SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005 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 by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock outstanding as of the close of
business on October 19, 2005:
792,725,729
SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in millions)
(unaudited)
September 30, December 31,
2005 2004
ASSETS
Current assets:
Cash and cash equivalents $2,428 $1,048
Short-term investments 185 257
Accounts and other receivables 334 248
Inventories of parts and supplies,
at cost 153 137
Fuel hedge contracts 944 428
Prepaid expenses and other
current assets 65 54
Total current assets 4,109 2,172
Property and equipment, at cost:
Flight equipment 10,786 10,037
Ground property and equipment 1,266 1,202
Deposits on flight equipment
purchase contracts 657 682
12,709 11,921
Less allowance for depreciation
and amortization 3,364 3,198
9,345 8,723
Other assets 1,292 442
$14,746 $11,337
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $495 $420
Accrued liabilities 2,038 1,047
Air traffic liability 776 529
Current maturities of long-term debt 149 146
Total current liabilities 3,458 2,142
Long-term debt less current maturities 1,861 1,700
Deferred income taxes 2,311 1,610
Deferred gains from sale and
leaseback of aircraft 140 152
Other deferred liabilities 221 209
Stockholders' equity:
Common stock 790 790
Capital in excess of par value 297 299
Retained earnings 4,474 4,089
Accumulated other comprehensive income 1,194 417
Treasury stock, at cost - (71)
Total stockholders' equity 6,755 5,524
$14,746 $11,337
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
OPERATING REVENUES:
Passenger $1,912 $1,612 $5,372 $4,694
Freight 32 28 99 82
Other 45 34 125 99
Total operating revenues 1,989 1,674 5,596 4,875
OPERATING EXPENSES:
Salaries, wages, and
Benefits 693 612 2,000 1,823
Fuel and oil 337 247 947 723
Maintenance materials
and repairs 110 113 319 351
Aircraft rentals 36 45 121 134
Landing fees and other
rentals 118 104 345 306
Depreciation and amortization 121 108 348 318
Other operating expenses 301 254 860 785
Total operating expenses 1,716 1,483 4,940 4,440
OPERATING INCOME 273 191 656 435
OTHER EXPENSES (INCOME):
Interest expense 32 21 89 62
Capitalized interest (10) (10) (28) (30)
Interest income (13) (5) (31) (14)
Other (gains) losses, net (104) 4 (112) 16
Total other expenses
(income) (95) 10 (82) 34
INCOME BEFORE INCOME TAXES 368 181 738 401
PROVISION FOR INCOME TAXES 141 62 276 143
NET INCOME $227 $119 $462 $258
NET INCOME PER SHARE, BASIC $ .29 $ .15 $ .59 $ .33
NET INCOME PER SHARE, DILUTED $ .28 $ .15 $ .57 $ .32
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 789 781 786 784
Diluted 810 812 811 815
See accompanying notes.
Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $227 $119 $462 $258
Adjustments to reconcile
net income to cash provided
by operating activities:
Depreciation and
amortization 121 108 348 318
Deferred income taxes 138 60 271 141
Amortization of deferred
gains on sale and leaseback
of aircraft (4) (4) (12) (12)
Amortization of scheduled
airframe inspections
& repairs 13 13 36 40
Changes in certain assets
and liabilities:
Accounts and other
receivables (42) (24) (85) (74)
Other current assets (83) (21) (93) (33)
Accounts payable and
accrued liabilities 216 111 1,006 393
Air traffic liability 28 (15) 246 182
Other (12) 13 (23) (7)
Net cash provided by
operating activities 602 360 2,156 1,206
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment, net (274) (496) (993) (1,366)
Change in short-term
investments, net (185) 16 72 36
Acquisition of assets from
ATA Airlines, Inc. - - (6) -
Net cash used in
investing activities (459) (480) (927) (1,330)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt - 350 300 408
Proceeds from Employee
stock plans 21 12 58 52
Payments of long-term debt and
capital lease obligations (1) (1) (136) (22)
Payments of cash dividends (4) (4) (14) (14)
Repurchase of common stock - (110) (55) (246)
Other, net - (3) (2) (7)
Net cash provided by
(used in) financing
activities 16 244 151 171
NET INCREASE IN CASH AND
CASH EQUIVALENTS 159 124 1,380 47
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 2,269 1,407 1,048 1,484
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $2,428 $1,531 $2,428 $1,531
CASH PAYMENTS FOR:
Interest, net of amount
capitalized $21 $14 $53 $31
Income taxes $3 $2 $3 $4
See accompanying notes.
Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Southwest Airlines Co. (Company or Southwest) have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The
unaudited condensed consolidated financial statements for the interim periods
ended September 30, 2005 and 2004, include all adjustments, which are, in the
opinion of management, necessary for a fair presentation of the results for
the interim periods. This includes all normal and recurring adjustments, and
other accounting entries as described herein. The Condensed Consolidated
Balance Sheet as of December 31, 2004, has been derived from the Company's
audited financial statements as of that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. Financial results for the
Company, and airlines in general, are seasonal in nature. Historically, the
Company's second and third fiscal quarters have been more profitable than its
first and fourth fiscal quarters. Operating results for the three and nine
months ended September 30, 2005, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2005. 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, 2004.
Certain prior period amounts have been reclassified to conform to the current
presentation including, but not limited to the following: in the Condensed
Consolidated Balance Sheet as of December 31, 2004, the Company has
reclassified certain amounts as "Short-term investments", that were
previously classified as "Cash and cash equivalents"; in the Condensed
Consolidated Statement of Cash Flows for the three and nine months ended
September 30, 2004, changes in the amounts of "Short-term investments" are
classified as cash flows from investing activities; in the Condensed
Consolidated Statement of Income for the three and nine months ended
September 30, 2004, amounts previously classified as "Agency commissions" are
now classified in "Other operating expenses."
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. See Note 10 for additional information.
The following table represents the effect on net income and earnings per
share if the Company had applied the fair value based method and recognition
provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," to stock-based Employee
compensation (in millions, except per share amounts):
Three months Nine months
ended September 30, ended September 30,
2005 2004 2005 2004
Net income, as reported $227 $119 $462 $258
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 (10) (41) (30) (63)
Pro forma net income $217 $78 $432 $195
Net income per share
Basic, as reported $.29 $.15 $.59 $.33
Basic, pro forma $.28 $.10 $.55 $.25
Diluted, as reported $.27 $.10 $.54 $.24
Diluted, pro forma $.27 $.10 $.54 $.24
3. DIVIDENDS
During the three month periods ended March 31, June 30, and September 30,
2005, dividends of $.0045 per share were declared on the 783 million shares,
787 million shares, and 790 million shares of common stock then outstanding,
respectively. During the three month periods ended March 31, June 30, and
September 30, 2004, dividends of $.0045 per share were declared on the 784
million shares, 785 million shares, and 779 million shares of common stock
then outstanding, respectively.
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 Nine months ended
September 30, September 30,
2005 2004 2005 2004
NUMERATOR:
Net income available to
common stockholders $227 $119 $462 $258
DENOMINATOR:
Weighted-average shares
outstanding, basic 789 781 786 784
Dilutive effect of Employee stock
Options 21 31 25 31
Adjusted weighted-average shares
outstanding, diluted 810 812 811 815
NET INCOME PER SHARE:
Basic $.29 $.15 $.59 $.33
Diluted $.28 $.15 $.57 $.32
5. FINANCIAL DERIVATIVE INSTRUMENTS
Fuel Contracts - Airline operators are inherently dependent upon energy to
operate and, therefore, are impacted by changes in jet fuel prices. Jet fuel
and oil expense for the three months ended September 30, 2005 and 2004,
represented approximately 19.6 percent and 16.7 percent, respectively, of
Southwest's operating expenses for those periods. The Company endeavors to
acquire jet fuel at the lowest possible prices. Because jet fuel is not
traded on an organized futures exchange, liquidity for jet fuel hedging is
limited. However, the Company has found commodities for effective hedging of
jet fuel costs, primarily crude oil, and refined products such as heating
oil, and unleaded gasoline. 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. In addition to the significant hedging positions the
Company had in place for the first nine months of 2005, the Company also has
significant future hedging positions. The Company currently has a mixture of
purchased call options, collar structures, and fixed price swap agreements in
place to hedge approximately 85 percent of its remaining 2005 total
anticipated jet fuel requirements. These positions are capped at crude
oil prices of $26 per barrel and the Company has also hedged the refinery
margins on the majority of those positions. As of September 30, 2005, the
"spot" market price for a barrel of crude oil was over $66. The Company is
over 70 percent hedged for 2006 at approximately $36 per barrel and has also
hedged the refinery margins on most of those positions. The Company is also
over 55 percent hedged for 2007 at approximately $37 per barrel, approximately
35 percent hedged for 2008 at approximately $37 perbarrel, and approximately 30
percent hedged for 2009 at approximately $39 per barrel.
The fair value of the Company's financial derivative instruments at September
30, 2005, was a net asset of approximately $2.2 billion. The current portion
of this net asset, approximately $944 million, is classified as "Fuel hedge
contracts" and the noncurrent portion, approximately $1.2 billion, 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.
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). Under SFAS 133, all derivatives designated as hedges that meet
certain requirements are granted special hedge accounting treatment.
Generally, utilizing the special hedge accounting, all periodic changes in
fair value of the derivatives designated as hedges that are considered to be
effective, as defined, are recorded in "Accumulated other comprehensive
income" until the underlying jet fuel is consumed. However, the Company is
exposed to the risk that periodic changes will not be effective, as defined,
or that the derivatives will no longer qualify for special hedge accounting.
To the extent that the periodic changes in the fair value of the
derivatives are not effective, that ineffectiveness is recorded to "Other
gains and losses" in the income statement. Likewise, if a hedge ceases to
qualify for hedge accounting, those periodic changes in the fair value of
derivative instruments are recorded to "Other gains and losses" in the
income statement in the period of the change.
Ineffectiveness is inherent in hedging jet fuel with derivative positions
based in other crude oil related commodities, especially given the magnitude
of the current fair market value of the Company's fuel hedge derivatives and
the recent volatility in the prices of refined products. Due to the
volatility in markets for crude oil and related products, the Company is
unable to predict the amount of ineffectiveness each period, including the
loss of hedge accounting, which could be determined on a derivative by
derivative basis or in the aggregate. This may result in increased
volatility in the Company's results. The significant increase in the amount
of hedge ineffectiveness and unrealized gains on derivative contracts
settling in future periods recorded during the first nine months of 2005
was due to a number of factors. These factors included: the recent
significant increase in energy prices, the number of derivative positions the
Company holds, significant weather events that have affected refinery
capacity and the production of refined products, and the volatility of the
different types of products the Company uses in hedging. The number of
instances in which the Company has discontinued hedge accounting for specific
hedges has increased recently, primarily due to these reasons. In these
cases, the Company has determined that the hedges will not regain
effectiveness in the time period remaining until settlement and therefore
must discontinue special hedge accounting, as defined by SFAS 133. When this
happens, any changes in fair value of the derivative instruments are marked
to market through earnings in the period of change. As the fair value of the
Company's hedge positions increases in amount, there is a higher degree of
probability that there will be continued variability recorded in the income
statement and that the amount of hedge ineffectiveness and unrealized gains
or losses recorded in future periods will be material. This is primarily due
to the fact that small differences in the correlation of crude oil related
products are leveraged over large dollar volumes.
During the three months ended September 30, 2005 and 2004, the Company
recognized $276 million and $131 million in gains in "Fuel and oil" expense,
respectively, from hedging activities. The Company also recognized
approximately $9 million and $6 million of net expense, respectively,
related to amounts excluded from the Company's measurements of hedge
effectiveness, in "Other (gains) losses, net" during third quarter 2005, and
third quarter 2004. During the three months ended September 30, 2005, the
Company recognized approximately $109 million of additional income in
"Other (gains) losses, net," related to the ineffectiveness of its hedges and
the loss of hedge accounting for certain hedges. Of this amount,
approximately $73 million of the additional income was unrealized, mark-to-
market changes in the fair value of derivatives due to the discontinuation of
hedge accounting for certain contracts that will settle in future periods,
approximately $14 million was ineffectiveness associated with hedges
designated for future periods, and $22 million was ineffectiveness and mark-
to-market gains related to hedges that settled during third quarter 2005.
During the three months ended September 30, 2004, the Company recognized
approximately $2 million of additional income in "Other (gains) losses, net,"
related to the ineffectiveness of its hedges.
As of September 30, 2005, the Company had approximately $1.2 billion in
unrealized gains, net of tax, in "Accumulated other comprehensive income"
related to fuel hedges. Included in this total are approximately $544
million in net unrealized gains (net of tax) that are expected to be realized
in earnings during the twelve months following September 30, 2005.
Interest Rate Swaps - In previous periods, the Company entered into interest
rate swap agreements relating to its $350 million 5.25% senior unsecured
notes due October 1, 2014, its $385 million 6.5% senior unsecured notes due
March 1, 2012 and its $375 million 5.496% Class A-2 pass-through
certificates due November 1, 2006. Under these interest rate swap
agreements, the Company pays the London InterBank Offered Rate (LIBOR) plus a
margin every six months on the notional amount of the debt, and receives the
fixed stated rate of the notes every six months until the date the notes
become due.
The Company's interest rate swap agreements qualify as fair value hedges, as
defined by SFAS 133. The fair value of the interest rate swap agreements,
which are adjusted regularly, are recorded in the Company's balance sheet as
an asset or liability, as necessary, with a corresponding adjustment to the
carrying value of the long-term debt. The fair value of the interest rate
swap agreements, excluding accrued interest, at September 30, 2005 was a
liability of approximately $25 million. This amount is recorded in "Other
deferred liabilities" in the unaudited Condensed Consolidated Balance Sheet.
In accordance with fair value hedging, the offsetting entry is an adjustment
to decrease the carrying value of long-term debt.
6. COMPREHENSIVE INCOME
Comprehensive income included changes in the fair value of certain financial
derivative instruments, which qualify for hedge accounting, and unrealized
gains and losses on certain investments. For the first nine months of 2005,
the Company's comprehensive income increased significantly, due to the
substantial change in the fair value of the Company's hedge positions. Since
comprehensive income is reported net of tax, there was also a significant
increase in the Company's deferred tax liability compared to December 31,
2004. See Note 5 for further information. Comprehensive income totaled $421
million and $1.2 billion, respectively, for the three and nine months ended
September 30, 2005. Comprehensive income totaled $353 million and $656
million, respectively, for the three and nine months ended September 30,
2004. The differences between net income and comprehensive income for each
of these periods was as follows (in millions):
Three months ended September 30,
2005 2004
Net income $227 $119
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $123 and $146 194 234
Other, net of deferred taxes of $0 and $0 - -
Total other comprehensive income 194 234
Comprehensive income $421 $353
Nine months ended September 30,
2005 2004
Net income $462 $258
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $493 and $252 777 397
Other, net of deferred taxes of $0 and $0 - 1
Total other comprehensive income 777 397
Comprehensive income $1,239 $656
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 June 30, 2005 $999 $1 $1,000
Third quarter 2005 changes in value 357 - 357
Reclassification to earnings (163) - (163)
Balance at September 30, 2005 $1,193 $1 $1,194
Accumulated
Fuel other
Hedge comprehensive
Derivatives Other income (loss)
Balance at December 31, 2004 $416 $1 $417
2005 changes in value 1,144 - 1,144
Reclassification to earnings (367) - (367)
Balance at September 30, 2005 $1,193 $1 $1,194
7. LONG-TERM DEBT
During February 2005, the Company issued $300 million senior unsecured Notes
(Notes) due 2017. The Notes bear interest at 5.125 percent, payable semi-
annually in arrears, with the first payment made on September 1, 2005.
Southwest used the net proceeds from the issuance of the Notes, approximately
$296 million, for general corporate purposes.
During first quarter 2005, the Company redeemed its $100 million senior
unsecured 8% Notes on their maturity date of March 1, 2005.
8. OTHER ASSETS AND ACCRUED LIABILITIES (in millions)
September 30, December 31,
2005 2004
Noncurrent fuel hedge contracts,
at fair value $1,211 $368
Other 81 74
Other assets $1,292 $442
September 30, December 31,
2005 2004
Counterparty fuel hedge deposits $1,195 $330
Accrued vacation pay 131 120
Accrued aircraft rent 109 127
Accrued profitsharing 115 89
Deferred income taxes 282 218
Other 206 163
Accrued liabilities $2,038 $1,047
9. POSTRETIREMENT BENEFITS
The following table sets forth the Company's periodic postretirement benefit
cost for each of the interim periods identified:
Three months ended September 30,
(In millions) 2005 2004
Service cost $3 $3
Interest cost 1 1
Amortization of prior service cost - 1
Recognized actuarial loss - -
Net periodic postretirement benefit cost $4 $5
Nine months ended September 30, 2005
(In millions) 2005 2004
Service cost $9 $8
Interest cost 3 3
Amortization of prior service cost 1 2
Recognized actuarial loss - -
Net periodic postretirement benefit cost $13 $13
10. RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment". SFAS
No. 123R is a revision of SFAS No. 123, "Accounting for Stock Based
Compensation", and supersedes APB 25. Among other items, SFAS 123R
eliminates the use of APB 25 and the intrinsic value method of accounting,
and requires companies to recognize the cost of employee services received in
exchange for awards of equity instruments, based on the grant date fair value
of those awards, in the financial statements. The effective date of SFAS
123R had been set for the first reporting period beginning after June 15,
2005, which is third quarter 2005 for calendar year companies.
However, on April 14, 2005, the Securities and Exchange Commission (SEC)
announced the effective date of SFAS 123R was suspended until January 1,
2006, for calendar year companies. Early adoption is allowed.
SFAS 123R permits companies to adopt its requirements using either a
"modified prospective" method, or a "modified retrospective" method. Under
the "modified prospective" method, compensation cost is recognized in the
financial statements beginning with the effective date, based on the
requirements of SFAS 123R for all share-based payments granted after that
date, and based on the requirements of SFAS 123 for all unvested awards
granted prior to the effective date of SFAS 123R. Under the "modified
retrospective" method, the requirements are the same as under the "modified
prospective" method, but also permits entities to restate financial
statements of previous periods based on proforma disclosures made in
accordance with SFAS 123.
The Company currently utilizes a standard option pricing model (i.e., Black-
Scholes) to measure the fair value of stock options granted to Employees.
While SFAS 123R permits entities to continue to use such a model, the
standard also permits the use of a "lattice" model. The Company has not yet
determined which model it will use to measure the fair value of employee
stock options granted after the adoption of SFAS 123R.
SFAS 123R also requires that the benefits associated with the tax deductions
in excess of recognized compensation cost be reported as a financing cash
flow, rather than as an operating cash flow as required under current
literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after the effective date. These
future amounts cannot be estimated because they depend on, among other
things, when employees exercise stock options.
The Company currently expects to adopt SFAS 123R effective January 1, 2006,
based on the new effective date announced by the SEC, and plans to utilize
the modified retrospective method. As such, the Company would restate prior
period financial statements upon adoption. The Company has not yet
determined the financial statement impact of adopting SFAS 123R for periods
beyond 2005.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Comparative Consolidated Operating Statistics
Relevant Southwest comparative operating statistics for the three and
nine months ended September 30, 2005 and 2004 are as follows:
Three months ended September 30,
2005 2004 Change
Revenue passengers carried 20,637,620 18,334,448 12.6 %
Enplaned passengers 23,595,749 21,102,752 11.8 %
Revenue passenger miles (RPMs) (000s) 16,365,420 14,164,101 15.5 %
Available seat miles (ASMs) (000s) 21,853,579 19,486,103 12.1 %
Load factor 74.9% 72.7% 2.2 pts.
Average length of passenger haul (miles) 793 773 2.6 %
Average aircraft stage length (miles) 612 576 6.3 %
Trips flown 261,812 248,981 5.2 %
Average passenger fare $92.63 $87.90 5.4 %
Passenger revenue yield per RPM (cents) 11.68 11.38 2.6 %
Operating revenue yield per ASM (cents) 9.10 8.59 5.9 %
Operating expenses per ASM (cents) 7.85 7.61 3.2 %
Operating expenses per ASM,
excluding fuel (cents) 6.31 6.34 (0.5)%
Fuel costs per gallon, excluding fuel
tax (GAAP) $1.006 $.803 25.3 %
Fuel consumed, in gallons (millions) 332 306 8.5 %
Number of Employees at period-end 31,382 30,657 2.4 %
Size of fleet at period-end 439 415 5.8 %
Nine months ended September 30,
2005 2004 Change
Revenue passengers carried 58,208,534 53,193,484 9.4 %
Enplaned passengers 66,154,155 60,921,204 8.6 %
Revenue passenger miles (RPMs) (000s) 45,083,739 40,282,260 11.9 %
Available seat miles (ASMs) (000s) 63,424,106 56,641,218 12.0 %
Load factor 71.1% 71.1% -
Average length of passenger haul (miles) 775 757 2.4 %
Average aircraft stage length (miles) 605 572 5.8 %
Trips flown 769,262 729,836 5.4 %
Average passenger fare $92.30 $88.23 4.6 %
Passenger revenue yield per RPM (cents) 11.92 11.65 2.3 %
Operating revenue yield per ASM (cents) 8.82 8.61 2.4 %
Operating expenses per ASM (cents) 7.79 7.84 (0.6)%
Operating expenses per ASM,
excluding fuel (cents) 6.30 6.56 (4.0)%
Fuel costs per gallon, excluding
fuel tax (GAAP) $.978 $.806 21.3 %
Fuel consumed, in gallons (millions) 961 891 7.9 %
Number of Employees at period-end 31,382 30,657 2.4 %
Size of fleet at period-end 439 415 5.8 %
Material Changes in Results of Operations
Summary
The Company's third quarter 2005 net income was $227 million ($.28 per
share, diluted), an increase of $108 million, or 90.8 percent, compared to
third quarter 2004 net income of $119 million ($.15 per share, diluted).
Third quarter 2005 represented the Company's 58th consecutive quarterly
profit. The Company's fuel hedging program once again greatly mitigated
record-high market fuel prices during third quarter 2005. The Company's fuel
hedging program resulted in a reduction to fuel and oil expense of $276
million and also resulted in an additional $22 million in gains from
derivative contracts that also settled in the period. In addition, the
Company recorded an additional $87 million ($53 million net tax, or $.07 per
share, diluted) in gains from hedge ineffectiveness on positions that settle
in future periods and for future period derivative contracts that did not
qualify for SFAS 133 hedge accounting during third quarter. See Note 5 to the
unaudited condensed consolidated financial statements. However, even with the
Company's strong hedge position, fuel cost per gallon increased 25.3 percent
versus third quarter 2004.
Third quarter 2005 operating income increased $82 million, or 42.9
percent, compared to third quarter 2004. This growth was primarily driven by
an 18.8 percent increase in revenues, and a good cost performance excluding
fuel. The increase in revenues primarily resulted from the 12.1 percent
increase in the Company's capacity (available seat miles) and strong industry
demand. The capacity increase, along with a 15.5 percent increase in revenue
passenger miles (RPMs), resulted in a third quarter 2005 load factor of 74.9
percent, which was the highest for any third quarter in the Company's
history. The third quarter 2004 load factor was 72.7 percent. RPM yields
also improved 2.6 percent as a result of modest fare increases, and the
Company's expansion efforts at Chicago Midway Airport, including $19 million in
revenues generated from the Company's codeshare arrangement with ATA Airlines
(ATA.) ATA continues to reorganize in Chapter 11, and is seeking exit
financing. As part of its reorganization efforts, ATA recently announced
it will be discontinuing service in Chicago Midway to Minneapolis, Newark, and
Boston in fourth quarter 2005. While the Company's codeshare activity will
decline, as a consequence, we will pursue opportunities to continue Southwest's
growth at Midway. We have been pleased with our expansion efforts at Midway
this year.
Third quarter 2005 CASM (cost per available seat mile) declined
slightly compared to third quarter 2004, excluding fuel. Including fuel
expense, third quarter 2005 CASM increased 3.2 percent. The largest
increases in unit costs were in fuel expense, as previously mentioned, and in
other operating expenses, primarily as a result of higher fuel taxes. The
Company continued its focus on controlling non-fuel costs. As a result of
increased workforce productivity, the Company has been able to continue
expanding flights without a commensurate increase in overall headcount.
At September 30, 2005, the Company's headcount per aircraft was 71 versus a
year-ago level of 74. These productivity enhancements have helped the
Company absorb cost pressures from wage and benefit increases. Based on recent
trends, however, the Company currently expects fourth quarter unit costs,
excluding fuel, to modestly exceed third quarter's 6.31 cents per ASM.
As a result of the recent worker strike at Boeing, which has since been
resolved, the Company's new aircraft deliveries from September through
December 2005 were impacted. The combination of this strike and the
reduction in service to New Orleans following Hurricane Katrina in August
2005, will result in the Company's year-over-year capacity growth for fourth
quarter 2005 being less than planned. The Company currently expects fourth
quarter 2005 capacity to grow approximately seven percent versus fourth
quarter 2004.
For the nine months ended September 30, 2005, net income was $462
million ($.57 per share, diluted), an increase of $204 million, or 79.1
percent, versus the comparable period of 2004 net income of $258 million
($.32 per share, diluted). Operating income for the nine months ended
September 30, 2005 increased $221 million, or 50.8 percent, compared to the
same period of 2004. This significant increase in operating income was
primarily due to the strengthening airline revenue environment and to the
Company's ongoing cost reduction efforts, which resulted in a 4.0
percent decrease in CASM, excluding fuel.
The Company began service to Fort Myers, Florida, on October 2, 2005,
representing the 61st city the Company now serves. The Company also has
announced that it will soon begin service to Denver, Colorado, representing
the 62nd city and 32nd state the Company serves. The starting date and
schedule for service to Denver will be announced during fourth quarter 2005.
Comparison of three months ended September 30, 2005, to three months ended
September 30, 2004
Revenues
Consolidated operating revenues increased by $315 million, or 18.8
percent, primarily due to a $300 million, or 18.6 percent, increase in
passenger revenues. The increase in passenger revenues was primarily due to
a 15.5 percent increase in revenue passenger miles (RPMs) flown.
Third quarter 2005 capacity, as measured by available seat miles
(ASMs), increased 12.1 percent compared to third quarter 2004. The capacity
increase resulted from the net addition of 24 aircraft (net of 13
retirements) since the end of third quarter 2004. The third quarter 2005
load factor was 74.9 percent, an increase of 2.2 points compared to the same
period of 2004. The Company also experienced a 12.6 percent increase in
revenue passengers carried compared to third quarter 2004.
The third quarter 2005 passenger yield per RPM increased 2.6 percent to
11.68 cents from 11.38 cents in third quarter 2004. The higher RPM yield was
primarily due to modest fare increases and an overall improvement in industry
demand, especially for the Company's low fares. Unit revenue (operating
revenue per ASM) also increased 5.9 percent, due to the combination of higher
RPM yields and the higher load factor. The Company's favorable load factor and
unit revenue trends have continued in October 2005. Based on bookings and
these traffic trends, the Company expects fourth quarter 2005 unit revenue
results to exceed the fourth quarter 2004 unit revenue of 8.18 cents, despite
year-over-year capacity growth of seven percent.
Consolidated freight revenues increased by $4 million, or 14.3 percent.
The majority of the increase was due to an increase in freight and cargo
revenues, primarily as a result of the increase in capacity versus third
quarter 2004. The Company expects fourth quarter 2005 freight revenue to be
in line with fourth quarter 2004, despite the planned capacity increase of
seven percent. Other revenues increased by $11 million, or 32.4 percent,
compared to third quarter 2004. In excess of 40 percent of the increase was in
excess baggage charges, as the Company modified its fee policy related to the
weight of checked baggage. The remainder of the increase was spread among
other items, including commissions earned from programs the Company sponsors
with certain business partners, such as the Company sponsored Chase Visa card,
and charter revenues. The Company expects another year-over-year other revenue
increase in fourth quarter 2005; however, at a lower rate than in third quarter
2005.
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 September 30, 2005 and
2004, followed by explanations of changes on a per-ASM basis:
Three months ended September 30, Per ASM Percent
2005 2004 Change Change
Salaries, wages, and benefits 3.17 3.14 .03 1.0
Fuel and oil 1.54 1.27 .27 21.3
Maintenance materials
and repairs .50 .58 (.08) (13.8)
Aircraft rentals .16 .23 (.07) (30.4)
Landing fees and other rentals .55 .53 .02 3.8
Depreciation .55 .55 - -
Other operating expenses 1.38 1.31 .07 5.3
Total 7.85 7.61 .24 3.2
Operating expenses per ASM were 7.85 cents, a 3.2 percent increase
compared to 7.61 cents for third quarter 2004. The majority of the year-
over-year CASM increase was due to higher fuel costs, as the Company's cost
per gallon of fuel increased 25.3 percent versus the prior year. Excluding
fuel, year-over-year CASM was approximately flat, as higher salaries, wages,
and benefits from an increase in profitsharing expense, and higher other
operating expenses were mostly offset by lower maintenance expense and
aircraft rentals.
Salaries, wages, and benefits expense per ASM increased 1.0 percent
primarily due to higher profitsharing expense, as a result of the significant
increase in the Company's earnings available for profitsharing versus third
quarter 2004. Excluding profitsharing expense, salaries, wages, and benefits
declined versus the prior year as a result of lower benefits expense per ASM,
specifically workers compensation expense. The Company currently expects
Salaries, wages, and benefits in fourth quarter 2005 to be up compared to the
3.06 cents per ASM experienced in fourth quarter 2004.
Fuel and oil expense per ASM increased 21.3 percent primarily due to an
increase in the average jet fuel price per gallon. The average fuel cost per
gallon in third quarter 2005 was $1.01, 25.3 percent higher than third
quarter 2004, including the effects of hedging activities. Prior to third
quarter 2005, the Company had hedged approximately 85 percent of its
anticipated fuel needs. This resulted in third quarter gains recorded in
fuel and oil expense of $276 million. In other efforts to control fuel
expense, the Company has added Blended Winglets to all of its Boeing 737-700
aircraft. These enhancements extend the range of these aircraft, enable the
aircraft to burn less fuel, lower potential engine maintenance costs, and
reduce takeoff noise. All new 737-700 aircraft now arrive from Boeing with
winglets installed. The Company has experienced annual fuel consumption
savings of approximately three percent for each aircraft outfitted with the
winglets.
For fourth quarter 2005, the Company has fuel hedges in place for
approximately 85 percent of its expected fuel consumption with a combination
of derivative instruments that effectively cap prices at approximately $26
per barrel of crude oil and has hedged the refinery margins on the majority
of those positions. The majority of the Company's near term hedge
positions are also in the form of option contracts. However, given the
unprecedented surge in Gulf Coast jet fuel refinery margins following
Hurricanes Katrina and Rita, the Company expects its fourth quarter 2005 jet
fuel cost per gallon to be well above the third quarter 2005 jet fuel cost
per gallon. Unless Gulf Coast jet fuel prices recede from current levels,
the Company's fourth quarter 2005 jet fuel cost per gallon could exceed
$1.25, excluding the impact of any ineffectiveness on the Company's hedges.
During the first nine months of 2005, because of the continued rise in
energy prices, the fair values of the Company's fuel hedge contracts have
increased significantly. At September 30, 2005, the estimated net fair value
of these contracts was $2.2 billion. 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 decreased 13.8 percent
primarily due to a decrease in repair events for aircraft engines. The
Company currently expects maintenance materials and repairs per ASM for
fourth quarter 2005 to be approximately flat with fourth quarter 2004.
Aircraft rentals per ASM decreased 30.4 percent compared to third
quarter 2004. The majority of the decrease per ASM was due to the
renegotiation of several aircraft leases over the past twelve months, that
resulted in both lower lease rates and the reclassification of four aircraft
from operating leases to capital leases. Expense associated with capital
lease aircraft is recorded as depreciation. In addition, all of the aircraft
acquired in 2004, except for one, and all of the aircraft acquired in 2005,
are owned by the Company. The Company currently expects another year-over-
year decline in aircraft rentals per ASM for fourth quarter 2005, but at a
lesser rate than the third quarter 2005 decrease.
Landing fees and other rentals per ASM were up 3.8 percent compared to
third quarter 2004. A slight increase in other rentals per ASM was mostly
offset by a slight decrease in landing fees per ASM. The Company expects an
increase in landing fees and other rentals per ASM in fourth quarter 2005
compared to fourth quarter 2004, primarily due to a large number of credits
from airports' audits of prior periods received in fourth quarter 2004. The
Company expects to receive a lesser amount of credits during fourth quarter
2005.
Depreciation expense per ASM was flat compared to third quarter 2005.
An increase in the number of aircraft owned or on capital lease was offset by
the retirement of equipment associated with the Company's 737-200 aircraft,
the remainder of which were phased out of the Company's fleet in January
2005. For fourth quarter 2005, the Company currently expects depreciation
per ASM to be up from third quarter 2005.
Other operating expenses per ASM increased 5.3 percent compared to
third quarter 2004. Approximately one-third of the increase was due to
higher fuel sales taxes due to the substantial increase in jet fuel prices.
Of the remainder of the increase, the most significant item was higher
credit card fees associated with the increase in revenues. The Company
currently expects Other operating expenses per ASM for fourth quarter 2005 to
be higher than the 1.36 cents per ASM experienced in fourth quarter 2004 due
to the same reasons noted for third quarter 2005.
Through the 2003 Emergency Wartime Supplemental Appropriations Act, the
federal government has continued 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. The government-provided
supplemental coverage from the Wartime Act is currently set to expire
on December 31, 2005. Although another extension beyond this date is
expected, if such coverage is not extended by the government, the Company
could incur substantially higher insurance costs in future periods.
Other
Interest expense increased $11 million, or 52.4 percent compared to
third quarter 2004. The majority of the increase was due to an increase in
interest rates, due to the fact that most of the Company's long-term debt is
at floating rates. See Notes 5 and 7 to the unaudited condensed consolidated
financial statements for more information.
Capitalized interest was flat compared to the prior year, as a decrease
in progress payment balances for future aircraft deliveries was offset by an
increase in interest rates.
Interest income increased by $8 million, or 160.0 percent, primarily
due to an increase in rates earned on cash and investments.
"Other (gains) losses, net" primarily includes amounts recorded in
accordance with SFAS 133. During third quarter 2005, the Company recognized
approximately $9 million of expense related to amounts excluded from the
Company's measurements of hedge effectiveness. Also in third quarter 2005,
the Company recognized approximately $109 million of additional income in
"Other (gains) losses, net," related to the ineffectiveness of its hedges and
the loss of hedge accounting for certain hedges. Of this amount,
approximately $73 million of the additional income was unrealized, mark-to-
market changes in the fair value of derivatives due to the discontinuation of
hedge accounting for certain contracts that will settle in future periods,
approximately $14 million was unrealized ineffectiveness associated with
hedges designated for future periods, and $22 million was ineffectiveness and
mark-to-market gains related to contracts that settled during third quarter
2005. See Note 5 to the unaudited condensed consolidated financial
statements for more information on the Company's hedging activities. In
third quarter 2004, the Company recognized approximately $6 million of
expense related to amounts excluded from the Company's measurements of hedge
effectiveness and $2 million in income related to the ineffectiveness of its
hedges.
The Company's effective tax rate increased to 38.3 percent in third
quarter 2005 from 34.1 percent in third quarter 2004. The prior year rate
was favorably impacted by an adjustment related to the ultimate resolution of
an airline industry-wide issue regarding the tax treatment of certain
aircraft engine maintenance costs. The Company currently expects its fourth
quarter 2005 effective rate to be 38 to 39 percent, and its full year 2005
effective rate to be in the 37 to 38 percent range.
Comparison of nine months ended September 30, 2005, to nine months ended]
September 30, 2004
Revenues
Consolidated operating revenues increased by $721 million, or 14.8
percent, primarily due to a $678 million, or 14.4 percent, increase in
passenger revenues. The increase in passenger revenues was primarily due to
an 11.9 percent increase in revenue passenger miles (RPMs) flown.
Capacity for the nine months ended September 30, 2005, as measured by
available seat miles (ASMs), increased 12.0 percent compared to the nine
months ended September 30, 2004. The capacity increase resulted from the net
addition of 24 aircraft (net of 13 retirements) since the end of third
quarter 2004. Load factor for the nine months ended September 30, 2005 was
71.1 percent, the same as the prior year. The Company also experienced a 9.4
percent increase in revenue passengers carried compared to the nine months
ended September 30, 2004.
Passenger yield per RPM for the nine months ended September 30, 2005
increased 2.3 percent to 11.92 cents from 11.65 cents in the nine months
ended September 30, 2004, primarily due to less fare discounting during the
same 2005 period. Unit revenue (operating revenue per ASM) increased 2.4
percent to 8.82 cents compared to the nine months ended September 30, 2004,
due to the increase in RPM yield and strong performances in both freight and
other revenues.
Consolidated freight revenues increased by $17 million, or 20.7
percent. Approximately 55 percent of the increase was due to an increase in
mail revenues, as the U.S. Postal Service shifted more business to commercial
carriers. Other revenues increased by $26 million, or 26.3 percent, compared
to the nine months ended September 30, 2004. Approximately one-third of the
increase was due to an increase in excess baggage charges, as the Company
modified its fee policy related to the weight of checked baggage. Another
one-third of the increase was from commissions earned from programs the
Company sponsors with certain business partners, such as the Company
sponsored Chase Visa card.
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 nine months ended September 30, 2005 and
2004, followed by explanations of changes on a per-ASM basis:
Nine months ended September 30, Per ASM Percent
2005 2004 Change Change
Salaries, wages, and benefits 3.15 3.22 (.07) (2.2)
Fuel and oil 1.49 1.28 .21 16.4
Maintenance materials
and repairs .50 .62 (.12) (19.4)
Aircraft rentals .19 .24 (.05) (20.8)
Landing fees and other rentals .55 .54 .01 1.9
Depreciation .55 .56 (.01) (1.8)
Other operating expenses 1.36 1.38 (.02) (1.4)
Total 7.79 7.84 (.05) (.6)
Operating expenses per ASM were 7.79 cents, a .6 percent decrease
compared to 7.84 cents for the nine months ended September 30, 2004. The
Company was able to hold approximately flat or reduce unit costs in every cost
category, except fuel expense, through a variety of cost reduction or
productivity efforts. These efforts, however, were almost entirely offset by
the significant increase in the cost of fuel. Excluding fuel, CASM was 4.0
percent lower than the nine months ended September 30, 2004, at 6.30 cents
per ASM.
Salaries, wages, and benefits expense per ASM decreased 2.2 percent.
In the nine months ended September 30, 2004, salaries, wages, and benefits
included approximately $13 million in severance and benefits associated with
the Company's Reservations Center consolidation, $11 million of bonus pay and
benefits associated with the Company's voluntary early-out plan offered to
all Employees except officers, and approximately $7 million in pay and
benefit increases associated with the Company's labor agreement with its
Flight Attendants (an additional $5 million related to per diem increases was
included in "Other operating expenses"). Excluding these costs, salaries,
wages, and benefits were approximately flat on a per ASM basis compared to
the nine months ended September 30, 2004. Higher average wage rates and
higher profitsharing expense per ASM from the increase in earnings were
offset by continued productivity efforts that have enabled the Company to
reduce headcount while continuing to grow its aircraft fleet, as well as
lower benefits expense, primarily health care.
Fuel and oil expense per ASM increased 16.4 percent primarily due to an
increase in the average jet fuel price per gallon. The average fuel cost per
gallon in the nine months ended September 30, 2005 was 97.8 cents, 21.3
percent higher than the nine months ended September 30, 2004, including the
effects of hedging activities. For the nine months ended September 30, 2005,
the Company was hedged for approximately 85 percent of its fuel needs,
resulting in gains recorded in fuel and oil expense of $627 million.
Maintenance materials and repairs per ASM decreased 19.4 percent
primarily due to a decrease in repair events for aircraft engines.
Aircraft rentals per ASM decreased 20.8 percent compared to the nine
months ended September 30, 2004. The majority of the decrease per ASM was
due to the Company's growth occurring with purchased aircraft. All of the
aircraft acquired in 2004, except for one, and all of the aircraft acquired
thus far in 2005, are owned by the Company.
Landing fees and other rentals per ASM were up slightly compared to the
nine months ended September 30, 2004, as higher landing fees per ASM were
mostly offset by a decline in other rentals per ASM. The Company experienced
a 3.7 percent increase in landing fees per ASM, primarily due to higher rates
paid. This was partially offset by a decrease in other rentals expense per
ASM, primarily due to efficiencies gained by capacity growth exceeding the
expansion of gate and counter space at airports.
Depreciation expense per ASM decreased 1.8 percent primarily due to the
retirement of equipment associated with the Company's 737-200 aircraft, the
remainder of which were phased out of the Company's fleet in January 2005.
Other operating expenses per ASM decreased 1.4 percent compared to the
nine months ended September 30, 2004. There were decreases per ASM in
several cost categories, including advertising costs, personnel expenses, and
insurance expense. These and other smaller decreases were partially
offset by higher fuel sales taxes due to the substantial increase in fuel
prices.
Other
Interest expense increased $27 million, or 43.5 percent compared to the
nine months ended September 30, 2004. The majority of the increase was due
to an increase in interest rates. The majority of the Company's long-term
debt is at floating rates. See Notes 5 and 7 to the unaudited condensed
consolidated financial statements for more information.
Capitalized interest decreased by $2 million, or 6.7 percent, primarily
due to a decrease in progress payment balances for future aircraft
deliveries.
Interest income increased by $17 million, or 121.4 percent, primarily
due to an increase in rates earned on cash and investments.
"Other (gains) losses, net" primarily includes 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. During the nine months ended September 30, 2005, the Company
recognized approximately $26 million of expense related to amounts excluded
from the Company's measurements of hedge effectiveness. Also during the nine
months ended September 30, the Company recognized approximately $134 million
of additional income in "Other (gains) losses, net," related to the
ineffectiveness of its hedges and the loss of hedge accounting for certain
hedges. Of this amount, approximately $85 million of the additional income
was unrealized, mark-to-market changes in the fair value of derivatives due
to the discontinuation of hedge accounting for certain contracts that will
settle in future periods, approximately $28 million was unrealized
ineffectiveness associated with hedges designated for future periods, and $21
million was ineffectiveness and mark-to-market gains related to contracts
that settled during the first nine months of 2005. For the nine months ended
September 30, 2004, the Company recognized approximately $18 million of
expense related to amounts excluded from the Company's measurements of hedge
effectiveness and $3 million in income related to the ineffectiveness of its
hedges.
The Company's effective tax rate increased to 37.4 percent in the nine
months ended September 30, 2005, from 35.7 percent in the nine months ended
September 30, 2004. The prior year rate was favorably impacted by an
adjustment related to the ultimate resolution of an airline industry-wide
issue regarding the tax treatment of certain aircraft engine maintenance
costs, and lower state income taxes.
Liquidity and Capital Resources
Net cash provided by operating activities was $2.2 billion for the nine
months ended September 30, 2005, compared to $1.2 billion in the same prior
year period. The increase was primarily due to an increase in Accounts
payable and accrued liabilities, primarily from an $865 million increase in
counterparty deposits associated with the Company's fuel hedging program
during 2005, and the increase in net earnings versus the prior year. See
Item 3, and Notes 5 and 8 to the unaudited condensed consolidated financial
statements. Net cash provided by operating activities was $2.1 billion for
the 12 months ended September 30, 2005. Cash generated from operating
activities for the 12 months ended September 30, 2005, was primarily used to
finance capital expenditures.
Net cash flows used in investing activities during the nine months
ended September 30, 2005, totaled $927 million compared to $1.3 billion in
2004. 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. In addition, investing activities for the nine
months ended September 30, 2005, was reduced $72 million by a change in the
balance of the Company's short-term investments, namely auction rate
securities. Cash flows used in investing activities for the 12 months ended
September 30, 2005, totaled $1.3 billion.
Net cash generated from financing activities during the nine months
ended September 30, 2005, was $151 million compared to $171 million generated
in 2004. The Company generated $300 million from the February 2005 issuance
of senior unsecured Notes due 2017. This was partially offset by cash used
to redeem the $100 million senior unsecured 8% Notes due March 1, 2005, and
to repurchase $55 million of the Company's common stock.
In fourth quarter 2004, Southwest was selected as the winning bidder at
a bankruptcy-court approved auction for certain ATA assets. As part of the
transaction, which was approved in December 2004, Southwest provided ATA with
$40 million in debtor-in-possession financing while ATA remains in
bankruptcy, and has also guaranteed the repayment of an ATA construction loan
to the City of Chicago for $7 million. The $40 million debtor-in-possession
financing, which was set to mature September 30, 2005, has been extended to
December 31, 2005 (coinciding with ATA's expected emergence from bankruptcy).
This loan is classified as "Accounts and other receivables" in the
Consolidated Balance Sheet, and the estimated fair value of the Company's
guarantee of the ATA construction loan, which is not material, is classified
as part of "Other deferred liabilities". The debtor-in-possession financing
bears interest at a rate equal to the higher of 8 percent or LIBOR plus
5 percent, and interest is payable to Southwest monthly. Upon ATA's
emergence from bankruptcy, Southwest has committed to convert the debtor-in-
possession financing to a term loan, payable over five years.
ATA is currently pursuing funding that would enable its emergence from
bankruptcy. Although ATA's planned emergence has been extended to December
31, 2005, there is no assurance that ATA will exit bankruptcy protection on
this date, or that funding will be found that would enable ATA to emerge from
bankruptcy. ATA has disclosed that, in addition to certain specific
reorganization objectives, it will need a capital infusion of $50 million to
$100 million to provide it with the liquidity necessary to continue as a
going concern through December 31, 2005. Although the Company's loan to ATA
is secured by certain specified assets, if ATA is unable to obtain adequate
funding and/or does not emerge from bankruptcy, loans made by Southwest to ATA
may not be repaid in full. As of September 30, 2005, Southwest has not
recorded an uncollectibility reserve for the ATA loan as management believes
the receivable is recoverable.
Contractual Obligations and Contingent Liabilities and Commitments
Southwest has contractual obligations and commitments primarily for
future purchases of aircraft, payment of debt, and lease arrangements.
Through the first nine months of 2005, the Company has received 27 new 737-
700 aircraft from Boeing. Prior to third quarter 2005, the Company had
expected a total of 34 new 737-700s for the year. However, due to a Boeing
labor dispute that was just resolved at the end of third quarter 2005, the
Company's remaining deliveries for 2005 are expected to be delayed, and one
of these aircraft is not expected to be delivered until January 2006. Based
on recent information provided by Boeing, the following table details the
Company's current firm orders, options, and purchase rights through 2012.
Current Schedule
Firm Options*
2005** 33 -
2006 33 -
2007 27 29
2008 6 45
2009-2012 - 177
Total 99 251
*Includes purchase rights
**Includes 27 aircraft delivered through September 30, 2005
The following table details information on the 439 aircraft in the
Company's fleet as of September 30, 2005:
Average Number Number Number
737 Type Seats Age (Yrs) of Aircraft Owned Leased
-300 137 14.4 194 112 82
-500 122 14.4 25 16 9
-700 137 3.6 220 218 2
TOTALS 9.0 439 346 93
The Company has the option, which must be exercised two years prior to
the contractual delivery date, to substitute -600s or -800s for the -700s.
Based on the current revised delivery schedule provided by Boeing following
the resolution of their labor dispute, aggregate funding needed for firm
aircraft commitments was approximately $1.4 billion, subject to adjustments
for inflation, due as follows: $188 million remaining in 2005, $704 million
in 2006, $445 million in 2007, and $80 million thereafter.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at September 30, 2005, of $2.4
billion, internally generated funds, and the Company's fully available $600
million revolving credit facility. The Company will also consider various
borrowing or leasing options to maximize earnings and supplement cash
requirements.
During first quarter 2005, the Company issued $300 million senior
unsecured Notes (Notes) due 2017. The Notes bear interest at 5.125 percent,
payable semi-annually in arrears, with the first payment due on September 1,
2005. Also during first quarter 2005, the Company redeemed its $100 million
8% senior unsecured notes on the maturity date of March 1, 2005. See Note 7
to the condensed consolidated financial statements.
The Company currently has outstanding shelf registrations for the
issuance of up to $1.3 billion in public debt securities and pass through
certificates, which it may utilize for aircraft financings or other purposes
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, 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.
- The availability and cost of war-risk and other aviation insurance,
including the federal government's provision of third party war-risk
coverage to airlines. The government's coverage currently extends to
December 31, 2005. However, there are no assurances that such coverage
will be extended beyond December 31, 2005.
- War or other military actions by the U.S. or others.
- Competitive factors, such as fare sales and capacity decisions, 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, 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.
- Factors affecting the Company's fuel expense, including, but not limited
to, the largely unpredictable prices of jet fuel, crude oil, heating oil,
and unleaded gasoline, the continued effectiveness of the Company's fuel
hedges, changes in the Company's overall fuel hedging strategy, and the
continued ability of commodities used in fuel hedging to qualify for
special hedge accounting.
- Disruptions to operations related to the supply of jet fuel, adverse
weather conditions, including catastrophic events such as hurricanes, and
air traffic control-related constraints.
- Internal failures of technology or large-scale external interruptions in
technology infrastructure, such as power, telecommunications, or the
internet.
- Risks involved with the Company's acquisition of certain assets from ATA
Airlines, Inc. (ATA), including the collectibility of loans made to ATA,
and the continued success of the Company's codeshare agreement with ATA.
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
As discussed in Note 5 to the unaudited condensed consolidated financial
statements, the Company utilizes financial derivative instruments to hedge
its exposure to material increases in jet fuel prices. During the first nine
months of 2005, because of the continued upward trend in energy
prices, the fair values of the Company's fuel hedge contracts have increased
significantly. At September 30, 2005, the estimated gross fair value of
outstanding contracts was $2.2 billion, compared to $796 million at December
31, 2004.
Outstanding financial derivative instruments expose the Company to credit
loss in the event of nonperformance by the counterparties to the agreements.
However, the Company does not expect any of the counterparties to fail to
meet their obligations. The credit exposure related to these financial
instruments is represented by the fair value of contracts with a positive
fair value at the reporting date. To manage credit risk, the Company selects
and periodically reviews counterparties based on credit ratings, limits its
exposure to a single counterparty, and monitors the market position of the
program and its relative market position with each counterparty. At September
30, 2005, the Company had agreements with seven counterparties containing
early termination rights and/or bilateral collateral provisions whereby
security is required if market risk exposure exceeds a specified threshold
amount or credit ratings fall below certain levels. At September 30, 2005,
the Company held $1.2 billion in fuel hedge related cash collateral deposits
and $150 million in U.S. Treasury Bills, under these bilateral collateral
provisions. These collateral deposits serve to decrease, but not totally
eliminate, the credit risk associated with the Company's hedging program.
The cash deposits, which can have a significant impact on the Company's cash
balance and cash flows as of and for a particular operating period, are
included in "Accrued liabilities" on the Consolidated Balance Sheet and are
included as "Operating cash flows" in the Consolidated Statement of Cash
Flows. In accordance with SFAS 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities, the U.S. Treasury
Bills, supplied as non-cash collateral by counterparties, are not reflected
on the Company's Consolidated Balance Sheet. See also Note 8 to the
unaudited condensed consolidated financial statements.
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, 2004
and Note 5 to the unaudited condensed consolidated financial statements for
further information about Market Risk.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure
that it is able to collect the information it is required to disclose in the
reports it files with the Securities and Exchange Commission (SEC), and to
process, summarize and disclose this information within the time periods
specified in the rules of the SEC. Based on an evaluation of the Company's
disclosure controls and procedures as of the end of the period covered by
this report conducted by the Company's management, with the participation of
the Chief Executive and Chief Financial Officers, the Chief Executive and
Chief Financial Officers believe that these controls and procedures are
effective to ensure that the Company is able to collect, process, and
disclose the information it is required to disclose in the reports it files
with the SEC within the required time periods.
Internal Control over Financial Reporting
There were no changes in the Company's internal control over financial
reporting (as defined in Rules 13(a)-15(f) and 15(d)-15(f) under the Exchange
Act) during the fiscal quarter ended September 30, 2005, that have materially
affected , or are reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to various legal proceedings and claims arising in the
ordinary course of business, including, but not limited to, examinations by
the Internal Revenue Service (IRS). The IRS regularly examines the Company's
federal income tax returns and, in the course thereof, 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 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. Unregistered Sales of Equity Securities and Use of Proceeds
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
a) Exhibits
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certifications of Chief Executive Officer and Chief
Financial Officer
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOUTHWEST AIRLINES CO.
October 21, 2005 By /s/ Laura Wright
Laura Wright
Chief Financial Officer
(Principal Financial and
Accounting Officer)
EXHIBIT INDEX
Exhibit No. Description
Exhibit 31.1 - Rule 13a-14(a) Certification of Chief Executive
Officer
Exhibit 31.2 - Rule 13a-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 - Section 1350 Certifications of Chief Executive
Officer and Chief Financial Officer