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, 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 (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. Box 36611, Dallas, Texas 75235-1611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 792-4000
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 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 26, 2002:
771,684,488
SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in thousands)
(unaudited)
March 31, 2002 December 31, 2001
ASSETS
Current assets:
Cash and cash equivalents $2,113,523 $2,279,861
Accounts and other receivables 133,136 71,283
Inventories of parts and supplies,
at cost 73,181 70,561
Deferred income taxes 46,400 46,400
Prepaid expenses and other
current assets 79,060 52,114
Total current assets 2,445,300 2,520,219
Property and equipment, at cost:
Flight equipment 7,654,679 7,534,119
Ground property and equipment 934,537 899,421
Deposits on flight equipment
purchase contracts 398,572 468,154
8,987,788 8,901,694
Less allowance for depreciation 2,528,918 2,456,207
6,458,870 6,445,487
Other assets 64,608 31,435
$8,968,778 $8,997,141
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $410,458 $504,831
Accrued liabilities 532,841 547,540
Air traffic liability 561,304 450,407
Aircraft purchase obligations 198,601 221,840
Short-term borrowings - 475,000
Current maturities of long-term debt 39,983 39,567
Total current liabilities 1,743,187 2,239,185
Long-term debt less current maturities 1,701,979 1,327,158
Deferred income taxes 1,109,750 1,058,143
Deferred gains from sale and leaseback
of aircraft 188,547 192,342
Other deferred liabilities 114,196 166,260
Stockholders' equity:
Common stock 771,250 766,774
Capital in excess of par value 66,579 50,409
Retained earnings 3,246,314 3,228,408
Accumulated other comprehensive
income (loss) 26,976 (31,538)
Total stockholders' equity 4,111,119 4,014,053
$8,968,778 $8,997,141
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in thousands, except per share amounts)
(unaudited)
Three months ended March 31,
2002 2001
OPERATING REVENUES:
Passenger $1,214,785 $1,381,276
Freight 20,789 25,781
Other 21,669 21,560
Total operating revenues 1,257,243 1,428,617
OPERATING EXPENSES:
Salaries, wages, and benefits 461,650 447,431
Fuel and oil 170,369 209,584
Maintenance materials and repairs 96,594 98,524
Agency commissions 14,133 30,494
Aircraft rentals 47,435 48,045
Landing fees and other rentals 83,180 70,018
Depreciation 84,595 77,692
Other operating expenses 249,922 236,672
Total operating expenses 1,207,878 1,218,460
OPERATING INCOME 49,365 210,157
OTHER EXPENSES (INCOME):
Interest expense 26,479 17,012
Capitalized interest (4,387) (6,199)
Interest income (9,591) (8,882)
Other (gains) losses, net 1,668 11,724
Total other expenses (income) 14,169 13,655
INCOME BEFORE INCOME TAXES 35,196 196,502
PROVISION FOR INCOME TAXES 13,811 75,457
NET INCOME $21,385 $121,045
NET INCOME PER SHARE, BASIC $ .03 $ .16
NET INCOME PER SHARE, DILUTED $ .03 $ .15
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 769,369 760,225
Diluted 810,763 807,744
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in thousands)
(unaudited)
Three months ended March 31,
2002 2001
NET CASH PROVIDED BY OPERATING
ACTIVITIES $92,553 $420,598
INVESTING ACTIVITIES:
Net purchases of property and
equipment (109,080) (254,328)
FINANCING ACTIVITIES:
Proceeds from long-term debt
obligations 385,000 -
Payments of long-term debt and
capital lease obligations (5,419) (5,019)
Payment of short term debt (475,000) -
Payment of trust arrangement (122,971) -
Payments of cash dividends (6,916) (6,570)
Proceeds from Employee stock plans 20,646 7,002
Proceeds from trust arrangement 59,193 -
Other, net (4,344) -
NET CASH USED IN
FINANCING ACTIVITIES (149,811) (4,587)
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (166,338) 161,683
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 2,279,861 522,995
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $2,113,523 $684,678
CASH PAYMENTS FOR:
Interest, net of amount capitalized $16,689 $18,086
Income taxes $286 $3,109
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) 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 period ended March
31, 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 months ended
March 31, 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 March 31, 2002, dividends
of $.0045 per share were declared on the 770.7 million shares of common stock
then outstanding. During the three months ended March 31, 2001, dividends of
$.0045 per share were declared on the 760.7 million shares of common stock then
outstanding.
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 March 31,
2002 2001
NUMERATOR:
Net income available to common
Stockholders $21,385 $121,045
DENOMINATOR:
Weighted-average shares
outstanding, basic 769,369 760,225
Dilutive effect of Employee stock
options 41,394 47,519
Adjusted weighted-average shares
outstanding, diluted 810,763 807,744
NET INCOME PER SHARE:
Basic $.03 $.16
Diluted $.03 $.15
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 first quarters of 2002 and 2001
represented approximately 14.1 percent and 17.2 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 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 has financial derivative instruments in the form of the
types of hedges it utilizes 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. At March 31, 2002, the Company had a mixture of purchased call
options, collar structures, and fixed price swap agreements in place to hedge
approximately 50 percent, 65 percent, and 80 percent of its second quarter,
third quarter, and fourth quarter 2002 total anticipated jet fuel requirements,
respectively. The Company also has agreements in place to hedge approximately
50 percent of its 2003 total anticipated jet fuel requirements, and a small
portion of its 2004-2005 total anticipated jet fuel requirements. As of March
31, 2002, the majority of the Company's remaining 2002 hedges are effectively
heating oil-based positions in the form of option contracts. The majority of
the remaining hedge positions are crude oil-based.
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 March 31, 2002, was a net
asset of approximately $78.5 million. The current portion of this net asset is
classified in "Prepaid expenses and other current assets" and the noncurrent
portion 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 first quarters of 2002 and 2001, the Company recognized $6.1 million
in losses (expense) and $24.4 million in gains in "Fuel and oil" expense,
respectively, from hedging activities. The Company recognized approximately
$5.9 million and $8.4 million of net expense, related to amounts excluded from
the Company's measurements of hedge effectiveness, in "Other (gains) losses,
net" during the first quarters of 2002 and 2001, respectively. The Company
recognized approximately $4.6 million as additional income and $2.5 million as
net expense in "Other (gains) losses, net," related to the ineffectiveness of
its hedges during the first quarters of 2002 and 2001, respectively.
As of March 31, 2002, the Company had approximately $27.8 million in unrealized
gains, net of tax, in "Accumulated other comprehensive income (loss)" related to
fuel hedges. Included in this total are approximately $15.4 million in net
unrealized gains that are expected to be realized in earnings during
the twelve months following March 31, 2002.
6. Comprehensive income - Comprehensive income includes 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 $79.9 million and $156.8 million for the
first quarters of 2002 and 2001, respectively. The differences between Net
income and Comprehensive income for each of these periods was as follows (in
thousands):
Three months ended March 31,
2002 2001
Net income $21,385 $121,045
Unrealized gain (loss) on
derivative instruments, net of
deferred taxes of $38,021 and
$23,575 58,858 36,494
Other, net of deferred taxes of
($222) and ($452) (344) (699)
Total other comprehensive income 58,514 35,795
Comprehensive income $79,899 $156,840
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 54,853 (344) 54,509
Reclassification to earnings 4,005 - 4,005
Balance at March 31, 2002 $27,795 ($819) $26,976
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 and was operating its normal
pre-September 11 flight schedule by September 18, 2001. From September 11 until
the Company resumed flight operations on September 14, 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. Although load factors returned to somewhat normal
levels during fourth quarter 2001, yields have continued to be significantly
below prior year 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 is determined based on that
airline's percentage of 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) will make
the final determination of the amount of eligible direct and incremental losses
incurred by each airline. Direct and incremental losses, while defined
generally in the Act, are subject to interpretation by the DOT. The DOT issued
its final rules with respect to the Act on April 16, 2002. Final
applications for grants, which are due to the DOT on or before May 16, 2002,
must be accompanied by Agreed Upon Procedures reports from independent auditors
and may be subject to additional audit or review by the DOT and Congress.
During the third and fourth quarters of 2001, the Company recognized a total of
$235 million from grants under the Act as "Other gains." The Company believes
its actual direct and incremental losses related to the September 11 terrorist
attacks exceed the total amount for which the Company will be ultimately
eligible. The Company expects to recognize approximately $40 million in
additional grants during second quarter 2002 under the Act upon completion and
approval of the final application based on the DOT's final interpretations of
the Act. However, due to remaining uncertainties regarding the interpretation
of the Act, no amounts have been accrued as a receivable at March 31, 2002.
The Company recorded total special charges of $48 million during the third and
fourth quarters of 2001 arising from the terrorist attacks. Total special
charges included a $30 million reduction in "Passenger revenue" resulting from
refunds of nonrefundable fares, $13 million in charges to "Other operating
expenses" for write-downs of various assets due to impairment, and other
charges that are 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.
9. Issuance of debt - During first quarter 2002, the Company issued
$385 million senior unsecured Notes (Notes). The Notes bear interest
at 6.5 percent, payable semi-annually in arrears, with the first payment due on
September 1, 2002. The Notes mature on March 1, 2012. Southwest will use the
net proceeds from the issuance of the Notes, approximately $380.2 million, for
general corporate purposes.
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, 2002 and 2001 are as follows:
Three months ended March 31,
2002 2001 Change
Revenue passengers carried 14,463,282 15,716,020 (8.0)%
Revenue passenger miles (RPMs)
(000s) 10,392,590 10,662,391 (2.5)%
Available seat miles (ASMs)
(000s) 16,519,957 15,852,999 4.2%
Load factor 62.9% 67.3% (4.4) pts.
Average length of passenger haul 719 678 6.0%
Trips flown 231,195 231,793 (0.3)%
Average passenger fare $83.99 $87.89 (4.4)%
Passenger revenue yield per RPM
(cents) 11.69 12.95 (9.7)%
Operating revenue yield per ASM
(cents) 7.61 9.01 (15.5)%
Operating expenses per ASM
(cents) 7.31 7.69 (4.9)%
Operating expenses per ASM,
excluding fuel (cents) 6.28 6.36 (1.3)%
Fuel costs per gallon,
excluding fuel tax (cents) 63.28 78.53 (19.4)%
Number of Employees at period-end 32,244 29,563 9.1%
Size of fleet at period-end 359 352 2.0%
Southwest operating expenses per ASM for the three months ended March 31,
2002 and 2001 are as follows (in cents except percent change):
Three months ended March 31,
Percent
2002 2001 Change
Salaries, wages, and benefits 2.64 2.49 6.0
Employee retirement plans .16 .33 (51.5)
Fuel and oil 1.03 1.32 (22.0)
Maintenance materials
and repairs .58 .62 (6.5)
Agency commissions .09 .19 (52.6)
Aircraft rentals .29 .30 (3.3)
Landing fees and other rentals .50 .44 13.6
Depreciation .51 .49 4.1
Other operating expenses 1.51 1.51 -
Total 7.31 7.69 (4.9)
Material Changes in Results of Operations
Summary
The operating environment for the airline industry continues to be a
challenging one. The combination of a weak domestic economic climate,
additional airport security regulations, dramatically increasing costs for
aviation insurance, and volatility in fuel prices, are expected to result in
billions of dollars in losses for the airline industry in 2002. During the
first quarter 2002, the Company was able to overcome these obstacles and report
a profit, albeit a small one.
Consolidated net income for first quarter 2002 was $21.4 million ($.03 per
share, diluted), as compared to first quarter 2001 net income of $121.0 million
($.15 per share, diluted). Operating income was $49.4 million compared to
operating income of $210.2 million in 2001. The decreases in net income and
operating income were due to the decrease in revenues. Substantial discounting
of airfares by the Company and the entire industry has stimulated demand, but
has also resulted in a much lower passenger revenue yield per RPM (passenger
yield) versus the prior year. In total, operating expenses declined slightly
from the same year ago period. Operating expenses per ASM decreased 4.9 percent
to $.0731 primarily due to lower jet fuel prices, agency commissions and
profitsharing. These decreases more than offset increases in airport security
and aviation insurance costs.
While the Company's recent promotional activity has been successful in
generating second quarter 2002 bookings, the Company expects its April load
factor to continue to trail year ago levels. (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, 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, general economic conditions, and variations in advance booking
trends.)
Security. Over the past several months, the Company has had to respond and
react swiftly to numerous new and changing Federal Security Directives. These
directives have dramatically changed the manner in which Customers, luggage, and
airplanes are protected and cleared for flight and have created various
challenges at each of the 59 airports we currently serve. However, these
enhanced security measures have not diminished our aircraft productivity or
impaired Southwest's reliable ontime performance record. Although, early on,
our Customers had to experience longer checkin lines during this transition
period, the Company has quickly implemented significant changes across our
network to reduce wait times. Although significant progress has been made since
the weeks following September 11, improving the overall airport experience
remains one of our primary operational goals and we have a number of projects
still underway to further expedite the checkin process.
Comparison of Three Months Ended March 31, 2002 to Three Months Ended March
31, 2001
Consolidated operating revenues decreased 12.0 percent primarily due to a
12.1 percent decrease in passenger revenues. As a result of heavy promotional
activities and weak business travel, the Company is carrying a greater
proportion of lower yielding discount fare passengers than in recent years.
However, the airline industry has continued to recover from the aftermath of the
September 11, 2001 terrorist attacks (terrorist attacks), and, as expected,
revenue yield trends improved from fourth quarter 2001. First quarter 2002
capacity, as measured by available seat miles (ASMs), increased 4.2 percent.
The increase in ASMs primarily resulted from the net addition of 7 aircraft (net
of five retirements) from April 2001 through March 2002. The first quarter 2002
load factor was 62.9 percent, a decrease of 4.4 points compared to 2001. The
Company experienced an 8.0 percent decrease in revenue passengers carried, a 2.5
percent decrease in RPMs, and a 9.7 percent decrease in passenger yield.
As a result of the terrorist attacks and weak economic conditions
throughout first quarter 2002, consolidated freight revenues decreased 19.4
percent. Subsequent to the resumption of service after the terrorist attacks,
the U.S. Postal Service made a decision to divert more of its mail shipments to
freight carriers and away from commercial airlines. As a result, the Company
expects year-over-year declines in freight revenues to continue throughout the
near term. (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 slightly 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 $.0731, a 4.9 percent decrease compared to
$.0769 for 2001. Excluding fuel expense, operating expenses per ASM declined
1.3 percent to $.0628. However, if the Company's business continues to improve,
second quarter 2002 unit costs, excluding fuel, are expected to increase
modestly compared to second quarter 2001. (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, labor issues, etc.)
Salaries, wages, and benefits per ASM increased 6.0 percent. Approximately
two-thirds 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 in order to alleviate excessive overtime and to comply
with enhanced federal security regulations. Approximately one-third of the
increase was in benefits, primarily due to increasing health care costs. Based
on the Company's recent hiring, the overall rise in health care costs, and the
expected growth in ASMs, we are expecting an increase in salaries, wages, and
benefits per ASM in second quarter 2002 compared to 2001. (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.)
Employee retirement plans expense per ASM decreased 51.5 percent, primarily
due to the decrease in Company earnings available for profitsharing.
Fuel and oil expense per ASM decreased 22.0 percent due to a 19.4 percent
decrease in the average jet fuel cost per gallon compared to 2001. The average
jet fuel cost per gallon in first quarter 2002 was $.6328 compared to $.7853 in
first quarter 2001, including the effects of hedging activities. See Note 5 to
the unaudited condensed consolidated financial statements. As of March 31,
2002, the Company had fuel derivatives in place to hedge approximately 50
percent, 65 percent, and 80 percent of its second quarter, third quarter, and
fourth quarter 2002 total anticipated jet fuel requirements. The majority of
the Company's near term hedge positions are in the form of option contracts,
which should enable the Company to benefit to a large extent 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 6.5 percent primarily
due to a decrease in engine repair expense per ASM. Virtually all the Company's
first quarter capacity growth versus the prior year was accomplished with new
aircraft, most of which have not yet begun to incur any meaningful engine repair
costs. The Company expects second quarter 2002 maintenance materials and
repairs per ASM to be slightly lower than second quarter 2001 expense due to a
decrease in scheduled engine repairs for the Company's 737-200 aircraft. (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 52.6 percent. Approximately 60
percent of the decrease was due to a change in the Company's commission rate
policy, and approximately 40 percent was due to the overall 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 28 percent
in first quarter 2001 to approximately 22 percent in first quarter 2002. Due
to the commission policy change in October 2001, the Company expects agency
commissions to show a year-over-year decrease in second quarter 2002 on a
per-ASM basis. (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.)
Aircraft rentals per ASM decreased 3.3 percent compared to first quarter
2001 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
first quarter 2002. Approximately 25.3 percent of the Company's aircraft fleet
was under operating lease at March 31, 2002, compared to 26.7 percent at March
31, 2001.
Landing fees and other rentals per ASM increased 13.6 percent.
Approximately 60 percent of the increase was due to an increase in other rentals
primarily as a result of the Company's expansion of facilities in several
airports, most notably Chicago Midway Airport and Baltimore/Washington
International Airport. Approximately 40 percent of the increase was due to an
increase in landing fee rates at certain airports as a result of capacity
reductions by other airlines. As a result of the terrorist attacks, most major
airlines reduced their flight schedules and/or have retired aircraft early due
to the decrease in demand for air travel. Since Southwest did not reduce the
number of flights it offers, the Company expects that the airport costs it
shares with other airlines on the basis of flights offered or passengers
carried, such as landing fees, will also show an increase on a per ASM basis in
second quarter 2002 compared to the prior year. However, due to the recent
reinstatement of certain routes by other carriers, the Company does not expect
the second quarter 2002 increase to be as large as the first quarter 2002
increase. (The immediately preceding two sentences are forward-looking
statements involving uncertainties that could result in actual results differing
materially from expected results. Such uncertainties include, but may not be
limited to, changes in competitors' flight schedules, demand for air travel,
etc.)
Depreciation expense per ASM increased 4.1 percent primarily due to a
higher percentage of owned aircraft. All 12 of the aircraft put in service by
the Company over the past twelve months have been purchased. This, along with
the retirement of five aircraft, three of which were leased, has increased the
Company's percentage of aircraft owned or on capital lease to 74.7 percent at
March 31, 2002 from 73.3 percent at March 31, 2001.
Other operating expenses per ASM was flat compared to the prior year. The
Company incurred substantial increases in aviation insurance costs from
increased rates imposed on airlines to counterbalance the losses insurers
incurred associated with the terrorist attacks and in airport security costs due
to additional procedures instituted by the federal government following the
terrorist attacks. The Company was able to offset these increases in first
quarter 2002 through cost control measures implemented immediately following the
terrorist attacks. The Company expects the heightened costs of aviation
insurance to continue for the foreseeable future. This increase is expected to
total in excess of $85 million for the full year 2002 compared to 2001. There
is no assurance the Company will continue to offset such increases with cost
reductions in other areas in future periods. The increases in airport security
costs are expected to subside in second quarter 2002 due to the newly
established Transportation Security Administration's overtaking of the majority
of U.S. airport security in February 2002, and all U.S. airport security during
second quarter 2002. (The immediately preceding four sentences are forward-
looking statements involving uncertainties that could result in actual results
differing materially from expected results. Such uncertainties include, but may
not be limited to, results of the Company's cost control efforts, changes in the
Transportation Security Administration's schedule or scope for taking over U.S.
airport security, etc.)
Interest expense increased 55.6 percent primarily due to three separate
borrowings executed by the Company over the past several months. Following the
terrorist attacks, the Company borrowed the full $475 million available under
its revolving credit facility. This borrowing was fully 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. Based on the Company's recent borrowings, we expect interest expense to
be higher on a year-over-year basis throughout 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 29.2 percent primarily due to a reduction in
progress payment balances for future aircraft deliveries.
Interest income increased 8.0 percent as substantially higher invested cash
balances were partially offset by a decrease in rates earned on investments.
Other losses in first quarter 2002 and 2001 are primarily related to net
charges recorded in accordance with SFAS 133, which the Company adopted January
1, 2001. The Company recognized approximately $5.9 million and $8.4 million of
net expense, related to amounts excluded from the Company's measurements of
hedge effectiveness, in "Other (gains) losses, net" during the first quarters
of 2002 and 2001, respectively. The Company recognized approximately $4.6
million as additional income and $2.5 million as net expense in "Other (gains)
losses, net," related to the ineffectiveness of its hedges during the first
quarters of 2002 and 2001, respectively. See Note 5 to the unaudited condensed
consolidated financial statements. As detailed in Note 7 to the unaudited
condensed consolidated financial statements, the Company may recognize gains
from additional grants from the Air Transportation Safety and System
Stabilization Act (the Act) of up to approximately $40 million during second
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 modifications or amendments to the Act, changes in the
expected requirements for or schedule of distributing grant funds, etc.)
Liquidity and Capital Resources
Net cash provided by operating activities was $92.6 million for the three
months ended March 31, 2002 and $1,156.6 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 first quarter 2002. See Notes 8
and 9 to the unaudited condensed consolidated financial statements. Cash
generated for the 12 months ended March 31, 2002 was primarily used to finance
aircraft-related capital expenditures and provide working capital.
During the 12 months ended March 31, 2002, net capital expenditures were
$852.6 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). Through the Trust, the Company accepted six of these
19 aircraft in first quarter 2002 and has announced its intention to accept
delivery of eight more of these aircraft in second quarter 2002. The
remaining five aircraft are scheduled for delivery in the first half of 2003,
although the Company has the ability to accelerate the delivery of these
aircraft at any time before their scheduled delivery dates. For these 19
aircraft, the Company has recorded the associated assets ("Flight equipment" or
"Deposits on flight equipment purchase contracts") and liabilities ("Aircraft
purchase obligations") in its financial statements as the aircraft have been
completed by Boeing and delivered to the Trust. As of March 31, 2002, 15 of the
19 aircraft have been delivered by Boeing to the Trust.
In addition to the aircraft that are part of the Trust, 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 has not changed since the terrorist attacks. 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, or will be, included as liabilities in the
Company's Condensed Consolidated Balance Sheet, aggregate (cash basis) funding
needed for firm commitments, as of March 31, 2002, is approximately $3.6
billion, subject to adjustments for inflation, due as follows: $359 million in
2002, $603 million in 2003, $643 million in 2004, $719 million in 2005, $632
million in 2006, and $614 million thereafter.
The Company has various options available to meet its capital and operating
commitments, including cash on hand at March 31, 2002 of $2.1 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 of the agreements is available to the Company for a full three-year term.
The Company's existing $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 registrations for the issuance of an
additional $319 million in public debt securities and pass through
certificates. The Company could utilize these to finance aircraft during 2002
and 2003.
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.
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 proceeding 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
During the first quarter of 2002, Herbert D. Kelleher exercised
unregistered options to purchase Southwest Airlines Co. Common Stock
as follows:
Number of Shares Purchased Option Price Date of Exercise
415,528 $1.00 1/15/2002
437,032 $2.24 1/15/2002
The issuance of the above shares to Mr. Kelleher was exempt from the
registration provisions of the Securities Act of 1933, as amended (the "Act"),
by reason of the provision of Section 4(2) of the Act because, among other
things, of the limited number of participants in such transactions and the
agreement and representation of Mr. Kelleher that he was acquiring such
securities for investment and not with a view to distribution thereof. The
certificates representing the shares issued to Mr. Kelleher contain a legend to
the effect that such shares are not registered under the Act and may not be
transferred except pursuant to a registration statement that has become
effective under the Act or to an exemption from such registration. The issuance
of such shares was not underwritten.
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 Southwest Airlines Co. Outside Director Incentive Plan
b) Reports on Form 8-K
On March 1, 2002, Southwest filed a current report on Form 8-K to file,
under Item 7 - Financial Statements and Exhibits, certain documents
related to the public offering of $385 million of its 6 1/2% Notes due
2012.
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 30, 2002 By /s/ Gary C. Kelly
Gary C. Kelly
Executive Vice President-
Chief Financial Officer
(Principal Financial and
Accounting Officer)
EXHIBIT INDEX
Exhibit No. Description
Exhibit 10.1 - Southwest Airlines Co. Outside Director Incentive Plan