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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file No. 1-7259
Southwest Airlines Co.
(Exact name of registrant as specified in its charter)
TEXAS 74-1563240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
P.O. Box 36611, Dallas, Texas 75235-1611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 792-4000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock outstanding as of the close of
business on April 14, 2004:
790,181,982
SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in millions)
(unaudited)
March 31, December 31,
(in millions) 2004 2003
ASSETS
Current assets:
Cash and cash equivalents $1,824 $1,865
Accounts and other receivables 178 132
Inventories of parts and supplies,
at cost 105 93
Fuel hedge contracts 231 164
Prepaid expenses and other
current assets 62 59
Total current assets 2,400 2,313
Property and equipment, at cost:
Flight equipment 8,794 8,646
Ground property and equipment 1,100 1,117
Deposits on flight equipment
purchase contracts 939 787
10,833 10,550
Less allowance for depreciation
and amortization 3,150 3,107
7,683 7,443
Other assets 188 122
$10,271 $9,878
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $443 $405
Accrued liabilities 731 650
Air traffic liability 700 462
Current maturities of long-term debt 307 206
Total current liabilities 2,181 1,723
Long-term debt less current maturities 1,270 1,332
Deferred income taxes 1,476 1,420
Deferred gains from sale and
leaseback of aircraft 164 168
Other deferred liabilities 155 183
Stockholders' equity:
Common stock 790 789
Capital in excess of par value 263 258
Retained earnings 3,896 3,883
Treasury stock (108) -
Accumulated other comprehensive income 184 122
Total stockholders' equity 5,025 5,052
$10,271 $9,878
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
Three months ended
March 31,
2004 2003
OPERATING REVENUES:
Passenger $1,428 $1,306
Freight 25 22
Other 31 23
Total operating revenues 1,484 1,351
OPERATING EXPENSES:
Salaries, wages, and benefits 589 516
Fuel and oil 230 208
Maintenance materials and repairs 114 106
Agency commissions 2 12
Aircraft rentals 45 45
Landing fees and other rentals 103 90
Depreciation and amortization 103 93
Other operating expenses 252 235
Total operating expenses 1,438 1,305
OPERATING INCOME 46 46
OTHER EXPENSES (INCOME):
Interest expense 19 26
Capitalized interest (10) (7)
Interest income (4) (5)
Other (gains) losses, net - (7)
Total other expenses (income) 5 7
INCOME BEFORE INCOME TAXES 41 39
PROVISION FOR INCOME TAXES 15 15
NET INCOME $26 $24
NET INCOME PER SHARE, BASIC $ .03 $ .03
NET INCOME PER SHARE, DILUTED $ .03 $ .03
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 785 778
Diluted 817 808
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
Three months ended
March 31,
(in millions) 2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $26 $24
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization 103 93
Deferred income taxes 16 12
Amortization of deferred gains on sale and
leaseback of aircraft (4) (4)
Amortization of scheduled airframe
inspections & repairs 14 12
Changes in certain assets and liabilities:
Accounts and other receivables (47) 16
Other current assets (15) (1)
Accounts payable and accrued liabilities 123 (7)
Air traffic liability 238 123
Other (37) (1)
Net cash provided by operating
activities 417 267
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (360) (193)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt 29 -
Proceeds from Employee stock plans 13 12
Payments of long-term debt and
capital lease obligations (7) (6)
Payments of cash dividends (7) (7)
Repurchase of common stock (125) -
Other, net (1) 1
Net cash provided by (used in)
financing activities (98) -
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (41) 74
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,865 1,815
CASH AND CASH EQUIVALENTS AT END OF PERIOD $1,824 $1,889
CASH PAYMENTS FOR:
Interest, net of amount capitalized $ 13 $ 22
Income taxes $ - $ -
See accompanying notes.
Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Southwest Airlines Co. (Company or Southwest) have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The
unaudited condensed consolidated financial statements for the interim periods
ended March 31, 2004 and 2003 include all adjustments which are, in the
opinion of management, necessary for a fair presentation of the results for
the interim periods. This includes all normal and recurring adjustments, and
other accounting entries as described herein. The Condensed Consolidated
Balance Sheet as of December 31, 2003 has been derived from the Company's
audited financial statements as of that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. Financial results for the Company, and
airlines in general, are seasonal in nature. Historically, the Company's
second and third fiscal quarters have been more profitable than its first and
fourth fiscal quarters. Operating results for the three months ended March 31,
2004 are not necessarily indicative of the results that may be expected for the
year ended December 31, 2004. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Southwest Airlines Co. Annual Report on Form 10-K for the year ended December
31, 2003.
2. STOCK-BASED EMPLOYEE COMPENSATION
The Company has stock-based compensation plans covering the majority of its
Employee groups, including plans adopted via collective bargaining, a plan
covering the Company's Board of Directors, and plans related to employment
contracts with certain Executive Officers of the Company. The Company
accounts for stock-based compensation utilizing the intrinsic value method in
accordance with the provisions of Accounting Principles Board Opinion No. 25
(APB 25), "Accounting for Stock Issued to Employees" and related
Interpretations. Accordingly, no compensation expense is recognized for
fixed option plans because the exercise prices of Employee stock options
equal or exceed the market prices of the underlying stock on the dates of
grant.
The following table represents the effect on net income and earnings per
share if the Company had applied the fair value based method and recognition
provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," to stock-based Employee
compensation (in millions, except per share amounts):
Three months ended March 31,
2004 2003
Net income, as reported $26 $24
Add: Stock-based Employee compensation
expense included in reported income,
net of related tax effects - -
Deduct: Total stock-based Employee
compensation expense determined under
fair value based methods for all awards,
net of related tax effects (12) (17)
Pro forma net income $14 $7
Net income per share
Basic, as reported $.03 $.03
Basic, pro forma $.02 $.01
Diluted, as reported $.03 $.03
Diluted, pro forma $.02 $.01
3. DIVIDENDS
During the three months ended March 31, 2004, dividends of $.0045 per share
were declared on the 784 million shares of common stock then outstanding.
During the three months ended March 31, 2003, dividends of $.0045 per share
were declared on the 778 million shares of common stock then outstanding.
4. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income per share (in millions except per share amounts):
Three months ended March 31,
2004 2003
NUMERATOR:
Net income available to
common stockholders $26 $24
DENOMINATOR:
Weighted-average shares
outstanding, basic 785 778
Dilutive effect of Employee stock
Options 32 30
Adjusted weighted-average shares
outstanding, diluted 817 808
NET INCOME PER SHARE:
Basic $.03 $.03
Diluted $.03 $.03
5. FINANCIAL DERIVATIVE INSTRUMENTS
Fuel Contracts - Airline operators are inherently dependent upon energy to
operate and, therefore, are impacted by changes in jet fuel prices. Jet fuel
and oil consumed in the three months ended March 31, 2004 and 2003,
represented approximately 16.0 percent and 15.9 percent, respectively, of
Southwest's operating expenses for those periods. The Company endeavors to
acquire jet fuel at the lowest possible prices. Because jet fuel is not
traded on an organized futures exchange, liquidity for jet fuel hedging is
limited. However, the Company has found that both crude oil and heating oil
contracts are effective commodities for hedging jet fuel. The Company
utilizes financial derivative instruments as hedges to decrease its exposure
to jet fuel price increases. The Company does not purchase or hold any
derivative financial instruments for trading purposes.
The Company utilizes financial derivative instruments for both short-term and
long-term time frames when it appears the Company can take advantage of
market conditions. The Company currently has a mixture of purchased call
options, collar structures, and fixed price swap agreements in place to hedge
over 80 percent of its 2004 total anticipated jet fuel requirements,
approximately 80 percent of its 2005 total anticipated jet fuel requirements,
and portions of its 2006-2007 total anticipated jet fuel requirements. As of
March 31, 2004, the majority of the Company's second quarter 2004 hedges are
effectively crude oil-based positions in the form of option contracts. The
majority of the remaining 2004 hedge positions are heating oil-based
positions. Beyond 2004, the majority of the hedge positions are crude oil-
based. For second quarter and the remainder of 2004, the Company's fuel
hedges are a combination of derivative instruments that effectively cap
prices under $24 per barrel.
The Company accounts for its fuel hedge derivative instruments as cash flow
hedges, as defined, in Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended
(SFAS 133). All changes in fair value that are considered to be effective,
as defined, are recorded in "Accumulated other comprehensive income" until
the underlying jet fuel is consumed. The fair value of the Company's
financial derivative instruments at March 31, 2004, was a net asset of
approximately $382 million. The current portion of this net asset,
approximately $231 million, is classified as "Fuel hedge contracts" and the
noncurrent portion, approximately $151 million, is classified in "Other
assets" in the Condensed Consolidated Balance Sheet. The fair value of the
derivative instruments, depending on the type of instrument, was determined
by the use of present value methods or standard option value models with
assumptions about commodity prices based on those observed in underlying
markets.
During the three months ended March 31, 2004 and 2003, the Company recognized
$63 million and $64 million in gains in "Fuel and oil" expense, respectively,
from hedging activities. During the three months ended March 31, 2004 and
2003, the Company also recognized approximately $6 million and $14 million of
additional income in "Other (gains) losses, net," related to the
ineffectiveness of its hedges, respectively. The Company recognized
approximately $6 million and $7 million of net expense related to amounts
excluded from the Company's measurements of hedge effectiveness, in "Other
(gains) losses, net" during first quarter 2004 and first quarter 2003,
respectively.
As of March 31, 2004, the Company had approximately $184 million in
unrealized gains, net of tax, in "Accumulated other comprehensive income"
related to fuel hedges. Included in this total are approximately $120
million in net unrealized gains that are expected to be realized in earnings
during the twelve months following March 31, 2004. Interest Rate Swaps -
During second quarter 2003, the Company entered into interest rate swap
agreements relating to its $385 million 6.5% senior unsecured notes due March
1, 2012 and $375 million 5.496% Class A-2 pass-through certificates due
November 1, 2006. Under the first interest rate swap agreement, the Company
pays the London InterBank Offered Rate (LIBOR) plus a margin ] every six
months and receives 6.5% every six months on a notional amount of $385
million until March 1, 2012. Under the second agreement, the Company pays
LIBOR plus a margin every six months and receives 5.496% every six months on
a notional amount of $375 million until November 1, 2006.
The Company's interest rate swap agreements qualify as fair value hedges, as
defined by SFAS 133. The fair value of the interest rate swap agreements,
which are adjusted regularly, are recorded in the Company's balance sheet as
an asset or liability, as necessary, with a corresponding adjustment to the
carrying value of the long-term debt. The fair value of the interest rate
swap agreements, excluding accrued interest, at March 31, 2004 was an asset
of approximately $1 million. This amount is recorded in "Other assets" in
the unaudited Condensed Consolidated Balance Sheet. In accordance with fair
value hedging, the offsetting entry is an adjustment to increase the carrying
value of long-term debt.
6. COMPREHENSIVE INCOME
Comprehensive income included changes in the fair value of certain financial
derivative instruments, which qualify for hedge accounting, and unrealized
gains and losses on certain investments. Comprehensive income totaled $88
million and $29 million for the three months ended March 31, 2004 and 2003,
respectively. The differences between net income and comprehensive income
for each of these periods was as follows (in millions):
Three months ended March 31,
2004 2003
Net income $26 $24
Unrealized gain (loss) on
derivative instruments,
net of deferred taxes of $40 and $4 61 7
Other, net of deferred taxes of $1 and $(1) 1 (2)
Total other comprehensive income 62 5
Comprehensive income $88 $29
A rollforward of the amounts included in "Accumulated other comprehensive
income," net of taxes, is shown below (in millions):
Accumulated
Fuel other
hedge comprehensive
derivatives Other income (loss)
Balance at December 31, 2003 $ 123 ($ 1) $ 122
2004 changes in value 96 1 97
Reclassification to earnings (35) - (35)
Balance at March 31, 2004 $ 184 $ - $ 184
7. REVOLVING CREDIT FACILITY
As of March 31, 2004, the Company is a party to two unsecured revolving
credit facilities from which it can borrow up to $575 million from a group of
banks. One of the facilities, for half of the total amount, is set to expire
during April 2004. The other facility, for half of the amount, is set to
expire in April 2005. At the Company's option, interest on the facilities
can be calculated on one of several different bases. For most borrowings,
Southwest would anticipate choosing a floating rate based upon LIBOR. If
fully drawn, the spread over LIBOR would be 75 basis points for both
facilities given Southwest's credit rating at March 31, 2004. As of March
31, 2004, there are no outstanding amounts borrowed under either facility.
The Company expects to terminate both of its current facilities in April
2004, and replace them with a single three-year facility at an amount and
terms comparable to the current three-year facility.
8. CONSOLIDATION OF RESERVATIONS CENTERS
In November 2003, the Company announced the consolidation of its nine
Reservations Centers into six, effective February 28, 2004. This decision
was made in response to the established shift by Customers to the internet as
a preferred way of booking travel. The Company's website, southwest.com, now
accounts for more than half of ticket bookings and, as a consequence, demand
for phone contact has dramatically decreased. During first quarter 2004, the
Company closed its Reservations Centers located in Dallas, Texas, Salt Lake
City, Utah, and Little Rock, Arkansas. The Company provided the 1,900
affected Employees at these locations the opportunity to relocate to another
of the Company's remaining six centers. Those Employees choosing not to
relocate, approximately 55% of the total affected, were offered support
packages, which included severance pay, flight benefits, medical coverage,
and job-search assistance, depending on length of service with the Company.
The total cost associated with the Reservations Center consolidation
recognized in first quarter 2004 was approximately $18 million. Employee
severance and benefit costs are reflected in "Salaries, wages, and benefits",
and the majority of other costs are reflected in "Other operating expenses"
in the Condensed Consolidated Statement of Income. The breakdown of the
costs incurred is as follows:
Consolidation
Employee of facilities
bonus pay and other
and benefits charges Total
Initial charge in first quarter 2004 $13 $5 $18
Non-cash charges - (1) (1)
Cash payments (10) (2) (12)
Balance at March 31, 2004 $3 $2 $5
9. AIRCRAFT FINANCING
In February 2004, the Company entered into a $29 million note due February
2006, utilizing one of its new 737-700 aircraft as collateral. The note is
non-interest bearing and accretes to face value at maturity at an annual rate
of 2.9%. The proceeds of this borrowing were used to fund the aircraft
purchase.
10. RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46), which requires the consolidation of
variable interest entities, as defined. FIN 46, as revised, was applicable
to financial statements of companies that have interests in "special purpose
entities", as defined, during 2003. FIN 46 is applicable to financial
statements of companies that have interests in all other types of entities,
in first quarter 2004. The Company did not have any variable interest
entities that were required to be consolidated as a result of FIN 46.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Comparative Consolidated Operating Statistics
Relevant Southwest comparative operating statistics for the three
months ended March 31, 2004 and 2003 are as follows:
SOUTHWEST AIRLINES CO.
COMPARATIVE CONSOLIDATED OPERATING STATISTICS
(unaudited)
Three months ended
March 31,
2004 2003 Change
Revenue passengers carried 15,995,061 15,077,537 6.1 %
Enplaned passengers 18,190,404 17,169,572 5.9 %
Revenue passenger miles (RPMs) (000s) 11,792,423 10,895,701 8.2 %
Available seat miles (ASMs) (000s) 18,381,592 17,399,132 5.6 %
Load factor 64.2% 62.6% 1.6 pts.
Average length of passenger haul (miles) 737 723 1.9 %
Average aircraft stage length (miles) 568 552 2.9 %
Trips flown 238,469 233,087 2.3 %
Average passenger fare $89.28 $86.64 3.0 %
Passenger revenue yield per RPM (cents) 12.11 11.99 1.0 %
Operating revenue yield per ASM (cents) 8.07 7.77 3.9 %
Operating expenses per ASM (cents) 7.82 7.50 4.3 %
Operating expenses per ASM,
excluding fuel (cents) 6.57 6.30 4.3 %
Fuel costs per gallon,
excluding fuel tax (cents) 79.6 74.8 6.4 %
Fuel consumed, in gallons (millions) 287 277 3.6 %
Number of Employees at period-end 31,522 33,140 (4.9)%
Size of fleet at period-end 393 377 4.2 %
Material Changes in Results of Operations
Summary
Despite the challenging airline revenue environment and record high
energy prices, Southwest reported its 52nd consecutive quarterly profit. The
Company's first quarter 2004 net income of $26 million ($.03 per share,
diluted), compared to first quarter 2003 net income of $24 million ($.03 per
share, diluted). The increase in net income was primarily due to strong
March 2004 Customer demand stimulated by fare sale activity and a weak year-
ago revenue performance due to the Iraq war, partially offset by higher first
quarter 2004 costs, which included $18 million of expense associated with the
consolidation of certain of the Company's reservations operations. See Note
8 to the Condensed Consolidated Financial Statements for further information
on the Company's Reservations Center consolidation.
The Company increased its capacity (available seat miles) by 5.6
percent compared to first quarter 2003. Year-over-year increases in capacity
are expected to continue and will accelerate throughout 2004 as the Company's
fleet expands by a net of 29 aircraft for the year. The Company's operating
costs per available seat mile (unit costs) increased 4.3 percent from first
quarter 2003. In addition to the costs associated with the consolidation of
the Company's reservations operations, the unit cost increase was primarily
due to higher labor, airport, and jet fuel costs, net of hedging gains and
improved fuel efficiency, partially offset by a decrease in commission
expense.
The Company continues its efforts to control costs. In addition to the
Company's successful hedging program and its consolidation of reservations
operations, effective December 15, 2003, the Company eliminated its travel
agency commission, which will lower operating costs by approximately $40
million annually. The Company is also in the process of adding Blended
Winglets to its 737-700 aircraft. Southwest expects fuel consumption savings
in excess of three percent annually for each aircraft outfitted with the
winglets.
Based on the Company's current revenue and cost outlook and, barring
any unforeseen event, the Company expects second quarter 2004 earnings to
exceed second quarter 2003 earnings, excluding the impact of the $271 million
(pretax) grant received from the Emergency Wartime Supplemental
Appropriations Act (Wartime Act).
The Company's Flight Attendants are subject to an agreement with the
TWU that became amendable in June 2002. In September 2003, the Company
requested the assistance of the National Mediation Board in the negotiations
for a new contract; however, as of April 16, 2004, a mutual agreement had not
been reached.
Comparison of three months ended March 31, 2004 to three months ended March
31, 2003
Revenues
Consolidated operating revenues increased by $133 million, or 9.8
percent, primarily due to a $122 million, or 9.3 percent increase in
passenger revenues. The increase in passenger revenues was primarily due to
an 8.2 percent increase in revenue passenger miles (RPMs) flown.
First quarter 2004 capacity, as measured by available seat miles
(ASMs), increased 5.6 percent compared to first quarter 2003. The capacity
increase resulted from the net addition of 16 aircraft (net of six
retirements) since the end of first quarter 2003. The first quarter 2004
load factor was 64.2 percent, an increase of 1.6 points compared to 2003.
The Company also experienced a 6.1 percent increase in revenue passengers
carried compared to first quarter 2003.
First quarter 2004 passenger yield per RPM increased 1.0 percent to
12.11 cents from 11.99 cents in first quarter 2003. Stronger year-over-year
increases in RPM yields in January and February were mostly offset by a lower
March yield, primarily due to a higher mix of discounted fares compared to
the prior year for March in response to the Company's first quarter 2004 fare
sales. Operating revenue yield per ASM (RASM or unit revenue) increased 3.9
percent to 8.07 cents compared to first quarter 2003, primarily due to the
increase in revenue relative to capacity. Based on current traffic and
booking trends, the Company expects a strong load factor performance in April
2004, comparable to the Company's March load factor of 73.6 percent.
Although RPM yields may be diluted with a higher mix of discounted fares,
second quarter unit revenues are expected to exceed the second quarter 2003
performance of 8.47 cents.
Consolidated freight revenues increased by $3 million, or 13.6 percent,
due to increases in freight and cargo revenues primarily from an increase in
the number of shipments. This increase more than offset a decrease in mail
revenues. The Company expects the trends of year-over-year increases in
freight and cargo and decreases in mail revenues to continue in second
quarter 2004. Other revenues increased 34.8 percent compared to first
quarter 2003 primarily due to a 36.9 percent increase in commissions earned
from programs the Company sponsors with certain business partners,
such as the Company sponsored Bank One Visa card. The Company expects the
trend of year-over-year increases in commissions to continue in second
quarter 2004.
Operating expenses
To a large extent, changes in operating expenses for airlines are
driven by changes in capacity, or ASMs. The following presents Southwest's
operating expenses per ASM for the three months ended March 31, 2004 and
2003, followed by explanations of changes on a per-ASM basis:
Three months ended March 31, Per ASM Percent
2004 2003 Change Change
Salaries, wages, and benefits 3.21 2.97 .24 8.1
Fuel and oil 1.25 1.20 .05 4.2
Maintenance materials
and repairs .62 .61 .01 1.6
Agency commissions .01 .07 (.06) (85.7)
Aircraft rentals .24 .26 (.02) (7.7)
Landing fees and other rentals .56 .51 .05 9.8
Depreciation .56 .53 .03 5.7
Other operating expenses 1.37 1.35 .02 1.5
Total 7.82 7.50 .32 4.3
Operating expenses per ASM were 7.82 cents, a 4.3 percent increase
compared to 7.50 cents for first quarter 2003. This increase was primarily
due to higher salaries, wages, and benefits, higher airport costs such as
space rentals, and higher fuel expense, partially offset by lower commissions
expense compared to first quarter 2003. Based on recent trends, the Company
currently expects second quarter 2004 overall unit costs to be in line with
first quarter's 7.82 cents per ASM, which reveals another year-over-year
increase. However, due to the recent implementation of cost saving
measures such as the elimination of travel agency commissions, the
consolidation of the Company's reservations operations, and the Company's
decision to retrofit its 737-700 aircraft with Blended Winglets, second half
2004 unit costs should recede from these levels.
Salaries, wages, and benefits expense per ASM increased 8.1 percent.
Total salaries, wages, and benefits expense of $589 million included
approximately $13 million of costs related to severance and relocation
packages, and a reduction of approximately $3 million in profitsharing expense
associated with the consolidation of the Company's reservations operations.
See Note 8 to the Condensed Consolidated Financial Statements for further
information on the Company's Reservations Center Consolidation.
Approximately 50 percent of the increase in salaries, wages, and benefits
per ASM was due to higher wages from higher average wage rates and approximately
30 percent of the increase was due to Employee severance pay and benefits
related to the Reservations center consolidation. The remainder of the increase
was due to an increase in benefits costs, primarily health care. The Company
currently expectscontinuing wage rate pressures in second quarter 2004.
Fuel and oil expense per ASM increased 4.2 percent primarily due to an
increase in the average fuel cost per gallon. The average fuel cost per
gallon in first quarter 2004 was 79.6 cents, 6.4 percent higher than first
quarter 2003, including the effects of hedging activities. For second
quarter and the remainder of 2004, the Company has fuel hedges in place for
over 80 percent of its expected fuel consumption with a combination of
derivative instruments that effectively cap prices under $24 per barrel of
crude oil. The majority of the Company's near term hedge positions are in
the form of option contracts. During first quarter 2004, because of the
spike in crude oil prices, the fair values of the Company's fuel hedge
contracts increased significantly, ending the quarter with an estimated
gross fair value of $382 million. See Note 5 to the unaudited condensed
consolidated financial statements for further discussion of the Company's
hedging activities.
Maintenance materials and repairs per ASM increased 1.6 percent
primarily due to an increase in repairs for 737-700 aircraft engines, which
is based on a time and materials basis. Expense for these aircraft engines
increased due to the growing number of this type of aircraft in the Company's
fleet, contributing to an increase in repairs for these aircraft engines.
This increase was partially offset by a decrease in expense for 737-200
aircraft engines. The Company is retiring the 737-200 aircraft and they are
currently expected to be completely phased out of the Company's fleet by the
end of January 2005. The Company expects second quarter 2004 maintenance
materials and repairs per ASM to approximate the first quarter 2004 level and
exceed second quarter 2003 expense primarily due to currently scheduled
maintenance activity.
Agency commissions per ASM decreased 85.7 percent primarily due to the
elimination of commissions paid to travel agents, effective December 15,
2003. The Company records commission expense in the period of travel, not the
period of sale. Consequently, the Company will continue to record small
amounts of commission expense until all pre-December 15, 2003 commissionable
sales have been flown. In first quarter 2003, approximately 17 percent of
passenger revenues were commissionable, based on the Company's previous policy
of paying a 5 percent commission to travel agents. For first quarter 2004,
approximately 15 percent of revenues were derived through travel agents, 57
percent through the Company's web site at southwest.com, and the remaining
portion primarily derived through the Company's Reservations Centers. Because
of the change in commission policy, the Company expects a similar year-over-
year comparison for second quarter and the remainder of 2004.
Aircraft rentals per ASM decreased 7.7 percent compared to first
quarter 2003 primarily due to the increase in ASMs relative to the number of
leased aircraft. Although ASMs increased 5.6 percent, the number of leased
aircraft declined by one as a result of a retirement in second quarter
2003. All of the aircraft acquired in 2003 and first quarter 2004 are owned
by the Company. Approximately 22.6 percent of the Company's aircraft fleet
were under operating lease at March 31, 2004, compared to 23.9 percent at
March 31, 2003. The Company currently expects a similar year-over-year
decline for second quarter 2004.
Landing fees and other rentals per ASM increased 9.8 percent compared
to first quarter 2003. Approximately 70 percent of the increase were in other
rentals expense primarily due to the Company's expansion of gate and counter
space at several airports. The remainder of the increase was in landing
fees, primarily due to first half 2003 credits from airports' audits of prior
periods. The amount of credits received in first half 2003 was more than the
amount of credits received in 2004.
Depreciation expense per ASM increased 5.7 percent primarily due to an
increase in owned aircraft. All 22 of the aircraft put into service by the
Company over the past twelve months are owned by the Company. This, along
with the retirement of one leased aircraft, has increased the Company's
percentage of aircraft owned or on capital lease to 77.4 percent at March 31,
2004 from 76.1 percent at March 31, 2003.
Other operating expenses per ASM increased 1.5 percent. The majority
of this increase was due to certain asset write-offs, including assets
written off in connection with the Reservations Center consolidation. See
Note 8 to the Condensed Consolidated Financial Statements. These and other
smaller increases were partially offset by a decrease in aviation insurance
costs. Following the September 2001 terrorist attacks, commercial aviation
insurers dramatically increased the premiums and reduced the amount of war-
risk coverage available to commercial carriers. The federal government
stepped in to provide supplemental third-party war-risk insurance coverage to
commercial carriers for renewable 60-days periods, at substantially lower
premiums than then-prevailing commercial rates and for levels of coverage not
available in the commercial market. The Emergency Wartime Supplemental
Appropriations Act extended the government's mandate to provide war-risk
insurance until August 31, 2004 and permits such coverage to be extended
until December 31, 2004. As a result of more coverage from government
insurance programs and a more stable aviation insurance market, the Company
was able to negotiate lower 2004 aviation insurance premiums than both 2002
and 2003. However, aviation insurance remains substantially higher than
before September 11, 2001.
Other
Interest expense decreased by $7 million, or 26.9 percent, primarily
due to lower effective interest rates. The Company executed two interest-
rate swaps in second quarter 2003 to convert a portion of its fixed-rate debt
to a lower floating rate. The Company entered into interest rate swap
agreements relating to its $385 million 6.5% senior unsecured notes due March
1, 2012 and $375 million 5.496% Class A-2 pass-through certificates due
November 1, 2006. See Note 5 to the unaudited condensed consolidated
financial statements for more information on the Company's hedging
activities. In addition, in October 2003, the Company redeemed $100 million
of senior unsecured 8 3/4% Notes originally issued in 1991.
Capitalized interest increased by $3 million, or 42.9 percent,
primarily due to an increase in progress payment balances for future aircraft
deliveries.
"Other (gains) losses, net" primarily consist of amounts recorded in
accordance with SFAS 133. See Note 5 to the unaudited condensed consolidated
financial statements for more information on the Company's hedging
activities. In first quarter 2004, the Company recognized approximately $6
million of expense related to amounts excluded from the Company's
measurements of hedge effectiveness and $6 million in income related to the
ineffectiveness of its hedges. In first quarter 2003, the Company recognized
approximately $7 million of expense related to amounts excluded from the
Company's measurements of hedge effectiveness and $14 million in income
related to the ineffectiveness of its hedges.
The Company's effective tax rate decreased to 37.90 percent in first
quarter 2004 from 38.5 percent in first quarter 2003 primarily due to the
Company's higher earnings in 2004.
Liquidity and Capital Resources
Net cash provided by operating activities was $417 million for the
three months ended March 31, 2004, compared to $267 million in the same prior
year period. Cash provided by operations in both first quarter 2004 and 2003
was primarily from advance ticket sales from seasonal promotional activity
that caused an increase in air traffic liability. These advance ticket sales
were significantly higher in 2004 than in 2003, due in large part to the Iraq
war in 2003. Net cash provided by operating activities was $1.5 billion for
the 12 months ended March 31, 2004. Cash generated from operating activities
for the 12 months ended March 31, 2004 was primarily used to finance capital
expenditures.
Cash flows used in investing activities during the three months ended
March 31, 2004, totaled $360 million compared to $193 million in 2003.
Investing activities in both years consisted primarily of payments for new
737-700 aircraft delivered to the Company and progress payments for future
aircraft deliveries. Cash flows used in investing activities for the 12
months ended March 31, 2004 totaled $1.4 billion.
Net cash used in financing activities during the three months ended
March 31, 2004, was $98 million compared to zero, net, used in financing
activities in 2003. Cash used in financing activities during 2004 was
primarily to repurchase the Company's common stock.
Contractual Obligations and Contingent Liabilities and Commitments
Southwest has contractual obligations and commitments primarily for
future purchases of aircraft, payment of debt, and lease arrangements.
Following the receipt of seven new 737-700 aircraft from Boeing in the first
quarter 2004, the Company has 40 remaining 737-700 aircraft deliveries for
the remainder of 2004. During 2004, the Company has also exercised options
for the purchase of three additional 737-700 aircraft to be delivered in
2005. The following table details the Company's current firm orders,
options, and purchase rights through 2012.
Current Schedule
Firm Options*
2004** 47 -
2005 31 3
2006 22 12
2007 25 29
2008 6 45
2009-2012 - 177
Total 131 266
* Includes purchase rights
** Includes 7 aircraft delivered through March 31, 2004, and one leased
aircraft
The following table details information on the 393 aircraft in the
Company's fleet as of March 31, 2004:
Average Number Number Number
737 Type Seats Age (Yrs) of Aircraft Owned Leased
- -200 122 21.5 21 19 2
- -300 137 12.8 194 110 84
- -500 122 12.9 25 16 9
- -700 137 3.4 153 152 1
TOTALS 9.6 393 297 96
On aircraft delivered from the manufacturer, the Company has the
option, which must be exercised two years prior to the contractual delivery
date, to substitute -600s or -800s for the -700s. Aggregate funding needed
for firm commitments, as of March 31, 2004, was approximately $3.0 billion,
subject to adjustments for inflation, due as follows: $955 million remaining
in 2004, $827 million in 2005, $645 million in 2006, $523 million in 2007,
and $95 million thereafter.
In January 2004, the Company's Board of Directors authorized the
repurchase of up to $300 million of the Company's common stock, utilizing
present and anticipated proceeds from the exercise of Employee stock options.
Repurchases will be made in accordance with applicable securities laws in the
open market or in private transactions from time to time, depending on
market conditions. No expiration date was given to this program. During
first quarter 2004, the Company repurchased approximately 8.5 million of its
common shares for a total of approximately $125 million. See Item 2 of Part
II of this filing for further information.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at March 31, 2004 of $1.8
billion and internally generated funds. As of March 31, 2004, the Company
has two fully available unsecured revolving credit facilities from which it
can borrow up to $575 million from a group of banks. One of the facilities,
for half of the total amount, is set to expire during April 2004. The other
facility, for half of the amount, is set to expire in April 2005. As of
March 31, 2004, there are no outstanding amounts borrowed under either
facility. The Company expects to terminate both of its current facilities in
April 2004, and replace them with a single three-year facility at an amount
and terms comparable to the current three-year facility. The Company will
also consider various borrowing or leasing options to maximize earnings and
supplement cash requirements.
The Company currently has outstanding shelf registrations for the
issuance of up to $1.0 billion in public debt securities and pass through
certificates, which it may utilize for aircraft financings in the future.
The Company expects that a portion of these securities will be issued in
2004.
Forward looking statements
Some statements in this Form 10-Q (or otherwise made by the Company or on the
Company's behalf from time to time in other reports, filings with the
Securities and Exchange Commission, news releases, conferences, World Wide
Web postings or otherwise) which are not historical facts may be "forward-
looking statements" within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act of
1995. Forward-looking statements include statements about Southwest's
estimates, expectations, beliefs, intentions, or strategies for the future,
and the assumptions underlying these forward-looking statements. Southwest
uses the words "anticipates," "believes," "estimates," "expects," "intends,"
"forecasts," "may," "will," "should," and similar expressions to identify
these forward-looking statements. Forward-looking statements involve risks
and uncertainties that could cause actual results to differ materially from
historical experience or the Company's present expectations. Factors that
could cause these differences include, but are not limited to:
- - Items directly linked to the September 11, 2001 terrorist attacks, such as
the adverse impact of new airline and airport security directives on the
Company's costs and Customer demand for travel, changes in the
Transportation Security Administration's scope for managing U.S. airport
security, the availability and cost of war-risk and other aviation
insurance, including the federal government's provision of third party
war-risk coverage, and the possibility of further terrorist attacks or
additional incidents that could cause the public to question the safety
and/or efficiency of air travel.
- - War or other military actions by the U.S. or others.
- - Competitive factors, such as fare sales and capacity decisions by the
Company and its competitors, changes in competitors' flight schedules,
mergers and acquisitions, codesharing programs, and airline bankruptcies.
- - General economic conditions, which could adversely affect the demand for
travel in general and consumer ticket purchasing habits, as well as
decisions by major freight Customers on how they allocate freight
deliveries among different types of carriers.
- - Factors that could affect the Company's ability to control its costs, such
as the results of Employee labor contract negotiations, Employee hiring
and retention rates, costs for health care, the largely unpredictable
prices of jet fuel, crude oil, and heating oil, the continued
effectiveness of the Company's fuel hedges, changes in the Company's
overall fuel hedging strategy, capacity decisions by the Company and its
competitors, unscheduled required aircraft airframe or engine repairs and
regulatory requirements, changes in commission policy, availability of
capital markets, and future financing decisions made by the Company.
- - Disruptions to operations due to adverse weather conditions and air
traffic control-related constraints.
Caution should be taken not to place undue reliance on the Company's forward-
looking statements, which represent the Company's views only as of the date
this report is filed. The Company undertakes no obligation to update publicly
or revise any forward-looking statement, whether as a result of new
information, future events or otherwise.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 7A. Quantitative and Qualitative Disclosures About Market Risk in
the Company's Annual Report on Form 10-K for the year ended December 31, 2003
and Note 5 to the unaudited condensed consolidated financial statements.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure
that it is able to collect the information it is required to disclose in the
reports it files with the Securities and Exchange Commission (SEC), and to
process, summarize and disclose this information within the time periods
specified in the rules of the SEC. Based on an evaluation of the Company's
disclosure controls and procedures as of the end of the period covered by
this report conducted by the Company's management, with the participation of
the Chief Executive and Chief Financial Officers, the Chief Executive and
Chief Financial Officers believe that these controls and procedures are
effective to ensure that the Company is able to collect, process and disclose
the information it is required to disclose in the reports it files with the
SEC within the required time periods.
Internal Control over Financial Reporting. During the period covered by this
report, there have been no changes in the Company's internal control over
financial reporting that have materially affected or are reasonably likely to
materially affect the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to various legal proceedings and claims arising in the
ordinary course of business, including, but not limited to, examinations by
the Internal Revenue Service (IRS). The IRS regularly examines the Company's
federal income tax returns and, in the course of which, proposes adjustments
to the Company's federal income tax liability reported on such returns. It
is the Company's practice to vigorously contest those proposed adjustments
that it deems lacking of merit.
The Company's management does not expect that the outcome in any of its
currently ongoing legal proceedings or the outcome of any proposed
adjustments presented to date by the IRS, individually or collectively, will
have a material adverse effect on the Company's financial condition, results
of operations or cash flow.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
Issuer Purchases of Equity Securities (1)
(a) (b) (c) (d)
Total number of Maximum dollar
shares purchased value that may
Total number Average as part of publicly yet be purchased
of shares price paid announced plans under the plans
Period purchased per share or programs or programs
January 1,
2004 through
January 31,
2004 923,000 $15.56 923,000 $285,637,931
February 1,
2004 through
February 29,
2004 5,762,000 $14.86 5,762,000 $199,989,557
March 1,
2004 through
March 31,
2004 1,780,000 $13.97 1,780,000 $175,117,457
Total (2) 8,465,000 8,465,000
(1) On January 22, 2004, the Company announced a program for the repurchase
of up to $300 million of the Company's common stock, utilizing present and
anticipated proceeds from the exercise of Employee stock options.
Repurchases will be made in accordance with applicable securities laws in the
open market or in private transactions from time to time, depending on
market conditions. No expiration date was given to this program.
(2) All shares were purchased pursuant to the publicly announced program.
Recent sales of Unregistered Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
b) Reports on Form 8-K
On April 15, 2004, Southwest filed a current report on Form 8-K to furnish
the Company's public announcement of its first quarter 2004 earnings.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOUTHWEST AIRLINES CO.
April 16, 2004 By /s/ Gary C. Kelly
Gary C. Kelly
Executive Vice President -
Chief Financial Officer
(Principal Financial and
Accounting Officer)
EXHIBIT INDEX
Exhibit No. Description
Exhibit 31.1 - Rule 13a-14(a) Certification of Chief Executive Officer
Exhibit 31.2 - Rule 13a-14(a) Certification of Chief Financial Officer
Exhibit 32.1 - Section 1350 Certification of Chief Executive Officer
Exhibit 32.2 - Section 1350 Certification of Chief Financial Officer