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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, 1998 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
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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 1, 1999:
$9,947,471,987
Number of shares of Common Stock outstanding as of the close of
business on March 1, 1999:
334,405,787 shares
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for Annual Meeting of
Shareholders, May 20, 1999: PART III
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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 1998, Southwest operated 280 Boeing 737 aircraft and
provided service to 53 airports in 52 cities in 26 states throughout the United
States. Southwest commenced service to Manchester, New Hampshire in June 1998,
and will commence service to Islip, New York in March 1999 and Raleigh-Durham,
North Carolina in June, 1999.
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 splits) 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 for
scheduled carrier service over the past five years was as follows:
1994 $.54
1995 $.55
1996 $.65
1997 $.62
1998 $.46
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.
Historically, the Company's principal hedging program utilizes the
purchase of crude oil call options at a nominal premium and at volumes of up to
30% of its quarterly fuel requirements. However, in order to provide greater
protection against increasing fuel costs during this time of exceedingly low
fuel prices, the Company has significantly increased its hedging activities. As
of January 1999, the Company had outstanding fixed price swap agreements for
hedging fuel prices on 77 percent and 74 percent of its fuel needs in first and
second quarter 1999, respectively. For more discussion of current fuel costs,
the impact of these costs on the Company's operations, and the effect of hedging
transactions, see Management's Discussion and Analysis of Financial Condition
and Results of Operations.
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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 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. 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 other seven aforementioned 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. 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, 1998, consisted of 23 Stage 2
aircraft and 257 Stage 3 aircraft, yielding a Stage 3 percentage of over 90
percent. As of December 31, 1998, of the 23 Stage 2 aircraft operated by the
Company, 12 are leased from third parties and 11 are owned by the Company. Based
upon the Company's current schedule for delivery of new Stage 3 aircraft,
including options, and the Company's
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planned retirement schedule for Stage 2 aircraft, assuming no hushkitting, the
Company will exceed the 85 percent compliance requirement by July 1, 1999;
however, the Company currently intends to hushkit at least 17 additional
aircraft. The Company plans to achieve 100 percent compliance by December 31,
1999.
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 San
Diego, Burbank, 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
1998 was 441 miles with an average duration of approximately one hour. At
yearend, Southwest served approximately 245 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 75 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, Manchester, 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 airlines, nor have any commuter feeder relationships.
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 January 1995, Southwest was the first major airline to introduce a
Ticketless travel option, 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 computer
reservation system 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
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the Internet's World Wide Web at http://www.southwest.com. At December 31, 1998,
approximately 70% 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 Customers can also receive flight
credits by using the services of non-airline partners, which include credit card
partners, a telephone company, car rental agencies, and the Southwest Airlines
Visa card. 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.
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 927,000, 782,000, and 494,000, during 1998, 1997, and 1996,
respectively. The amount of free travel award usage as a percentage of total
Southwest revenue passengers carried was 3.5 percent in 1998, 3.1 percent in
1997, and 2.0 percent in 1996.
The Company accounts for free travel awards using the incremental cost
method, regardless of the source of the credit (such as credit for flights or
use of business partner services), 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
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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, 1998 and 1997 was not material.
The number of Award Tickets for Southwest outstanding at December 31,
1998 and 1997 was approximately 688,000 and 485,000, 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 50-60 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, 1998 and 1997 was approximately 21,000 and 20,000, respectively. The Company
currently estimates that three to four trips will be redeemed per outstanding
Companion Pass.
EMPLOYEES
At December 31, 1998, Southwest had 25,844 active employees, consisting
of 7,898 flight, 1,163 maintenance, 13,719 ground customer service and 3,064
management, accounting, marketing, and clerical personnel.
Southwest has ten collective bargaining agreements covering
approximately 83 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 becomes
amendable in November 2002. Flight attendants are subject to an agreement with
the Transportation Workers Union of America, AFL-CIO ("TWU"), which becomes
amendable in May 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 2004 (described below). Flight dispatchers are
represented by the Southwest Airlines Employees Association, pursuant to an
agreement which will become amendable in November 2009. Aircraft cleaners and
stock clerks, mechanics, and flight simulator technicians are represented by the
International Brotherhood of Teamsters pursuant to separate agreements which
become amendable in August 2000, August 2000, August 2001, and October 2000,
respectively. The flight/ground school instructors and flight crew training
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 agreement,
effective through August 2004, subject to a right by the pilots to terminate the
agreement as of August 1999. After a vote of its membership, in September 1998
SWAPA notified the Company that it would not exercise its right to terminate the
agreement early, and the parties have executed a side letter providing that the
agreement will remain in effect through August 2004. Pilots have received no
wage increases (other than seniority and upgrade increases) in the first five
years of the agreement, and pursuant to the agreement and side letter will
receive three percent wage increases in each of the last five years of the
agreement. Initially, the pilots received options to purchase approximately 32.8
million shares of Southwest common stock at $8.89 per share (adjusted for stock
splits) over the term of the contract. The exercise price reflected a premium of
approximately five percent over the fair market value of the stock on the date
of the grant. Pilots hired subsequently receive additional grants at a five per
cent premium over the then current fair market value. Up to 40,500,000 shares
ultimately can be issued under the pilot stock option plan.
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ITEM 2. PROPERTIES
AIRCRAFT
Southwest operated a total of 280 Boeing 737 aircraft as of December 31,
1998, of which 99 and 13 were under operating and capital leases, respectively.
The remaining 168 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. At
December 31, 1998, Southwest had 25 737-700 aircraft in service.
In total, at December 31, 1998, the Company had 105 firm orders to
purchase Boeing 737 Aircraft as follows:
Type Seats 1999 2000 2001 2002 2003 2004
---- ----- ---- ---- ---- ---- ---- ----
737-700 137 32 21 21 21 5 5
The Company also has 62 options for deliveries in 2003 through 2006. The
Company has also contracted to purchase two used Boeing 737-300 aircraft for
delivery in the second quarter 1999.
The average age of the Company's fleet at December 31, 1998 was 8.4 years.
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, 1998, 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.
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 inspections 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
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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.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of Southwest, their positions, and their respective
ages (as of March 1, 1999) are as follows:
EXECUTIVE
OFFICER
CONTINUOUSLY
NAME POSITION AGE SINCE
---- -------- --- ------------
Herbert D. Kelleher Chairman of the Board, President, 67 1967
and Chief Executive Officer
Colleen C. Barrett Executive Vice President-Customers 54 1978
and Corporate Secretary
John G. Denison Executive Vice President- 54 1986
Corporate Services
James C. Wimberly Executive Vice President, 46 1985
Chief Operations Officer
Gary C. Kelly Vice President-Finance, 43 1986
Chief Financial Officer
James F. Parker Vice President-General Counsel 52 1986
Ron Ricks Vice President-Governmental Affairs 49 1986
Dave Ridley Vice President-Ground Operations 46 1998
Joyce C. Rogge Vice President - Marketing 41 1997
Elizabeth P. Sartain Vice President - People 44 1999
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
June Morris, a Director of the Company, filed a Form 4 reporting
transactions pursuant to one sell order in a report due five months earlier and
transactions pursuant to one sell order in a report one month late.
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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, as adjusted for the November 1997 and August 1998 three-for-two stock
splits, were:
PERIOD DIVIDEND HIGH LOW
------ -------- ---- ---
1998
1st Quarter $.00667 $21.42 $15.33
2nd Quarter .00667 20.71 16.83
3rd Quarter .00750 23.38 17.19
4th Quarter .00750 23.75 15.31
1997
1st Quarter $.00513 $11.11 $9.45
2nd Quarter .00513 12.45 9.55
3rd Quarter .00513 14.75 11.55
4th Quarter .00667 17.50 12.55
As of March 1, 1999, there were 9,741 holders of record of the
Company's common stock.
RECENT SALES OF UNREGISTERED SECURITIES
During 1998, 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
-------------------------- -------------- ----------------
151,875 $1.00 1/9/98
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.
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ITEM 6. SELECTED FINANCIAL DATA
The following financial information for the five years ended December
31, 1998 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.
YEARS ENDED DECEMBER 31,(1)
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1998 1997 1996 1995 1994
---- ---- ---- ---- ----
FINANCIAL DATA:
(in thousands except per share amounts)
Operating revenues ..................... $ 4,163,980 $ 3,816,821 $ 3,406,170 $ 2,872,751 $ 2,591,933
Operating expenses ..................... 3,480,369 3,292,585 3,055,335 2,559,220 2,275,224
----------- ----------- ----------- ----------- -----------
Operating income ....................... 683,611 524,236 350,835 313,531 316,709
Other expenses, net .................... (21,501) 7,280 9,473 8,391 17,186
----------- ----------- ----------- ----------- -----------
Income before income taxes ............. 705,112 516,956 341,362 305,140 299,523
Provision for income taxes ............. 271,681 199,184 134,025 122,514 120,192
----------- ----------- ----------- ----------- -----------
Net income ............................. $ 433,431 $ 317,772 $ 207,337 $ 182,626 $ 179,331
=========== =========== =========== =========== ===========
Net income per share, basic(1) ......... $ 1.30 $ .97 $ .64 $ .56 $ .56
Net income per share, diluted(1) ....... $ 1.23 $ .93 $ .61 $ .55 $ .54
Cash dividends per common share(1) ..... $ .02834 $ .02206 $ .01955 $ .01778 $ .01778
Total assets at period-end ............. $ 4,715,996 $ 4,246,160 $ 3,723,479 $ 3,256,122 $ 2,823,071
Long-term obligations at period-end .... $ 623,309 $ 628,106 $ 650,226 $ 661,010 $ 583,071
Stockholders' equity at period-end ..... $ 2,397,918 $ 2,009,018 $ 1,648,312 $ 1,427,318 $ 1,238,706
OPERATING DATA:
Revenue passengers carried ............. 52,586,400 50,399,960 49,621,504 44,785,573 42,742,602(3)
Revenue passenger miles (RPMs) (000s) .. 31,419,110 28,355,169 27,083,483 23,327,804 21,611,266
Available seat miles (ASMs) (000s) ..... 47,543,515 44,487,496 40,727,495 36,180,001 32,123,974
Load factor ............................ 66.1% 63.7% 66.5% 64.5% 67.3%
Average length of passenger haul (miles) 597 563 546 521 506
Trips flown ............................ 806,822 786,288 748,634 685,524 624,476
Average passenger fare ................. $ 75.38 $ 72.21 $ 65.88 $ 61.64 $ 58.44
Passenger revenue yield per RPM ........ 12.62(cent) 12.84(cent) 12.07(cent) 11.83(cent) 11.56(cent)
Operating revenue yield per ASM ........ 8.76(cent) 8.58(cent) 8.36(cent) 7.94(cent) 8.07(cent)
Operating expenses per ASM ............. 7.32(cent) 7.40(cent) 7.50(cent) 7.07(cent) 7.08(cent)
Fuel cost per gallon (average) ......... 45.67(cent) 62.46(cent) 65.47(cent) 55.22(cent) 53.92(cent)
Number of employees at year-end ........ 25,844 23,974 22,944 19,933 16,818
Size of fleet at year-end (2) .......... 280 261 243 224 199
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(1) On July 22, 1998 the Company's Board of Directors declared a three for
two stock split on the Company's Common Stock, distributed on August
20, 1998. 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, as well as prior stock splits previously disclosed.
(2) Includes leased aircraft.
(3) Includes certain estimates for Morris.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
YEAR IN REVIEW
In 1998, Southwest posted a record annual profit for the seventh consecutive
year and a profit for the 26th consecutive year. The Company also posted record
operating revenues; record operating income; the highest net profit margin since
1981 of 10.4 percent; and the highest operating profit margin since 1981 of 16.4
percent. The Company experienced strong revenue growth, low unit costs, and
continued strong demand for our product.
At the end of 1998, Southwest served 52 cities in 26 states. We added service to
Manchester, New Hampshire, in June 1998 and have been very pleased with the
results. We have plans to add new service to Islip, New York, on Long Island in
March 1999 and will begin serving at least one other new city in 1999. With the
net addition of at least 28 aircraft in 1999 (32 new Boeing 737-700s, two used
- -300s, and the retirement of six older -200s), we will also continue to add
additional flights to cities we already serve. We are actively pursuing the
acquisition of additional used 737-300s that would add to our 1999 expansion
efforts.
During 1998, Boeing experienced production delays related to the 737 production
line. These production delays, for the most part, have been remedied by Boeing
and we currently do not anticipate any significant delays in 1999.
Also during 1998, the Company's Customer Service and Reservations Sales Agents,
represented by the International Association of Machinists and Aerospace
Workers, AFL-CIO, and Flight Dispatchers, represented by the Southwest Airlines
Employees Association, ratified collective bargaining agreements which will run
through the years 2002 and 2009, respectively. In addition, in September 1998,
the Company's pilots voted to continue their ten-year agreement with the Company
which next becomes amendable in 2004.
RESULTS OF OPERATIONS
1998 COMPARED WITH 1997 The Company's consolidated net income for 1998 was
$433.4 million ($1.23 per share, diluted), as compared to the corresponding 1997
amount of $317.8 million ($.93 per share, diluted), an increase of 36.4 percent.
The prior years' earnings per share amounts have been restated for the 1998
three-for-two stock split (see Note 7 to the Consolidated Financial Statements).
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OPERATING REVENUES Consolidated operating revenues increased by 9.1 percent in
1998 to $4,164.0 million, compared to $3,816.8 million for 1997. This increase
in 1998 operating revenues was derived primarily from an 8.9 percent increase in
passenger revenues as a result of a 10.8 percent increase in revenue passenger
miles (RPMs) offset by a 1.7 percent decrease in passenger revenue yield per
RPM. While Southwest's passenger revenues increased 8.9 percent in 1998, the RPM
yield decline resulted from the higher load factors, a 6.0 percent increase in
passenger trip lengths, and higher federal excise taxes on domestic tickets.
Assuming load factors and passenger trip lengths continue to be above year-ago
levels, RPM yields will continue this trend. (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, but may not be limited to, competitive responses from other air
carriers and general economic conditions.)
The 10.8 percent increase in RPMs in 1998 exceeded the 6.9 percent increase in
available seat miles (ASMs), resulting in an increase in load factor from 63.7
percent in 1997 to 66.1 percent in 1998. The 1998 ASM growth resulted from the
net addition of 19 aircraft during the year. The load factor was 59.2 percent in
January 1999, up 5.2 points from January 1998.
Freight revenues in 1998 were $98.5 million, compared to $94.8 million in 1997.
The 3.9 percent increase in freight revenues fell short of the 6.9 percent
increase in ASMs for the same period. United States mail revenue declined 2.5
percent in 1998 and 9.4 percent for fourth quarter 1998 as the postal service
continues to shift away from commercial carriers. This trend is expected to
continue in 1999. Other air freight revenues increased 8.5 percent in 1998 due
to increased capacity.
Other revenues increased by 22.7 percent in 1998 to $101.7 million, compared to
$82.9 million in 1997. This increase is primarily due to increased revenues from
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 1998 were $3,480.4
million, compared to $3,292.6 million in 1997, an increase of 5.7 percent,
compared to the 6.9 percent increase in capacity. Operating expenses per ASM
decreased 1.1 percent in 1998, compared to 1997, primarily due to a 26.9 percent
decrease in average jet fuel price. The decrease in average jet fuel prices was
offset by a $36.1 million increase in Profitsharing
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and Employee savings plan contributions and an increase in maintenance costs
primarily due to unusually low aircraft engine overhaul costs in the first half
of 1997.
Unit costs are expected to continue to benefit in first quarter 1999, versus
first quarter 1998, from lower jet fuel prices. Excluding jet fuel costs,
operating expenses per ASM are expected to increase in first quarter 1999
compared to first quarter 1998 primarily due to higher Profitsharing and
Employee savings plan contributions and increased advertising primarily related
to the opening of Islip, New York, on Long Island on March 14, 1999. (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 1998 and 1997 were as follows:
OPERATING EXPENSES PER ASM
INCREASE PERCENT
1998 1997 (DECREASE) CHANGE
- --------------------------------------------------------------------------------
Salaries, wages,
and benefits......... 2.35(cent) 2.26(cent) .09(cent) 4.0%
Employee profitsharing
and savings plans.... .35 .30 .05 16.7
Fuel and oil.................. .82 1.11 (.29) (26.1)
Maintenance materials and
repairs.............. .64 .58 .06 10.3
Agency commissions............ .33 .35 (.02) (5.7)
Aircraft rentals.............. .43 .45 (.02) (4.4)
Landing fees and
other rentals........ .45 .46 (.01) (2.2)
Depreciation.................. .47 .44 .03 6.8
Other......................... 1.48 1.45 .03 2.1
- --------------------------------------------------------------------------------
Total....................... 7.32(cent) 7.40(cent) (.08)(cent) (1.1)%
- --------------------------------------------------------------------------------
Salaries, wages, and benefits per ASM increased 4.0 percent in 1998. This
increase resulted primarily from a 6.9 percent increase in 1998 average salary
and benefits cost per Employee. The increase in average salary and benefits cost
per Employee primarily is due to higher effective wage rates, lower productivity
in 1998 caused by Boeing aircraft delivery delays, and increased health care and
workers' compensation costs.
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Profitsharing and Employee savings plans expense per ASM increased 16.7 percent
in 1998, primarily due to higher earnings available for profitsharing.
Fuel and oil expenses per ASM decreased 26.1 percent in 1998, primarily due to a
26.9 percent decrease from 1997 in the average jet fuel cost per gallon. The
average price paid for jet fuel in 1998 was $.4567 compared to $.6246 in 1997.
During fourth quarter 1998, the average cost per gallon decreased 28.0 percent
to $.4346 compared to $.6040 in fourth quarter 1997. In January 1999, fuel
prices averaged approximately $.38 per gallon. Year-over-year decreases in jet
fuel prices are expected to continue in first quarter 1999 due to the continued
oversupply of crude oil and related products, along with the effects of the
Company's current fuel hedging positions. (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, but may not be limited to, the largely unpredictable levels of jet fuel
prices.)
Maintenance materials and repairs per ASM increased 10.3 percent in 1998,
compared to 1997, primarily as a result of an unusually low number of aircraft
engine overhauls in the first six months of 1997. Fourth quarter 1998
maintenance materials and repairs per ASM increased 3.2 percent over fourth
quarter 1997. We expect modest year-over-year unit-cost growth for maintenance
materials and repairs in 1999. (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, but may not be limited to, any unanticipated required aircraft airframe
or engine repairs.)
Agency commissions per ASM decreased 5.7 percent in 1998, when compared to 1997,
primarily due to a decrease in the percentage of commissionable sales.
Aircraft rentals per ASM decreased 4.4 percent in 1998, compared to 1997,
primarily due to a lower percentage of the aircraft fleet being leased.
Depreciation expense per ASM increased 6.8 percent in 1998, compared to 1997,
primarily due to a higher percentage of the aircraft fleet being owned.
Effective January 1, 1999, the Company will revise its estimated useful lives of
its Boeing 737-300/500 aircraft from 20 years to 23 years. This change in
accounting estimate will decrease aircraft depreciation by approximately $25
million in 1999.
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Other operating expenses per ASM increased 2.1 percent in 1998, compared to
1997, primarily due to increased costs resulting from the Year 2000 remediation
program and increased revenue related costs such as credit card processing and
communications, offset by lower insurance costs. Advertising costs are expected
to increase in first quarter 1999 as a result of opening a new city in March
1999. (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, but may not be limited to,
competitive responses from other air carriers and general economic conditions.)
OTHER "Other expenses (income)" included interest expense, capitalized interest,
interest income, and nonoperating gains and losses. Interest expense decreased
$7.2 million in 1998 primarily due to the February 1998 redemption of $100
million of senior unsecured 9 1/4% Notes originally issued in February 1991.
Capitalized interest increased $5.8 million in 1998 as a result of higher 1998
progress payment balances. Interest income for 1998 decreased primarily due to
lower invested cash balances. Nonoperating gains in 1998 primarily included
contractual penalties due from Boeing as a result of aircraft delivery delays.
INCOME TAXES The provision for income taxes, as a percentage of income before
taxes, was unchanged from 1997 to 1998.
1997 COMPARED WITH 1996 The Company's consolidated net income for 1997 was
$317.8 million ($.93 per share, diluted), as compared to the corresponding 1996
amount of $207.3 million ($.61 per share, diluted), an increase of 53.3 percent.
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 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
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
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activity in 1997. The 1997 ASM growth resulted from the addition of 18 aircraft
during the year.
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 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.
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.
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.
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Maintenance materials and repairs per ASM decreased 6.5 percent in 1997,
compared to 1996, primarily as a result of lower engine 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 senior unsecured 7 3/8% Debentures due March 1, 2027. Capitalized interest
decreased $2.5 million in 1997 as a result
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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.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided from operations was $886.1 million in 1998, compared to $610.6
million in 1997.
During 1998, capital expenditures of $947.1 million primarily were for the
purchase of 22 new 737-700 aircraft and four used 737-300 aircraft along with
progress payments for future aircraft deliveries. In February 1998, the Company
redeemed $100 million of senior unsecured 9 1/4% Notes originally issued in
February 1991. At December 31, 1998, capital commitments of the Company
primarily consisted of scheduled aircraft acquisitions and related flight
equipment.
As of July 22, 1998, the Board of Directors increased the Company's
authorization to repurchase shares of its outstanding common stock to $100
million. The Company completed this repurchase program during third quarter
1998, resulting in the repurchase of approximately 4.9 million post-split
shares.
As of December 31, 1998, Southwest had 105 new 737-700s on firm order, including
32 to be delivered in 1999, with options to purchase another 62. Aggregate
funding required for firm commitments approximated $2,492.5 million through the
year 2004, of which $715.9 million related to 1999. See Note 2 to the
Consolidated Financial Statements for further information.
The Company has various options available to meet its capital and operating
commitments, including cash on hand at December 31, 1998, of $378.5 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, 1998). 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
$318.8 million of public debt securities, which it currently intends to utilize
for aircraft financings in 1999 and 2000.
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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 1998
and 1997 represented approximately 11.2 and 15.0 percent of Southwest's
operating expenses, respectively. Southwest endeavors to acquire jet fuel at the
lowest prevailing prices possible.
The Company has historically hedged its exposure to jet fuel price market risk
only on a conservative, limited basis. In December 1998, in order to take
advantage of historically low jet fuel prices, Southwest increased its fuel
hedging activity by entering into fixed price swap agreements hedging
approximately 77 percent and 56 percent of its jet fuel needs in first and
second quarter 1999, respectively. In January 1999, the Company increased its
hedging position for second quarter 1999 to 74 percent. During 1999, the Company
may continue its fuel hedging activities at these higher levels to take
advantage of the historically low jet fuel prices.
The fair values of outstanding fixed price swap agreements and purchased crude
oil call options related to the Company's jet fuel price market risk at December
31, 1998 and 1997, and during the years then ended, were not material. A
hypothetical ten percent increase or decrease in the underlying fuel related
commodity prices from the December 31, 1998, prices would correspondingly change
the fair value of these derivative commodity instruments and their related cash
flows by approximately $10 million.
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 had
outstanding unsecured debt of $500 million and
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$600 million at December 31, 1998 and 1997, respectively, of which only $500
million was long-term at December 31, 1997. This long-term debt represents only
12.1 percent and 14.5 percent of total noncurrent assets at December 31, 1998
and 1997, respectively. The Company currently has an average maturity of ten
years for the long-term debt at fixed rates averaging 8.3 percent, which is
comparable to average rates prevailing over the last ten years.
At December 31, 1998, the Company operated 112 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 $379 million and $623
million at December 31, 1998 and 1997, respectively. 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, the interest rate
market risk implicit in these investments at December 31, 1998, 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.
A hypothetical 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.
The Company does not purchase or hold any derivative financial instruments for
trading purposes.
IMPACT OF THE YEAR 2000
The Company is in the process of converting its computer systems to be Year 2000
ready. This project encompasses information technology systems as well as
embedded technology assets. The
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project also includes an assessment of material third-party relationships and
associated risks. The project as it relates to internal systems and equipment
consists of four phases: identification, assessment, remediation, and testing.
This project is expected to be substantially completed by June 30, 1999.
FLIGHT SAFETY SYSTEMS The Company has completed all phases of its Year 2000
project as it relates to its aircraft fleet and onboard support systems. The
Company has determined there are no safety issues with these systems.
The Company also utilizes ground computer systems and equipment essential for
the maintenance of aircraft and the management of flight operations. The
identification, assessment, and remediation phases of the project with respect
to these systems and equipment are completed. The Company expects to complete
testing by mid-1999.
INTERNAL SYSTEMS The Company's critical internal systems include computer
hardware, software, and related equipment for customer reservations, ticketing,
flight and crew scheduling, revenue management, accounting functions, and
payroll, as well as airport activities including aircraft ground handling, bag
handling, and security. The computing hardware and telecommunications equipment
in the Company's central data center are essentially Year 2000 ready at this
time. The majority of the Company's vital and critical software systems are
either in testing or have already been made Year 2000 ready. While some systems
are currently in the testing phase, with a small number in the remediation
phase, the Company expects the majority of vital and critical systems to be Year
2000 ready by mid-1999.
THIRD PARTIES The Company has categorized its third party vendors with respect
to their potential impact on Company operations in the event any such third
party vendor has Year 2000 issues which are not dealt with on a timely basis.
The Company is also identifying and assessing the impact of Year 2000 issues as
they may affect the vendors' businesses (which, in turn, could affect the
Company). The Company has made initial contacts with all of its material third
party vendors and is in the process of evaluating their statements of Year 2000
compliance. In addition, the Company continues to work with other members of the
Air Transport Association, the airline industry trade group, to share
information and resources regarding vendors which are common to the entire
industry.
In management's experience, it is not always possible to obtain written
certification of Year 2000 compliance from third party
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vendors. Accordingly, in such cases, the Company is basing its assessment on its
own testing, other materials made available by such vendors, and other publicly
available information. Upon the conclusion of such assessment, the Company will
evaluate the need for contingency plans which may be needed in the event any
such vendor cannot demonstrate to the Company, on a timely basis, its Year 2000
compliance.
The Company expects this evaluation and assessment will be an ongoing process
through the balance of 1999.
YEAR 2000 COSTS The Company has expensed $11.0 million ($7.1 million in 1998) of
costs incurred to date related to the Year 2000 issue. The total remaining cost
of the Year 2000 project is presently estimated at approximately $7 million,
which will be expensed as incurred.
RISK OF YEAR 2000 ISSUES The Company believes its project to convert its
computer systems to be Year 2000 ready will be completed in a timely manner and
Year 2000 issues will not have a material adverse effect on operations. However,
it is possible the Company's or third parties' systems and equipment could fail
and result in the reduction or suspension of the Company's operations. The
Company is currently in the process of developing contingency plans related to
internal business critical systems and for those critical relationships with
third parties. There can be no guarantee, however, that the Company's systems
and equipment or third parties' systems and equipment on which Southwest relies
will be Year 2000 ready in a timely manner or that contingency plans will
mitigate the impact of any failure to complete plans in a timely manner.
The costs of the project, the dates on which the Company believes it will
complete the Year 2000 modifications and assessments, and the Company's analysis
of its risk in this area are based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the continued
availability of certain resources. 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 code,
as well as the cooperation needed from third party vendors and others upon whom
the Company must rely.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Management's Discussion and Analysis of Financial Condition and
Results of Operation-Market Risk".
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY 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, 1998 and 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1998. 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, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
/s/ ERNST & YOUNG LLP
Dallas, Texas
January 20, 1999
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SOUTHWEST AIRLINES CO.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31,
1998 1997
- -----------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents ...................... $ 378,511 $ 623,343
Accounts receivable ............................ 88,799 76,530
Inventories of parts and supplies,
at cost ...................................... 50,035 52,376
Deferred income taxes (Note 10) ................ 20,734 18,843
Prepaid expenses and other current
assets ....................................... 36,076 35,324
----------- -----------
Total current assets ....................... 574,155 806,416
Property and equipment, at cost
(Notes 2 and 5):
Flight equipment ............................... 4,709,059 3,987,493
Ground property and equipment .................. 720,604 601,957
Deposits on flight equipment
purchase contracts ........................... 309,356 221,874
----------- -----------
5,739,019 4,811,324
Less allowance for depreciation ................ 1,601,409 1,375,631
----------- -----------
4,137,610 3,435,693
Other assets ..................................... 4,231 4,051
----------- -----------
$ 4,715,996 $ 4,246,160
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................... $ 157,415 $ 160,891
Accrued liabilities (Note 3) ................... 477,448 426,950
Air traffic liability .......................... 200,078 153,341
Current maturities of long-term
debt (Note 4) ................................ 11,996 121,324
Other current liabilities ...................... 3,716 6,007
----------- -----------
Total current liabilities .................. 850,653 868,513
Long-term debt less current
maturities (Note 4) ............................ 623,309 628,106
Deferred income taxes (Note 10) .................. 549,207 438,981
Deferred gains from sale and
leaseback of aircraft .......................... 238,412 256,255
Other deferred liabilities ....................... 56,497 45,287
Commitments and contingencies (Notes 2, 5, and 10)
Stockholders' equity (Notes 7 and 8):
Common stock, $1.00 par value:
850,000,000 shares authorized;
335,904,306 and 221,207,083
shares issued in 1998 and
1997, respectively ........................... 335,904 221,207
Capital in excess of par value ................. 89,820 155,696
Retained earnings .............................. 2,044,975 1,632,115
Treasury stock, at cost: 3,601,121
shares in 1998 ............................... (72,781) --
----------- -----------
Total stockholders' equity .................. 2,397,918 2,009,018
----------- -----------
$ 4,715,996 $ 4,246,160
=========== ===========
SEE ACCOMPANYING NOTES.
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SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
1998 1997 1996
- -------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................ $ 433,431 $ 317,772 $ 207,337
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation .......................... 225,212 195,568 183,470
Deferred income taxes ................. 108,335 81,711 67,253
Amortization of deferred gains
on sale and leaseback of
aircraft ......................... (15,251) (15,414) (18,263)
Amortization of scheduled
airframe overhauls ................... 22,763 20,540 20,539
Changes in certain assets and
liabilities:
Accounts receivable .............. (12,269) (3,090) 6,341
Other current assets ............. 1,589 6,243 (19,534)
Accounts payable and
accrued liabilities .......... 53,194 8,751 132,096
Air traffic liability ............ 46,737 (4,757) 26,942
Other current liabilities ........ 19,293 (4,204) 5,334
Other ................................. 3,101 7,468 3,713
--------- --------- ---------
Net cash provided by
operating activities ........ 886,135 610,588 615,228
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ....... (947,096) (688,927) (677,431)
Net cash used in investing
activities .................. (947,096) (688,927) (677,431)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt ................ -- 98,764 --
Proceeds from aircraft sale and
leaseback transactions ................ -- -- 330,000
Payment of long-term debt and capital
lease obligations ..................... (118,859) (12,665) (12,695)
Payment of cash dividends ................. (9,284) (6,593) (6,216)
Proceeds from Employee stock plans ........ 44,272 40,335 15,592
Repurchase of common stock .................... (100,000) -- --
--------- --------- ---------
Net cash provided by (used in)
financing activities ........ (183,871) 119,841 326,681
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS .......................... (244,832) 41,502 264,478
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD ................................. 623,343 581,841 317,363
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD .................................... $ 378,511 $ 623,343 $ 581,841
========= ========= =========
CASH PAYMENTS FOR:
Interest, net of amount capitalized ............ $ 33,384 $ 42,372 $ 36,640
Income taxes ................................... 147,447 107,066 66,447
SEE ACCOMPANYING NOTES.
25
27
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
CAPITAL
IN EXCESS
COMMON OF RETAINED TREASURY
STOCK PAR VALUE EARNINGS STOCK TOTAL
- --------------------------------------------------------------------------------------------------------------------------
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 8) .......................... 1,079 14,513 -- -- 15,592
Tax benefit of options exercised .... -- 4,433 -- -- 4,433
Cash dividends, $.0195 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 7) .. 73,578 (73,578) -- -- --
Issuance of common stock upon
exercise of executive stock
options and pursuant to Employee
stock option and purchase plans
(Note 8) .......................... 2,517 37,818 -- -- 40,335
Tax benefit of options exercised .... -- 9,806 -- -- 9,806
Cash dividends, $.0221 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
Three-for-two stock split (Note 7) .. 111,894 (111,894) -- -- --
Purchase of shares of treasury
stock (Note 7) ................... -- -- -- (100,000) (100,000)
Issuance of common and treasury stock
upon exercise of executive stock
options and pursuant to Employee
stock option and purchase plans
(Note 8) .......................... 2,803 24,434 (10,184) 27,219 44,272
Tax benefit of options exercised .... -- 21,584 -- -- 21,584
Cash dividends, $.0283 per share .... -- -- (10,387) -- (10,387)
Net income - 1998 ................... -- -- 433,431 -- 433,431
----------- ----------- ----------- ----------- -----------
Balance at December 31, 1998 .......... $ 335,904 $ 89,820 $ 2,044,975 $ (72,781) $ 2,397,918
=========== =========== =========== =========== ===========
SEE ACCOMPANYING NOTES.
26
28
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
1998 1997 1996
- ------------------------------------------------------------------------------------
OPERATING REVENUES:
Passenger ...................... $ 3,963,781 $ 3,639,193 $ 3,269,238
Freight ........................ 98,500 94,758 80,005
Other .......................... 101,699 82,870 56,927
----------- ----------- -----------
Total operating revenues .... 4,163,980 3,816,821 3,406,170
OPERATING EXPENSES:
Salaries, wages, and
benefits (Note 9) ............ 1,285,942 1,136,542 999,719
Fuel and oil ................... 388,348 494,952 484,673
Maintenance materials and
repairs ...................... 302,431 256,501 253,521
Agency commissions ............. 157,766 157,211 140,940
Aircraft rentals ............... 202,160 201,954 190,663
Landing fees and other
rentals ...................... 214,907 203,845 187,600
Depreciation ................... 225,212 195,568 183,470
Other operating expenses ....... 703,603 646,012 614,749
----------- ----------- -----------
Total operating expenses .... 3,480,369 3,292,585 3,055,335
----------- ----------- -----------
OPERATING INCOME ................. 683,611 524,236 350,835
OTHER EXPENSES (INCOME):
Interest expense ............... 56,276 63,454 59,269
Capitalized interest ........... (25,588) (19,779) (22,267)
Interest income ................ (31,083) (36,616) (25,797)
Nonoperating (gains) losses,
net ........................... (21,106) 221 (1,732)
----------- ----------- -----------
Total other expenses (income) (21,501) 7,280 9,473
----------- ----------- -----------
INCOME BEFORE INCOME TAXES ....... 705,112 516,956 341,362
PROVISION FOR INCOME TAXES
(NOTE 10) ...................... 271,681 199,184 134,025
----------- ----------- -----------
NET INCOME ....................... $ 433,431 $ 317,772 $ 207,337
=========== =========== ===========
NET INCOME PER SHARE, BASIC
(NOTES 7, 8, AND 11) ........... $ 1.30 $ .97 $ .64
=========== =========== ===========
NET INCOME PER SHARE, DILUTED
(NOTES 7, 8, AND 11) ............. $ 1.23 $ .93 $ .61
=========== =========== ===========
SEE ACCOMPANYING NOTES.
27
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
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
estimated residual values over periods ranging from 20 to 25 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.
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
28
30
benefited, presently the lesser of ten years or the remaining life of the
aircraft. 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, 1998, 1997, and 1996 was
$119,739,000, $112,961,000, and $109,136,000, 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.
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. The cost of purchased crude oil call options and gains
and losses on fixed price swap agreements are deferred and charged or credited
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.
In 1998, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments
and Hedging Activities, which is required to be adopted in years beginning after
June 15, 1999. SFAS 133 permits early adoption as of the beginning of any fiscal
quarter after its issuance. The Company expects to adopt the new
29
31
Statement effective January 1, 2000. SFAS 133 will require the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. The Company has not yet determined what the effect of
SFAS 133 will be on the earnings and financial position of the Company.
2. COMMITMENTS
The Company's contractual purchase commitments consist primarily of scheduled
aircraft acquisitions. Thirty-two 737-700 aircraft are scheduled for delivery in
1999, 21 in 2000, 21 in 2001, 21 in 2002, five in 2003, and five 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 2000. Aggregate funding needed for firm commitments is
approximately $2,492.5 million, subject to adjustments for inflation, due as
follows: $715.9 million in 1999, $520.2 million in 2000, $498.7 million in 2001,
$515.8 million in 2002, $152.8 million in 2003, and $89.1 million in 2004.
3. ACCRUED LIABILITIES
- ---------------------------------------------------------------------------
(In thousands) 1998 1997
- ---------------------------------------------------------------------------
Employee profitsharing and
savings plans (Note 9)...... $ 123,195 $ 92,857
Aircraft rentals ................ 121,868 123,669
Vacation pay .................... 54,781 50,812
Other ........................... 177,604 159,612
-------------------------
$ 477,448 $ 426,950
=========================
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32
4. LONG-TERM DEBT
- ------------------------------------------------------------------
(In thousands) 1998 1997
- ------------------------------------------------------------------
9 1/4% Notes due 1998 .... $ -- $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 100,000 100,000
Capital leases (Note 5) .. 133,190 152,324
Other .................... 4,481 --
----------------------------
637,671 752,324
Less current maturities .. 11,996 121,324
Less debt discount ....... 2,366 2,894
----------------------------
$623,309 $628,106
============================
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 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
31
33
$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 9 1/4% Notes due February 15, 1998, were paid in full upon
maturity. The remaining Notes are not redeemable prior to maturity.
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 agreement, or prior similar agreements, at
December 31, 1998 or 1997.
5. LEASES
Total rental expense for operating leases charged to operations in 1998, 1997,
and 1996 was $306,629,000, $297,158,000, and $280,389,000, respectively. The
majority of the Company's terminal operations space, as well as 99 aircraft,
were under operating leases at December 31, 1998. The amounts applicable to
capital leases included in property and equipment were:
- ---------------------------------------------------------------------------------------
(In thousands) 1998 1997
- ---------------------------------------------------------------------------------------
Flight equipment........................... $230,486 $227,803
Less accumulated amortization.............. 133,073 122,346
-----------------------------------
$ 97,413 $105,457
===================================
Future minimum lease payments under capital leases and noncancelable operating
leases with initial or remaining terms in excess of one year at December 31,
1998, were:
32
34
- ----------------------------------------------------------
CAPITAL OPERATING
(In thousands) LEASES LEASES
- ----------------------------------------------------------
1999 ................. $ 20,245 $ 247,208
2000 ................. 16,871 235,955
2001 ................. 17,391 222,688
2002 ................. 17,561 208,311
2003 ................. 17,750 190,925
After 2003 ................. 120,049 1,901,005
-------------------------
Total minimum lease payments 209,867 $3,006,092
==========
Less amount representing
interest ................ 76,677
----------
Present value of minimum
lease payments .......... 133,190
Less current portion ....... 9,400
----------
Long-term portion .......... $ 123,790
==========
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. 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. Prior
to December 1998, outstanding call options and swap agreements were not
material. At December 31, 1998, the Company had hedged its exposure to fuel
price fluctuations on approximately 77 percent of its first quarter 1999 and 56
percent of its second quarter 1999 anticipated fuel requirements, or 290 million
gallons of fuel products. The fair value of these agreements at December 31,
1998, representing the amount the Company would receive if the agreements were
settled early, was not material.
33
35
Any outstanding call options or fixed swap agreements expose the Company to
credit loss in the event of nonperformance by the counterparties to the
agreements, but the Company does not expect any of the counterparties to fail to
meet its obligations. The credit exposure related to these financial instruments
is represented by the fair value of contracts with a positive fair value at the
reporting date. To manage credit risks, the Company selects counterparties based
on credit ratings, limits its exposure to a single counterparty, and monitors
the market position of the program and its relative market position with each
counterparty. At December 31, 1998, the Company had no collateral or other
security interests supporting these agreements but was in the process of
negotiating such agreements with a majority of the counterparties.
The Company does not hold or issue any financial instruments for trading
purposes.
The fair values of the Company's long-term debt were based on quoted market
prices. The carrying amounts and estimated fair values of the Company's
long-term debt at December 31, 1998, were as follows:
- -----------------------------------------------------------------------
(In thousands) CARRYING VALUE FAIR VALUE
- -----------------------------------------------------------------------
9.4% Notes due 2001 ......................... $100,000 $108,929
8 3/4% Notes due 2003 ....................... 100,000 112,702
8% Notes due 2005 ........................... 100,000 109,648
7 7/8% Notes due 2007 ....................... 100,000 111,390
7 3/8% Debentures due 2027................... 100,000 106,657
The carrying values of all other financial instruments approximate their fair
value.
7. 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, 1998, the Company had common stock reserved for issuance
pursuant to Employee stock benefit plans (69,453,206 shares) and upon exercise
of rights (405,357,512 shares) pursuant to the Common Stock Rights Agreement, as
amended (Agreement).
34
36
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 $7.41
and is exercisable only in the event of a proposed takeover, as defined by the
Agreement. The Company may redeem the Rights at $.0049 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 $7.41 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. On July 22,
1998, the Company's Board of Directors declared a three-for-two stock split,
distributing 111,894,315 shares on August 20, 1998. 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 splits.
As of July 22, 1998, the Company's Board of Directors increased the Company's
authorization to repurchase shares of its outstanding common stock to $100
million. The Company completed this repurchase program during third quarter
1998, resulting in the repurchase of 4,885,763 shares at an average cost of
$20.47 per share. All of the acquired shares are held as common stock in
treasury, less shares reissued under the Employee stock option and purchase
plans. When treasury shares are reissued, the Company uses a first-in, first-out
method and the excess of repurchase cost over reissuance price, if any, is
treated as a reduction of retained earnings.
8. STOCK PLANS
At December 31, 1998, the Company had seven 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.
35
37
The Company has six fixed option plans. Under the 1991 Incentive Stock Option
Plan, the Company may grant options to key Employees for up to 20,250,000 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 1,687,500
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 the 1995 Southwest Airlines Pilots' Association Non-Qualified Stock Option
Plan (SWAPA Plan), the Company may grant options to Pilots for up to 40,500,000
shares of common stock. An initial grant of approximately 32,788,000 shares was
made on January 12, 1995, at an option price of $8.89 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, 1998, 1997, and 1996, vest in six annual increments of 16.7
percent, 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.
Under the 1996 Incentive Stock Option Plan, the Company may grant options to key
Employees for up to 13,500,000 shares of common stock. Under the 1996
Non-Qualified Stock Option Plan, the Company may grant options to key Employees
and non-employee directors for up to 1,293,750 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 1998 Southwest Airlines Employee Association Non-Qualified Stock
Option Plan (SAEA Plan), the Company may grant options to Dispatchers for up to
1,050,000 shares of common stock. An initial grant of 738,000 shares was made on
September 10, 1998, at an option price of $19.62 per share, which exceeded the
market price of the Company's stock on that date. Options granted under the
initial grant vest in annual increments of varying percentages, depending on
seniority level, through 2006. On December 1 of each year of the agreement
beginning in 1998 and through December 1, 2008, additional options will be
granted to Dispatchers that become eligible during that year. No options were
granted on December 1, 1998. Options under all grants must
36
38
be exercised prior to June 30, 2012, or within a specified time upon retirement
or termination.
Under all fixed option plans, except the SWAPA and SAEA Plans, the exercise
price of each option equals the market price of the Company's stock on the date
of grant. Under the SWAPA and SAEA Plans, for additional options granted each
September 1 and December 1, respectively, 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 six fixed stock option plans, as adjusted
for stock splits, is summarized below:
- ----------------------------------------------------------------------------------------------------------------
INCENTIVE PLANS NON-QUALIFIED PLANS
-------------------------------------------------------------------
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
- ----------------------------------------------------------------------------------------------------------------
Outstanding December 31, 1995 .......... 11,726,729 $ 5.99 33,421,656 $ 8.83
Granted - Incentive Plans ........... 3,758,274 11.19 -- --
Granted - SWAPA Plan ................ -- -- 1,048,950 10.59
Granted - Other Non-Qualified Plans . -- -- 155,525 11.19
Exercised ........................... (890,658) 4.57 (653,367) 7.95
Surrendered ......................... (563,504) 8.96 (213,716) 8.89
---------- ----------
Outstanding December 31, 1996 .......... 14,030,841 7.35 33,759,048 8.91
Granted - Incentive Plans ........... 3,682,737 9.67 -- --
Granted - SWAPA Plan ................ -- -- 1,323,000 13.19
Granted - Other Non-Qualified Plans -- -- 218,109 9.67
Exercised ........................... (1,727,889) 6.03 (2,657,746) 8.85
Surrendered ......................... (1,005,019) 9.72 (148,818) 9.06
---------- ----------
Outstanding December 31, 1997 .......... 14,980,670 7.91 32,493,593 9.09
Granted - Incentive Plans ........... 2,738,597 17.72 -- --
Granted - SWAPA Plan ................ -- -- 902,475 19.36
Granted - SAEA Plan ................. -- -- 738,013 19.62
Granted - Other Non-Qualified Plans -- -- 256,191 17.69
Exercised ........................... (2,360,733) 6.27 (2,521,455) 9.07
Surrendered ......................... (834,289) 10.52 (247,252) 9.95
---------- ----------
Outstanding December 31, 1998 .......... 14,524,245 $ 9.89 31,621,565 $ 9.69
========== ==========
Exercisable December 31, 1998 .......... 3,132,557 12,271,309
Available for granting in future periods 11,995,971 6,768,712
37
39
The following table summarizes information about stock options outstanding under
the six fixed option plans at December 31, 1998:
- -----------------------------------------------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------------------------
WEIGHTED-
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING -AVERAGE NUMBER -AVERAGE
RANGE OF EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AT 12/31/98 LIFE PRICE AT 12/31/98 PRICE
- -----------------------------------------------------------------------------------------------------------------------
$2.68 to $3.47 3,307,850 2.03 yrs. $ 2.74 1,195,748 $ 2.86
$5.04 to $7.50 485,476 3.07 5.35 141,557 5.36
$8.36 to $10.83 32,844,404 7.85 8.97 12,009,216 8.94
$11.19 to $16.64 5,061,066 6.85 12.23 1,472,115 12.99
$17.71 to $19.62 4,447,014 9.59 18.37 585,230 18.57
------------- -------------
$2.68 to $19.62 46,145,810 7.44 yrs. $ 9.75 15,403,866 $ 9.19
============= =============
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 1998 or
1997. In 1996, the Company granted 325,000 options with an exercise price of
$1.00 per share and 1,125,000 options with an exercise price of $10.44 per share
related to the 1996 employment agreement. At December 31, 1998, 1997, and 1996,
total options of 3,688,000, 3,916,000, and 4,270,000 were outstanding,
respectively. At December 31, 1998, total options of 3,108,000 were exercisable
at exercise prices ranging from $1.00 to $10.44 per share. Options for 228,000,
354,000, and 379,500 shares were exercised in 1998, 1997, and 1996,
respectively.
Under the 1991 Employee Stock Purchase Plan (ESPP), at December 31, 1998, the
Company is authorized to issue up to a balance of 855,000 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 451,000 shares
in 1998, 660,000 shares in 1997, and 696,000 shares in 1996 at average prices of
$17.45, $10.67, and $10.25, respectively.
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
38
40
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
1998, 1997, and 1996, respectively: dividend yield of .16 percent, .22 percent,
and .16 percent; expected volatility of 38.20 percent, 38.23 percent, and 35.37
percent; risk-free interest rate of 4.66 percent, 5.80 percent, and 5.89
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 fixed option plans,
except the SAEA Plan, during 1998, 1997, and 1996 was $7.17, $4.08, and $4.52,
respectively, for the incentive plans; $7.14, $5.11, and $4.11, respectively,
for the SWAPA Plan; and $7.15, $4.08, and $4.52, respectively, for other
non-qualified plans. The weighted-average fair value of options granted in 1998
under the SAEA Plan was $7.25. 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 $6.21. No such options were granted in 1998 or
1997. The weighted-average fair value of each purchase right under the ESPP
granted in 1998, 1997, and 1996, which is equal to the ten percent discount from
the market value of the common stock at the end of each purchase period, was
$1.94, $1.19, and $1.14, 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 to expense primarily over the
vesting period. The Company's pro forma net income and net income per share is
as follows:
39
41
- ----------------------------------------------------------------------------------------------------
(In thousands except per share amounts)
1998 1997 1996
- ----------------------------------------------------------------------------------------------------
NET INCOME:
As reported $433,431 $317,772 $207,337
Pro forma $421,097 $306,553 $196,478
NET INCOME PER SHARE, BASIC:
As reported $ 1.30 $.97 $.64
Pro forma $ 1.26 $.93 $.60
NET INCOME PER SHARE, DILUTED:
As reported $ 1.23 $.93 $.61
Pro forma $ 1.20 $.90 $.60
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.
9. 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
1998, 1997, and 1996 was $120,697,000, $91,256,000, and $59,927,000,
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 1998, 1997, and 1996 were
$46,415,000, $39,744,000, and $35,125,000, respectively.
10. 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 and liabilities at December 31, 1998 and 1997 are as
follows:
40
42
(In thousands) 1998 1997
- ----------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Accelerated depreciation ........ $641,673 $543,547
Scheduled airframe maintenance .. 40,073 33,202
Other ........................... 95,485 83,607
Total deferred tax liabilities 777,231 660,356
DEFERRED TAX ASSETS:
Deferred gains from sale and
leaseback of aircraft ........ 107,157 112,659
Capital and operating leases .... 61,275 61,747
Other ........................... 80,326 65,812
Total deferred tax assets .... 248,758 240,218
Net deferred tax liability ... $528,473 $420,138
The provision for income taxes is composed of the following:
- -------------------------------------------------------------------
(In thousands) 1998 1997 1996
- -------------------------------------------------------------------
CURRENT:
Federal .................. $143,989 $102,938 $ 59,101
State .................... 19,357 14,535 7,671
-------- -------- --------
Total current ...... 163,346 117,473 66,772
DEFERRED:
Federal .................. 96,237 75,990 60,967
State .................... 12,098 5,721 6,286
-------- -------- --------
Total deferred ..... 108,335 81,711 67,253
-------- -------- --------
$271,681 $199,184 $134,025
======== ======== ========
The Company received a statutory notice of deficiency from the Internal Revenue
Service (IRS) in July 1995 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
41
43
several years. Management believes the final resolution of this controversy will
not have a material adverse effect upon the results of operations of the
Company.
The effective tax rate on income before income taxes differed from the federal
income tax statutory rate for the following reasons:
- -------------------------------------------------------------------------------
(In thousands) 1998 1997 1996
- -------------------------------------------------------------------------------
Tax at statutory U.S.
tax rates ....................... $ 246,789 $ 180,935 $ 119,477
Nondeductible items ............... 5,099 5,893 5,168
State income taxes,
net of federal benefit .......... 20,445 13,166 9,072
Other, net ........................ (652) (810) 308
--------- --------- ---------
Total income tax provision ..... $ 271,681 $ 199,184 $ 134,025
========= ========= =========
11. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
- -------------------------------------------------------------------------------
(In thousands except per share amounts)
1998 1997 1996
- -------------------------------------------------------------------------------
NUMERATOR:
Net income, available to common
stockholders-numerator for basic
and diluted earnings per share $433,431 $317,772 $207,337
DENOMINATOR:
Weighted-average shares
outstanding, basic 333,342 328,631 325,676
Dilutive effect of Employee stock
options 19,824 12,557 11,810
-------- -------- --------
Adjusted weighted-average shares
outstanding, diluted 353,166 341,188 337,486
======== ======== ========
NET INCOME PER SHARE:
Basic $ 1.30 $ .97 $ .64
Diluted $ 1.23 $ .93 $ .61
======== ======== ========
42
44
QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
-----------------------------------------------------------
1998 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ---- -------- ------- -------- -------
Operating revenues $942,653 $1,078,841 $1,094,830 $1,047,656
Operating income 111,693 208,548 203,919 159,451
Income before income taxes 114,057 216,547 211,055 163,453
Net income 70,008 133,393 129,645 100,385
Net income per share, basic .21 .40 .39 .30
Net income per share, diluted .20 .38 .37 .29
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 .16 .29 .28 .24
Net income per share, diluted .15 .28 .27 .23
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
43
45
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 20, 1999. 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 20, 1999.
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 20, 1999.
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 20, 1999.
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 Articles 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)); Amendment to Restated Articles 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, 1998 (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.
44
46
(incorporated by reference to Exhibit 4.1 to Southwest's
Annual Report on Form 10-K for the year ended December 31,
1997 (File No. 1-7259)); First Amendment to Competitive
Advance and Revolving Credit Facility Agreement dated August
7, 1998; Second Amendment to Competitive Advance and Revolving
Credit Facility Agreement dated January 20, 1999.
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 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 (incorporated by reference to Exhibit 10.2 to
Southwest's Annual Report on form 10-K for the year ended
December 31, 1997 (File No. 1-7259)); Supplemental Agreements
Nos. 5, 6, and 7.
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.
45
47
10.2 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)).
10.3 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)).
10.4 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)).
10.5 1991 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
33-40652)).
10.6 1991 Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.2 to Registration Statement on Form S-8
(File No. 33-40652)).
10.7 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)).
10.8 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)).
10.9 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)).
10.10 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)).
10.11 1996 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
333-20275)).
10.12 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 (incorporated by reference to
Exhibit 22 to Southwest's Annual Report on form 10-K for the
year ended December 31, 1997 (File No. 1-7259)).
23 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule.
27.2 Restated 1998 Financial Data Schedule
27.3 Restated 1997 Financial Data Schedule
27.4 Restated 1996 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 1998.
46
48
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 18, 1999
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 18, 1999 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
49
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
---------- -----------
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 Articles 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); Amendment to Restated Articles 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, 1998 (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.
(incorporated by reference to Exhibit 4.1 to Southwest's
Annual Report on Form 10-K for the year ended December 31,
1997 (File No. 1-7259)); First Amendment to Competitive
Advance and Revolving Credit Facility Agreement dated August
7, 1998; Second Amendment to Competitive Advance and Revolving
Credit Facility Agreement dated January 20, 1999.
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.
50
10.1 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 (incorporated by reference to Exhibit 10.2 to
Southwest's Annual Report on form 10- K for the year ended
December 31, 1997 (File No. 1-7259)); Supplemental Agreements
Nos. 5, 6, and 7.
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.
10.2 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)).
10.3 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)).
10.4 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)).
10.5 1991 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
33-40652)).
10.6 1991 Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.2 to Registration Statement on Form S-8
(File No. 33-40652)).
10.7 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)).
10.8 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)).
10.9 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)).
10.10 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)).
10.11 1996 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8 (File No.
333-20275)).
51
10.12 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 (incorporated by reference to
Exhibit 22 to Southwest's Annual Report on form 10-K for the
year ended December 31, 1997 (File No. 1-7259)).
23 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule.
27.2 Restated 1998 Financial Data Schedule
27.3 Restated 1997 Financial Data Schedule
27.4 Restated 1996 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 1998.