form10q.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
þ
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
For
the quarterly period ended March 31,
2008
|
¨
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
For
the transition period from ________ to
________
|
Commission
File No. 1-7259
Southwest
Airlines Co.
(Exact
name of registrant as specified in its charter)
TEXAS
|
74-1563240
|
(State
or other jurisdiction of
|
(IRS
Employer
|
incorporation
or organization)
|
Identification
No.)
|
|
|
P.O.
Box 36611, Dallas, Texas
|
75235-1611
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant's
telephone number, including area code: (214) 792-4000
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes þ No ¨
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule
12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated
filer ¨
Non-accelerated filer ¨ (Do not check if a
smaller reporting
company) Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes ¨No þ
|
Number of shares of Common Stock
outstanding as of the close of business on April 16, 2008: 731,757,810
|
SOUTHWEST AIRLINES
CO.
FORM
10-Q
SOUTHWEST
AIRLINES CO.
FORM
10-Q
Part I - FINANCIAL INFORMATION
Southwest
Airlines Co.
Condensed
Consolidated Balance Sheet
(in
millions)
(unaudited)
|
|
March
31, 2008
|
|
|
December
31, 2007
|
|
ASSETS
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
2,982 |
|
|
$ |
2,213 |
|
Short-term
investments
|
|
|
140 |
|
|
|
566 |
|
Accounts
and other receivables
|
|
|
350 |
|
|
|
279 |
|
Inventories
of parts and supplies, at cost
|
|
|
265 |
|
|
|
259 |
|
Fuel
derivative contracts
|
|
|
1,248 |
|
|
|
1,069 |
|
Prepaid
expenses and other current assets
|
|
|
65 |
|
|
|
57 |
|
Total
current assets
|
|
|
5,050 |
|
|
|
4,443 |
|
|
|
|
|
|
|
|
|
|
Property
and equipment, at cost:
|
|
|
|
|
|
|
|
|
Flight
equipment
|
|
|
13,408 |
|
|
|
13,019 |
|
Ground
property and equipment
|
|
|
1,555 |
|
|
|
1,515 |
|
Deposits
on flight equipment purchase contracts
|
|
|
541 |
|
|
|
626 |
|
|
|
|
15,504 |
|
|
|
15,160 |
|
Less
allowance for depreciation and amortization
|
|
|
4,413 |
|
|
|
4,286 |
|
|
|
|
11,091 |
|
|
|
10,874 |
|
Other
assets
|
|
|
1,890 |
|
|
|
1,455 |
|
|
|
$ |
18,031 |
|
|
$ |
16,772 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
787 |
|
|
$ |
759 |
|
Accrued
liabilities
|
|
|
3,756 |
|
|
|
3,107 |
|
Air
traffic liability
|
|
|
1,198 |
|
|
|
931 |
|
Current
maturities of long-term debt
|
|
|
40 |
|
|
|
41 |
|
Total
current liabilities
|
|
|
5,781 |
|
|
|
4,838 |
|
|
|
|
|
|
|
|
|
|
Long-term
debt less current maturities
|
|
|
2,079 |
|
|
|
2,050 |
|
Deferred
income taxes
|
|
|
2,611 |
|
|
|
2,535 |
|
Deferred
gains from sale and leaseback of aircraft
|
|
|
103 |
|
|
|
106 |
|
Other
deferred liabilities
|
|
|
272 |
|
|
|
302 |
|
Stockholders'
equity:
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
808 |
|
|
|
808 |
|
Capital
in excess of par value
|
|
|
1,212 |
|
|
|
1,207 |
|
Retained
earnings
|
|
|
4,811 |
|
|
|
4,788 |
|
Accumulated
other comprehensive income
|
|
|
1,492 |
|
|
|
1,241 |
|
Treasury
stock, at cost
|
|
|
(1,138 |
) |
|
|
(1,103 |
) |
Total
stockholders' equity
|
|
|
7,185 |
|
|
|
6,941 |
|
|
|
$ |
18,031 |
|
|
$ |
16,772 |
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
|
|
|
|
|
|
|
Southwest
Airlines Co.
Condensed
Consolidated Statement of Income
(in
millions, except per share amounts)
(unaudited)
|
|
Three
months ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
OPERATING
REVENUES:
|
|
|
|
|
|
|
Passenger
|
|
$ |
2,414 |
|
|
$ |
2,112 |
|
Freight
|
|
|
34 |
|
|
|
30 |
|
Other
|
|
|
82 |
|
|
|
56 |
|
Total
operating revenues
|
|
|
2,530 |
|
|
|
2,198 |
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|
Salaries,
wages, and benefits
|
|
|
800 |
|
|
|
767 |
|
Fuel
and oil
|
|
|
753 |
|
|
|
564 |
|
Maintenance
materials and repairs
|
|
|
143 |
|
|
|
136 |
|
Aircraft
rentals
|
|
|
38 |
|
|
|
39 |
|
Landing
fees and other rentals
|
|
|
171 |
|
|
|
136 |
|
Depreciation
and amortization
|
|
|
145 |
|
|
|
135 |
|
Other
operating expenses
|
|
|
392 |
|
|
|
337 |
|
Total
operating expenses
|
|
|
2,442 |
|
|
|
2,114 |
|
OPERATING
INCOME
|
|
|
88 |
|
|
|
84 |
|
OTHER
EXPENSES (INCOME):
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
28 |
|
|
|
29 |
|
Capitalized
interest
|
|
|
(8 |
) |
|
|
(13 |
) |
Interest
income
|
|
|
(7 |
) |
|
|
(13 |
) |
Other
(gains) losses, net
|
|
|
38 |
|
|
|
(68 |
) |
Total
other expenses (income)
|
|
|
51 |
|
|
|
(65 |
) |
|
|
|
|
|
|
|
|
|
INCOME
BEFORE INCOME TAXES
|
|
|
37 |
|
|
|
149 |
|
PROVISION
FOR INCOME TAXES
|
|
|
3 |
|
|
|
56 |
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$ |
34 |
|
|
$ |
93 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME PER SHARE, BASIC
|
|
|
$.05 |
|
|
|
$.12 |
|
|
|
|
|
|
|
|
|
|
NET
INCOME PER SHARE, DILUTED
|
|
|
$.05 |
|
|
|
$.12 |
|
|
|
|
|
|
|
|
|
|
WEIGHTED
AVERAGE SHARES
|
|
|
|
|
|
|
|
|
OUTSTANDING:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
733 |
|
|
|
786 |
|
Diluted
|
|
|
734 |
|
|
|
800 |
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
|
|
|
|
|
|
|
Southwest
Airlines Co.
Condensed
Consolidated Statement of Cash Flows
(in
millions)
|
|
Three
months ended March 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net
income
|
|
$ |
34 |
|
|
$ |
93 |
|
Adjustments
to reconcile net income to
|
|
|
|
|
|
|
|
|
cash
provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
145 |
|
|
|
135 |
|
Deferred
income taxes
|
|
|
(5 |
) |
|
|
42 |
|
Amortization
of deferred gains on sale and
|
|
|
|
|
|
|
|
|
leaseback
of aircraft
|
|
|
(3 |
) |
|
|
(4 |
) |
Share-based
compensation expense
|
|
|
5 |
|
|
|
13 |
|
Excess
tax benefits from share-based
|
|
|
|
|
|
|
|
|
compensation
arrangements
|
|
|
- |
|
|
|
(29 |
) |
Changes
in certain assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
and other receivables
|
|
|
(70 |
) |
|
|
(37 |
) |
Other
current assets
|
|
|
26 |
|
|
|
(56 |
) |
Accounts
payable and accrued liabilities
|
|
|
616 |
|
|
|
383 |
|
Air
traffic liability
|
|
|
267 |
|
|
|
210 |
|
Other,
net
|
|
|
(51 |
) |
|
|
(133 |
) |
Net
cash provided by operating activities
|
|
|
964 |
|
|
|
617 |
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchases
of property and equipment, net
|
|
|
(364 |
) |
|
|
(325 |
) |
Purchases
of short-term investments
|
|
|
(1,221 |
) |
|
|
(914 |
) |
Proceeds
from sales of short-term investments
|
|
|
1,459 |
|
|
|
968 |
|
Net
cash used in investing activities
|
|
|
(126 |
) |
|
|
(271 |
) |
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds
from Employee stock plans
|
|
|
11 |
|
|
|
78 |
|
Payments
of long-term debt and capital lease obligations
|
|
|
(19 |
) |
|
|
(9 |
) |
Payments
of cash dividends
|
|
|
(7 |
) |
|
|
(7 |
) |
Repurchase
of common stock
|
|
|
(54 |
) |
|
|
(209 |
) |
Excess
tax benefits from share-based
|
|
|
|
|
|
|
|
|
compensation
arrangements
|
|
|
- |
|
|
|
29 |
|
Net
cash used in financing activities
|
|
|
(69 |
) |
|
|
(118 |
) |
|
|
|
|
|
|
|
|
|
NET
CHANGE IN CASH AND
|
|
|
|
|
|
|
|
|
CASH
EQUIVALENTS
|
|
|
769 |
|
|
|
228 |
|
CASH
AND CASH EQUIVALENTS AT
|
|
|
|
|
|
|
|
|
BEGINNING
OF PERIOD
|
|
|
2,213 |
|
|
|
1,390 |
|
CASH
AND CASH EQUIVALENTS
|
|
|
|
|
|
|
|
|
AT
END OF PERIOD
|
|
$ |
2,982 |
|
|
$ |
1,618 |
|
|
|
|
|
|
|
|
|
|
CASH
PAYMENTS FOR:
|
|
|
|
|
|
|
|
|
Interest,
net of amount capitalized
|
|
$ |
25 |
|
|
$ |
19 |
|
Income
taxes
|
|
$ |
6 |
|
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
|
|
|
|
|
|
|
Southwest
Airlines Co.
Notes
to Condensed Consolidated Financial Statements
(unaudited)
1. BASIS
OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements of Southwest
Airlines Co. (Company or Southwest) have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. The unaudited
condensed consolidated financial statements for the interim periods ended March
31, 2008 and 2007, include all adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods. This includes all normal and recurring adjustments, but does
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. Financial
results for the Company, and airlines in general, are seasonal in
nature. Historically, the Company’s second and third fiscal quarters
have been more profitable than its first and fourth fiscal
quarters. However, as a result of the extensive nature of the
Company’s fuel hedging program, the volatility of commodities used by the
Company for hedging jet fuel, and the unique accounting requirements of SFAS
133, as amended, the Company has experienced significant volatility in its
results in all fiscal periods. See Note 5 for further
information. Operating results for the three months ended March 31,
2008, are not necessarily indicative of the results that may be expected for the
year ended December 31, 2008. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Southwest Airlines Co. Annual Report on Form 10-K for the year ended December
31, 2007.
2. SHARE-BASED
COMPENSATION
The
Company accounts for share-based compensation in accordance with SFAS No. 123R,
“Share-Based Payment”.
The
Company has share-based compensation plans covering Employees subject to
collective bargaining agreements (collective bargaining plans) and plans
covering Employees not subject to collective bargaining agreements (other
Employee plans). Vesting terms for both collective bargaining plans
and other Employee plans differ based on the grant made, and have ranged in
length from immediate vesting to vesting over ten years, and have also included
vesting periods in accordance with the period covered by a particular collective
bargaining agreement. For grants in any of the Company’s plans that are
subject to graded vesting over a service period, we recognize expense on a
straight-line basis over the requisite service period for the entire
award. None of the Company’s past grants have included
performance-based or market-based vesting conditions, as defined.
The fair
value of each option grant is estimated on the date of grant using a modified
Black-Scholes option pricing model. 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 the three months ended March 31, 2008 and 2007,
there were .2 million and .2 million stock options granted under the Company’s
plans related to collective bargaining agreements, respectively. The
fair value of options granted under these plans during the three months ended
March 31, 2008, ranged from $1.71 to $2.85, with a weighted-average fair value
of $2.11. The fair value of options granted under these plans during
the three months ended March 31, 2007, ranged from $3.26 to $6.33, with a
weighted-average fair value of $3.82. During the three months ended
March 31, 2008, there were 1.6 million stock options granted from the 2007
Equity Incentive Plan. The fair value of options granted under this
plan during the three months ended March 31, 2008, was $4.04. There
were no stock options granted from other Employee Plans during the three months
ended March 31, 2007.
The
unaudited Condensed Consolidated Statement of Income for the three months ended
March 31, 2008 and 2007 reflects share-based compensation cost of $5 million and
$13 million, respectively. The total tax benefit recognized from
share-based compensation arrangements for the three months ended March 31, 2008
and 2007, was $1 million and $4 million, respectively. The Company
currently estimates that share-based compensation expense will be approximately
$18 million for the full year 2008, before income taxes and
profitsharing.
As of
March 31, 2008, there was $40 million of total unrecognized compensation cost
related to share-based compensation arrangements, which is expected to be
recognized over a weighted-average period of 2.1 years. The total
recognition period for the remaining unrecognized compensation cost is
approximately eight years; however, the majority of this cost will be recognized
over the next two years, in accordance with vesting provisions.
Employee
Stock Purchase Plan
Under the
amended 1991 Employee Stock Purchase Plan (ESPP), which has been approved by
Shareholders, the Company is authorized to issue up to a remaining balance of
6.2 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 monthly purchase period. Common Stock purchases are paid
for through periodic payroll deductions. For the three months ended
March 31, 2008 and 2007, participants under the ESPP purchased .4 million shares
and .3 million shares at average prices of $10.94 and $13.67,
respectively. The weighted-average fair value of each purchase right
under the ESPP granted for the three months ended March 31, 2008 and 2007, which
is equal to the ten percent discount from the market value of the Common Stock
at the end of each monthly purchase period, was $1.22 and $1.52,
respectively.
3. DIVIDENDS
During
the three months ended March 31, 2008, dividends of $.0045 per share were
declared on the 731 million shares of Common Stock then
outstanding. During the three months ended March 31, 2007, dividends
of $.0045 per share were declared on the 787 million shares of Common Stock then
outstanding.
4. NET
INCOME PER SHARE
The
following table sets forth the computation of basic and diluted net income per
share (in millions except per share amounts):
|
|
Three
months ended March 31,
|
|
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
NUMERATOR:
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
34 |
|
|
|
$ |
93 |
|
|
|
|
|
|
|
|
|
|
|
DENOMINATOR:
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares
|
|
|
|
|
|
|
|
|
|
outstanding,
basic
|
|
|
733 |
|
|
|
|
786 |
|
Dilutive
effect of Employee stock
|
|
|
|
|
|
|
|
|
|
options
|
|
|
1 |
|
|
|
|
14 |
|
Adjusted
weighted-average shares
|
|
|
|
|
|
|
|
|
|
outstanding,
diluted
|
|
|
734 |
|
|
|
|
800 |
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME PER SHARE:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
$.05 |
|
|
|
|
$.12 |
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
$.05 |
|
|
|
|
$.12 |
|
5. FINANCIAL
DERIVATIVE INSTRUMENTS
Fuel
Contracts
Airline
operators are inherently dependent upon energy to operate and, therefore, are
significantly impacted by changes in jet fuel prices. Jet fuel and
oil consumed for the three months ended March 31, 2008 and 2007 represented
approximately 30.8 percent and 26.7 percent of Southwest’s operating expenses,
respectively. The primary reason that fuel and oil have become an
increasingly large portion of the Company’s operating expenses is due to the
dramatic increase in all energy prices over this period. The Company
endeavors to acquire jet fuel at the lowest possible cost. Because
jet fuel is not traded on an organized futures exchange, there are limited
opportunities to hedge directly in jet fuel. However, the Company has
found that financial derivative instruments in other commodities, such as crude
oil, and refined products such as heating oil and unleaded gasoline, can be
useful in decreasing its exposure to jet fuel price volatility. 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 frames. In addition to the significant fuel derivative positions
the Company had in place during the first three months of 2008, the Company also
has significant future positions. The Company currently has a mixture
of purchased call options, collar structures, and fixed price swap agreements in
place to decrease its exposure to jet fuel price volatility for over 70 percent
of its remaining 2008 total anticipated jet fuel requirements at average crude
oil equivalent prices of approximately $51 per barrel, and has also added
refinery margin contracts on most of those positions. Based on
current growth plans, the Company also has derivative positions for over 55
percent of anticipated jet fuel needs for 2009 at approximately $51 per barrel,
nearly 30 percent for 2010 at approximately $63 per barrel, over 15 percent for
2011 at approximately $64 per barrel, and over 15 percent for 2012 at
approximately $63 per barrel.
Upon
proper qualification, the Company accounts for its fuel 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 are reflected at fair value
in the Company’s unaudited Condensed Consolidated Balance Sheet, and 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 6 for further information on Accumulated
other comprehensive income. The Company is exposed to the risk that
periodic changes will not be perfectly effective, as defined, or that the
derivatives will no longer qualify for special hedge
accounting. Ineffectiveness, as defined, results when the change in
the fair value of the derivative instrument exceeds the change in the value of
the Company’s expected future cash outlay to purchase and consume jet
fuel. To the extent that the periodic changes in the fair value of
the derivatives exceed the change in the value of the Company’s expected future
cash outlay to purchase and consume jet fuel, that ineffectiveness is recorded
immediately to “Other (gains) and losses, net” in the income
statement. Likewise, if a hedge ceases to qualify for hedge
accounting, any change in the fair value of derivative instruments since the
last period is recorded to “Other (gains) and losses, net” in the income
statement in the period of the change.
All cash
flows associated with purchasing and selling derivatives are classified as
operating cash flows in the unaudited Condensed Consolidated Statement of Cash
Flows, either as a component of changes in Other current assets or Other, net,
depending on whether the derivative will settle within twelve months or beyond
twelve months, respectively. The following table presents the
location of pre-tax gains and/or losses on derivative instruments within the
unaudited Condensed Consolidated Statement of Income.
|
|
Three
months ended March 31,
|
|
(In
millions)
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
Fuel
hedge (gains) included in Fuel and oil expense
|
|
$ |
(291 |
) |
|
|
$ |
(79 |
) |
Mark-to-market
impact from fuel contracts settling in future
|
|
|
|
|
|
|
|
|
|
periods
- included in Other (gains) losses, net
|
|
|
7 |
|
|
|
|
(85 |
) |
Ineffectiveness
from fuel hedges settling in future periods -
|
|
|
|
|
|
|
|
|
|
included
in Other (gains) losses, net
|
|
|
- |
|
|
|
|
6 |
|
Realized
ineffectiveness and mark-to-market (gains) or
|
|
|
|
|
|
|
|
|
|
losses
- included in Other (gains) losses, net
|
|
|
16 |
|
|
|
|
(4 |
) |
Premium
cost of fuel contracts included in Other (gains) losses,
net
|
|
|
14 |
|
|
|
|
14 |
|
Also, the
following table presents the fair values of the Company’s remaining derivative
instruments, receivable amounts from settled/expired derivative contracts, and
the amounts of unrealized gains, net of tax, in Accumulated other comprehensive
income related to fuel hedges within the unaudited Condensed Consolidated
Balance Sheet.
|
|
March
31,
|
|
|
December
31,
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Fair
value of current fuel contracts (Fuel derivative
contracts)
|
|
$ |
1,248 |
|
|
$ |
1,069 |
|
Fair
value of noncurrent fuel contracts (Other assets)
|
|
|
1,503 |
|
|
|
1,318 |
|
Due
from third parties for settled fuel contracts (Accounts
|
|
|
|
|
|
|
|
|
and
other receivables)
|
|
|
122 |
|
|
|
109 |
|
Net
unrealized gains from fuel hedges, net of tax (Accumulated
|
|
|
|
|
|
|
|
|
other
comprehensive income)
|
|
|
1,481 |
|
|
|
1,221 |
|
The fair
value of derivative instruments, depending on the type of instrument, was
determined by the use of present value methods or standard option valuation
models with assumptions about commodity prices based on those observed in
underlying markets. See Note 12 for further
information. Included in the above $1,481 million net unrealized
gains from fuel hedges are approximately $671 million in net unrealized gains
that are expected to be realized in earnings during the twelve months following
March 31, 2008. In addition, as of March 31, 2008, the Company had
already recognized gains due to ineffectiveness and derivatives that do not
qualify for hedge accounting totaling $148 million, net of
taxes. These gains were recognized in first quarter 2008 and prior
periods, and are reflected in Retained earnings as of March 31, 2008, but the
underlying derivative instruments will not expire/settle until future periods,
including some during the remainder of 2008.
Interest
Rate Swaps
The
Company has interest rate swap agreements relating to its $350 million 5.25%
senior unsecured notes due 2014, its $385 million 6.5% senior unsecured notes
due 2012, its $300 million 5.125% senior unsecured notes due 2017, and its $100
million 7.375% senior unsecured notes due 2027. Under each of these
interest rate swap agreements, the Company pays the London InterBank Offered
Rate (LIBOR) plus a margin every six months on the notional amount of the debt,
and receives the fixed stated rate of the notes every six months until the date
the notes become due.
The
Company’s interest rate swap agreements qualify as fair value hedges, as defined
by SFAS 133. The fair value of the interest rate swap agreements,
which are adjusted regularly, are recorded in the Company’s balance sheet as an
asset or liability, as necessary, with a corresponding adjustment to the
carrying value of the long-term debt. The fair value of the interest
rate swap agreements, excluding accrued interest, at March 31, 2008, was an
asset of approximately $63 million. This entire amount is recorded in
Other assets in the unaudited Condensed Consolidated Balance
Sheet. In accordance with fair value hedging, the offsetting entry is
an adjustment to increase the carrying value of long-term debt.
6. COMPREHENSIVE
INCOME
Comprehensive
income included changes in the fair value of certain financial derivative
instruments, which qualify for hedge accounting, and unrealized gains and losses
on certain investments. Comprehensive income totaled $285 million for
the three months ended March 31, 2008, and $227 million for the three months
ended March 31, 2007. The differences between net income and
comprehensive income for each of these periods were as follows:
|
|
Three
months ended March 31,
|
|
(In
millions)
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
34 |
|
|
|
$ |
93 |
|
Unrealized
gain (loss) on derivative instruments,
|
|
|
|
|
|
|
|
|
|
net
of deferred taxes of ($151) and ($84)
|
|
|
260 |
|
|
|
|
135 |
|
Other,
net of deferred taxes of $6 and $0
|
|
|
(9 |
) |
|
|
|
(1 |
) |
Total
other comprehensive income
|
|
|
251 |
|
|
|
|
134 |
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income
|
|
$ |
285 |
|
|
|
$ |
227 |
|
A
rollforward of the amounts included in Accumulated other comprehensive income,
net of taxes, is shown below:
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
Fuel
|
|
|
|
|
|
other
|
|
|
|
hedge
|
|
|
|
|
|
comprehensive
|
|
(In
millions)
|
|
derivatives
|
|
|
Other
|
|
|
income
(loss)
|
|
Balance
at December 31, 2007
|
|
$ |
1,220 |
|
|
$ |
21 |
|
|
$ |
1,241 |
|
2008
changes in value
|
|
|
430 |
|
|
|
(9 |
) |
|
|
421 |
|
Reclassification
to earnings
|
|
|
(170 |
) |
|
|
- |
|
|
|
(170 |
) |
Balance
at March 31, 2008
|
|
$ |
1,480 |
|
|
$ |
12 |
|
|
$ |
1,492 |
|
7. OTHER
ASSETS AND ACCRUED LIABILITIES
|
|
March
31,
|
|
|
December
31,
|
|
(In
millions)
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Noncurrent
fuel hedge contracts, at fair value
|
|
$ |
1,503 |
|
|
$ |
1,318 |
|
Auction
rate securities
|
|
|
180 |
|
|
|
- |
|
Other
|
|
|
207 |
|
|
|
137 |
|
Other
assets
|
|
$ |
1,890 |
|
|
$ |
1,455 |
|
|
March
31,
|
|
December
31,
|
|
(In
millions)
|
2008
|
|
2007
|
|
|
|
|
|
|
Retirement
Plans
|
$ 144
|
|
$
132
|
|
Aircraft
Rentals
|
102
|
|
125
|
|
Vacation
Pay
|
168
|
|
164
|
|
Advances
and deposits
|
2,589
|
|
2,020
|
|
Deferred
income taxes
|
434
|
|
370
|
|
Other
Accrued Benefit
|
155
|
|
132
|
|
Other
|
164
|
|
164
|
|
Accrued
liabilities
|
$ 3,756
|
|
$
3,107
|
|
8. POSTRETIREMENT
BENEFITS
The
following table sets forth the Company’s periodic postretirement benefit cost
for each of the interim periods identified:
|
|
Three
months ended March 31,
|
|
(In
millions)
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
3 |
|
|
|
$ |
4 |
|
Interest
cost
|
|
|
1 |
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Net
periodic postretirement benefit cost
|
|
$ |
4 |
|
|
|
$ |
5 |
|
9. PROJECT
EARLY DEPARTURE
Project
Early Departure was a voluntary early retirement program offered in July 2007 to
eligible Employees, in which the Company offered a cash bonus of $25,000 plus
medical/dental continuation coverage and travel privileges based on
eligibility. A total of 608 out of approximately 8,500 eligible
Employees elected to participate in the program. The participants’ last day of
work falls between September 30, 2007 and April 30, 2008, based on the
operational needs of particular work locations and departments.
Project
Early Departure resulted in a pre-tax, pre-profitsharing, one-time charge of
approximately $25 million during third quarter 2007. Approximately $9
million of this amount remains to be paid and is recorded as an accrued
liability in the accompanying unaudited condensed Consolidated Balance Sheet as
of March 31, 2008.
10. LONG-TERM
DEBT
On
September 1, 2007, the Company redeemed its $100 million senior unsecured 7 7/8%
notes on their scheduled maturity date.
On
October 3, 2007, the Company issued $500 million Pass Through Certificates
consisting of $412 million 6.15% Series A certificates and $88 million 6.65%
Series 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 16 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 semi-annually, beginning February 1, 2008. Also beginning
February 1, 2008, principal payments on the equipment notes held for both series
of certificates are due semi-annually until the balance of the certificates
mature on August 1, 2022. The Company plans to use the proceeds from
the issuance of the Pass Through Certificates for general corporate
purposes.
11. CONTINGENCIES
On March
6, 2008, the F.A.A. notified the Company that it was seeking to fine the Company
approximately $10 million in connection with an incident concerning the
Company’s potential non-compliance with an airworthiness
directive. The Company has started an “informal conference” with the
F.A.A., which is a process through which the Company and the F.A.A. may explore
common ground (or differences) to determine whether the matter will be formally
litigated or resolved. The F.A.A. is continuing to audit the Company’s
compliance with airworthiness directives.
In
connection with the above incident, the Company has been named as a defendant in
two putative class actions on behalf of persons who purchased air travel from
the Company while the Company was allegedly in violation of F.A.A. safety
regulations. Claims alleged by the plaintiffs in these two putative class
actions include breach of contract, breach of warranty, fraud/misrepresentation,
unjust enrichment, and negligent and reckless operation of an
aircraft. The Company believes that the class action lawsuits are
without merit and intends to vigorously defend itself. The Company has also
recently received letters from four Shareholders demanding the Company commence
an action on behalf of the Company against members of its Board of Directors and
any other allegedly culpable parties for damages resulting from alleged breach
of fiduciary duties owed by them to the Company. To date, none of
these Shareholders has filed a derivative lawsuit in connection with these
demands. The Company is currently evaluating these
demands.
The
Company is from time to time subject to various other legal proceedings and
claims arising in the ordinary course of business, including, but not limited
to, examinations by the Internal Revenue Service.
The
Company's management does not expect that the outcome in any of its currently
ongoing legal proceedings or the outcome of any proposed adjustments presented
to date by the IRS, individually or collectively, will have a material adverse
effect on the Company's financial condition, results of operations, or cash
flow.
12. FAIR
VALUE MEASUREMENTS
In
September 2006, the FASB issued statement No. 157, “Fair Value
Measurements” (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value in
accordance with accounting principles generally accepted in the United States,
and expands disclosures about fair value measurements. The Company has adopted
the provisions of SFAS 157 as of January 1, 2008, for financial instruments.
Although the adoption of SFAS 157 did not materially impact its financial
condition, results of operations, or cash flow, the Company is now required to
provide additional disclosures as part of its financial statements.
SFAS 157
establishes a three-tier fair value hierarchy, which prioritizes the inputs used
in measuring fair value. These tiers include: Level 1, defined as
observable inputs such as quoted prices in active markets; Level 2, defined as
inputs other than quoted prices in active markets that are either directly or
indirectly observable; and Level 3, defined as unobservable inputs in which
little or no market data exists, therefore requiring an entity to develop its
own assumptions.
As of
March 31, 2008, the Company held certain assets that are required to be measured
at fair value on a recurring basis. These included the Company’s
derivative instruments—both related to fuel and interest rates, and certain
investments, including investments associated with the Company’s Excess Benefit
Plan, and auction rate securities.
The
Company’s fuel derivative instruments consist of over-the-counter (OTC)
contracts, which are not traded on a public exchange. These contracts
include both swaps as well as different types of option
contracts. See Note 5 for further information on the Company’s
derivative instruments and hedging activities. The fair values of
swap contracts are determined based on inputs that are readily available in
public markets or can be derived from information available in publicly quoted
markets. Therefore, the Company has categorized these swap contracts
as Level 2. The Company determines the value of option contracts
utilizing a standard option pricing model based on inputs that are either
readily available in public markets, can be derived from information available
in publicly quoted markets, or are quoted by counterparties to these
contracts. In situations where the Company obtains inputs via quotes
from its counterparties, it verifies the reasonableness of these quotes via
similar quotes from another counterparty as of each date for which financial
statements are prepared. The Company has consistently applied these
valuation techniques in all periods presented and believes it has obtained the
most accurate information available for the types of derivative contracts it
holds. Due to the fact that certain of the inputs utilized to
determine the fair value of option contracts are unobservable (principally
volatility), the Company has categorized these option contracts as Level
3.
The
Company’s interest rate derivative instruments also consist of OTC swap
contracts. The inputs utilized to determine the fair values of these
contracts are obtained in quoted public markets. The Company has consistently
applied these valuation techniques in all periods presented.
The
Company’s investments associated with its Excess Benefit Plan consist of mutual
funds that are publicly traded and for which market prices are readily
available.
The
Company also has invested in auction rate security instruments, which are
classified as available for sale securities and reflected at fair
value. However, due to recent events in credit markets, the auction
events for some of these instruments held by the Company failed during first
quarter 2008. Therefore, the fair values of these securities are
estimated utilizing a discounted cash flow analysis or other type of valuation
model as of March 31, 2008. These analyses consider, among other
items, the collateralization underlying the security investments, the
creditworthiness of the counterparty, the timing of expected future cash flows,
and the expectation of the next time the security is expected to have a
successful auction. These securities were also compared, when
possible, to other observable market data with similar characteristics to the
securities held by the Company.
As a
result of the temporary declines in fair value for the Company’s auction rate
securities, which the Company attributes to liquidity issues rather than credit
issues, it has recorded an unrealized loss of $10 million to accumulated other
comprehensive income. The majority of the auction rate security
instruments held by the Company at March 31, 2008, totaling $180 million, were
in securities collateralized by student loan portfolios, which are guaranteed by
the United States government. Due to the Company’s belief that the
market for these student loan collateralized instruments may take in excess of
twelve months to fully recover, the Company has classified these investments as
noncurrent and has included them in Other assets on the unaudited Condensed
Consolidated Balance Sheet at March 31, 2008. The remainder of the
instruments, totaling $140 million, were in tax-exempt bond investments, for
which the market has recently had a number of successful auctions. As
of March 31, 2008, the Company continues to earn interest on virtually all of
its auction rate security instruments. Any future fluctuation in fair
value related to these instruments that the Company deems to be temporary,
including any recoveries of previous write-downs, would be recorded to
accumulated other comprehensive income. If the Company determines
that any future valuation adjustment was other than temporary, it would record a
charge to earnings as appropriate.
The
Company’s assets measured at fair value on a recurring basis subject to the
disclosure requirements of SFAS 157 at March 31, 2008, were as
follows:
|
|
|
|
|
Fair Value
Measurements at Reporting Date Using
|
|
|
|
|
|
|
Quoted
Prices in
|
|
|
|
|
|
Significant
|
|
|
|
|
|
|
Active
Markets for
|
|
|
Significant
Other
|
|
|
Unobservable
|
|
(in
millions)
|
|
|
|
|
Identical
Assets
|
|
|
Observable
Inputs
|
|
|
Inputs
|
|
Description
|
|
3/31/2008
|
|
|
(Level
1)
|
|
|
(Level
2)
|
|
|
(Level
3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction
Rate Securities
|
|
$ |
320 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
320 |
|
Other
Available-for-sale Securities
|
|
|
25 |
|
|
|
25 |
|
|
|
- |
|
|
|
- |
|
Interest
Rate Derivatives
|
|
|
63 |
|
|
|
- |
|
|
|
63 |
|
|
|
- |
|
Fuel
Derivatives
|
|
|
2,761 |
|
|
|
- |
|
|
|
901 |
|
|
|
1,860 |
|
Other
Available-for-sale Securities
|
|
|
11 |
|
|
|
- |
|
|
|
- |
|
|
|
11 |
|
Total
assets measured at fair value
|
|
$ |
3,180 |
|
|
$ |
25 |
|
|
$ |
964 |
|
|
$ |
2,191 |
|
Based on
market conditions, the Company changed its valuation methodology for auction
rate securities to a discounted cash flow analysis during first quarter
2008. Accordingly, these securities changed from Level 1 to Level 3
within SFAS 157’s hierarchy since the Company’s initial adoption of SFAS 157 at
January 1, 2008.
The
following table presents the Company’s assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) as defined in
SFAS 157 at March 31, 2008:
|
|
Fair Value
Measurements Using Significant
|
|
|
|
Unobservable Inputs
(Level 3)
|
|
|
|
Fuel
|
|
|
Auction
Rate
|
|
|
Other
|
|
|
|
|
(in
millions)
|
|
Derivatives
|
|
|
Securities
|
|
|
Investments
|
|
|
Total
|
|
Balance
at 12/31/07
|
|
$ |
1,725 |
|
|
$ |
- |
|
|
$ |
12 |
|
|
$ |
1,737 |
|
Transfers
to Level 3
|
|
|
- |
|
|
|
463 |
|
|
|
- |
|
|
|
463 |
|
Total
gains or (losses) (realized or unrealized)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included
in earnings
|
|
|
(34 |
) |
|
|
- |
|
|
|
(1 |
) |
|
|
(35 |
) |
Included
in other comprehensive income
|
|
|
415 |
|
|
|
(10 |
) |
|
|
- |
|
|
|
405 |
|
Purhases
and settlements (net)
|
|
|
(246 |
) |
|
|
(133 |
) |
|
|
- |
|
|
|
(379 |
) |
Balance
at 3/31/08
|
|
$ |
1,860 |
|
|
$ |
320 |
|
|
$ |
11 |
|
|
$ |
2,191 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
amount of total gains or (losses) for the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
period
included in earnings attributable to the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
change
in unrealized gains or losses relating to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
assets
still held at 3/31/08
|
|
$ |
(26 |
) |
|
$ |
- |
|
|
$ |
(1 |
) |
|
$ |
(27 |
) |
All
settlements from fuel derivative contracts that are deemed “effective” as
defined in SFAS 133, are included in Fuel and oil expense in the period that the
underlying fuel is consumed in operations. Any “ineffectiveness”
associated with these derivative contracts, as defined in SFAS 133, are recorded
in earnings immediately. See Note 5 for further information on SFAS
133 and hedging. Gains and losses (realized and unrealized) included
in earnings related to fuel derivatives for first quarter 2008 are reported in
Other (gains) losses, net.
Gains and
losses (realized and unrealized) included in earnings related to other
investments for first quarter 2008 are reported in Other operating
expenses.
13. RECENT
ACCOUNTING PRONOUNCEMENTS
In March
2008, the FASB issued Statement No. 161, “Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No. 133”
(Statement 161). Statement 161 requires entities that utilize
derivative instruments to provide qualitative disclosures about their objectives
and strategies for using such instruments, as well as any details of
credit-risk-related contingent features contained within
derivatives. Statement 161 also requires entities to disclose
additional information about the amounts and location of derivatives located
within the financial statements, how the provisions of SFAS 133 has been
applied, and the impact that hedges have on an entity’s financial position,
financial performance, and cash flows. Statement 161 is effective for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company currently provides an abundance
of information about its hedging activities and use of derivatives in its
quarterly and annual filings with the SEC, including many of the disclosures
contained within Statement 161. Thus, the Company currently does not
anticipate the adoption of Statement 161 will have a material impact on the
disclosures already provided.
14. SUBSEQUENT
EVENTS
In early
April 2008, the Company's sole codeshare partner, ATA Airlines, Inc. (ATA)
declared bankruptcy and discontinued all scheduled passenger service.
Southwest and ATA have had a codeshare agreement since February 2005.
Southwest also marketed and sold ATA-only flights. Operating revenues from the
Company's codeshare and marketing relationship with ATA were approximately $40
million in 2007. However, ATA had recently decreased service in codeshare
markets with Southwest, and the Company had already anticipated declining
codeshare revenues in 2008. In first quarter 2008, the Company recognized
approximately $6 million in codeshare and marketing related
revenues. Given ATA’s cessation of commercial service, Southwest is
no longer conducting codeshare operations with ATA and is pursuing codeshare
opportunities with other carriers, both domestic and international.
Southwest offered
assistance to all Customers who purchased a ticket on www.southwest.com and were
scheduled to travel on ATA service, which included purchasing tickets for those
Customers on other airlines. The estimated cost associated with
accommodating codeshare and ATA passengers who purchased a ticket from Southwest
is expected to be in the $5 million range. This cost will be reflected as
a reduction to second quarter 2008's operating income.
15. TAX
RATE
The
Company’s effective tax rate was 8.9 percent in first quarter 2008 compared to
37.7 percent in first quarter 2007. The lower rate in first quarter
2008 was due primarily to the reversal of a state of Illinois tax law change
during first quarter 2008 that resulted in a net $12 million ($.01 per share,
diluted) decrease to state deferred tax liabilities. This law had
been enacted during fourth quarter 2007, resulting in a similar increase to tax
expense. As a result of this law change, the Company currently
expects its full year 2008 effective rate to be approximately 38 to 39
percent.
Item
2. Management's
Discussion and Analysis of Financial Condition and Results of
Operations
Comparative
Consolidated Operating Statistics
Relevant Southwest comparative
operating statistics for the three months ended March 31, 2008 and 2007 are as
follows:
|
|
Three
months ended March 31,
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
passengers carried
|
|
|
21,504,821 |
|
|
|
19,960,933 |
|
|
|
7.7 |
% |
Enplaned
passengers
|
|
|
24,708,615 |
|
|
|
22,903,073 |
|
|
|
7.9 |
% |
Revenue
passenger miles (RPMs) (000s)
|
|
|
17,592,159 |
|
|
|
16,109,071 |
|
|
|
9.2 |
% |
Available
seat miles (ASMs) (000s)
|
|
|
25,193,437 |
|
|
|
23,678,376 |
|
|
|
6.4 |
% |
Load
factor
|
|
|
69.8 |
% |
|
|
68.0 |
% |
|
1.8
|
pts |
Average
length of passenger haul (miles)
|
|
|
818 |
|
|
|
807 |
|
|
|
1.4 |
% |
Average
aircraft stage length (miles)
|
|
|
627 |
|
|
|
627 |
|
|
|
0.0 |
% |
Trips
flown
|
|
|
294,790 |
|
|
|
276,900 |
|
|
|
6.5 |
% |
Average
passenger fare
|
|
|
$112.24 |
|
|
|
$105.79 |
|
|
|
6.1 |
% |
Passenger
revenue yield per RPM (cents)
|
|
|
13.72 |
|
|
|
13.11 |
|
|
|
4.7 |
% |
Operating
revenue yield per ASM (cents)
|
|
|
10.04 |
|
|
|
9.28 |
|
|
|
8.2 |
% |
Operating
expenses per ASM (cents)
|
|
|
9.69 |
|
|
|
8.93 |
|
|
|
8.5 |
% |
Fuel
costs per gallon, excluding fuel tax
|
|
|
$2.01 |
|
|
|
$1.60 |
|
|
|
25.6 |
% |
Fuel
consumed, in gallons (millions)
|
|
|
373 |
|
|
|
352 |
|
|
|
6.0 |
% |
Full-time
equivalent Employees at period-end
|
|
|
33,895 |
|
|
|
32,962 |
|
|
|
2.8 |
% |
Size
of fleet at period-end
|
|
|
527 |
|
|
|
489 |
|
|
|
7.8 |
% |
Material
Changes in Results of Operations
Summary
The
Company’s first quarter 2008 net income was $34 million ($.05 per share,
diluted), representing the Company’s 68th
consecutive quarterly profit. This, however, did not compare
favorably to the Company’s first quarter 2007 profit of $93 million ($.12 per
share, diluted). Both first quarter 2008 and first quarter 2007 had
significant adjustments related to derivative contracts the Company utilizes in
attempting to hedge against jet fuel price increases. In first
quarter 2008, hedge ineffectiveness associated with the derivatives Southwest
uses for hedging purposes resulted in unrealized expense related to these
contracts. Primarily as a result of the first quarter 2008
fluctuation in prices for fuel derivatives that will settle in future periods or
that were ineffective, as defined, or that did not qualify for special hedge
accounting, the Company recorded $23 million in net losses, which are included
in “Other (gains) losses, net.” In first quarter 2007, the Company
recorded a total of $83 million in gains associated with fuel derivatives that
were ineffective, as defined, or did not qualify for special hedge
accounting. See Note 5 to the unaudited condensed consolidated
financial statements for further information on the Company’s hedging
activities.
First
quarter 2008 operating income increased $4 million, or 4.8 percent, compared to
first quarter 2007, as an increase in operating revenues outpaced higher
operating costs, most notably fuel and oil expense. Due to the
significant unrealized adjustments recorded to “Other (gains) losses, net,”
which is below the operating income line, the Company believes operating income
provides a better indication of the Company’s financial performance in both
years than does net income. Although the Company’s fuel hedging
program has resulted in significant unrealized gains and losses being recorded
to “Other (gains) losses, net” for several years, it also continues to provide
excellent economic benefits to the Company. The Company’s hedging
program resulted in the realization of approximately $302 million in cash
settlements for first quarter 2008 compared to $65 million in cash settlements
for first quarter 2007. The majority of the $302 million in first
quarter 2008 cash settlements were reflected as a reduction to Fuel and oil
expense. Even including this first quarter 2008 hedge position, fuel
cost per gallon increased 25.6 percent versus first quarter 2007.
In
addition to the strong fuel hedge position held by the Company, the higher first
quarter operating income was largely driven by a strong revenue
performance. Operating revenues grew 15.1 percent as a result of
strong demand for low fares, the revenue initiatives introduced by the Company
in fourth quarter 2007, and the fact that the Easter holiday fell in March of
2008 versus falling in April of 2007. In addition, the Company
believes it has benefited from its prior decision to slow its growth rate in
2008 due to continued signs of a domestic economic slowdown coupled with the
unprecedented high prices for fuel. In fact, these factors were also
the primary drivers in the Company’s April 2008 announcement to reduce its
flight schedule again in August 2008, which will bring its 2008 ASM capacity
growth to roughly 3.5 percent versus our previous year-over-year guidance of
four to five percent. The Company believes that recent capacity
reductions by many domestic airlines, as well as recent airline bankruptcies,
have given or are expected to increase the likelihood that airlines could raise
fares to combat the enormous fuel burden in today’s domestic airline
environment.
The
Company continues to be cautious of current domestic economic conditions, as
recessionary fears have continued to proliferate. In recent history,
all periods of U.S. economic recession have produced significant declines in the
dollars spent on commercial air travel. However, the Company believes
that, given its operating cost structure, strong balance sheet, and tremendous
fuel hedging advantage, it is in a better position to withstand such a drop than
the vast majority of its airline competitors.
In early April 2008, the Company's sole
codeshare partner, ATA Airlines, Inc. (ATA) declared bankruptcy and discontinued
all scheduled passenger service. Southwest and ATA have had a
codeshare agreement since February 2005. Southwest also marketed and sold
ATA-only flights. The Company's codeshare and marketing relationship with ATA
boosted operating revenues by approximately $40 million in 2007.
However, ATA had recently decreased service in codeshare markets with Southwest,
and the Company had already anticipated declining codeshare revenues in
2008. In first quarter 2008, the Company recognized approximately $6
million in codeshare and marketing related revenues. Given ATA’s
cessation of commercial service, Southwest is no longer conducting codeshare
operations with ATA and is pursuing codeshare opportunities with other carriers,
both domestic and international. Southwest offered assistance to
all Customers who purchased a ticket on www.southwest.com and were scheduled to
travel on ATA service, which included purchasing tickets for those Customers on
other airlines. The estimated cost associated with accommodating
codeshare and ATA passengers who purchased a ticket from Southwest is expected
to be in the $5 million range. This cost will be reflected as a reduction
to second quarter 2008's operating income.
Based on
our current forecast, the Company expects second quarter 2008 capacity to grow
approximately five percent versus second quarter 2007. However, the
Company will continue to take steps to restore its profit margins, including an
ongoing rigorous review of its flight schedule to eliminate nonproductive
flying. Presently, the Company still plans to accept 29 new Boeing
737-700s in 2008, but it is reviewing its previous plan to retire 22 aircraft in
light of recent dramatic industry developments. The Company has
flexibility to adjust its fleet plans and is well-positioned to respond to a
rapidly changing environment.
Comparison
of three months ended March 31, 2008, to three months ended March 31,
2007
Revenues
Consolidated operating revenues
increased by $332 million, or 15.1 percent, due primarily to a $302 million, or
14.3 percent, increase in Passenger revenues. Approximately 45
percent of the increase in Passenger revenues was primarily attributable to the
increase in capacity, as the Company added 38 aircraft since the end of first
quarter 2007 (less five aircraft retirements). Of the remainder of
the Passenger revenue increase, the majority was due to the 4.7 percent increase
in Passenger yield per Revenue Passenger Mile (RPM). The Company’s
first quarter 2008 load factor also increased 1.8 points versus first quarter
2007 and represented a Company record for the quarter at 69.8
percent. As a result of this higher load factor and the higher RPM
yields, Passenger revenues per available seat mile also increased 7.4 percent
compared to first quarter 2007. The Company has not detected any
significant impact to its revenues or future bookings as a result of the
F.A.A.’s proposed action against the Company in first quarter
2008. See Note 11 to the unaudited condensed consolidated financial
statements for further information.
Taking into account the Easter shift to March this year (vs. April last year),
traffic thus far in April has been solid and bookings for the remainder of
second quarter 2008 appear strong. Barring a further slowdown in the
domestic economy, based on current trends, which include encouraging results
from the Company’s revenue initiatives and the airline industry's domestic
capacity outlook, the Company expects favorable year-over-year unit revenue
results again in second quarter 2008.
Consolidated freight revenues increased
by $4 million, or 13.3 percent, primarily as a result of higher rates
charged. The Company expects a comparable increase in consolidated
freight revenues for second quarter 2008 compared to second quarter
2007. Other revenues increased by $26 million, or 46.4 percent,
compared to first quarter 2007, due primarily to higher commissions earned from
programs the Company sponsors with certain business partners, such as the
Company sponsored co-branded Visa card. This included a new long term
agreement signed with a business partner during second quarter 2007, which
resulted in higher rates and certain incentives that the Company had not
received in previous agreements for our co-branded Visa card. The
Company expects another increase in Other revenues for second quarter 2008, but
more in line with the Company’s capacity growth.
Operating
expenses
Consolidated operating expenses for
first quarter 2008 increased $328 million, or 15.5 percent, compared to first
quarter 2007, versus a 6.4 percent increase in capacity compared to first
quarter 2007. Historically, changes in operating expenses for
airlines are typically driven by changes in capacity, or ASMs. The
following presents Southwest’s operating expenses per ASM for first quarter 2008
and first quarter 2007 followed by explanations of these changes on a per-ASM
basis and/or on a dollar basis (in cents, except for percentages):
|
|
Three
months ended March 31,
|
|
|
Per
ASM
|
|
|
Percent
|
|
|
|
2008
|
|
|
|
2007
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries,
wages, and benefits
|
|
|
3.17 |
|
|
|
|
3.24 |
|
|
|
(.07 |
) |
|
|
(2.2 |
) |
Fuel
and oil
|
|
|
2.99 |
|
|
|
|
2.38 |
|
|
|
.61 |
|
|
|
25.6 |
|
Maintenance
materials
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
repairs
|
|
|
.57 |
|
|
|
|
.58 |
|
|
|
(.01 |
) |
|
|
(1.7 |
) |
Aircraft
rentals
|
|
|
.15 |
|
|
|
|
.16 |
|
|
|
(.01 |
) |
|
|
(6.3 |
) |
Landing
fees and other rentals
|
|
|
.68 |
|
|
|
|
.58 |
|
|
|
.10 |
|
|
|
17.2 |
|
Depreciation
|
|
|
.58 |
|
|
|
|
.57 |
|
|
|
.01 |
|
|
|
1.8 |
|
Other
operating expenses
|
|
|
1.55 |
|
|
|
|
1.42 |
|
|
|
.13 |
|
|
|
9.2 |
|
Total
|
|
|
9.69 |
|
|
|
|
8.93 |
|
|
|
.76 |
|
|
|
8.5 |
|
Operating expenses per ASM were 9.69
cents, an 8.5 percent increase compared to 8.93 cents for first quarter
2007. In excess of 80 percent of the increase per ASM was due to
higher fuel costs, as the Company’s average cost per gallon of fuel increased
25.6 percent versus the prior year, net of hedging. On a dollar
basis, operating expenses increased $328 million. Over 55 percent of
this dollar increase was due to higher fuel and oil expense, primarily as a
result of the significant increase in fuel cost per gallon. The
majority of the remainder of the dollar increase was due to the Company’s
increase in capacity versus first quarter 2007. Based on current unit
operating cost trends and various cost pressures, the Company expects second
quarter 2008 unit costs to be higher than first quarter 2008’s 9.69 cents per
ASM, due primarily to higher fuel and oil expense and higher planned maintenance
costs.
Salaries, wages, and benefits expense per ASM declined slightly compared to
first quarter 2007, but on a dollar basis increased $33 million. On a per-ASM
basis, the Company’s Salaries, wages and benefits decreased as a result of lower
share-based compensation expense versus first quarter 2007. See Note
2 to the unaudited condensed consolidated financial statements for further
information on share-based compensation. In addition, the Company
continues its efforts to enhance its workforce productivity as the number of
full-time equivalent Employees per aircraft in the Company’s fleet declined to
64 at March 31, 2008, versus 67 at March 31, 2007. On a dollar basis,
Salaries, wages and benefits increased due primarily to higher wages from a 2.8
percent increase in headcount, partially offset by lower share-based
compensation expense. The Company currently expects
Salaries, wages, and benefits per ASM in second quarter 2008 to be lower than
second quarter 2007, excluding profitsharing, due primarily to lower expected
share-based compensation expense.
Fuel and
oil expense increased $189 million, and on a per ASM basis increased 25.6
percent, due primarily to a change in the fuel hedge held by the Company in
first quarter 2008 versus first quarter 2007 as well as higher average prices,
excluding hedging. In first quarter 2008, the Company held fuel
derivative instruments that hedged a smaller portion of its fuel consumption
than in first quarter 2007. In addition, this hedge was at a higher
average fuel price than the Company’s hedge in first quarter
2007. The Company’s average fuel cost per gallon in first quarter
2008 was $2.01, which was 25.6 percent higher than first quarter 2007, including
the effects of hedging activities. Excluding hedging, the Company’s
average fuel cost per gallon in first quarter 2008 was $2.79 versus $1.82 in
first quarter 2007. For first quarter 2008, the Company had protected
over 70 percent of its anticipated fuel needs at a crude oil-equivalent price of
approximately $51 per barrel, resulting in gains recorded in Fuel and oil
expense of $291 million. First quarter 2007 hedging gains recorded in
Fuel and oil expense were $79 million.
For
second quarter 2008, the Company has fuel derivatives in place for approximately
70 percent of its expected fuel consumption with a combination of derivative
instruments that effectively cap prices at approximately $51 per barrel of crude
oil and has added refinery margins on the majority of those
positions. Based on this protection and market prices as of April 16,
we are currently estimating our second quarter 2008 jet fuel cost per gallon to
be in the $2.35 range, significantly higher than first quarter 2008 even with
anticipated hedging gains significantly higher than first quarter 2008, and
excluding the effects of any ineffectiveness from the Company’s fuel hedging
program. The majority of the Company's near term fuel derivatives are
in the form of option contracts. At March 31, 2008, the estimated net
fair value of the Company’s fuel derivative contracts was $2.8
billion. See Note 5 to the unaudited condensed consolidated financial
statements for further discussion of the Company’s hedging activities. The
Company has also continued its efforts to conserve fuel, and in 2007 began
installing Aviation Partners Boeing Blended Winglets on a significant number of
its 737-300 aircraft (substantially all 737-700 aircraft are already equipped
with winglets). Installations on these 737-300 aircraft are expected
to be completed in late 2008 or early 2009. This and other fuel
conservation efforts resulted in a 1.9 percent decrease in the Company’s fuel
burn rate for first quarter 2008 versus first quarter 2007.
Maintenance materials and repairs
increased 5.1 percent, and on a dollar basis increased $7 million compared to
first quarter 2007, but decreased 1.7 percent on a per-ASM basis compared to
first quarter 2007. The majority of the increase on a dollar basis
was due to an increase in inspection and repair events for
airframes. This increase in airframe maintenance was due to the
maturing of the Company’s fleet as well as the ongoing transition to a new
airframe maintenance program for 737-300 and 737-500 aircraft, which began in
2006. The decrease in maintenance materials and repairs per ASM
compared to first quarter 2007 was due primarily to a decline in expense related
to the Company’s 737-700 aircraft engines. The Company expects
Maintenance materials and repairs per ASM for second quarter 2008 to be up
significantly versus second quarter 2007 based on currently scheduled
maintenance events for airframes and engines.
Aircraft
rentals per ASM decreased 6.3 percent compared to first quarter 2007, and, on a
dollar basis, expense decreased $1 million. The decrease per ASM was
due primarily to the 6.4 percent increase in ASMs, combined with the slight
reduction in expense on a dollar basis. The slight decrease in
expense on a dollar basis was due to the retirement of five formerly leased
737-300 aircraft in first quarter 2008, partially offset by the lease of two
737-700 aircraft from a third party in second quarter 2007. The
Company currently expects Aircraft rentals per ASM for second quarter 2008 to be
at approximately the same level as first quarter 2008.
Landing
fees and other rentals increased $35 million on a dollar basis, and on a per ASM
basis increased 17.2 percent compared to first quarter 2007. The
majority of the increases on both a dollar basis and a per ASM basis were due to
a higher amount of audit settlement charges paid to airports in first quarter
2008. The Company currently expects Landing fees and other rentals
per ASM in second quarter 2008 to be in the low 60 cents per ASM range in second
quarter 2007. The increase is expected to be due primarily to higher
space rentals in airports as a result of both space increases by the Company to
accommodate new flight activity and higher rates charged by those airports for
gate and terminal space.
Depreciation expenses per ASM increased
by $10 million on a dollar basis compared to first quarter 2007, but only
slightly on a per-ASM basis. The increase on a dollar basis was due
primarily to the Company’s net addition of 38 Boeing 737s to its fleet over the
past twelve months. For second quarter 2008, the Company expects
Depreciation expenses per ASM to be comparable to first quarter 2008’s .58
cents.
Other operating expenses per ASM
increased 9.2 percent compared to first quarter 2007, and, on a dollar basis,
increased $55 million. Approximately 30 percent of the increase per
ASM was due to higher advertising costs, and approximately 30 percent of the
increase per ASM was due to a proposed fine of approximately $10 million by the
F.A.A. related to an incident concerning the Company’s alleged non-compliance
with an airworthiness directive. The majority of the remainder of the
increase was due primarily to higher fuel taxes associated with the significant
increase in fuel costs, excluding the impact of hedging. The largest
items contributing to the dollar increase were a $13 million increase in
advertising costs, the $10 million fine proposed by the F.A.A., and a $9 million
increase in fuel taxes. With respect to the F.A.A.’s proposed fine,
the Company has started an “informal conference” with the F.A.A., which is a
process through which the Company and the F.A.A. may explore common ground (or
differences) to determine whether the matter will be formally litigated or
resolved. The Company has accrued the entire amount in the period
during which the F.A.A. proposed the fine, which was first quarter
2008. For second quarter 2008, the Company currently expects Other
operating expenses per ASM to exceed first quarter 2008’s 1.55 cents, excluding
any impact the Company may have from the sale of aircraft.
Through the 2003 Emergency Wartime
Supplemental Appropriations Act, the federal government has continued to provide
renewable, supplemental, first-party war-risk insurance coverage to commercial
carriers, at substantially lower premiums than prevailing commercial rates and
for levels of coverage not available in the commercial
market. The government-provided supplemental coverage from the
Wartime Act is currently set to expire on August 31, 2008. Although
another extension beyond this date is expected, if such coverage is not extended
by the government, the Company could incur substantially higher insurance costs
or unavailability of adequate coverage in future periods.
Other
Interest expense decreased $1 million,
or 3.4 percent, compared to first quarter 2007, due primarily to a decrease in
market interest rates. The majority of the Company’s long-term debt
is at floating rates. See Notes 5 and 10 to the unaudited condensed
consolidated financial statements for more information.
Capitalized interest decreased $5
million compared to the prior year due primarily to a decline in both interest
rates and a decrease in progress payment balances for scheduled future aircraft
deliveries.
Interest income decreased by $6
million, or 46.2 percent, due primarily to a decrease in the average balance of
invested cash and short-term investments. The Company’s cash and cash
equivalents and short-term investments as of March 31, 2008 and 2007, included
$2.6 billion and $885 million, respectively, in collateral deposits received
from the counterparties of the Company’s fuel derivative
instruments. Although these amounts are not restricted in any way,
the Company generally must remit the investment earnings from these amounts back
to the counterparties. Depending on the fair value of the Company’s
fuel derivative instruments, the amounts of collateral deposits held at any
point in time can fluctuate significantly. Therefore, the Company
generally excludes the cash collateral deposits in its decisions related to
long-term cash planning and forecasting. See Item 3 for further
information on these collateral deposits and Note 5 to the unaudited condensed
consolidated financial statements for further information on fuel derivative
instruments.
Other (gains) losses, net, primarily
includes amounts recorded in accordance with the Company’s hedging activities
and SFAS 133. The following table displays the components of Other
(gains) losses, net, for the three months ended March 31, 2008 and
2007:
|
|
Three
months ended March 31,
|
|
(In
millions)
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
Mark-to-market
impact from fuel contracts settling in future
|
|
|
|
|
|
|
|
periods
- included in Other (gains) losses, net
|
|
$ |
7 |
|
|
|
$ |
(85 |
) |
Ineffectiveness
from fuel hedges settling in future periods -
|
|
|
|
|
|
|
|
|
|
included
in Other (gains) losses, net
|
|
|
- |
|
|
|
|
6 |
|
Realized
ineffectiveness and mark-to-market (gains) or
|
|
|
|
|
|
|
|
|
|
losses
- included in Other (gains) losses, net
|
|
|
16 |
|
|
|
|
(4 |
) |
Premium
cost of fuel contracts included in Other (gains) losses,
net
|
|
|
14 |
|
|
|
|
14 |
|
Other
|
|
|
1 |
|
|
|
|
1 |
|
|
|
$ |
38 |
|
|
|
$ |
(68 |
) |
For the
expense related to amounts excluded from the Company's measurements of hedge
effectiveness (i.e., the premium cost of option and collar derivative contracts
that settled during first quarter 2008), the Company expects a similar expense
relating to these items in second quarter 2008.
The Company’s effective tax rate was
8.9 percent in first quarter 2008 compared to 37.7 percent in first quarter
2007. The lower rate in first quarter 2008 was due primarily to the
reversal of a state of Illinois tax law change during first quarter 2008 that
resulted in a net $12 million ($.01 per share, diluted) decrease to state
deferred tax liabilities. This law had been enacted during fourth
quarter 2007, resulting in a similar increase to tax expense. As a
result of this law change, the Company currently expects its full year 2008
effective rate to be approximately 38 to 39 percent.
Liquidity
and Capital Resources
Net cash provided by operating
activities was $964 million for the three months ended March 31, 2008, compared
to $617 million provided by operating activities in the same prior year
period. The operating cash flows in the first quarter of both years
were largely impacted by fluctuations in counterparty deposits associated with
the Company’s fuel hedging program. There was an increase in
counterparty deposits of $570 million for the three months ended March 31, 2008,
versus an increase of $345 million during the three months ended March 31, 2007
(counterparty deposits are classified in Accrued liabilities in the unaudited
condensed Consolidated Balance Sheet). The fluctuations in these
deposits in both years have been due to large changes in the fair value of the
Company’s fuel derivatives portfolio. The fair value of the Company’s
fuel derivatives increased from $2.4 billion at December 31, 2007, to $2.8
billion at March 31, 2008, and increased from $1.0 billion at December 31, 2006,
to $1.4 billion at March 31, 2007. Depending on the fair value of the
Company’s fuel derivative instruments, the amounts of collateral deposits held
at any point in time can fluctuate significantly. Therefore, the
Company generally excludes the cash collateral deposits in its decisions related
to long-term cash planning and forecasting. See Item 3, and Notes 5
and 7 to the unaudited condensed consolidated financial
statements. Cash flows from operating activities for both years were
also impacted by changes in Air traffic liability. For the three
months ended March 31, 2008, there was a $267 million increase in Air traffic
liability, as a result of seasonal bookings for future travel. This
compared to the prior year $210 million increase in Air traffic
liability. Net cash provided by operating activities is primarily
used to finance capital expenditures.
Net cash
flows used in investing activities during the three months ended March 31, 2008,
totaled $126 million compared to $271 million in 2007. Investing
activities in both years consisted of payments for new 737-700 aircraft
delivered to the Company and progress payments for future aircraft deliveries,
as well as changes in the balance of the Company’s short-term investments,
namely auction rate securities. During the three months ended March
31, 2008, the Company’s short-term investments decreased by a net $238 million,
versus a net decrease of $54 million during the same prior year
period.
Net cash
used in financing activities during the three months ended March 31, 2008, was
$69 million compared to $118 million used in financing activities for the same
period in 2007. During the three months ended March 31, 2008, the
Company repurchased $54 million of its Common Stock, representing a total of 4.4
million shares. During the three months ended March 31, 2007, the
Company repurchased $209 million of its Common Stock, representing a total of
13.5 million shares. This outflow was partially offset by $78 million received
from Employees’ exercise of stock options.
Contractual
Obligations and Contingent Liabilities and Commitments
Southwest has contractual obligations
and commitments primarily for future purchases of aircraft, payment of debt, and
lease arrangements. Through the first three months of 2008, the
Company purchased 12 new 737-700 aircraft from Boeing and is scheduled to
receive 17 more 737-700 aircraft from Boeing during the remainder of 2008 (nine
in second quarter, five in third quarter, and three in fourth
quarter). The Company also retired five of its older leased 737-300
aircraft during first quarter 2008. Based on recent dramatic industry
developments, the Company is currently reviewing its previous plan to retire 22
of its aircraft during 2008. However, the Company has made
adjustments to its delivery schedule for new Boeing aircraft for 2009 and
subsequent years. As of April 17, 2008, Southwest’s firm orders and
options to purchase new 737-700 aircraft from Boeing are reflected in the
following table:
|
|
The
Boeing Company
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase
|
|
|
|
|
|
|
Firm
|
|
|
Options
|
|
|
Rights
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
29 |
|
|
|
- |
|
|
|
- |
|
|
|
29
|
* |
2009
|
|
|
14 |
|
|
|
- |
|
|
|
- |
|
|
|
14 |
|
2010
|
|
|
16 |
|
|
|
6 |
|
|
|
- |
|
|
|
22 |
|
2011
|
|
|
13 |
|
|
|
19 |
|
|
|
- |
|
|
|
32 |
|
2012
|
|
|
13 |
|
|
|
27 |
|
|
|
- |
|
|
|
40 |
|
2013
|
|
|
19 |
|
|
|
1 |
|
|
|
- |
|
|
|
20 |
|
2014
|
|
|
10 |
|
|
|
8 |
|
|
|
- |
|
|
|
18 |
|
2015
|
|
|
11 |
|
|
|
6 |
|
|
|
- |
|
|
|
17 |
|
Through
2018
|
|
|
- |
|
|
|
- |
|
|
|
54 |
|
|
|
54 |
|
Total
|
|
|
125 |
|
|
|
67 |
|
|
|
54 |
|
|
|
246 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Currently
plan to reduce fleet by 22 aircraft, bringing 2008 net
additions
|
|
to
seven aircraft.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table details information on the 527 aircraft in the Company’s
fleet as of March 31, 2008:
|
|
|
|
|
|
Average
|
|
|
Number
|
|
|
Number
|
|
|
Number
|
|
737
Type
|
|
|
Seats
|
|
|
Age
(Yrs)
|
|
|
of
Aircraft
|
|
|
Owned
|
|
|
Leased
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-300
|
|
|
|
137 |
|
|
|
16.8 |
|
|
|
189 |
|
|
|
112 |
|
|
|
77 |
|
|
-500
|
|
|
|
122 |
|
|
|
16.9 |
|
|
|
25 |
|
|
|
16 |
|
|
|
9 |
|
|
-700
|
|
|
|
137 |
|
|
|
4.2 |
|
|
|
313 |
|
|
|
309 |
|
|
|
4 |
|
TOTALS
|
|
|
|
|
|
|
|
9.3 |
|
|
|
527 |
|
|
|
437 |
|
|
|
90 |
|
The Company has the option, which must
be exercised two years prior to the contractual delivery date, to substitute
-600s or -800s for the -700s. Based on the above delivery schedule,
aggregate funding needed for firm aircraft commitments was approximately $3.5
billion, subject to adjustments for inflation, due as follows: $407 million
remaining in 2008, $439 million in 2009, $473 million in 2010, $523 million in
2011, $529 million in 2012, $558 million in 2013, and $549 million
thereafter.
The Company has various options
available to meet its capital and operating commitments, including cash on hand
and short term investments at March 31, 2008, of $3.1 billion, internally
generated funds, and the Company’s fully available $600 million revolving credit
facility. As discussed in Note 10 to the unaudited condensed
consolidated financial statements, on October 3, 2007, the Company issued $500
million Pass Through Certificates consisting of $412 million 6.15% Series A
certificates and $88 million 6.65% Series B certificates. The Company
will also consider various borrowing or leasing options to maximize earnings and
supplement cash requirements.
In January 2008, the Company’s Board of
Directors authorized the repurchase of up to $500 million of the Company’s
Common Stock. Repurchases may 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 had repurchased 4.4
million shares for a total of $54 million as part of this program through
February 15, 2008; however, the Company has not repurchased any additional
shares from that date through the date of this filing. The Company
does not believe it is prudent to repurchase shares at the
current time considering today's unstable financial markets and soaring
fuel prices. See Item 2 of Part II of this Form 10-Q for further
information on this repurchase program.
The Company currently has outstanding
shelf registrations for the issuance of up to $540 million in public debt
securities and pass-through certificates, which it may utilize for aircraft
financings or other purposes in the future.
Fair
value measurements
As discussed in Note 12 to the
unaudited condensed consolidated financial statements, the Company adopted the
provisions of Statement 157 effective January 1, 2008. The Company
has determined that it utilizes unobservable (Level 3) inputs in determining the
fair value of its auction rate security investments and its fuel derivative
option contracts, which totaled $321 million and $1.9 billion, respectively, at
March 31, 2008, as well as $11 million in other investments.
The
Company’s auction rate security instruments are classified as available for sale
securities and reflected at fair value. In prior periods, due to the
auction process which took place every 30-35 days for most securities, quoted
market prices were readily available, which would qualify as Level 1 under
Statement 157. However, due to events in credit markets during first
quarter 2008, the auction events for most of these instruments failed, and,
therefore, the Company has determined the estimated fair values of these
securities utilizing a discounted cash flow analysis or other type of valuation
model as of March 31, 2008. These analyses consider, among other
items, the collateralization underlying the security investments, the expected
future cash flows, including the final maturity, associated with the securities,
and the expectation of the next time the security is expected to have a
successful auction. These securities were also compared, when
possible, to other observable market data with similar characteristics to the
securities held by the Company. Due to these events, the Company
reclassified these instruments as Level 3 during first quarter 2008 and recorded
a temporary unrealized decline in fair value of $10 million, with an offsetting
entry to accumulated other comprehensive income. The Company
currently believes that this temporary decline in fair value is due entirely to
liquidity issues, because the underlying assets for the majority of securities
are almost entirely backed by the U.S. government. In addition, the
Company’s holdings of auction rate securities represented less than ten percent
of its total cash, cash equivalent, and investment balance at March 31, 2008,
which it believes allows it sufficient time for the securities to return to full
value. Because the Company believes that the current decline in fair
value is temporary and based only on liquidity issues in the credit markets, any
difference between its estimate and an estimate that would be arrived at by
another party would have no impact on the Company’s earnings, since such
difference would also be recorded to accumulated other comprehensive
income. The Company will re-evaluate each of these factors as market
conditions change in subsequent periods.
The
Company determines the value of fuel derivative option contracts utilizing a
standard option pricing model based on inputs that are either readily available
in public markets, can be derived from information available in publicly quoted
markets, or are quoted by its counterparties. In situations where the Company
obtains inputs via quotes from its counterparties, it verifies the
reasonableness of these quotes via similar quotes from another counterparty as
of each date for which financial statements are prepared. The Company
has consistently applied these valuation techniques in all periods presented and
believes it has obtained the most accurate information available for the types
of derivative contracts it holds. Due to the fact that certain inputs
used in determining estimated fair value of its option contracts are considered
unobservable (primarily volatility), as defined in Statement 157, the Company
has categorized these option contracts as Level 3.
As noted in Note 5 to the unaudited
condensed consolidated financial statements, any changes in the fair values of
fuel derivative instruments are subject to the requirements of SFAS
133. Any changes in fair value that are considered to be effective,
as defined, are offset within accumulated other comprehensive income until the
period in which the expected cash flow impacts earnings. Any changes
in the fair value of fuel derivatives that are ineffective, as defined, or do
not qualify for special hedge accounting, are reflected in earnings within Other
(gains)/losses, net, in the period of the change. Because the Company
has extensive historical experience in valuing the derivative instruments it
holds, and such experience is continually evaluated against its counterparties
each period when such instruments expire and are settled for cash, the Company
believes it is unlikely that an independent third party would value the
Company’s derivative contracts at a significantly different amount than what is
reflected in the Company’s financial statements. In addition, the
Company also has bilateral credit provisions in some of its counterparty
agreements, which provide for parties to provide cash collateral when the fair
values of fuel derivatives with a single party exceeds certain threshold
levels. Since this cash collateral is based on the estimated fair
value of the Company’s outstanding fuel derivative contracts, this provides
further validation to the Company’s estimate of fair values. See Item
3, Quantitative and Qualitative Disclosures About Market Risk, for further
information.
Forward
looking statements
Some
statements in this Form 10-Q (or otherwise made by the Company or on the
Company’s behalf from time to time in other reports, filings with the Securities
and Exchange Commission, news releases, conferences, Internet postings, or
otherwise) that are not historical facts may be “forward-looking statements”
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements are based on, and include statements about, Southwest’s estimates,
expectations, beliefs, intentions, or strategies for the future, and the
assumptions underlying these forward-looking statements. Specific
forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts and include, without limitation,
statements regarding (i) the anticipated impact on the Company’s
operations of domestic economic conditions, as well as recent industry events
such as competitor bankruptcy filings, capacity reductions, and announcements
related to potential industry consolidation; (ii) the Company’s expectations
with respect to second quarter 2008 and full year 2008 revenues and operating
expenses; (iii) the Company’s plans for capacity growth; (iv) the Company’s
anticipated liquidity, including anticipated needs for, and sources of, funds
and its plans and expectations for managing exposure to material increases in
jet fuel prices; and (v) the Company’s expectations and intentions relating to
outstanding litigation and other claims relating to the F.A.A.’s audits of the
Company. While management believes that these forward-looking statements are
reasonable as and when made, forward-looking statements are not guarantees of
future performance and involve risks and uncertainties that are difficult to
predict. Therefore, actual results may differ materially from what is
expressed in or indicated by the Company’s forward-looking statements or from
historical experience or the Company’s present expectations. Factors
that could cause these differences include, among others:
|
(i)
|
the
price and availability of aircraft fuel and the Company’s ability to pass
fuel cost increases through to the consumer in the form of fare
increases;
|
|
(ii)
|
the
Company’s ability to timely and effectively prioritize its revenue and
cost reduction initiatives and its related ability to timely and
effectively implement, transition, and maintain the necessary information
technology systems and infrastructure to support these
initiatives;
|
|
(iii)
|
the
extent and timing of the Company’s investment of incremental operating
expenses and capital expenditures to develop and implement its initiatives
and its corresponding ability to effectively control its operating
expenses;
|
|
(iv)
|
the
Company’s dependence on third party arrangements to assist with
implementation of certain of its
initiatives;
|
(v)
|
the
impact of governmental regulations and inquiries on the Company’s
operating costs, as well as its operations generally, and the impact of
developments affecting the Company’s outstanding litigation and other
claims against the Company;
|
(vi)
|
the
impact of certain pending technological initiatives on the Company’s
technology infrastructure, including its point of sale, ticketing, revenue
accounting, payroll and financial reporting
areas;
|
(vii)
|
competitor
capacity and load factors;
|
(viii)
|
the
Company’s ability to obtain financing on acceptable terms, and other
uncertainties created by the current instability of the credit markets;
and
|
|
(ix)
|
other
factors as set forth in the Company’s filings with the Securities and
Exchange Commission, including the detailed factors discussed under the
heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the
year ended December 31, 2007.
|
Caution
should be taken not to place undue reliance on the Company’s forward-looking
statements, which represent the Company’s views only as of the date this report
is filed. The Company undertakes no obligation to update publicly or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
As
discussed in Note 5 to the unaudited condensed consolidated financial
statements, the Company utilizes financial derivative instruments to hedge its
exposure to material increases in jet fuel prices. During the first
three months of 2008, the fair values of the Company’s fuel derivative contracts
increased along with increases in fuel prices. At March 31, 2008, the
estimated gross fair value of outstanding contracts was $2.8 billion, compared
to $2.4 billion at December 31, 2007.
Outstanding
financial derivative instruments expose the Company to credit loss in the event
of nonperformance by the counterparties to the agreements. However,
the Company does not expect any of the counterparties to fail to meet their
obligations. The credit exposure related to these financial
instruments is represented by the fair value of contracts with a positive fair
value at the reporting date. To manage credit risk, the Company
selects and periodically reviews counterparties based on credit ratings, limits
its exposure to a single counterparty, and monitors the market position of the
program and its relative market position with each counterparty. At March 31,
2008, the Company had agreements with nine 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 March 31, 2008, the Company
held $2.6 billion in fuel derivative 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 Company’s hedging program. The cash deposits, which can have a significant
impact on the Company’s cash balance, are included in Accrued liabilities on the
unaudited Condensed Consolidated Balance Sheet. Cash flows as of and
for a particular operating period are included as Operating cash flows in the
unaudited Condensed Consolidated Statement of Cash Flows. See also
Note 7 to the unaudited condensed consolidated financial
statements.
The
Company has investments in auction rate securities, which are classified as
available for sale securities and reflected at fair value. Due
primarily to instability in credit markets, the Company sold a portion of these
investments, and ended first quarter 2008 with investments valued at a total of
$320 million, of which $140 million are classified as Short-term investments and
$180 million are classified as Other assets in the unaudited Condensed
Consolidated Balance Sheet as of March 31, 2008. Auction rate
securities held at December 31, 2007, were $566 million, all of which were
classified as Short-term investments. For a complete discussion on
auction rate securities, including the Company’s methodology for estimating
their fair value, see Note 12 to the unaudited condensed consolidated financial
statements.
See Item 7A “Quantitative and
Qualitative Disclosures About Market Risk” in the Company’s Annual Report on
Form 10-K for the year ended December 31, 2007, and Note 5 to the unaudited
condensed consolidated financial statements for further information about Market
Risk.
Item 4.
Controls and Procedures
Disclosure
Controls and Procedures
The
Company maintains disclosure controls and procedures (as defined in Rule
13a-15(e) of the Securities Exchange Act) designed to provide reasonable
assurance that the information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in the SEC’s rules
and forms. These include controls and procedures designed to ensure
that this information is accumulated and communicated to the Company’s
management, including its Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required
disclosure. Management, with the participation of the Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness of the
Company’s disclosure controls and procedures as of March 31,
2008. Based on this evaluation, the Company’s Chief Executive Officer
and Chief Financial Officer have concluded that the Company’s disclosure
controls and procedures were effective as of March 31, 2008, at the reasonable
assurance level.
Internal
Control over Financial Reporting
There
were no changes in the Company’s internal control over financial reporting (as
defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter
ended March 31, 2008, that have materially affected, or are reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
PART II.
OTHER INFORMATION
Item
1. Legal Proceedings
On March
6, 2008, the F.A.A. notified the Company that it was seeking to fine the Company
approximately $10 million in connection with an incident concerning the
Company’s potential non-compliance with an airworthiness
directive. The Company has started an “informal conference” with the
F.A.A., which is a process through which the Company and the F.A.A. may explore
common ground (or differences) to determine whether the matter will be formally
litigated or resolved. The F.A.A. is continuing to audit the Company’s
compliance with airworthiness directives.
In
connection with the above incident, the Company has been named as a defendant in
two putative class actions on behalf of persons who purchased air travel from
the Company while the Company was allegedly in violation of F.A.A. safety
regulations. Claims alleged by the plaintiffs in these two putative class
actions include breach of contract, breach of warranty, fraud/misrepresentation,
unjust enrichment, and negligent and reckless operation of an
aircraft. The Company believes that the class action lawsuits are
without merit and intends to vigorously defend itself. The Company has also
recently received letters from four Shareholders demanding the Company commence
an action on behalf of the Company against members of its Board of Directors and
any other allegedly culpable parties for damages resulting from alleged breach
of fiduciary duties owed by them to the Company. To date, none of
these Shareholders has filed a derivative lawsuit in connection with these
demands. The Company is currently evaluating these
demands.
The
Company is from time to time subject to various other legal proceedings and
claims arising in the ordinary course of business, including, but not limited
to, examinations by the Internal Revenue Service.
The
Company's management does not expect that the outcome in any of its currently
ongoing legal proceedings or the outcome of any proposed adjustments presented
to date by the IRS, individually or collectively, will have a material adverse
effect on the Company's financial condition, results of operations, or cash
flow.
Item 1A.
Risk Factors
There have been no material changes to
the factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K
for the year ended December 31, 2007.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
(c)
Issuer
Purchases of Equity Securities (1)
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
(d)
|
|
|
|
|
|
|
|
|
|
Total
number of
|
|
|
Maximum
dollar
|
|
|
|
|
|
|
|
|
|
shares
purchased
|
|
|
value
of shares that
|
|
|
|
Total
number
|
|
|
Average
|
|
|
as
part of publicly
|
|
|
may
yet be purchased
|
|
|
|
of
shares
|
|
|
price
paid
|
|
|
announced
plans
|
|
|
under
the plans
|
|
Period
|
|
purchased
|
|
|
per
share
|
|
|
or
programs
|
|
|
or
programs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
1, 2008 through January 31, 2008
|
|
|
600,000 |
|
|
$ |
12.02 |
|
|
|
600,000 |
|
|
$ |
492,787,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February
1, 2008 through February 28, 2008
|
|
|
3,800,000 |
|
|
$ |
12.34 |
|
|
|
3,800,000 |
|
|
$ |
445,880,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
1, 2008 through March 31, 2008
|
|
|
- |
|
|
$ |
- |
|
|
|
- |
|
|
$ |
445,880,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4,400,000 |
|
|
|
|
|
|
|
4,400,000 |
|
|
|
|
|
(1) On
January 17, 2008, the Company’s Board of Directors authorized the repurchase of
up to $500 million of the Company’s Common Stock. Repurchases may 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 had repurchased 4.4 million shares for a
total of $54 million as part of this program through February 15, 2008; however,
the Company has not repurchased any additional shares from that date through the
date of this filing. The Company does not believe it is
prudent to repurchase shares currently considering today's
unstable financial markets and soaring fuel prices.
Item
3. Defaults upon Senior Securities
None
Item
4. Submission of Matters to a Vote of Security
Holders
None
Item
5. Other Information
None
Item
6. Exhibits
|
3.1
|
Restated
Articles of Incorporation of Southwest (incorporated by reference
to
|
|
|
Exhibit 4.1
to Southwest’s 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 Southwest’s 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 Southwest’s 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
Southwest’s
|
|
|
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 Southwest’s Quarterly Report on Form 10-Q for
the
|
|
|
quarter
ended June 30, 2001 (File No. 1-7259)); Articles of Amendment
to
|
|
|
Articles
of Incorporation of Southwest Airlines Co. (incorporated
by
|
|
|
reference
to Exhibit 3.1 to Southwest’s Quarterly Report on Form 10-Q for
the
|
|
|
quarter
ended June 30, 2007 (File No. 1-7259)).
|
|
3.2
|
Amended
and Restated Bylaws of Southwest, effective September 20,
2007
|
|
|
(incorporated
by reference to Exhibit 3.1 to Southwest’s Current
Report
|
|
|
on
Form 8-K dated September 20, 2007 (File
No. 1-7259)).
|
|
10.1
|
Supplemental
Agreement No. 57 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
|
10.2
|
Supplemental
Agreement No. 58 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
|
10.3
|
Supplemental
Agreement No. 59 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
|
31.1
|
Rule
13a-14(a) Certification of Chief Executive Officer
|
|
31.2
|
Rule
13a-14(a) Certification of Chief Financial Officer
|
|
32.1
|
Section
1350 Certifications of Chief Executive Officer and Chief Financial
Officer
|
(1) Pursuant
to 17 CRF 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.
SIGNATURES
Pursuant to the requirements of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.
|
SOUTHWEST
AIRLINES CO.
|
|
|
|
April
18, 2008
|
By
|
/s/ Laura
Wright
|
|
|
|
|
|
Laura
Wright
|
|
|
Chief
Financial Officer
|
|
|
(On
behalf of the Registrant and in
|
|
|
her
capacity as Principal Financial
|
|
|
and
Accounting Officer)
|
|
|
|
EXHIBIT
INDEX
|
3.1
|
Restated
Articles of Incorporation of Southwest (incorporated by reference
to
|
|
|
Exhibit 4.1
to Southwest’s 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 Southwest’s 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 Southwest’s 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
Southwest’s
|
|
|
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 Southwest’s Quarterly Report on Form 10-Q for
the
|
|
|
quarter
ended June 30, 2001 (File No. 1-7259)); Articles of Amendment
to
|
|
|
Articles
of Incorporation of Southwest Airlines Co. (incorporated
by
|
|
|
reference
to Exhibit 3.1 to Southwest’s Quarterly Report on Form 10-Q for
the
|
|
|
quarter
ended June 30, 2007 (File No. 1-7259)).
|
|
3.2
|
Amended
and Restated Bylaws of Southwest, effective September 20,
2007
|
|
|
(incorporated
by reference to Exhibit 3.1 to Southwest’s Current
Report
|
|
|
on
Form 8-K dated September 20, 2007 (File
No. 1-7259)).
|
|
10.1
|
Supplemental
Agreement No. 57 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
|
10.2
|
Supplemental
Agreement No. 58 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
|
10.3
|
Supplemental
Agreement No. 59 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
|
31.1
|
Rule
13a-14(a) Certification of Chief Executive Officer
|
|
31.2
|
Rule
13a-14(a) Certification of Chief Financial Officer
|
|
32.1
|
Section
1350 Certifications of Chief Executive Officer and Chief Financial
Officer
|
(1) Pursuant
to 17 CRF 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.