent portion, approximately $233 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, 2004 and 2003, the Company recognized
$87 million and $36 million in gains in "Fuel and oil" expense, respectively,
from hedging activities. During the three months ended June 30, 2004, the
Company also recognized approximately $5 million of additional 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 2004 and second
quarter 2003.
As of June 30, 2004, the Company had approximately $287 million in unrealized
gains, net of tax, in "Accumulated other comprehensive income" related to
fuel hedges. Included in this total are approximately $172 million in net
<Page>
unrealized gains that are expected to be realized in earnings during the
twelve months following June 30, 2004.
Interest Rate Swaps - 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 Company's balance sheet as
an asset or liability, 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, 2004 was a liability
of approximately $32 million. This amount is recorded in "Other deferred
liabilities" in the unaudited Condensed Consolidated Balance Sheet. In
accordance with fair value hedging, the offsetting entry is an adjustment to
decrease the carrying value of long-term debt.
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 $215
million and $304 million, respectively, for the three and six months ended
June 30, 2004. Comprehensive income totaled $261 million and $290 million,
respectively, for the three and six months ended June 30, 2003. The
differences between net income and comprehensive income for each of these
periods was as follows (in millions):
<Page>
<Table>
<Caption>
Three months ended June 30,
2004 2003
Net income $113 $246
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $66 and $9 102 13
Other, net of deferred taxes of $0 and $1 - 2
Total other comprehensive income 102 15
Comprehensive income $215 $261
Six months ended June 30,
2004 2003
Net income $139 $270
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $106 and $13 164 20
Other, net of deferred taxes of $1 and $0 1 -
Total other comprehensive income 165 20
Comprehensive income $304 $290
</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, 2003 $123 ($1) $122
2004 changes in value 249 1 250
Reclassification to earnings (85) - (85)
Balance at June 30, 2004 $287 ($0) $287
</Table>
7. REVOLVING CREDIT FACILITY
During second quarter 2004, the Company replaced its former revolving credit
facility with a new facility. Under the new facility, the Company can borrow
up to $575 million from a group of banks. The facility expires in April 2007
and is unsecured. At the Company's option, interest on the facility 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 given Southwest's credit
rating at June 30, 2004. The facility also contains a financial covenant
requiring a minimum coverage ratio of adjusted pretax income to fixed
obligations, as defined. As of June 30, 2004, there are no outstanding amounts
borrowed under this facility.
8. CONSOLIDATION OF RESERVATIONS CENTERS
<Page>
In November 2003, the Company announced the consolidation of its nine
Reservations Centers into six, effective February 28, 2004. This decision
was made in response to the established shift by Customers to the internet as
a preferred way of booking travel. The Company's website, southwest.com, now
accounts for more than half of ticket bookings and, as a consequence, demand
for phone contact has dramatically decreased. During first quarter 2004, the
Company closed its Reservations Centers located in Dallas, Texas, Salt Lake
City, Utah, and Little Rock, Arkansas. The Company provided the 1,900
affected Employees at these locations the opportunity to relocate to another
of the Company's remaining six centers. Those Employees choosing not to
relocate, approximately 55% of the total affected, were offered support
packages, which included severance pay, flight benefits, medical coverage,
and job-search assistance, depending on length of service with the Company.
The total cost associated with the Reservations Center consolidation,
recognized in first quarter 2004, was approximately $18 million. Employee
severance and benefit costs were reflected in "Salaries, wages, and
benefits," and the majority of other costs were reflected in "Other operating
expenses" in the Condensed Consolidated Statement of Income. The breakdown
of the costs incurred and a rollforward of the amounts accrued is as follows
(in millions):
<Table>
<Caption>
Consolidation
Employee of facilities
bonus pay and other
and benefits charges Total
Initial charge in first quarter 2004 $13 $5 $18
Non-cash charges - (1) (1)
Cash payments (10) (2) (12)
Balance at March 31, 2004 $3 $2 $5
Non-cash charges - 1 1
Cash payments - (1) (1)
Balance at June 30, 2004 $3 $2 $5
</Table>
9. AIRCRAFT FINANCINGS
In February 2004 and April 2004, the Company entered into two separate $29
million two-year notes, utilizing two new 737-700 aircraft as collateral.
Both of the notes are non-interest bearing and accrete to face value at
maturity at annual rates of 2.9% and 3.4%, respectively. The proceeds
of these borrowings were used to fund the individual aircraft purchases.
10. 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
included 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.
11. RECENTLY ISSUED ACCOUNTING STANDARDS
<Page>
During March 2004, the FASB issued an exposure draft of a new standard
entitled "Share Based Payment", which would amend SFAS No. 123, "Accounting
for Stock Based Compensation," and SFAS No. 95, "Statement of Cash Flows."
Among other items, the new standard would require the expensing, in the
financial statements, of stock options issued by the Company. The new
standard, as proposed, would be effective January 1, 2005, for calendar year
companies. Although the Company has not yet completed an analysis to
quantify the exact impact the new standard will have on its future financial
performance, the disclosures in Note 2 provide detail as to the Company's
financial performance as if the Company had applied the fair value based
method and recognition provisions of SFAS No. 123 to stock-based Employee
compensation to the current reporting periods.
<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, 2004 and 2003 are as follows:
<Table>
<Caption>
Three months ended
June 30,
2004 2003 Change
Revenue passengers carried 18,863,975 17,063,283 10.6 %
Enplaned passengers 21,627,986 19,446,533 11.2 %
Revenue passenger miles (RPMs) (000s) 14,325,737 12,550,665 14.1 %
Available seat miles (ASMs) (000s) 18,773,522 17,893,765 4.9 %
Load factor 76.3% 70.1% 6.2 pts.
Average length of passenger haul (miles) 759 736 3.1 %
Average aircraft stage length (miles) 571 556 2.7 %
Trips flown 242,386 237,518 2.0 %
Average passenger fare $87.67 $85.87 2.1 %
Passenger revenue yield per RPM (cents) 11.54 11.67 (1.1)%
Operating revenue yield per ASM (cents) 9.14 8.47 7.9 %
Operating expenses per ASM (cents) 8.09 7.68 5.3 %
Operating expenses per ASM,
excluding fuel (cents) 6.79 6.60 2.9 %
Fuel costs per gallon,
excluding fuel tax (cents) 81.9 67.4 21.5 %
Fuel consumed, in gallons (millions) 298 286 4.2 %
Number of Employees at period-end 31,408 32,902 (4.5)%
Size of fleet at period-end 405 379 6.9 %
</Table>
<Page>
<Table>
<Caption>
Six months ended
June 30,
2004 2003 Change
Revenue passengers carried 34,859,036 32,140,820 8.5 %
Enplaned passengers 39,818,390 36,616,105 8.7 %
Revenue passenger miles (RPMs) (000s) 26,118,160 23,446,366 11.4 %
Available seat miles (ASMs) (000s) 37,155,115 35,292,897 5.3 %
Load factor 70.3% 66.4% 3.9 pts.
Average length of passenger haul (miles) 749 729 2.7 %
Average aircraft stage length (miles) 570 554 2.9 %
Trips flown 480,855 470,605 2.2 %
Average passenger fare $88.41 $86.23 2.5 %
Passenger revenue yield per RPM (cents) 11.80 11.82 (0.2)%
Operating revenue yield per ASM (cents) 8.61 8.12 6.0 %
Operating expenses per ASM (cents) 7.96 7.59 4.9 %
Operating expenses per ASM,
excluding fuel (cents) 6.68 6.45 3.6 %
Fuel costs per gallon,
excluding fuel tax (cents) 80.8 71.0 13.8 %
Fuel consumed, in gallons (millions) 585 563 3.9 %
Number of Employees at period-end 31,408 32,902 (4.5)%
Size of fleet at period-end 405 379 6.9 %
</Table>
Material Changes in Results of Operations
Summary
The Company's second quarter 2004 net income was $113 million ($.14 per
share, diluted), compared to second quarter 2003 net income of $246 million
($.30 per share, diluted). Despite the challenging airline revenue
environment and record high energy prices prevalent in second quarter
2004, Southwest reported its 53rd consecutive quarterly profit. As disclosed
in Note 10 to the condensed consolidated financial statements, results for
second quarter and the six months ended June 30, 2003, included $271 million
(government grant) as "Other gains" from the Emergency Wartime Supplemental
Appropriations Act (Wartime Act). The Company believes that excluding
the impact of the government grant will enhance comparative analysis of
results. The grant was made to stabilize and support the airline industry as
a result of the 2003 war with Iraq. The grant was not indicative of the
Company's operating performance for 2003, and should not be considered in
developing trend analysis for future periods. The following table reconciles
results reported in accordance with Generally Accepted Accounting Principles
(GAAP) for 2003 with results excluding the impact of the government grant
received in that period:
<Page>
<Table>
<Caption>
SOUTHWEST AIRLINES CO.
RECONCILIATION OF REPORTED AMOUNTS TO NON-GAAP ITEMS (SEE NOTE)
(unaudited)
Three months ended Six months ended
June 30, June 30,
(In millions, except per share
amounts and per ASM amounts)
2004 2003 2004 2003
Operating expenses, as reported $1,519 $1,375 $2,957 $2,680
Profitsharing impact
of government grant (41) (41)
Operating expenses,
excluding grant impact $1,519 $1,334 $2,957 $2,639
Operating expenses per ASM,
as reported $.0809 $.0768 $.0796 $.0759
Profitsharing impact of
government grant - (.0022) - (.0011)
Operating expenses per ASM,
excluding grant impact $.0809 $.0746 $.0796 $.0748
Operating income, as reported $197 $140 $243 $186
Profitsharing impact of
government grant 41 41
Operating income,
excluding grant impact $197 $181 $243 $227
Net income, as reported $113 $246 $139 $270
Government grant,
net of income taxes
and profitsharing (143) (143)
Net income, excluding
grant impact $113 $103 $139 $127
Net income per share, diluted,
as reported $.14 $.30 $.17 $.33
Government grant, net of
income taxes
and profitsharing (.17) (.17)
Net income per share, diluted,
excluding grant impact $.14 $.13 $.17 $.16
</Table>
Excluding the impact of the 2003 government grant, net income for
second quarter 2004 increased $10 million, or 9.7 percent compared to the
prior year, and net income for the six months ended June 30, 2004, increased
$12 million, or 9.4 percent compared to 2003. Excluding the government
grant, operating income increased $16 million, or 8.8 percent compared to
second quarter 2003, and $16 million, or 7.0 percent for the six months ended
June 30, 2004, compared to the prior year. These increases were driven
largely by an improvement in revenues.
Results for second quarter and the six months ended June 30, 2004 also
included the following items:
- During second quarter 2004, the Company offered a voluntary early
out option to all of its Employees, except officers. Employees had
until June 25, 2004, to accept the offer, which consisted of bonus pay,
medical benefits, and flight benefits, based on years of service with
the Company. More than 1,000 Employees accepted the offer, resulting
in $11 million in charges in second quarter 2004. These charges are
reflected in Salaries, wages, and benefits. The Employees accepting
the offer are required to work through at least July 31, 2004. The
Company anticipates that a majority of these positions will not be
replaced, and that future annual cost savings will exceed the charges
incurred.
<Page>
- During second quarter 2004, the Company and the Transport Workers
Union Local 556 reached a tentative labor agreement (contract) for
the Company's Flight Attendants. The contract, which must be
ratified by a majority of the Company's Flight Attendants, is for the
period from June 1, 2002, to May 31, 2008. As a result, the Company
recorded a $12 million second quarter 2004 charge for pay, per diem and
benefit increases, most of which was retroactive to the date when the
previous agreement became amendable. Approximately $7 million of the
$12 million charge relates to pay and benefit increases included in
"Salaries, wages, and benefits" (approximately 60 percent of the total
charge), and approximately $5 million related to per diem increases
(approximately 40 percent of total charge) for this group. The portion
of the $12 million charge which relates to second quarter 2004 is not
material. Voting on the tentative contract is expected to be complete
by the end of July 2004.
- Operating expenses for the six months ended June 30, 2004, also
included $18 million of expense associated with the consolidation of
certain of the Company's reservations operations. See Note 8 to the
Condensed Consolidated Financial Statements for further information
on the Company's Reservations Center consolidation.
Despite the impact of these items, the 2004 increases in net income,
excluding the 2003 government grant, were primarily due to stronger seasonal
revenues driven by increased fare sale activity and weaker year-ago revenue
performances resulting from the Iraq war. The increases in revenue were
partially offset by higher 2004 costs, which included higher fuel prices,
higher aircraft maintenance, higher advertising expenses, and higher salaries,
wages, and benefits.
For second quarter 2004, the Company increased its capacity (available
seat miles) by 4.9 percent compared to second quarter 2003. Year-over-year
increases in capacity are expected to continue and will accelerate throughout
2004 as the Company's fleet expands by a net of 29 aircraft for the year.
The Company's operating costs per available seat mile (unit costs or CASM)
increased 5.3 percent from second quarter 2003. On a unit basis, higher
labor, maintenance, and market jet fuel costs were partially offset by
substantial hedging gains, improved fuel efficiency, and a decrease in
commission expense.
The Company continues its efforts to control costs. In addition to the
Company's successful hedging program, over the past 7 months the Company has
consolidated its reservations operations, eliminated its travel agency
commission, and provided a voluntary early out option to all of its
Employees, except officers. Additionally, Southwest continues to look for
ways to increase the productivity of its workforce. The Company is also in
the process of adding Blended Winglets to its 737-700 aircraft. As of June
30, 2004, Blended Winglets have been installed on 82 Boeing 737-700 aircraft.
The Company will begin receiving -700s with winglets factory-installed from
Boeing in August 2004 and expects to have all -700s retrofitted with
winglets by March 2005. Southwest expects annual fuel consumption savings of
approximately three percent for each aircraft outfitted with the winglets.
Based on the Company's current revenue and cost outlook and, barring
any unforeseen event, the Company expects third quarter 2004 earnings to
exceed third quarter 2003 earnings due to improved revenues, which are
expected to more than offset higher labor and fuel costs.
During second quarter 2004, the Company began service to Philadelphia,
Pennsylvania, representing the 59th city and 31st state to which we fly.
Thus far, the Company has been very pleased with the load factors and overall
initial results of this new Southwest city.
<Page>
Comparison of three months ended June 30, 2004, to three months ended June
30, 2003
Revenues
Consolidated operating revenues increased by $201 million, or 13.3
percent, primarily due to a $189 million, or 12.9 percent increase in
passenger revenues. The increase in passenger revenues was primarily due to
a 14.1 percent increase in revenue passenger miles (RPMs) flown.
Second quarter 2004 capacity, as measured by available seat miles
(ASMs), increased 4.9 percent compared to second quarter 2003. The capacity
increase resulted from the net addition of 26 aircraft (net of eight
retirements) since the end of second quarter 2003. The second quarter 2004
load factor was 76.3 percent, an increase of 6.2 points compared to 2003.
The second quarter 2004 load factor was the highest for any quarter in the
Company's history. The Company also experienced a 10.6 percent increase in
revenue passengers carried compared to second quarter 2003.
The second quarter 2004 passenger yield per RPM decreased 1.1 percent
to 11.54 cents from 11.67 cents in second quarter 2003. The lower RPM yield
was primarily due to a higher mix of discounted fares compared to the prior
year resulting from increased fare sales in 2004. Operating revenue yield
per ASM (RASM or unit revenue) increased 7.9 percent to 9.14 cents compared
to first quarter 2003, primarily due to higher passenger load factors. Thus
far, favorable load factors and unit revenue trends have continued in July.
Bookings for the remainder of July and for August are also strong due to high
demand for vacation travel. Bookings for September are building nicely as a
result of recent fare sales. Based on these trends, the Company expects
year-over-year unit revenue growth again in third quarter 2004, although at a
slower pace than second quarter due to toughening comparisons. The Company
also expects third quarter 2004 unit revenues to be below the second
quarter 2004 unit revenues of 9.14 cents, which is consistent with historical
seasonal trends.
Consolidated freight revenues increased by $3 million, or 12.0 percent,
due to increases in freight and cargo revenues primarily from an increase in
the number of shipments. This increase more than offset a decrease in mail
revenues. The Company expects another year-over-year increase in freight and
cargo revenue in third quarter 2004. Other revenues increased by $9 million,
or 36.0 percent, compared to second quarter 2003 primarily due to a 53.2
percent increase in commissions earned from programs the Company sponsors
with certain business partners, such as the Company sponsored Bank One Visa
card. The Company expects another year-over-year increase in these
commissions in third quarter 2004.
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, 2004 and 2003,
followed by explanations of changes on a per-ASM basis:
<Page>
<Table>
<Caption>
Three months ended June 30, Per ASM Percent
2004 2003 Change Change
Salaries, wages, and benefits 3.31 3.28 .03 .9
Fuel and oil 1.31 1.08 .23 21.3
Maintenance materials
and repairs .66 .58 .08 13.8
Agency commissions - .07 (.07) (100.0)
Aircraft rentals .24 .26 (.02) (7.7)
Landing fees and other rentals .53 .51 .02 3.9
Depreciation .57 .53 .04 7.5
Other operating expenses 1.47 1.37 .10 7.3
Total 8.09 7.68 .41 5.3
</Table>
Operating expenses per ASM were 8.09 cents, a 5.3 percent increase
compared to 7.68 cents for second quarter 2003. As previously mentioned, the
Company's second quarter 2003 unit costs included the impact of a $41 million
increase in profitsharing expense, which related to the $271 million
government grant. Excluding the impact of this item, second quarter
operating expenses per ASM increased 8.4 percent. In addition to the
expenses associated with the voluntary early out option and tentative
agreement with Flight Attendants, the CASM increase was driven by higher
labor, aircraft maintenance, and jet fuel costs.
Based on current plans and barring any unforeseen events, third and
fourth quarter 2004 CASM will decline from first half 2004 levels. For 2004,
the Company's cost goal was to achieve flat overall unit costs compared to
2003's unit cost, excluding the government grant, of 7.54 cents. While jet
fuel price increases have been dramatically mitigated by the Company's hedging
program (80 percent hedged in 2004 at less than $24 per barrel of crude oil),
fuel prices are still higher than 2003. With the exception of higher fuel
costs and certain charges associated with: 1) the consolidation of nine
reservations centers into six during first quarter 2004; 2) a voluntary early
out offer in second quarter 2004 accepted by just over 1,000 Employees; and 3)
higher than planned retroactive pay, per diem, and benefits associated with the
tentative agreement with the Flight Attendants TWU Local 556, the Company's
first half 2004 spending was in line with the Company's first half 2004 budget.
Based on current plans, the Company expects third quarter 2004 CASM,
excluding fuel, to approximate or slightly exceed third quarter 2003's CASM of
6.34 cents. While the Company expects fourth quarter 2004 CASM, excluding fuel,
to be lower than the same year ago quarter, CASM for full year 2004 will likely
exceed 2003's CASM, excluding fuel and the impact of the government grant, of
6.38 cents due to lower ASM capacity in second half 2004 than previously
estimated. The Company currently expects a year-over-year capacity growth of 7.7
percent and 8.9 percent for third and fourth quarter 2004, respectively.
Salaries, wages, and benefits expense per ASM increased .9 percent.
Excluding the second quarter 2003 profitsharing impact of the $271 million
government grant from the prior year, approximately 35 percent of the
increase in Salaries, wages, and benefits per ASM was due to higher average
wage rates, approximately 25 percent of the increase was due to the costs
associated with the voluntary early out option offered by the Company
in second quarter 2004, 20 percent was due to an increase in benefits costs,
including both health care and workers compensation, and 15 percent was due
to the retroactive pay and benefits associated with the tentative labor
contract reached with the Company's Flight Attendants in second quarter 2004.
The Company currently expects continuing wage rate pressures in third quarter
2004; however, Salaries, wages, and benefits will be lower than second
quarter 2004's 3.31 cents per ASM, barring any unforeseen events.
Fuel and oil expense per ASM increased 21.3 percent primarily due to an
increase in the average jet fuel price per gallon. The average fuel cost per
gallon in second quarter 2004 was 81.9 cents, 21.5 percent higher than second
quarter 2003, including the effects of hedging activities. For third
quarter and the remainder of 2004, the Company has fuel hedges in place for
over 80 percent of its expected fuel consumption with a combination of
derivative instruments that effectively cap prices under $24 per barrel of
crude oil. The majority of the Company's near term hedge positions are in
the form of option contracts. During the first half of 2004, because of the
spike in energy prices, the fair values of the Company's fuel hedge contracts
have increased significantly. At June 30, 2004, the estimated gross fair
value of these contracts was $548 million. See Note 5 to the unaudited
condensed consolidated financial statements for further discussion of the
Company's hedging activities.
<Page>
Maintenance materials and repairs per ASM increased 13.8 percent
primarily due to an increase in repairs for 737-700 aircraft engines, which
are based on a time and materials basis. Expense for these aircraft engines
increased due to the growing number of this type of aircraft in the
Company's fleet, contributing to an increase in repairs for these aircraft
engines. The Company expects third quarter 2004 maintenance materials and
repairs per ASM to fall below third quarter 2003 expense primarily due to
less scheduled maintenance activity.
Agency commissions per ASM decreased to zero due to the elimination of
commissions paid to travel agents, effective December 15, 2003. In second
quarter 2003, approximately 16 percent of passenger revenues were
commissionable, based on the Company's previous policy of paying a 5
percent commission to travel agents. For second quarter 2004, approximately
14 percent of revenues were derived through travel agents, 57 percent through
the Company's web site at southwest.com, and the remaining portion primarily
derived through the Company's Reservations Centers. Because of the change in
commission policy, the Company expects a similar year-over-year comparison
for third quarter and remainder of 2004.
Aircraft rentals per ASM decreased 7.7 percent compared to second
quarter 2003. Approximately half of the decrease per ASM was due to the
increase in ASMs relative to the expense from leased aircraft, and half was
due to the negotiation of lower lease rates on several aircraft in 2004. All
of the aircraft acquired in 2003 are owned by the Company, and all of the
aircraft acquired thus far in 2004, except for one, are owned by the Company.
The Company currently expects a similar year-over-year decline in aircraft
rentals per ASM for third quarter 2004.
Landing fees and other rentals per ASM increased 3.9 percent compared
to second quarter 2003. Approximately 60 percent of the increase was in
other rentals expense primarily due to the Company's expansion of gate and
counter space at several airports. The remainder of the increase was in
landing fees, primarily due to slightly higher rates paid. The Company
currently expects year-over-year increases in landing fees and other rentals
per ASM for third quarter 2004.
Depreciation expense per ASM increased 7.5 percent primarily due to an
increase in owned aircraft. Only one of the 34 aircraft put into service by
the Company over the past twelve months has been leased; the remainder are
owned by the Company. This has increased the Company's percentage of
aircraft owned or on capital lease to 77.8 percent at June 30, 2004 from 76.5
percent at June 30, 2003.
Other operating expenses per ASM increased 7.3 percent. Approximately
20 percent was due to retroactive per diem costs associated with the tentative
labor contract reached with the Company's Flight Attendants, and 20 percent of
the increase was due to higher advertising expense, associated with fare sales
offered by the Company and the Company's start of operations in Philadelphia
during second quarter 2004. The remainder of the increase was spread among
other items such as personnel expenses and credit card processing fees
associated with the increase in revenues. The Company currently expects Other
operating expenses per ASM for third quarter 2004 to decline from second
quarter 2004.
<Page>
Other
Interest expense decreased by $1 million, or 4.3 percent, primarily due
to the Company's October 2003 redemption of $100 million of senior unsecured
8 3/4% Notes originally issued in 1991.
Capitalized interest increased by $2 million, or 25.0 percent,
primarily due to an increase in progress payment balances for future aircraft
deliveries.
Interest income decreased by $2 million, or 28.6 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 10 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. During second quarter 2003, the Company
recognized $6 million of expense related to amounts excluded from the
Company's measurements of hedge effectiveness. In second quarter 2004, the
Company recognized approximately $6 million of expense related to amounts
excluded from the Company's measurements of hedge effectiveness and $5
million in expense related to the ineffectiveness of its hedges.
The Company's effective tax rate decreased to 36.8 percent in second
quarter 2004 from 38.0 percent in second quarter 2003 primarily due to lower
state income tax rates. The Company currently expects the second half 2004
effective tax rate to approximate 37 percent.
Comparison of six months ended June 30, 2004 to six months ended June 30, 2003
Revenues
Consolidated operating revenues increased by $334 million, or 11.7
percent, primarily due to a $311 million, or 11.2 percent, increase in
passenger revenues. The increase in passenger revenues was primarily due to
an 11.4 percent increase in revenue passenger miles (RPMs) flown.
First half 2004 capacity, as measured by available seat miles (ASMs),
increased 5.3 percent compared to the first half of 2003. The capacity
increase resulted from the net addition of 26 aircraft (net of eight
retirements) since June 30, 2003. The first half 2004 load factor was 70.3
percent, an increase of 3.9 points compared to 2003. The Company also
experienced a 8.5 percent increase in revenue passengers carried compared to
the first half of 2003.
First half 2004 passenger yield per RPM was basically flat compared to
the first half of 2003. Stronger year-over-year increases in RPM yields in
January and February were offset by lower March - June yields, primarily due
to a higher mix of discounted fares compared to the prior year in response
to the Company's 2004 fare sales. Operating revenue yield per ASM (RASM or
unit revenue) increased 6.0 percent to 8.61 cents compared to the first half
of 2003, primarily due to the increase in load factors.
<Page>
Consolidated freight revenues increased by $7 million, or 14.9 percent,
due to increases in freight and cargo revenues primarily from an increase in
the number of shipments. This increase more than offset a decrease in mail
revenues. Other revenues increased $16 million, or 33.3 percent compared to
the first half of 2003, primarily due to a 45.4 percent increase in
commissions earned from programs the Company sponsors with certain business
partners, such as the Company sponsored Bank One 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 six months ended June 30, 2004 and 2003,
followed by explanations of changes on a per-ASM basis:
<Table>
<Caption>
Six months ended June 30, Per ASM Percent
2004 2003 Change Change
Salaries, wages, and benefits 3.26 3.13 .13 4.2
Fuel and oil 1.28 1.14 .14 12.3
Maintenance materials
and repairs .64 .60 .04 6.7
Agency commissions .01 .07 (.06) (85.7)
Aircraft rentals .24 .26 (.02) (7.7)
Landing fees and other rentals .54 .51 .03 5.9
Depreciation .56 .53 .03 5.7
Other operating expenses 1.43 1.35 .08 5.9
Total 7.96 7.59 .37 4.9
</Table>
Operating expenses per ASM were 7.96 cents, a 4.9 percent increase
compared to 7.59 cents for the first half of 2003. Excluding the impact of
the $41 million increase in profitsharing expense, which related to the $271
million government grant, the first half 2004 increase in operating expenses
per ASM increased 6.4 percent, primarily due to higher salaries, wages, and
benefits, and higher fuel expense. These and other smaller increases were
partially offset by lower commissions expense compared to 2003.
Salaries, wages, and benefits expense per ASM increased 4.2 percent,
inclusive of $41 million in additional expense from the profitsharing impact
of the 2003 government grant. Excluding the profitsharing impact of the 2003
government grant, approximately 40 percent the increase per ASM was due to
higher average wage rates, 20 percent was due to higher benefits costs,
primarily health care, and 15 percent was due to costs incurred from the
consolidation of the Company's Reservations operations in first quarter 2004.
See Note 8 to the unaudited condensed consolidated financial statements. The
remainder of the increase was primarily due to the costs associated with the
second quarter voluntary early out option offered by the Company, and
the retroactive pay and benefits related to the tentative labor contract with
the Company's Flight Attendants in second quarter 2004.
<Page>
Fuel and oil expense per ASM increased 12.3 percent primarily due to an
increase in the average fuel price per gallon. The average fuel cost per
gallon for the first half of 2004 was 80.8 cents, 13.8 percent higher than
the first half of 2003, 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 6.7 percent
primarily due to an increase in repairs for 737-700 aircraft engines, which
are based on a time and materials basis. Expense for these aircraft engines
increased due to the growing number of this type of aircraft in the Company's
fleet, contributing to an increase in repairs for these aircraft engines.
This increase was partially offset by a decrease in expense for 737-200
aircraft engines. The Company is retiring the 737-200 aircraft, and they are
currently expected to be completely phased out of the Company's fleet by the
end of January 2005.
Agency commissions per ASM decreased 85.7 percent primarily due to the
elimination of commissions paid to travel agents, effective December 15,
2003. The Company records commission expense in the period of travel, not
the period of sale. Consequently, the Company recognized small amounts of
commission expense as all pre-December 15, 2003 commissionable sales were
flown. In the first half of 2003, approximately 17 percent of passenger
revenues were commissionable, based on the Company's previous policy of
paying a 5 percent commission to travel agents. For the first half of 2004,
approximately 14 percent of revenues were derived through travel agents, 57
percent through the Company's web site at southwest.com, and the remaining
portion primarily derived through the Company's Reservations Centers.
Aircraft rentals per ASM decreased 7.7 percent compared to the first
half of 2003 primarily due to the increase in ASMs relative to the number of
leased aircraft. The majority of the decrease per ASM was due to the
increase in ASMs relative to the expense from leased aircraft. All of the
aircraft acquired in 2003 are owned by the Company and all of the aircraft
acquired thus far in 2004, except for one, are owned by the Company.
Landing fees and other rentals per ASM increased 5.9 percent compared
to the first half of 2003. Approximately 70 percent of the increase was in
other rentals expense primarily due to the Company's expansion of gate and
counter space at several airports. The remainder of the increase was in
landing fees, primarily due to slightly higher rates paid.
Depreciation expense per ASM increased 5.7 percent primarily due to an
increase in owned aircraft. Only one of the 34 aircraft put into service by
the Company over the past twelve months has been leased; the remainder are
owned by the Company. These additional owned aircraft have increased the
Company's percentage of aircraft owned or on capital lease to 77.8 percent at
June 30, 2004, from 76.5 percent at June 30, 2003.
Other operating expenses per ASM increased 5.9 percent. Approximately
25 percent of the increase was due to higher advertising expense, associated
with fare sales offered by the Company and the Company's start of operations
in Philadelphia during May 2004, and 25 percent of the increase was due to
certain asset write-offs, including assets written off in connection with the
Reservations Center consolidation in first quarter 2004. See Note 8 to the
<Page>
Condensed Consolidated Financial Statements. The remainder of the increase
was spread among items such as higher fuel taxes, personnel expenses, and
credit card processing fees.
Other
Interest expense decreased by $9 million, or 18.4 percent, primarily
due to lower effective interest rates. The Company executed two interest-
rate swaps in April 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. In addition, in October 2003
the Company redeemed $100 million of senior unsecured 8 3/4% Notes originally
issued in 1991.
Capitalized interest increased by $5 million, or 33.3 percent,
primarily due to an increase in progress payment balances for future aircraft
deliveries.
Interest income decreased by $3 million, or 25.0 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 10 to the unaudited
condensed consolidated financial statements for more information on this
grant. Also included in 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. In the first half of 2003, 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 the first half of 2004, the Company
recognized approximately $12 million of expense related to amounts excluded
from the Company's measurements of hedge effectiveness and $1 million in
additional income related to the ineffectiveness of its hedges.
The Company's effective tax rate decreased to 37.0 percent for the
first half of 2004 from 38.1 percent in the first half of 2003, primarily due
to lower state income tax rates.
Liquidity and Capital Resources
Net cash provided by operating activities was $847 million for the six
months ended June 30, 2004, compared to $905 million in the same prior year
period. The decrease was primarily due to higher net income in 2003, largely
attributable to the $271 million government grant. The lower 2004 net income
was partially offset by an increase in Accounts payable and accrued
liabilities, primarily due to higher counterparty deposits associated with
the Company's fuel hedging program. See Item 3 and Note 5 to the unaudited
condensed consolidated financial statements. Net cash provided by operating
activities was $1.3 billion for the 12 months ended June 30, 2004. Cash
generated from operating activities for the 12 months ended June 30, 2004,
was primarily used to finance capital expenditures.
<Page>
Cash flows used in investing activities during the six months ended
June 30, 2004, totaled $870 million compared to $518 million in 2003.
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, 2004 totaled $1.6 billion.
Net cash used in financing activities during the six months ended June
30, 2004, was $74 million compared to $2 million generated from financing
activities in 2003. Net cash used in 2004 was primarily to repurchase the
Company's common stock.
Contractual Obligations and Contingent Liabilities and Commitments
Southwest has contractual obligations and commitments primarily for
future purchases of aircraft, payment of debt, and lease arrangements.
Following the receipt of 22 new 737-700 aircraft from Boeing in the first
half 2004, the Company has 25 737-700 aircraft deliveries for the remainder
of 2004. The Company also recently exercised options for the purchase of
three additional 737-700 aircraft to be delivered in 2005. The following
table details the Company's current (as of July 15, 2004) firm orders,
options, and purchase rights through 2012.
<Table>
<Caption>
Current Schedule
Firm Options*
2004** 47 -
2005 34 -
2006 22 12
2007 25 29
2008 6 45
2009-2012 - 177
Total 134 263
*Includes purchase rights
**Includes 22 aircraft delivered through June 30, 2004
</Table>
The following table details information on the 405 aircraft in the
Company's fleet as of June 30, 2004:
<Table>
<Caption>
Average Number Number Number
737 Type Seats Age (Yrs) of Aircraft Owned Leased
-200 122 21.8 18 16 2
-300 137 13.2 194 110 84
-500 122 13.2 25 16 9
-700 137 3.3 168 166 2
TOTALS 9.5 405 308 97
</Table>
On aircraft to be delivered from the manufacturer, 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
<Page>
for firm commitments, as of June 30, 2004, was approximately $2.8 billion,
subject to adjustments for inflation, due as follows: $617 million remaining
in 2004, $887 million in 2005, $645 million in 2006, $523 million in 2007,
and $95 million thereafter.
In January 2004, the Company's Board of Directors authorized the
repurchase of up to $300 million of the Company's common stock, utilizing
present and anticipated proceeds from the exercise of Employee stock options.
Repurchases will be made in accordance with applicable securities laws in the
open market or in private transactions from time to time, depending on
market conditions. No expiration date was given to this program. During the
first half of 2004, the Company repurchased approximately 9.2 million of its
common shares for a total of approximately $136 million. See Item 2 of Part
II of this filing for further information.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at June 30, 2004, of $1.8
billion, internally generated funds, and the Company's fully available $575
million revolving credit facility. 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.
The Company expects that a portion of these securities will be issued in
2004.
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
Company's costs and Customer demand for travel, changes in the Transportation
Security Administration's scope for managing U.S. airport security, 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.
- - The availability and cost of war-risk and other aviation insurance,
including the federal government's provision of third party war-risk coverage
to airlines. The government's coverage currently expires on August 31, 2004,
but can be extended to December 31, 2004, by the Department of Transportation.
- - War or other military actions by the U.S. or others.
<Page>
- - 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.
- - Internal failures of technology or large-scale external interruptions in
technology infrastructure, such as power, telecommunications, or the
internet.
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
As discussed in Note 5 to the unaudited condensed consolidated financial
statements, the Company utilizes financial derivative instruments to hedge
its exposure to material increases in jet fuel prices. During the first half
of 2004, because of the spike in energy prices, the fair values of the
Company's fuel hedge contracts has increased significantly. At June 30,
2004, the estimated gross fair value of these contracts was $548 million,
compared to $251 million at December 31, 2003.
Outstanding financial derivative instruments expose the Company to credit
loss in the event of nonperformance by the counterparties to the agreements.
However, the Company does not expect any of the counterparties to fail to
meet their obligations. The credit exposure related to these financial
instruments is represented by the fair value of contracts with a positive
fair value at the reporting date. To manage credit risk, the Company selects
and periodically reviews counterparties based on credit ratings, limits its
exposure to a single counterparty, and monitors the market position of the
program and its relative market position with each counterparty. At June 30,
2004, the Company had agreements with seven counterparties containing early
termination rights and/or bilateral collateral provisions whereby security is
required if market risk exposure exceeds a specified threshold amount or
credit ratings fall below certain levels. At June 30, 2004, the Company held
$265 million in collateral deposits under these bilateral collateral
provisions. These collateral deposits serve to decrease, but not totally
eliminate, the credit risk associated with the Company's hedging program.
The deposits are included in Accrued liabilities on the unaudited
Condensed Consolidated Balance Sheet.
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, 2003
and Note 5 to the unaudited condensed consolidated financial statements for
further information about Market Risk.
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.
<Page>
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.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
Issuer Purchases of Equity Securities (1)
<Table>
<Caption>
(a) (b) (c) (d)
Total number of Maximum dollar
shares purchased value that may
Total number Average as part of publicly yet be purchased
of shares price paid announced plans under the plans
Period purchased per share or programs or programs
April 1,
2004 through
April 30,
2004 - $ - - $175,117,457
May 1,
2004 through
May 31,
2004 320,000 $15.48 320,000 $170,164,609
June 1,
2004 through
June 30,
2004 366,000 $15.56 366,000 $164,470,512
Total (2) 686,000 686,000
</Table>
(1) On January 22, 2004, the Company announced a program for the repurchase
of up to $300 million of the Company's common stock, utilizing present
and anticipated proceeds from the exercise of Employee stock options.
Repurchases will be made in accordance with applicable securities laws in
the open market or in private transactions from time to time, depending
on market conditions. No expiration date was given to this program.
(2) All shares were purchased pursuant to the publicly announced program.
Recent sales of Unregistered Securities
None
Item 3. Defaults upon Senior Securities
<Page>
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 19, 2004. 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 2006: Rollin W. King: 715,175,761
shares voted for and 40,634,132 shares withheld; June M. Morris: 596,227,703
shares voted for and 159,582,189 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 2007: Herbert D. Kelleher: 628,639,588
shares voted for and 127,170,304 shares withheld; C. Webb Crockett:
534,730,984 shares voted for and 221,078,909 shares withheld; William
P. Hobby: 712,427,269 shares voted for and 43,382,624 shares withheld; Travis
C. Johnson: 732,205,685 shares voted for and 23,604,207 shares withheld.
There were no broker non-votes on this matter.
Additionally, the following current directors of the Company continued to
serve as directors as of the Annual Meeting: Colleen C. Barrett, William H.
Cunningham, Nancy B. Loeffler, Louis E. Caldera, John T. Montford, and James
F. Parker.
(ii) The Company's selection of Ernst & Young LLP as independent auditors for
the fiscal year ending December 31, 2004 was ratified as follows: 743,451,280
shares voted for, 7,778,622 shares voted against, and 4,579,990 shares
withheld.
Item 5. Other Information
Effective July 15, 2004, the Company announced that Vice Chairman of the Board
and Chief Executive Officer, James F. Parker had retired effective July 15,
2004. Gary Kelly, formerly Executive Vice President - Chief Financial Officer,
succeeds Mr. Parker as Vice Chairman and Chief Executive Officer. Laura Wright,
formerly the Company's Vice President - Finance and Treasurer succeeds Mr. Kelly
as Chief Financial Officer.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
10.1 Revolving Credit Facility Agreement among Southwest Airlines Co.,
the banks party thereto, and JPMorgan Chase Bank, as
Administrative Agent, dated as of April 20, 2004.
10.2 Amendment No. 5 to the Southwest Airlines Co. Profit Sharing
Plan.
10.3 Supplemental Agreements Nos. 34, 35, 36, 37, and 38 to Purchase
Agreement No. 1810, dated January 19, 1994 between The Boeing
<Page>
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.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
b) Reports on Form 8-K
On July 15, 2004, Southwest filed a current report on Form 8-K to furnish the
Company's public announcement of its second quarter 2004 earnings, and the
announcement of Executive changes.
<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 19, 2004 By /s/ Laura H. Wright
Laura H. Wright
Chief Financial Officer
(Principal Financial and
Accounting Officer)
<Page>
EXHIBIT INDEX
Exhibit No. Description
Exhibit 10.1 - Revolving Credit Facility Agreement among
Southwest Airlines Co., the banks party thereto,
and JPMorgan Chase Bank, as Administrative Agent,
dated as of April 20, 2004.
Exhibit 10.2 - Amendment No. 5 to the Southwest Airlines Co.
Profit Sharing Plan.
Exhibit 10.3 - Supplemental Agreements Nos. 34, 35, 36, 37, and
38 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 31.1 - Rule 13a-14(a) Certification of Chief Executive
Officer
Exhibit 31.2 - Rule 13a-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 - Section 1350 Certification of Chief Executive
Officer
Exhibit 32.2 - Section 1350 Certification of Chief Financial
Officer