þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

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 ¨

Large accelerated filer þ  Accelerated filer ¨  Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No þ

Table of Contents

		March 31, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents		$	1,618		$	1,390
Short-term investments			315			369
Accounts and other receivables			278			241
Inventories of parts and supplies, at cost			174			181
Fuel derivative contracts			558			369
Prepaid expenses and other current assets			56			51
Total current assets			2,999			2,601
Property and equipment, at cost:
Flight equipment			12,041			11,769
Ground property and equipment			1,384			1,356
Deposits on flight equipment purchase contracts			757			734
			14,182			13,859
Less allowance for depreciation and amortization			3,897			3,765
			10,285			10,094
Other assets			954			765
		$	14,238		$	13,460
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	643		$	643
Accrued liabilities			1,748			1,323
Air traffic liability			1,010			799
Current maturities of long-term debt			123			122
Total current liabilities			3,524			2,887
Long-term debt less current maturities			1,556			1,567
Deferred income taxes			2,183			2,104
Deferred gains from sale and leaseback of aircraft			117			120
Other deferred liabilities			304			333
Stockholders' equity:
Common stock			808			808
Capital in excess of par value			1,155			1,142
Retained earnings			4,264			4,307
Accumulated other comprehensive income			716			582
Treasury stock, at cost			(389	)		(390	)
Total stockholders' equity			6,554			6,449
		$	14,238		$	13,460
See accompanying notes.

Table of Contents

		Three months ended March 31,
		2007			2006
OPERATING REVENUES:
Passenger		$	2,112		$	1,938
Freight			30			35
Other			56			46
Total operating revenues			2,198			2,019
OPERATING EXPENSES:
Salaries, wages, and benefits			767			716
Fuel and oil			564			501
Maintenance materials and repairs			136			104
Aircraft rentals			39			40
Landing fees and other rentals			136			120
Depreciation and amortization			135			124
Other operating expenses			337			316
Total operating expenses			2,114			1,921
OPERATING INCOME			84			98
OTHER EXPENSES (INCOME):
Interest expense			29			34
Capitalized interest			(13	)		(12	)
Interest income			(13	)		(18	)
Other (gains) losses, net			(68	)		(2	)
Total other expenses (income)			(65	)		2
INCOME BEFORE INCOME TAXES			149			96
PROVISION FOR INCOME TAXES			56			35
NET INCOME		$	93		$	61
NET INCOME PER SHARE, BASIC		$	.12		$	.08
NET INCOME PER SHARE, DILUTED		$	.12		$	.07
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic			786			803
Diluted			800			836
See accompanying notes.

Table of Contents

(unaudited) 

		Three months ended March 31,
		2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	93		$	61
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization			135			124
Deferred income taxes			42			35
Amortization of deferred gains on sale and
leaseback of aircraft			(4	)		(4	)
Share-based compensation expense			13			22
Excess tax benefits from share-based compensation arrangements			(29	)		(28	)
Changes in certain assets and liabilities:
Accounts and other receivables			(37	)		(13	)
Other current assets			(56	)		14
Accounts payable and accrued liabilities			383			317
Air traffic liability			210			280
Other			(133	)		(57	)
Net cash provided by (used in) operating activities			617			751
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net			(325	)		(262	)
Purchases of short-term investments			(914	)		(850	)
Proceeds from sales of short-term investments			968			782
Proceeds from ATA Airlines, Inc. debtor in possession loan			-			20
Other			-			1
Net cash used in investing activities			(271	)		(309	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Employee stock plans			78			107
Payments of long-term debt and capital lease obligations			(9	)		(37	)
Payments of cash dividends			(7	)		(7	)
Repurchase of common stock			(209	)		(214	)
Excess tax benefits from share-based compensation arrangements			29			28
Other			-			1
Net cash provided by (used in) financing activities			(118	)		(122	)
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS			228			320
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD			1,390			2,280
CASH AND CASH EQUIVALENTS
AT END OF PERIOD		$	1,618		$	2,600
CASH PAYMENTS FOR:
Interest, net of amount capitalized		$	19		$	20
Income taxes		$	1		$	-
See accompanying notes.

Table of Contents

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, 2007 and 2006, 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, 2007, are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. 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, 2006.

Certain prior period amounts have been reclassified to conform to the current presentation. In the unaudited Condensed Consolidated Statement of Cash Flows for the period ended March 31, 2006, “Purchases of short-term investments” and “Proceeds from sales of short-term investments” are shown as gross amounts instead of being netted into a single line item within investing activities.

2. SHARE-BASED COMPENSATION

The Company has stock option plans covering Employees subject to collective bargaining agreements (collective bargaining plans) and stock plans covering Employees not subject to collective bargaining agreements (other Employee plans). None of the collective bargaining plans were required to be approved by shareholders. Options granted to Employees under collective bargaining plans are non-qualified, granted at or above the fair market value of the Company’s Common Stock on the date of grant, and generally have terms ranging from six to twelve years. Neither Executive Officers nor members of the Company’s Board of Directors are eligible to participate in any of these collective bargaining plans. Options granted to Employees through other Employee plans are both qualified as incentive stock options under the Internal Revenue Code of 1986 and non-qualified stock options, granted at the fair market value of the Company’s Common Stock on the date of grant, and have ten-year terms. All of the options included in the Company’s definition of other Employee Plans have been approved by Shareholders, except the plan covering non-management, non-contract Employees, which had options outstanding to purchase 5.4 million shares of the Company’s Common Stock as of March 31, 2007. Although the Company does not have a formal policy per se, upon option exercise, the Company will typically issue Treasury stock, to the extent such shares are available.

 

Vesting terms for the collective bargaining plans differ based on the grant made, and have ranged in length from immediate vesting to vesting periods in accordance with the period covered by the respective collective bargaining agreement. For other Employee Plans, as defined, options vest and become fully exercisable over three, five, or ten years of continued employment, depending upon the grant type. 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 grants include performance-based or market-based vesting conditions, as defined.

The unaudited Condensed Consolidated Statement of Income for the three months ended March 31, 2007 and 2006 reflects share-based compensation cost of $13 million and $22 million, respectively. The total tax benefit recognized from share-based compensation arrangements for the three months ended March 31, 2007 and 2006, was $4 million and $6 million, respectively. The Company currently estimates that share-based compensation expense will be approximately $40 million for the full year 2007, before income taxes and profitsharing.

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 7.5 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, 2007 and 2006, participants under the plan purchased .3 million shares and .3 million shares at average prices of $13.67 and $14.86, respectively. The weighted-average fair value of each purchase right under the ESPP granted for the three months ended March 31, 2007 and 2006, 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 $1.52 and $1.65, respectively.

 

In 2001, the Board adopted the Southwest Airlines Co. Outside Director Incentive Plan. The purpose of the plan is to align more closely the interests of the non-Employee Directors with those of the Company’s Shareholders and to provide the non-Employee Directors with retirement income. To accomplish this purpose, the plan compensates each non-Employee Director based on the performance of the Company’s Common Stock and defers the receipt of such compensation until after the non-Employee Director ceases to be a Director of the Company. Pursuant to the plan, on the date of the 2002 Annual Meeting of Shareholders, the Company granted 750 non-transferable Performance Shares to each non-Employee Director who had served as a Director since at least May 2001. Thereafter, on the date of each Annual Meeting of Shareholders, the Company has granted 750 Performance Shares to each non-Employee Director who has served since the previous Annual Meeting. These annual grants are set to increase to 1,000 shares effective with the May 2007 Annual Meeting. A Performance Share is a unit of value equal to the Fair Market Value of a share of Southwest Common Stock, based on the average closing sale price of the Common Stock as reported on the New York Stock Exchange during a specified period. On the 30^th calendar day following the date a non-Employee Director ceases to serve as a Director of the Company for any reason, Southwest will pay to such non-Employee Director an amount equal to the Fair Market Value of the Common Stock during the 30 days preceding such last date of service multiplied by the number of Performance Shares then held by such Director. The plan contains provisions contemplating adjustments on changes in capitalization of the Company. The Company accounts for grants made under this plan as liability awards, as defined.  The fair value of the awards as of March 31, 2007, which is not material to the Company, is included in Accrued liabilities in the accompanying Condensed Consolidated Balance Sheet.

 

3. DIVIDENDS

4. NET INCOME PER SHARE

		Three months ended March 31,
		2007			2006
NUMERATOR:
Net income available to
common shareholders		$	93		$	61
DENOMINATOR:
Weighted-average shares
outstanding, basic			786			803
Dilutive effect of Employee stock
options			14			33
Adjusted weighted-average shares
outstanding, diluted			800			836
NET INCOME PER SHARE:
Basic		$	.12		$	.08
Diluted		$	.12		$	.07

5. FINANCIAL DERIVATIVE INSTRUMENTS

 

 

During the three months ended March 31, 2007 and 2006, the Company recognized gains in Fuel and oil expense of $79 million and $116 million, respectively, from hedging activities. At March 31, 2007, approximately $35 million due from third parties from settled derivative contracts is included in Accounts and other receivables in the accompanying unaudited Condensed Consolidated Balance Sheet. The fair value of the Company's financial derivative instruments at March 31, 2007, was a net asset of approximately $1.4 billion. The current portion of these financial derivative instruments, $558 million, is classified as Fuel hedge contracts and the long-term portion, $819 million, is classified as Other assets in the unaudited Condensed Consolidated Balance Sheet. The fair value of the derivative instruments, depending on the type of instrument, was determined by the use of present value methods or standard option value models with assumptions about commodity prices based on those observed in underlying markets.

As of March 31, 2007, the Company had approximately $719 million in unrealized gains, net of tax, in Accumulated other comprehensive income related to fuel hedges. Included in this total are approximately $319 million in net unrealized gains that are expected to be realized in earnings during the twelve months following March 31, 2007.

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, 2007, was a liability of approximately $30 million. This entire amount is recorded in Other deferred liabilities in the unaudited Condensed Consolidated Balance Sheet. In accordance with fair value hedging, the offsetting entry is an adjustment to decrease the carrying value of long-term debt.

 

6. COMPREHENSIVE INCOME

Comprehensive income included changes in the fair value of certain financial derivative instruments, which qualify for hedge accounting, and unrealized gains and losses on certain investments. Comprehensive income totaled $227 million for the three months ended March 31, 2007 and $178 million for the three months ended March 31, 2006. The differences between net income and comprehensive income for each of these periods were as follows (in millions):

		Three months ended March 31,
		2007					2006
Net income		$	93				$	61
Unrealized gain (loss) on derivative instruments,
net of deferred taxes of $84 and $72			135					116
Other, net of deferred taxes of $0 and $1			(1	)				1
Total other comprehensive income			134					117
Comprehensive income		$	227				$	178

								Accumulated
		Fuel						other
		hedge						comprehensive
		derivatives			Other			income (loss)
Balance at December 31, 2006		$	584		$	(2	)	$	582
2007 changes in value			174			(1	)		173
Reclassification to earnings			(39	)		-			(39
Balance at March 31, 2007		$	719		$	(3	)	$	716

 

7. OTHER ASSETS AND ACCRUED LIABILITIES (in millions)

		March 31,			December 31,
		2007			2006
Noncurrent fuel derivatives contracts, at fair value		$	819		$	630
Other			135			135
Other assets		$	954		$	765
			March 31,			December 31,
			2007			2006
Retirement Plans		$	174		$	165
Aircraft Rentals			109			128
Vacation Pay			156			151
Advances and deposits			885			546
Deferred income taxes			125			78
Other			299			255
Accrued liabilities		$	1,748		$	1,323

8. POSTRETIREMENT BENEFITS

		Three months ended March 31,
(In millions)		2007				2006
Service cost		$	4			$	4
Interest cost			1				1
Amortization of prior service cost			-				-
Recognized actuarial loss			-				-
Net periodic postretirement benefit cost		$	5			$	5

 

9. CONTINGENCIES

10. RECENT ACCOUNTING PRONOUNCEMENTS

Table of Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Relevant Southwest comparative operating statistics for the three months ended March 31, 2007 and 2006 are as follows:

		Three months ended March 31,
		2007			2006			Change
Revenue passengers carried			19,960,933			19,199,488			4.0	%
Enplaned passengers			22,903,073			22,015,484			4.0	%
Revenue passenger miles (RPMs) (000s)			16,109,071			15,280,497			5.4	%
Available seat miles (ASMs) (000s)			23,678,376			22,079,458			7.2	%
Load factor			68.0	%		69.2	%		(1.2)	pts
Average length of passenger haul (miles)			807			796			1.4	%
Average aircraft stage length (miles)			627			617			1.6	%
Trips flown			276,900			262,449			5.5	%
Average passenger fare			$105.79			$100.94			4.8	%
Passenger revenue yield per RPM (cents)			13.11			12.68			3.4	%
Operating revenue yield per ASM (cents)			9.28			9.15			1.4	%
Operating expenses per ASM (cents)			8.93			8.70			2.6	%
Operating expenses per ASM, excluding fuel (cents)			6.54			6.43			1.7	%
Fuel costs per gallon, excluding fuel tax			$1.59			$1.51			5.3	%
Fuel consumed, in gallons (millions)			354			329			7.6	%
Fulltime equivalent Employees at period-end			32,961			31,396			5.0	%
Size of fleet at period-end			489			451			8.4	%

Table of Contents

Summary

First quarter 2007 represented the Company’s 64^th consecutive quarterly profit. Net income was $93 million ($.12 per share, diluted), 52.5 percent higher than first quarter 2006, primarily due to an increase in ineffectiveness and mark-to-market adjustments related to the Company’s fuel derivative contracts. In first quarter 2007, forward prices for the commodities Southwest uses for hedging jet fuel increased, resulting in an increase in the unrealized gains related to the higher fair values of these contracts. Primarily as a result of these rising prices for fuel derivatives that will settle in future periods that were ineffective, as defined, or did not qualify for special hedge accounting, the Company recorded $83 million in gains, which are included in Other (gains) losses. In first quarter 2006, when commodity prices rose by a smaller amount, the Company recorded a total of $13 million in gains associated with fuel derivatives that were ineffective, as defined, or did not qualify for special hedge accounting. See Note 5 and Note 1 to the unaudited condensed consolidated financial statements for further information on the Company’s hedging activities and for information on the seasonal nature of the Company’s financial results. As a result of a less favorable fuel hedge position in 2007 versus 2006, our hedging program resulted in the realization of approximately $65 million in cash settlements for first quarter 2007 compared to $133 million in cash settlements for first quarter 2006. Considering the ineffectiveness associated with the hedges, these 2007 settlements resulted in a reduction to Fuel and oil expense of $79 million in first quarter 2007. However, even with this hedge position, fuel cost per gallon increased 5.3 percent versus first quarter 2006.

 

Consolidated operating revenues increased by $179 million, or 8.9 percent, primarily due to a $174 million, or 9.0 percent, increase in Passenger revenues. The increase in Passenger revenues was primarily attributable to the 7.2 percent increase in capacity, as the Company added 38 aircraft since the end of first quarter 2006 (and had no aircraft retirements). The Company was also able to achieve a 3.4 percent increase in RPM yield primarily from modest fare increases. However, this yield increase was partially offset by a lower load factor compared to first quarter 2006. The first quarter 2007 load factor was 68.0 percent, compared to 69.2 percent in first quarter 2006. Unit revenue increased 1.4 percent, primarily due to the higher RPM yields, partially offset by the lower load factor.

 

Consolidated freight revenues decreased by $5 million, or 14.3 percent, primarily as a result of the Company’s decision to discontinue the carrying of mail for the U.S. Postal Service effective as of the end of second quarter 2006. Therefore, the Company had an $8 million shortfall in mail revenues versus first quarter 2006. This decrease was partially offset by higher freight and cargo revenues, primarily as a result of higher rates charged. The Company also expects a decline in consolidated freight revenues for second quarter 2007 compared to the level recorded in second quarter 2006, although at a lower rate than the first quarter 2007 decline. Other revenues increased by $10 million, or 21.7 percent, compared to first quarter 2006. The increase was primarily due to higher commissions earned from programs the Company sponsors with certain business partners, such as the Company sponsored Chase Visa card. The Company expects a year-over-year Other revenue increase in second quarter 2007 at a similar rate than experienced in first quarter 2007.

To a large extent, except for the potential for large swings in market prices for fuel, changes in operating expenses for airlines are driven by changes in capacity, or ASMs. The following presents Southwest’s operating expenses per ASM for the three months ended March 31, 2007 and 2006, followed by explanations of changes on a per-ASM basis (in cents, except for percentages):

		Three months ended March 31,							Per ASM			Percent
		2007				2006			Change			Change
Salaries, wages, and benefits			3.24				3.24			-			-
Fuel and oil			2.38				2.27			.11			4.8
Maintenance materials
and repairs			.58				.47			.11			23.4
Aircraft rentals			.16				.18			(.02	)		(11.1	)
Landing fees and other rentals			.58				.55			.03			5.5
Depreciation			.57				.56			.01			1.8
Other operating expenses			1.42				1.43			(.01	)		(0.7	)
Total			8.93				8.70			.23			2.6

 

        Operating expenses per ASM were 8.93 cents, a 2.6 percent increase compared to 8.70 cents for first quarter 2006. Approximately half of the year-over-year CASM increase was due to higher fuel costs, as the Company’s average cost per gallon of fuel increased 5.3 percent versus the prior year, net of hedging, and half was due to higher maintenance materials and repairs expense. Excluding fuel, year-over-year CASM increased 1.7 percent to 6.54 cents, almost exclusively due to the increase in maintenance costs. Based on current unit operating cost trends, the Company expects second quarter 2007 unit costs, excluding fuel, to be comparable to second quarter 2006’s 6.68 cents per ASM.

Salaries, wages, and benefits expense per ASM was flat compared to first quarter 2006. Higher salaries expense, primarily associated with an increase in wage rates, was offset by lower profitsharing expense and lower share-based compensation expense. The Company’s profitsharing contributions are based on income before taxes excluding primarily unrealized gains and losses from fuel derivative contracts. Excluding these items from first quarter of both years resulted in a 47 percent decrease in profitsharing contributions for first quarter 2007. See Note 2 to the unaudited condensed consolidated financial statements for further information on share-based compensation. The Company currently expects Salaries, wages, and benefits per ASM in second quarter 2007 to be lower than the 3.43 cents reported in second quarter 2006, primarily due to lower profitsharing expense and lower share-based compensation expense.

Fuel and oil expense per ASM increased 4.8 percent primarily due to a weaker hedge position held by the Company in first quarter 2007 versus first quarter 2006, partially offset by slightly lower market jet fuel prices. In first quarter 2007, the Company held fuel derivative instruments that were at higher average crude oil-equivalent prices than in first quarter 2006. The Company’s average fuel cost per gallon in first quarter 2007 was $1.59, 5.3 percent higher than first quarter 2006, including the effects of hedging activities. For first quarter 2007, the Company had protected against 100 percent of its anticipated fuel needs at a crude oil-equivalent price of approximately $50 per barrel, resulting in gains recorded in Fuel and oil expense of $79 million. First quarter 2006 hedging gains recorded in Fuel and oil expense were $116 million. 

               For second quarter 2007, the Company has fuel derivatives in place for over 95 percent of its expected fuel consumption with a combination of derivative instruments that effectively cap prices at approximately $50 per barrel of crude oil and has added refinery margins on the majority of those positions. Based on this protection and current market prices, the Company is hopeful its second quarter 2007 jet fuel cost per gallon will not exceed $1.70. The majority of the Company's near term fuel derivatives are in the form of option contracts. At March 31, 2007, the estimated net fair value of the Company’s fuel derivative contracts was $1.4 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 has begun installing Aviation Partners Boeing Blended Winglets on a significant number of its 737-300 aircraft (all 737-700 aircraft have already been equipped with winglets). Installations on these 737-300 aircraft are expected to be completed in 2008.

 

 

 

Other operating expenses per ASM declined slightly compared to first quarter 2006’s performance of 1.43 cents primarily due to a decrease in advertising costs. Advertising costs were lower in first quarter 2007 primarily due to the timing of certain advertising and promotions compared to the prior year. For second quarter 2007, the Company expects a slight increase in Other operating expenses per ASM compared to second quarter 2006’s 1.45 cents, primarily due to higher advertising costs.

Through the 2003 Emergency Wartime Supplemental Appropriations Act, the federal government has continued to provide supplemental first-party war-risk insurance coverage to commercial carriers for renewable 60-day periods, at substantially lower premiums than prevailing commercial rates and for levels of coverage not available in the commercial market. The government-provided supplemental coverage from the Wartime Act is currently set to expire on December 31, 2007. Although another extension beyond this date is expected, if such coverage is not extended by the government, the Company could incur substantially higher insurance costs in future periods.

 

Interest expense decreased $5 million, or 14.7 percent, compared to first quarter 2006. An increase in interest rates was more than offset by a lower debt balance outstanding, and the conversion of $400 million in fixed-rate debt to floating rates in first quarter 2007. The majority of the Company’s long-term debt is at floating rates. See Note 5 to the unaudited condensed consolidated financial statements for more information.

Capitalized interest increased $1 million, or 8.3 percent, compared to the prior year, primarily due to a slight increase in the balances that qualify for interest capitalization—primarily progress payments made for future aircraft deliveries.

Interest income decreased by $5 million, or 27.8 percent, primarily due to a decrease in invested cash and short-term investments.

Other (gains) losses, net, primarily includes amounts recorded in accordance with the Company’s hedging activities and SFAS 133. During first quarter 2007, the Company recognized approximately $14 million of 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 2007). The Company expects a similar expense relating to these items in second quarter 2007. Also in first quarter 2007, the Company recognized approximately $83 million of net gains in Other (gains) losses, net, related to the ineffectiveness of its hedges and the loss of hedge accounting for certain fuel derivatives. Of this net total, approximately $85 million was unrealized, mark-to-market gains in the fair value of certain derivatives that will settle in future periods that no longer qualified for special hedge accounting and $4 million was ineffectiveness and mark-to-market gains related to contracts that settled during first quarter 2007. These were partially offset by $6 million in losses related to unrealized ineffectiveness from hedges designated for future periods. See Note 5 to the unaudited condensed consolidated financial statements for more information on the Company’s hedging activities. In first quarter 2006, the Company recognized approximately $11 million of expense related to amounts excluded from the Company's measurements of hedge effectiveness and $13 million in gains related to the ineffectiveness of its hedges and the loss of hedge accounting for certain fuel derivatives. This $13 million consisted of approximately $40 million in gains from unrealized, mark-to-market changes in the fair value of derivatives due to the discontinuation of hedge accounting for certain contracts that will settle in future periods, partially offset by $10 million in ineffectiveness expense and mark-to-market losses associated with contracts that settled during first quarter 2006, and $17 million in losses related to unrealized ineffectiveness from hedges designated for future periods.

The Company’s effective tax rate was 37.7 percent in first quarter 2007 compared to 36.3 percent in first quarter 2006. The slightly higher rate in first quarter 2007 was primarily due to a lower deduction related to disqualifying dispositions of incentive stock options from Employee stock option exercises during first quarter 2007 versus the prior year. See Note 2 to the unaudited condensed consolidated financial statements. The Company currently expects its full year 2007 effective rate to be approximately 38 percent.

 

Net cash provided by operating activities was $617 million for the three months ended March 31, 2007, compared to $751 million in the same prior year period. The operating cash flows in both periods were largely impacted by fluctuations in counterparty deposits associated with the Company’s fuel hedging program. There was an increase in counterparty deposits of $345 million for the three months ended March 31, 2007, versus an increase of $205 million during the three months ended March 31, 2006. The larger increase in these deposits during 2007 has been due to a larger increase in the fair value of the Company’s fuel derivative portfolio versus the same prior year period. The fair value of the Company’s fuel derivatives increased from $1.0 billion at December 31, 2006, to $1.4 billion at March 31, 2007. Cash flows from operating activities for the three months ended March 31, 2007, were also impacted by the $210 million increase in Air traffic liability, as a result of seasonal bookings for future travel. However, this was lower than the $280 million increase Air traffic liability in first quarter 2006, thereby accounting for the majority of the year-over-year decrease in operating cash flows. See Item 3, and Notes 5 and 7 to the unaudited condensed consolidated financial statements. Net cash provided by operating activities is primarily used to finance capital expenditures.

 

Southwest has contractual obligations and commitments primarily for future purchases of aircraft, payment of debt, and lease arrangements. Through the first three months of 2007, the Company purchased eight new 737-700 aircraft from Boeing. Southwest’s firm orders and options to purchase Boeing 737-700 aircraft are as follows:

 

		The Boeing Company
								Purchase			Previously
		Firm			Options			Rights			Owned				Total
2007			37									2	*			39	**
2008			32			2										34
2009			18			18										36
2010			10			32										42
2011			10			30										40
2012			10			30										40
2008-2014			-			-			54							54
			117			112			54			2				285
*Intend to lease two previously owned 737-700 aircraft from a third party.
**2007 delivery dates: eight in first quarter, eleven in second quarter, eleven
in third quarter and nine in fourth quarter.

The following table details information on the 489 aircraft in the Company’s fleet as of March 31, 2007:

					Average			Number			Number			Number
737 Type		Seats			Age (Yrs)			of Aircraft			Owned			Leased
-300			137			15.9			194			112			82
-500			122			15.9			25			16			9
-700			137			4.1			270			268			2
TOTALS						9.4			489			396			93

 

 

The Company has various options available to meet its capital and operating commitments, including cash on hand and short term investments at March 31, 2007, of $1.9 billion, internally generated funds, and the Company’s fully available $600 million revolving credit facility. The Company will also consider various borrowing or leasing options to maximize earnings and supplement cash requirements.

In November 2006, the Company’s Board of Directors authorized the repurchase of up to $400 million of the Company’s Common Stock. Repurchases were made in accordance with applicable securities laws in the open market or in private transactions from time to time, depending on market conditions. This program was completed during first quarter 2007, resulting in the repurchase of 25.6 million shares. In March 2007, the Company’s Board of Directors authorized an additional repurchase of up to $300 million of the Company’s Common Stock. As of March 31, 2007, the Company had repurchased .6 million shares for $9 million as part of this program. See Item 2 of Part II of this filing for further information on these two repurchase programs.

The Company currently has outstanding shelf registrations for the issuance of up to $1.0 billion in public debt securities and pass-through certificates, which it may utilize for aircraft financings or other purposes in the future.

 

(i)	the price and availability of aircraft fuel;

(ii)	the impact of governmental regulations on our operating costs, as well as our operations generally;

(iii)

competitor capacity and load factors; and

(iv)	other factors as set forth in our filings with the Securities and Exchange Commission, including the detailed factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006.

 

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Item 4. Controls and Procedures

 

Item 1. Legal Proceedings

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

		(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, 2007 through January 31, 2007			4,200,000		$	15.72			4,200,000		$	133,723,357
February 1, 2007 through February 28, 2007			5,700,000		$	15.44			5,700,000		$	45,715,357
March 1, 2007 through March 31, 2007			3,632,600		$	15.11			3,632,600		$	290,826,771
Total			13,532,600						13,532,600

 

Item 3. Defaults upon Senior Securities

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information

Item 6. Exhibits

a)  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)).
	3.2	Bylaws of Southwest, as amended through January 2007 (incorporated by reference
		to Exhibit 3.2 to Southwest’s Current Report on Form 8-K dated January 18, 2007).
	10.1	Supplemental Agreement No. 52 to Purchase Agreement No. 1810,
		dated January 19, 1994 between The Boeing Company and Southwest.
		Pursuant to 17 CFR 240.24b-2, confidential information has been omitted
		and has been filed separately with the Securities and Exchange Commission
		pursuant to a Confidential Treatment Application filed with the
		Commission.
	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

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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 20, 2007	By	/s/ Laura H. Wright
		Laura H. Wright
		Chief Financial Officer
		(On behalf of the Registrant and in
		her capacity as Principal Financial
		and Accounting Officer)

Table of Contents

 

	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)).
	3.2	Bylaws of Southwest, as amended through January 2007 (incorporated by reference
		to Exhibit 3.2 to Southwest’s Current Report on Form 8-K dated January 18, 2007).
	10.1	Supplemental Agreement No. 52 to Purchase Agreement No. 1810,
		dated January 19, 1994 between The Boeing Company and Southwest.
		Pursuant to 17 CFR 240.24b-2, confidential information has been omitted
		and has been filed separately with the Securities and Exchange Commission
		pursuant to a Confidential Treatment Application filed with the
		Commission.
	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