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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 September 30, 2002 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 October 25, 2002:
774,646,919
SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in thousands)
(unaudited)
September 30, 2002 December 31, 2001
ASSETS
Current assets:
Cash and cash equivalents $1,944,031 $2,279,861
Accounts and other receivables 125,161 71,283
Inventories of parts and supplies,
at cost 79,226 70,561
Deferred income taxes 46,441 46,400
Prepaid expenses and other current
assets 165,769 52,114
Total current assets 2,360,628 2,520,219
Property and equipment, at cost:
Flight equipment 7,894,347 7,534,119
Ground property and equipment 1,026,958 899,421
Deposits on flight equipment
purchase contracts 318,625 468,154
9,239,930 8,901,694
Less allowance for depreciation 2,720,149 2,456,207
6,519,781 6,445,487
Other assets 73,872 31,435
$8,954,281 $8,997,141
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $371,253 $504,831
Accrued liabilities 521,153 547,540
Air traffic liability 497,040 450,407
Aircraft purchase obligations 20,409 221,840
Short-term borrowings - 475,000
Current maturities of long-term debt 30,025 39,567
Total current liabilities 1,439,880 2,239,185
Long-term debt less current maturities 1,660,907 1,327,158
Deferred income taxes 1,232,760 1,058,143
Deferred gains from sale and leaseback
of aircraft 180,956 192,342
Other deferred liabilities 116,995 166,260
Stockholders' equity:
Common stock 774,033 766,774
Capital in excess of par value 83,820 50,409
Retained earnings 3,416,542 3,228,408
Accumulated other comprehensive
income (loss) 48,388 (31,538)
Total stockholders' equity 4,322,783 4,014,053
$8,954,281 $8,997,141
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in thousands, except per share amounts)
(unaudited)
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
OPERATING REVENUES:
Passenger $1,344,081 $1,292,569 $3,984,231 $4,179,174
Freight 20,430 20,801 63,332 71,451
Other 26,680 21,755 73,669 66,902
Total operating
Revenues 1,391,191 1,335,125 4,121,232 4,317,527
OPERATING EXPENSES:
Salaries, wages,
and benefits 510,106 463,747 1,473,008 1,384,220
Fuel and oil 202,969 192,367 561,668 609,980
Maintenance materials
and repairs 98,531 103,067 296,593 304,501
Agency commissions 12,451 23,240 41,710 83,818
Aircraft rentals 46,540 48,302 140,362 144,226
Landing fees and
other rentals 86,635 79,259 257,789 226,433
Depreciation 92,040 81,722 263,186 237,627
Other operating
expenses 250,778 250,435 757,411 732,717
Total operating
expenses 1,300,050 1,242,139 3,791,727 3,723,522
OPERATING INCOME 91,141 92,986 329,505 594,005
OTHER EXPENSES (INCOME):
Interest expense 26,847 14,271 79,588 47,743
Capitalized interest (4,344) (6,070) (12,823) (17,909)
Interest income (9,960) (10,251) (29,072) (29,369)
Other (gains)
losses, net (45,726) (150,834) (36,946) (136,283)
Total other expenses
(income) (33,183) (152,884) 747 (135,818)
INCOME BEFORE
INCOME TAXES 124,324 245,870 328,758 729,823
PROVISION FOR
INCOME TAXES 49,437 94,906 130,188 282,181
NET INCOME $74,887 $150,964 $198,570 $447,642
NET INCOME PER
SHARE, BASIC $ .10 $ .20 $ .26 $ .59
NET INCOME PER
SHARE, DILUTED $ .09 $ .19 $ .25 $ .55
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic 773,353 763,811 771,592 762,072
Diluted 804,605 806,860 808,270 807,056
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in thousands)
(unaudited)
Nine months ended September 30,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $198,570 $447,642
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation 263,186 237,627
Deferred income taxes 122,752 209,994
Amortization of deferred gains on sale and
leaseback of aircraft (11,386) (11,385)
Amortization of scheduled airframe
inspections & repairs 34,571 30,814
Income tax benefit from Employee stock
option exercises - 30,745
Changes in certain assets and liabilities:
Accounts and other receivables (53,878) 42,785
Other current assets (14,612) 2,279
Accounts payable and accrued liabilities (138,258) 67,032
Air traffic liability 46,633 145,024
Income Taxes - 35,218
Other (41,228) 12,385
Net cash provided by operating activities 406,350 1,250,160
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property and equipment (372,479) (666,795)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt 385,000 -
Proceeds from revolving credit facility - 475,000
Proceeds from trust arrangement 119,142 -
Proceeds from Employee stock plans 40,670 29,263
Payments of long-term debt and
capital lease obligations (56,068) (107,792)
Payments of trust arrangement (364,848) -
Payment of revolving credit facility (475,000) -
Payments of cash dividends (13,872) (13,440)
Other, net (4,725) -
Net cash provided by (used in)
investing activities (369,701) 383,031
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (335,830) 966,396
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 2,279,861 522,995
CASH AND CASH EQUIVALENTS AT END OF PERIOD $1,944,031 $1,489,391
CASH PAYMENTS FOR:
Interest, net of amount capitalized $60,661 $38,303
Income taxes $2,053 $12,150
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 September 30, 2002 and 2001 include
all adjustments (which include only normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the results for
the interim periods. The Condensed Consolidated Balance Sheet as of December
31, 2001 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.
Operating results for the three and nine months ended September 30, 2002 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2002. 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, 2001.
2. Dividends - During the three months ended September 30, 2002, June
30, 2002 and March 31, 2002, dividends of $.0045 per share were declared on the
773.6 million, 772.3 million and 770.7 million shares of common stock then
outstanding, respectively. During the three months ended September 30, 2001,
June 30, 2001 and March 31, 2001, dividends of $.0045 per share were declared
on the 764.0 million, 762.7 million and 760.7 million shares of common stock
then outstanding, respectively.
3. Net income per share - The following table sets forth the
computation of basic and diluted net income per share (in thousands except per
share amounts):
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
NUMERATOR:
Net income
available to
common
stockholders $74,887 $150,964 $198,570 $447,642
DENOMINATOR:
Weighted-average
Shares
outstanding,
basic 773,353 763,811 771,592 762,072
Dilutive effect of
Employee stock
options 31,252 43,049 36,678 44,984
Adjusted weighted-
average shares
outstanding,
diluted 804,605 806,860 808,270 807,056
NET INCOME PER SHARE:
Basic $.10 $.20 $.26 $.59
Diluted $.09 $.19 $.25 $.55
4. Accounting changes - Effective January 1, 2001, the Company adopted
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended (SFAS 133). SFAS 133 requires
the Company to record all financial derivative instruments on its balance sheet
at fair value. Derivatives that are not designated as hedges must be adjusted
to fair value through income. If a derivative is designated as a hedge,
depending on the nature of the hedge, changes in its fair value that are
considered to be effective, as defined, either offset the change in fair value
of the hedged assets, liabilities, or firm commitments through earnings or are
recorded in "Accumulated other comprehensive income (loss)" until the hedged
item is recorded in earnings. Any portion of a change in a derivative's fair
value that is considered to be ineffective, as defined, is recorded immediately
in "Other (gains) losses, net" in the Condensed Consolidated Statement of
Income. Any portion of a change in a derivative's fair value that the Company
elects to exclude from its measurement of effectiveness is required to be
recorded immediately in earnings.
Upon adoption of SFAS 133, the Company recorded the fair value of its fuel
derivative instruments in the Condensed Consolidated Balance Sheet and a
deferred gain of $46.1 million, net of tax, in "Accumulated other comprehensive
income (loss)", of which $45.5 million was recognized in earnings in 2001. See
Note 6 for further information on Comprehensive income. The 2001 adoption
of SFAS 133 has resulted in more volatility in the Company's financial
statements than in the past due to the changes in market values of its
derivative instruments and some ineffectiveness that has been experienced in
its fuel hedges. See Note 5 for further information on the Company's
derivative instruments.
5. Financial derivative instruments - 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 September 30,
2002 and 2001 represented approximately 15.6 percent and 15.5 percent of
Southwest's operating expenses, respectively. 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. As of October 17, 2002, the Company had a mixture of purchased call
options, collar structures, and fixed price swap agreements in place to hedge
approximately 80 percent of its fourth quarter 2002 total anticipated jet fuel
requirements. The Company also had agreements in place to hedge approximately
76 percent of its 2003 total anticipated jet fuel requirements, and smaller
portions of its 2004-2008 total anticipated jet fuel requirements. As of
October 17, 2002, the majority of the Company's remaining 2002 hedges and first
quarter 2003 hedges are effectively heating oil-based positions in the form of
option contracts. The majority of the remaining hedge positions are crude oil-
based option contracts.
The Company accounts for its fuel hedge derivative instruments as cash flow
hedges, as defined in SFAS 133. Therefore, all changes in fair value that are
considered to be effective are recorded in "Accumulated other comprehensive
income (loss)" until the underlying jet fuel is consumed. The fair value of
the Company's financial derivative instruments at September 30, 2002, was a net
asset of approximately $151.6 million. The current portion of this net asset,
approximately $109.1 million, is classified in "Prepaid expenses and other
current assets" and the noncurrent portion, approximately $42.5 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 September 30, 2002 and 2001, the Company
recognized $15.0 million and $23.5 million in gains in "Fuel and oil" expense,
respectively, from hedging activities. The Company recognized approximately
$7.9 million and $504,000 of net expense, related to amounts excluded from the
Company's measurements of hedge effectiveness, in "Other (gains) losses, net"
during the three months ended September 30, 2002 and 2001, respectively. The
Company recognized approximately $6.0 million in additional income and $4.4
million in net expense in "Other (gains) losses, net," related to the
ineffectiveness of its hedges during the three months ended September 30,
2002 and 2001, respectively.
As of September 30, 2002, the Company had approximately $51.2 million in
unrealized gains, net of tax, in "Accumulated other comprehensive income
(loss)" related to fuel hedges. Included in this total are approximately $47.3
million in net unrealized gains that are expected to be realized in earnings
during the twelve months following September 30, 2002.
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 $92.8 million and $278.5 million for the three and
nine months ended September 30, 2002, respectively. Comprehensive income
totaled $120.4 million and $449.0 million for the three and nine months ended
September 30, 2001, respectively. The differences between Net income and
Comprehensive income for each of these periods was as follows (in thousands):
Three months ended September 30,
2002 2001
Net income $74,887 $150,964
Unrealized gain (loss) on
derivative instruments,
net of deferred taxes of
$12,753 and ($19,364) 19,486 (29,975)
Other, net of deferred taxes of
($1,025) and ($375) (1,587) (580)
Total other comprehensive income 17,899 (30,555)
Comprehensive income $92,786 $120,409
Nine months ended September 30,
2002 2001
Net income $198,570 $447,642
Unrealized gain (loss) on
derivative instruments,
net of deferred taxes of
$53,340 and $1,656 82,274 2,563
Other, net of deferred taxes of
($1,516) and ($777) (2,348) (1,202)
Total other comprehensive income 79,926 1,361
Comprehensive income $278,496 $449,003
A rollforward of the amounts included in "Accumulated other comprehensive
income (loss)," net of taxes, is shown below (in thousands):
Accumulated
Fuel other
hedge comprehensive
derivatives Other income (loss)
Balance at December 31, 2001 ($31,063) ($475) ($31,538)
2002 changes in value 90,367 (2,348) 88,019
Reclassification to earnings (8,093) - (8,093)
Balance at September 30, 2002 $51,211 ($2,823) $48,388
7. September 11, 2001 Terrorist Attacks - On September 11, 2001,
terrorists hijacked and used two American Airlines, Inc. aircraft and two
United Air Lines, Inc. aircraft in terrorist attacks on the United States
(terrorist attacks). As a result of these terrorist attacks, the Federal
Aviation Administration (FAA) immediately suspended all commercial airline
flights. The Company resumed flight activity on September 14, 2001, and was
operating its normal pre-September 11 flight schedule by September 18, 2001.
From September 11, 2001, until the Company resumed flight operations on
September 14, 2001, Southwest cancelled approximately 9,000 flights.
Once the Company resumed operations, load factors (percentage of seats filled)
and yields (revenue per mile flown) were severely impacted, along with increased
ticket refund activity. Load factors returned to somewhat normal levels during
fourth quarter 2001. Yields, however, have continued to be weak and below pre-
September 11, 2001 levels.
On September 22, 2001, President Bush signed into law the Air Transportation
Safety and System Stabilization Act (the Act). The Act provides for up to $5
billion in cash grants to qualifying U.S. airlines and freight carriers to
compensate for direct and incremental losses, as defined in the Act, from
September 11, 2001 through December 31, 2001, associated with the terrorist
attacks. Each airline's total eligible grant was determined based on that
airline's percentage of available seat miles (ASMs) during August 2001 to total
eligible carriers' ASMs for August 2001, less an amount set aside for eligible
carriers for whom the use of ASM formula would result in an insufficient
representation of their share of direct and incremental losses.
The Department of Transportation (DOT) has made a final determination of the
amount of eligible direct and incremental losses incurred by Southwest, and the
Company has received 100 percent of its eligible grants as of September 30,
2002, totaling $282.8 million. The Company recognized $235.3 million in "Other
gains" from grants under the Act during the second half of 2001 and recognized
an additional $47.5 million as "Other gains" from grants under the Act in third
quarter 2002 following the receipt of its final payment during the quarter.
Representatives of the DOT or other governmental agencies may perform
additional audit and/or review(s) of the Company's previously submitted final
application. While the Act is subject to significant interpretation of direct
and incremental losses, management believes the Company's eligible direct and
incremental losses are sufficient to retain 100 percent of its eligible grant
following additional audits or reviews, should they occur.
The Company recorded total special charges of $58 million during third quarter
2001 arising from the terrorist attacks. Total special charges included a $30
million reduction in "Passenger revenue." As a result of the events of
September 11, 2001, and Southwest's subsequent temporary relaxation in its
refund policies, the Company experienced refunds far in excess of its
historical refund levels including significant refunds of nonrefundable
tickets. As a result, the Company revised its estimates of refunds, exchanges,
and forfeitures of unused tickets as of September 30, 2001 and recorded a $30
million increase in "Air traffic liability" and a corresponding decrease in
"Passenger revenues." Total special charges also included $15 million in
charges primarily to "Other operating expenses" for write-downs of various
assets due to impairment. Other miscellaneous charges totaling approximately $13
million were also included in "Other (gains) losses, net."
8. Credit facility - In September 2001, the Company borrowed the full
$475 million available under its unsecured revolving credit line with a group
of banks. Borrowings under the credit line bore interest at six-month LIBOR
plus 15.5 basis points. The Company repaid this unsecured revolving credit line
in full, plus accrued interest, in March 2002.
On April 23, 2002, the Company entered into new unsecured revolving credit
facility agreements totaling $575 million with a group of banks. Half of the
total amount of these agreements is available to the Company for three
renewable one-year terms from April 23, 2002. The other half is available to
the Company for a full three-year term. The Company's previous $475 million
revolving credit facility was simultaneously cancelled on April 23, 2002.
9. Issuance of debt - During first quarter 2002, the Company issued
$385 million senior unsecured Notes (Notes) due 2012. The Notes bear interest
at 6.5 percent, payable semi-annually in arrears, with the first payment due on
September 1, 2002. Southwest used the net proceeds from the issuance of the
Notes, approximately $380.2 million, for general corporate purposes.
10. Financing activities - In November 2001, Southwest entered into a
trust arrangement with a special purpose entity (the Trust) and assigned its
purchase agreement with Boeing to the Trust with respect to 19 Boeing 737-700
aircraft originally scheduled to be delivered from September 2001 through April
2002. For the 19 Trust aircraft, the Company recorded the associated assets
("Flight equipment") and liabilities ("Aircraft purchase obligations") in its
financial statements as the aircraft were completed by Boeing and delivered to
the Trust. In the unaudited Condensed Consolidated Statement of Cash Flows,
the Trust's receipt of these aircraft has been recorded as "Purchases of
property and equipment" and "Proceeds from trust arrangement." As of September
30, 2002, 18 of these aircraft had been delivered to and paid for by Southwest
and recorded in the unaudited Condensed Consolidated Statement of Cash Flows as
"Payments of trust arrangement." The one remaining aircraft in the Trust will
be delivered to Southwest in fourth quarter 2002, thereby relieving the
remaining $20.4 million in "Aircraft purchase obligations" in the unaudited
Condensed Consolidated Balance Sheet.
11. Recently issued accounting standards - In July 2002, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 146 (SFAS No. 146), "Accounting for Costs Associated with Exit or Disposal
Activities", which is effective for exit or disposal activities that are
initiated after December 31, 2002. SFAS No. 146 nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." The Company is currently reviewing this statement but
does not expect it to have a material impact on future financial statements or
results of operations.
12. Prepaid expenses and other current assets (in thousands):
September 30, December 31,
2002 2001
Fuel hedge contracts, at fair value $109,141 $ -
Prepaid insurance 24,454 25,645
Other 32,174 26,469
$165,769 $52,114
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Comparative Consolidated Operating Statistics
Relevant Southwest comparative operating statistics for the three and
nine months ended September 30, 2002 and 2001 are as follows:
Three months ended September 30,
2002 2001 Change
Revenue passengers carried 16,255,950 16,207,719 0.3%
Revenue passenger miles (RPMs) (000s) 11,917,932 11,260,082 5.8%
Available seat miles (ASMs) (000s) 17,611,104 16,290,821 8.1%
Load factor 67.7% 69.1% (1.4) pts.
Average length of passenger haul 733 695 5.5%
Trips flown 241,143 235,083 2.6%
Average passenger fare $82.68 $81.60 b. 1.3%
Passenger revenue yield per RPM (cents) 11.28 11.75 b. (4.0)%
Operating revenue yield per ASM (cents) 7.90 8.38 b. (5.7)%
Operating expenses per ASM (cents) 7.38 7.53 b. (2.0)%
Operating expenses per ASM,
excluding fuel (cents) 6.23 6.35 b. (1.9)%
Fuel costs per gallon, excluding
fuel tax (cents) 70.18 69.84 0.5%
Fuel consumed, in gallons 286,969,704 273,222,520 5.0%
Number of Employees at period-end 33,609 30,946 8.6%
Size of fleet at period-end 370 358 3.4%
Nine months ended September 30,
2002 2001 Change
Revenue passengers carried 47,491,651 49,450,492 (4.0)%
Revenue passenger miles (RPMs) (000s) 34,309,389 33,710,859 1.8%
Available seat miles (ASMs) (000s) 51,303,936 48,587,630 5.6%
Load factor 66.9% 69.4% (2.5) pts.
Average length of passenger haul 722 682 5.9%
Trips flown 709,168 705,273 0.6%
Average passenger fare $83.14 a. $85.12 b. (2.3)%
Passenger revenue yield per RPM (cents) 11.51 a. 12.49 b. (7.8)%
Operating revenue yield per ASM (cents) 7.96 a. 8.95 b. (11.1)%
Operating expenses per ASM (cents) 7.39 7.63 b. (3.1)%
Operating expenses per ASM, excluding
fuel (cents) 6.30 6.38 b. (1.3)%
Fuel costs per gallon, excluding
fuel tax (cents) 67.06 74.40 (9.9)%
Fuel consumed, in gallons 834,508,270 812,984,333 2.6%
Number of Employees at period-end 33,609 30,946 8.6%
Size of fleet at period-end 370 358 3.4%
a. Amounts exclude $36 million in revenue during second quarter 2002 related to
a reduction in "Air traffic liability"
b. Amounts exclude special items related to last year's terrorist attacks (See
Note 7)
To a large extent, changes in operating expenses for airlines are driven
by changes in capacity or ASMs flown. The following presents Southwest
operating expenses per ASM for the three and nine months ended September 30,
2002 and 2001 (in cents except percent change):
Three months ended September 30, Per ASM Percent
2002 2001 Change Change
Salaries, wages, and benefits 2.65 2.59 .06 2.3
Employee retirement plans .25 .27 (.02) (7.4)
Fuel and oil 1.15 1.18 (.03) (2.5)
Maintenance materials
and repairs .56 .63 (.07) (11.1)
Agency commissions .07 .14 (.07) (50.0)
Aircraft rentals .26 .30 (.04) (13.3)
Landing fees and other rentals .49 .49 - -
Depreciation .52 .50 .02 4.0
Other operating expenses 1.43 1.52 (.09) (5.9)
Total 7.38 7.62 (.24) (3.1)
Nine months ended September 30, Per ASM Percent
2002 2001 Change Change
Salaries, wages, and benefits 2.64 2.51 .13 5.2
Employee retirement plans .23 .33 (.10) (30.3)
Fuel and oil 1.10 1.26 (.16) (12.7)
Maintenance materials
and repairs .58 .63 (.05) (7.9)
Agency commissions .08 .17 (.09) (52.9)
Aircraft rentals .27 .30 (.03) (10.0)
Landing fees and other rentals .50 .46 .04 8.7
Depreciation .51 .49 .02 4.1
Other operating expenses 1.48 1.51 (.03) (2.0)
Total 7.39 7.66 (.27) (3.5)
Material Changes in Results of Operations
Summary
The airline industry continues to suffer from a persistently weak revenue
and economic environment primarily due to a decline in full-fare traffic. In
addition, the airline industry has experienced challenging operating conditions
resulting from increased airport security measures and substantial increases in
aviation insurance and security fees following the terrorist attacks. However,
the Company has benefited from reduced distribution costs and cost reduction
measures implemented post-September 11, 2001. While the Company's
profitability levels have been considerably below pre-September 11, 2001
levels, Southwest has reported profitable earnings performances since September
11, 2001 through third quarter 2002.
Special charges and/or Unusual items. Financial results for both 2001 and
2002 have been distorted by the September 11, 2001 terrorist attacks and the
resulting aftermath. During third quarter 2001, the Company recorded $168.7
million in "Other gains" that the Company recognized from grants under the Act
and special charges of approximately $58 million arising from the terrorist
attacks. See Note 7 to the unaudited condensed consolidated financial
statements for more information on the special charges. Also, the Company
estimated its adverse revenue impact resulting from the terrorist attacks was
approximately $188 million for third quarter 2001.
During second quarter 2002, the Company recognized $36 million in
additional passenger revenue from a reduction in estimated refunds, exchanges,
and forfeited tickets included in "Air traffic liability." As the demand for
full fare unrestricted air transportation has weakened, Southwest's mix of
discounted nonrefundable fares has increased. Nonrefundable fares are the
primary source of forfeited tickets, and this change in Customer travel
patterns led to a second quarter 2002 reduction in estimated liabilities for
estimated refunds, exchanges, and forfeited tickets as of June 30, 2002 and a
corresponding increase in "Passenger revenue." Also, during third quarter
2002, the Company recognized approximately $47.5 million in "Other gains" from
grants under the Act (see Note 7).
Consolidated net income for third quarter 2002 was $74.9 million ($.09
per share, diluted), 50.4 percent below the third quarter 2001 net income of
$151.0 million ($.19 per share, diluted). Third quarter 2002 operating income
was $91.1 million compared to operating income of $137.6 million in 2001,
excluding special charges and unusual items. The decrease in operating income
was primarily due to increases in salaries, wages, and benefits, fuel expense,
depreciation expense, and aviation insurance, which more than offset a slight
increase in passenger revenues and lower commission expense. Excluding special
charges and unusual items, third quarter 2002 net income was $50.5 million, or
$.06 per share, diluted, compared to third quarter 2001 net income of $82.8
million, or $.10 per share, diluted.
For the nine months ended September 30, 2002, net income was $198.6
million ($.25 per share, diluted), as compared to net income of $447.6 million
($.55 per share, diluted) in the same prior year period. For the nine months
ended September 30, 2002, operating income decreased 44.5 percent to $329.5
million compared to operating income of $594.0 million in 2001. The decrease
in operating income was primarily due to a decrease in revenues resulting from
the lingering impact of the prior year terrorist attacks and continued weak
economic conditions. Although the Company has experienced significant increases
in aviation insurance and security fees, we have been able to mitigate such
increases through lower agency commissions, profitsharing expense, and other
cost reduction efforts implemented following the terrorist attacks.
Excluding special charges and unusual items, net income for the nine months
ended 2002 was $156.3 million ($.19 per share, diluted), versus $379.5 million
($.47 per share, diluted) for the same period in 2001.
Security. The Company has responded and reacted swiftly to numerous new
and changing Federal Security Directives, which have dramatically changed the
manner in which Customers, luggage, and airplanes are protected and cleared for
flight. This has created various challenges at each of the 59 airports we
currently serve. Thus far, these enhanced security measures were implemented
in such a way as to not diminish our aircraft productivity. The Company has
successfully implemented its new Automated Boarding Pass and is in the process
of installing self-service RAPID CHECK-IN kiosks at airports. Through
initiatives such as these and the diligent efforts of the Transportation
Security Administration (TSA), the overall airport experience for our Customers
has improved tremendously since September 11, 2001. We will continue to
aggressively implement changes to further improve Customer Service and our
operational efficiency. The Aviation and Transportation Security Act requires
the TSA to perform 100 percent inspection of checked baggage by December 31,
2002. However, the TSA has not announced how it intends to comply with this
requirement, and, thus, we are unable to predict what impact new procedures may
have on the Company's operations and financial performance.
Insurance. Following the terrorist attacks, commercial aviation insurers
significantly increased the premiums for coverage related to acts of terrorism
(war-risk coverage) and reduced the amount of coverage available to commercial
carriers. At that time, the federal government, through passage of the Act,
supplemented the amount of coverage available to commercial carriers for
renewable 60-days periods. Thus far, this supplemental coverage has been
extended through December 15, 2002. If the supplemental coverage from the
federal government is not extended beyond this date, the Company's insurance
costs would most likely increase substantially. (The immediately preceding
sentence is a forward-looking statement involving uncertainties that could
result in actual results differing materially from expected results. Such
uncertainties include, but may not be limited to, costs and availability of
insurance including the federal government's coverage of third party war-risk
coverage, etc.)
Aircraft and Engine Maintenance. The cost of scheduled engine inspections
and repairs and routine maintenance costs for aircraft and engines are charged
to maintenance expense as incurred. Scheduled airframe inspections and repairs,
known as "D" checks, are generally performed every ten years. Costs related to
"D" checks are capitalized and amortized over the estimated period benefited,
presently the least of ten years, the time until the next "D" check, 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.
In 2001, the American Institute of Certified Public Accountants (AICPA)
issued a Proposed Statement of Position entitled "Accounting for Certain Costs
and Activities Related to Property, Plant, and Equipment" (Proposed SOP).
Although the AICPA continues to deliberate the Proposed SOP, if implemented, the
Proposed SOP could change the way in which the Company accounts for its property
and equipment and certain aircraft maintenance costs, including "D" checks.
Comparison of Three Months Ended September 30, 2002 to Three Months Ended
September 30, 2001
Consolidated operating revenues increased by $56.1 million, or 4.2
percent, primarily due to a $51.5 million, or 4.0 percent increase in passenger
revenues. The increase in passenger revenues was primarily due to: the
cancellation of approximately 9,000 flights from September 11 through September
17, 2001 following the terrorist attacks; the subsequent decline in air traffic
demand upon the resumption of scheduled service; and the $30 million special
charge to reduce third quarter 2001 passenger revenue as a result of the
terrorist attacks (see Note 7 to the unaudited condensed consolidated financial
statements).
Third quarter 2002 capacity, as measured by ASMs, increased 8.1 percent.
Approximately half of the increase in ASMs related to the cancellation of
approximately 9,000 scheduled flights following the terrorist attacks, with the
remaining portion resulting from the net addition of 12 aircraft (net of six
retirements) from October 2001 through September 2002. The third quarter
2002 load factor was 67.7 percent, a decrease of 1.4 points compared to 2001.
The Company also experienced a slight increase in revenue passengers carried
and a 5.8 percent increase in RPMs. Excluding special charges, passenger yield
decreased 4.0 percent and operating revenue per ASM (RASM) declined 5.7 percent
compared to 2001, a quarter which included the direct, adverse impact from the
September 11, 2001 terrorist attacks. Revenue trends did not improve from
second quarter 2002 and were negatively affected by the September 11
anniversary.
If current revenue and booking trends continue for the remainder of the
fourth quarter, unit revenues may exceed last year's fourth quarter unit revenue
performance of $.0741. While we are hopeful our revenue trends will, in fact,
improve, it is impossible to predict whether they will or what effect a
potential war with Iraq might have. The uncertain revenue outlook, coupled with
the cost pressures including aviation insurance premiums and security fees, make
it impossible to predict whether the Company will earn a profit in fourth
quarter 2002. (The immediately preceding three sentences are forward-looking
statements that involve uncertainties that could result in actual results
differing materially from expected results. Some significant factors include,
but may not be limited to, additional incidents that could cause the public to
question the safety and/or efficiency of air travel, competitive pressure such
as fare sales and capacity changes by other carriers, war or other military
actions by the U.S., general economic conditions, and variations in advance
booking trends.)
Consolidated freight revenues decreased by $.4 million, or 1.8 percent
primarily due to a large decrease in U.S. mail shipments as the U.S. Postal
Service diverted more of its mail shipments to freight carriers and away from
commercial airlines once commercial air service was restored following the
terrorist attacks. This trend had not reversed through September 11, 2002,
making comparisons difficult. However, for fourth quarter 2002, the Company
expects a year-over-year increase in consolidated freight revenues compared to
fourth quarter 2001 primarily due to increases in capacity and cargo shipments.
(The immediately preceding sentence is a forward-looking statement that
involves uncertainties that could result in actual results differing materially
from expected results. Some significant factors include, but may not be limited
to, decisions by major freight customers on how they allocate freight deliveries
among different types of carriers, general economic conditions, etc.) Other
revenues increased in third quarter 2002 by $4.9 million, or 22.6 percent
primarily due to an increase in commissions earned from programs the Company
sponsors with certain business partners, such as the Company sponsored First USA
Visa card. That increase was partially offset by a decline in charter revenues.
Operating expenses per ASM (CASM) were $.0738, a 3.1 percent decrease
compared to $.0762 for 2001. Excluding fuel expense and third quarter 2001
special charges, operating expenses per ASM declined 1.9 percent to $.0623.
The cancellation of approximately 9,000 flights as a result of the terrorist
attacks impacted several of the operating expense captions in the Condensed
Consolidated Statements of Income, for the three and nine months ended
September 30, 2001, that are measured as a percentage of ASMs. However, the
captions that typically fluctuate with actual flight activity, such as fuel and
landing fees, were not materially affected on a per ASM basis. Based on
current cost trends, we expect fourth quarter 2002's CASM to exceed third
quarter 2002 levels primarily as a result of higher fuel prices, labor costs,
and maintenance costs. (The immediately preceding sentence is a forward-
looking statement that involves uncertainties that could result in actual
results differing materially from expected results. Some significant factors
include, but may not be limited to, capacity changes by the Company and its
competitors, changing security requirements, premiums for aviation liability
insurance, labor issues, etc.)
Salaries, wages, and benefits per ASM increased 2.3 percent. The
increase was due to increases in headcount in certain operational areas to
comply with changing Federal Security Directives and for projects designed to
improve the overall airport experience of our Customers, as well as wage rate
increases. For these same reasons, we are expecting an increase in salaries,
wages, and benefits per ASM in fourth quarter 2002 compared to third quarter
2002. (The immediately preceding sentence is a forward-looking statement that
involves uncertainties that could result in actual results differing materially
from expected results. Some significant factors include, but may not be limited
to, Employee hiring and retention rates, the results of Employee labor contract
negotiations, costs for health care, capacity decisions made by the Company,
etc.)
The Company's Pilots are subject to an agreement with the Southwest
Airlines Pilots' Association (SWAPA.) In August 2002, the Company's
agreement with its Pilots, which was to become amendable in September 2004, was
extended for two additional years, until September 2006. As part of the
extension, the Pilots received pay raises and options to purchase up to a total
of 39.2 million shares of the Company's common stock, subject to the
requirements of the terms of the 2002 SWAPA Nonqualified Stock Option Plan,
which became effective in August 2002.
The Company's Professional Flight Instructors are subject to an agreement
with the Southwest Airlines Professional Flight Instructors Association
(SWAPIA.) The Company's agreement with its Flight Instructors, which was to
become amendable in December 2010, was extended for two additional years, until
December 2012. As part of the extension, the Flight Instructors received
options to purchase up to a total of 250,000 shares of the Company's common
stock, subject to the requirements of the terms of the 2002 SWAPIA Nonqualified
Stock Option Plan, which became effective in August 2002.
The Company's Mechanics are subject to an agreement with the
International Brotherhood of Teamsters (the Teamsters), which became amendable
in August 2001. The Company reached an agreement with the Teamsters, which was
ratified by its membership in October 2002. As part of the agreement, which
expires in August 2005, the Mechanics received retroactive pay raises and
options to purchase up to a total of 4.1 million shares of the Company's common
stock.
The Company's Ramp, Operations, and Provisioning Agents are subject to an
agreement with the Transport Workers Union of America (TWU), which becomes
amendable in June 2006. The Company has provided the TWU a proposal to extend
the contract for two years to June 2008 in exchange for the granting of options
to purchase the Company's common stock. The proposal will be presented to the
TWU membership for voting in fourth quarter 2002.
The Company's Flight Attendants are subject to an agreement with the TWU,
which became amendable in June 2002. The Company's Customer Service and
Reservations Agents are subject to an agreement with the International
Association of Machinists and Aerospace Workers, which becomes amendable in
November 2002. The Company is currently involved in negotiations with both of
these groups.
Employee retirement plans expense per ASM decreased 7.4 percent,
primarily due to the decrease in Company earnings available for profitsharing.
Fuel and oil expense per ASM decreased 2.5 percent primarily due to a
decrease in the Company's fuel burn rate per ASM flown. The average jet fuel
cost per gallon in third quarter 2002 was $.7018, a slight increase compared to
$.6984 in third quarter 2001, including the effects of hedging activities. See
Note 5 to the unaudited condensed consolidated financial statements for further
discussion of the Company's hedging activities. As of October 17, 2002, the
Company had fuel derivatives in place to hedge approximately 80 percent of its
fourth quarter 2002 total anticipated jet fuel requirements. As of September
30, 2002, the fair value of all the Company's fuel derivatives was a net asset
of approximately $151.6 million versus a net liability of approximately $19.4
million at December 31, 2001. The significant increase in fair value of fuel
derivatives is due to the Company's addition of future years' positions and an
increase in the current and forward market prices for crude oil and heating
oil. The majority of the Company's near term hedge positions are in the form of
option contracts, which should enable the Company to benefit from a decline in
jet fuel prices. (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 prices of jet fuel, crude oil,
and heating oil prices, the continued effectiveness of the Company's fuel
hedges, and changes in the Company's overall fuel hedging strategy.)
Maintenance materials and repairs per ASM decreased 11.1 percent
primarily due to a decrease in the number of outsourced heavy maintenance
events versus third quarter 2001. The Company expects fourth quarter 2002
maintenance materials and repairs per ASM to be higher than third quarter 2002
expense due to currently scheduled maintenance. (The immediately preceding
sentence is a forward-looking statement involving uncertainties that could
result in actual results differing materially from expected results. Such
uncertainties include, but may not be limited to, any unscheduled required
aircraft airframe or engine repairs and regulatory requirements.)
Agency commissions per ASM decreased 50.0 percent primarily due to a
change in the Company's commission rate policy. Effective October 15, 2001,
the Company reduced the commission paid to travel agents to five percent (with
no cap), regardless of the type of ticket sold. Previously, the Company paid
an eight percent commission rate on ticketless bookings by travel agents.
Further, the percentage of commissionable revenues decreased from approximately
23 percent in third quarter 2001 to approximately 19 percent in third quarter
2002. The Company currently expects commissionable revenues to remain in the 19
percent range in fourth quarter 2002. (The immediately preceding sentence is a
forward-looking statement involving uncertainties that could result in actual
results differing materially from expected results. Such uncertainties
include, but may not be limited to, changes in consumer ticket purchasing
habits and further commission policy changes.)
Aircraft rentals per ASM decreased 13.3 percent compared to third quarter
2001 due to a reduction in the number of aircraft under lease. The Company
retired two leased aircraft in fourth quarter 2001 and one leased aircraft in
each of the first and second quarters of 2002. All of the aircraft acquired in
2002 have been purchased. Approximately 24.3 percent of the Company's aircraft
fleet was under operating lease at September 30, 2002, compared to 26.3 percent
at September 30, 2001.
Landing fees and other rentals per ASM were flat compared to third
quarter 2001 as a 12.4 percent increase in landing fees per ASM was offset by a
6.7 percent decrease in other rentals per ASM. The increase in landing fees
expense per ASM primarily was due to third quarter 2001 credits from airports'
audits of prior periods. The amount of credits received in third quarter 2002
was substantially less than the same prior year period. The decrease in other
rentals expense per ASM was primarily due to an abnormally large amount of
charges the Company paid to various airports in third quarter 2001 from audits
of prior periods. No such charges were incurred during third quarter 2002.
Depreciation expense per ASM increased 4.0 percent primarily due to an
increase in owned aircraft. All 18 of the aircraft put into service by the
Company over the past twelve months have been purchased. This, along with the
retirement of six aircraft, four of which were leased, has increased the
Company's percentage of aircraft owned or on capital lease to 75.7 percent at
September 30, 2002 from 73.7 percent at September 30, 2001.
Other operating expenses per ASM decreased 5.9 percent primarily due to
third quarter 2001 special charges incurred to write down the value of certain
assets. See Note 7 to the unaudited condensed consolidated financial
statements for more information on the special charges. Excluding third quarter
2001 charges, other operating expenses per ASM were flat compared to the prior
year as substantial increases in aviation insurance costs were offset through
various cost control measures implemented immediately following the prior year
terrorist attacks, including reductions in personnel related expenses and
office expenses.
Interest expense increased by $12.6 million, or 88.1 percent primarily
due to two separate borrowings executed by the Company over the past twelve
months. During the fourth quarter 2001, the Company issued $614.3 million in
long-term debt in the form of Pass-Through Certificates and in first quarter
2002 issued $385 million in unsecured notes (see Note 9 to the unaudited
condensed consolidated financial statements). The increase in expense caused
by these borrowings was partially offset by a decrease in interest rates on the
Company's floating rate debt. Based on these borrowings, interest expense will
be higher on a year-over-year basis in fourth quarter 2002. (The immediately
preceding sentence is a forward-looking statement involving uncertainties that
could result in actual results differing materially from expected results.
Such uncertainties include, but may not be limited to, subsequent financing
decisions made by the Company.)
Capitalized interest decreased by $1.7 million, or 28.4 percent primarily
due to a reduction in progress payment balances for future aircraft deliveries.
Interest income decreased by $.3 million, or 2.8 percent as higher
invested cash balances were more than offset by a decrease in rates earned on
investments.
In third quarter 2002 and 2001, "Other (gains) losses, net" included
$47.5 million and $168.7 million, respectively, of government grant funds from
the Act. See Note 7 to the unaudited condensed consolidated financial
statements for more information on the grants. Also reflected in "Other
(gains) losses, net" in third quarter 2002 and 2001 are net charges 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.
The Company recognized $7.9 million and $504,000 of expense related to amounts
excluded from the Company's measurements of hedge effectiveness, during the
third quarters of 2002 and 2001, respectively. In addition, the Company
recognized approximately $6.0 million in additional income and $4.4 million as
net expense related to the ineffectiveness of its hedges during the third
quarters of 2002 and 2001, respectively.
Comparison of Nine Months Ended September 30, 2002 to Nine Months Ended
September 30, 2001
Consolidated operating revenues decreased by $196.3 million, or 4.5
percent, primarily due to a $194.9 million decrease in passenger revenues. The
decrease in passenger revenues primarily was due to a weaker domestic airline
revenue environment compared to the same period in 2001, especially for
business or full fare Customers. Excluding unusual items (as previously
discussed and in Note 7 to the unaudited condensed consolidated financial
statements), passenger yield was $.1151, a decrease of 7.8 percent compared to
the same period of 2001. Capacity increased 5.6 percent, primarily as a result
of the net addition of 12 aircraft (net of six retirements) from October 2001
through September 2002. The Company's load factor for the nine months ended
September 30, 2002, was 66.9 percent, a decrease of 2.5 points compared to the
same period in 2001. The Company also experienced a 4.0 percent decrease in
revenue passengers carried and a 1.8 percent increase in RPMs.
Consolidated freight revenues decreased by $8.1 million, or 11.4 percent
primarily due to a decrease in U.S. mail shipments. Other revenues increased
by $6.8 million, or 10.1 percent primarily due to an increase in commissions
earned from programs the Company sponsors with certain business partners, such
as the Company sponsored First USA Visa card. That increase was partially
offset by a decline in charter revenues.
Operating expenses per ASM were $.0739, a 3.5 percent decrease compared to
$.0766 for 2001. Excluding fuel expense and 2001 special charges, operating
expenses per ASM declined 1.3 percent to $.0630.
Salaries, wages, and benefits per ASM increased 5.2 percent.
Approximately 74 percent of the increase was in salaries and wages, as the
Company's headcount growth exceeded the increase in ASMs. The Company has
increased headcount in certain operational areas to comply with enhanced
federal security regulations, and to aid in projects designed to improve the
overall airport experience of its Customers. Approximately 26 percent of the
increase primarily was due to increasing health care costs.
Employee retirement plans expense per ASM decreased 30.3 percent,
primarily due to the decrease in Company earnings available for profitsharing.
Fuel and oil expense per ASM decreased 12.7 percent primarily due to a
9.9 percent decrease in the average jet fuel cost per gallon compared to 2001.
The average jet fuel cost per gallon in 2002 was $.6706 compared to $.7440 in
2001, including the effects of hedging activities. See Note 5 to the unaudited
condensed consolidated financial statements for more information on the
Company's hedging activities.
Maintenance materials and repairs per ASM decreased 7.9 percent primarily
due to a decrease in airframe maintenance expense per ASM. This decrease
primarily was due to a decrease in the number of outsourced heavy maintenance
events versus 2001.
Agency commissions per ASM decreased 52.9 percent. Approximately half of
the decrease was due to a change in the Company's commission rate policy, and
half was due to the decline in revenues and the mix of commissionable revenues.
Effective October 15, 2001, the Company reduced the commission paid to travel
agents to five percent (with no cap), regardless of the type of ticket sold.
Previously, the Company paid an eight percent commission rate on ticketless
bookings by travel agents. The percentage of commissionable revenues decreased
from approximately 25 percent in 2001 to approximately 20 percent in 2002.
Aircraft rentals per ASM decreased 10.0 percent due to a lower percentage
of the aircraft fleet being leased. The Company retired two leased aircraft in
fourth quarter 2001 and one leased aircraft in each of the first and second
quarter 2002. Approximately 24.3 percent of the Company's aircraft fleet was
under operating lease at September 30, 2002, compared to 26.3 percent at
September 30, 2001.
Landing fees and other rentals per ASM increased 8.7 percent.
Approximately 60 percent of the increase was due to an increase in Southwest's
share of landing fee rates at certain airports as a result of capacity
reductions by other airlines. Approximately 40 percent of the increase was due
to an increase in airport terminal rentals resulting from the Company's
expansion of facilities in several airports, most notably Chicago Midway
Airport and Baltimore/Washington International Airport.
Depreciation expense per ASM increased 4.1 percent due to a higher number
of owned aircraft. All 18 of the aircraft put into service by the Company over
the past twelve months have been purchased. This, along with the retirement of
six aircraft, four of which were leased, has increased the Company's percentage
of aircraft owned or on capital lease to 75.7 percent at September 30, 2002
from 73.7 percent at September 30, 2001.
Other operating expenses per ASM decreased 2.0 percent due to the 2001
special charges incurred. See Note 7 to the unaudited condensed consolidated
financial statements for more information on the 2001 special charges.
Excluding these third quarter 2001 charges, other operating expenses per ASM
were flat compared to the prior year as substantial increases in aviation
insurance costs were offset with various cost control measures implemented
immediately following the prior year terrorist attacks resulting in decreases in
areas such as personnel related expenses and office expenses.
Interest expense increased by $31.8 million, or 66.7 percent due to three
separate borrowings executed by the Company since the terrorist attacks. In
September 2001, the Company borrowed $475 million under its revolving credit
facility. This borrowing was repaid in March 2002. During the fourth quarter
2001, the Company issued $614.3 million in long-term debt in the form of Pass-
Through Certificates and, in first quarter 2002, issued $385 million in
unsecured notes (see Note 9 to the unaudited condensed consolidated financial
statements). The increase in expense caused by these borrowings was partially
offset by a decrease in interest rates on the Company's floating rate debt and
the July 2001 redemption of $100 million of unsecured notes.
Capitalized interest decreased by $5.1 million, or 28.4 percent primarily
due to a reduction in progress payment balances for future aircraft deliveries.
Interest income decreased by $.3 million, or 1.0 percent compared to the
same period of 2001 as substantially higher invested cash balances were more
than offset by a decrease in rates earned on investments.
In 2002 and 2001, "Other (gains) losses, net" included $47.5 million and
$168.7 million, respectively, recognized as the Company's share of government
grant funds from the Act. See Note 7 to the unaudited condensed consolidated
financial statements for more information on the grants. Also reflected in
"Other (gains) losses, net" in 2002 and 2001 are net charges 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.
The Company recognized approximately $19.9 million and $13.6 million of
expense, related to amounts excluded from the Company's measurements of hedge
effectiveness during 2002 and 2001, respectively. The Company recognized
approximately $8.0 million as additional income and $5.2 million as net expense
related to the ineffectiveness of its hedges during 2002 and 2001, respectively.
Liquidity and Capital Resources
Net cash provided by operating activities was $406.4 million for the nine
months ended September 30, 2002 and $640.8 million for the 12 months then
ended. In addition, the Company issued $385 million in unsecured notes and
repaid its $475 million revolving credit facility during the nine months ended
September 30, 2002. See Notes 8 and 9 to the unaudited condensed consolidated
Financial statements. Cash generated for the 12 months ended September 30,
2002 was primarily used to finance aircraft-related capital expenditures and to
provide working capital.
During the 12 months ended September 30, 2002, net capital expenditures
were $703.5 million, which primarily related to the purchase of new 737-700
aircraft and progress payments for future aircraft deliveries.
The Company's contractual purchase commitments consist primarily of
scheduled aircraft acquisitions. As a result of the terrorist attacks, the
Company modified its future delivery dates to defer the acquisition of 19 new
737-700 aircraft that were either already in production at Boeing or were
scheduled to be built through April 2002 through an arrangement with a special
purpose trust (the Trust). The Trust was formed primarily to facilitate the
refinancing of the Company's near-term aircraft purchase obligations with
Boeing. Through the Trust, the Company had accepted 18 of these 19 aircraft as
of September 30, 2002, and has scheduled the one remaining aircraft for
delivery in October 2002. For the 19 Trust aircraft, the Company recorded the
associated assets ("Flight equipment") and liabilities ("Aircraft purchase
obligations") in its financial statements as the aircraft were completed by
Boeing and delivered to the Trust. All 19 aircraft were reflected in the
Company's financial statements as of September 30, 2002. The cost of
refinancing these aircraft obligations, approximately $5 million, was expensed.
See Note 10 to the unaudited condensed consolidated financial statements for
more information on the Trust.
As of September 30, 2002, in addition to the one remaining aircraft that
will be delivered from the Trust in October 2002, the Company has contractual
purchase commitments, aircraft purchase options, and aircraft purchase rights
with Boeing for a total of 417 aircraft through 2012. This total includes four
aircraft deliveries in fourth quarter 2002, 17 firm aircraft deliveries in
2003, and future commitments, including options and purchase rights, of 396
aircraft for 2004 through 2012. 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 737-700s. Including the amounts associated with the
Trust that are included as liabilities in the Company's Condensed Consolidated
Balance Sheet, aggregate (cash basis) funding needed for firm commitments, as
of September 30, 2002, is approximately $3.4 billion, subject to adjustments for
inflation, due as follows: $224 million in 2002, $ 571 million in 2003, $643
million in 2004, $719 million in 2005, $632 million in 2006, and $613 million
thereafter.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at September 30, 2002 of $1.9
billion and internally generated funds. On April 23, 2002, the Company entered
into new unsecured revolving credit facility agreements totaling $575 million
with a group of banks. Half of the total amount of these agreements is
available to the Company for three renewable one-year terms from April 23,
2002. The other half is available to the Company for a full three-year term.
The Company's previous $475 million revolving credit facility, which was fully
repaid in March 2002 (See Note 8 to the financial statements), was
simultaneously cancelled on April 23, 2002. The Company will also consider
various borrowing or leasing options to maximize earnings and supplement cash
requirements.
The Company has outstanding shelf registration statements for the
issuance of an additional $319 million in public debt securities and pass
through certificates, which the Company could utilize to finance aircraft
during 2002 and 2003. The Company plans to file a registration statement in
fourth quarter 2002 that would allow the issuance of up to a total of $1
billion in public debt securities and pass through certificates.
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,
2001 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 their evaluation of the Company's
disclosure controls and procedures which took place as of a date within 90 days
of the filing date of this report, 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.
The Company also maintains a system of internal controls designed to
provide reasonable assurance that: transactions are executed in accordance with
management's general or specific authorization; transactions are recorded as
necessary (1) to permit preparation of financial statements in conformity with
generally accepted accounting principles, and (2) to maintain accountability
for assets; access to assets is permitted only in accordance with management's
general or specific authorization; and the recorded accountability for assets
is compared with the existing assets at reasonable intervals and appropriate
action is taken with respect to any differences.
Since the date of the most recent evaluation of the Company's internal
controls by the Chief Executive and Chief Financial Officers, there have been
no significant changes in such controls or in other factors that could have
significantly affected those controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
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 and Use of Proceeds
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
10.1 3-year Competitive Advance and Revolving Credit Facility
Agreement among Southwest Airlines Co., the banks party thereto,
and JPMorgan Chase Bank, as Administrative Agent as of April 23,
2002
10.2 364-day Competitive Advance and Revolving Credit Facility
Agreement among Southwest Airlines Co., the banks party thereto,
and JPMorgan Chase Bank, as Administrative Agent as of April 23,
2002
10.3 Supplemental Agreements Nos. 20, 21, 22, 23 and 24 to
Purchase Agreement No. 1810, dated January 19, 1994 between The
Boeing Company and Southwest.
Pursuant to 17 CFR 240.24b-2, confidential information has been
omitted and has been filed separately with the Securities and
Exchange Commission pursuant to a Confidential Treatment
Application filed with the Commission.
99.1 Certifications Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
b) Reports on Form 8-K
On July 30, 2002, Southwest filed a current report on Form 8-K
to file executed sworn statements required by SEC Order 4-460
from its Chief Executive Officer and its Chief Financial
Officer.
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.
October 30, 2002 By /s/ Gary C. Kelly
Gary C. Kelly
Executive Vice President -
Chief Financial Officer
(Principal Financial and
Accounting Officer)
CERTIFICATION
I, Gary C. Kelly, Executive Vice President and Chief Financial Officer of
Southwest Airlines Co., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Southwest
Airlines Co.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
October 30, 2002 By /s/ Gary C. Kelly
Gary C. Kelly
Executive Vice President - Chief
Financial Officer
CERTIFICATION
I, James F. Parker, Chief Executive Officer of Southwest Airlines Co.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Southwest
Airlines Co.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
October 30, 2002 By /s/ James F. Parker
James F. Parker
Chief Executive Officer
EXHIBIT INDEX
Exhibit No. Description
Exhibit 10.1 - 3-year Competitive Advance and Revolving Credit Facility
Agreement among Southwest Airlines Co., the banks party
thereto, and JPMorgan Chase Bank, as Administrative
Agent as of April 23, 2002
Exhibit 10.2 - 364-day Competitive Advance and Revolving Credit
Facility Agreement among Southwest Airlines Co., the
banks party thereto, and JPMorgan Chase Bank, as
Administrative Agent as of April 23, 2002
Exhibit 10.3 - Supplemental Agreements Nos. 20, 21, 22, 23 and 24 to
Purchase Agreement No. 1810, dated January 19, 1994
between The Boeing Company and Southwest.
Pursuant to 17 CFR 240.24b-2, confidential information
has been omitted and has been filed separately with the
Securities and Exchange Commission pursuant to a
Confidential Treatment Application filed with the
Commission.
Exhibit 99.1 - Certifications Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002