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EXHIBIT 99.3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
YEAR IN REVIEW
Southwest and the airline industry continued to post record profits in 1996.
Southwest's net income for the first half of 1996 benefitted from the lapse in
the ten percent federal ticket tax on December 31, 1995. Net income for the
second half of 1996 fell below year ago levels primarily due to significant
increases in jet fuel prices.
Southwest continued to maintain our advantage as the low cost leader in the
industry. Despite this advantage, we continue pursuing numerous cost reduction
efforts, which have proven to be beneficial.
We added 22 new Boeing 737-300 aircraft to our fleet in 1996 and retired three
- -200s. Our fleet remains one of the youngest fleets in the industry with an
average age of 7.9 years. In October 1997, we will be the launch customer for
the new Boeing 737-700 aircraft. In total for 1997, we will accept delivery of
15 -300s and four -700s. We currently plan to retire four -200s in fourth
quarter 1997.
Our expansion into Florida in 1996 has been successful with strong load
factors. We added Jacksonville, Florida service beginning January 15, 1997.
Service to Providence, Rhode Island, which began October 27, 1996, also looks
promising. Our current plans for capacity growth in 1997 will be primarily
directed to cities we presently serve, either with increased frequencies or new
routes. We may begin service to one more new city later in 1997.
Proposed FAA "funding reform" continues to present uncertainty as to how or if
any changes would impact Southwest. While Congress reinstated the ten percent
ticket tax in August 1996, the tax lapsed again as of December 31, 1996. At the
current time, Southwest is unable to predict how this FAA funding issue will be
resolved and what impact, if any, resolution of this uncertainty will have on
future operating results.
RESULTS OF OPERATIONS
1996 COMPARED WITH 1995 The Company's consolidated net income for 1996 was
$207.3 million ($1.37 per share), as compared to the corresponding 1995 amount
of $182.6 million ($1.23 per share), an increase of 13.5 percent.
OPERATING REVENUES Consolidated operating revenues increased by 18.6 percent in
1996 to $3,406.2 million, compared to $2,872.8
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million for 1995. This increase in 1996 operating revenues was derived
primarily from an 18.4 percent increase in passenger revenues. Revenue
passenger miles (RPMs) increased 16.1 percent in 1996, compared to a 12.6
percent increase in available seat miles (ASMs), resulting in an increase in
load factor from 64.5 percent in 1995 to 66.5 percent in 1996. The 1996 ASM
growth resulted from the net addition of 19 aircraft during the year: 22
additions and three retirements.
In December 1995, because of the impasse in the federal budget, Congress
allowed the ten percent federal ticket tax to lapse. This benefitted
Southwest's revenues until late August when Congress reimposed the tax through
December 31, 1996. The reimposition of the ticket tax negatively impacted
revenues in third and fourth quarters 1996 as compared to revenue trends in the
first half of 1996.
In celebration of the Company's 25th Anniversary, Southwest launched a fare
sale in July for travel between August 19 and October 31, 1996. The sale was
extremely popular and resulted in record advance bookings, with more than four
and a half million seats sold. Although July and early August load factors and
revenues were negatively impacted by the telephone line congestion experienced
during the sale, revenues for September and October 1996 were positively
impacted with very heavy passenger volumes.
Freight revenues in 1996 were $80.0 million, compared to $65.8 million in 1995.
The 21.5 percent increase in freight revenues exceeded the 12.6 percent
increase in ASMs for the same period primarily due to increased air freight
volumes and United States mail services primarily resulting from the
development of new markets added in 1995 and early 1996.
Other revenues increased by 23.3 percent in 1996 to $56.9 million, compared to
$46.2 million in 1995. This increase is primarily due to increased charter
revenue.
OPERATING EXPENSES Consolidated operating expenses for 1996 were $3,055.3
million, compared to $2,559.2 million in 1995, an increase of 19.4 percent,
compared to the 12.6 percent increase in capacity. Operating expenses per ASM
increased 6.1 percent in 1996 compared to 1995, primarily due to significantly
higher jet fuel prices along with the 4.3 cent per gallon federal jet fuel tax
implemented October 1, 1995. Excluding jet fuel costs and related taxes,
operating expenses per ASM were up 3.1 percent in 1996 compared to 1995.
Unit costs are expected to increase in first quarter 1997 versus first quarter
1996, due to higher jet fuel prices. (The
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immediately preceding sentence is a forward-looking statement which involves
uncertainties that could result in actual results differing materially from
expected results. Such uncertainties include, but may not be limited to, the
largely unpredictable levels of fuel prices.)
Operating expenses per ASM for 1996 and 1995 were as follows:
OPERATING EXPENSES PER ASM
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PERCENT
1996 1995 INCREASE CHANGE
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Salaries, wages,
and benefits ... 2.22(cents) 2.17(cents) .05(cents) 2.3%
Employee profitsharing
and savings plans .. .23 .23 -- --
Fuel and oil ............ 1.19 1.01 .18 17.8
Maintenance materials and
repairs ........ .62 .60 .02 3.3
Agency commissions ...... .35 .34 .01 2.9
Aircraft rentals ........ .47 .47 -- --
Landing fees and
other rentals .. .46 .44 .02 4.5
Depreciation ............ .45 .43 .02 4.7
Other ................... 1.51 1.38 .13 9.4
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TOTAL ................... 7.50(cents) 7.07(cents) .43(cents) 6.1%
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Salaries, wages, and benefits per ASM increased 2.3 percent in 1996. This
increase resulted primarily from a 16.2 percent increase in 1996 average
headcount, which outpaced the 1996 capacity (ASM) increase of 12.6 percent, and
offset a 0.8 percent decrease in average salary and benefits cost per Employee.
The 16.2 percent increase in average headcount was primarily the result of a
24.3 percent increase in Reservations Sales Agents in 1996. Excluding
Reservations Sales Agents, total average headcount increased 13.1 percent, in
line with capacity.
Southwest's mechanics are subject to an agreement with the International
Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America (the
Teamsters), which became amendable August 16, 1995. The Company reached an
agreement with the Teamsters which was ratified by its membership in March
1996. The Company's flight attendants are subject to an agreement with the
Transport Workers Union of America, AFL-CIO (TWU), which became amendable May
31, 1996. Southwest is currently in negotiations with TWU to amend the
contract.
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Fuel and oil expenses per ASM increased 17.8 percent in 1996, primarily due to
an 18.6 percent increase in the average jet fuel cost per gallon from 1995. The
average price paid for jet fuel in 1996 was $.6547 compared to $.5522 in 1995.
During fourth quarter 1996, the average cost per gallon increased 25.0 percent
to $.7323 compared to $.5859 in fourth quarter 1995. In January 1997, fuel
prices have averaged approximately $.76 per gallon.
Maintenance materials and repairs per ASM increased 3.3 percent in 1996
compared to 1995 primarily as a result of increased scheduled airframe
inspections during 1996.
Agency commissions per ASM increased 2.9 percent in 1996 compared to 1995,
which was slightly slower than the 5.2 percent increase in passenger revenues
per ASM.
Landing fees and other rentals per ASM increased 4.5 percent in 1996 compared
to 1995, which included an airport credit of $4.9 million.
Depreciation expense per ASM increased 4.7 percent in 1996 compared to 1995 due
to an increase in the percentage of owned aircraft.
Other operating expenses per ASM increased 9.4 percent in 1996 compared to
1995. This increase was primarily due to increased advertising costs resulting
from the expansion into Florida and Providence, Rhode Island, as well as a new
advertising campaign; the 4.3 cents per gallon tax on commercial aviation jet
fuel purchased for use in domestic operations, which became effective October
1, 1995; and increased airport security costs. The additional fuel tax
increased 1996 and 1995 "other operating expenses" by $32.7 million and $7.4
million, respectively.
OTHER "Other expenses (income)" included interest expense, capitalized
interest, interest income, and nonoperating gains and losses. Capitalized
interest decreased $9.1 million in 1996 as a result of certain amendments to
aircraft purchase contracts during third quarter 1995 that affected the timing
of payments. Interest income for 1996 increased $5.7 million primarily due to
higher invested cash balances.
INCOME TAXES The provision for income taxes, as a percentage of income before
taxes decreased in 1996 to 39.3 percent from 40.2 percent in 1995. The decrease
was primarily the result of lower effective state tax rates.
1995 COMPARED WITH 1994 The Company's consolidated net income for 1995 was
$182.6 million ($1.23 per share), as compared to the
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corresponding 1994 amount of $179.3 million ($1.22 per share), an increase of
1.8 percent.
Operating Revenues Consolidated operating revenues increased by 10.8 percent in
1995 to $2,872.8 million, compared to $2,591.9 million for 1994. This increase
in 1995 operating revenues was derived from a 10.5 percent increase in
passenger revenues. RPMs increased 7.9 percent in 1995, compared to a 12.6
percent increase in ASMs, resulting in a decrease in load factor from 67.3
percent in 1994 to 64.5 percent in 1995. The 1995 ASM growth resulted from the
addition of 25 aircraft during the year.
Freight revenues in 1995 were $65.8 million, compared to $54.4 million in 1994.
The 21.0 percent increase in freight revenues exceeded the 12.6 percent
increase in ASMs for the same period primarily due to increased air freight
volumes and United States mail services primarily resulting from the
development of new markets added throughout 1994 and 1995.
Operating Expenses Consolidated operating expenses for 1995 were $2,559.2
million, compared to $2,275.2 million in 1994, an increase of 12.5 percent,
compared to the 12.6 percent increase in ASMs. For the second consecutive year,
operating expenses on a per-ASM basis decreased year-over-year, down .1 percent
in 1995.
Salaries, wages, and benefits per ASM increased 1.9 percent in 1995. This
increase resulted primarily from a 17.8 percent increase in 1995 average
headcount, which outpaced the 1995 capacity (ASM) increase of 12.6 percent, and
offset a 2.6 percent decrease in average salary and benefits cost per Employee.
The 17.8 percent increase in average headcount was primarily the result of a
44.6 percent increase in Reservations Sales Agents in 1995. Excluding
Reservations Sales Agents, total average headcount increased only 11.4 percent.
The Reservations Sales Agent increase coincided with increased demand for
reservations capacity following 1994 enhancements to Southwest's ticket
delivery systems for direct Customers.
Employee profitsharing and savings plans expense per ASM increased 4.5 percent
in 1995. The increase is primarily the result of increased matching
contributions to Employee savings plans resulting from increased Employee
participation and higher matching rates in 1995 for non-contract Employees and
certain Employee groups covered by collective bargaining agreements.
Fuel and oil expenses per ASM increased 1.0 percent in 1995, primarily due to a
2.4 percent increase in the average jet fuel cost per gallon from 1994. Jet
fuel prices remained relatively stable throughout most of 1995, with quarterly
averages through
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the first three quarters ranging from $.53 to $.55 per gallon. During fourth
quarter 1995, the average cost per gallon increased to $.59 and, in January
1996, averaged approximately $.62 per gallon.
Maintenance materials and repairs per ASM increased 1.7 percent in 1995
compared to 1994 primarily as a result of performing more engine overhauls
during 1995.
Agency commissions per ASM decreased 17.1 percent in 1995 compared to 1994, due
to a lower mix of travel agency sales in 1995. The lower travel agency sales
mix resulted from 1994 enhancements to Southwest's ticket delivery systems for
direct Customers, as described below.
In response to actions taken by our competitor-owned reservations systems in
1994, we reduced our operating costs and enhanced our ticket delivery systems
by developing our own Southwest Airlines Air Travel ("SWAT") system allowing
high-volume travel agents direct access to reservations; introduced overnight
ticket delivery for travel agents; reduced to three the number of advance days
reservations required for overnight delivery of tickets to consumers (Ticket By
Mail); developed our own Ticketless system, which was rolled out system-wide on
January 31, 1995; and effective March 30, 1995 subscribed to a new level of
service with SABRE that automates the booking process for SABRE travel
agencies.
Aircraft rentals per ASM increased 11.9 percent in 1995. The increase primarily
resulted from second and third quarter 1995 sale/leaseback transactions
involving ten new 737-300 aircraft and a higher percentage of the fleet
consisting of leased aircraft.
Other operating expenses per ASM decreased 2.8 percent in 1995 compared to
1994. This decrease was primarily due to operating efficiencies resulting from
the transition of Morris operating functions to Southwest commencing first
quarter 1994, and lower communications costs. Communications costs decreased
approximately 15 percent per ASM primarily due to lower negotiated rates,
increased reservations operations efficiencies, and enhancements to the
Company's ticket delivery system.
In August 1993, the Revenue Reconciliation Act of 1993 was enacted, which,
among other things, included an assessment of a 4.3 cents per gallon tax on
commercial aviation jet fuel purchased for use in domestic operations, which
became effective September 30, 1995. This additional fuel tax increased 1995
"other operating expenses" by $7.4 million.
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Other "Other expenses (income)" included interest expense, capitalized
interest, interest income, and nonoperating gains and losses. Interest expense
increased $5.4 million in 1995 due to the March 1995 issuance of $100 million
senior unsecured 8% Notes due 2005. Capitalized interest increased $5.0 million
in 1995 as a result of higher levels of progress payments on aircraft compared
to 1994. Interest income for 1995 increased $10.9 million primarily due to
higher invested cash balances and higher short-term interest rates.
Income Taxes The provision for income taxes as a percentage of income before
taxes was relatively unchanged year over year.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided from operations was $615.2 million in 1996, compared to $456.4
million in 1995. During 1996, additional funds of $330.0 million were generated
from the sale and leaseback of ten new 737-300 aircraft subject to long-term
operating leases (increasing total commitments for operating leases by $588.8
million).
During 1996, capital expenditures of $677.4 million primarily were for the
purchase of 22 new 737-300 aircraft, one used 737-200 aircraft previously
leased by the Company, and progress payments for future aircraft deliveries. At
December 31, 1996, capital commitments of the Company consisted primarily of
scheduled aircraft acquisitions.
The Company recently announced its intention to order 20 hushkits for our
737-200 fleet, with an option for 14 more, for delivery in 1997-1999. These
hushkits, with an approximate cost of $1.0 million per aircraft, will make the
Stage 2 -200 aircraft compliant with Stage 3 noise requirements.
As of January 1997, Southwest had 78 new 737s on firm order, including 19 to be
delivered in 1997, with options to purchase another 67. Aggregate funding
required for firm commitments approximated $1,960.1 million through the year
2001 of which $515.1 million related to 1997. See Note 2 to the Consolidated
Financial Statements for further information.
In September 1996, the Company's Board of Directors reaffirmed a 1990
authorization for the Company to purchase shares of its common stock from
time-to-time on the open market. The authorization reaffirmed the purchase of
up to 2,500,000 shares. As of February 21, 1997, no shares have been purchased
pursuant to this authority since 1990.
The Company has various options available to meet its capital and operating
commitments, including cash on hand at December 31, 1996
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of $581.8 million, internally generated funds, and a revolving credit line with
a group of banks of up to $460 million (none of which had been drawn at
December 31, 1996). In addition, 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
$114.4 million of public debt securities which it currently intends to utilize
for aircraft financings in 1997.
Cash provided from operations was $456.4 million in 1995 as compared to $412.7
million in 1994. During 1995, additional funds of $321.7 million were generated
from the sale and leaseback of ten new 737-300 aircraft subject to long-term
operating leases (increasing total commitments for operating leases by $607.9
million). In addition, $98.8 million was generated from the March 1995 issuance
of $100 million in senior unsecured 8% Notes due 2005. These proceeds were
primarily used to finance aircraft-related capital expenditures and to provide
working capital.