1
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997 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 (I.R.S. 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
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
Common Stock ($1.00 par value) New York Stock Exchange, Inc.
Common Share Purchase Rights New York Stock Exchange, Inc.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Aggregate market value of Common Stock held by nonaffiliates as of
March 2, 1998:
$6,365,558,997
Number of shares of Common Stock outstanding as of the close of business
on March 2, 1998:
222,627,708 shares
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for Annual Meeting of
Shareholders, May 21, 1998: PART III
================================================================================
2
PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
Southwest Airlines Co. (Southwest) is a major domestic airline that
provides primarily shorthaul, high frequency, point-to-point, low fare service.
Southwest was incorporated in Texas and commenced Customer Service on June 18,
1971 with three Boeing 737 aircraft serving three Texas cities - Dallas,
Houston, and San Antonio.
At yearend 1997, Southwest operated 261 Boeing 737 aircraft and provided
service to 52 airports in 51 cities in 25 states throughout the United States.
Southwest commenced service to Jackson, Mississippi in August 1997.
On December 31, 1993, Southwest acquired Morris Air Corporation (Morris) in
a stock-for-stock exchange, issuing approximately 3.6 million shares (not
adjusted for subsequent stock split) of Southwest Common Stock in exchange for
all of the outstanding shares of Morris. During 1994, the operations of Morris
were substantially integrated with those of Southwest, and Morris ceased service
as a certificated air carrier in March 1995. Unless the context requires
otherwise, references in this annual report to the "Company" include Southwest
and Morris.
The business of the Company is somewhat seasonal. Quarterly operating
income and, to a lesser extent, revenues tend to be lower in the first quarter
(January 1 - March 31).
FUEL
The cost of fuel is an item having significant impact on the Company's
operating results. The Company's average cost of jet fuel per gallon (excluding
taxes) for scheduled carrier service over the past five years was as follows:
1993 $.59
1994 $.54
1995 $.55
1996 $.65
1997 $.62
The Company is unable to predict the extent of future fuel cost changes.
The Company has standard industry arrangements with major fuel suppliers.
Standard industry fuel contracts do not provide material protection against
price increases or for assured availability of supplies. Although market
conditions can significantly impact the price of jet fuel, at present these
conditions have not resulted in an inadequate supply of jet fuel. For more
discussion of current jet fuel costs and the impact of these costs on the
Company's operations, see Management's Discussion and Analysis of Financial
Condition and Results of Operations.
REGULATION
Economic. The Dallas Love Field section of the International Air
Transportation Competition Act of 1979, as amended in 1997, (commonly known as
the "Wright Amendment"), as it affects Southwest's scheduled service, provides
that no common carrier may provide scheduled passenger air transportation for
compensation between Love Field and one or more points outside Texas, except
that an air carrier may
1
3
transport individuals by air on a flight between Love Field and one or more
points within the states of Alabama, Arkansas, Kansas, Louisiana, Mississippi,
New Mexico, Oklahoma, and Texas if (a) "such air carrier does not offer or
provide any through service or ticketing with another air carrier" and (b) "such
air carrier does not offer for sale transportation to or from, and the flight or
aircraft does not serve, any point which is outside any such states." Southwest
does not interline or offer joint fares with any other air carrier at Love
Field. The Wright Amendment does not restrict Southwest's intrastate Texas
flights or its air service from points other than Love Field to points beyond
Texas and the four contiguous states.
The Department of Transportation (DOT) has significant regulatory
jurisdiction over passenger airlines. Unless exempted, no air carrier may
furnish air transportation over any route without a DOT certificate of
authorization, which does not confer either exclusive or proprietary rights. The
Company's certificates are unlimited in duration and permit the Company to
operate among any points within the United States, its territories and
possessions, except as limited by the Wright Amendment, as do the certificates
of all other U.S. carriers. DOT may revoke such certificates, in whole or in
part, for intentional failure to comply with any provisions of subchapter IV of
the Federal Aviation Act of 1958, or any order, rule or regulation issued
thereunder or any term, condition or limitation of such certificate; provided
that, with respect to revocation, the certificate holder has first been advised
of the alleged violation and has been given a reasonable time to effect
compliance.
DOT prescribes uniform disclosure standards regarding terms and conditions
of carriage, and prescribes that terms incorporated into the Contract of
Carriage by reference are not binding upon passengers unless notice is given in
accordance with its regulations.
Safety. The Company is subject to the jurisdiction of the Federal Aviation
Administration (FAA) with respect to its aircraft maintenance and operations,
including equipment, ground facilities, dispatch, communications, flight
training personnel, and other matters affecting air safety. To ensure compliance
with its regulations, the FAA requires airlines to obtain operating,
airworthiness and other certificates which are subject to suspension or
revocation for cause. The Company has obtained such certificates. The FAA,
acting through its own powers or through the appropriate U. S. Attorney, also
has the power to bring proceedings for the imposition and collection of fines
for violation of the Federal Air Regulations.
Environmental. The Airport Noise and Capacity Act of 1990 (ANCA) requires
the phase out of Stage 2 airplanes (which meet less stringent noise emission
standards than later model Stage 3 airplanes) in the contiguous 48 states by
December 31, 1999. FAA rules establish a future interim compliance date for ANCA
of December 31, 1998. An operator may comply by either implementing a reduction
of the operator's base level, as defined in ANCA, of Stage 2 aircraft by at
least 75 percent at December 31, 1998, or by operating a fleet that is at least
75 percent Stage 3 by December 31, 1998. Operation of Stage 2 aircraft after
December 31, 1999 is prohibited, subject, however, to an extension of the final
compliance date to December 31, 2003, if at least 85 percent of the aircraft
used by the operator in the contiguous United States will comply with Stage 3
noise levels by July 1, 1999 and the operator successfully obtains a waiver from
the FAA of the December 31, 1999 final phaseout date. Statutory requirements to
obtain a waiver include a determination by the FAA that the waiver is in the
public interest or would enhance competition or benefit service to small
communities. There is no assurance that such a waiver is obtainable.
The Company's fleet, as of December 31, 1997, consisted of 42 Stage 2
aircraft and 219 Stage 3 aircraft, yielding a Stage 3 percentage of over 80
percent. Accordingly, the Company exceeds the Stage 3 fleet percentage
requirement for the December 31, 1998 interim compliance date.
As of December 31, 1997, of the 42 Stage 2 aircraft operated by the
Company, 24 are leased from third parties and 18 are owned by the Company.
Because the Company already complies with the
2
4
December 31, 1998 interim compliance requirement of a 75 percent Stage 3 fleet,
the Company could operate its 42 remaining Stage 2 aircraft until December 31,
1999. Based upon the Company's current schedule for delivery of new Stage 3
aircraft, including options, and the Company's planned retirement schedule for
Stage 2 aircraft, assuming no hushkitting, the Company will achieve 85 percent
compliance by July 1, 1999; however, the Company currently intends to hushkit at
least 20 aircraft. This would qualify the Company to apply for a waiver from the
final compliance date, which, if obtained, could permit the Company to continue
operation of the then remaining Stage 2 aircraft until, at the latest, December
31, 2003.
ANCA also requires the FAA to establish parameters within which any new
Stage 2 and Stage 3 noise or access restrictions at individual airports must be
developed. The published rules generally provide that local noise restrictions
on Stage 3 aircraft first effective after October 1990 require FAA approval, and
establish a regulatory notice and review process for local restrictions on Stage
2 aircraft first proposed after October 1990. Certain airports, including Dallas
Love Field, Los Angeles, San Diego, San Francisco, and Orange County, have
established airport restrictions to limit noise, including restrictions on
aircraft types to be used and limits on the number of hourly or daily operations
or the time of such operations. In some instances, these restrictions have
caused curtailments in service or increases in operating costs and such
restrictions could limit the ability of Southwest to expand its operations at
the affected airports. Local authorities at other airports are considering
adopting similar noise regulations.
Operations at John Wayne Airport, Orange County, California, are governed
by the Airport's Phase 2 Commercial Airline Access Plan and Regulation (the
"Plan"). Pursuant to the Plan, each airline is allocated total annual seat
capacity to be operated at the airport, subject to renewal/reallocation on an
annual basis. Service at this airport may be adjusted annually to meet these
requirements.
The Company is subject to various other federal, state, and local laws and
regulations relating to the protection of the environment, including the
discharge of materials into the environment.
MARKETING AND COMPETITION
Southwest focuses principally on point-to-point, rather than hub and
spoke, service in shorthaul markets with frequent, conveniently timed flights,
and low fares. For example, Southwest's average aircraft trip length in 1997 was
425 miles with an average duration of approximately one hour. At yearend,
Southwest served 229 one-way nonstop city pairs.
Southwest's point-to-point route system, as compared to hub and spoke,
provides for more direct nonstop routings for shorthaul customers and,
therefore, minimizes connections, delays, and total trip time. Southwest focuses
on nonstop, not connecting, traffic. As a result, approximately 80 percent of
the Company's Customers fly nonstop. In addition, Southwest serves many
conveniently-located satellite or downtown airports such as Dallas Love Field,
Houston Hobby, Chicago Midway, Baltimore, Burbank, Oakland, San Jose,
Providence, and Ft. Lauderdale airports, which are typically less congested than
other airlines' hub airports and enhance the Company's ability to sustain high
employee productivity and reliable ontime performance. This operating strategy
also permits the Company to achieve high asset utilization. Aircraft are
scheduled to minimize the amount of time the aircraft is at the gate,
approximately 20 minutes, thereby reducing the number of aircraft and gate
facilities that would otherwise be required.
Southwest does not interline with other domestic jet airlines, nor have any
commuter feeder relationships. However, in late 1996, the Company entered into a
marketing relationship with Icelandair, pursuant to which Icelandair may offer
travel to Customers traveling between Chicago, Cleveland, Louisville or
Providence and various foreign Icelandair destinations, via Baltimore. Southwest
provides the domestic portion of the travel on its regularly scheduled service.
3
5
Southwest employs a very simple fare structure, featuring low,
unrestricted, unlimited, everyday coach fares. The Company operates only one
aircraft type, the Boeing 737, which simplifies scheduling, maintenance, flight
operations, and training activities.
In May 1994, the computer reservations systems (CRSs) owned by United
Airlines (Apollo) and Continental Airlines (System One) disabled automated
ticketing for Southwest travel. Rather than pay the new fees associated with CRS
participation in Apollo and System One, Southwest took the following actions:
Southwest introduced a Ticketless travel option, available system-wide in
January 31, 1995, eliminating the need to print a paper ticket altogether, and
improved access to Ticket By Mail for direct Customers by reducing the time
limit from seven days out from the date of travel to three days. Southwest also
entered into a new arrangement with SABRE, the CRS in which Southwest has
historically participated to a limited extent, providing for ticketing and
automated booking on Southwest in a very cost-effective manner. In 1996,
Southwest began offering Ticketless travel through the Company's home page on
the Internet's World Wide Web at http://www.southwest.com. At December 31, 1997,
approximately 60 percent of Southwest's Customers were choosing the Ticketless
travel option.
The airline industry is highly competitive as to fares, frequent flyer
benefits, routes, and service, and some carriers competing with the Company have
greater financial resources, larger fleets, and wider name recognition. Several
of the Company's larger competitors have initiated or are studying low-cost,
shorthaul service in markets served by the Company, which represents a more
direct threat in Southwest's market niche. Profit levels in the air transport
industry are highly sensitive to changes in operating and capital costs and the
extent to which competitors match an airline's fares and services. The
profitability of a carrier in the airline industry is also impacted by general
economic trends.
The Company is also subject to varying degrees of competition from surface
transportation in its shorthaul markets, particularly the private automobile. In
shorthaul air services which compete with surface transportation, price is a
competitive factor, but frequency and convenience of scheduling, facilities,
transportation safety, and Customer Service may be of equal or greater
importance to many passengers.
INSURANCE
The Company carries insurance of types customary in the airline industry
and at amounts deemed adequate to protect the Company and its property and to
comply both with federal regulations and certain of the Company's credit and
lease agreements. The policies principally provide coverage for public and
passenger liability, property damage, cargo and baggage liability, loss or
damage to aircraft, engines, and spare parts, and workers' compensation.
FREQUENT FLYER AWARDS
Southwest's frequent flyer program, Rapid Rewards, is based on trips flown
rather than mileage. Rapid Rewards offers two types of travel awards. The Rapid
Rewards Award Ticket ("Award Ticket") offers one free roundtrip travel award to
any Southwest destination after flying eight roundtrips (or 16 one-way trips) on
Southwest within a consecutive twelve-month period. The Rapid Rewards Companion
Pass ("Companion Pass") is granted after flying 50 roundtrips (or 100 one-way
trips) on Southwest within a consecutive twelve-month period. The Companion Pass
offers unlimited free roundtrip travel to any Southwest destination for a
companion of the qualifying Rapid Rewards member. In order for the companion to
use this pass, the Rapid Rewards member must purchase a ticket or use an Award
Ticket. Additionally, the Rapid Rewards member and companion must travel
together on the same flight.
4
6
The trips flown as credit towards a free travel award are valid for twelve
months only; the free travel awards are automatically generated when earned by
the Customer rather than allowing the Customer to bank the trip credits
indefinitely; and the free travel awards are valid for one year with an
automatic expiration date. Based on the issuance of free travel awards to
qualified members, coupled with the foregoing program characteristics and the
use of "black out" dates for the free travel awards during peak holiday periods,
the financial impact of free travel awards used on the Company's consolidated
financial statements has not been material. Free travel awards redeemed were
approximately 782,000, 494,000, and 435,000 during 1997, 1996, and 1995,
respectively. The amount of free travel award usage as a percentage of total
Southwest revenue passengers carried was 3.1 percent in 1997, 2.0 percent in
1996, and 1.9 percent in 1995.
The Company accounts for free travel awards using the incremental cost
method, consistent with the other major airlines. This method recognizes an
average incremental cost to provide roundtrip transportation to one additional
passenger. The incremental cost to provide free transportation is accrued at the
time an award is earned and revenue is subsequently recognized, at the amount
accrued, when the free travel award is used. The estimated incremental costs
include passenger costs such as beverage and snack supplies, baggage claims,
baggage handling, and liability insurance; operations costs such as security
services, airport rentals, fuel, oil, and into-plane charges; and reservations
costs, such as communications and system operations fees. The liability for free
travel awards earned but not used at December 31, 1997 and 1996 was not
material.
The number of Award Tickets for Southwest outstanding at December 31, 1997
and 1996 was approximately 485,000 and 399,000, respectively. These numbers do
not include partially earned Award Tickets. The Company currently does not have
a system to accurately estimate partially earned Award Tickets. However, these
partially earned Award Tickets may equate to approximately 60-70 percent of the
current outstanding Award Tickets. Since the inception of Rapid Rewards in 1987,
approximately 15 percent of all Award Tickets have expired without being used.
The number of Companion Passes for Southwest outstanding at December 31,
1997 and 1996 was approximately 20,000 and 30,000, respectively. The Company
currently estimates that three to four trips will be redeemed per outstanding
Companion Pass.
EMPLOYEES
At December 31, 1997, Southwest had 23,974 active employees, consisting of
6,459 flight, 1,116 maintenance, 13,723 ground customer service and 2,676
management, accounting, marketing, and clerical personnel.
Southwest has ten collective bargaining agreements covering approximately
84 percent of its employees. Southwest's Customer service and Reservation
employees are subject to an agreement with the International Association of
Machinists and Aerospace Workers, AFL-CIO (IAM), which became amendable in
November 1997 and is currently in negotiations. Flight attendants are subject to
an agreement with the Transportation Workers Union of America, AFL-CIO (TWU),
which becomes amendable May 31, 2002. Fleet service employees are subject to an
agreement with the TWU which becomes amendable in December 1999. The pilots are
subject to an agreement with the Southwest Airlines Pilots' Association (SWAPA),
which becomes amendable in September 1999 (described below). Flight dispatchers
are represented by the Southwest Airlines Employees Association, pursuant to an
agreement which became amendable in November 1997 and is currently in
negotiations. Aircraft cleaners and stock clerks; mechanics, flight simulator
technicians and flight crew training instructors are represented by the
International Brotherhood of Teamsters pursuant to separate agreements which
become amendable in August 2000, August 2001, October 2000 and December 2000,
respectively. The flight/ground school
5
7
instructors are subject to an agreement with the Southwest Airlines Professional
Instructors Association, which becomes amendable in December 2000.
In January 1995, Southwest's pilots ratified a ten-year labor contract that
calls for no wage increases in the first five years and three percent annual
wage increases in three of the last five years of the contract. Initially, the
pilots received options to purchase approximately 21.8 million shares of
Southwest common stock at $13.33 per share over the term of the contract. Pilots
hired subsequently receive additional grants at a five percent premium over the
then current fair market value. Up to 27,000,000 shares ultimately can be issued
under the stock option plan. Pilots are eligible for profitability bonuses of up
to three percent of compensation in three of the first five years and
profitability-based pay increases up to three percent in two of the second five
years of the contract. The pilot group may choose to reopen the contract after
five years, in which event all unexercised options will terminate on December 1,
1999.
ITEM 2. PROPERTIES
AIRCRAFT
Southwest operated a total of 261 Boeing 737 aircraft as of December 31,
1997, of which 106 and 13 were under operating and capital leases, respectively.
The remaining 142 aircraft were owned.
Southwest is the launch customer for the Boeing 737-700 aircraft, the
newest generation of the Boeing 737 aircraft type. The first 737-700 Aircraft
was delivered in December 1997 and entered revenue service in January 1998.
In total, at December 31, 1997, the Company had 126 firm orders to purchase
Boeing 737 Aircraft as follows:
Type Seats 1998 1999 2000 2001 2002 2003 2004
---- ----- ---- ---- ---- ---- ---- ---- ----
737-700 137 22 25 23 21 21 8 6
The Company also has 62 options for deliveries in 2003 through 2006.
The average age of the Company's fleet at December 31, 1997 was 8.3 years.
The Company has an agreement with CFM International, Inc. (CFM) (a joint
company of SNECMA (France) and General Electric Company) dated May 28, 1981, as
amended, for the supply of spare engines for its Boeing 737-300, -500, and -700
aircraft. CFM also supplies the engines to The Boeing Company for original
installation on such aircraft. CFM is the sole manufacturer of engines for use
on the Boeing 737-300, -500, and -700 aircraft.
GROUND FACILITIES AND SERVICES
Southwest leases terminal passenger service facilities at each of the
airports it serves to which it has added various leasehold improvements. The
Company leases land on a long-term basis for its maintenance centers located at
Dallas Love Field, Houston Hobby, and Phoenix Sky Harbor, its training center
near Love Field which houses five 737 simulators, and its corporate headquarters
also located near Love Field. The maintenance, training center, and corporate
headquarters buildings on these sites were built and are owned by Southwest. At
December 31, 1997, the Company operated nine reservation centers. The
reservation centers located in Little Rock, Arkansas; Chicago, Illinois;
Albuquerque, New Mexico; and Oklahoma City, Oklahoma occupy leased space. The
Company owns its Dallas, Texas; Houston, Texas; Phoenix, Arizona; Salt Lake
City, Utah; and San Antonio, Texas reservation centers.
6
8
The Company performs substantially all line maintenance on its aircraft and
provides ground support services at most of the airports it serves. However, the
Company has arrangements with certain aircraft maintenance firms for major
component overhauls and repairs for its airframes and engines, which comprise
the majority of the annual maintenance costs.
In recent years, many airports have increased or sought to increase the
rates charged to airlines. The extent to which such charges are limited by
statute and the ability of airlines to contest such charges has been subject to
litigation and to administrative proceedings before the Department of
Transportation. To the extent the limitations on such charges are relaxed or the
ability of airlines to challenge such charges is restricted, the rates charged
by airports to airlines may increase substantially. Management cannot predict
the magnitude of any such increase.
ITEM 3. LEGAL PROCEEDINGS
The Company received a statutory notice of deficiency from the Internal
Revenue Service (the "IRS") in which the IRS proposed to disallow deductions
claimed by the Company on its federal income tax returns for the taxable years
1989 through 1991 for the costs of certain aircraft inspection and maintenance
procedures. The IRS has proposed similar adjustments to the tax returns of
numerous other members of the airline industry. In response to the statutory
notice of deficiency, the Company filed a petition in the United States Tax
Court on October 30, 1997, seeking a determination that the IRS erred in
disallowing the deductions claimed by the Company and that there is no
deficiency in the Company's tax liability for the taxable years in issue. It is
expected that the Tax Court's decision will not be entered for several years.
Management believes that the final resolution of this controversy will not have
a materially adverse effect upon the financial condition or results of
operations of the Company. This forward-looking statement is based on
management's current understanding of the relevant law and facts; it is subject
to various contingencies including the views of legal counsel, changes in the
IRS' position, the potential cost and risk associated with litigation and the
actions of the IRS, judges, and juries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None to be reported.
7
9
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of Southwest, their positions, and their respective
ages (as of March 1, 1998) are as follows:
OFFICER
CONTINUOUSLY
NAME POSITION AGE SINCE
---- -------- --- ------------
Herbert D. Kelleher Chairman of the Board, President, 66 1967
and Chief Executive Officer
Colleen C. Barrett Executive Vice President-Customers 53 1978
and Corporate Secretary
Gary A. Barron Executive Vice President, 53 1978
Chief Operations Officer
John G. Denison Executive Vice President- 53 1986
Corporate Services
Gary C. Kelly Vice President-Finance, 42 1986
Chief Financial Officer
James F. Parker Vice President-General Counsel 51 1986
Ron Ricks Vice President-Governmental Affairs 48 1986
Joyce C. Rogge Vice President - Advertising and Promotions 40 1994
James C. Wimberly Vice President-Ground Operations 45 1985
Executive officers are elected annually at the first meeting of Southwest's
Board of Directors following the annual meeting of shareholders or appointed by
the President pursuant to Board authorization.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Due to a clerical error, Colleen C. Barrett, Executive Vice President -
Customers and Corporate Secretary filed a Form 4, reporting an exercise of
employee stock options, which was one week late.
8
10
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Southwest's common stock is listed on the New York Stock Exchange and is
traded under the symbol LUV. The high and low sales prices of the common stock
on the Composite Tape and the quarterly dividends per share paid on the common
stock were:
PERIOD DIVIDEND HIGH LOW
------ -------- ---- ---
1997
1st Quarter $.00770 $16.67 $14.17
2nd Quarter .00770 18.67 14.33
3rd Quarter .00770 22.13 17.33
4th Quarter .01000 26.25 18.83
1996
1st Quarter $.00733 $22.00 $14.75
2nd Quarter .00733 22.17 17.17
3rd Quarter .00733 19.33 14.25
4th Quarter .00733 17.33 13.75
As of March 2, 1998, there were 9,141 holders of record of the Company's
common stock.
RECENT SALES OF UNREGISTERED SECURITIES
During 1997, Herbert D. Kelleher, President and Chief Executive Officer,
exercised unregistered options to purchase Southwest Common Stock as follows
(the numbers have not been adjusted for the subsequent stock split):
Number of Shares Purchased Exercise Price Date of Exercise
-------------------------- -------------- ----------------
123,750 $1.00 01/14/97
33,750 4.889 01/14/97
The issuance of the above options and shares to Mr. Kelleher were deemed
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 which has become
effective under the Act or to an exemption from such registration. The issuance
of such shares was not underwritten.
ITEM 6. SELECTED FINANCIAL DATA
The following financial information for each of the five years ended
December 31, 1997 has been derived from the Company's consolidated financial
statements. This information should be read in conjunction with the Consolidated
Financial Statements and related notes thereto included elsewhere herein.
9
11
YEARS ENDED DECEMBER 31,
------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
FINANCIAL DATA:
(in thousands except per share amounts)
Operating revenues ....................... $ 3,816,821 $ 3,406,170 $ 2,872,751 $ 2,591,933 $ 2,296,673
Operating expenses ....................... 3,292,585 3,055,335 2,559,220 2,275,224 2,004,700
----------- ----------- ----------- ----------- -----------
Operating income ......................... 524,236 350,835 313,531 316,709 291,973
Other expenses, net ...................... 7,280 9,473 8,391 17,186 32,336
----------- ----------- ----------- ----------- -----------
Income before income taxes and cumula-
tive effect of accounting changes ..... 516,956 341,362 305,140 299,523 259,637
Provision for income taxes ............... 199,184 134,025 122,514 120,192 105,353
----------- ----------- ----------- ----------- -----------
Income before cumulative effect of
accounting changes ............. 317,772 207,337 182,626 179,331 154,284
Cumulative effect of accounting changes -- -- -- -- 15,259 (2)
----------- ----------- ----------- ----------- -----------
Net income ............................... $ 317,772 $ 207,337 $ 182,626 $ 179,331 $ 169,543
=========== =========== =========== =========== ===========
Net income per share, basic(1) ........... $ 1.45 $ .95 $ .85 $ .84 $ .72 (3)
Net income per share, diluted(1) ......... $ 1.40 $ .92 $ .82 $ .82 $ .70 (3)
Cash dividends per common share(1) ....... $ .0331 $ .02932 $ .02667 $ .02667 $ .02578
Total assets at period-end ............... $ 4,246,160 $ 3,723,479 $ 3,256,122 $ 2,823,071 $ 2,576,037
Long-term obligations at period-end ...... $ 628,106 $ 650,226 $ 661,010 $ 583,071 $ 639,136
Stockholders' equity at period-end ....... $ 2,009,018 $ 1,648,312 $ 1,427,318 $ 1,238,706 $ 1,054,019
OPERATING DATA:
Revenue passengers carried ............... 50,399,960 49,621,504 44,785,573 42,742,602 (5) 36,955,221 (5)
Revenue passenger miles (RPMs) (000s) .... 28,355,169 27,083,483 23,327,804 21,611,266 18,827,288
Available seat miles (ASMs) (000s) ....... 44,487,496 40,727,495 36,180,001 32,123,974 27,511,000
Load factor .............................. 63.7% 66.5% 64.5% 67.3% 68.4%
Average length of passenger haul (miles).. 563 546 521 506 509
Trips flown .............................. 786,288 748,634 685,524 624,476 546,297
Average passenger fare ................... $ 72.21 $ 65.88 $ 61.64 $ 58.44 $ 59.97
Passenger revenue yield per RPM .......... 12.84 c. 12.07 c. 11.83 c. 11.56 c. 11.77 c.
Operating revenue yield per ASM .......... 8.58 c. 8.36 c. 7.94 c. 8.07 c. 8.35 c.
Operating expenses per ASM ............... 7.40 c. 7.50 c. 7.07 c. 7.08 c. 7.25 c.(6)
Fuel cost per gallon (average) ........... 62.46 c. 65.47 c. 55.22 c. 53.92 c. 59.15 c.
Number of employees at year end .......... 23,974 22,944 19,933 16,818 15,175
Size of fleet at year end (4) ............ 261 243 224 199 178
- ------------------
(1) On September 25, 1997 the Company's Board of Directors declared a
three-for-two stock split on the Company's Common Stock, distributed on
November 26, 1997. Except as specifically noted elsewhere, all share and per
share data in this annual report have been restated to give effect to the
stock split. Net income per share data has been restated in accordance with
Statement of Financial Accounting Standards No. 128, Earnings per Share.
(2) Includes the net cumulative effect of adopting Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes and Statement of
Financial Accounting Standards No. 106, Employers' Accounting for
Postretirement Benefits Other than Pensions.
(3) Before cumulative effect of accounting change.
(4) Includes leased aircraft.
(5) Includes certain estimates for Morris.
(6) Excludes merger expenses of $10.8 million.
10
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
YEAR IN REVIEW
In 1997, Southwest posted a record annual profit for the sixth consecutive year
and a profit for the 25th consecutive year. Net income for 1997 benefited from
record passenger revenue yields and continued cost control, widening our
industry-leading cost advantage.
At the end of 1997, Southwest served 51 cities in 25 states. We added service to
Jacksonville, Florida and Jackson, Mississippi in 1997 and have been very
pleased with the results, thus far. We also expanded our existing service to
certain cities in 1997, especially Nashville, Providence, and our Florida
markets. Plans for 1998 include the addition of 14 more aircraft, net, and
service to two new cities. We will continue to add additional flights to cities
we already serve. Any further expansion in 1998 will be dependent upon
additional aircraft availability.
We were the launch customer for the new Boeing 737-700 aircraft, taking our
first delivery in December 1997. The -700 is expected to contribute to our low
cost advantage as it is more fuel efficient, less maintenance intensive, and has
a lower capital outlay than the -300. We added 18 new Boeing 737s to our fleet
in 1997: 15 -300s and three -700s. In 1998, we are currently scheduled to
receive 22 -700s and retire eight older -200s (three in first quarter 1998; one
in second quarter 1998; and four in fourth quarter 1998). We currently are
interested in adding more 737 aircraft in 1998 if we can find aircraft at
reasonable prices.
At the present time, Boeing is experiencing production delays related to the 737
production line. Thus far, these delays have not had a significant impact on our
operations as we were able to defer the retirement of some older -200s and have
earned cash penalty payments from Boeing. Boeing currently expects delays to
continue in 1998, which temporarily delays our expansion. Boeing will continue
to compensate Southwest for these production delays.
11
13
In August 1997, the Taxpayer Relief Act of 1997 was enacted, which included,
among other things, a revision of the then current ten percent federal excise
tax on domestic tickets. Effective October 1, 1997, through September 30, 1998,
the tax rate was reduced to nine percent of the amount paid for transportation
beginning on or after October 1, 1997, and a new $1.00 flight segment tax was
imposed. From October 1, 1998 to September 30, 1999, the tax rate will decrease
to eight percent and the segment tax will increase to $2.00. Beginning October
1, 1999, the tax rate will change to 7.5 percent of the ticket price. The
segment tax will increase to $2.25 from October 1, 1999 to December 31, 1999;
$2.50 during 2000; $2.75 during 2001; and $3.00 per segment during 2002.
Thereafter, the $3.00 segment tax will be indexed to changes in the Consumer
Price Index (CPI). The legislation also included a new tax on the sale of
frequent flier miles, raised the international departure fee, and instituted a
new international arrival fee.
Management estimates these changes may increase Southwest's tax burden by
roughly $30 million in 1998 as the effect of the new tax is to shift an
increasing portion of the excise tax burden to low fare, shorthaul carriers such
as Southwest. Effective October 1, 1997, the Company raised fares to offset the
increased excise taxes. While the fare increases mitigated the additional tax
burden in fourth quarter 1997, management cannot accurately predict the future
effects of tax or fare increases. (This paragraph contains forward-looking
statements which involve uncertainties that could result in actual results
differing materially from expected results. Some significant factors include,
but may not be limited to, regulations implementing the tax, competitors'
responses to the tax, and the ability to pass through the tax in the form of
fare increases.)
On October 27, 1997, the International Air Transportation Competition Act of
1979 was amended to allow scheduled service from Dallas Love Field to Alabama,
Mississippi, and Kansas. The Company now offers scheduled service from Dallas
Love Field to Jackson via connecting flights through Houston and service from
Dallas Love Field to Birmingham via connecting flights through New Orleans and
Houston. No additional flights have been added, thus far, from Dallas Love Field
to Alabama, Mississippi, or Kansas.
12
14
RESULTS OF OPERATIONS
1997 COMPARED WITH 1996 The Company's consolidated net income for 1997 was
$317.8 million ($1.40 per share, diluted), as compared to the corresponding 1996
amount of $207.3 million ($.92 per share, diluted), an increase of 53.3 percent.
The prior years' earnings per share amounts have been restated for the 1997
three-for-two stock split (see Note 6 to the Consolidated Financial Statements).
OPERATING REVENUES Consolidated operating revenues increased by 12.1 percent in
1997 to $3,816.8 million, compared to $3,406.2 million for 1996. This increase
in 1997 operating revenues was derived primarily from an 11.3 percent increase
in passenger revenues as a result of a 4.7 percent increase in revenue passenger
miles (RPMs) and a 6.4 percent increase in passenger revenue yield per RPM.
Southwest's passenger revenues benefited from a strong U.S. economy, strong
demand for air travel, increased fares, and a favorable mix of higher yielding
fares.
The 4.7 percent increase in RPMs in 1997, coupled with a 9.2 percent increase in
available seat miles (ASMs), resulted in a decrease in load factor from 66.5
percent in 1996 to 63.7 percent in 1997. The decrease in load factor was
primarily the result of less promotional fare activity in 1997. The 1997 ASM
growth resulted from the addition of 18 aircraft during the year.
The January 1998 load factor decreased to 54.0 percent from 60.2 percent in
January 1997 due to heavy promotional fare activities in the 1997 period.
However, revenue yield per passenger mile continues to be strong in January 1998
despite difficult comparisons due to the lapse of the federal excise tax from
January 1 to March 7, 1997. Comparisons in February and March will be more
difficult due to fare increases in February 1997. (The immediately preceding
sentence is a forward-looking statement which involves uncertainties that could
result in actual results differing materially from expected results. Some
significant factors include, but may not be limited to, competitive pressure
such as fare sales and capacity changes by other carriers, general economic
conditions, and variations in advance booking trends.)
Freight revenues in 1997 were $94.8 million, compared to $80.0 million in 1996.
The 18.4 percent increase in freight revenues exceeded the 9.2 percent increase
in ASMs for the same period primarily due to an increase in United States mail
services and
13
15
increased air freight volumes resulting, in part, from the United Parcel Service
labor strike during third quarter 1997.
Other revenues increased by 45.6 percent in 1997 to $82.9 million, compared to
$56.9 million in 1996. This increase is primarily due to the sale of frequent
flyer segment credits to participating partners in the Company's Rapid Rewards
frequent flyer program.
OPERATING EXPENSES Consolidated operating expenses for 1997 were $3,292.6
million, compared to $3,055.3 million in 1996, an increase of 7.8 percent,
compared to the 9.2 percent increase in capacity. Operating expenses per ASM
decreased 1.3 percent in 1997, compared to 1996, primarily due to lower jet fuel
prices; lower aircraft engine repair costs; and favorable results from numerous
Companywide cost reduction efforts.
Unit costs are expected to benefit in first quarter 1998, versus first quarter
1997, from lower jet fuel prices. Excluding jet fuel costs, operating expenses
per ASM are expected to increase primarily due to higher maintenance costs as
management believes first quarter 1998 maintenance unit costs will be higher
than the same period in 1997 due to an unusually low number of aircraft engine
overhauls performed in first quarter 1997. (The immediately preceding two
sentences are forward-looking statements which involve 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 jet fuel prices.)
Operating expenses per ASM for 1997 and 1996 were as follows:
OPERATING EXPENSES PER ASM
INCREASE PERCENT
1997 1996 (DECREASE) CHANGE
---- ---- ---------- ------
Salaries, wages, and benefits ............... 2.26 c. 2.22 c. .04 c. 1.8%
Employee profitsharing and savings plans .... .30 .23 .07 30.4
Fuel and oil ................................ 1.11 1.19 (.08) (6.7)
Maintenance materials and repairs ........... .58 .62 (.04) (6.5)
Agency commissions .......................... .35 .35 -- --
Aircraft rentals ............................ .45 .47 (.02) (4.3)
Landing fees and other rentals .............. .46 .46 -- --
Depreciation ................................ .44 .45 (.01) (2.2)
Other ....................................... 1.45 1.51 (.06) (4.0)
---- ---- ---- ----
TOTAL ....................................... 7.40 c. 7.50 c. (.10) c. (1.3)%
---- ---- ---- ----
14
16
Salaries, wages, and benefits per ASM increased 1.8 percent in 1997. This
increase resulted primarily from a 2.4 percent increase in 1997 average salary
and benefits cost per Employee, partially offset by slower growth in the number
of Employees. The increase in average salary and benefits cost per Employee
primarily is due to increased health care costs.
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.
The Company reached an agreement with the TWU, which was ratified by its
membership in December 1997. The new contract becomes amendable in May 2002.
The Company's Customer Service and Reservations Sales Agents are subject to an
agreement with the International Association of Machinists and Aerospace
Workers, AFL-CIO (IAM), which became amendable in November 1997 and is currently
under negotiation. Flight Dispatchers are represented by the Southwest Airlines
Employees Association, pursuant to an agreement which became amendable in
November 1997 and is also currently under negotiation.
Profitsharing and Employee savings plans expense per ASM increased 30.4 percent
in 1997, primarily due to higher earnings available for profitsharing.
Fuel and oil expenses per ASM decreased 6.7 percent in 1997, primarily due to a
4.6 percent decrease from 1996 in the average jet fuel cost per gallon, coupled
with a slight decrease in the average fuel burn rate from 1996. The average
price paid for jet fuel in 1997 was $.6246 compared to $.6547 in 1996. During
fourth quarter 1997, the average cost per gallon decreased 17.5 percent to
$.6040 compared to $.7323 in fourth quarter 1996. In January 1998, fuel prices
averaged approximately $.53 per gallon.
Maintenance materials and repairs per ASM decreased 6.5 percent in 1997,
compared to 1996, primarily as a result of lower engine
15
17
overhaul costs in the first three quarters of 1997, when compared to the same
periods in 1996.
On August 1, 1997, the Company signed a ten-year engine maintenance contract
with General Electric Engine Services, Inc. (General Electric). Under the terms
of the contract, Southwest will pay General Electric a rate per flight hour in
exchange for General Electric performing substantially all engine maintenance
for the CFM56-3 engines on the 737-300 and 737-500 aircraft. The Company has a
similar agreement with General Electric with respect to the engines on the
737-700 aircraft. Maintenance on the Pratt & Whitney JT8-D engines on the
737-200 aircraft will continue to be performed by General Electric on a time and
materials basis. By consolidating its engine repair work and committing to ten
years, Southwest believes it will spend substantially less over the course of
the contract versus what it would have spent absent this new agreement. (The
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 the number of unscheduled engine
removals, labor rates, and competition in the engine overhaul market.)
Agency commissions per ASM remained unchanged in 1997, when compared to 1996, as
the mix of commissionable sales was relatively unchanged.
Aircraft rentals per ASM decreased 4.3 percent in 1997, compared to 1996,
primarily due to a lower percentage of the aircraft fleet being leased.
Depreciation expense per ASM decreased 2.2 percent in 1997, compared to 1996,
due to an increase in the average life of depreciable assets.
Other operating expenses per ASM decreased 4.0 percent in 1997, compared to
1996, primarily due to lower credit card processing costs, insurance rates,
passenger costs, communications costs, and favorable results from numerous other
Companywide cost reduction efforts.
OTHER "Other expenses (income)" included interest expense, capitalized interest,
interest income, and nonoperating gains and losses. Interest expense increased
$4.2 million in 1997 primarily due to the February 1997 issuance of $100 million
of
16
18
senior unsecured 7 3/8% Debentures due March 1, 2027. Capitalized interest
decreased $2.5 million in 1997 as a result of the timing of payments related to
aircraft purchase contracts. Interest income for 1997 increased $10.8 million
primarily due to higher invested cash balances.
INCOME TAXES The provision for income taxes, as a percentage of income before
taxes, decreased in 1997 to 38.5 percent from 39.3 percent in 1996. The decrease
resulted from lower effective state tax rates, including a reduced California
income tax rate.
1996 COMPARED WITH 1995 The Company's consolidated net income for 1996 was
$207.3 million ($.92 per share, diluted), as compared to the corresponding 1995
amount of $182.6 million ($.82 per share, diluted), 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 million for 1995. This increase
in 1996 operating revenues was derived primarily from an 18.4 percent increase
in passenger revenues. RPMs increased 16.1 percent in 1996, compared to a 12.6
percent increase in 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 excise tax to lapse. This benefited Southwest's revenues
until late August 1996 when Congress reimposed the tax through December 31,
1996. The reimposition of the excise tax negatively impacted revenue trends 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 1996 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 telephone line congestion experienced
during the sale, revenues for September and October 1996 were positively
impacted with very heavy passenger volumes.
17
19
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.
Other revenues increased by 23.3 percent in 1996 to $56.9 million, compared to
$46.2 million in 1995. This increase primarily was 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 a 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.
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 .8 percent decrease in average salary and benefits cost per Employee.
The 16.2 percent increase in average headcount primarily was 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.
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.
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.
18
20
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 cent 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
primarily was the result of lower effective state tax rates.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided from operations was $610.6 million in 1997, compared to $615.2
million in 1996. (Operating cash flows in 1996 were inflated by $79.4 million
due to a one-time deferral allowed by the federal government for payment of
excise taxes. On a pro forma basis, operating cash flows would have been $690.0
million in 1997 versus $535.8 million in 1996.)
During 1997, additional funds of $98.8 million were generated from the February
issuance of $100 million of senior unsecured 7 3/8% Debentures due March 1,
2027. These proceeds primarily were used to finance aircraft-related capital
expenditures and to provide working capital.
19
21
During 1997, capital expenditures of $688.9 million primarily were for the
purchase of 15 new 737-300 aircraft and three new 737-700 aircraft along with
progress payments for future aircraft deliveries. At December 31, 1997, capital
commitments of the Company primarily consisted of scheduled aircraft
acquisitions and related flight equipment.
As of December 31, 1997, Southwest had 126 new 737-700s on firm order, including
22 to be delivered in 1998, with options to purchase another 62. Aggregate
funding required for firm commitments approximated $3,109.8 million through the
year 2004, of which $565.7 million related to 1998. See Note 2 to the
Consolidated Financial Statements for further information.
As of December 31, 1997, the Company had authority from its Board of Directors
to purchase up to 2,500,000 shares of its common stock from time to time on the
open market. No shares have been purchased since 1990.
The Company has various options available to meet its capital and operating
commitments, including cash on hand at December 31, 1997, of $623.3 million,
internally generated funds, and a revolving credit line with a group of banks of
up to $475 million (none of which had been drawn at December 31, 1997). 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
$414.4 million of public debt securities, which it currently intends to utilize
for aircraft financings in 1998 and 1999.
MARKET RISK
In 1997, the Securities and Exchange Commission issued new rules (Item 305 of
Regulation S-K), which require disclosure of material risks, as defined in Item
305, related to market risk sensitive financial instruments. As defined,
Southwest currently has market risk sensitive instruments related to jet fuel
prices and interest rates.
Airline operators are inherently dependent upon energy to operate and,
therefore, are impacted by changes in jet fuel prices. Jet fuel consumed in 1997
represented approximately 15.0 percent of
20
22
Southwest's operating expenses. Southwest endeavors to acquire jet fuel at the
lowest prevailing prices possible.
The Company hedges its exposure to jet fuel price market risk only on a
conservative, limited basis. The fair value of outstanding derivative commodity
instruments (primarily purchased crude oil call options) related to the
Company's jet fuel price market risk during 1997 and at December 31, 1997 was
immaterial. For further discussion, see Note 1 to the Consolidated Financial
Statements.
Airline operators are also inherently capital intensive, as the vast majority of
the Company's assets are aircraft, which are long lived. The Company's strategy
is to capitalize itself conservatively and grow capacity steadily and
profitably. While Southwest does use financial leverage, it has maintained a
strong balance sheet and "A-" or equivalent credit ratings on its senior
unsecured debt with three rating agencies (Standard & Poor's, Moody's, and Duff
& Phelps).
As disclosed in Note 4 to the Consolidated Financial Statements, the Company has
outstanding unsecured debt of $600 million at December 31, 1997, of which only
$500 million is long-term. This long-term debt represents only 14.5 percent of
total noncurrent assets at December 31, 1997. The Company has an average
maturity of 11 years for the long-term debt at fixed rates averaging 7.8
percent, which is below average rates prevailing over the last ten years.
At December 31, 1997, the Company operated 119 aircraft under operating and
capital leases at rates that are substantially fixed. As defined in Item 305,
leases are not market risk sensitive financial instruments and, therefore, are
not included in the interest rate sensitivity analysis below. Commitments
related to leases are disclosed in Note 5 to the Consolidated Financial
Statements.
The Company does not have significant exposure to changing interest rates on its
long-term debt because the interest rates are fixed and the financial leverage
is modest. Additionally, the Company does not have significant exposure to
changing interest rates on invested cash, which was $623 million at December 31,
1997. The Company invests available cash in certificates of deposit and
investment grade commercial paper that have maturities of three months or
less. As a result,
21
23
the interest rate market risk implicit in these investments at December 31,
1997, is low, as the investments mature within three months. The Company has not
undertaken any additional actions to cover interest rate market risk and is not
a party to any other interest rate market risk management activities.
The Company does not purchase or hold any derivative financial instruments for
trading purposes.
INTEREST RATE SENSITIVITY A ten percent change in market interest rates over the
next year would not impact the Company's earnings or cash flow as the interest
rates on the Company's long-term debt are fixed and its cash investments are
short-term. A ten percent change in market interest rates would not have a
material effect on the fair value of the Company's publicly traded long-term
debt or its short-term cash investments.
IMPACT OF THE YEAR 2000
Based on a recently completed assessment, the Company has determined that it
will be required to modify, upgrade, or replace significant portions of its
internal software, including financial, reservations, maintenance, and human
resources related software, so that its computer systems will properly utilize
dates beyond December 31, 1999. As of December 31, 1997, the Company has
commenced its year 2000 remediation program, has secured substantially all the
required resources, and expects to substantially complete its internal year 2000
efforts by March 31, 1999. The Company believes that by completing the planned
remediation program, the year 2000 issue will not adversely impact the Company's
operations or operating results. However, if the program is not completed, or
not completed timely, the year 2000 issue could have a material impact on the
operations of the Company.
In addition, the Company has contacted its critical suppliers and other entities
to determine the extent to which the Company's interface systems are vulnerable
to those third parties' failure to remediate their own year 2000 issues. While
the Company has not been informed of any material risks associated with these
entities, there is no guarantee that the systems of these critical suppliers or
other entities, including the Federal Aviation Administration, on which the
Company relies, will be
22
24
timely converted and will not have an adverse effect on the Company's systems or
operations.
The Company has expensed $4.0 million of costs incurred to date related to the
year 2000 issue. The total remaining cost of the year 2000 project is presently
estimated at $15 million, which will be expensed as incurred. These amounts
include only costs directly related to resolving the year 2000 issue. The costs
of the project and the date on which the Company believes it will complete the
year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the continued
availability of certain resources. However, there can be no guarantee that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area and the ability to locate and correct all relevant computer codes.
23
25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Management's Discussion and Analysis of Financial Condition and
Results of Operation-Market Risk."
24
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
REPORT OF ERNST & YOUNG LLP
INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
SOUTHWEST AIRLINES CO.
We have audited the accompanying consolidated balance sheets of Southwest
Airlines Co. as of December 31, 1997 and 1996, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Southwest Airlines
Co. at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Dallas, Texas
January 23, 1998
25
27
SOUTHWEST AIRLINES CO.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31,
1997 1996
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ...................... $ 623,343 $ 581,841
Accounts receivable ............................ 76,530 73,440
Inventories of parts and supplies,
at cost ...................................... 52,376 51,094
Deferred income taxes (Note 9) ................. 18,843 11,560
Prepaid expenses and other current
assets ....................................... 35,324 33,055
---------- ----------
Total current assets ....................... 806,416 750,990
Property and equipment, at cost (Notes 2 and 5):
Flight equipment ............................... 3,987,493 3,435,304
Ground property and equipment .................. 601,957 523,958
Deposits on flight equipment
purchase contracts ........................... 221,874 198,366
---------- ----------
4,811,324 4,157,628
Less allowance for depreciation ................ 1,375,631 1,188,405
---------- ----------
3,435,693 2,969,223
Other assets ..................................... 4,051 3,266
---------- ----------
$4,246,160 $3,723,479
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................... $ 160,891 $ 214,232
Accrued liabilities (Note 3) ................... 426,950 368,625
Air traffic liability .......................... 153,341 158,098
Current maturities of long-term
debt (Note 4) ................................ 121,324 12,327
Other current liabilities ...................... 6,007 12,122
---------- ----------
Total current liabilities .................. 868,513 765,404
Long-term debt less current
maturities (Note 4) ............................ 628,106 650,226
Deferred income taxes (Note 9) ................... 438,981 349,987
Deferred gains from sale and
leaseback of aircraft .......................... 256,255 274,891
Other deferred liabilities ....................... 45,287 34,659
Commitments and contingencies
(Notes 2, 5, and 9)
Stockholders' equity (Notes 6 and 7):
Common stock, $1.00 par value:
680,000,000 shares authorized;
221,207,083 and 145,112,090
shares issued and
outstanding in 1997 and
1996, respectively ........................... 221,207 145,112
Capital in excess of par value ................. 155,696 181,650
Retained earnings .............................. 1,632,115 1,321,550
---------- ----------
Total stockholders' equity .................. 2,009,018 1,648,312
---------- ----------
$4,246,160 $3,723,479
========== ==========
SEE ACCOMPANYING NOTES.
26
28
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
1997 1996 1995
----------- ----------- -----------
OPERATING REVENUES:
Passenger ....................... $ 3,639,193 $ 3,269,238 $ 2,760,756
Freight ......................... 94,758 80,005 65,825
Other ........................... 82,870 56,927 46,170
----------- ----------- -----------
Total operating revenues ..... 3,816,821 3,406,170 2,872,751
OPERATING EXPENSES:
Salaries, wages, and
benefits (Note 8) ............. 1,136,542 999,719 867,984
Fuel and oil .................... 494,952 484,673 365,670
Maintenance materials and
repairs ....................... 256,501 253,521 217,259
Agency commissions .............. 157,211 140,940 123,380
Aircraft rentals ................ 201,954 190,663 169,461
Landing fees and other
rentals ....................... 203,845 187,600 160,322
Depreciation .................... 195,568 183,470 156,771
Other operating expenses ........ 646,012 614,749 498,373
----------- ----------- -----------
Total operating expenses ..... 3,292,585 3,055,335 2,559,220
----------- ----------- -----------
OPERATING INCOME .................. 524,236 350,835 313,531
OTHER EXPENSES (INCOME):
Interest expense ................ 63,454 59,269 58,810
Capitalized interest ............ (19,779) (22,267) (31,371)
Interest income ................. (36,616) (25,797) (20,095)
Nonoperating (gains) losses,
net ............................ 221 (1,732) 1,047
----------- ----------- -----------
Total other expenses ......... 7,280 9,473 8,391
----------- ----------- -----------
INCOME BEFORE INCOME TAXES ........ 516,956 341,362 305,140
PROVISION FOR INCOME TAXES
(NOTE 9) ........................ 199,184 134,025 122,514
----------- ----------- -----------
NET INCOME ........................ $ 317,772 $ 207,337 $ 182,626
=========== =========== ===========
NET INCOME PER SHARE, BASIC
(NOTES 6, 7, AND 10) ............ $ 1.45 $ .95 $ .85
=========== =========== ===========
NET INCOME PER SHARE, DILUTED
(NOTES 6, 7, AND 10) .............. $ 1.40 $ .92 $ .82
=========== =========== ===========
SEE ACCOMPANYING NOTES.
27
29
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
CAPITAL
IN EXCESS
COMMON OF RETAINED
STOCK PAR VALUE EARNINGS TOTAL
------------ ------------ ------------ ------------
Balance at December 31, 1994 ........... $ 143,256 $ 151,746 $ 943,704 $ 1,238,706
Issuance of common stock upon
exercise of executive stock
options and pursuant to Employee
stock option and purchase plans
(Note 7) ........................... 777 9,907 -- 10,684
Tax benefit of options exercised ..... -- 1,051 -- 1,051
Cash dividends, $.02667 per share .... -- -- (5,749) (5,749)
Net income - 1995 .................... -- -- 182,626 182,626
------------ ------------ ------------ ------------
Balance at December 31, 1995 ........... 144,033 162,704 1,120,581 1,427,318
Issuance of common stock upon
exercise of executive stock
options and pursuant to Employee
stock option and purchase plans
(Note 7) ........................... 1,079 14,513 -- 15,592
Tax benefit of options exercised ..... -- 4,433 -- 4,433
Cash dividends, $.02932 per share .... -- -- (6,368) (6,368)
Net income - 1996 .................... -- -- 207,337 207,337
------------ ------------ ------------ ------------
Balance at December 31, 1996 ........... 145,112 181,650 1,321,550 1,648,312
Three-for-two stock split (Note 6) ... 73,578 (73,578) -- --
Issuance of common stock upon
exercise of executive stock
options and pursuant to Employee
stock option and purchase plans
(Note 7) ........................... 2,517 37,818 -- 40,335
Tax benefit of options exercised ..... -- 9,806 -- 9,806
Cash dividends, $.0331 per share ..... -- -- (7,207) (7,207)
Net income - 1997 .................... -- -- 317,772 317,772
------------ ------------ ------------ ------------
Balance at December 31, 1997 ........... $ 221,207 $ 155,696 $ 1,632,115 $ 2,009,018
============ ============ ============ ============
SEE ACCOMPANYING NOTES.
28
30
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
1997 1996 1995
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................. $ 317,772 $ 207,337 $ 182,626
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation ......................... 195,568 183,470 156,771
Deferred income taxes ................ 81,711 67,253 48,147
Amortization of deferred gains
on sale and leaseback of
aircraft .......................... (15,414) (18,263) (24,286)
Amortization of scheduled
airframe overhauls .................. 20,540 20,539 17,337
Changes in certain assets and
liabilities:
Accounts receivable ............... (3,090) 6,341 (4,089)
Other current assets .............. 6,243 (19,534) (11,857)
Accounts payable and
accrued liabilities .............. 8,751 132,096 61,937
Air traffic liability ............. (4,757) 26,942 25,017
Other current liabilities ......... (4,204) 5,334 1,050
Other ................................ 7,468 3,713 3,789
--------- --------- ---------
Net cash provided by
operating activities .......... 610,588 615,228 456,442
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ..... (688,927) (677,431) (728,643)
--------- --------- ---------
Net cash used in investing
activities .................... (688,927) (677,431) (728,643)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt .............. 98,764 -- 98,811
Proceeds from aircraft sale and
leaseback transactions ............... -- 330,000 321,650
Payment of long-term debt and capital
lease obligations .................... (12,665) (12,695) (10,379)
Payment of cash dividends ............... (6,593) (6,216) (5,749)
Proceeds from Employee stock plans ...... 40,335 15,592 10,693
--------- --------- ---------
Net cash provided by
financing activities ......... 119,841 326,681 415,026
--------- --------- ---------
NET INCREASE IN CASH AND CASH
EQUIVALENTS ............................. 41,502 264,478 142,825
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD ............................... 581,841 317,363 174,538
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD .................................. $ 623,343 $ 581,841 $ 317,363
========= ========= =========
CASH PAYMENTS FOR:
Interest, net of amount capitalized ....... $ 42,372 $ 36,640 $ 25,277
Income taxes .............................. 107,066 66,447 73,928
SEE ACCOMPANYING NOTES.
29
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION Southwest Airlines Co. (Southwest) is a major domestic
airline that provides shorthaul, high frequency, point-to-point, low fare
service. The consolidated financial statements include the accounts of Southwest
and its wholly owned subsidiaries (the Company). All significant intercompany
balances and transactions have been eliminated. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from these estimates. Certain prior year amounts have been reclassified for
comparison purposes.
CASH AND CASH EQUIVALENTS Cash equivalents consist of certificates of deposit
and investment grade commercial paper issued by major corporations and financial
institutions that are highly liquid and have original maturities of three
months or less. Cash and cash equivalents are carried at cost, which
approximates market value.
INVENTORIES Inventories of flight equipment expendable parts, materials, and
supplies are carried at average cost. These items are charged to expense when
issued for use.
PROPERTY AND EQUIPMENT Depreciation is provided by the straight-line method to
residual values over periods ranging from 12 to 20 years for flight equipment
and 3 to 30 years for ground property and equipment. Property under capital
leases and related obligations are recorded at an amount equal to the present
value of future minimum lease payments computed on the basis of the Company's
incremental borrowing rate or, when known, the interest rate implicit in the
lease. Amortization of property under capital leases is on a straight-line basis
over the lease term and is included in depreciation expense. The Company records
impairment losses on long-lived assets used in operations when events and
circumstances indicate that the assets might be impaired and the undiscounted
cash flows to be generated by those assets are less than the carrying amounts of
those assets.
30
32
AIRCRAFT AND ENGINE MAINTENANCE The cost of engine overhauls and routine
maintenance costs for aircraft and engines are charged to maintenance expense as
incurred. Scheduled airframe overhaul costs are capitalized and amortized over
the estimated period benefited, presently ten years. Modifications that
significantly enhance the operating performance or extend the useful lives of
aircraft or engines are capitalized and amortized over the remaining life of the
asset.
REVENUE RECOGNITION Passenger revenue is recognized when transportation is
provided. Tickets sold but not yet used are included in "Air traffic liability,"
which includes estimates that are evaluated and adjusted periodically. Any
adjustments resulting therefrom are included in results of operations for the
periods in which the evaluations are completed.
FREQUENT FLYER PROGRAM The Company accrues the estimated incremental cost of
providing free travel awards earned under its Rapid Rewards frequent flyer
program. The Company also sells flight segment credits to companies
participating in its Rapid Rewards frequent flyer program. The revenue from the
sale of flight segment credits is recognized when the credits are sold.
ADVERTISING The Company expenses the costs of advertising as incurred.
Advertising expense for the years ended December 31, 1997, 1996, and 1995 was
$112,961,000, $109,136,000, and $92,087,000, respectively.
STOCK-BASED EMPLOYEE COMPENSATION Pursuant to Statement of Financial Accounting
Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation, the
Company accounts for stock-based compensation plans utilizing the provisions of
Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued
to Employees and related Interpretations because, as discussed in Note 7, the
alternative fair value accounting provided for under SFAS 123 requires use of
option valuation models that were not developed for use in valuing employee
stock options.
EARNINGS PER SHARE In 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings per
Share. SFAS 128 replaced the calculation of primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of stock options.
Diluted earnings
31
33
per share is similar to the previously reported fully diluted earnings per
share. Earnings per share amounts for all periods have been restated and
presented to conform to the SFAS 128 requirements.
DERIVATIVE FINANCIAL INSTRUMENTS The Company utilizes purchased crude oil call
options and fixed price swap agreements to hedge a portion of its exposure to
fuel price fluctuations. At December 31, 1997, 1996, and 1995, and during the
years then ended, outstanding call options and swap agreements were immaterial.
The cost of purchased crude oil call options and gains and losses on fixed price
swap agreements are deferred and expensed to fuel expense in the same month that
the underlying fuel being hedged is used. Gains and losses resulting from
hedging positions terminated or settled early are recorded to fuel expense in
the month of termination or settlement. Gains and losses on hedging transactions
have not been material.
Any such agreements expose the Company to credit loss in the event of
nonperformance by the other parties to the agreements. The Company does not
anticipate such nonperformance.
The Company does not hold or issue any financial instruments for trading
purposes.
2. COMMITMENTS
The Company's contractual purchase commitments consist primarily of scheduled
aircraft acquisitions. Twenty-two 737-700 aircraft are scheduled for delivery in
1998, 25 in 1999, 23 in 2000, 21 in 2001, 21 in 2002, eight in 2003, and six in
2004. In addition, the Company has options to purchase up to 62 -700s during
2003-2006. The Company has the option, which must be exercised two years prior
to the contractual delivery date, to substitute 737-600s or 737-800s for the
- -700s scheduled subsequent to 1999. Aggregate funding needed for these
commitments is approximately $3,109.8 million, subject to adjustments for
inflation, due as follows: $565.7 million in 1998, $747.1 million in 1999,
$574.1 million in 2000, $510.1 million in 2001, $434.5 million in 2002, $172.8
million in 2003, and $105.5 million in 2004.
32
34
3. ACCRUED LIABILITIES
(IN THOUSANDS)
1997 1996
-------- --------
Aircraft rentals ............................. $123,669 $121,384
Employee profitsharing and savings plans
(Note 8) ................................... 92,857 61,286
Vacation pay ................................. 50,812 44,763
Other ........................................ 159,612 141,192
-------- --------
$426,950 $368,625
======== ========
4. LONG-TERM DEBT
(IN THOUSANDS)
1997 1996
-------- --------
9 1/4% Notes due 1998 ............... $100,000 $100,000
9.4% Notes due 2001 ................. 100,000 100,000
8 3/4% Notes due 2003 ............... 100,000 100,000
8% Notes due 2005.................... 100,000 100,000
7 7/8% Notes due 2007................ 100,000 100,000
7 3/8% Debentures due 2027........... 100,000 --
Capital leases (Note 5) ............. 152,324 165,610
Other ............................... -- 10
-------- --------
752,324 665,620
Less current maturities ............. 121,324 12,327
Less debt discount .................. 2,894 3,067
-------- --------
$628,106 $650,226
======== ========
On February 28, 1997, the Company issued $100 million of senior unsecured 7 3/8%
Debentures due March 1, 2027. Interest is payable semi-annually on March 1 and
September 1. The Debentures may be redeemed, at the option of the Company, in
whole at any time or in part from time to time, at a redemption price equal to
the greater of the principal amount of the Debentures plus accrued interest at
the date of redemption or the sum of the present values of the remaining
scheduled payments of principal and
33
35
interest thereon, discounted to the date of redemption at the comparable
treasury rate plus 20 basis points, plus accrued interest at the date of
redemption.
On March 7, 1995, the Company issued $100 million of senior unsecured 8% Notes
due March 1, 2005. Interest is payable semi-annually on March 1 and September 1.
The Notes are not redeemable prior to maturity.
On September 9, 1992, the Company issued $100 million of senior unsecured 7 7/8%
Notes due September 1, 2007. Interest is payable semi-annually on March 1 and
September 1. The Notes are not redeemable prior to maturity.
During 1991, the Company issued $100 million of senior unsecured 9 1/4% Notes,
$100 million of senior unsecured 9.4% Notes, and $100 million of senior
unsecured 8 3/4% Notes due February 15, 1998, July 1, 2001, and October 15,
2003, respectively. Interest on the Notes is payable semi-annually. The Notes
are not redeemable prior to maturity.
The fair values, based on quoted market prices, of these securities at December
31, 1997, were as follows (in thousands):
9 1/4% Notes due 1998 ............... $100,350
9.4% Notes due 2001 ................. 110,150
8 3/4% Notes due 2003 ............... 111,630
8% Notes due 2005 .................. 108,920
7 7/8% Notes due 2007................ 109,410
7 3/8% Debentures due 2027........... 105,660
In addition to the credit facilities described above, Southwest has an unsecured
Bank Credit Agreement with a group of banks that permits Southwest to borrow
through May 6, 2002, on a revolving credit basis, up to $475 million. Interest
rates on borrowings under the Credit Agreement can be, at the option of
Southwest, the greater of the agent bank's prime rate or the federal funds rate
plus .5 percent, .17 percent over LIBOR, or a fixed rate offered by the banks at
the time of borrowing. The commitment fee is .08 percent per annum. There were
no outstanding borrowings under this
34
36
agreement, or prior similar agreements, at December 31, 1997 or 1996.
5. LEASES
Total rental expense for operating leases charged to operations in 1997, 1996,
and 1995 was $297,158,000, $280,389,000, and $247,033,000, respectively. The
majority of the Company's terminal operations space, as well as 106 aircraft,
were under operating leases at December 31, 1997. The amounts applicable to
capital leases included in property and equipment were (in thousands):
1997 1996
-------- --------
Flight equipment ............................ $227,803 $226,677
Less accumulated amortization ............... 122,346 111,815
-------- --------
$105,457 $114,862
======== ========
Future minimum lease payments under capital leases and noncancelable operating
leases with initial or remaining terms in excess of one year at December 31,
1997, were (in thousands):
CAPITAL OPERATING
LEASES LEASES
-------- ----------
1998 ..................... $ 32,026 $ 234,828
1999 ..................... 20,245 227,679
2000 ..................... 16,871 224,302
2001 ..................... 17,391 209,862
2002 ..................... 17,561 196,410
After 2002 ..................... 137,799 2,147,915
-------- ----------
Total minimum lease payments ... 241,893 $3,240,996
==========
Less amount representing
interest .................... 89,569
--------
Present value of minimum
lease payments .............. 152,324
Less current portion ........... 21,324
--------
Long-term portion .............. $131,000
========
35
37
The aircraft leases generally can be renewed, at rates based on fair market
value at the end of the lease term, for one to five years. Most aircraft leases
have purchase options at or near the end of the lease term at fair market value,
but generally not to exceed a stated percentage of the lessor's defined cost of
the aircraft.
6. COMMON STOCK
The Company has one class of common stock. Holders of shares of common stock are
entitled to receive dividends when and if declared by the Board of Directors and
are entitled to one vote per share on all matters submitted to a vote of the
shareholders.
At December 31, 1997, the Company had common stock reserved for issuance
pursuant to Employee stock benefit plans (49,254,768 shares) and upon exercise
of rights (270,461,851 shares) pursuant to the Common Stock Rights Agreement, as
amended (Agreement).
Pursuant to the Agreement, each outstanding share of the Company's common stock
is accompanied by one common share purchase right (Right). Each Right entitles
its holder to purchase one share of common stock at an exercise price of $11.11
and is exercisable only in the event of a proposed takeover, as defined by the
Agreement. The Company may redeem the Rights at $.0074 per Right prior to the
time that 15 percent of the common stock has been acquired by a person or group.
If the Company is acquired, as defined in the Agreement, each Right will entitle
its holder to purchase for $11.11 that number of the acquiring company's or the
Company's common shares, as provided in the Agreement, having a market value of
two times the exercise price of the Right. The Rights will expire no later than
July 30, 2006.
On September 25, 1997, the Company's Board of Directors declared a three-for-two
stock split, distributing 73,577,983 shares on November 26, 1997. Unless
otherwise stated, all per share data presented in the accompanying consolidated
financial statements and notes thereto have been restated to give effect to the
stock split.
36
38
7. STOCK PLANS
At December 31, 1997, the Company had six stock-based compensation plans and
other stock options outstanding, which are described below. The Company applies
APB 25 and related Interpretations in accounting for its stock-based
compensation. Accordingly, no compensation expense is recognized for its fixed
option plans because the exercise prices of the Company's Employee stock options
equal or exceed the market prices of the underlying stock on the dates of the
grants. Compensation expense for other stock options is not material.
The Company has five fixed option plans. Under the 1991 Incentive Stock Option
Plan, the Company may grant options to key Employees for up to 13,500,000 shares
of common stock. Under the 1991 Non-Qualified Stock Option Plan, the Company may
grant options to key Employees and non-employee directors for up to 1,125,000
shares of common stock. All options granted under these plans have ten-year
terms and vest and become fully exercisable at the end of three, five, or ten
years of continued employment, depending upon the grant type.
Under the 1995 Southwest Airlines Pilots' Association Non-Qualified Stock Option
Plan (SWAPA Plan), the Company may grant options to Pilots for up to 27,000,000
shares of common stock. An initial grant of approximately 21,750,000 shares was
made on January 12, 1995, at an option price of $13.33 per share, which exceeded
the market price of the Company's stock on that date. Options granted under the
initial grant vest in ten annual increments of ten percent. On September 1 of
each year of the agreement beginning in 1996, additional options will be granted
to Pilots that become eligible during that year. Additional options granted on
September 1, 1997 and 1996, vest in seven annual increments of 14.3 percent and
eight annual increments of 12.5 percent, respectively. Options under all grants
must be exercised prior to January 31, 2007, or within a specified time upon
retirement or termination. In the event that the Southwest Airlines Pilots'
Association exercises its option to make the collective bargaining agreement
amendable on September 1, 1999, any unexercised options will be canceled on
December 1, 1999.
Under the 1996 Incentive Stock Option Plan, the Company may grant options to key
Employees for up to 9,000,000 shares of common stock. Under the 1996
Non-Qualified Stock Option Plan, the Company may grant options to key Employees
and non-employee
37
39
directors for up to 862,500 shares of common stock. All options
granted under these plans have ten-year terms and vest and become fully
exercisable at the end of three, five, or ten years of continued employment,
depending upon the grant type.
Under all fixed option plans, except the SWAPA Plan, the exercise price of each
option equals the market price of the Company's stock on the date of grant.
Under the SWAPA Plan, for additional options granted each September 1, the
exercise price will be equal to 105 percent of the fair value of such stock on
the date of the grant.
Information regarding the Company's five fixed stock option plans, as adjusted
for the three-for-two stock split on November 26, 1997, is summarized below:
38
40
INCENTIVE PLANS NON-QUALIFIED PLANS
--------------- -------------------
AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE
------- PRICE ------- PRICE
----- -----
Outstanding December 31, 1994.......... 7,217,943 $ 8.05 532,883 $ 9.07
Granted - Incentive Plans............ 1,474,821 12.53 -- --
Granted - SWAPA Plan................. -- -- 21,790,575 13.33
Granted - Other Non-Qualified
Plans............................ -- -- 139,973 12.51
Exercised............................ (412,587) 5.67 (90,765) 10.08
Surrendered.......................... (462,358) 8.47 (91,562) 13.07
---------- ----------
Outstanding December 31, 1995.......... 7,817,819 8.98 22,281,104 13.24
Granted - Incentive Plans............ 2,505,516 16.79 -- --
Granted - SWAPA Plan................. -- -- 699,300 15.88
Granted - Other Non-Qualified
Plans............................ -- -- 103,683 16.78
Exercised............................ (593,772) 6.85 (435,578) 11.93
Surrendered.......................... (375,669) 13.44 (142,477) 13.33
---------- ----------
Outstanding December 31, 1996.......... 9,353,894 11.03 22,506,032 13.36
Granted - Incentive Plans........... 2,455,158 14.51 -- --
Granted - SWAPA Plan................ -- -- 882,000 19.79
Granted - Other Non-Qualified
Plans............................ -- -- 145,406 14.51
Exercised........................... (1,151,926) 9.04 (1,771,831) 13.27
Surrendered......................... (670,013) 14.58 (99,212) 13.59
---------- ----------
Outstanding December 31, 1997.......... 9,987,113 $11.87 21,662,395 $13.63
========== ==========
Exercisable December 31, 1997.......... 2,081,222 7,132,653
Available for granting in future
periods................................ 9,244,087 4,853,562
39
41
The following table summarizes information about stock options outstanding under
the five fixed option plans at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE
- --------------- ----------- ---- ----- ----------- -----
$ 4.01 to $ 5.21 3,084,861 3.04 yrs. $ 4.09 993,711 $ 4.25
$ 7.56 to $ 8.04 415,464 4.03 7.97 92,589 7.83
$11.25 to $16.79 26,244,958 8.81 13.73 7,621,620 13.54
$17.29 to $24.96 1,904,225 7.55 19.82 505,955 21.85
---------- ---------
$ 4.01 to $24.96 31,649,508 8.11 yrs. $13.08 9,213,875 $ 12.93
========== =========
The Company has granted options to purchase the Company's common stock related
to employment contracts with the Company's president and chief executive
officer. Depending upon the grant, these options have terms of ten years from
the date of grant or ten years from the date exercisable and vest and become
fully exercisable over three or four years. No options were granted in 1997 or
1995. In 1996, the Company granted 217,000 options with an exercise price of
$1.00 per share and 750,000 options with an exercise price of $15.67 per share
related to the 1996 employment agreement. At December 31, 1997, 1996, and 1995,
total options of 2,611,000, 2,847,000, and 2,133,000 were outstanding,
respectively. At December 31, 1997, total options of 2,031,000 were exercisable
at exercise prices ranging from $1.00 to $15.67 per share. Options for 236,000,
253,000, and 101,000 shares were exercised in 1997, 1996, and 1995,
respectively.
Under the 1991 Employee Stock Purchase Plan (ESPP), at December 31, 1997, the
Company is authorized to issue up to a balance of 871,000 shares of common stock
to Employees of the Company at a price equal to 90 percent of the market value
at the end of each purchase period. Common stock purchases are paid for through
periodic payroll deductions. Participants under the plan received 440,000 shares
in 1997, 464,000 shares in 1996, and 583,000 shares in 1995 at average prices of
$16.00, $15.37, and $12.79, respectively.
40
42
Pro forma information regarding net income and net income per share is required
by SFAS 123 and has been determined as if the Company had accounted for its
Employee stock-based compensation plans and other stock options under the fair
value method of SFAS 123. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions used for grants under the fixed option
plans in 1997, 1996, and 1995, respectively: dividend yield of .22 percent, .16
percent, and .21 percent; expected volatility of 38.23 percent, 35.37 percent,
and 36.85 percent; risk-free interest rate of 5.80 percent, 5.89 percent, and
7.79 percent; and expected lives of 5.0 years for all periods. Assumptions for
the stock options granted in 1996 to the Company's president and chief executive
officer were the same as for the fixed option plans except for the
weighted-average expected lives of 8.0 years.
The weighted-average fair value of options granted under the five fixed option
plans during 1997, 1996, and 1995 was $6.12, $6.78, and $5.61, respectively, for
the incentive plans; $7.67, $6.16, and $5.31, respectively, for the SWAPA Plan;
and $6.12, $6.78, and $5.61, respectively, for other non-qualified plans. The
weighted-average fair value of options granted in 1996 to the Company's
president and chief executive officer relative to an employment contract was
$9.32. No such options were granted in 1997 or 1995. The weighted-average fair
value of each purchase right under the ESPP granted in 1997, 1996, and 1995,
which is equal to the ten percent discount from the market value of the common
stock at the end of each purchase period, was $1.78, $1.71, and $1.43,
respectively.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including expected stock price volatility. Because the
Company's Employee stock options have characteristics significantly different
from those of traded options and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its Employee stock options.
For purposes of pro forma disclosures, the estimated fair value of stock-based
compensation plans and other options is amortized
41
43
to expense primarily over the vesting period. The Company's pro forma net income
and net income per share is as follows (in thousands except per share amounts):
1997 1996 1995
---- ---- ----
NET INCOME: As reported $317,772 $207,337 $182,626
Pro forma $306,553 $196,478 $167,907
NET INCOME PER SHARE, BASIC: As reported $ 1.45 $ .95 $ .85
Pro forma $ 1.40 $ .90 $ .78
NET INCOME PER SHARE, DILUTED: As reported $ 1.40 $ .92 $ .82
Pro forma $ 1.34 $ .89 $ .76
As required, the pro forma disclosures above include only 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.
8. EMPLOYEE PROFITSHARING AND SAVINGS PLANS
Substantially all of Southwest's Employees are members of the Southwest Airlines
Co. Profitsharing Plan. Total profitsharing expense charged to operations in
1997, 1996, and 1995 was $91,256,000, $59,927,000, and $54,033,000,
respectively.
The Company sponsors Employee savings plans under Section 401(k) of the Internal
Revenue Code. The plans cover substantially all full-time Employees. The amount
of matching contributions varies by Employee group. Company contributions
generally vest over five years with credit for prior years' service granted.
Company matching contributions expensed in 1997, 1996, and 1995 were
$39,744,000, $35,125,000, and $28,954,000, respectively.
9. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The components of
deferred tax assets
42
44
and liabilities at December 31, 1997 and 1996 are as follows (in thousands):
1997 1996
-------- --------
DEFERRED TAX LIABILITIES:
Accelerated depreciation............... $543,547 $467,372
Scheduled airframe maintenance......... 33,202 30,984
Other.................................. 83,607 78,195
-------- --------
Total deferred tax liabilities...... 660,356 576,551
DEFERRED TAX ASSETS:
Deferred gains from sale and
leaseback of aircraft............... 112,659 114,514
Capital and operating leases........... 61,747 58,252
Alternative minimum tax credit
carryforward....................... -- 6,019
Other.................................. 65,812 59,339
-------- --------
Total deferred tax assets .......... 240,218 238,124
-------- --------
Net deferred tax liability ......... $420,138 $338,427
======== ========
The provision for income taxes is composed of the following (in thousands):
1997 1996 1995
-------- -------- --------
CURRENT:
Federal ............... $102,938 $ 59,101 $ 64,420
State ................. 14,535 7,671 9,947
-------- -------- --------
Total current ...... 117,473 66,772 74,367
DEFERRED:
Federal ............... 75,990 60,967 44,580
State ................. 5,721 6,286 3,567
-------- -------- --------
Total deferred ..... 81,711 67,253 48,147
-------- -------- --------
$199,184 $134,025 $122,514
======== ======== ========
Southwest has received examination reports from the Internal Revenue Service
(IRS) proposing certain adjustments to Southwest's income tax returns for 1989
through 1991. The adjustments relate to aircraft maintenance costs incurred by
Southwest, as well as
43
45
other members of the aviation industry, during that time period. Southwest
intends to vigorously protest the adjustments proposed, with which it does not
agree. The industry's difference with the IRS involves complex issues of law and
fact that are likely to take a substantial period of time to resolve. Management
believes that final resolution of such protest will not have a materially
adverse effect upon the results of operations of Southwest.
The effective tax rate on income before income taxes differed from the federal
income tax statutory rate for the following reasons (in thousands):
1997 1996 1995
--------- --------- ---------
Tax at statutory
U.S. tax rates ........ $ 180,935 $ 119,477 $ 106,799
Nondeductible items ..... 5,893 5,168 4,488
State income taxes,
net of federal
benefit ............... 13,166 9,072 8,784
Other, net .............. (810) 308 2,443
--------- --------- ---------
Total income tax
provision ........... $ 199,184 $ 134,025 $ 122,514
========= ========= =========
10. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (in thousands except per share amounts):
1997 1996 1995
-------- -------- --------
NUMERATOR:
Net income, available to common
stockholders-numerator for basic
and diluted earnings per share $317,772 $207,337 $182,626
======== ======== ========
DENOMINATOR:
Weighted-average shares
outstanding, basic 219,088 217,118 215,517
Dilutive effect of Employee stock
options 8,371 7,873 6,247
-------- -------- --------
Adjusted weighted-average shares
outstanding, diluted 227,459 224,991 221,764
======== ======== ========
NET INCOME PER SHARE:
Basic $ 1.45 $ .95 $ .85
======== ======== ========
Diluted $ 1.40 $ .92 $ .82
======== ======== ========
44
46
QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
------------------
1997 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ---- -------- -------- -------- --------
Operating revenues ................ $887,095 $956,892 $997,241 $975,593
Operating income .................. 87,203 156,407 151,770 128,856
Income before income taxes ........ 83,401 153,823 150,387 129,345
Net income ........................ 50,874 93,832 92,511 80,555
Net income per share, basic ....... .23 .43 .42 .36
Net income per share, diluted ..... .23 .42 .41 .35
1996 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ---- -------- -------- -------- --------
Operating revenues ................ $772,529 $910,308 $891,492 $831,841
Operating income .................. 57,393 142,206 102,934 48,302
Income before income taxes ........ 54,771 139,989 100,243 46,359
Net income ........................ 33,000 85,316 60,858 28,163
Net income per share, basic ....... .15 .39 .28 .13
Net income per share, diluted ..... .15 .38 .27 .13
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None to be reported.
45
47
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See "Election of Directors" incorporated herein by reference, from pages
1-4 of the definitive Proxy Statement for Southwest's Annual Meeting of
Shareholders to be held May 21, 1998. See "Executive Officers of the Registrant"
in Part I following Item 4 for information relating to executive officers.
ITEM 11. EXECUTIVE COMPENSATION
See "Compensation of Executive Officers," incorporated herein by reference,
from pages 6-9 of the definitive Proxy Statement for Southwest's Annual Meeting
of Shareholders to be held May 21, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
See "Voting Securities and Principal Shareholders," incorporated herein by
reference, from pages 4-5 of the definitive Proxy Statement for Southwest's
Annual Meeting of Shareholders to be held May 21, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See "Election of Directors" incorporated herein by reference, from pages
1-4 of the definitive Proxy Statement for Southwest's Annual Meeting of
Shareholders to be held May 21, 1998.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
The financial statements included in Item 8 above are filed as part of
this annual report.
2. Financial Statement Schedules:
There are no financial statement schedules filed as part of this annual
report, since the required information is included in the consolidated
financial statements, including the notes thereto, or the circumstances
requiring inclusion of such schedules are not present.
3. Exhibits:
3.1 Restated Articles of Incorporation of Southwest (incorporated by
reference to Exhibit 4.1 to Southwest's Registration Statement
on Form S-3 (File No. 33-52155)); Amendment to Restated Article
of Incorporation of Southwest (incorporated by reference to
Exhibit 4.1 to Southwest's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1996 (File No. 1-7259).
3.2 Bylaws of Southwest, as amended through February 1994
(incorporated by reference to Exhibit 3.2 to Southwest's Annual
Report on Form 10-K for the year ended December 31, 1993 (File
No. 1-7259)).
4.1 Restated Credit Agreement dated May 6, 1997, between Southwest
and Bank of America National Trust and Savings Association, and
the other banks named therein, and such banks.
46
48
4.2 Specimen certificate representing Common Stock of Southwest
(incorporated by reference to Exhibit 4.2 to Southwest's Annual
Report on Form 10-K for the year ended December 31, 1994 (File
No. 1-7259)).
4.3 Indenture dated as of December 1, 1985 between Southwest and
MBank Dallas, N.A., Trustee, relating to an unlimited amount of
Debt Securities (incorporated by reference to Exhibit 4.1 of
Southwest's Current Report on Form 8-K dated February 26, 1986
(File No. 1-7259)) and First Supplemental Indenture dated as of
January 21, 1988, substituting MTrust Corp, National
Association, as Trustee, thereunder (incorporated by reference
to Exhibit 4.3 on Southwest's Annual Report on Form 10-K for the
year ended December 31, 1987 (File 1-7259)).
4.4 Amended and Restated Rights Agreement dated July 18, 1996
between Southwest and Continental Stock Transfer & Trust
Company, as Rights Agent (incorporated by reference to Exhibit
1, Southwest's Registration Statement on Form 8-A/A dated August
12, 1996 (File No. 1-7259)).
4.5 Indenture dated as of June 20, 1991 between Southwest Airlines
Co. and Bank of New York, successor to NationsBank of Texas,
N.A. (formerly NCNB Texas National Bank), Trustee (incorporated
by reference to Exhibit 4.1 to Southwest's Current Report on
Form 8-K dated June 24, 1991 (File No. 1-7259)).
4.6 Indenture dated as of February 25, 1997 between the Company and
U.S. Trust Company of Texas, N.A. (incorporated by reference to
Exhibit 4.1 to Southwest's Annual Report on Form 10-K for the
year ended December 31, 1996 (File No. 1-7259)).
Southwest is not filing any other instruments evidencing any
indebtedness because the total amount of securities authorized
under any single such instrument does not exceed 10% of its
total consolidated assets. Copies of such instruments will be
furnished to the Securities and Exchange Commission upon
request.
10.1 General Terms Agreement between CFM International, Inc. and
Southwest (with all amendments through March 29, 1990) dated May
28, 1981 (incorporated by reference to Exhibit 10.2 on
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1989 (File No. 1-7259)); Amendments from November
6, 1989 through March 29, 1993 (incorporated by reference to
Exhibit 10.2 on Southwest's Annual Report on Form 10-K for the
year ended December 31, 1992 (File No. 1-7259)); Amendments from
March 29, 1993 through March 29, 1994 (incorporated by reference
to Exhibit 10.2 to Southwest's Annual Report on Form 10-K for
the year ended December 31, 1993 (File No. 1-7259)); Amendment
No. 7 and Letter Agreement No. 11, each dated as of January 19,
1994 (incorporated by reference to Exhibit 10.2 to Southwest's
Annual Report on Form 10-K for the year ended December 31, 1993
(File No. 1-7259)).
10.2 Purchase Agreement No. 1810, dated January 19, 1994 between The
Boeing Company and Southwest (incorporated by reference to
Exhibit 10.4 to Southwest's Annual Report on Form 10-K for the
year ended December 31, 1993 (File No. 1-7259)); Supplemental
Agreement No. 1. (incorporated by reference to Exhibit 10.3 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1996 (File No. 1-7259)).; Supplemental Agreements
No. 2, 3 and 4.
47
49
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.
The following exhibits filed under paragraph 10 of Item 601 are
the Company's compensation plans and arrangements.
10.3 Form of Executive Employment Agreement between Southwest and
certain key employees pursuant to Executive Service Recognition
Plan (incorporated by reference to Exhibit 28 to Southwest
Quarterly Report on Form 10-Q for the quarter ended June 30,
1987 (File No. 1-7259)).
10.4 1992 stock option agreements between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10.8 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1991 (File No. 1-7259)).
10.5 1987 stock option agreement between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10.11 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1987 (File No. 1-7259)).
10.6 1996 employment contract between Southwest and Herbert D.
Kelleher and related stock option agreements (incorporated by
reference to Exhibit 10.8 to Southwest's Annual Report on Form
10-K for the year ended December 31, 1996 (File No. 1-7259)).
10.7 1991 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
33-40652)).
10.8 1991 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 4.2 to Registration Statement on Form S-8 (File No.
33-40652)).
10.9 1991 Employee Stock Purchase Plan as amended May 20, 1992
(incorporated by reference to Exhibit 10.13 to Southwest's
Annual Report on Form 10-K for the year ended December 31, 1992
(File No. 1-7259)).
10.10 Southwest Airlines Co. Profit Sharing Plan (incorporated by
reference to Exhibit 10.13 to Southwest's Annual Report on Form
10-K for the year ended December 31, 1991 (File No. 1-7259)).
10.11 Southwest Airlines Co. 401(k) Plan (incorporated by reference to
Exhibit 10.14 to Southwest's Annual Report on Form 10-K for the
year ended December 31, 1991 (File No. 1-7259)).
10.12 Southwest Airlines Co. 1995 SWAPA Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 10.14 to Southwest's
Annual Report on Form 10-K for the year ended December 31, 1994
(File No. 1-7259)).
10.13 1996 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
333-20275)).
10.14 1996 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 4.2 to Registration Statement on Form S-8 (File No.
333-20275)).
22 Subsidiaries of Southwest.
48
50
23 Consent of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule.
A copy of each exhibit may be obtained at a price of 15 cents per page,
$10.00 minimum order, by writing to: Director of Investor Relations, Southwest
Airlines Co., P.O. Box 36611, Dallas, Texas 75235-1611.
(b) There were no Form 8-K's filed during the fourth quarter of 1997.
49
51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
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.
March 19, 1998
By /s/ Gary C. Kelly
--------------------------------------
Gary C. Kelly
Vice President-Finance,
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on March 19, 1998 on
behalf of the registrant and in the capacities indicated.
Signature Capacity
--------- --------
/s/ Herbert D. Kelleher Chairman of the Board of Directors,
- ----------------------------- President and Chief Executive Officer
Herbert D. Kelleher
/s/ Gary C. Kelly Vice President-Finance
- ----------------------------- (Chief Financial and Accounting Officer)
Gary C. Kelly
/s/ Samuel E. Barshop Director
- -----------------------------
Samuel E. Barshop
/s/ Gene H. Bishop Director
- -----------------------------
Gene H. Bishop
/s/ C. Webb Crockett Director
- -----------------------------
C. Webb Crockett
/s/ William P. Hobby, Jr. Director
- -----------------------------
William P. Hobby, Jr.
/s/ Travis C. Johnson Director
- -----------------------------
Travis C. Johnson
/s/ R.W. King Director
- -----------------------------
R. W. King
/s/ Walter M. Mischer, Sr. Director
- -----------------------------
Walter M. Mischer, Sr.
/s/ June M. Morris Director
- -----------------------------
June M. Morris
50
52
INDEX TO EXHIBITS
3.1 Restated Articles of Incorporation of Southwest (incorporated by
reference to Exhibit 4.1 to Southwest's Registration Statement
on Form S-3 (File No. 33-52155)); Amendment to Restated Article
of Incorporation of Southwest (incorporated by reference to
Exhibit 4.1 to Southwest's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1996 (File No. 1-7259).
3.2 Bylaws of Southwest, as amended through February 1994
(incorporated by reference to Exhibit 3.2 to Southwest's Annual
Report on Form 10-K for the year ended December 31, 1993 (File
No. 1-7259)).
4.1 Restated Credit Agreement dated May 6, 1997, between Southwest
and Bank of America National Trust and Savings Association, and
the other banks named therein, and such banks.
4.2 Specimen certificate representing Common Stock of Southwest
(incorporated by reference to Exhibit 4.2 to Southwest's Annual
Report on Form 10-K for the year ended December 31, 1994 (File
No. 1-7259)).
4.3 Indenture dated as of December 1, 1985 between Southwest and
MBank Dallas, N.A., Trustee, relating to an unlimited amount of
Debt Securities (incorporated by reference to Exhibit 4.1 of
Southwest's Current Report on Form 8-K dated February 26, 1986
(File No. 1-7259)) and First Supplemental Indenture dated as of
January 21, 1988, substituting MTrust Corp, National
Association, as Trustee, thereunder (incorporated by reference
to Exhibit 4.3 on Southwest's Annual Report on Form 10-K for the
year ended December 31, 1987 (File 1-7259)).
4.4 Amended and Restated Rights Agreement dated July 18, 1996
between Southwest and Continental Stock Transfer & Trust
Company, as Rights Agent (incorporated by reference to Exhibit
1, Southwest's Registration Statement on Form 8-A/A dated August
12, 1996 (File No. 1-7259)).
4.5 Indenture dated as of June 20, 1991 between Southwest Airlines
Co. and Bank of New York, successor to NationsBank of Texas,
N.A. (formerly NCNB Texas National Bank), Trustee (incorporated
by reference to Exhibit 4.1 to Southwest's Current Report on
Form 8-K dated June 24, 1991 (File No. 1-7259)).
4.6 Indenture dated as of February 25, 1997 between the Company and
U.S. Trust Company of Texas, N.A. (incorporated by reference to
Exhibit 4.1 to Southwest's Annual Report on Form 10-K for the
year ended December 31, 1996 (File No. 1-7259)).
Southwest is not filing any other instruments evidencing any
indebtedness because the total amount of securities authorized
under any single such instrument does not exceed 10% of its
total consolidated assets. Copies of such instruments will be
furnished to the Securities and Exchange Commission upon
request.
10.1 General Terms Agreement between CFM International, Inc. and
Southwest (with all amendments through March 29, 1990) dated May
28, 1981 (incorporated by reference to Exhibit 10.2 on
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1989 (File No. 1-7259)); Amendments from November
6, 1989 through March 29,
E-1
53
1993 (incorporated by reference to Exhibit 10.2 on Southwest's
Annual Report on Form 10-K for the year ended December 31, 1992
(File No. 1-7259)); Amendments from March 29, 1993 through March
29, 1994 (incorporated by reference to Exhibit 10.2 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1993 (File No. 1-7259)); Amendment No. 7 and Letter
Agreement No. 11, each dated as of January 19, 1994
(incorporated by reference to Exhibit 10.2 to Southwest's Annual
Report on Form 10-K for the year ended December 31, 1993 (File
No. 1-7259)).
10.2 Purchase Agreement No. 1810, dated January 19, 1994 between The
Boeing Company and Southwest (incorporated by reference to
Exhibit 10.4 to Southwest's Annual Report on Form 10-K for the
year ended December 31, 1993 (File No. 1-7259)); Supplemental
Agreement No. 1. (incorporated by reference to Exhibit 10.3 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1996 (File No. 1-7259)).; Supplemental Agreements
No. 2, 3 and 4.
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.
The following exhibits filed under paragraph 10 of Item 601 are
the Company's compensation plans and arrangements.
10.3 Form of Executive Employment Agreement between Southwest and
certain key employees pursuant to Executive Service Recognition
Plan (incorporated by reference to Exhibit 28 to Southwest
Quarterly Report on Form 10-Q for the quarter ended June 30,
1987 (File No. 1-7259)).
10.4 1992 stock option agreements between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10.8 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1991 (File No. 1-7259)).
10.5 1987 stock option agreement between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10.11 to
Southwest's Annual Report on Form 10-K for the year ended
December 31, 1987 (File No. 1-7259)).
10.6 1996 employment contract between Southwest and Herbert D.
Kelleher and related stock option agreements (incorporated by
reference to Exhibit 10.8 to Southwest's Annual Report on Form
10-K for the year ended December 31, 1996 (File No. 1-7259)).
10.7 1991 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
33-40652)).
10.8 1991 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 4.2 to Registration Statement on Form S-8 (File No.
33-40652)).
10.9 1991 Employee Stock Purchase Plan as amended May 20, 1992
(incorporated by reference to Exhibit 10.13 to Southwest's
Annual Report on Form 10-K for the year ended December 31, 1992
(File No. 1-7259)).
10.10 Southwest Airlines Co. Profit Sharing Plan (incorporated by
reference to Exhibit 10.13 to Southwest's Annual Report on Form
10-K for the year ended December 31, 1991 (File No. 1-7259)).
E-2
54
10.11 Southwest Airlines Co. 401(k) Plan (incorporated by reference to
Exhibit 10.14 to Southwest's Annual Report on Form 10-K for the
year ended December 31, 1991 (File No. 1-7259)).
10.12 Southwest Airlines Co. 1995 SWAPA Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 10.14 to Southwest's
Annual Report on Form 10-K for the year ended December 31, 1994
(File No. 1-7259)).
10.13 1996 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
333-20275)).
10.14 1996 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 4.2 to Registration Statement on Form S-8 (File No.
333-20275)).
22 Subsidiaries of Southwest.
23 Consent of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule.
A copy of each exhibit may be obtained at a price of 15 cents per page,
$10.00 minimum order, by writing to: Director of Investor Relations, Southwest
Airlines Co., P.O. Box 36611, Dallas, Texas 75235-1611.
E-3