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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, 2003 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 17, 2003:
778,897,115
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, 2003 December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents $1,889 $1,815
Accounts and other receivables 159 175
Inventories of parts and supplies,
at cost 95 86
Fuel hedge contracts 97 113
Prepaid expenses and other
current assets 36 43
Total current assets 2,276 2,232
Property and equipment, at cost:
Flight equipment 8,110 8,025
Ground property and equipment 1,062 1,042
Deposits on flight equipment
purchase contracts 468 389
9,640 9,456
Less allowance for depreciation
and amortization 2,906 2,810
6,734 6,646
Other assets 94 76
$9,104 $8,954
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $367 $362
Accrued liabilities 514 529
Air traffic liability 535 412
Current maturities of long-term debt 132 131
Total current liabilities 1,548 1,434
Long-term debt less current maturities 1,547 1,553
Deferred income taxes 1,243 1,227
Deferred gains from sale and leaseback
of aircraft 180 184
Other deferred liabilities 127 134
Stockholders' equity:
Common stock 778 777
Capital in excess of par value 146 136
Retained earnings 3,476 3,455
Accumulated other comprehensive
income 59 54
Total stockholders' equity 4,459 4,422
$9,104 $8,954
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
Three months ended March 31,
2003 2002
OPERATING REVENUES:
Passenger $1,306 $1,215
Freight 22 21
Other 23 21
Total operating revenues 1,351 1,257
OPERATING EXPENSES:
Salaries, wages, and benefits 516 462
Fuel and oil 208 170
Maintenance materials and repairs 106 97
Agency commissions 12 14
Aircraft rentals 45 47
Landing fees and other rentals 90 83
Depreciation and amortization 93 85
Other operating expenses 235 250
Total operating expenses 1,305 1,208
OPERATING INCOME 46 49
OTHER EXPENSES (INCOME):
Interest expense 26 26
Capitalized interest (7) (4)
Interest income (5) (10)
Other (gains) losses, net (7) 2
Total other expenses 7 14
INCOME BEFORE INCOME TAXES 39 35
PROVISION FOR INCOME TAXES 15 14
NET INCOME $24 $21
NET INCOME PER SHARE, BASIC $ .03 $ .03
NET INCOME PER SHARE, DILUTED $ .03 $ .03
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic 778 769
Diluted 808 811
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
Three months ended March 31,
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 24 $ 21
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization 93 85
Deferred income taxes 12 14
Amortization of deferred gains on sale and
leaseback of aircraft (4) (4)
Amortization of scheduled airframe
inspections & repairs 12 11
Changes in certain assets and liabilities:
Accounts and other receivables 16 (62)
Other current assets (1) 17
Accounts payable and accrued liabilities (7) (86)
Air traffic liability 123 111
Other (1) (14)
Net cash provided by operating activities 267 93
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (193) (109)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt - 385
Proceeds from trust arrangement - 59
Proceeds from Employee stock plans 12 20
Payments of long-term debt and
capital lease obligations (6) (5)
Payments of trust arrangement - (123)
Payment of revolving credit facility - (475)
Payments of cash dividends (7) (7)
Other, net 1 (4)
Net cash used in financing activities - (150)
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 74 (166)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 1,815 2,280
CASH AND CASH EQUIVALENTS AT END OF PERIOD $1,889 $2,114
CASH PAYMENTS FOR:
Interest, net of amount capitalized $ 22 $ 17
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, 2003 and 2002 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, 2002 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 months ended March 31, 2003 are not necessarily
indicative of the results that may be expected for the year ended December
31, 2003. 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, 2002.
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):
(In millions, except per share amounts) 2003 2002
Net income, as reported $ 24 $ 21
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 (17) (8)
Pro forma net income $ 7 $ 13
Net income per share
Basic, as reported $ .03 $ .03
Basic, pro forma $ .01 $ .02
Diluted, as reported $ .03 $ .03
Diluted, pro forma $ .01 $ .02
As required, the pro forma disclosures above include options granted since
January 1, 1995. Consequently, the effects of applying SFAS 123 for
providing pro forma disclosures may not be representative of the effects on
reported net income for future years until all options outstanding are
included in the pro forma disclosures. For purposes of pro forma
disclosures, the estimated fair value of stock-based compensation plans and
other options is amortized to expense primarily over the vesting period.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." SFAS No. 148 amends the transition
and disclosure provisions of SFAS No. 123. The Company is currently
evaluating SFAS No. 148 to determine if it will adopt SFAS No. 123 to account
for Employee stock options using the fair value method and, if so, when to
begin transition to that method. If the Company had adopted the prospective
transition method prescribed by SFAS 148 in first quarter 2003, compensation
expense of $11 million would have been recorded. After related profitsharing
and income tax effects, this would have reduced net income by $6 million, or
$.01 per share, diluted.
3. DIVIDENDS
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.
During the three months ended March 31, 2002, dividends of $.0045 per share
were declared on the 771 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,
2003 2002
NUMERATOR:
Net income available to
common stockholders $ 24 $ 21
DENOMINATOR:
Weighted-average shares
outstanding, basic 778 769
Dilutive effect of Employee stock
options 30 42
Adjusted weighted-average shares
outstanding, diluted 808 811
NET INCOME PER SHARE:
Basic $ .03 $ .03
Diluted $ .03 $ .03
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 March 31, 2003 and 2002 represented
approximately 15.9 percent and 14.1 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. The Company was hedged for 100 percent of its first
quarter 2003 fuel consumption. For second quarter 2003, the Company has fuel
hedges in place for 100 percent of its expected fuel consumption with option
contracts in the $24 per barrel range. As of March 31, 2003, the Company
also had agreements in place to hedge approximately 85 percent of its second
half 2003 total anticipated jet fuel requirements with option contracts under
$24 per barrel, and approximately 80 percent of its anticipated 2004
requirements with option contracts approximating $23 per barrel. As of March
31, 2003, the majority of the Company's remaining 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 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, 2003, was a net asset of
approximately $162 million. The current portion of this net asset,
approximately $97 million, is classified as "Fuel hedge contracts" and the
noncurrent portion, approximately $65 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, 2003 and 2002, the Company recognized
$64 million in gains and $6 million in losses (expense) in "Fuel and oil"
expense, respectively, from hedging activities. The Company also recognized
approximately $14 million and $5 million in additional income in "Other
(gains) losses, net," related to the ineffectiveness of its hedges during the
three months ended March 31, 2003 and 2002, respectively. The Company
recognized approximately $7 million and $6 million 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 March 31, 2003 and
2002, respectively.
As of March 31, 2003, the Company had approximately $63 million in unrealized
gains, net of tax, in "Accumulated other comprehensive income" related to
fuel hedges. Included in this total are approximately $39 million in net
unrealized gains that are expected to be realized in earnings during the
twelve months following March 31, 2003.
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 $29
million and $80 million for the three months ended March 31, 2003 and 2002,
respectively. The differences between net income and comprehensive income
for each of these periods was as follows (in millions):
Three months ended March 31,
2003 2002
Net income $ 24 $ 21
Unrealized gain (loss) on
derivative instruments,
net of deferred taxes
of $4 and $38 7 59
Other, net of deferred taxes
of ($1) and $0 (2) -
Total other comprehensive income 5 59
Comprehensive income $ 29 $ 80
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, 2002 $ 56 ($2) $ 54
2003 changes in value 44 (2) 42
Reclassification to earnings (37) - (37)
Balance at March 31, 2003 $ 63 ($4) $ 59
7. REVOLVING CREDIT FACILITY
In April 2002, the Company entered into 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, was set to expire on
April 23, 2003 but has been renewed for an additional year. This facility
now expires in April 2004. The other facility, for half of the amount,
expires in April 2005. The effective borrowing rate of the credit facility
would vary depending on factors in place at the time funds were drawn, as
defined in the agreements.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN
45). FIN 45 requires that a liability for the fair value of an obligation
for guarantees issued or modified after December 31, 2002 be recorded in the
financial statements of the guarantor. Guarantees pre-existing before the
implementation of FIN 45 are required to be disclosed in financial statements
issued after December 15, 2002. While the Company has various guarantees
included in contracts in the normal course of business, primarily in the form
of indemnities, these guarantees would only result in immaterial increases in
future costs, and do not represent significant commitments or contingent
liabilities of the indebtedness of others.
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 is applicable to variable
interest entities created after January 31, 2003. Variable interest entities
created prior to February 1, 2003, must be consolidated effective July 1,
2003. Disclosures are required currently if the Company expects to
consolidate any variable interest entities. The Company does not currently
believe that any material entities will be consolidated with Southwest as a
result of FIN 46.
9. RECENT EVENTS
On April 16, 2003, the Emergency Wartime Supplemental Appropriations Act
(Wartime Act) was signed into law. Among other items, the legislation
includes a $2.3 billion cash reimbursement for security fees remitted to the
Transportation Security Administration since the 2001 terrorist attacks.
Southwest expects to receive its proportional share of security fees paid, as
defined, during second quarter 2003.
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, 2003 and 2002 are as follows:
Three months ended March 31,
2003 2002 Change
Revenue passengers carried 15,077,537 14,463,282 4.2%
Revenue passenger miles
(RPMs) (000s) 10,895,701 10,392,590 4.8%
Available seat miles
(ASMs) (000s) 17,399,132 16,519,957 5.3%
Load factor 62.6% 62.9% (.3) pts.
Average length of passenger haul 723 719 0.6%
Trips flown 233,087 231,195 0.8%
Average passenger fare $86.64 $83.99 3.2%
Passenger revenue yield per
RPM (cents) 11.99 11.69 2.6%
Operating revenue yield per
ASM (cents) 7.77 7.61 2.1%
Operating expenses per ASM (cents) 7.50 7.31 2.6%
Operating expenses per ASM,
excluding fuel (cents) 6.30 6.28 0.3%
Fuel costs per gallon,
excluding fuel tax (cents) 74.8 63.3 18.2%
Fuel consumed, in gallons (millions) 277 268 3.4%
Number of Employees at period-end 33,140 32,244 2.8%
Size of fleet at period-end 377 359 5.0%
Material Changes in Results of Operations
Summary
Despite the decline in full-fare traffic brought about by the weak
airline revenue and economic environment, the onset of war with Iraq, crude
oil prices spiking near $40 per barrel during the quarter, and considering
the first quarter historically is the slowest of the year for air travel,
turning a profit in first quarter 2003 was quite an accomplishment for any
airline. For Southwest, this was achieved as a result of the Company's
continuous efforts to control costs, maintain high productivity levels, and
offer outstanding Customer service. While the Company's profitability levels
continue to be considerably below pre-September 11, 2001 levels, Southwest
has reported profitable earnings performances each quarter since September
11, 2001 through first quarter 2003. In fact, the Company's first quarter
2003 earnings performance represented its 48th consecutive quarterly profit.
Consolidated net income for first quarter 2003 was $24 million ($.03
per share, diluted), 14.3 percent above the first quarter 2002 net income of
$21 million ($.03 per share, diluted). First quarter 2003 operating income
was $46 million compared to operating income of $49 million in 2002 as higher
revenues and lower commissions expense were offset by higher salaries, wages,
and benefits expenses and higher fuel costs.
In addition to war-related revenue pressures, the Company's financial
performance continues to be adversely affected by weak economic conditions
and the lingering impact of the 2001 terrorist attacks. Although the Company
continues to experience significantly higher costs for aviation insurance and
airport security compared to pre-September 11, 2001, thus far, Southwest has
been able to mitigate a portion of such increases through lower agency
commissions and other cost reduction efforts implemented following the
terrorist attacks. Barring any unforeseen event, the Company also expects to
be profitable in second quarter 2003, excluding proceeds to be received from
the Emergency Wartime Supplemental Appropriations Act (see Note 9 to the
unaudited condensed consolidated financial statements). However, given the
recent disruption in revenue trends attributable to the war with Iraq, the
Company may not be able to match its second quarter 2002 profit of $102
million, which included $36 million (pretax), related to a reduction in
air traffic liability.
Comparison of Three Months Ended March 31, 2003 to Three Months Ended March
31, 2002
Revenues
Consolidated operating revenues increased by $94 million, or 7.5
percent, primarily due to a $91 million, or 7.5 percent increase in passenger
revenues. The increase in passenger revenues was primarily due to a 4.8
percent increase in revenue passenger miles (RPMs) flown.
First quarter 2003 capacity, as measured by available seat miles
(ASMs), increased 5.3 percent compared to first quarter 2002. The capacity
increase resulted from the net addition of 18 aircraft (net of one
retirement) from March 2002 through March 2003. The first quarter 2003 load
factor was 62.6 percent, a decrease of .3 points compared to 2002. The
Company also experienced a 4.2 percent increase in revenue passengers carried
compared to first quarter 2002.
First quarter 2003 passenger yield per RPM increased 2.6 percent to
11.99 cents from 11.69 cents in first quarter 2002. Operating revenue yield
per ASM and average passenger fare increased 2.1 percent and 3.2 percent to
7.77 cents and $86.64, respectively, compared to first quarter 2002.
Although the Company's revenues had shown signs of recovery during
fourth quarter 2002 and early first quarter 2003, those trends were disrupted
with the commencement of the war with Iraq. Since the beginning of the war,
bookings for second quarter 2003 have softened further. Currently, the
Company expects only modest revenue growth, if any, compared to second
quarter 2002's operating revenue of $1.47 billion, which included $36 million
in additional revenue related to a reduction in estimated refunds and
exchanges included in air traffic liability.
Consolidated freight revenues increased by $1 million, or 4.8 percent
as a 13.6 percent increase in freight and cargo revenues more than offset a
13.2 percent decrease in U.S. mail revenues. The increase in freight and
cargo revenues was primarily due to moderate rate increases taken by the
Company. The decrease in U.S. Mail revenue was due to the U.S. Postal
Service diverting more of its mail shipments to freight carriers and away
from commercial airlines. For second quarter 2003, the Company expects a
year-over-year increase in consolidated freight revenues compared to second
quarter 2002 primarily due to increases in capacity and cargo shipments.
Other revenues increased in first quarter 2003 by $2 million, or 9.5 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
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, 2003 and 2002
followed by explanations of changes on a per ASM basis:
Three months ended March 31, Per ASM Percent
2003 2002 Change Change
Salaries, wages,
and benefits 2.97 2.80 .17 6.1
Fuel and oil 1.20 1.03 .17 16.5
Maintenance materials
and repairs .61 .58 .03 5.2
Agency commissions .07 .09 (.02) (22.2)
Aircraft rentals .26 .29 (.03) (10.3)
Landing fees and
other rentals .51 .50 .01 2.0
Depreciation .53 .51 .02 3.9
Other operating
expenses 1.35 1.51 (.16) (10.6)
Total 7.50 7.31 .19 2.6
Operating expenses per ASM were 7.50 cents, a 2.6 percent increase
compared to 7.31 cents for first quarter 2002. This increase was primarily
due to higher labor and jet fuel costs, net of fuel hedging gains. Excluding
fuel expense from both periods, operating expenses per ASM were 6.30 cents,
approximately the same as first quarter 2002 as the increase in labor costs
was offset primarily by decreases in security costs and aviation insurance
costs. Based on first quarter 2003 costs, the Company expects modest year
over year unit cost growth again in second quarter 2003.
Salaries, wages, and benefits expense per ASM increased 6.1 percent due
to a 7.1 percent increase in salaries and wages per ASM, a 3.7 percent
increase in benefits expense per ASM, and a 2.9 percent increase in Employee
retirement plans expense per ASM. The majority of the increase in salaries
and wages was due to higher average wage rates. The increase in benefits
expense per ASM was primarily due to higher health care costs. The increase
in Employee retirement plans expense per ASM was primarily due to a slight
increase in Company earnings available for profitsharing. The Company also
expects an increase in salaries, wages, and benefits per ASM in second
quarter 2003 due to the continued impact of higher average wage rates and
higher anticipated health care costs.
Fuel and oil expense per ASM increased 16.5 percent primarily due to an
increase in average fuel cost per gallon. The average fuel cost per gallon
in first quarter 2003 was 74.8 cents, an 18.2 percent increase compared to
63.3 cents per gallon in first quarter 2002, including the effects of hedging
activities. The Company's fuel hedging program resulted in the recognition
of $77 million in fuel hedging gains during first quarter 2003, of which $64
million was recorded in "Fuel and oil." The remaining gains are included in
"Other (gains) losses, net." For second quarter 2003, the Company has
fuel hedges in place for 100 percent of its expected fuel consumption with
option contracts in the $24 per barrel range. The majority of the Company's
near term hedge positions are in the form of option contracts. 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 5.2 percent
primarily due to an increase in contract rates for outsourced engine
maintenance. The Company outsources all of its engine maintenance work for
737-300 and 737-500 aircraft and expense is based on the number of hours
flown for those aircraft and the rate charged per hour flown. The number of
hours flown for the 737-300 and 737-500 aircraft was comparable to the prior
year. The Company expects second quarter 2003 maintenance materials and
repairs per ASM to be higher than second quarter 2002 expense due to the
increase in contract rates for outsourced engine maintenance.
Agency commissions per ASM decreased 22.2 percent primarily due to a
decline in commissionable revenues. The percentage of commissionable
revenues decreased from approximately 22 percent in first quarter 2002 to
approximately 17 percent in first quarter 2003. Approximately 50 percent of
revenues in first quarter 2003 were derived through the Company's web site at
www.southwest.com versus 46 percent of revenues in first quarter 2002. Based
on recent trends, the Company currently expects commissionable revenues to
remain in the 17 percent range in second quarter 2003.
Aircraft rentals per ASM decreased 10.3 percent compared to first
quarter 2002 primarily due to the increase in ASMs relative to the number of
leased aircraft. Although ASMs increased 5.3 percent, the number of leased
aircraft declined by one, as a result of a retirement in second quarter 2002.
All of the aircraft acquired in 2002 and 2003 have been purchased.
Approximately 23.9 percent of the Company's aircraft fleet was under
operating lease at March 31, 2003, compared to 25.3 percent at March 31,
2002.
Landing fees and other rentals per ASM increased 2.0 percent compared
to first quarter 2002 as a 6.5 percent increase in other rentals per ASM was
partially offset by a 2.5 percent decrease in landing fees per ASM. The
increase in other rentals expense per ASM was primarily due to the Company's
expansion of gate and counter space at several airports such as Houston
William P. Hobby Airport (HOU) and Las Vegas McCarran International Airport
(LAS). The decrease in landing fees expense per ASM primarily was due to
first quarter 2003 credits from airports' audits of prior periods. The
amount of credits received in first quarter 2003 was more than the credits
received in the same prior year period.
Depreciation expense per ASM increased 3.9 percent primarily due to an
increase in owned aircraft. All 19 of the aircraft put into service by the
Company over the past twelve months have been purchased. This, along with
the retirement of one leased aircraft, has increased the Company's percentage
of aircraft owned or on capital lease to 76.1 percent at March 31, 2003 from
74.7 percent at March 31, 2002.
Other operating expenses per ASM decreased 10.6 percent. Approximately
half of the decrease was attributable to a decrease in security expense. In
first quarter 2002, the Company incurred a substantial increase in costs due
to additional procedures instituted by the federal government following the
2001 terrorist attacks. During first quarter 2002, however, the newly
established Transportation Security Administration took over many of those
procedures. The other half of the decrease in other operating expenses per
ASM was attributable to a decrease in aviation insurance costs. Following
the 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
prevailing commercial rates and for levels of coverage not available in the
commercial market. In November 2002, Congress passed the Homeland Security
Act of 2002, which mandated the federal government provide third party,
passenger, and hull war-risk insurance coverage to commercial carriers
through August 31, 2003, and which permits such coverage to be extended by
the government through December 31, 2003. The Emergency Wartime Supplemental
Appropriations Act (see Note 9 to the unaudited condensed consolidated
financial statements) extends 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 2003 aviation insurance premiums than 2002.
However, aviation insurance remains substantially higher than before
September 11, 2001. The Company currently expects a year-over-year decrease
in other operating expenses per ASM for second quarter 2003, primarily from
lower aviation insurance costs; however, second quarter 2003 other operating
unit costs are expected to exceed first quarter's performance of 1.35 cents.
Other
Interest expense was flat compared to the prior year as an increase in
interest expense caused by the March 1, 2002 issuance of $385 million in
unsecured notes was offset by a decrease in interest from the repayment of
the Company's $475 million revolving credit facility in March 2002 and from
a decrease in year-over-year interest rates on the Company's floating rate
debt in 2003.
Capitalized interest increased by $3 million, primarily due to an
increase in progress payment balances for future aircraft deliveries.
Interest income decreased by $5 million, or 50.0 percent, primarily due
to a decrease in rates earned on investments.
In first quarter 2003 and 2002, "Other (gains) losses, net" primarily
included 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. The Company recognized $7 million and $6
million of expense related to amounts excluded from the Company's
measurements of hedge effectiveness, during the first quarters of 2003 and
2002, respectively. Also, the Company recognized approximately $14 million
and $5 million in additional income related to the ineffectiveness of its
hedges during the first quarters of 2003 and 2002, respectively.
Liquidity and Capital Resources
Net cash provided by operating activities was $267 million for the
three months ended March 31, 2003 compared to $93 million in the prior year
first quarter. The increase was primarily due to the first quarter 2002
payment of $186 million in excise tax payments that had been deferred from
fourth quarter 2001 as provided for in the Air Transportation Safety and
System Stabilization Act. Net cash provided by operating activities was
$694 million for the 12 months ended March 31, 2003. Cash generated from
operating activities for the 12 months ended March 31, 2003 was primarily
used to finance aircraft-related capital expenditures.
Cash flows used in investing activities in first quarter 2003 totaled
$193 million compared to $109 million in 2002. 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, 2003 totaled
$687 million.
There was no net cash used in financing activities in first quarter
2003 compared to $150 million used in 2002. Cash used in financing
activities during first quarter 2002 was primarily for the repayment of the
Company's $475 million revolving credit facility that the Company drew down
in September 2001 and for the repayment of a special purpose trust through
which the Company had financed the purchase of 19 new aircraft during 2001
and 2002. The trust was dissolved prior to December 31, 2002. These
investing activities were partially offset by cash generated from the
issuance of $385 million in unsecured notes in March 2002.
Contractual Obligations and Contingent Liabilities and Commitments
Southwest has contractual obligations and commitments primarily with
regards to future purchases of aircraft, payment of debt, and lease
arrangements. Following the receipt of two new 737-700 aircraft from Boeing
in the first quarter 2003, the Company has 15 remaining 737-700 aircraft
deliveries for 2003. Also, during first quarter 2003, the Company exercised
options to acquire four more 737-700 aircraft from Boeing in 2004. This
change brings the Company's total firm orders to 25 for 2004 with options for
nine additional aircraft. The Company's commitment beyond 2004 has not
changed and includes firm orders, options, and purchase rights for 362
aircraft for 2005 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. Aggregate funding needed for firm
commitments, as of March 31, 2003, is approximately $3.2 billion, subject to
adjustments for inflation, due as follows: $501 million in 2003, $725
million in 2004, $726 million in 2005, $645 million in 2006, $523 million in
2007, and $95 million thereafter.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at March 31, 2003 of $1.9
billion and internally generated funds. The Company has two 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
amount, was set to expire on April 23, 2003 but has been renewed for an
additional year. This facility now expires in April 2004. The other
facility, for half of the amount, expires in April 2005. 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.
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, 2002 and Note 4 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 Amendment No. 1 to Southwest Airlines Co. 2002 Customer
Service/Reservations Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 4.3 to Registration
Statement on Form S-8(File No. 333-104245)).
99.1 Certifications Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2003
b) Reports on Form 8-K
On April 21, 2003, Southwest filed a current report on Form 8-K to
furnish the Company's public announcement of its first quarter
2003 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 22, 2003 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.
April 22, 2003 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.
April 22, 2003 By /s/ James F. Parker
James F. Parker
Chief Executive Officer
EXHIBIT INDEX
Exhibit No. Description
Exhibit 10.1 - Amendment No. 1 to Southwest Airlines Co. 2002
Customer Service/Reservations Non-Qualified Stock
Option Plan (incorporated by reference to Exhibit 4.3
to Registration Statement on Form S-8 (File No. 333-
104245)).
Exhibit 99.1 - Certifications Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2003