e10vk
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2005 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period
from to |
Commission File
No. 1-7259
Southwest Airlines Co.
(Exact name of registrant as specified in its charter)
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Texas |
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74-1563240 |
(State or other jurisdiction of
incorporation or organization) |
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(I.R.S. employer
identification no.) |
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P.O. Box 36611 |
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Dallas, Texas |
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75235-1611 |
(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code:
(214) 792-4000
Securities registered pursuant to Section 12(b) of the
Act:
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Title of Each Class |
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Name of Each Exchange on Which Registered |
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Common Stock ($1.00 par value) |
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New York Stock Exchange, Inc. |
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE
ACT:
None
Indicate by check mark whether the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes þ No o
Indicate by check mark whether the registrant is not required to
file reports pursuant to Section 13 or Section 15(d)
of the
Act. Yes o No þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any
amendment to this
Form 10-K. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2 of the
Exchange Act.
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2 of the
Exchange
Act). Yes o No þ
The aggregate market value of the Common Stock held by
non-affiliates of the registrant was approximately
$10,876,320,000, computed by reference to the closing sale price
of the stock on the New York Stock Exchange on June 30,
2005, the last trading day of the registrants most
recently completed second fiscal quarter.
Number of shares of Common Stock outstanding as of the close of
business on January 24, 2006: 804,661,597 shares
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for Annual Meeting of
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Shareholders, May 17, 2006: |
PART III |
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TABLE OF CONTENTS
PART I
Item 1. Business
Description of Business
Southwest Airlines Co. (Southwest or the
Company) is a major domestic airline that provides
point-to-point,
low-fare service. Historically, routes served by Southwest had
been predominantly short-haul, with high frequencies. In recent
years, the Company has complemented this service with more
medium to long-haul routes, including transcontinental service.
Southwest was incorporated in Texas in 1967 and commenced
Customer Service on June 18, 1971, with three Boeing 737
aircraft serving three Texas cities Dallas, Houston,
and San Antonio.
At year-end 2005, Southwest operated 445 Boeing 737 aircraft and
provided service to 61 cities in 31 states throughout
the United States. Based on monthly data for October 2005 (the
latest available data), Southwest Airlines is the largest
carrier in the United States based on originating domestic
passengers boarded and scheduled domestic departures. The
Company began service to Pittsburgh, Pennsylvania in May 2005,
Ft. Myers, Florida in October 2005, and Denver, Colorado in
January 2006.
One of Southwests primary competitive strengths is its low
operating costs. Southwest has the lowest costs, adjusted for
stage length, on a per mile basis, of all the major airlines.
Among the factors that contribute to its low cost structure are
a single aircraft type, an efficient, high-utilization,
point-to-point route
structure, and hardworking, innovative, and highly productive
Employees.
The business of the Company is somewhat seasonal. Quarterly
operating income and, to a lesser extent, revenues tend to be
lower in the first quarter (January 1 -
March 31) and fourth quarter (October 1 -
December 31) of most years.
Southwests filings with the Securities and Exchange
Commission (SEC), including its annual report on
Form 10-K,
quarterly reports on
Form 10-Q, current
reports on
Form 8-K and
amendments to those reports, are accessible free of charge at
www.southwest.com.
Fuel
The cost of fuel is an item that has significant impact on the
Companys operating results. The Companys average
cost of jet fuel, net of hedging gains and excluding fuel taxes,
over the past five years was as follows:
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Cost | |
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Average Cost | |
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Percent of | |
Year |
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(Millions) | |
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Per Gallon | |
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Operating Expenses | |
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2001
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$ |
771 |
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$ |
.71 |
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15.6 |
% |
2002
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$ |
762 |
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$ |
.68 |
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14.9 |
% |
2003
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$ |
830 |
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$ |
.72 |
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15.2 |
% |
2004
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$ |
1,000 |
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$ |
.83 |
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16.7 |
% |
2005
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$ |
1,342 |
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$ |
1.03 |
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19.8 |
% |
From October 1, 2005, through December 31, 2005, the
average cost per gallon was $1.20. See Managements
Discussion and Analysis of Financial Condition and Results of
Operations for a discussion of fuel costs and more detail
on Southwests fuel hedging activities.
Regulation
Economic. The Dallas Love Field section of the
International Air Transportation Competition Act of 1979, as
amended in 1997 and 2005 (commonly known as the Wright
Amendment), as it affects Southwests scheduled
service, provides that no common carrier may provide scheduled
passenger air transportation for compensation between Love Field
and one or more points outside Texas, except that an air carrier
may transport individuals by air on a flight between Love Field
and one or more points within the states of Alabama, Arkansas,
Kansas, Louisiana, Mississippi, Missouri, New Mexico, Oklahoma,
and Texas if (a) such air carrier does not offer or
provide any through service or ticketing with another air
carrier and (b) such air carrier does not offer
for sale transportation to or from, and the flight or aircraft
does not serve, any point which is outside any such
states. The Wright Amendment does not restrict flights
operated with aircraft having 56 or fewer passenger seats. The
Wright Amendment does not restrict Southwests intrastate
Texas flights or its air service from points other than Love
Field.
The Department of Transportation (DOT) has
significant regulatory jurisdiction over passenger airlines.
Unless exempted, no air carrier may furnish air transportation
over any route without a DOT certificate of public convenience
and necessity, which does not confer either exclusive or
proprietary rights. The Companys certificates are
unlimited in duration and permit the Company to operate among
any points within the United States, its territories and
possessions, except as limited by the Wright Amendment, as do
the certificates of all other U.S. carriers. DOT may revoke
such
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certificates, in whole or in part, for intentional failure to
comply with certain provisions of the U.S. Transportation
Code, or any order or regulation issued thereunder or any term
of such certificate; provided that, with respect to revocation,
the certificate holder has first been advised of the alleged
violation and fails to comply after being given a reasonable
time to do so.
DOT prescribes uniform disclosure standards regarding terms and
conditions of carriage and prescribes that terms incorporated
into the Contract of Carriage by reference are not binding upon
passengers unless notice is given in accordance with its
regulations.
Safety. The Company and its third-party maintenance
providers are subject to the jurisdiction of the Federal
Aviation Administration (FAA) with respect to its
aircraft maintenance and operations, including equipment, ground
facilities, dispatch, communications, flight training personnel,
and other matters affecting air safety. To ensure compliance
with its regulations, the FAA requires airlines to obtain
operating, airworthiness, and other certificates, which are
subject to suspension or revocation for cause. The Company has
obtained such certificates. The FAA, acting through its own
powers or through the appropriate U.S. Attorney, also has
the power to bring proceedings for the imposition and collection
of fines for violation of the Federal Air Regulations.
The Company is subject to various other federal, state, and
local laws and regulations relating to occupational safety and
health, including Occupational Safety and Health Administration
(OSHA) and Food and Drug Administration
(FDA) regulations.
Security. In November 2001, President Bush signed into
law the Aviation and Transportation Security Act, or the
Aviation Security Act. This law federalized substantially all
aspects of civil aviation security, creating the Transportation
Security Administration (TSA), which is part of the
Department of Homeland Security. The Aviation Security Act
generally provides for enhanced aviation security measures.
Under the Aviation Security Act, substantially all security
screeners at airports are federal employees and significant
other elements of airline and airport security are overseen and
performed by federal employees, including federal security
managers, federal law enforcement officers, and federal air
marshals. The law mandates, among other things, improved flight
deck security, deployment of federal air marshals onboard
flights, improved airport perimeter access security, airline
crew security training, enhanced security screening of
passengers, baggage, cargo, mail, employees, and vendors,
enhanced training and qualifications of security screening
personnel, additional provision of passenger data to
U.S. Customs, and enhanced background checks. Beginning
February 1, 2002, a $2.50 per enplanement security fee
is imposed on passengers (maximum of $5.00 per one-way
trip). This fee was suspended by Congress from June 1
through September 30, 2003. Pursuant to authority granted
to the TSA to impose additional fees on air carriers if
necessary to cover additional federal aviation security costs,
the TSA has imposed an annual Security Infrastructure Fee, which
approximated $26 million for Southwest in 2004 and
$50 million in 2005. Like the FAA, the TSA may impose and
collect fines for violations of its regulations.
Enhanced security measures have had, and will continue to have,
a significant impact on the airport experience for passengers.
While these security requirements have not impacted aircraft
utilization, they have impacted our business. The Company has
invested significantly in facilities, equipment, and technology
to process Customers efficiently and restore the airport
experience. The Company has implemented its Automated Boarding
Passes and RAPID CHECK-IN self service kiosks in all airports it
serves to reduce the number of lines in which a Customer must
wait. The Company has installed gate readers at all of its
airports to improve the boarding reconciliation process, has
introduced baggage checkin through RAPID CHECK-IN kiosks at
certain airport locations, and has also introduced Internet
checkin and transfer boarding passes at the time of checkin.
Environmental. Certain airports, including San Diego
and Orange County, have established airport restrictions to
limit noise, including restrictions on aircraft types to be
used, and limits on the number of hourly or daily operations or
the time of such operations. In some instances, these
restrictions have caused curtailments in service or increases in
operating costs and such restrictions could limit the ability of
Southwest to expand its operations at the affected airports.
Local authorities at other airports may consider adopting
similar noise regulations, but such regulations are subject to
the provisions of the Airport Noise and Capacity Act of 1990 and
regulations promulgated thereunder.
Operations at John Wayne Airport, Orange County, California, are
governed by the Airports Phase 2 Commercial Airline
Access Plan and Regulation (the Plan). Pursuant to
the Plan, each airline is allocated total annual seat capacity
to be operated at the airport, subject to renewal/reallocation
on an annual
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basis. Service at this airport may be adjusted annually to meet
these requirements.
The Company is subject to various other federal, state, and
local laws and regulations relating to the protection of the
environment, including the discharge or disposal of materials
such as chemicals, hazardous waste, and aircraft deicing fluid.
Regulatory developments pertaining to such things as control of
engine exhaust emissions from ground support equipment and
prevention of leaks from underground aircraft fueling systems
could increase operating costs in the airline industry. The
Company does not believe, however, that such environmental
regulatory developments will have a material impact on the
Companys capital expenditures or otherwise adversely
effect its operations, operating costs, or competitive position.
Additionally, in conjunction with airport authorities, other
airlines, and state and local environmental regulatory agencies,
the Company is undertaking voluntary investigation or
remediation of soil or groundwater contamination at several
airport sites. The Company does not believe that any
environmental liability associated with such sites will have a
material adverse effect on the Companys operations, costs,
or profitability.
Customer Service Commitment. From time to time, the
airline transportation industry has been faced with possible
legislation dealing with certain Customer service practices. As
a compromise with Congress, the industry, working with the Air
Transport Association, has responded by adopting and filing with
the DOT written plans disclosing how it would commit to
improving performance. Southwest Airlines Customer Service
Commitment is a comprehensive plan which embodies the Mission
Statement of Southwest Airlines: dedication to the highest
quality of Customer Service delivered with a sense of warmth,
friendliness, individual pride, and Company Spirit. The Customer
Service Commitment can be reviewed by clicking on About
SWA at www.southwest.com. The DOT and Congress monitor the
industrys plans, and there can be no assurance that
legislation or regulations will not be proposed in the future to
regulate airline Customer service practices.
Marketing and Competition
Southwest focuses principally on
point-to-point, rather
than hub-and-spoke, service in markets with frequent,
conveniently timed flights and low fares. At year-end, Southwest
served 374 nonstop city pairs. Southwests average aircraft
trip stage length in 2005 was 607 miles with an average
duration of approximately 1.7 hours. Examples of markets
offering frequent daily flights are: Dallas to Houston Hobby,
29 weekday roundtrips; Phoenix to Las Vegas,
19 weekday roundtrips; and Los Angeles International to
Oakland, 22 weekday roundtrips. Southwest complements these
high-frequency shorthaul routes with longhaul nonstop service
between markets such as Baltimore and Los Angeles, Phoenix and
Tampa Bay, Las Vegas and Nashville, and Houston and Oakland.
Southwests
point-to-point route
system, as compared to hub-and-spoke, provides for more direct
nonstop routings for Customers and, therefore, minimizes
connections, delays, and total trip time. Southwest focuses on
nonstop, not connecting, traffic. As a result, approximately
79 percent of the Companys Customers fly nonstop. In
addition, Southwest serves many conveniently located secondary
or downtown airports such as Dallas Love Field, Houston Hobby,
Chicago Midway, Baltimore-Washington International, Burbank,
Manchester, Oakland, San Jose, Providence,
Ft. Lauderdale/ Hollywood, and Long Island Islip airports,
which are typically less congested than other airlines hub
airports and enhance the Companys ability to sustain high
Employee productivity and reliable ontime performance. This
operating strategy also permits the Company to achieve high
asset utilization. Aircraft are scheduled to minimize the amount
of time the aircraft are at the gate, currently approximately 25
minutes, thereby reducing the number of aircraft and gate
facilities than would otherwise be required. The Company
operates only one aircraft type, the Boeing 737, which
simplifies scheduling, maintenance, flight operations, and
training activities.
In first quarter 2005, Southwest began its first codeshare
arrangement, with ATA Airlines. Under its codeshare arrangement
with ATA, Southwest may market and sell tickets for certain
flights on ATA that are identified by Southwests
designator code, e.g., WN Flight 123. Conversely, ATA may market
and sell tickets under its code designator (TZ) for certain
flights on Southwest Airlines. Any flight bearing a Southwest
code designator that is operated by ATA is disclosed in
Southwests reservations systems and on the Customers
flight itinerary, boarding pass, and ticket, if a paper ticket
is issued. In December 2005, Southwest enhanced the codeshare
arrangement with ATA, subject to certain conditions, including
ATAs confirmed Plan of Reorganization, which must be
fulfilled by February 28, 2006. Other than the ATA
agreement, Southwest does not interline or offer joint fares
with other airlines, nor does Southwest have any commuter feeder
relationships.
3
Southwest employs a relatively simple fare structure, featuring
low, unrestricted, unlimited, everyday coach fares, as well as
even lower fares available on a restricted basis. The
Companys highest non-codeshare, oneway unrestricted walkup
fare offered is $299 for any flight. Even lower walkup fares are
available on Southwests short and medium haul flights.
Southwest was the first major airline to introduce a Ticketless
travel option, eliminating the need to print and then process a
paper ticket altogether, and the first to offer Ticketless
travel through the Companys home page on the Internet,
www.southwest.com. For the year ended December 31, 2005,
more than 93 percent of Southwests Customers chose
the Ticketless travel option and approximately 65 percent
of Southwests passenger revenues came through its Internet
site, which has become a vital part of the Companys
distribution strategy. The Company has not paid commissions to
travel agents for sales since December 15, 2003.
The airline industry is highly competitive as to fares, frequent
flyer benefits, routes, and service, and some carriers competing
with the Company have larger fleets and wider name recognition.
Certain major United States airlines have established marketing
or codesharing alliances with each other, including Northwest
Airlines/ Continental Airlines/ Delta Air Lines; American
Airlines/ Alaska Airlines; and United Airlines/ US Airways.
Since the terrorist attacks on September 11, 2001, the
airline industry, as a whole, has incurred substantial losses.
The war in Iraq and significant increases in the cost of fuel
have exacerbated industry challenges. As a result, a number of
carriers, including UAL, the parent of United Airlines, US
Airways, Delta Air Lines, Inc., Northwest Airlines Corporation,
the parent of Northwest Airlines, Aloha, and ATA Airlines, Inc.
have sought relief from financial obligations in bankruptcy.
Other, smaller carriers have ceased operation entirely. America
West Airlines, US Airways, Aloha, ATA, and others received
federal loan guarantees authorized by federal law; America West
Airlines and USAirways have since merged. Since
September 11, low cost carriers such as AirTran, JetBlue,
and Frontier have accelerated their growth. Faced with
increasing low fare and lower cost competition, growing customer
demand for lower fares, and record high energy costs, legacy
carriers have aggressively sought to reduce their cost
structures, largely through downsized work forces and
renegotiated collective bargaining and vendor agreements.
Southwest has maintained its low cost competitive advantage and
has reduced its cost structure (excluding fuel) through
increased productivity.
The Company is also subject to varying degrees of competition
from surface transportation in its shorthaul markets,
particularly the private automobile. In shorthaul air services
that compete with surface transportation, price is a competitive
factor, but frequency and convenience of scheduling, facilities,
transportation safety and security procedures, and Customer
Service are also of great importance to many passengers.
Insurance
The Company carries insurance of types customary in the airline
industry and at amounts deemed adequate to protect the Company
and its property and to comply both with federal regulations and
certain of the Companys credit and lease agreements. The
policies principally provide coverage for public and passenger
liability, property damage, cargo and baggage liability, loss or
damage to aircraft, engines, and spare parts, and workers
compensation.
Following the terrorist attacks, commercial aviation insurers
significantly increased the premiums and reduced the amount of
war-risk coverage available to commercial carriers. The federal
Homeland Security Act of 2002 requires the federal government to
provide third party, passenger, and hull war-risk insurance
coverage to commercial carriers through a period of time that
has now been extended to December 31, 2006. The Company is
unable to predict whether the government will extend this
insurance coverage past December 31, 2006, whether
alternative commercial insurance with comparable coverage will
become available at reasonable premiums, and what impact this
will have on the Companys ongoing operations or future
financial performance.
Frequent Flyer Awards
Southwests frequent flyer program, Rapid Rewards, is based
on trips flown rather than mileage. Rapid Rewards Customers earn
a credit for each one-way trip flown or two credits for each
roundtrip flown. Rapid Rewards Customers can also receive
credits by using the services of non-airline partners, which
include car rental agencies, hotels, telecommunication
companies, and credit card partners, including the Southwest
Airlines
Chase®
Visa card. Rapid Rewards offers two types of travel awards. The
Rapid Rewards Award Ticket (Award Ticket) offers one
free roundtrip award valid to any destination available on
Southwest after the accumulation of 16 credits. The Rapid Re-
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wards Companion Pass (Companion Pass) is granted for
flying 50 roundtrips (or 100 one-way trips) on Southwest or
earning 100 credits within a consecutive twelve-month period.
The Companion Pass offers unlimited free roundtrip travel to any
destination available on Southwest for a designated companion of
the qualifying Rapid Rewards member. In order for the designated
companion to use this pass, the Rapid Rewards member must
purchase a ticket or use an Award Ticket. Additionally, the
Rapid Rewards member and designated companion must travel
together on the same flight.
Award Tickets and Companion Passes are automatically generated
when earned by the Customer rather than allowing the Customer to
bank credits indefinitely. Beginning August 10, 2005, all
Rapid Rewards credits are valid for 24 months, rather than
the previous period of 12 months. Any credits in a Rapid
Rewards members account as of August 10, 2005 are
valid for an additional 12 months. Award Tickets are valid
for 12 months after issuance.
Award Tickets issued before February 10, 2006 have no seat
restrictions, but are subject to published Black out
dates. Beginning February 10, 2006, there will be no
systemwide Black out dates for Award Tickets, but
Award Tickets will be subject to seat restrictions. Companion
travel will still have no seat restrictions or Black
out dates.
The Company also sells credits to business partners including
credit card companies, hotels, telecommunication companies, and
car rental agencies. These credits may be redeemed for Award
Tickets having the same program characteristics as those earned
by flying.
Customers redeemed approximately 2.6 million,
2.5 million and 2.5 million Award Tickets and flights
on Companion Passes during 2005, 2004, and 2003, respectively.
The amount of free travel award usage as a percentage of total
Southwest revenue passengers carried was 6.6 percent in
2005, 7.1 percent in 2004, and 7.5 percent in 2003.
The number of fully earned Award Tickets and partially earned
awards outstanding at each of December 31, 2005 and 2004
was approximately 6.8 million, approximately
78 percent of which were partially earned awards. However,
due to the expected expiration of a portion of credits making up
these partial awards, not all of them will eventually turn into
useable Award Tickets. Also, not all Award Tickets will be
redeemed for future travel. Since the inception of Rapid Rewards
in 1987, approximately 14 percent of all fully earned Award
Tickets have expired without being used. The number of Companion
Passes for Southwest outstanding at December 31, 2005 and
2004 was approximately 60,000 for each date. The Company
currently estimates that an average of 3 to 4 trips will be
redeemed per outstanding Companion Pass.
The Company accounts for its frequent flyer program obligations
by recording a liability for the estimated incremental cost of
flight awards the Company expects to be redeemed (except for
credits sold to business partners). This method recognizes an
average incremental cost to provide roundtrip transportation to
one additional passenger. The estimated incremental cost
includes direct passenger costs such as fuel, food, and other
operational costs, but does not include any contribution to
overhead or profit. The incremental cost is accrued at the time
an award is earned and revenue is subsequently recognized, at
the amount accrued, when the free travel award is used. Revenue
from the sale of credits and associated with future travel is
deferred and recognized when the ultimate free travel award is
flown or the credits expire unused. Accordingly, Southwest does
not accrue incremental cost for the expected redemption of free
travel awards for credits sold to business partners. The
liability for free travel awards earned but not used at
December 31, 2005 and 2004 was not material.
Employees
At December 31, 2005, Southwest had 31,729 active
Employees, consisting of 12,230 flight, 1,987 maintenance,
13,351 ground, Customer, and fleet service and 4,161 management,
accounting, marketing, and clerical personnel.
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Southwest has ten collective bargaining agreements covering
approximately 82 percent of its Employees. The following
table sets forth the Companys Employee groups and
collective bargaining status:
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Employee Group |
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Represented by |
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Agreement Amendable on |
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Customer Service and Reservations Agents
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International Association of Machinists and Aerospace Workers,
AFL-CIO
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November 2008 (or 2006 at the Unions option under certain
conditions)
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Flight Attendants
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Transportation Workers of America, AFL-CIO (TWU)
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June 2008
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Ramp, Operations, and Provisioning and Freight Agents
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TWU
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June 2008 (or 2006 at the Unions option under certain
conditions)
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Pilots
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Southwest Airlines Pilots Association
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September 2006
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Flight Dispatchers
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Southwest Airlines Employee Association
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December 2009
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Aircraft Appearance Technicians
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Aircraft Mechanics Fraternal Association (AMFA)
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February 2009
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Stock Clerks
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International Brotherhood of Teamsters (Teamsters)
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August 2008
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Mechanics
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AMFA
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August 2008
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Flight Simulator Technicians
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Teamsters
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November 2011
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Flight/ Ground School Instructors and Flight Crew Training
Instructors
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Southwest Airlines Professional Instructors Association
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December 2012
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In addition to the other information contained in this
Form 10-K, the
following risk factors should be considered carefully in
evaluating Southwests business. The Companys
business, financial condition, or results of operations could be
materially adversely affected by any of these risks. Please note
that additional risks not presently known to the Company or that
the Company currently deems immaterial may also impair its
business and operations.
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Southwests business is dependent on the price and
availability of aircraft fuel. |
The cost of fuel is largely unpredictable, and has a significant
impact on the Companys operating results. Also,
significant disruptions in the supply of aircraft fuel could
have a negative impact on the Companys operations and
operating results. Due to the competitive nature of the airline
industry, the Company generally has not been able to increase
fares when fuel prices have risen in the past and the Company
may not be able to do so in the future. From time to time the
Company enters into hedging arrangements to protect against
rising fuel costs. Changes in the Companys overall fuel
hedging strategy, the continued ability of the commodities used
in fuel hedging (principally crude oil, heating oil, and
unleaded gasoline) to qualify for special hedge accounting, and
the continued effectiveness of the Companys fuel hedges
pursuant to highly complex accounting rules, are all significant
factors impacting the Companys operating results. For more
information on Southwests fuel hedging arrangements, see
Managements Discussion and Analysis of Financial
Condition and Results of Operations, and Note 10 to
the Consolidated Financial Statements.
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Southwests business is labor-intensive. |
Historically, the Companys relationships with its
Employees have been very good. However, the results of labor
contract negotiations (approximately 82% of the Companys
Employees are represented for collective bargaining purposes by
labor unions), Employee hiring and retention rates, and costs
for health care are items with potentially significant impact on
the Companys operating results.
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Southwest relies on technology to operate its business and
any failure of these systems could harm the Companys
business. |
Southwest is increasingly dependent on automated systems and
technology to operate its business, enhance Customer service,
and increase Employee productivity, including the Companys
computerized airline reservation system, flight operations
systems, telecommunication systems, website, Automated Boarding
Passes system, and the RAPID CHECK-IN self service kiosks. Any
disruptions in these systems due to internal failures of
technology or large-scale external interruptions in technology
infrastructure, such as power, telecommunications, or the
internet, could result in the loss of revenue or important data,
increase the Companys expenses, and generally harm the
Companys business.
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The travel industry continues to face on-going security
concerns and cost burdens. |
The attacks of September 11, 2001 materially impacted, and
continue to impact, air travel and the results of operations for
Southwest and the airline industry generally. Substantially all
security screeners at airports are now federal employees and
significant other elements of airline and airport security are
now overseen and performed by federal employees, including
federal security managers, federal law enforcement officers, and
federal air marshals. Enhanced security procedures, including
enhanced security screening of passengers, baggage, cargo, mail,
employees and vendors, introduced at airports since the
terrorist attacks of September 11 have increased costs to
airlines.
Additional terrorist attacks, even if not made directly on the
airline industry, or the fear of such attacks (including
elevated national threat warnings or selective cancellation or
redirection of flights due to terror threats) could negatively
affect Southwest and the airline industry. The war in Iraq
further decreased demand for air travel during the first half of
2003, and additional international hostilities could potentially
have a material adverse impact on the Companys results of
operations.
|
|
|
Insurance cost increases or reductions in insurance
coverage may adversely impact the Companys operations and
financial results. |
The Company carries insurance for public liability, passenger
liability, property damage, and all-risk coverage for damage to
its aircraft. The terrorist attacks of September 11, 2001
led to a significant increase in insurance premiums and a
decrease in the insurance coverage available to commercial
airline carriers. Accordingly, the Companys insurance
costs increased significantly. The federal Homeland Security Act
of 2002 requires the federal government to provide third party,
passenger, and hull war-risk insurance coverage to commercial
carriers through a period of time that has now been extended to
December 31, 2006. If the federal insurance program
terminates, the Company would likely face a material increase in
the cost of war risk insurance.
|
|
|
Changes in or additional government regulation could
increase the Companys operating costs or limit the
Companys ability to conduct business. |
Airlines are subject to extensive regulatory requirements. These
requirements often impose substantial costs on airlines.
Additional laws, regulations, taxes, and airport rates and
charges have been proposed from time to time that could
significantly increase the Companys costs or reduce
revenues.
|
|
|
The airline industry is intensely competitive. |
The airline industry is extremely competitive. Southwests
competitors include other major domestic airlines as well as
regional and new entrant airlines, and other forms of
transportation, including rail and private automobiles. The
Companys revenues are sensitive to the actions of other
carriers in the areas of capacity, pricing, scheduling,
codesharing, and promotions. Additional mergers and acquisitions
in the airline industry, and airline restructuring through
bankruptcy may make other carriers more competitive with the
Company.
|
|
|
Disruptions to operations due to factors beyond
Southwests control could adversely affect the
Company. |
Like all other airlines, Southwest is subject to delays caused
by factors beyond its control, including adverse weather
conditions, air traffic congestion at airports, and increased
security measures. Delays frustrate passengers, reduce aircraft
utilization, and increase costs, all of which negatively affect
profitability. During snow, rain, fog, storms, or other adverse
weather conditions, flights may be cancelled or significantly
delayed. Catastrophic weather conditions such as hurricanes may
disrupt operations, and revenues, for a substantial period of
time.
7
|
|
|
Southwests low cost structure is one of its primary
competitive advantages and many factors could affect the
Companys ability to control its costs. |
Factors affecting the Companys ability to control its
costs include the price and availability of fuel, 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, regulatory requirements,
availability of capital markets, and future financing decisions
made by the Company.
Item 1B. Unresolved
Staff Comments
None.
Item 2. Properties
Aircraft
Southwest operated a total of 445 Boeing 737 aircraft as of
December 31, 2005, of which 84 and 9 were under operating
and capital leases, respectively. The remaining 352 aircraft
were owned.
The following table details information on the 445 aircraft in
the Companys fleet as of December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Age | |
|
Number of | |
|
Number | |
|
Number | |
737 Type |
|
Seats | |
|
(Yrs) | |
|
Aircraft | |
|
Owned | |
|
Leased | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
-300
|
|
|
137 |
|
|
|
14.7 |
|
|
|
194 |
|
|
|
112 |
|
|
|
82 |
|
-500
|
|
|
122 |
|
|
|
14.7 |
|
|
|
25 |
|
|
|
16 |
|
|
|
9 |
|
-700
|
|
|
137 |
|
|
|
3.8 |
|
|
|
226 |
|
|
|
224 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
|
|
|
|
9.1 |
|
|
|
445 |
|
|
|
352 |
|
|
|
93 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In total, at December 31, 2005, the Company had firm orders
and options to purchase Boeing 737 aircraft as follows:
Firm Orders and Options to Purchase Boeing 737-700
Aircraft
|
|
|
|
|
|
|
|
|
|
|
|
|
Delivery Year |
|
Firm Orders | |
|
Options | |
|
Purchase Rights | |
|
|
| |
|
| |
|
| |
2006
|
|
|
33 |
|
|
|
|
|
|
|
|
|
2007
|
|
|
28 |
|
|
|
8 |
|
|
|
20 |
|
2008
|
|
|
6 |
|
|
|
25 |
|
|
|
20 |
|
2009-2012
|
|
|
|
|
|
|
|
|
|
|
177 |
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
67 |
|
|
|
33 |
|
|
|
217 |
|
|
|
|
|
|
|
|
|
|
|
In January 2006, the Company exercised one of its 2007 options
to bring firm orders and options to 29 and 7, respectively,
for that year.
Ground Facilities and Services
Southwest leases terminal passenger service facilities at each
of the airports it serves, to which it has added various
leasehold improvements. The Company leases land on a long-term
basis for its maintenance centers located at Dallas Love Field,
Houston Hobby, Phoenix Sky Harbor, and Chicago Midway, its
training center near Love Field, which houses seven 737
simulators, and its corporate headquarters, also located near
Love Field. The maintenance, training center, and corporate
headquarters buildings on these sites were built and are owned
by Southwest. At December 31, 2005, the Company operated
six reservation centers. The reservation centers located in
Chicago, Albuquerque, and Oklahoma City occupy leased space. The
Company owns its Houston, Phoenix, and San Antonio
reservation centers.
Southwest has entered into a concession agreement with the Town
of Islip, New York which gives the Company the right to
construct, furnish, occupy, and maintain a new concourse at the
airport. Phase I of this project, which began operations in
August 2004, includes four gates. Phase II of the project,
which includes an additional four gates, is currently expected
to be completed in June 2006. When all phases of construction
are complete, the entire new concourse will become the property
of the Town of Islip. In return for constructing the new
concourse, Southwest will receive fixed-rent abatements for a
total of 25 years; however, the Company will still be
required to pay variable rents for common use areas and manage
the new concourse.
The Company performs substantially all line maintenance on its
aircraft and provides ground support
8
services at most of the airports it serves. However, the Company
has arrangements with certain aircraft maintenance firms for
major component inspections and repairs for its airframes and
engines, which comprise the majority of the annual aircraft
maintenance costs.
Item 3. Legal
Proceedings
On December 8, 2005, Southwest Airlines Flight 1248 was
involved in an accident at Chicago Midway Airport while the
aircraft, a Boeing 737-700, was landing. The aircraft overran
the runway onto a roadway and collided with an automobile.
Several occupants of the vehicles involved in the accident were
injured, one fatally. The Company continues to cooperate fully
with all federal, state, and local regulatory and investigatory
agencies to determine the cause of this accident. The Company is
currently unable to predict the amount of claims, if any,
relating to this accident which may ultimately be made against
it and how those claims might be resolved. At this time, the
Company has no reason to believe that the costs to defend any
claims and any potential liability exposure will not be covered
by the insurance maintained by the Company. Consequently, the
Company does not expect any litigation arising from the accident
involving Flight 1248 to have a material adverse affect on the
financial position or results of operation of the Company.
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 Companys federal income tax
returns and, in the course of those examinations, proposes
adjustments to the Companys federal income tax liability
reported on such returns. It is the Companys practice to
vigorously contest those proposed adjustments that it deems
lacking merit. The Companys management does not expect 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 Companys financial condition, results of
operations, or cash flows.
Item 4. Submission of
Matters to a Vote of Security Holders
None to be reported.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of Southwest, their positions, and their
respective ages (as of January 1, 2006) are as follows:
|
|
|
|
|
|
|
Name |
|
Position |
|
Age | |
|
|
|
|
| |
Herbert D. Kelleher
|
|
Chairman of the Board |
|
|
74 |
|
Gary C. Kelly
|
|
Vice Chairman of the Board and Chief Executive Officer |
|
|
50 |
|
Colleen C. Barrett
|
|
President and Secretary |
|
|
61 |
|
Donna D. Conover
|
|
Executive Vice President Customer Operations |
|
|
52 |
|
Michael G. Van de Ven
|
|
Executive Vice President Aircraft Operations |
|
|
44 |
|
Laura H. Wright
|
|
Senior Vice President Finance and Chief Financial
Officer |
|
|
45 |
|
Joyce C. Rogge
|
|
Senior Vice President Marketing |
|
|
48 |
|
Executive officers are elected annually at the first meeting of
Southwests Board of Directors following the annual meeting
of shareholders or appointed by the Chief Executive Officer
pursuant to Board authorization. Each of the above individuals
has worked for Southwest Airlines Co. for more than the past
five years.
9
PART II
|
|
Item 5. |
Market for Registrants Common Equity, Related
Stockholder Matters, and Issuer Purchases of Equity
Securities |
Southwests common stock is listed on the New York Stock
Exchange and is traded under the symbol LUV. The high and low
sales prices of the common stock on the Composite Tape and the
quarterly dividends per share paid on the common stock were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period |
|
Dividend | |
|
High | |
|
Low | |
|
|
| |
|
| |
|
| |
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st Quarter
|
|
$ |
0.00450 |
|
|
$ |
16.45 |
|
|
$ |
13.60 |
|
|
2nd Quarter
|
|
|
0.00450 |
|
|
|
15.50 |
|
|
|
13.56 |
|
|
3rd Quarter
|
|
|
0.00450 |
|
|
|
14.85 |
|
|
|
13.05 |
|
|
4th Quarter
|
|
|
0.00450 |
|
|
|
16.95 |
|
|
|
14.54 |
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st Quarter
|
|
$ |
0.00450 |
|
|
$ |
16.60 |
|
|
$ |
12.88 |
|
|
2nd Quarter
|
|
|
0.00450 |
|
|
|
17.06 |
|
|
|
13.56 |
|
|
3rd Quarter
|
|
|
0.00450 |
|
|
|
16.85 |
|
|
|
13.18 |
|
|
4th Quarter
|
|
|
0.00450 |
|
|
|
16.74 |
|
|
|
13.45 |
|
As of December 31, 2005, there were 11,496 holders of
record of the Companys common stock.
Recent Sales of Unregistered Securities
During 2005, Herbert D. Kelleher, Chairman of the Board,
exercised unregistered options to purchase Southwest Common
Stock as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Shares |
|
Exercise | |
|
Date of | |
|
Date of | |
Purchased |
|
Price | |
|
Exercise | |
|
Option Grant | |
|
|
| |
|
| |
|
| |
948,830
|
|
$ |
4.64 |
|
|
|
12/15/05 |
|
|
|
01/01/96 |
|
The issuance of the above options and shares to
Mr. Kelleher were deemed exempt from the registration
provisions of the Securities Act of 1933, as amended (the
Securities Act), by reason of the provision of
Section 4(2) of the Securities 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 Securities Act and may not be transferred
except pursuant to a registration statement which has become
effective under the Securities Act or to an exemption from such
registration. The issuance of such shares was not underwritten.
Securities Authorized for Issuance under Equity Compensation
Plans
The following table provides information as of December 31,
2005, regarding compensation plans (including individual
compensation arrangements) under which equity securities of
Southwest are authorized for issuance.
Equity Compensation Plan Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities Remaining | |
|
|
Number of Securities to be | |
|
Weighted-Average | |
|
Available for Future Issuance Under | |
|
|
Issued upon Exercise of | |
|
Exercise Price of | |
|
Equity Compensation Plans | |
|
|
Outstanding Options, | |
|
Outstanding Options, | |
|
(Excluding Securities | |
|
|
Warrants, and Rights | |
|
Warrants, and Rights* | |
|
Reflected in Column (a)) | |
|
|
| |
|
| |
|
| |
Plan Category |
|
(a) | |
|
(b) | |
|
(c) | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
|
|
|
(In thousands) | |
Equity Compensation Plans Approved by Security Holders
|
|
|
30,045 |
|
|
|
13.67 |
|
|
|
5,872 |
|
Equity Compensation Plans not Approved by Security Holders
|
|
|
111,574 |
|
|
|
11.89 |
|
|
|
30,317 |
|
|
Total
|
|
|
141,619 |
|
|
|
12.27 |
|
|
|
36,189 |
|
|
|
* |
As adjusted for stock splits. |
See Note 13 to the Consolidated Financial Statements for
information regarding the material features of the above plans.
Each of the above plans provides that the number of shares with
respect to which options may be granted, and the number of
shares of Common Stock subject to an outstanding option, shall
be proportionately adjusted in the event of a subdivision or
consolidation of shares or the payment of a stock dividend on
Common Stock, and the purchase price per share of outstanding
options shall be proportionately revised.
10
|
|
Item 6. |
Selected Financial Data |
The following financial information for the five years ended
December 31, 2005, has been derived from the Companys
Consolidated Financial Statements. This information should be
read in conjunction with the Consolidated Financial Statements
and related notes thereto included elsewhere herein.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions, except per share amounts) | |
Financial Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
$ |
7,584 |
|
|
$ |
6,530 |
|
|
$ |
5,937 |
|
|
$ |
5,522 |
|
|
$ |
5,555 |
|
|
Operating expenses
|
|
|
6,764 |
|
|
|
5,976 |
|
|
|
5,454 |
|
|
|
5,105 |
|
|
|
4,924 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
820 |
|
|
|
554 |
|
|
|
483 |
|
|
|
417 |
|
|
|
631 |
|
|
Other expenses (income) net
|
|
|
(54 |
) |
|
|
65 |
|
|
|
(225 |
) |
|
|
24 |
|
|
|
(197 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
874 |
|
|
|
489 |
|
|
|
708 |
|
|
|
393 |
|
|
|
828 |
|
|
Provision for income taxes
|
|
|
326 |
|
|
|
176 |
|
|
|
266 |
|
|
|
152 |
|
|
|
317 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
548 |
|
|
$ |
313 |
|
|
$ |
442 |
|
|
$ |
241 |
|
|
$ |
511 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share, basic
|
|
$ |
.70 |
|
|
$ |
.40 |
|
|
$ |
.56 |
|
|
$ |
.31 |
|
|
$ |
.67 |
|
|
Net income per share, diluted
|
|
$ |
.67 |
|
|
$ |
.38 |
|
|
$ |
.54 |
|
|
$ |
.30 |
|
|
$ |
.63 |
|
|
Cash dividends per common share
|
|
$ |
.0180 |
|
|
$ |
.0180 |
|
|
$ |
.0180 |
|
|
$ |
.0180 |
|
|
$ |
.0180 |
|
|
Total assets at period-end
|
|
$ |
14,218 |
|
|
$ |
11,337 |
|
|
$ |
9,878 |
|
|
$ |
8,954 |
|
|
$ |
8,997 |
|
|
Long-term obligations at period-end
|
|
$ |
1,394 |
|
|
$ |
1,700 |
|
|
$ |
1,332 |
|
|
$ |
1,553 |
|
|
$ |
1,327 |
|
|
Stockholders equity at period-end
|
|
$ |
6,675 |
|
|
$ |
5,524 |
|
|
$ |
5,052 |
|
|
$ |
4,422 |
|
|
$ |
4,014 |
|
Operating Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue passengers carried
|
|
|
77,693,875 |
|
|
|
70,902,773 |
|
|
|
65,673,945 |
|
|
|
63,045,988 |
|
|
|
64,446,773 |
|
|
Enplaned passengers
|
|
|
88,379,900 |
|
|
|
81,066,038 |
|
|
|
74,719,340 |
|
|
|
72,462,123 |
|
|
|
73,628,723 |
|
|
Revenue passenger miles (RPMs) (000s)
|
|
|
60,223,100 |
|
|
|
53,418,353 |
|
|
|
47,943,066 |
|
|
|
45,391,903 |
|
|
|
44,493,916 |
|
|
Available seat miles (ASMs) (000s)
|
|
|
85,172,795 |
|
|
|
76,861,296 |
|
|
|
71,790,425 |
|
|
|
68,886,546 |
|
|
|
65,295,290 |
|
|
Load factor(1)
|
|
|
70.7 |
% |
|
|
69.5 |
% |
|
|
66.8 |
% |
|
|
65.9 |
% |
|
|
68.1 |
% |
|
Average length of passenger haul (miles)
|
|
|
775 |
|
|
|
753 |
|
|
|
730 |
|
|
|
720 |
|
|
|
690 |
|
|
Average stage length (miles)
|
|
|
607 |
|
|
|
576 |
|
|
|
558 |
|
|
|
537 |
|
|
|
514 |
|
|
Trips flown
|
|
|
1,028,639 |
|
|
|
981,591 |
|
|
|
949,882 |
|
|
|
947,331 |
|
|
|
940,426 |
|
|
Average passenger fare
|
|
$ |
93.68 |
|
|
$ |
88.57 |
|
|
$ |
87.42 |
|
|
$ |
84.72 |
|
|
$ |
83.46 |
|
|
Passenger revenue yield per RPM
|
|
|
12.09 |
¢ |
|
|
11.76 |
¢ |
|
|
11.97 |
¢ |
|
|
11.77 |
¢ |
|
|
12.09 |
¢ |
|
Operating revenue yield per ASM
|
|
|
8.90 |
¢ |
|
|
8.50 |
¢ |
|
|
8.27 |
¢ |
|
|
8.02 |
¢ |
|
|
8.51 |
¢ |
|
Operating expenses per ASM
|
|
|
7.94 |
¢ |
|
|
7.77 |
¢ |
|
|
7.60 |
¢ |
|
|
7.41 |
¢ |
|
|
7.54 |
¢ |
|
Operating expenses per ASM, excluding fuel
|
|
|
6.37 |
¢ |
|
|
6.47 |
¢ |
|
|
6.44 |
¢ |
|
|
6.30 |
¢ |
|
|
6.36 |
¢ |
|
Fuel cost per gallon (average)
|
|
$ |
1.03 |
|
|
$ |
.83 |
|
|
$ |
.72 |
|
|
$ |
.68 |
|
|
$ |
.71 |
|
|
Number of Employees at year-end
|
|
|
31,729 |
|
|
|
31,011 |
|
|
|
32,847 |
|
|
|
33,705 |
|
|
|
31,580 |
|
|
Size of fleet at year-end(2)
|
|
|
445 |
|
|
|
417 |
|
|
|
388 |
|
|
|
375 |
|
|
|
355 |
|
|
|
(1) |
Revenue passenger miles divided by available seat miles. |
|
(2) |
Includes leased aircraft. |
11
|
|
Item 7. |
Managements Discussion and Analysis of Financial
Condition and Results of Operations |
Year in Review
In 2005, Southwest posted a profit for its 33rd consecutive
year, and also extended its number of consecutive profitable
quarters to 59. Southwests 2005 profit was
$548 million, representing a 75.1% increase compared to our
2004 profit of $313 million. This performance was driven
primarily by strong revenue growth, as the Company grew
capacity, and effective cost control measures, including a
successful fuel hedge program. For the fifth consecutive year,
the airline industry as a whole is expected to suffer a
substantial net loss, as additional carriers filed for
bankruptcy protection and many underwent or continued massive
efforts to restructure or merge their businesses, gain wage
concessions from their employees, and slash costs.
The revenue environment in the airline industry strengthened
considerably throughout 2005. As a result of the extensive
restructuring in the domestic airline industry in 2004 and 2005,
several carriers reduced domestic capacity. Industry capacity
reductions and strong demand resulted in high load factors for
many airlines. In fact, Southwest set new monthly load-factor
records for four separate months during 2005, and recorded a
Company-record load factor of 70.7 percent for the full
year. The Company was also able to modestly raise its fares over
the course of the year, resulting in an increase in passenger
revenue yield per RPM (passenger revenues divided by revenue
passenger miles) of 2.8 percent compared to 2004. Unit
revenue (total revenue divided by ASMs) also increased a healthy
4.7 percent compared to 2004 levels, as a result of the
higher load factors and higher RPM yields.
The Company once again benefited from a strong fuel hedge and an
intense focus on controlling non-fuel costs. As reflected in the
Consolidated Statement of Income, the Companys fuel
hedging program resulted in a reduction to Fuel and oil
expense during 2005 of $892 million. The
Companys hedge program also resulted in earnings
variability throughout 2005, primarily due to unrealized gains
and losses relating to fuel contracts settling in future
periods, recorded in accordance with Statement of Financial
Accounting Standard 133 (SFAS 133), Accounting for
Derivative Instruments and Hedging Activities, as amended.
For 2005, these amounts total a net gain of $110 million,
and are reflected in Other (gains) losses, net,
in the Consolidated Statement of Income.
Although the Companys fuel hedge in place for 2006 is not
as strong as that in 2005, absent a significant decrease from
the current level of market energy prices the Company will
continue to have a considerable competitive advantage compared
to airlines that have not hedged fuel. The Company hopes to
overcome the impact of higher anticipated 2006 fuel prices
through improved revenue management and control of non-fuel
costs. As a result of cost-control efforts instituted over the
past 3 years, the Company was able to produce a reduction
in non-fuel unit costs (cost per ASM) of 1.5 percent in
2005 compared to 2004. The Companys Employees again
increased their productivity and improved the overall efficiency
of the Companys operations. The Companys headcount
per aircraft decreased from 74 at December 31, 2004, to 71
at December 31, 2005. Furthermore, since the end of 2003,
the Companys headcount per aircraft has decreased
16.5 percent.
The Company moves forward into 2006 with a focused and measured
growth plan. The Companys low-cost competitive advantage,
protective fuel hedging position, and excellent Employees will
allow Southwest to continue to react quickly to market
opportunities. The Company added Pittsburgh, Pennsylvania, and
Fort Myers, Florida, to its route system in 2005, and
continued to grow its Chicago Midway service. The Company has
increased its capacity at Chicago Midway Airport nearly
60 percent since third quarter 2004 and plans to continue
to add service to this market. The Company began service to
Denver, Colorado, in January 2006, and has already announced
plans to add service and destinations in March 2006. Denver
represents the 62nd city to which the Company flies.
In December 2005, we completed a transaction with ATA Airlines,
Inc. (ATA), as a part of ATAs bankruptcy proceedings,
acquiring the leasehold rights to four additional gates at
Chicago Midway in exchange for a $20 million reduction in
our outstanding
debtor-in-possession
loan. The codeshare agreement with ATA was recently expanded to
include ATA flights from DFW International Airport to Chicago
Midway. The Company also recently announced an additional
codeshare expansion to include connecting service through
Houston Hobby and Oakland, beginning April 2006. Based on
current codeshare markets, first quarter 2006 codeshare revenue
is estimated to be in the $10 million range. See
Note 3 to the Consolidated Financial Statements for further
information on the Companys relationship and recent
transactions with ATA.
12
During 2005, the Company added 33 new 737-700 aircraft to its
fleet and retired its remaining five 737-200 aircraft, resulting
in a net available seat mile (ASM) capacity increase of
10.8 percent. This brought the Companys all-737 fleet
to 445 aircraft at the end of 2005. ASM capacity currently is
expected to grow approximately 8 percent in 2006 with the
planned addition of 33 new Boeing 737-700 aircraft.
Results of Operations
The Companys consolidated net income for 2005 was
$548 million ($.67 per share, diluted), as compared to
2004 net income of $313 million ($.38 per share,
diluted), an increase of $235 million or 75.1 percent.
Operating income for 2005 was $820 million, an increase of
$266 million, or 48.0 percent, compared to 2004. The
increase in operating income primarily was due to higher
revenues from the Companys fleet growth, improved load
factors, and higher fares, which more than offset a significant
increase in the cost of jet fuel. The larger percentage increase
in net income compared to operating income primarily was due to
variability in Other (gains) losses, net, due to unrealized
2005 gains resulting from the Companys fuel hedging
activities, in accordance with SFAS 133.
Operating Revenues. Consolidated operating revenues
increased $1.1 billion, or 16.1 percent, primarily due
to a $1.0 billion, or 15.9 percent, increase in
passenger revenues. The increase in passenger revenues primarily
was due to an increase in capacity, an increase in RPM yield,
and an increase in load factor. Holding other factors constant
(such as yields and load factor), almost 70 percent of the
increase in passenger revenue was due to the Companys
10.8 percent increase in available seat miles compared to
2004. The Company increased available seat miles as a result of
the net addition of 28 aircraft (33 new 737-700 aircraft net of
five 737-200 aircraft retirements). Approximately
18 percent of the increase in passenger revenue was due to
the 2.8 percent increase in passenger yields. Average
passenger fares increased 5.8 percent compared to 2004,
primarily due to lower fare discounting because of the strong
demand for air travel coupled with the availability of fewer
seats from industrywide domestic capacity reductions. The
remainder of the passenger revenue increase primarily was due to
the 1.2 point increase in the Companys load factor
compared to 2004. The 70.7 percent load factor for 2005
represented the highest annual load factor in the Companys
history.
The Company continues to be encouraged by the airline revenue
environment. Although the Company significantly downsized its
New Orleans operations following Hurricane Katrina during third
quarter 2005, some of those flights have been added back as
demand has increased to that city. In addition, because of
strong industry demand, the Company was able to quickly
re-deploy available aircraft from the New Orleans reduction in
service to meet service needs in other cities within the
Companys network. The outlook for first quarter 2006 is
favorable as the Company continues to enjoy strong revenue
momentum and benefit from reductions in competitive capacity.
Based on current traffic and revenue trends, the Company expects
its January load factor and unit revenues to exceed January 2005
levels. While bookings for February and March are excellent, the
shift in timing of the Easter holiday into April during 2006
versus March of 2005 will impact first quarter
2006 year-over-year trends. As a result, our first quarter
2006 unit revenue growth may not match fourth quarter
2005s superb growth rate of 11.7 percent.
Consolidated freight revenues increased $16 million, or
13.7 percent. Approximately 65 percent of the increase
was due to an increase in freight and cargo revenues, primarily
due to higher rates charged on shipments. The remaining
35 percent of the increase was due to higher mail revenues.
The U.S. Postal Service periodically reallocates the amount
of mail business given to commercial and freight air carriers
and, during 2005, shifted more business to commercial carriers.
Other revenues increased $39 million, or 29.3 percent,
compared to 2004. Approximately 35 percent of the increase
was from commissions earned from programs the Company sponsors
with certain business partners, such as the Company sponsored
Chase®
Visa card. An additional 35 percent 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
during second quarter 2005. Among other changes, the limit at
which baggage charges apply was reduced to 50 pounds per checked
bag. The Company expects continued year-over-year increases in
both freight and other revenues in first quarter 2006, although
at lower rates than experienced in 2005.
13
Operating Expenses. Consolidated operating expenses for
2005 increased $788 million, or 13.2 percent, compared
to the 10.8 percent increase in capacity. To a large
extent, changes in operating expenses for airlines are driven by
changes in capacity, or ASMs. The following presents
Southwests operating expenses per ASM for 2005 and 2004
followed by explanations of these changes on a per-ASM basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase | |
|
Percent | |
|
|
2005 | |
|
2004 | |
|
(Decrease) | |
|
Change | |
|
|
| |
|
| |
|
| |
|
| |
Salaries, wages, and benefits
|
|
|
3.17 |
¢ |
|
|
3.18 |
¢ |
|
|
(.01 |
)¢ |
|
|
(.3 |
)% |
Fuel and oil
|
|
|
1.57 |
|
|
|
1.30 |
|
|
|
.27 |
|
|
|
20.8 |
|
Maintenance materials and repairs
|
|
|
.51 |
|
|
|
.59 |
|
|
|
(.08 |
) |
|
|
(13.6 |
) |
Aircraft rentals
|
|
|
.19 |
|
|
|
.23 |
|
|
|
(.04 |
) |
|
|
(17.4 |
) |
Landing fees and other rentals
|
|
|
.53 |
|
|
|
.53 |
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
.55 |
|
|
|
.56 |
|
|
|
(.01 |
) |
|
|
(1.8 |
) |
Other
|
|
|
1.42 |
|
|
|
1.38 |
|
|
|
.04 |
|
|
|
2.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
7.94 |
¢ |
|
|
7.77 |
¢ |
|
|
.17 |
¢ |
|
|
2.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses per ASM increased 2.2 percent to 7.94
cents, primarily due to an increase in jet fuel prices, net of
hedging gains. The Company was able to hold flat or reduce unit
costs in every cost category, except fuel expense and other
operating expense, through a variety of cost reduction and
productivity efforts. These efforts, however, were entirely
offset by the significant increase in the cost of fuel.
Excluding fuel, CASM was 1.5 percent lower than 2004, at
6.37 cents. For first quarter 2006, the Company currently
expects operating expenses per ASM, excluding fuel, to exceed
the first quarter 2005 level of 6.32 cents, but improve from
fourth quarter 2005s 6.57 cents. A portion of the expected
year-over-year increase compared to first quarter 2005 will be
attributable to the Companys January 1, 2006,
adoption of SFAS 123R, Share-Based Payment
(SFAS 123R).
Salaries, wages, and benefits expense per ASM decreased
..3 percent compared to 2004, primarily due to productivity
efforts that have enabled the Company to grow overall headcount
at a rate that is less than the growth in ASMs. This decrease
was partially offset by higher average wage rates, and higher
profitsharing expense associated with the Companys higher
earnings.
On January 1, 2006, the Company will be required to adopt
SFAS 123R, which, among other things, will require the
recording in the financial statements of non-cash compensation
expense related to stock options. Prior to 2006, the Company had
only shown, as permitted by SFAS 123, pro forma financial
results including the effects of share-based compensation
expense in the footnotes to the financial statements. See
Note 1 to the Consolidated Financial Statements for these
pro forma results related to years 2005, 2004, and 2003. As a
result of this accounting change, the Company expects its first
quarter 2006 salaries, wages, and benefits to experience an
increase in expense of approximately $20 million that was
not present in first quarter 2005, due to the Companys
previous method of accounting under SFAS 123. Based on
stock options issued to Employees prior to January 1, 2006,
for the full year 2006, the Company expects salaries, wages, and
benefits to experience an expense increase of approximately
$65 million due to the adoption of SFAS 123R. See
Note 2 to the Consolidated Financial Statements for more
information on the 2006 adoption of SFAS 123R.
The Companys Pilots are subject to an agreement with the
Southwest Airlines Pilots Association, which becomes
amendable during September 2006. The Companys Customer
Service and Reservations Agents are subject to an agreement with
the International Association of Machinists and Aerospace
Workers (IAM), which becomes amendable during
November 2008, but which may become amendable during 2006 at the
IAMs option, under certain conditions. The Companys
Ramp, Operations, and Provisioning and Freight Agents are
subject to an agreement with the Transportation Workers of
America, AFL-CIO (TWU), which becomes amendable
during November 2008, but which may become amendable during 2006
at the TWUs option, under certain conditions. The Company
is currently unable to predict whether its contracts with the
IAM and TWU will become amendable during 2006.
Fuel and oil expense per ASM increased 20.8 percent,
primarily due to a 24.8 percent increase in the average jet
fuel cost per gallon, net of hedging gains. The average cost per
gallon of jet fuel in 2005 was $1.03 compared to 82.8 cents in
2004, excluding fuel-related taxes and net of hedging gains. The
Companys
14
2005 and 2004 average jet fuel costs are net of approximately
$892 million and $455 million in gains from hedging
activities, respectively. See Note 10 to the Consolidated
Financial Statements. The increase in fuel prices was partially
offset by steps the Company has taken to improve the fuel
efficiency of its aircraft. These steps primarily included the
addition of blended winglets to all of the Companys
737-700 aircraft, and the upgrade of certain engine components
on many aircraft. The Company estimates that these and other
efficiency gains saved the Company approximately
$70 million during 2005, at average unhedged market jet
fuel prices.
As detailed in Note 10 to the Consolidated Financial
Statements, the Company has hedges in place for over
70 percent of its anticipated fuel consumption in 2006 with
a combination of derivative instruments that effectively cap
prices at average crude oil equivalent price of approximately
$36 per barrel, and has hedged the refinery margins on the
majority of those positions. Considering current market prices,
the Company is forecasting a significant increase compared to
the Companys first quarter 2005 average fuel price per
gallon of 90.3 cents, primarily because the Companys hedge
position is not as strong and market jet fuel prices are
currently higher in 2006. The Company has a lower percentage of
its fuel hedged, and the hedges in place are at higher average
crude oil-equivalent prices. The majority of the Companys
near term hedge positions are in the form of option contracts,
which protect the Company in the event of rising jet fuel prices
and allow the Company to benefit in the event of declining
prices.
Maintenance materials and repairs per ASM decreased
13.6 percent compared to 2004, primarily due to a decrease
in repair events for aircraft engines. Currently, the Company
expects a decrease in maintenance materials and repairs expense
per ASM in first quarter 2006, versus first quarter 2005, due to
a decrease in the number of scheduled maintenance events. Also,
see Note 2 to the Consolidated Financial Statements for
discussion of a first quarter 2006 change in the Companys
accounting for heavy maintenance on its 737-300 and 737-500
aircraft.
Aircraft rentals per ASM decreased 17.4 percent. Of the 33
aircraft the Company acquired during 2005, all are owned. In
addition, during 2005, the Company renegotiated the leases on
four aircraft, and, as a result, reclassified these aircraft
from operating leases to capital leases. These transactions have
increased the Companys percentage of aircraft owned or on
capital lease to 81 percent at December 31, 2005, from
79 percent at December 31, 2004. Based on the
Companys scheduled 2006 capacity increases and current
aircraft financing plans, the Company expects a year-over-year
decline in aircraft rental expense per ASM in first quarter 2006
versus first quarter 2005.
Depreciation expense per ASM decreased 1.8 percent. An
increase in depreciation expense per ASM from 33 new 737-700
aircraft purchased during 2005 and the higher percentage of
owned aircraft, was more than offset by lower expense associated
with the Companys retirement of its 737-200 fleet and all
737-200 remaining spare parts by the end of January 2005. Based
on the Companys scheduled 2006 aircraft purchase
commitments and capital expenditure plans, the Company expects
first quarter 2006 depreciation expense per ASM to be slightly
above the first quarter 2005 level of 55 cents per ASM.
Other operating expenses per ASM increased 2.9 percent
compared to 2004. Approximately 75 percent of the increase
relates to higher 2005 security fees in the form of a
$24 million retroactive assessment the Company received
from the Transportation Security Administration in January 2006.
The Company intends to vigorously contest this assessment;
however, if it is unsuccessful in reversing or modifying it,
2006 security fees will be at similar levels. The remainder of
the increase primarily related to higher fuel taxes as a result
of the substantial increase in fuel prices compared to 2004.
Based on current market jet fuel prices and expected higher
security fees in 2006, the Company presently expects an increase
in Other operating expenses per ASM in first quarter compared to
the same 2005 period.
Other. Other expenses (income) included
interest expense, capitalized interest, interest income, and
other gains and losses. Interest expense increased by
$34 million, or 38.6 percent, primarily due to an
increase in floating interest rates. The majority of the
Companys long-term debt is at floating rates. Excluding
the effect of any new debt offerings the Company may execute
during 2006, the Company expects an increase in interest expense
compared to 2005, due to higher expected floating interest
rates, partially offset by the borrowings due to be repaid in
2006 on their redemption dates. See Note 10 to the
Consolidated Financial Statements for more information.
Capitalized interest was flat compared to 2004 as lower 2005
progress payment balances for scheduled future aircraft
deliveries were offset by higher interest rates. Interest income
increased $26 million, or 123.8 percent, primarily due
to an increase in rates earned on cash and investments.
Other (gains) losses, net primarily in-
15
cludes amounts recorded in accordance with SFAS 133. See
Note 10 to the Consolidated Financial Statements for more
information on the Companys hedging activities. During
2005, the Company recognized approximately $35 million of
expense related to amounts excluded from the Companys
measurements of hedge effectiveness. Also during 2005, the
Company recognized approximately $110 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 additional income,
approximately $77 million 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 $9 million was unrealized
ineffectiveness associated with hedges designated for future
periods, and $24 million was ineffectiveness and
mark-to-market gains
related to contracts that settled during 2005. For 2004, the
Company recognized approximately $24 million of expense
related to amounts excluded from the Companys measurements
of hedge effectiveness and $13 million in expense related
to the ineffectiveness of its hedges and unrealized
mark-to-market changes
in the fair value of certain derivative contracts.
Income Taxes. The provision for income taxes, as a
percentage of income before taxes, increased to
37.29 percent in 2005 from 35.94 percent in 2004. The
2004 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. Although the Company expects its
2006 effective tax rate to be in the 38 percent range, the
adoption of SFAS 123R will make it more difficult to
forecast future rates, due to the difference in treatment of
certain types of stock options for tax purposes. See Note 2
to the Consolidated Financial Statements for further information.
The Companys consolidated net income for 2004 was
$313 million ($.38 per share, diluted), as compared to
2003 net income of $442 million ($.54 per share,
diluted), a decrease of $129 million or 29.2 percent.
Operating income for 2004 was $554 million, an increase of
$71 million, or 14.7 percent compared to 2003.
16
As disclosed in Note 17 to the Consolidated Financial
Statements, results for 2003 included $271 million as
Other gains from the Emergency Wartime Supplemental
Appropriations Act (Wartime Act). The Company believes that
excluding the impact of this special item enhances comparative
analysis of results. The grant was made to stabilize and support
the airline industry as a result of the 2003 war with Iraq.
Financial results including the grant were not indicative of the
Companys operating performance for 2003, nor should they
be considered in developing trend analysis for future periods.
There were no special items in 2004. The following table
reconciles and compares results reported in accordance with
Generally Accepted Accounting Principles (GAAP) for 2004
and 2003 with results excluding the impact of the government
grant received in 2003:
|
|
|
|
|
|
|
|
|
|
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
|
(In millions, except | |
|
|
per share and per | |
|
|
ASM amounts) | |
Operating expenses, as reported
|
|
$ |
5,976 |
|
|
$ |
5,454 |
|
Profitsharing impact of government grant
|
|
|
|
|
|
|
(40 |
) |
|
|
|
|
|
|
|
Operating expenses, excluding grant impact
|
|
$ |
5,976 |
|
|
$ |
5,414 |
|
|
|
|
|
|
|
|
Operating expenses per ASM, as reported
|
|
$ |
.0777 |
|
|
$ |
.0760 |
|
Profitsharing impact of government grant
|
|
|
|
|
|
|
(.0006 |
) |
|
|
|
|
|
|
|
Operating expenses per ASM, excluding grant impact
|
|
$ |
.0777 |
|
|
$ |
.0754 |
|
|
|
|
|
|
|
|
Operating income, as reported
|
|
$ |
554 |
|
|
$ |
483 |
|
Profitsharing impact of government grant
|
|
|
|
|
|
|
40 |
|
|
|
|
|
|
|
|
Operating income, excluding impact of government grants
|
|
$ |
554 |
|
|
$ |
523 |
|
|
|
|
|
|
|
|
Net income, as reported
|
|
$ |
313 |
|
|
$ |
442 |
|
Government grant, net of income taxes and profitsharing
|
|
|
|
|
|
|
(144 |
) |
|
|
|
|
|
|
|
Net income, excluding government grants
|
|
$ |
313 |
|
|
$ |
298 |
|
|
|
|
|
|
|
|
Net income per share, diluted, as reported
|
|
$ |
.38 |
|
|
$ |
.54 |
|
Government grant, net of income taxes and profitsharing
|
|
|
|
|
|
|
(.18 |
) |
|
|
|
|
|
|
|
Net income per share, diluted, excluding government grants
|
|
$ |
.38 |
|
|
$ |
.36 |
|
|
|
|
|
|
|
|
Excluding the government grant received, consolidated net income
for 2004 increased $15 million, or 5.0 percent,
compared to 2003 net income of $298 million. The
increase primarily was due to higher revenues from the
Companys fleet growth and addition of capacity, which
slightly exceeded higher costs. Excluding the impact of the 2003
government grant, 2004 operating income increased
$31 million, or 5.9 percent, compared to 2003.
Operating Revenues. Consolidated operating revenues
increased $593 million, or 10.0 percent, primarily due
to a $539 million, or 9.4 percent, increase in
passenger revenues. The increase in passenger revenues primarily
was due to an 11.4 percent increase in RPMs flown, driven
by the Companys growth and a 2.7 point increase in the
Companys load factor compared to 2003.
The Company increased ASMs by 7.1 percent compared to 2003,
primarily as a result of the net addition of 29 aircraft during
2004 (47 new aircraft, net of 18 aircraft retirements). The
Companys load factor for 2004 (RPMs divided by ASMs) was
69.5 percent, compared to 66.8 percent for 2003.
Although this represented a strong load factor performance for
the Company, passenger yields for 2004 (passenger revenue
divided by RPMs) remained under considerable pressure due to
significant capacity increases by a large majority of carriers.
Passenger yields for 2004 declined to $.1176, compared to $.1197
in 2003, a decrease of 1.8 percent, because of heavy fare
discounting arising as a result of the glut in industry seats
available.
Consolidated freight revenues increased $23 million, or
24.5 percent. Approximately 70 percent of the increase
was due to an increase in freight and cargo revenues, primarily
due to more units shipped. The
17
remaining 30 percent of the increase was due to higher mail
revenues, as the U.S. Postal Service shifted more business
to commercial carriers. Other revenues increased
$31 million, or 30.4 percent, primarily due to an
increase in commissions earned from programs the Company
sponsors with certain business partners, such as the
Company-sponsored
Chase®
Visa card.
Operating Expenses. Consolidated operating expenses for
2004 increased $522 million, or 9.6 percent, compared
to the 7.1 percent increase in capacity. To a large extent,
changes in operating expenses for airlines are driven by changes
in capacity, or ASMs. The following presents Southwests
operating expenses per ASM for 2004 and 2003 followed by
explanations of these changes on a per-ASM basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase | |
|
Percent | |
|
|
2004 | |
|
2003 | |
|
(Decrease) | |
|
Change | |
|
|
| |
|
| |
|
| |
|
| |
Salaries, wages, and benefits
|
|
|
3.18 |
¢ |
|
|
3.10 |
¢ |
|
|
.08 |
¢ |
|
|
2.6 |
% |
Fuel and oil
|
|
|
1.30 |
|
|
|
1.16 |
|
|
|
.14 |
|
|
|
12.1 |
|
Maintenance materials and repairs
|
|
|
.59 |
|
|
|
.60 |
|
|
|
(.01 |
) |
|
|
(1.7 |
) |
Aircraft rentals
|
|
|
.23 |
|
|
|
.25 |
|
|
|
(.02 |
) |
|
|
(8.0 |
) |
Landing fees and other rentals
|
|
|
.53 |
|
|
|
.52 |
|
|
|
.01 |
|
|
|
1.9 |
|
Depreciation and amortization
|
|
|
.56 |
|
|
|
.53 |
|
|
|
.03 |
|
|
|
5.7 |
|
Other
|
|
|
1.38 |
|
|
|
1.44 |
|
|
|
(.06 |
) |
|
|
(4.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
7.77 |
¢ |
|
|
7.60 |
¢ |
|
|
.17 |
¢ |
|
|
2.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses per ASM increased 2.2 percent to $.0777,
primarily due to an increase in jet fuel prices, net of hedging
gains, and an increase in salaries, wages, and benefits. These
increases were partially offset by the Companys
elimination of commissions paid to travel agents, which was
effective December 15, 2003.
Salaries, wages, and benefits expense per ASM increased
2.6 percent, inclusive of $40 million in additional
expense from the profitsharing impact of the 2003 government
grant. Excluding the profitsharing impact of the 2003 government
grant, approximately 70 percent of the increase per ASM was
due to higher salaries expense, primarily from higher average
wage rates, and 25 percent was due to higher benefits
costs, primarily health care and workers compensation. For
fourth quarter 2004 versus 2003, salaries, wages, and benefits
per ASM decreased 1.0 percent, as the Company benefited
from increased labor productivity. This increase in productivity
was driven primarily by headcount reductions from the
Companys reservations center consolidation and early-out
program during 2004, and reduced hiring. See Note 9 to the
Consolidated Financial Statements.
During second quarter 2004, the Company and the Transport
Workers Union Local 556 reached a tentative labor agreement for
the Companys Flight Attendants, which included both pay
increases and the issuance of stock options. During July 2004, a
majority of the Companys Flight Attendants ratified the
labor agreement, which is for the period from June 1, 2002,
to May 31, 2008.
During third quarter 2004, the Company and the Aircraft
Mechanics Fraternal Association, representing the Companys
Mechanics, agreed to extend the date the current agreement
becomes amendable to August 2008. The extension included both
pay raises and the issuance of stock options, and was ratified
by a majority of the Companys Mechanics.
During third quarter 2004, the Company and the International
Brotherhood of Teamsters, representing the Companys Flight
Simulator Technicians, agreed to extend the date the current
agreement becomes amendable to November 2011. The extension
included both pay raises and the issuance of stock options, and
was ratified by a majority of the Companys Simulator
Technicians.
Fuel and oil expense per ASM increased 12.1 percent,
primarily due to a 14.5 percent increase in the average jet
fuel cost per gallon, net of hedging gains. The average cost per
gallon of jet fuel in 2004 was 82.8 cents compared to 72.3 cents
in 2003, excluding fuel-related taxes but including the effects
of hedging activities. The Companys 2004 and 2003 average
jet fuel costs are net of approximately $455 million and
$171 million in gains from hedging activities,
respectively. See Note 10 to the Consolidated Financial
Statements. The increase in fuel prices was partially offset by
steps the Company took to improve the fuel efficiency of its
aircraft. These steps primarily included the addi-
18
tion of blended winglets to 177 of the Companys 737-700
aircraft as of December 31, 2004, and the upgrade of
certain engine components on many aircraft. The Company
estimates that these and other efficiency gains saved the
Company approximately $28 million in 2004, at average
unhedged market jet fuel prices.
Aircraft rentals per ASM and depreciation and amortization
expense per ASM were both impacted by a higher percentage of the
aircraft fleet being owned. Aircraft rentals per ASM decreased
8.0 percent while depreciation and amortization expense per
ASM increased 5.7 percent. Of the 47 aircraft the Company
acquired during 2004, 46 are owned and one is on operating
lease. This, along with the retirement of 16 owned and two
leased aircraft, increased the Companys percentage of
aircraft owned or on capital lease to 79 percent at
December 31, 2004, from 77 percent at
December 31, 2003.
Landing fees and other rentals per ASM increased
1.9 percent primarily due to the Companys expansion
of gate and counter space at several airports across our system.
Other operating expenses per ASM decreased 4.2 percent
compared to 2003 primarily due to the elimination of commissions
paid to travel agents, effective December 15, 2003. In
addition to this change, an increase in expense from higher fuel
taxes as a result of the substantial increase in fuel prices was
mostly offset by lower advertising expense.
Other. Other expenses (income) included
interest expense, capitalized interest, interest income, and
other gains and losses. Interest expense decreased by
$3 million, or 3.3 percent, primarily due to the
Companys October 2003 redemption of $100 million of
senior unsecured
83/4% Notes
originally issued in 1991. This decrease was partially offset by
the Companys September 2004 issuance of $350 million
5.25% senior unsecured notes and the fourth quarter 2004
issuance of $112 million in floating-rate financing.
Concurrently with the September 2004 issuance, the Company
entered into an interest-rate swap agreement to convert this
fixed-rate debt to floating rate. See Note 10 to the
Consolidated Financial Statements for more information on the
interest-rate swap agreement. Capitalized interest increased
$6 million, or 18.2 percent, primarily as a result of
higher 2004 progress payment balances for scheduled future
aircraft deliveries, compared to 2003. Interest income decreased
$3 million, or 12.5 percent, primarily due to a
decrease in average invested cash balances. Other gains in 2003
primarily resulted from the government grant of
$271 million received pursuant to the Wartime Act. See
Note 17 to the Consolidated Financial Statements for
further discussion of the grant. Other losses in 2004 primarily
include amounts recorded in accordance with SFAS 133. See
Note 10 to the Consolidated Financial Statements for more
information on the Companys hedging activities. During
2004, the Company recognized approximately $24 million of
expense related to amounts excluded from the Companys
measurements of hedge effectiveness and $13 million in
expense related to the ineffectiveness of its hedges and
unrealized
mark-to-market changes
in the fair value of certain derivative contracts.
Income Taxes. The provision for income taxes, as a
percentage of income before taxes, decreased to
35.94 percent in 2004 from 37.60 percent in 2003.
Approximately half of the rate reduction was due to lower
effective state income tax rates. The remainder of the decrease
primarily was due to a favorable adjustment related to the
ultimate resolution of an industry-wide issue regarding the tax
treatment of certain aircraft engine maintenance costs.
Liquidity and Capital Resources
Net cash provided by operating activities was $2.2 billion
in 2005 compared to $1.2 billion in 2004. For the Company,
operating cash inflows primarily are derived from providing air
transportation for Customers. The vast majority of tickets are
purchased prior to the day on which travel is provided and, in
some cases, several months before the anticipated travel date.
Operating cash outflows primarily are related to the recurring
expenses of operating the airline. For 2005, the increase in
operating cash flows primarily was due to an increase in
Accounts payable and accrued liabilities and higher
net income in 2005 versus 2004. There was a $1.0 billion
increase in accrued liabilities, primarily related to a
$620 million increase in counterparty deposits associated
with the Companys fuel hedging program. For further
information on the Companys hedging program and
counterparty deposits, see Note 10 to the Consolidated
Financial Statements, and Item 7A. Qualitative and
Quantitative Disclosures about Market Risk, respectively. Cash
generated in 2005 and in 2004 primarily was used to finance
aircraft-related capital expenditures and to provide working
capital.
Cash flows used in investing activities in 2005 totaled
$1.2 billion compared to $1.7 billion in 2004.
Investing activities in both years primarily consisted of
payments for new 737-700 aircraft delivered to the Company and
progress payments for future aircraft deliveries. The Company
purchased 33 new 737-700
19
aircraft in 2005 versus the purchase of 46 new 737-700s in 2004.
In addition, progress payments for future deliveries were higher
in 2004 than 2005. See Note 4 to the Consolidated Financial
Statements. Investing activities for 2004 were also reduced
$124 million by a change in the balance of the
Companys short-term investments, namely auction rate
securities. Also, 2005 and 2004 included payments of
$6 million and $34 million, respectively, for certain
ATA assets. See Note 3 to the Consolidated Financial
Statements for further information on the Companys
transaction with ATA.
Net cash provided by financing activities was $213 million
in 2005, primarily from the issuance of $300 million senior
unsecured 5.125% notes in February 2005, net of the
redemption of the Companys $100 million senior
unsecured 8% notes in March 2005. During 2005, the Company also
received proceeds of $132 million from Employee exercises
of stock options under its stock plans and repurchased
$55 million of its common stock. In 2004, net cash provided
by financing activities was $133 million, primarily from
the issuance of $520 million in long-term debt. The
majority of the debt issuance was the $350 million senior
unsecured notes issued in September 2004, and the fourth quarter
2004 issuance of $112 million in floating-rate financing.
The largest 2004 cash outflows in financing activities were from
the Companys repurchase of $246 million of its common
stock during 2004, and the redemption of long-term debt,
primarily the $175 million Aircraft Secured Notes that came
due in November 2004. See Note 7 to the Consolidated
Financial Statements for more information on the issuance and
redemption of long-term debt.
The Company has various options available to meet its 2006
capital and operating commitments, including cash on hand and
short-term investments at December 31, 2005, of
$2.5 billion, internally generated funds, and a
$600 million bank revolving line of credit. In addition,
the Company will also consider various borrowing or leasing
options to maximize earnings and supplement cash requirements.
The Company believes it has access to a wide variety of
financing arrangements because of its excellent credit ratings,
unencumbered assets, modest leverage, and consistent
profitability.
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. The
Company may issue a portion of these securities in 2006,
primarily to replace debt that is coming due and to fund current
fleet growth plans.
Off-Balance Sheet Arrangements, Contractual Obligations, and
Contingent Liabilities and Commitments
Southwest has contractual obligations and commitments primarily
with regard to future purchases of aircraft, payment of debt,
and lease arrangements. Along with the receipt of 33 new 737-700
aircraft in 2005, the Company has exercised its remaining
options for aircraft to be delivered in 2006, and some of its
options for aircraft to be delivered in 2007. As of January
2006, the Company had firm orders for 33 737-700 aircraft in
2006, 29 in 2007, and six in 2008. The Company also had options
for seven 737-700 aircraft in 2007, 25 in 2008, and an
additional 217 purchase rights for 737-700 aircraft for the
years 2007 through 2012. The Company has the option to
substitute 737-600s or -800s for the -700s. This option is
applicable to aircraft ordered from the manufacturer and must be
exercised two years prior to the contractual delivery date.
The Company has engaged in off-balance sheet arrangements in the
leasing of aircraft. The leasing of aircraft provides
flexibility to the Company effectively as a source of financing.
Although the Company is responsible for all maintenance,
insurance, and expense associated with operating the aircraft,
and retains the risk of loss for leased aircraft, it has not
made any guarantees to the lessors regarding the residual value
(or market value) of the aircraft at the end of the lease terms.
As shown in Item 2., and as disclosed in Note 8 to the
Consolidated Financial Statements, the Company operates 93
aircraft leased from third parties, of which 84 are operating
leases. As prescribed by GAAP, assets and obligations under
operating leases are not included in the Companys
Consolidated Balance Sheet. Disclosure of the contractual
obligations associated with the Companys leased aircraft
are included below as well as in Note 8 to the Consolidated
Financial Statements.
20
The following table aggregates the Companys material
expected contractual obligations and commitments as of
December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations by Period | |
|
|
| |
|
|
|
|
Beyond | |
|
|
Contractual Obligations |
|
2006 | |
|
2007-2008 | |
|
2009-2010 | |
|
2010 | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions) | |
Long-term debt(1)
|
|
$ |
596 |
|
|
$ |
123 |
|
|
$ |
28 |
|
|
$ |
1,222 |
|
|
$ |
1,969 |
|
Interest commitments(2)
|
|
|
37 |
|
|
|
51 |
|
|
|
45 |
|
|
|
214 |
|
|
|
347 |
|
Capital lease commitments(3)
|
|
|
16 |
|
|
|
32 |
|
|
|
31 |
|
|
|
12 |
|
|
|
91 |
|
Operating lease commitments
|
|
|
332 |
|
|
|
583 |
|
|
|
454 |
|
|
|
1,164 |
|
|
|
2,533 |
|
Aircraft purchase commitments(4)
|
|
|
740 |
|
|
|
538 |
|
|
|
|
|
|
|
|
|
|
|
1,278 |
|
Other purchase commitments
|
|
|
44 |
|
|
|
26 |
|
|
|
24 |
|
|
|
11 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations
|
|
$ |
1,765 |
|
|
$ |
1,353 |
|
|
$ |
582 |
|
|
$ |
2,623 |
|
|
$ |
6,323 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
Includes current maturities, but excludes amounts associated
with interest rate swap agreements |
|
(2) |
Related to fixed-rate debt |
|
(3) |
Includes amounts classified as interest |
|
(4) |
Firm orders from the manufacturer |
The Company may issue a portion of its $1.3 billion in
outstanding shelf registrations as public debt securities during
2006.
There were no outstanding borrowings under the revolving credit
facility at December 31, 2005. See Note 6 to the
Consolidated Financial Statements for more information on the
Companys revolving credit facility.
In January 2004, the Companys Board of Directors
authorized the repurchase of up to $300 million of the
Companys common stock, utilizing present and anticipated
proceeds from the exercise of Employee stock options.
Repurchases were made in accordance with applicable securities
laws in the open market or in private transactions from time to
time, depending on market conditions. This program was completed
during first quarter 2005, resulting in the total repurchase of
approximately 20.9 million of its common shares.
In January 2006, the Companys Board of Directors
authorized the repurchase of up to $300 million of the
Companys common stock. Repurchases will be made in
accordance with applicable securities laws in the open market or
in private transactions from time to time, depending on market
conditions.
Critical Accounting Policies and Estimates
The Companys Consolidated Financial Statements have been
prepared in accordance with United States GAAP. The
Companys significant accounting policies are described in
Note 1 to the Consolidated Financial Statements. The
preparation of financial statements in accordance with GAAP
requires the Companys management to make estimates and
assumptions that affect the amounts reported in the Consolidated
Financial Statements and accompanying footnotes. The
Companys estimates and assumptions are based on historical
experience and changes in the business environment. However,
actual results may differ from estimates under different
conditions, sometimes materially. Critical accounting policies
and estimates are defined as those that are both most important
to the portrayal of the Companys financial condition and
results and require managements most subjective judgments.
The Companys most critical accounting policies and
estimates are described below.
As described in Note 1 to the Consolidated Financial
Statements, tickets sold for passenger air travel are initially
deferred as Air traffic liability. Passenger revenue
is recognized and air traffic liability is reduced when the
service is provided (i.e., when the flight takes place).
Air traffic liability represents tickets sold for
future travel dates and estimated future refunds and exchanges
of tickets sold for past travel dates. The balance in Air
traffic liability fluctuates throughout the year based on
seasonal travel patterns and fare sale activity. The
Companys Air traffic liability balance at
December 31, 2005 was $649 million, compared to
$529 million as of December 31, 2004.
21
Estimating the amount of tickets that will be refunded,
exchanged, or forfeited involves some level of subjectivity and
judgment. The majority of the Companys tickets sold are
nonrefundable, which is the primary source of forfeited tickets.
According to the Companys Contract of
Carriage, tickets that are sold but not flown on the
travel date can be reused for another flight, up to a year from
the date of sale, or can be refunded (if the ticket is
refundable). A small percentage of tickets (or partial tickets)
expire unused. Fully refundable tickets are rarely forfeited.
Air traffic liability includes an estimate of the
amount of future refunds and exchanges, net of forfeitures, for
all unused tickets once the flight date has passed. These
estimates are based on historical experience over many years.
The Company and members of the airline industry have
consistently applied this accounting method to estimate revenue
from forfeited tickets at the date travel is provided. Estimated
future refunds and exchanges included in the air traffic
liability account are constantly evaluated based on subsequent
refund and exchange activity to validate the accuracy of the
Companys estimates with respect to forfeited tickets.
Holding other factors constant, a ten-percent change in the
Companys estimate of the amount of refunded, exchanged, or
forfeited tickets for 2005 would have resulted in a
$13 million change in Passenger revenues recognized for
that period.
Events and circumstances outside of historical fare sale
activity or historical Customer travel patterns, as noted, can
result in actual refunds, exchanges, or forfeited tickets
differing significantly from estimates. The Company evaluates
its estimates within a narrow range of acceptable amounts. If
actual refunds, exchanges, or forfeiture experience results in
an amount outside of this range, estimates and assumptions are
reviewed and adjustments to Air traffic liability
and to Passenger revenue are recorded, as necessary.
Additional factors that may affect estimated refunds and
exchanges include, but may not be limited to, the Companys
refund and exchange policy, the mix of refundable and
nonrefundable fares, and promotional fare activity. The
Companys estimation techniques have been consistently
applied from year to year; however, as with any estimates,
actual refund, exchange, and forfeiture activity may vary from
estimated amounts. No material adjustments were recorded for
years 2003, 2004, or 2005.
The Company believes it is unlikely that materially different
estimates for future refunds, exchanges, and forfeited tickets
would be reported based on other reasonable assumptions or
conditions suggested by actual historical experience and other
data available at the time estimates were made.
|
|
|
Accounting for Long-Lived Assets |
As of December 31, 2005, the Company had approximately
$12.9 billion (at cost) of long-lived assets, including
$11.0 billion (at cost) in flight equipment and related
assets. Flight equipment primarily relates to the 361 Boeing 737
aircraft in the Companys fleet at December 31, 2005,
which are either owned or on capital lease. The remaining 84
Boeing 737 aircraft in the Companys fleet at
December 31, 2005, are on operating lease. In accounting
for long-lived assets, the Company must make estimates about the
expected useful lives of the assets, the expected residual
values of the assets, and the potential for impairment based on
the fair value of the assets and the cash flows they generate.
The following table shows a breakdown of the Companys
long-lived asset groups along with information about estimated
useful lives and residual values of these groups:
|
|
|
|
|
|
|
|
|
|
|
Estimated | |
|
|
|
|
Residual | |
|
|
Estimated Useful Life |
|
Value | |
|
|
|
|
| |
Aircraft and engines
|
|
23 to 25 years |
|
|
15% |
|
Aircraft parts
|
|
Fleet life |
|
|
4% |
|
Ground property and equipment
|
|
5 to 30 years |
|
|
0%-10% |
|
Leasehold improvements
|
|
5 years or lease term |
|
|
0% |
|
In estimating the lives and expected residual values of its
aircraft, the Company primarily has relied upon actual
experience with the same or similar aircraft types and
recommendations from Boeing, the manufacturer of the
Companys aircraft. Aircraft estimated useful lives are
based on the number of cycles flown (one take-off
and landing). The Company has made a conversion of cycles into
years based on both its historical and anticipated future
utilization of the aircraft. Subsequent revisions to these
estimates, which can be significant, could be caused by changes
to the Companys maintenance program, changes in
utilization of the aircraft (actual cycles during a given period
of time), governmental regulations on aging aircraft, and
changing market prices of new and used aircraft of the same or
similar types. The Company evaluates its estimates and
assumptions each reporting period and, when warranted, adjusts
these estimates and assumptions. Generally, these adjustments
are accounted for on a prospective basis through depreciation
and amortization
22
expense, as required by GAAP. The Company does not expect its
transition to a new, more efficient heavy maintenance program
for 737-300 and 737-500 airframes in 2006 to have an impact on
the estimated useful lives for those aircraft. See Note 2
to the Consolidated Financial Statements for more information on
this change.
When appropriate, the Company evaluates its long-lived assets
for impairment. Factors that would indicate potential impairment
may include, but are not limited to, significant decreases in
the market value of the long-lived asset(s), a significant
change in the long-lived assets physical condition, and
operating or cash flow losses associated with the use of the
long-lived asset. While the airline industry as a whole has
experienced many of these indicators, Southwest has continued to
operate all of its aircraft, generate positive cash flow, and
produce profits. Consequently, the Company has not identified
any impairments related to its existing aircraft fleet. The
Company will continue to monitor its long-lived assets and the
airline operating environment.
The Company believes it unlikely that materially different
estimates for expected lives, expected residual values, and
impairment evaluations would be made or reported based on other
reasonable assumptions or conditions suggested by actual
historical experience and other data available at the time
estimates were made.
|
|
|
Financial Derivative Instruments |
The Company utilizes financial derivative instruments primarily
to manage its risk associated with changing jet fuel prices, and
accounts for them under Statement of Financial Accounting
Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended
(SFAS 133). See Qualitative and Quantitative
Disclosures about Market Risk for more information on
these risk management activities and see Note 10 to the
Consolidated Financial Statements for more information on
SFAS 133, the Companys fuel hedging program, and
financial derivative instruments.
SFAS 133 requires that all derivatives be marked to market
(fair value) and recorded on the Consolidated Balance Sheet. At
December 31, 2005, the Company was a party to over 400
financial derivative instruments, related to fuel hedging, for
year 2006 and beyond. The fair value of the Companys fuel
hedging financial derivative instruments recorded on the
Companys Consolidated Balance Sheet as of
December 31, 2005, was $1.7 billion, compared to
$796 million at December 31, 2004. The large increase
in fair value primarily was due to the dramatic increase in
energy prices throughout 2005, and the Companys addition
of derivative instruments to increase its hedge positions in
future years. Changes in the fair values of these instruments
can vary dramatically, as was evident during 2005, based on
changes in the underlying commodity prices. Market price changes
can be driven by factors such as supply and demand, inventory
levels, weather events, refinery capacity, political agendas,
and general economic conditions, among other items. The
financial derivative instruments utilized by the Company
primarily are a combination of collars, purchased call options,
and fixed price swap agreements. The Company does not purchase
or hold any derivative instruments for trading purposes.
The Company enters into financial derivative instruments with
third party institutions in
over-the-counter
markets. Since the majority of the Companys financial
derivative instruments are not traded on a market exchange, the
Company estimates their fair values. Depending on the type of
instrument, the values are 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. Also, since there is not a reliable forward market for
jet fuel, the Company must estimate the future prices of jet
fuel in order to measure the effectiveness of the hedging
instruments in offsetting changes to those prices, as required
by SFAS 133. Forward jet fuel prices are estimated through
the observation of similar commodity futures prices (such as
crude oil, heating oil, and unleaded gasoline) and adjusted
based on historical variations to those like commodities.
Fair values for financial derivative instruments and forward jet
fuel prices are both estimated prior to the time that the
financial derivative instruments settle, and the time that jet
fuel is purchased and consumed, respectively. However, once
settlement of the financial derivative instruments occurs and
the hedged jet fuel is purchased and consumed, all values and
prices are known and are recognized in the financial statements.
Based on these actual results once all values and prices become
known, the Companys estimates have proved to be materially
accurate.
Estimating the fair value of these fuel hedging derivatives and
forward prices for jet fuel will also result in changes in their
values from period to period and thus determine how they are
accounted for under SFAS 133. To the extent that the total
change in the estimated fair value of a fuel hedging instrument
differs from the change in the estimated price of the associated
jet fuel
23
to be purchased, both on a cumulative and a
period-to-period basis,
ineffectiveness of the fuel hedge can result, as defined by
SFAS 133. This could result in the immediate recording of
noncash charges or income, even though the derivative instrument
may not expire until a future period. Likewise, if a cash flow
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 considering the recent volatility in the prices of
refined products. In addition, given the magnitude of the
Companys fuel hedge portfolio total market value,
ineffectiveness can be highly material to financial results. 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
Companys results. Prior to 2005, the Company had not
experienced significant ineffectiveness in its fuel hedges
accounted for under SFAS 133, in relation to the fair value
of the underlying financial derivative instruments. The
significant increase in the amount of hedge ineffectiveness and
unrealized gains on derivative contracts settling in future
periods recorded during 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 the foregoing 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 Companys hedge positions increases in amount,
there is a higher degree of probability that there will be
continued and correspondingly higher 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.
SFAS 133 is a complex accounting standard with stringent
requirements, including the documentation of a Company hedging
strategy, statistical analysis to qualify a commodity for hedge
accounting both on a historical and a prospective basis, and
strict contemporaneous documentation that is required at the
time each hedge is executed by the Company. As required by
SFAS 133, the Company assesses the effectiveness of each of
its individual hedges on a quarterly basis. The Company also
examines the effectiveness of its entire hedging program on a
quarterly basis utilizing statistical analysis. This analysis
involves utilizing regression and other statistical analyses
that compare changes in the price of jet fuel to changes in the
prices of the commodities used for hedging purposes (crude oil,
heating oil, and unleaded gasoline).
The Company continually looks for better and more accurate
methodologies in forecasting future cash flows relating to its
jet fuel hedging program. These estimates are used in the
measurement of effectiveness for the Companys fuel hedges,
as required by SFAS 133. Any changes to the Companys
methodology for estimating future cash flows (i.e., jet
fuel prices) will be applied prospectively, in accordance with
SFAS 133. While the Company would expect that a change in
the methodology for estimating future cash flows would result in
more effective hedges over the long-term, such a change could
result in more ineffectiveness, as defined, in the short-term,
due to the prospective nature of enacting the change.
The Company also utilizes financial derivative instruments in
the form of interest rate swap agreements. The primary objective
for the Companys use of interest rate hedges is to reduce
the volatility of net interest income by better matching the
repricing of its assets and liabilities. Concurrently, the
Companys interest rate hedges are also intended to take
advantage of market conditions in which short-term rates are
significantly lower than the fixed longer term rates on the
Companys long-term debt. During 2003, the Company entered
into interest rate swap agreements relating to its
$385 million 6.5% senior unsecured notes due 2012, and
$375 million 5.496%
Class A-2
pass-through certificates due 2006. The floating rate paid under
each agreement sets in arrears. Under the first agreement, the
Company pays the London InterBank Offered Rate (LIBOR) plus
a margin every six months and receives 6.5% every six months on
a notional amount of $385 million until 2012. The average
floating rate paid
24
under this agreement during 2005 is estimated to be
6.46 percent based on actual and forward rates at
December 31, 2005. Under the second agreement, the Company
pays LIBOR plus a margin every six months and receives 5.496%
every six months on a notional amount of $375 million until
November 1, 2006. Based on actual and forward rates at
December 31, 2005, the average floating rate paid under
this agreement during 2005 is estimated to be 6.73 percent.
During 2004, the Company also entered into an interest rate swap
agreement relating to its $350 million 5.25% senior
unsecured notes due 2014. Under this agreement, the Company pays
LIBOR plus a margin every six months and receives 5.25% every
six months on a notional amount of $350 million until 2014.
The floating rate is set in advance. The average floating rate
paid under this agreement during 2005 was 3.82 percent.
The Companys interest rate swap agreements qualify as fair
value hedges, as defined by SFAS 133. In addition, these
interest rate swap agreements qualify for the
shortcut method of accounting for hedges, as defined
by SFAS 133. Under the shortcut method, the
hedges are assumed to be perfectly effective, and, thus, there
is no ineffectiveness to be recorded in earnings. The fair value
of the interest rate swap agreements, which are adjusted
regularly, are recorded in the Consolidated Balance Sheet, 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 December 31,
2005, was a liability of approximately $31 million. The
comparable fair value of these same agreements at
December 31, 2004, was a liability of $16 million. The
long-term portion of these amounts are recorded in Other
deferred liabilities in the Consolidated Balance Sheet for
each respective year and the current portion is reflected in
Accrued liabilities. In accordance with fair value
hedging, the offsetting entry is an adjustment to decrease the
carrying value of long-term debt. See Note 10 to the
Consolidated Financial Statements.
The Company believes it is unlikely that materially different
estimates for the fair value of financial derivative
instruments, and forward jet fuel prices, would be made or
reported based on other reasonable assumptions or conditions
suggested by actual historical experience and other data
available at the time estimates were made.
Forward-Looking Statements
Some statements in this
Form 10-K (or
otherwise made by the Company or on the Companys 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
Southwests 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
Companys present expectations. Factors that could cause
these differences include, but are not limited to, those set
forth under Item 1A Risk Factors.
Caution should be taken not to place undue reliance on the
Companys forward-looking statements, which represent the
Companys 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 7A. |
Qualitative and Quantitative Disclosures About Market
Risk |
Southwest has interest rate risk in its floating rate debt
obligations and interest rate swaps, and has commodity price
risk in jet fuel required to operate its aircraft fleet. The
Company purchases jet fuel at prevailing market prices, but
seeks to manage market risk through execution of a documented
hedging strategy. Southwest has market sensitive instruments in
the form of fixed rate debt instruments and financial derivative
instruments used to hedge its exposure to jet fuel price
increases. The Company also operates 93 aircraft under operating
and capital leases. However, leases are not considered market
sensitive financial instruments and, therefore, are not included
in the interest rate sensitivity analysis below. Commitments
related to leases are disclosed in Note 8 to the
Consolidated Financial Statements. The Company does not purchase
or hold any derivative financial instruments for trading
purposes. See Note 10 to the Consolidated Financial
Statements for
25
information on the Companys accounting for its hedging
program and for further details on the Companys financial
derivative instruments.
Fuel hedging. The Company utilizes its fuel hedges, on
both a short-term and a long-term basis, as a form of insurance
against significant increases in fuel prices. The Company
believes there is significant risk in not hedging against the
possibility of such fuel price increases. The Company expects to
consume approximately 1.4 billion gallons of jet fuel in
2006. Based on this usage, a change in jet fuel prices of just
one cent per gallon would impact the Companys Fuel
and oil expense by approximately $14 million per
year, excluding any impact of the Companys fuel hedges.
The fair values of outstanding financial derivative instruments
related to the Companys jet fuel market price risk at
December 31, 2005, were net assets of $1.7 billion.
The current portion of these financial derivative instruments,
or $640 million, is classified as Fuel hedge
contracts in the Consolidated Balance Sheet. The long-term
portion of these financial derivative instruments, or
$1.0 billion, is included in Other assets. The
fair values of the derivative instruments, depending on the type
of instrument, were determined by use of present value methods
or standard option value models with assumptions about commodity
prices based on those observed in underlying markets. An
immediate ten-percent increase or decrease in underlying
fuel-related commodity prices from the December 31, 2005,
prices would correspondingly change the fair value of the
commodity derivative instruments in place by approximately
$420 million. Changes in the related commodity derivative
instrument cash flows may change by more or less than this
amount based upon further fluctuations in futures prices as well
as related income tax effects. This sensitivity analysis uses
industry standard valuation models and holds all inputs constant
at December 31, 2005, levels, except underlying futures
prices.
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 will periodically review
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 December 31, 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 December 31,
2005, the Company held $950 million in cash collateral
deposits under these bilateral collateral provisions. These
collateral deposits serve to decrease, but not totally
eliminate, the credit risk associated with the Companys
hedging program. The deposits are included in Accrued
liabilities on the Consolidated Balance Sheet. See also
Note 10 to the Consolidated Financial Statements.
Financial market risk. The vast majority of the
Companys assets are aircraft, which are long-lived. The
Companys strategy is to maintain a conservative balance
sheet and grow capacity steadily and profitably. While the
Company uses financial leverage, it has maintained a strong
balance sheet and an A credit rating on its senior
unsecured fixed-rate debt with Standard & Poors
and Fitch ratings agencies, and a Baa1 credit rating
with Moodys rating agency. The Companys 1999 and
2004 French Credit Agreements do not give rise to significant
fair value risk but do give rise to interest rate risk because
these borrowings are floating-rate debt. In addition, as
disclosed in Note 10 to the Consolidated Financial
Statements, the Company has converted certain of its long-term
debt to floating rate debt by entering into interest rate swap
agreements. This includes the Companys $385 million
6.5% senior unsecured notes due 2012, the $375 million
5.496% Class A-2
pass-through certificates due 2006, and the $350 million
5.25% senior unsecured notes due 2014. Although there is
interest rate risk associated with these floating rate
borrowings, the risk for the 1999 and 2004 French Credit
Agreements is somewhat mitigated by the fact that the Company
may prepay this debt under certain conditions. See Notes 6
and 7 to the Consolidated Financial Statements for more
information on the material terms of the Companys
short-term and long-term debt.
Excluding the $385 million 6.5% senior unsecured
notes, and the $350 million 5.25% senior unsecured
notes that were converted to a floating rate as previously
noted, the Company had outstanding senior unsecured notes
totaling $500 million at December 31, 2005. These
senior unsecured notes currently have a weighted-average
maturity of 11.3 years at fixed rates averaging
6.125 percent at December 31, 2005, which is
comparable to average rates prevailing for similar debt
instruments over the last ten years. The fixed-rate portion of
26
the Companys pass-through certificates consists of its
Class A certificates and Class B certificates, which
totaled $154 million at December 31, 2005. These
Class A and Class B certificates had fixed rates
averaging 5.7 percent at December 31, 2005 and mature
during 2006. The carrying value of the Companys floating
rate debt totaled $1.2 billion, and this debt had a
weighted-average maturity of 6.0 years at floating rates
averaging 6.27 percent at December 31, 2005. In total,
the Companys fixed rate debt and floating rate debt
represented 6.2 percent and 11.6 percent,
respectively, of total noncurrent assets at December 31,
2005.
The Company also has some risk associated with changing interest
rates due to the short-term nature of its invested cash, which
totaled $2.3 billion, and short-term investments, which
totaled $251 million, at December 31, 2005. The
Company invests available cash in certificates of deposit,
highly rated money market instruments, investment grade
commercial paper, auction rate securities, and other highly
rated financial instruments. Because of the short-term nature of
these investments, the returns earned parallel closely with
short-term floating interest rates. The Company has not
undertaken any additional actions to cover interest rate market
risk and is not a party to any other material market interest
rate risk management activities.
A hypothetical ten percent change in market interest rates as of
December 31, 2005, would not have a material effect on the
fair value of the Companys fixed rate debt instruments.
See Note 10 to the Consolidated Financial Statements for
further information on the fair value of the Companys
financial instruments. A change in market interest rates could,
however, have a corresponding effect on the Companys
earnings and cash flows associated with its floating rate debt,
invested cash, and short-term investments because of the
floating-rate nature of these items. Assuming floating market
rates in effect as of December 31, 2005, were held constant
throughout a 12-month
period, a hypothetical ten percent change in those rates would
correspondingly change the Companys net earnings and cash
flows associated with these items by less than $2 million.
Utilizing these assumptions and considering the Companys
cash balance, short-term investments, and floating-rate debt
outstanding at December 31, 2005, an increase in rates
would have a net positive effect on the Companys earnings
and cash flows, while a decrease in rates would have a net
negative effect on the Companys earnings and cash flows.
However, a ten percent change in market rates would not impact
the Companys earnings or cash flow associated with the
Companys publicly traded fixed-rate debt.
The Company is also subject to various financial covenants
included in its credit card transaction processing agreement,
the revolving credit facility, and outstanding debt agreements.
Covenants include the maintenance of minimum credit ratings. For
the revolving credit facility, the Company shall also maintain,
at all times, a Coverage Ratio, as defined in the agreement, of
not less than 1.25 to 1.0. The Company met or exceeded the
minimum standards set forth in these agreements as of
December 31, 2005. However, if conditions change and the
Company fails to meet the minimum standards set forth in the
agreements, it could reduce the availability of cash under the
agreements or increase the costs to keep these agreements intact
as written.
27
|
|
Item 8. |
Financial Statements and Supplementary Data |
SOUTHWEST AIRLINES CO.
CONSOLIDATED BALANCE SHEET
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions, except | |
|
|
share data) | |
ASSETS |
Current assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
2,280 |
|
|
$ |
1,048 |
|
|
Short-term investments
|
|
|
251 |
|
|
|
257 |
|
|
Accounts and other receivables
|
|
|
258 |
|
|
|
248 |
|
|
Inventories of parts and supplies, at cost
|
|
|
150 |
|
|
|
137 |
|
|
Fuel hedge contracts
|
|
|
641 |
|
|
|
428 |
|
|
Prepaid expenses and other current assets
|
|
|
40 |
|
|
|
54 |
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
3,620 |
|
|
|
2,172 |
|
Property and equipment, at cost:
|
|
|
|
|
|
|
|
|
|
Flight equipment
|
|
|
10,999 |
|
|
|
10,037 |
|
|
Ground property and equipment
|
|
|
1,256 |
|
|
|
1,202 |
|
|
Deposits on flight equipment purchase contracts
|
|
|
660 |
|
|
|
682 |
|
|
|
|
|
|
|
|
|
|
|
12,915 |
|
|
|
11,921 |
|
|
Less allowance for depreciation and amortization
|
|
|
3,488 |
|
|
|
3,198 |
|
|
|
|
|
|
|
|
|
|
|
9,427 |
|
|
|
8,723 |
|
Other assets
|
|
|
1,171 |
|
|
|
442 |
|
|
|
|
|
|
|
|
|
|
$ |
14,218 |
|
|
$ |
11,337 |
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
Current liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$ |
524 |
|
|
$ |
420 |
|
|
Accrued liabilities
|
|
|
2,074 |
|
|
|
1,047 |
|
|
Air traffic liability
|
|
|
649 |
|
|
|
529 |
|
|
Current maturities of long-term debt
|
|
|
601 |
|
|
|
146 |
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
3,848 |
|
|
|
2,142 |
|
Long-term debt less current maturities
|
|
|
1,394 |
|
|
|
1,700 |
|
Deferred income taxes
|
|
|
1,896 |
|
|
|
1,610 |
|
Deferred gains from sale and leaseback of aircraft
|
|
|
136 |
|
|
|
152 |
|
Other deferred liabilities
|
|
|
269 |
|
|
|
209 |
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
|
Common stock, $1.00 par value: 2,000,000,000 shares
authorized; 801,641,645 and 790,181,982 shares issued in
2005 and 2004, respectively
|
|
|
802 |
|
|
|
790 |
|
|
Capital in excess of par value
|
|
|
424 |
|
|
|
299 |
|
|
Retained earnings
|
|
|
4,557 |
|
|
|
4,089 |
|
|
Accumulated other comprehensive income
|
|
|
892 |
|
|
|
417 |
|
|
Treasury stock, at cost: 5,199,192 shares in 2004
|
|
|
|
|
|
|
(71 |
) |
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
6,675 |
|
|
|
5,524 |
|
|
|
|
|
|
|
|
|
|
$ |
14,218 |
|
|
$ |
11,337 |
|
|
|
|
|
|
|
|
See accompanying notes.
28
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions, except | |
|
|
per share amounts) | |
OPERATING REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Passenger
|
|
$ |
7,279 |
|
|
$ |
6,280 |
|
|
$ |
5,741 |
|
|
Freight
|
|
|
133 |
|
|
|
117 |
|
|
|
94 |
|
|
Other
|
|
|
172 |
|
|
|
133 |
|
|
|
102 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
7,584 |
|
|
|
6,530 |
|
|
|
5,937 |
|
OPERATING EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries, wages, and benefits
|
|
|
2,702 |
|
|
|
2,443 |
|
|
|
2,224 |
|
|
Fuel and oil
|
|
|
1,342 |
|
|
|
1,000 |
|
|
|
830 |
|
|
Maintenance materials and repairs
|
|
|
430 |
|
|
|
457 |
|
|
|
430 |
|
|
Aircraft rentals
|
|
|
163 |
|
|
|
179 |
|
|
|
183 |
|
|
Landing fees and other rentals
|
|
|
454 |
|
|
|
408 |
|
|
|
372 |
|
|
Depreciation and amortization
|
|
|
469 |
|
|
|
431 |
|
|
|
384 |
|
|
Other operating expenses
|
|
|
1,204 |
|
|
|
1,058 |
|
|
|
1,031 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
6,764 |
|
|
|
5,976 |
|
|
|
5,454 |
|
|
|
|
|
|
|
|
|
|
|
OPERATING INCOME
|
|
|
820 |
|
|
|
554 |
|
|
|
483 |
|
OTHER EXPENSES (INCOME):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
122 |
|
|
|
88 |
|
|
|
91 |
|
|
Capitalized interest
|
|
|
(39 |
) |
|
|
(39 |
) |
|
|
(33 |
) |
|
Interest income
|
|
|
(47 |
) |
|
|
(21 |
) |
|
|
(24 |
) |
|
Other (gains) losses, net
|
|
|
(90 |
) |
|
|
37 |
|
|
|
(259 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses (income)
|
|
|
(54 |
) |
|
|
65 |
|
|
|
(225 |
) |
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE INCOME TAXES
|
|
|
874 |
|
|
|
489 |
|
|
|
708 |
|
PROVISION FOR INCOME TAXES
|
|
|
326 |
|
|
|
176 |
|
|
|
266 |
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$ |
548 |
|
|
$ |
313 |
|
|
$ |
442 |
|
|
|
|
|
|
|
|
|
|
|
NET INCOME PER SHARE, BASIC
|
|
$ |
.70 |
|
|
$ |
.40 |
|
|
$ |
.56 |
|
|
|
|
|
|
|
|
|
|
|
NET INCOME PER SHARE, DILUTED
|
|
$ |
.67 |
|
|
$ |
.38 |
|
|
$ |
.54 |
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
29
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, 2005, 2004, and 2003 | |
|
|
| |
|
|
|
|
Accumulated | |
|
|
|
|
|
|
Capital in | |
|
|
|
Other | |
|
|
|
|
Common | |
|
Excess of | |
|
Retained | |
|
Comprehensive | |
|
Treasury | |
|
|
|
|
Stock | |
|
Par Value | |
|
Earnings | |
|
Income (Loss) | |
|
Stock | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In millions, except per share amounts) | |
Balance at December 31, 2002
|
|
$ |
777 |
|
|
$ |
136 |
|
|
$ |
3,455 |
|
|
$ |
54 |
|
|
$ |
|
|
|
$ |
4,422 |
|
|
Issuance of common stock pursuant to Employee stock plans
|
|
|
12 |
|
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
93 |
|
|
Tax benefit of options exercised
|
|
|
|
|
|
|
41 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41 |
|
|
Cash dividends, $.018 per share
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
Comprehensive income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
442 |
|
|
|
|
|
|
|
|
|
|
|
442 |
|
|
|
Unrealized gain on derivative instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
66 |
|
|
|
|
|
|
|
66 |
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003
|
|
$ |
789 |
|
|
$ |
258 |
|
|
$ |
3,883 |
|
|
$ |
122 |
|
|
$ |
|
|
|
$ |
5,052 |
|
|
Purchase of shares of treasury stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(246 |
) |
|
|
(246 |
) |
|
Issuance of common and treasury stock pursuant to Employee stock
plans
|
|
|
1 |
|
|
|
6 |
|
|
|
(93 |
) |
|
|
|
|
|
|
175 |
|
|
|
89 |
|
|
Tax benefit of options exercised
|
|
|
|
|
|
|
35 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
35 |
|
|
Cash dividends, $.018 per share
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
Comprehensive income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
313 |
|
|
|
|
|
|
|
|
|
|
|
313 |
|
|
|
Unrealized gain on derivative instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
293 |
|
|
|
|
|
|
|
293 |
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
608 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
$ |
790 |
|
|
$ |
299 |
|
|
$ |
4,089 |
|
|
$ |
417 |
|
|
$ |
(71 |
) |
|
$ |
5,524 |
|
|
Purchase of shares of treasury stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55 |
) |
|
|
(55 |
) |
|
Issuance of common and treasury stock pursuant to Employee
stock plans
|
|
|
12 |
|
|
|
60 |
|
|
|
(66 |
) |
|
|
|
|
|
|
126 |
|
|
|
132 |
|
|
Tax benefit of options exercised
|
|
|
|
|
|
|
65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65 |
|
|
Cash dividends, $.018 per share
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
(14 |
) |
|
Comprehensive income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
548 |
|
|
|
|
|
|
|
|
|
|
|
548 |
|
|
|
Unrealized gain on derivative instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
474 |
|
|
|
|
|
|
|
474 |
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,023 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
$ |
802 |
|
|
$ |
424 |
|
|
$ |
4,557 |
|
|
$ |
892 |
|
|
$ |
|
|
|
$ |
6,675 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
30
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions) | |
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
548 |
|
|
$ |
313 |
|
|
$ |
442 |
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
469 |
|
|
|
431 |
|
|
|
384 |
|
|
|
Deferred income taxes
|
|
|
257 |
|
|
|
184 |
|
|
|
183 |
|
|
|
Amortization of deferred gains on sale and leaseback of aircraft
|
|
|
(16 |
) |
|
|
(16 |
) |
|
|
(16 |
) |
|
|
Amortization of scheduled airframe inspections and repairs
|
|
|
49 |
|
|
|
52 |
|
|
|
49 |
|
|
|
Income tax benefit from Employee stock option exercises
|
|
|
65 |
|
|
|
35 |
|
|
|
41 |
|
|
|
Changes in certain assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts and other receivables
|
|
|
(9 |
) |
|
|
(75 |
) |
|
|
43 |
|
|
|
|
Other current assets
|
|
|
(59 |
) |
|
|
(44 |
) |
|
|
(19 |
) |
|
|
|
Accounts payable and accrued liabilities
|
|
|
855 |
|
|
|
231 |
|
|
|
129 |
|
|
|
|
Air traffic liability
|
|
|
120 |
|
|
|
68 |
|
|
|
50 |
|
|
|
Other
|
|
|
(50 |
) |
|
|
(22 |
) |
|
|
50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
2,229 |
|
|
|
1,157 |
|
|
|
1,336 |
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment, net
|
|
|
(1,210 |
) |
|
|
(1,775 |
) |
|
|
(1,238 |
) |
|
Change in short-term investments, net
|
|
|
6 |
|
|
|
124 |
|
|
|
(381 |
) |
|
Payment for assets of ATA Airlines, Inc.
|
|
|
(6 |
) |
|
|
(34 |
) |
|
|
|
|
|
Debtor in possession loan to ATA Airlines, Inc.
|
|
|
|
|
|
|
(40 |
) |
|
|
|
|
|
Other
|
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(1,210 |
) |
|
|
(1,726 |
) |
|
|
(1,619 |
) |
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of long-term debt
|
|
|
300 |
|
|
|
520 |
|
|
|
|
|
|
Proceeds from Employee stock plans
|
|
|
132 |
|
|
|
88 |
|
|
|
93 |
|
|
Payments of long-term debt and capital lease obligations
|
|
|
(149 |
) |
|
|
(207 |
) |
|
|
(130 |
) |
|
Payments of cash dividends
|
|
|
(14 |
) |
|
|
(14 |
) |
|
|
(14 |
) |
|
Repurchase of common stock
|
|
|
(55 |
) |
|
|
(246 |
) |
|
|
|
|
|
Other, net
|
|
|
(1 |
) |
|
|
(8 |
) |
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
213 |
|
|
|
133 |
|
|
|
(48 |
) |
|
|
|
|
|
|
|
|
|
|
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
1,232 |
|
|
|
(436 |
) |
|
|
(331 |
) |
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
|
|
|
1,048 |
|
|
|
1,484 |
|
|
|
1,815 |
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS AT END OF PERIOD
|
|
$ |
2,280 |
|
|
$ |
1,048 |
|
|
$ |
1,484 |
|
|
|
|
|
|
|
|
|
|
|
CASH PAYMENTS FOR:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest, net of amount capitalized
|
|
$ |
71 |
|
|
$ |
38 |
|
|
$ |
62 |
|
|
Income taxes
|
|
$ |
8 |
|
|
$ |
2 |
|
|
$ |
51 |
|
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES:
In December 2005, the Company obtained the rights to four of ATA
Airlines, Inc. (ATA) leased Chicago Midway Airport gates in
exchange for a $20 million reduction of the Debtor in
possession loan to ATA:
|
|
|
|
|
Rights to Chicago Midway Gates acquired
|
|
$ |
20 |
|
Debtor in possession loan to ATA reduction
|
|
$ |
(20 |
) |
See accompanying notes.
31
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
|
|
1. |
Summary of Significant Accounting Policies |
Basis Of Presentation. Southwest Airlines Co. (Southwest)
is a major domestic airline that provides
point-to-point,
low-fare service. The Consolidated Financial Statements include
the accounts of Southwest and its wholly owned subsidiaries (the
Company). All significant intercompany balances and transactions
have been eliminated. The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States (GAAP) requires management to make estimates
and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results
could differ from these estimates.
Certain prior period amounts have been reclassified to conform
to the current presentation. In the 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 Consolidated Statement of Cash Flows for 2004 and 2003,
changes in the amounts of Short-term investments are
classified as cash flows from investing activities. In the
Consolidated Statement of Income for 2004 and 2003, amounts
previously classified as Agency commissions are now
classified in Other operating expenses.
Cash And Cash Equivalents. Cash in excess of that
necessary for operating requirements is invested in short-term,
highly liquid, income-producing investments. Investments with
maturities of three months or less are classified as cash and
cash equivalents, which primarily consist of certificates of
deposit, money market funds, and investment grade commercial
paper issued by major corporations and financial institutions.
Cash and cash equivalents are stated at cost, which approximates
market value.
Short-Term Investments. Short-term investments consist of
auction rate securities with auction reset periods of less than
12 months. These investments are classified as
available-for-sale securities and are stated at fair value.
Unrealized gains and losses, net of tax, are recognized in
Accumulated other comprehensive income (loss) in the
accompanying Consolidated Balance Sheet. Realized gains and
losses are reflected in Interest income in the
accompanying Consolidated Income Statement.
Inventories. Inventories of flight equipment expendable
parts, materials, and supplies are carried at average cost.
These items are generally charged to expense when issued for use.
Property And Equipment. Depreciation is provided by the
straight-line method to estimated residual values over periods
generally ranging from 23 to 25 years for flight equipment
and 5 to 30 years for ground property and equipment once
the asset is placed in service. Residual values estimated for
aircraft are 15 percent and for ground property and
equipment range from zero to 10 percent. Property under
capital leases and related obligations are recorded at an amount
equal to the present value of future minimum lease payments
computed on the basis of the Companys incremental
borrowing rate or, when known, the interest rate implicit in the
lease. Amortization of property under capital leases is on a
straight-line basis over the lease term and is included in
depreciation expense.
In estimating the lives and expected residual values of its
aircraft, the Company primarily has relied upon actual
experience with the same or similar aircraft types and
recommendations from Boeing, the manufacturer of the
Companys aircraft. Subsequent revisions to these
estimates, which can be significant, could be caused by changes
to the Companys maintenance program, modifications or
improvements to the aircraft, changes in utilization of the
aircraft (actual flight hours or cycles during a given period of
time), governmental regulations on aging aircraft, changing
market prices of new and used aircraft of the same or similar
types, etc. The Company evaluates its estimates and assumptions
each reporting period and, when warranted, adjusts these
estimates and assumptions. Generally, these adjustments are
accounted for on a prospective basis through depreciation and
amortization expense, as required by GAAP.
When appropriate, the Company evaluates its long-lived assets
used in operations for impairment. Impairment losses would be
recorded when events and circumstances indicate that an asset
might be impaired and the undiscounted cash flows to be
generated by that asset are less than the carrying amounts of
the asset. Factors that would indicate potential impairment
include, but are not limited to, significant decreases in the
market value of the long-lived asset(s), a significant change in
the long-lived assets physical condition,
32
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
operating or cash flow losses associated with the use of the
long-lived asset, etc. While the airline industry as a whole has
experienced many of these indicators, Southwest has continued to
operate all of its aircraft and continues to experience positive
cash flow.
Aircraft And Engine Maintenance. The cost of scheduled
engine inspections and repairs and routine maintenance costs for
all aircraft and engines are charged to maintenance expense as
incurred. For the Companys 737-300 and 737-500 aircraft
fleet types, scheduled airframe inspections and repairs, known
as D checks, are generally performed every ten years. Costs
related to D checks are capitalized and amortized over the
estimated period benefited, presently the least of ten years,
the time until the next D check, or the remaining life of the
aircraft. Modifications that significantly enhance the operating
performance or extend the useful lives of aircraft or engines
are capitalized and amortized over the remaining life of the
asset.
As of December 31, 2005, the majority of the Companys
fleet was made up of its newest aircraft type, the 737-700. This
aircraft type is maintained under a next-generation
maintenance program, called MSG-3, in which tasks are bundled
based on data gathered relative to fleet performance. Scheduled
maintenance is still performed at recommended intervals;
however, this program does not contain a D check. The costs of
scheduled airframe inspections and repairs under this
maintenance program are expensed as incurred, as those expenses
more readily approximate the underlying scheduled maintenance
tasks. See Note 2 regarding a 2006 change in the
Companys maintenance program for 737-300 and 737-500
aircraft.
Intangible Assets. Intangible assets primarily consist of
leasehold rights to airport owned gates acquired by the Company
during 2004 and 2005. These assets are amortized on a
straight-line basis over the expected useful life of the lease,
approximately 20 years. The accumulated amortization
related to the Companys intangible assets at
December 31, 2004, and 2005, was not material. The Company
periodically assesses its intangible assets for impairment in
accordance with SFAS 142, Goodwill and Other Intangible
Assets;however, no impairments have been noted.
Revenue Recognition. Tickets sold are initially deferred
as Air traffic liability. Passenger revenue is
recognized when transportation is provided. Air traffic
liability primarily represents tickets sold for future
travel dates and estimated refunds and exchanges of tickets sold
for past travel dates. The majority of the Companys
tickets sold are nonrefundable. Tickets that are sold but not
flown on the travel date can be reused for another flight, up to
a year from the date of sale, or refunded (if the ticket is
refundable). A small percentage of tickets (or partial tickets)
expire unused. The Company estimates the amount of future
refunds and exchanges, net of forfeitures, for all unused
tickets once the flight date has passed. These estimates are
based on historical experience over many years. The Company and
members of the airline industry have consistently applied this
accounting method to estimate revenue from forfeited tickets at
the date travel is provided. Estimated future refunds and
exchanges included in the air traffic liability account are
constantly evaluated based on subsequent refund and exchange
activity to validate the accuracy of the Companys revenue
recognition method with respect to forfeited tickets.
Events and circumstances outside of historical fare sale
activity or historical Customer travel patterns can result in
actual refunds, exchanges or forfeited tickets differing
significantly from estimates; however, these differences have
historically not been material. Additional factors that may
affect estimated refunds, exchanges, and forfeitures include,
but may not be limited to, the Companys refund and
exchange policy, the mix of refundable and nonrefundable fares,
and fare sale activity. The Companys estimation techniques
have been consistently applied from year to year; however, as
with any estimates, actual refund and exchange activity may vary
from estimated amounts.
Frequent Flyer Program. The Company accrues the estimated
incremental cost of providing free travel for awards earned
under its Rapid Rewards frequent flyer program. The Company also
sells frequent flyer credits and related services to companies
participating in its Rapid Rewards frequent flyer program. Funds
received from the sale of flight segment credits are accounted
for under the residual value method. The portion of those funds
associated with future travel are deferred and recognized as
Passenger revenue when the ultimate free travel
awards are flown or the credits expire unused. The portion of
the funds not associated with future travel are recognized in
Other revenue in the period earned.
33
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Advertising. The Company expenses the costs of
advertising as incurred. Advertising expense for the years ended
December 31, 2005, 2004, and 2003 was $173 million,
$158 million, and $155 million, respectively.
Stock-based Employee Compensation. The Company has
stock-based compensation plans covering the majority of its
Employee groups, including a plan covering the Companys
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. Compensation expense for
other stock options is not material.
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions, except | |
|
|
per share amounts) | |
Net income, as reported
|
|
$ |
548 |
|
|
$ |
313 |
|
|
$ |
442 |
|
Add: Stock-based Employee compensation expense included in
reported income, net of related tax effects
|
|
|
|
|
|
|
|
|
|
|
|
|
Deduct: Stock-based Employee compensation expense determined
under fair value based methods for all awards, net of related
tax effects
|
|
|
(43 |
) |
|
|
(74 |
) |
|
|
(57 |
) |
|
|
|
|
|
|
|
|
|
|
Pro forma net income
|
|
$ |
505 |
|
|
$ |
239 |
|
|
$ |
385 |
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic, as reported
|
|
$ |
.70 |
|
|
$ |
.40 |
|
|
$ |
.56 |
|
|
Basic, pro forma
|
|
$ |
.63 |
|
|
$ |
.31 |
|
|
$ |
.49 |
|
|
Diluted, as reported
|
|
$ |
.67 |
|
|
$ |
.38 |
|
|
$ |
.54 |
|
|
Diluted, pro forma
|
|
$ |
.62 |
|
|
$ |
.30 |
|
|
$ |
.48 |
|
As required, the pro forma disclosures above include options
granted since January 1, 1995. For purposes of pro forma
disclosures, the estimated fair value of stock-based
compensation plans and other options is amortized to expense
primarily over the vesting period. For options with graded
vesting, expense is recognized on a straight-line basis over the
vesting period. See Note 13 for further discussion of the
Companys stock-based Employee compensation and Note 2
for further information regarding the Companys
January 1, 2006, adoption of SFAS 123R.
Financial Derivative Instruments. The Company accounts
for financial derivative instruments utilizing Statement of
Financial Accounting Standards No. 133 (SFAS 133),
Accounting for Derivative Instruments and Hedging
Activities, as amended. The Company utilizes various
derivative instruments, including crude oil, unleaded gasoline,
and heating oil-based derivatives, to hedge a portion of its
exposure to jet fuel price increases. These instruments
primarily consist of purchased call options, collar structures,
and fixed-price swap agreements, and are accounted for as
cash-flow hedges, as defined by SFAS 133. The Company has
also entered into interest rate swap agreements to convert a
portion of its fixed-rate debt to floating rates. These interest
rate hedges are accounted for as fair value hedges, as defined
by SFAS 133.
Since the majority of the Companys financial derivative
instruments are not traded on a market exchange, the Company
estimates their fair values. Depending on the type of
instrument, the values are determined by the use of present
value methods or standard option value models with assumptions
about commodity prices based on those observed in underlying
34
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
markets. Also, since there is not a reliable forward market for
jet fuel, the Company must estimate the future prices of jet
fuel in order to measure the effectiveness of the hedging
instruments in offsetting changes to those prices, as required
by SFAS 133. Forward jet fuel prices are estimated through
the observation of similar commodity futures prices (such as
crude oil, heating oil, and unleaded gasoline) and adjusted
based on historical variations to those like commodities. See
Note 10 for further information on SFAS 133 and
financial derivative instruments.
Income Taxes. The Company accounts for deferred income
taxes utilizing Statement of Financial Accounting Standards
No. 109 (SFAS 109), Accounting for Income
Taxes, as amended. SFAS 109 requires an asset and
liability method, whereby deferred tax assets and liabilities
are recognized based on the tax effects of temporary differences
between the financial statements and the tax bases of assets and
liabilities, as measured by current enacted tax rates. When
appropriate, in accordance with SFAS 109, the Company
evaluates the need for a valuation allowance to reduce deferred
tax assets.
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.
Pro forma disclosure is no longer an alternative under the new
standard. Although early adoption is allowed, the Company will
adopt SFAS 123R as of the required effective date for
calendar year companies, which is January 1, 2006.
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 permit 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 more complex binomial, or lattice model. Based
upon research done by the Company on the alternative models
available to value option grants, and in conjunction with the
type and number of stock options expected to be issued in the
future, the Company has determined that it will continue to use
the Black-Scholes model for option valuation as of the current
time.
SFAS 123R includes several modifications to the way that
income taxes are recorded in the financial statements. The
expense for certain types of option grants is only deductible
for tax purposes at the time that the taxable event takes place,
which could cause variability in the Companys effective
tax rates recorded throughout the year. SFAS 123R does not
allow companies to predict when these taxable events
will take place. Furthermore, it 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. However, the amount of operating cash
flows recognized in prior periods for such excess tax
deductions, as shown in the Companys Consolidated
Statement of Cash Flows, were $65 million,
$35 million, and $41 million, respectively, for 2005,
2004, and 2003.
The Company is still evaluating which method of adoption it will
use. Subject to a complete review of the requirements of
SFAS 123R, based on stock options granted to Employees
through December 31, 2005, the Company expects that the
adoption of SFAS 123R on
35
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
January 1, 2006, will reduce first quarter net earnings by
approximately $10 million ($.01 per share, diluted).
See Note 13 for further information on the Companys
stock-based compensation plans.
|
|
|
Aircraft and Engine Maintenance |
In first quarter 2006, the Company will begin transitioning the
maintenance program for performing planned airframe maintenance
on its fleet of 737-300 and
737-500 aircraft. The
previous program utilized was a periodic hard time
program, which required specific activities, including
replacement of specified components, and D checks that were
capitalized and amortized over the estimated period benefited.
This estimated period was the least of ten years, the next D
check, or the remaining life of the aircraft (the
MSG-2 program.) The
Companys new program for these aircraft is a
top-down program, which requires more frequent
inspections in many cases, with repairs and replacements
performed when defects are detected rather than at stipulated
intervals without regard to the condition of the components (the
MSG-3
program). The
MSG-3 program does not
include D checks.
Due to the change in the nature of the maintenance activities
performed, the Company will change its method of accounting for
scheduled airframe and inspection repairs for
737-300 and
737-500 aircraft from
the deferral method to the direct expense method, effective
January 1, 2006. Under the direct expense method, the cost
of scheduled airframe and inspection repairs is expensed as
incurred. The Company believes the direct expense method is
preferable to its former method because it more closely aligns
with the nature of activities performed, it eliminates any
judgment in determining which costs should be deferred versus
expensed, it matches the method currently utilized on the
Companys 737-700 fleet, and it is the predominant method
utilized for airframe maintenance in the airline industry,
particularly among the largest airlines. The remaining net
unamortized balance of previously capitalized D checks in
the Companys Consolidated Balance Sheet was a net asset of
$216 million at December 31, 2005.
The Company will record the change in accounting in accordance
with Statement of Financial Accounting Standards No. 154,
Accounting Changes and Error Corrections (SFAS 154),
which is also effective for calendar year companies on
January 1, 2006. SFAS 154 requires that all elective
accounting changes be made on a retrospective basis, resulting
in the restatement of all prior period financial statements
presented. As such, concurrent with the filing of the
Companys first quarter 2006
Form 10-Q, the
Company will restate prior period results as a result of this
change.
|
|
3. |
Acquisition of Certain Assets |
In fourth quarter 2004, Southwest was selected as the winning
bidder at a bankruptcy-court approved auction for certain ATA
Airlines, Inc. (ATA) assets. As part of the transaction, which
was approved in December 2004, Southwest agreed to pay
$40 million for certain ATA assets, consisting of the
leasehold rights to six of ATAs leased Chicago Midway
Airport gates and the rights to a leased aircraft maintenance
hangar at Chicago Midway Airport. In addition, Southwest
provided ATA with $40 million in
debtor-in-possession
financing while ATA remains in bankruptcy, and also guaranteed
the repayment of an ATA construction loan to the City of Chicago
for $7 million. As part of this original transaction,
Southwest also committed, upon ATAs emergence from
bankruptcy, to convert the
debtor-in-possession
financing to a term loan, payable over five years, and to invest
$30 million in cash into ATA convertible preferred stock.
During fourth quarter 2005, ATA, although still in bankruptcy,
entered into an agreement in which an investor, MatlinPatterson
Global Opportunities Partners II
(MatlinPatterson) would provide financing to enable
ATA to emerge from bankruptcy in early 2006. As part of this
transaction, Southwest entered into an agreement with ATA to
acquire the leasehold rights to four additional leased gates at
Chicago Midway Airport in exchange for a $20 million
reduction in the Companys
debtor-in-possession
loan. This resulted in a $20 million increase to intangible
assets, classified in Other assets, and a corresponding
$20 million decrease in Accounts and other receivables on
the Consolidated Balance Sheet. Since this transaction was
non-cash, it is not reflected in the Consolidated Statement of
Cash Flows. Upon ATAs emergence from bankruptcy, it will
repay the remaining $20 million balance of the
debtor-in-possession
financing, and will provide a letter of credit to support
Southwests obligation under the construction loan to the
City of Chicago. In addition, as part of the 2005 agreement,
Southwest has also been relieved of its commitment to purchase
ATA converti-
36
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
ble preferred stock. The 2005 agreement is subject to certain
conditions including ATAs successful emergence from
bankruptcy on or before February 28, 2006.
Southwest and ATA agreed on a code share arrangement, which was
approved by the Department of Transportation in January 2005.
Under the agreement, which has since been expanded, each carrier
can exchange passengers on certain designated flights. Sales of
the code share flights began January 16, 2005, with travel
dates beginning February 4, 2005. As part of the December
2005 agreement with ATA, Southwest has enhanced its codeshare
arrangement with ATA, subject to certain conditions, including
ATAs confirmation of a Plan of Reorganization, which must
be fulfilled by February 28, 2006.
The Companys contractual purchase commitments primarily
consist of scheduled aircraft acquisitions from Boeing. As of
December 31, 2005, the Company had contractual purchase
commitments with Boeing for 33
737-700 aircraft
deliveries in 2006, 28 scheduled for delivery in 2007, and six
in 2008. During January 2006, the Company exercised an
additional option for 2007 to bring our commitment to 29
aircraft for that year. In addition, the Company has options and
purchase rights for an additional 249
737-700s that it may
acquire during 2007-2012, following the January 2006 option
exercise. 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. As of
December 31, 2005, aggregate funding needed for firm
commitments is approximately $1.3 billion, subject to
adjustments for inflation, due as follows: $740 million in
2006, $458 million in 2007, and $80 million in 2008.
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions) | |
Retirement plans (Note 14)
|
|
$ |
142 |
|
|
$ |
89 |
|
Aircraft rentals
|
|
|
116 |
|
|
|
127 |
|
Vacation pay
|
|
|
135 |
|
|
|
120 |
|
Advances and deposits
|
|
|
955 |
|
|
|
334 |
|
Deferred income taxes
|
|
|
489 |
|
|
|
218 |
|
Other
|
|
|
237 |
|
|
|
159 |
|
|
|
|
|
|
|
|
|
Accrued liabilities
|
|
$ |
2,074 |
|
|
$ |
1,047 |
|
|
|
|
|
|
|
|
|
|
6. |
Revolving Credit Facility |
The Company has a revolving credit facility under which it can
borrow up to $600 million from a group of banks. The
facility expires in August 2010 and is unsecured. At the
Companys option, interest on the facility can be
calculated on one of several different bases. For most
borrowings, Southwest would anticipate choosing a floating rate
based upon LIBOR. If fully drawn, the spread over LIBOR would be
62.5 basis points given Southwests credit rating at
December 31, 2005. The facility also contains a financial
covenant requiring a minimum coverage ratio of adjusted pretax
income to fixed obligations, as defined. As of December 31,
2005, the Company is in compliance with this covenant, and there
are no outstanding amounts borrowed under this facility.
37
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions) | |
8% Notes due 2005
|
|
$ |
|
|
|
$ |
100 |
|
Zero coupon Notes due 2006
|
|
|
58 |
|
|
|
58 |
|
Pass Through Certificates
|
|
|
523 |
|
|
|
544 |
|
77/8% Notes
due 2007
|
|
|
100 |
|
|
|
100 |
|
French Credit Agreements due 2012
|
|
|
41 |
|
|
|
44 |
|
61/2% Notes
due 2012
|
|
|
370 |
|
|
|
377 |
|
51/4% Notes
due 2014
|
|
|
340 |
|
|
|
348 |
|
51/8% Notes
due 2017
|
|
|
300 |
|
|
|
|
|
French Credit Agreements due 2017
|
|
|
106 |
|
|
|
111 |
|
73/8% Debentures
due 2027
|
|
|
100 |
|
|
|
100 |
|
Capital leases (Note 8)
|
|
|
74 |
|
|
|
80 |
|
|
|
|
|
|
|
|
|
|
|
2,012 |
|
|
|
1,862 |
|
Less current maturities
|
|
|
601 |
|
|
|
146 |
|
Less debt discount and issue costs
|
|
|
17 |
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
$ |
1,394 |
|
|
$ |
1,700 |
|
|
|
|
|
|
|
|
In first quarter 2005, the Company redeemed its
$100 million senior unsecured 8% Notes on their
maturity date of March 1, 2005.
During February 2005, the Company issued $300 million
senior unsecured 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.
In fourth quarter 2004, the Company entered into four identical
13-year floating-rate
financing arrangements, whereby it borrowed a total of
$112 million from French banking partnerships. Although the
interest on the borrowings are at floating rates, the Company
estimates that, considering the full effect of the net
present value benefits included in the transactions, the
effective economic yield over the
13-year term of the
loans will be approximately LIBOR minus 45 basis points.
Principal and interest are payable semi-annually on June 30
and December 31 for each of the loans, and the Company may
terminate the arrangements in any year on either of those dates,
with certain conditions. The Company pledged four aircraft as
collateral for the transactions.
In September 2004, the Company issued $350 million senior
unsecured Notes due 2014. The notes bear interest at
5.25 percent, payable semi-annually in arrears, on
April 1 and October 1. Concurrently, the Company entered
into an interest-rate swap agreement to convert this fixed-rate
debt to a floating rate. See Note 10 for more information
on the interest-rate swap agreement. Southwest used the net
proceeds from the issuance of the notes, approximately
$346 million, for general corporate purposes.
In February 2004 and April 2004, the Company issued two separate
$29 million two-year notes, each secured by one new
737-700 aircraft. Both
of the notes are non-interest bearing and accrete to face value
at maturity at annual rates of 2.9 percent and
3.4 percent, respectively. The proceeds of these borrowings
were used to fund the individual aircraft purchases.
On March 1, 2002, the Company issued $385 million
senior unsecured Notes due March 1, 2012. The notes bear
interest at 6.5 percent, payable semi-annually on
March 1 and September 1. Southwest used the net
proceeds from the issuance of the notes, approximately
$380 million, for general corporate purposes. During 2003,
the Company entered into an interest rate swap agreement
relating to these notes. See Note 10 for further
information.
38
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
On October 30, 2001, the Company issued $614 million
Pass Through Certificates consisting of $150 million 5.1%
Class A-1
certificates, $375 million 5.5%
Class A-2
certificates, and $89 million 6.1% Class B
certificates. A separate trust was established for each class of
certificates. The trusts used the proceeds from the sale of
certificates to acquire equipment notes, which were issued by
Southwest on a full recourse basis. Payments on the equipment
notes held in each trust will be passed through to the holders
of certificates of such trust. The equipment notes were issued
for each of 29 Boeing 737 -700 aircraft owned by
Southwest and are secured by a mortgage on such aircraft.
Interest on the equipment notes held for the certificates is
payable semiannually, on May 1 and November 1.
Beginning May 1, 2002, principal payments on the equipment
notes held for the
Class A-1
certificates are due semiannually until the balance of the
certificates mature on May 1, 2006. The entire principal of
the equipment notes for the
Class A-2 and
Class B certificates are scheduled for payment on
November 1, 2006. During 2003, the Company entered into an
interest rate swap agreement relating to the $375 million
5.5% Class A-2
certificates. See Note 10 for further information.
In fourth quarter 1999, the Company entered into two identical
13-year floating rate
financing arrangements, whereby it borrowed a total of
$56 million from French banking partnerships. Although the
interest on the borrowings are at floating rates, the Company
estimates that, considering the full effect of the net
present value benefits included in the transactions, the
effective economic yield over the
13-year term of the
loans will be approximately LIBOR minus 67 basis points.
Principal and interest are payable semi-annually on June 30
and December 31 for each of the loans and the Company may
terminate the arrangements in any year on either of those dates,
with certain conditions. The Company pledged two aircraft as
collateral for the transactions.
On February 28, 1997, the Company issued $100 million
of senior unsecured
73/8% Debentures
due March 1, 2027. Interest is payable semi-annually on
March 1 and September 1. The debentures may be redeemed, at
the option of the Company, in whole at any time or in part from
time to time, at a redemption price equal to the greater of the
principal amount of the debentures plus accrued interest at the
date of redemption or the sum of the present values of the
remaining scheduled payments of principal and interest thereon,
discounted to the date of redemption at the comparable treasury
rate plus 20 basis points, plus accrued interest at the
date of redemption.
During 1992, the Company issued $100 million of senior
unsecured
77/8% Notes
due September 1, 2007. Interest is payable semi-annually on
March 1 and September 1. The notes are not redeemable
prior to maturity.
The net book value of the assets pledged as collateral for the
Companys secured borrowings, primarily aircraft and
engines, was $856 million at December 31, 2005.
As of December 31, 2005, aggregate annual principal
maturities (not including amounts associated with interest rate
swap agreements, and interest on capital leases) for the
five-year period ending December 31, 2010, were
$612 million in 2006, $127 million in 2007,
$28 million in 2008, $29 million in 2009,
$30 million in 2010, and $1.2 billion thereafter.
The Company had nine aircraft classified as capital leases at
December 31, 2005. The amounts applicable to these aircraft
included in property and equipment were:
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions) | |
Flight equipment
|
|
$ |
164 |
|
|
$ |
173 |
|
Less accumulated depreciation
|
|
|
113 |
|
|
|
126 |
|
|
|
|
|
|
|
|
|
|
$ |
51 |
|
|
$ |
47 |
|
|
|
|
|
|
|
|
Total rental expense for operating leases, both aircraft and
other, charged to operations in 2005, 2004, and 2003 was
$409 million, $403 million, and $386 million,
respectively. The majority of the Companys terminal
operations
39
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
space, as well as 84 aircraft, were under operating leases at
December 31, 2005. Future minimum lease payments under
capital leases and noncancelable operating leases with initial
or remaining terms in excess of one year at December 31,
2005, were:
|
|
|
|
|
|
|
|
|
|
|
Capital Leases | |
|
Operating Leases | |
|
|
| |
|
| |
|
|
(In millions) | |
2006
|
|
$ |
16 |
|
|
$ |
332 |
|
2007
|
|
|
16 |
|
|
|
309 |
|
2008
|
|
|
16 |
|
|
|
274 |
|
2009
|
|
|
16 |
|
|
|
235 |
|
2010
|
|
|
15 |
|
|
|
219 |
|
After 2010
|
|
|
12 |
|
|
|
1,164 |
|
|
|
|
|
|
|
|
Total minimum lease payments
|
|
|
91 |
|
|
$ |
2,533 |
|
|
|
|
|
|
|
|
Less amount representing interest
|
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
|
Present value of minimum lease payments
|
|
|
74 |
|
|
|
|
|
Less current portion
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
|
|
Long-term portion
|
|
$ |
63 |
|
|
|
|
|
|
|
|
|
|
|
|
The aircraft leases generally can be renewed at rates based on
fair market value at the end of the lease term for one to five
years. Most aircraft leases have purchase options at or near the
end of the lease term at fair market value, generally limited to
a stated percentage of the lessors defined cost of the
aircraft.
|
|
9. |
Consolidation of Reservations Centers |
In November 2003, the Company announced the consolidation of its
nine Reservations Centers into six, effective February 28,
2004. This decision was made in response to the established
shift by Customers to the internet as a preferred way of booking
travel. The Companys website, www.southwest.com,
now accounts for almost 70 percent of ticket bookings and,
as a consequence, demand for phone contact has dramatically
decreased. During first quarter 2004, the Company closed its
Reservations Centers located in Dallas, Texas, Salt Lake City,
Utah, and Little Rock, Arkansas. The Company provided the 1,900
affected Employees at these locations the opportunity to
relocate to another of the Companys remaining six centers.
Those Employees choosing not to relocate, approximately 55% of
the total affected, were offered support packages, which
included severance pay, flight benefits, medical coverage, and
job-search assistance, depending on length of service with the
Company. The total cost associated with the Reservations Center
consolidation, recognized in first quarter 2004, was
approximately $18 million. Employee severance and benefit
costs were reflected in Salaries, wages, and
benefits, and the majority of other costs in Other
operating expenses in the Consolidated Statement of
Income. The total remaining amount accrued (not yet paid) was
immaterial at December 31, 2005.
|
|
10. |
Derivative and Financial 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 2005, 2004, and 2003
represented approximately 19.8 percent, 16.7 percent,
and 15.2 percent of Southwests operating expenses,
respectively. The Company endeavors to acquire jet fuel at the
lowest possible cost. Because jet fuel is not traded on an
organized futures exchange, liquidity for 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 has utilized financial derivative instruments for
both short-term and long-term time
40
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
frames. In addition to the significant hedging positions the
Company had in place during 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 over
70 percent of its 2006 total anticipated jet fuel
requirements at average crude oil equivalent prices of
approximately $36 per barrel, and has also hedged the
refinery margins on most of those positions. The Company is also
over 60 percent hedged for 2007 at approximately
$39 per barrel, over 35 percent hedged for 2008 at
approximately $38 per barrel, and approximately
30 percent hedged for 2009 at approximately $39 per
barrel.
The Company accounts for its fuel hedge derivative instruments
as cash flow hedges, as defined in Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended
(SFAS 133). 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. See Note 11 for further information on
Accumulated other comprehensive income. 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. Ineffectiveness, as defined, results
when the change in the total fair value of the derivative
instrument does not exactly equal the change in the value of the
Companys expected future cash outlay to purchase jet fuel.
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 Companys 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
Companys results. The significant increase in the amount
of hedge ineffectiveness and unrealized gains on derivative
contracts settling in future periods recorded during the
Companys most recent five fiscal quarters was due to a
number of factors. These factors included: the recent
significant fluctuation 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 Companys 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 2005, the Company recognized approximately
$110 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 $77 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 $9 million was
ineffectiveness associated with hedges designated for future
periods, and $24 million was ineffectiveness and
mark-to-market gains
related to hedges that settled during 2005. During 2004, the
Company recognized approximately $13 million of additional
expense in Other (gains) losses, net, related
41
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
to the ineffectiveness of its hedges. During 2003, the Company
recognized approximately $16 million of additional income
in Other (gains) losses, net, related to the
ineffectiveness of its hedges. During 2005, 2004, and 2003, the
Company recognized approximately $35 million,
$24 million, and $29 million of net expense,
respectively, related to amounts excluded from the
Companys measurements of hedge effectiveness, in
Other (gains) losses, net.
During 2005, 2004, and 2003, the Company recognized gains in
Fuel and oil expense of $890 million,
$455 million, and $171 million, respectively, from
hedging activities. At December 31, 2005 and 2004,
approximately $83 million and $51 million,
respectively, due from third parties from expired derivative
contracts, is included in Accounts and other
receivables in the accompanying Consolidated Balance
Sheet. The fair value of the Companys financial derivative
instruments at December 31, 2005, was a net asset of
approximately $1.7 billion. The current portion of these
financial derivative instruments, $640 million, is
classified as Fuel hedge contracts and the long-term
portion, $1.1 billion, is classified as Other
assets in the 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.
As of December 31, 2005, the Company had approximately
$890 million in unrealized gains, net of tax, in
Accumulated other comprehensive income (loss)
related to fuel hedges. Included in this total are approximately
$327 million in net unrealized gains that are expected to
be realized in earnings during 2006.
During 2003, the Company entered into interest rate swap
agreements relating to its $385 million 6.5% senior
unsecured notes due 2012 and $375 million 5.496%
Class A-2
pass-through certificates due 2006. The floating rate paid under
each agreement is set in arrears. Under the first agreement, the
Company pays the London InterBank Offered Rate (LIBOR) plus
a margin every six months and receives 6.5% every six months on
a notional amount of $385 million until 2012. The average
floating rate paid under this agreement during 2005 is estimated
to be 6.46 percent based on actual and forward rates at
December 31, 2005. Under the second agreement, the Company
pays LIBOR plus a margin every six months and receives 5.496%
every six months on a notional amount of $375 million until
2006. Based on actual and forward rates at December 31,
2005, the average floating rate paid under this agreement during
2005 is estimated to be 6.73 percent.
During 2004, the Company entered into an interest rate swap
agreement relating to its $350 million 5.25% senior
unsecured notes due 2014. Under this agreement, the Company pays
LIBOR plus a margin every six months and receives 5.25% every
six months on a notional amount of $350 million until 2014.
The floating rate is set in advance. The average floating rate
paid under this agreement during 2005 was 3.82 percent.
The primary objective for the Companys use of interest
rate hedges is to reduce the volatility of net interest income
by better matching the repricing of its assets and liabilities.
Concurrently, the Companys interest rate hedges are also
intended to take advantage of market conditions in which
short-term rates are significantly lower than the fixed longer
term rates on the Companys long-term debt. The
Companys 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 Consolidated Balance Sheet, 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 December 31, 2005, was a
liability of approximately $31 million. The long-term
portion of this amount is recorded in Other deferred
liabilities in the Consolidated Balance Sheet and the
current portion is reflected in Accrued liabilities.
In accordance with fair value hedging, the offsetting entry is
an adjustment to decrease the carrying value of long-term debt.
See Note 7.
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,
42
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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
December 31, 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 December 31,
2005, the Company held $950 million in fuel hedge related
cash collateral deposits under these bilateral collateral
provisions. These collateral deposits serve to decrease, but not
totally eliminate, the credit risk associated with the
Companys hedging program. The cash deposits, which can
have a significant impact on the Companys 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.
The carrying amounts and estimated fair values of the
Companys long-term debt and fuel contracts at
December 31, 2005 were as follows:
|
|
|
|
|
|
|
|
|
|
|
Carrying | |
|
Estimated | |
|
|
Value | |
|
Fair Value | |
|
|
| |
|
| |
|
|
(In millions) | |
Zero coupon Notes due 2006
|
|
$ |
58 |
|
|
$ |
58 |
|
Pass Through Certificates
|
|
|
523 |
|
|
|
525 |
|
77/8% Notes
due 2007
|
|
|
100 |
|
|
|
104 |
|
French Credit Agreements due 2012
|
|
|
41 |
|
|
|
41 |
|
61/2% Notes
due 2012
|
|
|
370 |
|
|
|
392 |
|
51/4% Notes
due 2014
|
|
|
340 |
|
|
|
332 |
|
51/8% Notes
due 2017
|
|
|
300 |
|
|
|
282 |
|
French Credit Agreements due 2017
|
|
|
106 |
|
|
|
106 |
|
73/8% Debentures
due 2027
|
|
|
100 |
|
|
|
111 |
|
Fuel Contracts
|
|
|
1,678 |
|
|
|
1,678 |
|
The estimated fair values of the Companys publicly held
long-term debt were based on quoted market prices. The carrying
values of all other financial instruments approximate their fair
value.
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 $1.0 billion,
$608 million, and $510 million for 2005, 2004, and
2003, respectively. The differences between Net
income and Comprehensive income for these
years are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions) | |
Net income
|
|
$ |
548 |
|
|
$ |
313 |
|
|
$ |
442 |
|
|
Unrealized gain (loss) on derivative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
instruments, net of deferred taxes of $300, $185 and $43
|
|
|
474 |
|
|
|
293 |
|
|
|
66 |
|
|
Other, net of deferred taxes of $0, $1 and $1
|
|
|
1 |
|
|
|
2 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive income
|
|
|
475 |
|
|
|
295 |
|
|
|
68 |
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$ |
1,023 |
|
|
$ |
608 |
|
|
$ |
510 |
|
|
|
|
|
|
|
|
|
|
|
43
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
A rollforward of the amounts included in Accumulated other
comprehensive income (loss), net of taxes for 2005, 2004,
and 2003, is shown below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fuel | |
|
|
|
Accumulated Other | |
|
|
Hedge | |
|
|
|
Comprehensive | |
|
|
Derivatives | |
|
Other | |
|
Income (Loss) | |
|
|
| |
|
| |
|
| |
|
|
(In millions) | |
Balance at December 31, 2003
|
|
$ |
123 |
|
|
$ |
(1 |
) |
|
$ |
122 |
|
|
2004 changes in fair value
|
|
|
558 |
|
|
|
2 |
|
|
|
560 |
|
|
Reclassification to earnings
|
|
|
(265 |
) |
|
|
|
|
|
|
(265 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
|
416 |
|
|
|
1 |
|
|
|
417 |
|
|
2005 changes in fair value
|
|
|
999 |
|
|
|
1 |
|
|
|
1,000 |
|
|
Reclassification to earnings
|
|
|
(525 |
) |
|
|
|
|
|
|
(525 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
$ |
890 |
|
|
$ |
2 |
|
|
$ |
892 |
|
|
|
|
|
|
|
|
|
|
|
The Company has one class of common stock. Holders of shares of
common stock are entitled to receive dividends when and if
declared by the Board of Directors and are entitled to one vote
per share on all matters submitted to a vote of the
shareholders. At December 31, 2005, the Company had
236 million shares of common stock reserved for issuance
pursuant to Employee stock benefit plans (of which
36 million shares have not been granted.)
In January 2004, the Companys Board of Directors
authorized the repurchase of up to $300 million of the
Companys common stock, utilizing proceeds from the
exercise of Employee stock options. Repurchases were made in
accordance with applicable securities laws in the open market or
in private transactions from time to time, depending on market
conditions. During first quarter 2005, the Company completed
this program. In total, the Company repurchased approximately
20.9 million of its common shares during the course of the
program.
In January 2006, the Companys Board of Directors
authorized the repurchase of up to $300 million of the
Companys common stock. Repurchases will be made in
accordance with applicable securities laws in the open market or
in private transactions from time to time, depending on market
conditions.
The Company has stock plans covering Employees subject to
collective bargaining agreements (collective bargaining plans)
and stock plans covering Employees not subject to collective
bargaining agreements (other Employee plans). None of the
collective bargaining plans were required to be approved by
shareholders. Options granted to Employees under collective
bargaining plans are granted at or above the fair market value
of the Companys common stock on the date of grant, and
generally have terms ranging from six to twelve years. Vesting
terms differ based on the grant made, and have ranged in length
from immediate vesting to vesting periods in accordance with the
period covered by the respective collective bargaining
agreement. Neither Executive Officers nor members of the
Companys Board of Directors are eligible to participate in
any of these collective bargaining plans. Options granted to
Employees through other Employee plans are granted at the fair
market value of the Companys common stock on the date of
grant, have ten-year terms, and vest and become fully
exercisable over three, five, or ten years of continued
employment, depending upon the grant type. All of the options
included under the heading of Other Employee Plans
have been approved by shareholders, except the plan covering
non-management, non-contract Employees, which had
6.3 million options outstanding to purchase the
Companys common stock as of December 31, 2005.
44
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Aggregated information regarding the Companys fixed stock
option plans is summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collective Bargaining Plans | |
|
Other Employee Plans | |
|
|
| |
|
| |
|
|
|
|
Wtd. Average | |
|
|
|
Wtd. Average | |
|
|
Options | |
|
Exercise Price | |
|
Options | |
|
Exercise Price | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands, except exercise prices) | |
Outstanding December 31, 2002
|
|
|
104,020 |
|
|
$ |
9.51 |
|
|
|
34,152 |
|
|
$ |
11.47 |
|
|
Granted
|
|
|
26,674 |
|
|
|
13.53 |
|
|
|
4,770 |
|
|
|
14.63 |
|
|
Exercised
|
|
|
(7,422 |
) |
|
|
6.78 |
|
|
|
(3,318 |
) |
|
|
7.95 |
|
|
Surrendered
|
|
|
(3,214 |
) |
|
|
12.69 |
|
|
|
(1,052 |
) |
|
|
13.57 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding December 31, 2003
|
|
|
120,058 |
|
|
|
10.47 |
|
|
|
34,552 |
|
|
|
12.21 |
|
|
Granted
|
|
|
14,131 |
|
|
|
14.41 |
|
|
|
4,255 |
|
|
|
15.05 |
|
|
Exercised
|
|
|
(7,222 |
) |
|
|
6.59 |
|
|
|
(3,133 |
) |
|
|
6.79 |
|
|
Surrendered
|
|
|
(6,264 |
) |
|
|
13.62 |
|
|
|
(1,453 |
) |
|
|
14.54 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding December 31, 2004
|
|
|
120,703 |
|
|
|
10.98 |
|
|
|
34,221 |
|
|
|
12.94 |
|
|
Granted
|
|
|
1,697 |
|
|
|
14.91 |
|
|
|
6,662 |
|
|
|
15.60 |
|
|
Exercised
|
|
|
(14,739 |
) |
|
|
6.13 |
|
|
|
(3,800 |
) |
|
|
7.09 |
|
|
Surrendered
|
|
|
(2,417 |
) |
|
|
13.89 |
|
|
|
(1,263 |
) |
|
|
15.60 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding December 31, 2005
|
|
|
105,244 |
|
|
$ |
11.65 |
|
|
|
35,820 |
|
|
$ |
13.96 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable December 31, 2005
|
|
|
76,283 |
|
|
$ |
10.73 |
|
|
|
20,395 |
|
|
$ |
13.78 |
|
Available for grant in future periods
|
|
|
28,798 |
|
|
|
|
|
|
|
5,359 |
|
|
|
|
|
The following table summarizes information about stock options
outstanding under the fixed option plans at December 31,
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding | |
|
Options Exercisable | |
|
|
| |
|
| |
|
|
Options | |
|
Wtd-Average | |
|
|
|
Options | |
|
|
|
|
Outstanding at | |
|
Remaining | |
|
Wtd-Average | |
|
Exercisable at | |
|
Wtd-Average | |
Range of Exercise Prices |
|
12/31/05 (000s) | |
|
Contractual Life | |
|
Exercise Price | |
|
12/31/05 (000s) | |
|
Exercise Price | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
$ 3.95 to $5.87
|
|
|
25,906 |
|
|
|
1.0 yrs |
|
|
$ |
4.12 |
|
|
|
25,272 |
|
|
$ |
4.12 |
|
$ 7.04 to $10.49
|
|
|
6,565 |
|
|
|
3.1 yrs |
|
|
|
8.91 |
|
|
|
4,274 |
|
|
|
8.78 |
|
$10.87 to $16.30
|
|
|
93,277 |
|
|
|
5.8 yrs |
|
|
|
13.74 |
|
|
|
58,479 |
|
|
|
13.60 |
|
$16.32 to $23.93
|
|
|
15,316 |
|
|
|
6.1 yrs |
|
|
|
18.27 |
|
|
|
8,653 |
|
|
|
18.81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ 3.72 to $23.93
|
|
|
141,064 |
|
|
|
4.9 yrs |
|
|
$ |
12.24 |
|
|
|
96,678 |
|
|
$ |
11.37 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Under the amended 1991 Employee Stock Purchase Plan (ESPP),
which has been approved by shareholders, as of December 31,
2005, the Company is authorized to issue up to a remaining
balance of 2.0 million shares of common stock to Employees
of the Company. These shares may be issued at a price equal to
90 percent of the market value at the end of each purchase
period. Common stock purchases are paid for through periodic
payroll deductions. Participants under the plan received
1.5 million shares in 2005, 1.5 million shares in
2004, and 1.4 million shares in 2003, at average prices of
$13.19, $13.47, and $14.04, respectively. The weighted-average
fair value of each purchase right under the ESPP granted in
2005, 2004, and 2003, which is equal to the ten percent discount
from the market value of the common stock at the end of each
purchase period, was $1.47, $1.50, and $1.56, respectively.
45
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Pro forma information regarding net income and net income per
share, as disclosed in Note 1, has been determined as if
the Company had accounted for its Employee stock-based
compensation plans and other stock options under the fair value
method of SFAS 123. The fair value of each option grant is
estimated on the date of grant using a modified Black-Scholes
option pricing model with the following weighted-average
assumptions used for grants under the fixed option plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Wtd-average risk-free interest rate
|
|
|
4.1 |
% |
|
|
3.1 |
% |
|
|
2.6 |
% |
Expected life of option (years)
|
|
|
4.7 |
|
|
|
4.0 |
|
|
|
4.2 |
|
Expected stock volatility
|
|
|
26.2 |
% |
|
|
34.0 |
% |
|
|
34.0 |
% |
Expected dividend yield
|
|
|
0.09 |
% |
|
|
0.11 |
% |
|
|
0.13 |
% |
The Black-Scholes option valuation model was developed for use
in estimating the fair value of short-term traded options that
have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of somewhat
subjective assumptions including expected stock price
volatility. During 2005, the Company modified its method of
determining expected future volatility associated with options
granted. Prior to 2005, the Company primarily had determined
this volatility by observation of historical volatility trends,
subject to adjustment by exclusion of outliers that were not
deemed typical of trends noted during the periods observed. For
2005, the Company relied on observations of both historical
volatility trends as well as implied future volatility
observations as determined by independent third parties.
The fair value of options granted under the fixed option plans
during 2005 ranged from $2.90 to $6.79. The fair value of
options granted under the fixed option plans during 2004 ranged
from $3.45 to $7.83. The fair value of options granted under the
fixed option plans during 2003 ranged from $3.33 to $8.17.
|
|
14. |
Employee Retirement Plans |
|
|
|
Defined Contribution Plans |
The Company has defined contribution plans covering
substantially all Southwest Employees. The Southwest Airlines
Co. Profitsharing Plan is a money purchase defined contribution
plan and Employee stock purchase plan. The Company also sponsors
Employee savings plans under section 401(k) of the Internal
Revenue Code, which include Company matching contributions. The
401(k) plans cover substantially all Employees. Contributions
under all defined contribution plans are primarily based on
Employee compensation and performance of the Company.
Company contributions to all retirement plans expensed in 2005,
2004, and 2003 were $264 million, $200 million, and
$219 million, respectively.
|
|
|
Postretirement Benefit Plans |
The Company provides postretirement benefits to qualified
retirees in the form of medical and dental coverage. Employees
must meet minimum levels of service and age requirements as set
forth by the Company, or as specified in collective bargaining
agreements with specific workgroups. Employees meeting these
requirements, as defined, may use accrued sick time to pay for
medical and dental premiums from the age of retirement until
age 65.
The following table shows the change in the Companys
accumulated postretirement benefit obligation (APBO) for
the years ended December 31, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions) | |
APBO at beginning of period
|
|
$ |
80 |
|
|
$ |
77 |
|
|
Service cost
|
|
|
12 |
|
|
|
10 |
|
|
Interest cost
|
|
|
4 |
|
|
|
5 |
|
|
Benefits paid
|
|
|
(2 |
) |
|
|
(1 |
) |
|
Actuarial (gain) loss
|
|
|
|
|
|
|
(11 |
) |
|
Plan amendments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
APBO at end of period
|
|
$ |
94 |
|
|
$ |
80 |
|
|
|
|
|
|
|
|
During first quarter 2004, the Company closed its Reservations
Centers located in Dallas, Texas, Salt Lake City, Utah, and
Little Rock, Arkansas. In excess of 1,000 Employees at these
locations did not elect to relocate to the Companys
remaining centers and, instead, accepted severance packages
offered by the Company. See Note 9 for further information.
Also during
46
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2004, the Company offered an early-out option to substantially
all Employees, primarily in an effort to alleviate overstaffing
in certain areas of the Company. As a result of the reduction in
headcount associated with these events, the Company remeasured
its benefit obligation, resulting in the 2004 gain.
The assumed healthcare cost trend rates have a significant
effect on the amounts reported for the Companys plan. A
one-percent change in all healthcare cost trend rates used in
measuring the APBO at December 31, 2005, would have the
following effects:
|
|
|
|
|
|
|
|
|
|
|
1% Increase | |
|
1% Decrease | |
|
|
| |
|
| |
|
|
(In millions) | |
Increase (decrease) in total service and interest costs
|
|
$ |
2 |
|
|
$ |
(1 |
) |
Increase (decrease) in the APBO
|
|
$ |
7 |
|
|
$ |
(7 |
) |
The Companys plans are unfunded, and benefits are paid as
they become due. For 2005, both benefits paid and Company
contributions to the plans were each $2 million. For 2004,
both benefits paid and Company contributions to the plans were
each $1 million. Estimated future benefit payments expected
to be paid for each of the next five years are $4 million
in 2006, $6 million in 2007, $8 million in 2008,
$10 million in 2009, $12 million in 2010, and
$84 million for the next five years thereafter.
The following table shows the calculation of the accrued
postretirement benefit cost recognized in Other deferred
liabilities on the Companys Consolidated Balance
Sheet at December 31, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions) | |
Funded status
|
|
$ |
(94 |
) |
|
$ |
(80 |
) |
Unrecognized net actuarial loss
|
|
|
6 |
|
|
|
4 |
|
Unrecognized prior service cost
|
|
|
4 |
|
|
|
8 |
|
|
|
|
|
|
|
|
Cost recognized on Consolidated Balance Sheet
|
|
$ |
(84 |
) |
|
$ |
(68 |
) |
|
|
|
|
|
|
|
The Companys periodic postretirement benefit cost for the
years ended December 31, 2005, 2004, and 2003, included the
following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions) | |
Service cost
|
|
$ |
12 |
|
|
$ |
10 |
|
|
$ |
9 |
|
Interest cost
|
|
|
4 |
|
|
|
5 |
|
|
|
4 |
|
Amortization of prior service cost
|
|
|
2 |
|
|
|
2 |
|
|
|
2 |
|
Recognized actuarial loss
|
|
|
|
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Net periodic postretirement benefit cost
|
|
$ |
18 |
|
|
$ |
18 |
|
|
$ |
16 |
|
|
|
|
|
|
|
|
|
|
|
Unrecognized prior service cost is expensed using a
straight-line amortization of the cost over the average future
service of Employees expected to receive benefits under the
plan. The Company used the following actuarial assumptions to
account for its postretirement benefit plans at December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Wtd-average discount rate
|
|
|
5.25 |
% |
|
|
6.25 |
% |
|
|
6.75 |
% |
Assumed healthcare cost trend rate(1)
|
|
|
9.00 |
% |
|
|
10.00 |
% |
|
|
10.00 |
% |
|
|
(1) |
The assumed healthcare cost trend rate is assumed to decrease to
8.50% for 2006, then decline gradually to 5% by 2013 and remain
level thereafter. |
47
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts
used for income tax purposes. The components of deferred tax
assets and liabilities at December 31, 2005 and 2004, are
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In millions) | |
DEFERRED TAX LIABILITIES:
|
|
|
|
|
|
|
|
|
|
Accelerated depreciation
|
|
$ |
2,251 |
|
|
$ |
2,027 |
|
|
Scheduled airframe maintenance
|
|
|
87 |
|
|
|
83 |
|
|
Fuel hedges
|
|
|
564 |
|
|
|
264 |
|
|
Other
|
|
|
3 |
|
|
|
11 |
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
2,905 |
|
|
|
2,385 |
|
DEFERRED TAX ASSETS:
|
|
|
|
|
|
|
|
|
|
Deferred gains from sale and leaseback of aircraft
|
|
|
76 |
|
|
|
83 |
|
|
Capital and operating leases
|
|
|
70 |
|
|
|
73 |
|
|
Accrued employee benefits
|
|
|
132 |
|
|
|
110 |
|
|
State taxes
|
|
|
57 |
|
|
|
52 |
|
|
Net operating loss carry forward
|
|
|
164 |
|
|
|
186 |
|
|
Other
|
|
|
21 |
|
|
|
53 |
|
|
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
520 |
|
|
|
557 |
|
|
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$ |
2,385 |
|
|
$ |
1,828 |
|
|
|
|
|
|
|
|
The provision for income taxes is composed of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions) | |
CURRENT:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$ |
60 |
|
|
$ |
(8 |
) |
|
$ |
73 |
|
|
State
|
|
|
9 |
|
|
|
|
|
|
|
10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current
|
|
|
69 |
|
|
|
(8 |
) |
|
|
83 |
|
DEFERRED:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
241 |
|
|
|
178 |
|
|
|
170 |
|
|
State
|
|
|
16 |
|
|
|
6 |
|
|
|
13 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred
|
|
|
257 |
|
|
|
184 |
|
|
|
183 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
326 |
|
|
$ |
176 |
|
|
$ |
266 |
|
|
|
|
|
|
|
|
|
|
|
For the year 2004, Southwest Airlines Co. had a tax net
operating loss of $616 million for federal income tax
purposes. The Company carried a portion of this net operating
loss back to prior periods, resulting in a $35 million
refund of federal taxes previously paid. This refund was
received during 2005. The Company applied a portion of this
2004 net operating loss to the 2005 tax year, resulting in
the payment of no federal taxes for this year. The
$69 million current tax provision relates to the tax
benefit of stock options exercised during 2005. The remaining
portion of the Companys federal net operating loss that
can be carried forward to future years is estimated at
$453 million, and expires in 2024.
48
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The effective tax rate on income before income taxes differed
from the federal income tax statutory rate for the following
reasons:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions) | |
Tax at statutory U.S. tax rates
|
|
$ |
306 |
|
|
$ |
171 |
|
|
$ |
247 |
|
Nondeductible items
|
|
|
8 |
|
|
|
7 |
|
|
|
7 |
|
State income taxes, net of federal benefit
|
|
|
16 |
|
|
|
4 |
|
|
|
15 |
|
Other, net
|
|
|
(4 |
) |
|
|
(6 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total income tax provision
|
|
$ |
326 |
|
|
$ |
176 |
|
|
$ |
266 |
|
|
|
|
|
|
|
|
|
|
|
The Internal Revenue Service (IRS) regularly examines the
Companys federal income tax returns and, in the course of
which, may propose adjustments to the Companys federal
income tax liability reported on such returns. It is the
Companys practice to vigorously contest those proposed
adjustments that it deems lacking of merit. The Companys
management does not expect that the outcome of any proposed
adjustments presented to date by the IRS, individually or
collectively, will have a material adverse effect on the
Companys financial condition, results of operations, or
cash flows.
The following table sets forth the computation of net income per
share, basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In millions, except per | |
|
|
share amounts) | |
Net income
|
|
$ |
548 |
|
|
$ |
313 |
|
|
$ |
442 |
|
Weighted-average shares outstanding, basic
|
|
|
789 |
|
|
|
783 |
|
|
|
783 |
|
Dilutive effect of Employee stock options
|
|
|
25 |
|
|
|
32 |
|
|
|
39 |
|
|
|
|
|
|
|
|
|
|
|
Adjusted weighted-average shares outstanding, diluted
|
|
|
814 |
|
|
|
815 |
|
|
|
822 |
|
|
|
|
|
|
|
|
|
|
|
Net income per share, basic
|
|
$ |
.70 |
|
|
$ |
.40 |
|
|
$ |
.56 |
|
|
|
|
|
|
|
|
|
|
|
Net income per share, diluted
|
|
$ |
.67 |
|
|
$ |
.38 |
|
|
$ |
.54 |
|
|
|
|
|
|
|
|
|
|
|
The Company has excluded 12 million, 31 million, and
10 million shares from its calculations of net income per
share, diluted, in 2005, 2004, and 2003, respectively, as they
represent antidilutive stock options for the respective periods
presented.
On April 16, 2003, as a result of the United States war
with Iraq, the Emergency Wartime Supplemental Appropriations Act
(Wartime Act) was signed into law. Among other items, the
legislation included a $2.3 billion government grant for
airlines. Southwest received $271 million as its
proportional share of the grant during second quarter 2003. This
amount is included in Other (gains) losses in the
accompanying Consolidated Income Statement for 2003. Also as
part of the Wartime Act, the Company received approximately
$5 million as a reimbursement for the direct cost of
reinforcing cockpit doors on all of the Companys aircraft.
The Company accounted for this reimbursement as a reduction of
capitalized property and equipment.
49
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
THE BOARD OF DIRECTORS AND SHAREHOLDERS
SOUTHWEST AIRLINES CO.
We have audited the accompanying consolidated balance sheets of
Southwest Airlines Co. as of December 31, 2005 and 2004,
and the related consolidated statements of income,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2005. These
financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Southwest Airlines Co. at
December 31, 2005 and 2004, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2005, in conformity with
United States generally accepted accounting principles.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Southwest Airlines Co.s internal control
over financial reporting as of December 31, 2005, based on
criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated January 30,
2006 expressed an unqualified opinion thereon.
Dallas, Texas
January 30, 2006
50
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
THE BOARD OF DIRECTORS AND SHAREHOLDERS
SOUTHWEST AIRLINES CO.
We have audited managements assessment, included in the
accompanying Managements Report on Internal Control over
Financial Reporting, that Southwest Airlines Co. maintained
effective internal control over financial reporting as of
December 31, 2005, based on criteria established in
Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Southwest Airlines management is
responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express an opinion on managements assessment and an
opinion on the effectiveness of the companys internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Southwest
Airlines Co. maintained effective internal control over
financial reporting as of December 31, 2005, is fairly
stated, in all material respects, based on the COSO criteria.
Also, in our opinion, Southwest Airlines Co. maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2005, based on the COSO
criteria.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Southwest Airlines Co. as of
December 31, 2005 and 2004, and the related consolidated
statements of income, stockholders equity, and cash flows
for each of the three years in the period ended
December 31, 2005 of Southwest Airlines Co. and our report
dated January 30, 2006 expressed an unqualified opinion
thereon.
Dallas, TX
January 30, 2006
51
QUARTERLY FINANCIAL DATA
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended | |
|
|
| |
|
|
March 31 | |
|
June 30 | |
|
Sept. 30 | |
|
Dec. 31 | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In millions except per share amounts) | |
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
$ |
1,663 |
|
|
$ |
1,944 |
|
|
$ |
1,989 |
|
|
$ |
1,987 |
|
|
Operating income
|
|
|
106 |
|
|
|
277 |
|
|
|
273 |
|
|
|
163 |
|
|
Income before income taxes
|
|
|
114 |
|
|
|
256 |
|
|
|
368 |
|
|
|
136 |
|
|
Net income
|
|
|
76 |
|
|
|
159 |
|
|
|
227 |
|
|
|
86 |
|
|
Net income per share, basic
|
|
|
.10 |
|
|
|
.20 |
|
|
|
.29 |
|
|
|
.11 |
|
|
Net income per share, diluted
|
|
|
.09 |
|
|
|
.20 |
|
|
|
.28 |
|
|
|
.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31 | |
|
June 30 | |
|
Sept. 30 | |
|
Dec. 31 | |
|
|
| |
|
| |
|
| |
|
| |
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
$ |
1,484 |
|
|
$ |
1,716 |
|
|
$ |
1,674 |
|
|
$ |
1,655 |
|
|
Operating income
|
|
|
46 |
|
|
|
197 |
|
|
|
191 |
|
|
|
120 |
|
|
Income before income taxes
|
|
|
41 |
|
|
|
179 |
|
|
|
181 |
|
|
|
89 |
|
|
Net income
|
|
|
26 |
|
|
|
113 |
|
|
|
119 |
|
|
|
56 |
|
|
Net income per share, basic
|
|
|
.03 |
|
|
|
.14 |
|
|
|
.15 |
|
|
|
.07 |
|
|
Net income per share, diluted
|
|
|
.03 |
|
|
|
.14 |
|
|
|
.15 |
|
|
|
.07 |
|
|
|
Item 9. |
Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure |
None.
|
|
Item 9A. |
Controls and Procedures |
Disclosure Controls and Procedures. The Company maintains
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 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
Companys disclosure controls and procedures as of the end
of the period covered by this report conducted by the
Companys 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.
The certifications of the Companys Chief Executive Officer
and Chief Financial Officer required under Section 302 of
the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and
31.2 to this report. Additionally, in 2005 the Companys
Chief Executive Officer certified to the New York Stock Exchange
(NYSE) that he was not aware of any violation by the
Company of the NYSEs corporate governance listing
standards.
Managements Report on Internal Control over Financial
Reporting. Management of the Company is responsible for
establishing and maintaining effective internal control over
financial reporting as defined in
Rules 13a-15(f)
under the Securities Exchange Act of 1934. The Companys
internal control over financial reporting is designed to provide
reasonable assurance to the Companys management and board
of directors regarding the preparation and fair presentation of
published financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial
statement preparation and presentation.
Management assessed the effectiveness of the Companys
internal control over financial reporting as of
December 31, 2005. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in
Internal Control Integrated Framework. Based
on this assessment, management believes that, as of
December 31, 2005, the Companys
52
internal control over financial reporting is effective based on
those criteria.
Managements assessment of the effectiveness of internal
control over financial reporting as of December 31, 2005,
has been audited by Ernst & Young, LLP, the independent
registered public accounting firm who also audited the
Companys consolidated financial statements.
Ernst & Youngs attestation report on
managements assessment of the Companys internal
control over financial reporting is included herein.
|
|
Item 9B. |
Other Information |
None.
PART III
|
|
Item 10. |
Directors and Executive Officers of the Registrant |
The information required by Item 401 of
Regulation S-K
regarding directors is included under Election of
Directors in the definitive Proxy Statement for
Southwests Annual Meeting of Shareholders to be held
May 17, 2006, and is incorporated herein by reference. The
information required by Item 401 of
Regulation S-K
regarding executive officers is included under Executive
Officers of the Registrant in Part I following
Item 4 of this Report. The information required by
Item 405 of
Regulation S-K is
included under Section 16(a) Beneficial Ownership
Reporting Compliance in the definitive Proxy Statement for
Southwests Annual Meeting of Shareholders to be held
May 17, 2006, and is incorporated herein by reference.
In the wake of well-publicized corporate scandals, the
Securities and Exchange Commission and the New York Stock
Exchange have issued multiple new regulations, requiring the
implementation of policies and procedures in the corporate
governance area. Since beginning business in 1971, Southwest has
thrived on a culture that encourages an entrepreneurial spirit
in its Employees, and has emphasized personal responsibility,
initiative, and the use of independent, good judgment. The
Golden Rule is one of the core values, and there is a
top-down insistence on the highest ethical standards
at all times.
In complying with new regulations requiring the institution of
policies and procedures, it has been the goal of
Southwests Board of Directors and senior leadership to do
so in a way which does not inhibit or constrain Southwests
unique culture, and which does not unduly impose a bureaucracy
of forms and checklists. Accordingly, formal, written policies
and procedures have been adopted in the simplest possible way,
consistent with legal requirements. The Companys Corporate
Governance Guidelines, its charters for each of its Audit,
Compensation and Nominating and Corporate Governance Committees
and its Code of Ethics covering all Employees are available on
the Companys website, www.southwest.com, and a copy will
be mailed upon request to Investor Relations, Southwest Airlines
Co., P.O. Box 36611, Dallas, TX 75235. The Company intends
to disclose any amendments to or waivers of the Code of Ethics
on behalf of the Companys Chief Executive Officer, Chief
Financial Officer, Controller, and persons performing similar
functions on the Companys website, at www.southwest.com,
under the About SWA caption, promptly following the
date of such amendment or waiver.
|
|
Item 11. |
Executive Compensation |
See Compensation of Executive Officers, incorporated
herein by reference from the definitive Proxy Statement for
Southwests Annual Meeting of Shareholders to be held
May 17, 2006.
|
|
Item 12. |
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters |
See Voting Securities and Principal Shareholders,
incorporated herein by reference from the definitive Proxy
Statement for Southwests Annual Meeting of Shareholders to
be held May 17, 2006.
|
|
Item 13. |
Certain Relationships and Related Transactions |
See Election of Directors incorporated herein by
reference from the definitive Proxy Statement for
Southwests Annual Meeting of Shareholders to be held
May 17, 2006.
|
|
Item 14. |
Principal Accounting Fees and Services |
See Relationship with Independent Auditors
incorporated herein by reference from the definitive Proxy
Statement for Southwests Annual Meeting of Shareholders to
be held May 17, 2006.
53
PART IV
|
|
Item 15. |
Exhibits, Financial Statement Schedules |
(a) 1. Financial Statements:
|
|
|
The financial statements included in Item 8 above are filed
as part of this annual report. |
|
|
|
2. Financial Statement Schedules: |
|
|
|
There are no financial statement schedules filed as part of this
annual report, since the required information is included in the
consolidated financial statements, including the notes thereto,
or the circumstances requiring inclusion of such schedules are
not present. |
|
|
|
|
|
|
3 |
.1 |
|
Restated Articles of Incorporation of Southwest (incorporated by
reference to Exhibit 4.1 to Southwests Registration
Statement on Form S-3 (File No. 33-52155)); Amendment
to Restated Articles of Incorporation of Southwest (incorporated
by reference to Exhibit 3.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended June 30,
1996 (File No. 1-7259)); Amendment to Restated Articles of
Incorporation of Southwest (incorporated by reference to
Exhibit 3.1 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998 (File
No. 1-7259)); Amendment to Restated Articles of
Incorporation of Southwest (incorporated by reference to
Exhibit 4.2 to Southwests Registration Statement on
Form S-8 (File No. 333-82735); Amendment to Restated
Articles of Incorporation of Southwest (incorporated by
reference to Exhibit 3.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended June 30,
2001 (File No. 1-7259)). |
|
3 |
.2 |
|
Bylaws of Southwest, as amended through January 2005
(incorporated by reference to Exhibit 3.2 to
Southwests Current Report on Form 8-K dated
January 25, 2005 (File No. 1-7259)). |
|
4 |
.1 |
|
$600,000,000 Competitive Advance and Revolving Credit Facility
Agreement dated as of April 20, 2004 (incorporated by
reference to Exhibit 10.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended June 30,
2004 (File No. 1-7259)); First Amendment, dated as of
August 9, 2005, to Competitive Advance Revolving Credit
Agreement (incorporated by reference to Exhibit 10.1 to
Southwests Current Report on Form 8-K dated
August 12, 2005 (File No. 1-7259)). |
|
4 |
.2 |
|
Specimen certificate representing Common Stock of Southwest
(incorporated by reference to Exhibit 4.2 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1994 (File No. 1-7259)). |
|
4 |
.3 |
|
Indenture dated as of February 14, 2005, between Southwest
Airlines Co. and The Bank of New York Trust Company, N.A.,
Trustee (incorporated by reference to Exhibit 4.2 to
Southwests Current Report on Form 8-K dated
February 14, 2005 (File No. 1-7259)) |
|
4 |
.4 |
|
Indenture dated as of September 17, 2004 between Southwest
Airlines Co. and Wells Fargo Bank, N.A., Trustee (incorporated
by reference to Exhibit 4.1 to Southwests
Registration Statement on Form S-3 dated October 30,
2002 (File No. 1-7259)). |
|
4 |
.5 |
|
Indenture dated as of June 20, 1991, between Southwest
Airlines Co. and Bank of New York, successor to NationsBank of
Texas, N.A. (formerly NCNB Texas National Bank), Trustee
(incorporated by reference to Exhibit 4.1 to
Southwests Current Report on Form 8-K dated
June 24, 1991 (File No. 1-7259)). |
|
4 |
.6 |
|
Indenture dated as of February 25, 1997, between the
Company and U.S. Trust Company of Texas, N.A. (incorporated
by reference to Exhibit 4.2 to Southwests Annual
Report on Form 10-K for the year ended December 31,
1996 (File No. 1-7259)). |
|
|
|
|
Southwest is not filing any other instruments evidencing any
indebtedness because the total amount of securities authorized
under any single such instrument does not exceed 10% of its
total consolidated assets. Copies of such instruments will be
furnished to the Securities and Exchange Commission upon request. |
54
|
|
|
|
|
|
10 |
.1 |
|
Purchase Agreement No. 1810, dated January 19, 1994,
between The Boeing Company and Southwest (incorporated by
reference to Exhibit 10.4 to Southwests Annual Report
on Form 10-K for the year ended December 31, 1993
(File No. 1-7259)); Supplemental Agreement No. 1.
(incorporated by reference to Exhibit 10.3 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1996 (File No. 1-7259));
Supplemental Agreements No. 2, 3 and 4 (incorporated by
reference to Exhibit 10.2 to Southwests Annual Report
on Form 10-K for the year ended December 31, 1997
(File No. 1-7259)); Supplemental Agreements
Nos. 5, 6, and 7; (incorporated by reference to
Exhibit 10.1 to Southwests Annual Report on
Form 10-K for the year ended December 31, 1998 (File
No. 1-7259)); Supplemental Agreements Nos. 8, 9, and
10 (incorporated by reference to Exhibit 10.1 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1999 (File No. 1-7259)); Supplemental
Agreements Nos. 11, 12, 13 and 14 (incorporated by
reference to Exhibit 10.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2000 (File No. 1-7259)); Supplemental
Agreements Nos. 15, 16, 17, 18 and 19 (incorporated by
reference to Exhibit 10.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2001 (File No. 1-7259)); Supplemental
Agreements Nos. 20, 21, 22, 23 and 24 (incorporated by
reference to Exhibit 10.3 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2002 (File No. 1-7259)); Supplemental
Agreements Nos. 25, 26, 27, 28 and 29 to Purchase
Agreement No. 1810, dated January 19, 1994, between
The Boeing Company and Southwest (incorporated by reference to
Exhibit 10.8 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)); Supplemental Agreements Nos. 30, 31, 32,
and 33 to Purchase Agreement No. 1810, dated
January 19, 1993 between The Boeing Company and Southwest;
(incorporated by reference to Exhibit 10.1 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2003 (File No. 1-7259));
Supplemental Agreements Nos. 34, 35, 36, 37, and 38
(incorporated by reference to Exhibit 10.3 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (File No. 1-7259));
Supplemental Agreements Nos. 39 and 40 (incorporated by
reference to Exhibit 10.6 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2004 (File No. 1-7259)); Supplemental
Agreement No. 41; Supplemental Agreement Nos. 42, 43
and 44 (incorporated by reference to Exhibit 10.1 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005 (File No. 1-7259));
Supplemental Agreement No. 45 (incorporated by reference to
Exhibit 10.1 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2005 (File
No. 1-7259)). |
|
|
|
|
Pursuant to 17 CFR 240.24b-2, confidential information has
been omitted and has been filed separately with the Securities
and Exchange Commission pursuant to a Confidential Treatment
Application filed with the Commission. |
|
|
|
|
The following exhibits filed under paragraph 10 of
Item 601 are the Companys compensation plans and
arrangements. |
|
10 |
.2 |
|
Form of Executive Employment Agreement between Southwest and
certain key employees pursuant to Executive Service Recognition
Plan (incorporated by reference to Exhibit 28 to Southwest
Quarterly Report on Form 10-Q for the quarter ended
June 30, 1987 (File No. 1-7259)). |
|
10 |
.3 |
|
1996 stock option agreements between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10.8 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1996 (File No. 1-7259)). |
|
10 |
.4 |
|
2001 stock option agreements between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001 (File No. 1-7259)). |
|
10 |
.5 |
|
1991 Incentive Stock Option Plan (incorporated by reference to
Exhibit 10.6 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.6 |
|
1991 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 10.7 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.7 |
|
1991 Employee Stock Purchase Plan as amended September 21,
2000 (incorporated by reference to Exhibit 4 to Amendment
No. 1 to Registration Statement on Form S-8 (file
No. 33-40653)). |
55
|
|
|
|
|
|
10 |
.8 |
|
Southwest Airlines Co. Profit Sharing Plan (incorporated by
reference to Exhibit 10.8 to Southwests Annual Report
on Form 10-K for the year ended December 31, 2000
(File No. 1-729)); Amendment No. 1 to Southwest
Airlines Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.11 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2001 (File
No. 1-7259)); Amendment No. 2 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.9 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)); Amendment No. 3 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.1 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)); Amendment No. 4 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.8 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2003 (File
No. 1-7259)); Amendment No. 5 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.2 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2004 (File
No. 1-7259)); Amendment No. 6 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.8 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2004 (File
No. 1-7259)); Amendment No. 7 to Southwest Airlines
Co. Profit Sharing Plan. |
|
10 |
.9 |
|
Southwest Airlines Co. 401(k) Plan (incorporated by reference to
Exhibit 10.12 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2001 (File
No. 1-7259)); Amendment No. 1 to Southwest Airlines Co.
401(k) Plan (incorporated by reference to Exhibit 10.10 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2002 (File No. 1-7259)); Amendment
No. 2 to Southwest Airlines Co. 401(k) Plan (incorporated
by reference to Exhibit 10.10 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2002 (File No. 1-7259)); Amendment No. 3 to Southwest
Airlines Co. 401(k) Plan (incorporated by reference to
Exhibit 10.2 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)); Amendment No. 4 to Southwest Airlines
Co. 401(k) Plan (incorporated by reference to Exhibit 10.9
to Southwests Annual Report on Form 10-K for the year
ended December 31, 2003 (File No. 1-7259)); Amendment
No. 5 to Southwest Airlines Co. 401(k) Plan (incorporated
by reference to Exhibit 10.9 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2004 (File No. 1-7259)); Amendment No. 6 to Southwest
Airlines Co. 401(k) Plan. |
|
10 |
.10 |
|
Southwest Airlines Co. 1995 SWAPA Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 10.14 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1994 (File No. 1-7259)). |
|
10 |
.11 |
|
1996 Incentive Stock Option Plan (incorporated by reference to
Exhibit 10.12 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.12 |
|
1996 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 10.13 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.13 |
|
Employment Contract dated as of July 15, 2004, between
Southwest and Herbert D. Kelleher (incorporated by reference to
Exhibit 10.3 to Southwests Quarterly Report on
Form 10-Q the quarter ended September 30, 2004 (File
No. 1-7259)). |
|
10 |
.14 |
|
Employment Contract dated as of July 15, 2004, between
Southwest and Gary C. Kelly (incorporated by reference to
Exhibit 10.4 to Southwests Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004
(File No. 1-7259)). |
|
10 |
.15 |
|
Employment Contract dated as of July 15, 2004, between
Southwest and Colleen C. Barrett (incorporated by reference to
Exhibit 10.5 to Southwests Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004
(File No. 1-7259)). |
|
10 |
.16 |
|
Severance Contract dated as of July 15, 2004, between
Southwest and James F. Parker (incorporated by reference to
Exhibit 10.2 to Southwests Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004
(File No. 1- 7259)). |
|
10 |
.17 |
|
Southwest Airlines Co. Outside Director Incentive Plan
(incorporated by reference to Exhibit 10.1 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002 (File No. 1-7259)). |
|
10 |
.18 |
|
1998 SAEA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 10.17 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2002 (File No. 1-7259)). |
|
10 |
.19 |
|
1999 SWAPIA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 10.18 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2002 (File No. 1-7259)). |
56
|
|
|
|
|
|
10 |
.20 |
|
LUV 2000 Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-53610)). |
|
10 |
.21 |
|
2000 Aircraft Appearance Technicians Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 4.1 to
Registration Statement on Form S-8 (File
No. 333-52388)); Amendment No. 1 to 2000 Aircraft
Appearance Technicians Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.4 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003 (File No. 1-7259)). |
|
10 |
.22 |
|
2000 Stock Clerks Non-Qualified Stock Option Plan (incorporated
by reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-52390)); Amendment No. 1
to 2000 Stock Clerks Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.5 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003 (File No. 1-7259)). |
|
10 |
.23 |
|
2000 Flight Simulator Technicians Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 4.1 to
Registration Statement on Form S-8 (File
No. 333-53616)); Amendment No. 1 to 2000 Flight
Simulator Technicians Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.6 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003 (File No. 1-7259)). |
|
10 |
.24 |
|
2002 SWAPA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-98761)). |
|
10 |
.25 |
|
2002 Bonus SWAPA Non-Qualified Stock Option Plan (incorporated
by reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-98761)). |
|
10 |
.26 |
|
2002 SWAPIA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.2 to Registration Statement on
Form S-8 (File No. 333-100862)). |
|
10 |
.27 |
|
2002 Mechanics Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.2 to Registration Statement on
Form S-8 (File No. 333-100862)). |
|
10 |
.28 |
|
2002 Ramp, Operations, Provisioning and Freight Non-Qualified
Stock Option Plan (incorporated by reference to
Exhibit 10.27 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.29 |
|
2002 Customer Service/Reservations Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 10.28 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2002 (File No. 1-7259))); Amendment
No. 1 to 2002 Customer Service/Reservations Non-Qualified
Stock Option Plan (incorporated by reference to Exhibit 4.3
to Registration Statement on Form S-8 (File
No. 333-104245)). |
|
10 |
.30 |
|
2003 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 10.3 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)). |
|
14 |
|
|
Code of Ethics (incorporated by reference to Exhibit 14 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2003 (File No. 1-7259)). |
|
21 |
|
|
Subsidiaries of Southwest (incorporated by reference to
Exhibit 22 to Southwests Annual Report on
Form 10-K for the year ended December 31, 1997 (File
No. 1-7259)). |
|
23 |
|
|
Consent of Ernst & Young LLP, Independent Registered
Public Accounting Firm. |
|
31 |
.1 |
|
Rule 13a-14(a) Certification of Chief Executive Officer. |
|
31 |
.2 |
|
Rule 13a-14(a) Certification of Chief Financial Officer. |
|
32 |
|
|
Section 1350 Certification of Chief Executive Officer and
Chief Financial Officer. |
A copy of each exhibit may be obtained at a price of
15 cents per page, $10.00 minimum order, by writing to:
Investor Relations, Southwest Airlines Co., P.O. Box 36611,
Dallas, Texas 75235-1611.
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
January 31, 2006
|
|
|
|
|
Laura Wright |
|
Senior Vice President Finance, |
|
Chief Financial Officer |
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on January 31, 2006 on behalf of the registrant and in the
capacities indicated.
|
|
|
|
|
Signature |
|
Capacity |
|
|
|
|
/s/ Herbert D. Kelleher
Herbert D. Kelleher |
|
Chairman of the Board of Directors |
|
/s/ Gary C. Kelly
Gary C. Kelly |
|
Chief Executive Officer and Director |
|
/s/ Colleen C. Barrett
Colleen C. Barrett |
|
President and Director |
|
/s/ Laura Wright
Laura Wright |
|
Sr. Vice President Finance and Chief Financial
Officer
(Chief Financial and Accounting Officer) |
|
/s/ C. Webb Crockett
C. Webb Crockett |
|
Director |
|
/s/ William H.
Cunningham
William H. Cunningham |
|
Director |
|
/s/ William P. Hobby
William P. Hobby |
|
Director |
|
/s/ Travis C. Johnson
Travis C. Johnson |
|
Director |
|
/s/ R. W. King
R. W. King |
|
Director |
|
/s/ John T. Montford
John T. Montford |
|
Director |
58
|
|
|
|
|
Signature |
|
Capacity |
|
|
|
|
/s/ June M. Morris
June M. Morris |
|
Director |
|
/s/ Louis Caldera
Louis Caldera |
|
Director |
|
/s/ Nancy Loeffler
Nancy Loeffler |
|
Director |
59
INDEX TO THE EXHIBITS
|
|
|
|
|
|
3 |
.1 |
|
Restated Articles of Incorporation of Southwest (incorporated by
reference to Exhibit 4.1 to Southwests Registration
Statement on Form S-3 (File No. 33-52155)); Amendment
to Restated Articles of Incorporation of Southwest (incorporated
by reference to Exhibit 3.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended June 30,
1996 (File No. 1-7259)); Amendment to Restated Articles of
Incorporation of Southwest (incorporated by reference to
Exhibit 3.1 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998 (File
No. 1-7259)); Amendment to Restated Articles of
Incorporation of Southwest (incorporated by reference to
Exhibit 4.2 to Southwests Registration Statement on
Form S-8 (File No. 333-82735); Amendment to Restated
Articles of Incorporation of Southwest (incorporated by
reference to Exhibit 3.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended June 30,
2001 (File No. 1-7259)). |
|
3 |
.2 |
|
Bylaws of Southwest, as amended through January 2005
(incorporated by reference to Exhibit 3.2 to
Southwests Current Report on Form 8-K dated
January 25, 2005 (File No. 1-7259)). |
|
4 |
.1 |
|
$600,000,000 Competitive Advance and Revolving Credit Facility
Agreement dated as of April 20, 2004 (incorporated by
reference to Exhibit 10.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended June 30,
2004 (File No. 1-7259)); First Amendment, dated as of
August 9, 2005, to Competitive Advance Revolving Credit
Agreement (incorporated by reference to Exhibit 10.1 to
Southwests Current Report on Form 8-K dated
August 12, 2005 (File No. 1-7259)). |
|
4 |
.2 |
|
Specimen certificate representing Common Stock of Southwest
(incorporated by reference to Exhibit 4.2 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1994 (File No. 1-7259)). |
|
4 |
.3 |
|
Indenture dated as of February 14, 2005, between Southwest
Airlines Co. and The Bank of New York Trust Company, N.A.,
Trustee (incorporated by reference to Exhibit 4.2 to
Southwests Current Report on Form 8-K dated
February 14, 2005 (File No. 1-7259)) |
|
4 |
.4 |
|
Indenture dated as of September 17, 2004 between Southwest
Airlines Co. and Wells Fargo Bank, N.A., Trustee (incorporated
by reference to Exhibit 4.1 to Southwests
Registration Statement on Form S-3 dated October 30,
2002 (File No. 1-7259)). |
|
4 |
.5 |
|
Indenture dated as of June 20, 1991, between Southwest
Airlines Co. and Bank of New York, successor to NationsBank of
Texas, N.A. (formerly NCNB Texas National Bank), Trustee
(incorporated by reference to Exhibit 4.1 to
Southwests Current Report on Form 8-K dated
June 24, 1991 (File No. 1-7259)). |
|
4 |
.6 |
|
Indenture dated as of February 25, 1997, between the
Company and U.S. Trust Company of Texas, N.A. (incorporated
by reference to Exhibit 4.2 to Southwests Annual
Report on Form 10-K for the year ended December 31,
1996 (File No. 1-7259)). |
|
|
|
|
Southwest is not filing any other instruments evidencing any
indebtedness because the total amount of securities authorized
under any single such instrument does not exceed 10% of its
total consolidated assets. Copies of such instruments will be
furnished to the Securities and Exchange Commission upon request. |
|
10 |
.1 |
|
Purchase Agreement No. 1810, dated January 19, 1994,
between The Boeing Company and Southwest (incorporated by
reference to Exhibit 10.4 to Southwests Annual Report
on Form 10-K for the year ended December 31, 1993
(File No. 1-7259)); Supplemental Agreement No. 1.
(incorporated by reference to Exhibit 10.3 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1996 (File No. 1-7259));
Supplemental Agreements No. 2, 3 and 4 (incorporated by
reference to Exhibit 10.2 to Southwests Annual Report
on Form 10-K for the year ended December 31, 1997
(File No. 1-7259)); Supplemental Agreements
Nos. 5, 6, and 7; (incorporated by reference to
Exhibit 10.1 to Southwests Annual Report on
Form 10-K for the year ended December 31, 1998 (File
No. 1-7259)); Supplemental Agreements Nos. 8, 9, and
10 (incorporated by reference to Exhibit 10.1 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1999 (File No. 1-7259)); Supplemental
Agreements Nos. 11, 12, 13 and 14 (incorporated by
reference to Exhibit 10.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2000 (File No. 1-7259)); Supplemental
Agreements Nos. 15, 16, 17, 18 and 19 (incorporated by
reference to Exhibit 10.1 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2001 (File No. 1-7259)); Supplemental
Agreements Nos. 20, 21, 22, 23 and 24 (incorporated by
reference to Exhibit 10.3 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2002 (File No. 1-7259)); Supplemental
Agreements Nos. 25, 26, 27, 28 and 29 to Purchase
Agreement No. 1810, dated January 19, 1994, between
The Boeing Company and Southwest (incorporated by reference to
Exhibit 10.8 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)); Supplemental Agreements Nos. 30, 31, 32,
and 33 to Purchase |
|
|
|
|
|
|
|
|
|
Agreement No. 1810, dated January 19, 1993 between The
Boeing Company and Southwest; (incorporated by reference to
Exhibit 10.1 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2003 (File
No. 1-7259)); Supplemental Agreements Nos. 34, 35, 36,
37, and 38 (incorporated by reference to Exhibit 10.3 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (File No. 1-7259));
Supplemental Agreements Nos. 39 and 40 (incorporated by
reference to Exhibit 10.6 to Southwests Quarterly
Report on Form 10-Q for the quarter ended
September 30, 2004 (File No. 1-7259)); Supplemental
Agreement No. 41; Supplemental Agreement Nos. 42, 43
and 44 (incorporated by reference to Exhibit 10.1 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005 (File No. 1-7259));
Supplemental Agreement No. 45 (incorporated by reference to
Exhibit 10.1 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2005 (File
No. 1-7259)). |
|
|
|
|
Pursuant to 17 CFR 240.24b-2, confidential information has
been omitted and has been filed separately with the Securities
and Exchange Commission pursuant to a Confidential Treatment
Application filed with the Commission. |
|
|
|
|
The following exhibits filed under paragraph 10 of
Item 601 are the Companys compensation plans and
arrangements. |
|
10 |
.2 |
|
Form of Executive Employment Agreement between Southwest and
certain key employees pursuant to Executive Service Recognition
Plan (incorporated by reference to Exhibit 28 to Southwest
Quarterly Report on Form 10-Q for the quarter ended
June 30, 1987 (File No. 1-7259)). |
|
10 |
.3 |
|
1996 stock option agreements between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10.8 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1996 (File No. 1-7259)). |
|
10 |
.4 |
|
2001 stock option agreements between Southwest and Herbert D.
Kelleher (incorporated by reference to Exhibit 10 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001 (File No. 1-7259)). |
|
10 |
.5 |
|
1991 Incentive Stock Option Plan (incorporated by reference to
Exhibit 10.6 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.6 |
|
1991 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 10.7 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.7 |
|
1991 Employee Stock Purchase Plan as amended September 21,
2000 (incorporated by reference to Exhibit 4 to Amendment
No. 1 to Registration Statement on Form S-8 (file
No. 33-40653)). |
|
10 |
.8 |
|
Southwest Airlines Co. Profit Sharing Plan (incorporated by
reference to Exhibit 10.8 to Southwests Annual Report
on Form 10-K for the year ended December 31, 2000
(File No. 1-729)); Amendment No. 1 to Southwest
Airlines Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.11 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2001 (File
No. 1-7259)); Amendment No. 2 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.9 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)); Amendment No. 3 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.1 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)); Amendment No. 4 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.8 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2003 (File
No. 1-7259)); Amendment No. 5 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.2 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2004 (File
No. 1-7259)); Amendment No. 6 to Southwest Airlines
Co. Profit Sharing Plan (incorporated by reference to
Exhibit 10.8 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2004 (File
No. 1-7259)); Amendment No. 7 to Southwest Airlines
Co. Profit Sharing Plan. |
|
10 |
.9 |
|
Southwest Airlines Co. 401(k) Plan (incorporated by reference to
Exhibit 10.12 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2001 (File
No. 1-7259)); Amendment No. 1 to Southwest Airlines Co.
401(k) Plan (incorporated by reference to Exhibit 10.10 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2002 (File No. 1-7259)); Amendment
No. 2 to Southwest Airlines Co. 401(k) Plan (incorporated
by reference to Exhibit 10.10 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2002 (File No. 1-7259)); Amendment No. 3 to Southwest
Airlines Co. 401(k) Plan (incorporated by reference to
Exhibit 10.2 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)); Amendment No. 4 to Southwest Airlines
Co. 401(k) Plan (incorporated by reference to Exhibit 10.9
to Southwests Annual Report on Form 10-K for the year
ended December 31, 2003 (File No. 1-7259)); Amendment
No. 5 to Southwest Airlines Co. 401(k) Plan (incorporated
by reference to Exhibit 10.9 to Southwests Annual |
|
|
|
|
|
|
|
|
|
Report on Form 10-K for the year ended December 31,
2004 (File No. 1-7259)); Amendment No. 6 to Southwest
Airlines Co. 401(k) Plan. |
|
10 |
.10 |
|
Southwest Airlines Co. 1995 SWAPA Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 10.14 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 1994 (File No. 1-7259)). |
|
10 |
.11 |
|
1996 Incentive Stock Option Plan (incorporated by reference to
Exhibit 10.12 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.12 |
|
1996 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 10.13 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
10 |
.13 |
|
Employment Contract dated as of July 15, 2004, between
Southwest and Herbert D. Kelleher (incorporated by reference to
Exhibit 10.3 to Southwests Quarterly Report on
Form 10-Q the quarter ended September 30, 2004 (File
No. 1-7259)). |
|
10 |
.14 |
|
Employment Contract dated as of July 15, 2004, between
Southwest and Gary C. Kelly (incorporated by reference to
Exhibit 10.4 to Southwests Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004
(File No. 1-7259)). |
|
10 |
.15 |
|
Employment Contract dated as of July 15, 2004, between
Southwest and Colleen C. Barrett (incorporated by reference to
Exhibit 10.5 to Southwests Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004
(File No. 1-7259)). |
|
10 |
.16 |
|
Severance Contract dated as of July 15, 2004, between
Southwest and James F. Parker (incorporated by reference to
Exhibit 10.2 to Southwests Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004
(File No. 1-7259)). |
|
10 |
.17 |
|
Southwest Airlines Co. Outside Director Incentive Plan
(incorporated by reference to Exhibit 10.1 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002 (File No. 1-7259)). |
|
10 |
.18 |
|
1998 SAEA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 10.17 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2002 (File No. 1-7259)). |
|
10 |
.19 |
|
1999 SWAPIA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 10.18 to Southwests Annual
Report on Form 10-K for the year ended December 31,
2002 (File No. 1-7259)). |
|
10 |
.20 |
|
LUV 2000 Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-53610)). |
|
10 |
.21 |
|
2000 Aircraft Appearance Technicians Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 4.1 to
Registration Statement on Form S-8 (File
No. 333-52388)); Amendment No. 1 to 2000 Aircraft
Appearance Technicians Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.4 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003 (File No. 1-7259)). |
|
10 |
.22 |
|
2000 Stock Clerks Non-Qualified Stock Option Plan (incorporated
by reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-52390)); Amendment No. 1
to 2000 Stock Clerks Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.5 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003 (File No. 1-7259)). |
|
10 |
.23 |
|
2000 Flight Simulator Technicians Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 4.1 to
Registration Statement on Form S-8 (File
No. 333-53616)); Amendment No. 1 to 2000 Flight
Simulator Technicians Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 10.6 to
Southwests Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003 (File No. 1-7259)). |
|
10 |
.24 |
|
2002 SWAPA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-98761)). |
|
10 |
.25 |
|
2002 Bonus SWAPA Non-Qualified Stock Option Plan (incorporated
by reference to Exhibit 4.1 to Registration Statement on
Form S-8 (File No. 333-98761)). |
|
10 |
.26 |
|
2002 SWAPIA Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.2 to Registration Statement on
Form S-8 (File No. 333-100862)). |
|
10 |
.27 |
|
2002 Mechanics Non-Qualified Stock Option Plan (incorporated by
reference to Exhibit 4.2 to Registration Statement on
Form S-8 (File No. 333-100862)). |
|
10 |
.28 |
|
2002 Ramp, Operations, Provisioning and Freight Non-Qualified
Stock Option Plan (incorporated by reference to
Exhibit 10.27 to Southwests Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-7259)). |
|
|
|
|
|
|
10 |
.29 |
|
2002 Customer Service/Reservations Non-Qualified Stock Option
Plan (incorporated by reference to Exhibit 10.28 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2002 (File No. 1-7259))); Amendment
No. 1 to 2002 Customer Service/Reservations Non-Qualified
Stock Option Plan (incorporated by reference to Exhibit 4.3
to Registration Statement on Form S-8 (File
No. 333-104245)). |
|
10 |
.30 |
|
2003 Non-Qualified Stock Option Plan (incorporated by reference
to Exhibit 10.3 to Southwests Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003 (File
No. 1-7259)). |
|
14 |
|
|
Code of Ethics (incorporated by reference to Exhibit 14 to
Southwests Annual Report on Form 10-K for the year
ended December 31, 2003 (File No. 1-7259)). |
|
21 |
|
|
Subsidiaries of Southwest (incorporated by reference to
Exhibit 22 to Southwests Annual Report on
Form 10-K for the year ended December 31, 1997 (File
No. 1-7259)). |
|
23 |
|
|
Consent of Ernst & Young LLP, Independent Registered
Public Accounting Firm. |
|
31 |
.1 |
|
Rule 13a-14(a) Certification of Chief Executive Officer. |
|
31 |
.2 |
|
Rule 13a-14(a) Certification of Chief Financial Officer. |
|
32 |
|
|
Section 1350 Certification of Chief Executive Officer and
Chief Financial Officer. |