10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on April 20, 2009
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
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þ
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QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the quarterly period ended March 31,
2009
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or
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¨
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TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the transition period from ________ to
________
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Commission
File No. 1-7259
Southwest
Airlines Co.
(Exact
name of registrant as specified in its charter)
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TEXAS
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74-1563240
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(State
or other jurisdiction of
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(IRS
Employer
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incorporation
or organization)
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Identification
No.)
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P.O.
Box 36611, Dallas, Texas
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75235-1611
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(Address
of principal executive offices)
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(Zip
Code)
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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 has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files). Yes þ (registrant is not yet
required to provide financial disclosure in an Interactive Data File format, but
has been providing the information in this format voluntarily) 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
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Number
of shares of Common Stock outstanding as of the close of business on April
15, 2009: 740,813,556
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1
SOUTHWEST AIRLINES
CO.
TABLE OF
CONTENTS TO FORM 10-Q
SOUTHWEST
AIRLINES CO.
FORM
10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest
Airlines Co.
Condensed Consolidated Balance Sheet
(in
millions)
(unaudited)
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March
31, 2009
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December
31, 2008
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|||||||
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ASSETS
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||||||||
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Current
assets:
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||||||||
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Cash
and cash equivalents
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$ | 1,145 | $ | 1,368 | ||||
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Short-term
investments
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989 | 435 | ||||||
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Accounts
and other receivables
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231 | 209 | ||||||
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Inventories
of parts and supplies, at cost
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171 | 203 | ||||||
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Deferred
income taxes
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365 | 365 | ||||||
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Prepaid
expenses and other current assets
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95 | 73 | ||||||
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Total
current assets
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2,996 | 2,653 | ||||||
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Property
and equipment, at cost:
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||||||||
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Flight
equipment
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13,650 | 13,722 | ||||||
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Ground
property and equipment
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1,798 | 1,769 | ||||||
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Deposits
on flight equipment purchase contracts
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333 | 380 | ||||||
| 15,781 | 15,871 | |||||||
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Less
allowance for depreciation and amortization
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4,968 | 4,831 | ||||||
| 10,813 | 11,040 | |||||||
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Other
assets
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370 | 375 | ||||||
| $ | 14,179 | $ | 14,068 | |||||
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LIABILITIES
AND STOCKHOLDERS' EQUITY
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||||||||
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Current
liabilities:
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||||||||
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Accounts
payable
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$ | 693 | $ | 668 | ||||
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Accrued
liabilities
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1,016 | 1,012 | ||||||
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Air
traffic liability
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1,251 | 963 | ||||||
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Current
maturities of long-term debt
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163 | 163 | ||||||
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Total
current liabilities
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3,123 | 2,806 | ||||||
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Long-term
debt less current maturities
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3,447 | 3,498 | ||||||
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Deferred
income taxes
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1,895 | 1,904 | ||||||
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Deferred
gains from sale and leaseback of aircraft
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111 | 105 | ||||||
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Other
deferred liabilities
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675 | 802 | ||||||
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Stockholders'
equity:
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||||||||
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Common
stock
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808 | 808 | ||||||
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Capital
in excess of par value
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1,219 | 1,215 | ||||||
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Retained
earnings
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4,819 | 4,919 | ||||||
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Accumulated
other comprehensive loss
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(922 | ) | (984 | ) | ||||
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Treasury
stock, at cost
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(996 | ) | (1,005 | ) | ||||
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Total
stockholders' equity
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4,928 | 4,953 | ||||||
| $ | 14,179 | $ | 14,068 | |||||
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See
accompanying notes.
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||||||||
Southwest
Airlines Co.
Condensed Consolidated Statement of Operations
(in
millions, except per share amounts)
(unaudited)
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Three
months ended March 31,
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||||||||
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2009
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2008
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|||||||
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OPERATING
REVENUES:
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||||||||
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Passenger
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$ | 2,252 | $ | 2,414 | ||||
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Freight
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30 | 34 | ||||||
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Other
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75 | 82 | ||||||
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Total
operating revenues
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2,357 | 2,530 | ||||||
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OPERATING
EXPENSES:
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||||||||
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Salaries,
wages, and benefits
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836 | 800 | ||||||
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Fuel
and oil
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698 | 800 | ||||||
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Maintenance
materials and repairs
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184 | 143 | ||||||
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Aircraft
rentals
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45 | 38 | ||||||
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Landing
fees and other rentals
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166 | 171 | ||||||
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Depreciation
and amortization
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150 | 145 | ||||||
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Other
operating expenses
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328 | 345 | ||||||
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Total
operating expenses
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2,407 | 2,442 | ||||||
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OPERATING
INCOME (LOSS)
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(50 | ) | 88 | |||||
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OTHER
EXPENSES (INCOME):
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||||||||
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Interest
expense
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44 | 28 | ||||||
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Capitalized
interest
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(6 | ) | (8 | ) | ||||
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Interest
income
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(4 | ) | (7 | ) | ||||
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Other
(gains) losses, net
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23 | 38 | ||||||
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Total
other expenses (income)
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57 | 51 | ||||||
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INCOME
(LOSS) BEFORE INCOME TAXES
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(107 | ) | 37 | |||||
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PROVISION
(BENEFIT) FOR INCOME TAXES
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(16 | ) | 3 | |||||
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NET
INCOME (LOSS)
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$ | (91 | ) | $ | 34 | |||
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NET
INCOME (LOSS) PER SHARE, BASIC
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$ | (.12 | ) | $ | .05 | |||
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NET
INCOME (LOSS) PER SHARE, DILUTED
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$ | (.12 | ) | $ | .05 | |||
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WEIGHTED
AVERAGE SHARES
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||||||||
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OUTSTANDING:
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||||||||
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Basic
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740 | 733 | ||||||
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Diluted
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740 | 734 | ||||||
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See
accompanying notes.
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||||||||
Southwest
Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in
millions)
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Three
months ended March 31,
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|||||||||
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2009
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2008
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||||||||
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CASH
FLOWS FROM OPERATING ACTIVITIES:
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|||||||||
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Net
income (loss)
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$ | (91 | ) | $ | 34 | ||||
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Adjustments
to reconcile net income (loss) to
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|||||||||
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cash
provided by operating activities:
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|||||||||
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Depreciation
and amortization
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150 | 145 | |||||||
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Deferred
income taxes
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(16 | ) | (5 | ) | |||||
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Amortization
of deferred gains on sale and
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leaseback
of aircraft
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(3 | ) | (3 | ) | |||||
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Share-based
compensation expense
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3 | 5 | |||||||
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Excess
tax benefits from share-based
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|||||||||
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compensation
arrangements
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3 | - | |||||||
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Changes
in certain assets and liabilities:
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|||||||||
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Accounts
and other receivables
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(22 | ) | (70 | ) | |||||
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Other
current assets
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(46 | ) | 220 | ||||||
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Accounts
payable and accrued liabilities
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47 | 46 | |||||||
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Air
traffic liability
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288 | 267 | |||||||
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Other,
net
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(27 | ) | 325 | ||||||
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Net
cash provided by operating activities
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286 | 964 | |||||||
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CASH
FLOWS FROM INVESTING ACTIVITIES:
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|||||||||
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Purchases
of property and equipment, net
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(85 | ) | (364 | ) | |||||
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Purchases
of short-term investments
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(1,697 | ) | (1,221 | ) | |||||
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Proceeds
from sales of short-term investments
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1,144 | 1,459 | |||||||
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Net
cash used in investing activities
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(638 | ) | (126 | ) | |||||
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CASH
FLOWS FROM FINANCING ACTIVITIES:
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|||||||||
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Proceeds
from sale and leaseback transactions
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173 | - | |||||||
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Proceeds
from Employee stock plans
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4 | 11 | |||||||
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Payments
of long-term debt and capital lease obligations
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(35 | ) | (19 | ) | |||||
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Payments
of cash dividends
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(7 | ) | (7 | ) | |||||
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Repurchase
of common stock
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- | (54 | ) | ||||||
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Excess
tax benefits from share-based
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|||||||||
|
compensation
arrangements
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(3 | ) | - | ||||||
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Other,
net
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(3 | ) | - | ||||||
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Net
cash provided by (used in) financing activities
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129 | (69 | ) | ||||||
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NET
CHANGE IN CASH AND
|
|||||||||
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CASH
EQUIVALENTS
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(223 | ) | 769 | ||||||
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CASH
AND CASH EQUIVALENTS AT
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|||||||||
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BEGINNING
OF PERIOD
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1,368 | 2,213 | |||||||
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CASH
AND CASH EQUIVALENTS
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|||||||||
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AT
END OF PERIOD
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$ | 1,145 | $ | 2,982 | |||||
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CASH
PAYMENTS FOR:
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|||||||||
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Interest,
net of amount capitalized
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$ | 36 | $ | 25 | |||||
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Income
taxes
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$ | 1 | $ | 6 | |||||
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See
accompanying notes.
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|||||||||
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, 2009 and 2008, 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 financial performance is better
in the second and third fiscal quarters than its first and fourth fiscal
quarters. However, as a result of significant fluctuations in the
price of jet fuel in some periods, the nature of the Company’s fuel hedging
program, the periodic volatility of commodities used by the Company for hedging
jet fuel, and the accounting requirements of Statement of Financial Accounting
Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” as amended (SFAS 133), the Company has experienced and may continue
to experience significant volatility in its results in certain fiscal
periods. See Note 5 for further information. Operating results for
the three months ended March 31, 2009, are not necessarily indicative of the
results that may be expected for the year ended December 31,
2009. 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, 2008.
Certain
prior period amounts have been reclassified to conform to the current
presentation. In the unaudited Condensed
Consolidated Balance Sheet as of December 31, 2008, the Company's cash
collateral deposits related to fuel derivatives that have been provided to a
counterparty have been adjusted to show a “net” presentation against the
fair value of the Company's fuel derivative instruments. The entire
portion of cash collateral deposits as of December 31, 2008, $240 million, has
been reclassified to reduce “Other deferred liabilities.” In the
Company’s 2008 Form 10-K filing, these cash collateral deposits were presented
“gross” and all were included as an increase to “Prepaid expenses and other
current assets.” This change in presentation was made in order to
comply with the requirements of Financial Accounting Standards Board (FASB)
Staff Position FIN 39-1 (FIN 39-1), which was required to be adopted by the
Company effective January 1, 2008. Following the Company’s 2008 Form
10-K filing on February 2, 2009, the Company became aware that the requirements
of FIN 39-1 had not been properly applied to its financial derivative
instruments within the financial statements. The Company determined
that the effect of this error was not material to its financial statements and
disclosures taken as a whole, and decided to apply FIN 39-1 prospectively
beginning with this first quarter 2009 Form 10-Q. The Company has
made related retrospective adjustments to “Other current assets,” “Accounts
payable and accrued liabilities” and “Other, net” within the unaudited Condensed
Consolidated Statement of Cash Flows for the three months ended March 31, 2008;
however, these adjustments have no net impact on “Net cash provided by operating
activities,” as previously reported for such period. See Note 5
for further information on cash collateral deposits and the fair value of the
Company's fuel derivative instruments.
2. NEW
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” (SFAS 161). SFAS 161
requires entities that use 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. SFAS 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 have been applied, and the
impact that hedges have on an entity’s financial position, financial
performance, and cash flows. The Company adopted the provisions of
SFAS 161 effective January 1, 2009. See Note 5 for the Company’s disclosures
about its derivative instruments and hedging activities.
In
January 2009, the FASB released Proposed Staff Position SFAS 107-b and
Accounting Principles Board (APB) Opinion No. 28-a, “Interim Disclosures about
Fair Value of Financial Instruments” (SFAS 107-b and APB 28-a). This
proposal amends FASB Statement No. 107, “Disclosures about Fair Values of
Financial Instruments,” to require disclosures about fair value of financial
instruments in interim financial statements as well as in annual financial
statements. The proposal also amends APB Opinion No. 28, “Interim
Financial Reporting,” to require those disclosures in all interim financial
statements. This proposal is effective for interim periods ending
after June 15, 2009, but early adoption is permitted for interim periods ending
after March 15, 2009. The Company plans to adopt SFAS 107-b and APB
28-a and provide the additional disclosure requirements for second quarter
2009.
In March
2009, the FASB released Proposed Staff Position SFAS 157-e, “Determining Whether
a Market Is Not Active and a Transaction Is Not Distressed” (SFAS
157-e). This proposal provides additional guidance in determining
whether a market for a financial asset is not active and a transaction is not
distressed for fair value measurement purposes as defined in SFAS 157, “Fair
Value Measurements.” SFAS 157-e is effective for interim periods
ending after June 15, 2009, but early adoption is permitted for interim periods
ending after March 15, 2009. The Company plans to adopt the
provisions of SFAS 157-e during second quarter 2009, but does not believe this
guidance will have a significant impact on the Company’s financial position,
cash flows, or disclosures.
In March
2009, the FASB issued Proposed Staff Position SFAS 115-a, SFAS 124-a, and EITF
99-20-b, “Recognition and Presentation of Other-Than-Temporary
Impairments.” This proposal provides guidance in determining whether
impairments in debt securities are other than temporary, and modifies the
presentation and disclosures surrounding such instruments. This
Proposed Staff Position is effective for interim periods ending after June 15,
2009, but early adoption is permitted for interim periods ending after March 15,
2009. The Company plans to adopt the provisions of this Proposed
Staff Position during second quarter 2009, but does not believe this guidance
will have a significant impact on the Company’s financial position, cash flows,
or disclosures.
3. DIVIDENDS
During
the three months ended March 31, 2009, dividends of $.0045 per share were
declared on the 740 million shares of Common Stock then
outstanding. 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.
4. NET
INCOME (LOSS) PER SHARE
The
following table sets forth the computation of basic and diluted net income
(loss) per share (in millions except per share amounts):
|
Three
months ended March 31,
|
|||||||||
|
2009
|
2008
|
||||||||
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NUMERATOR:
|
|||||||||
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Net
income (loss)
|
$ | (91 | ) | $ | 34 | ||||
|
DENOMINATOR:
|
|||||||||
|
Weighted-average
shares
|
|||||||||
|
outstanding,
basic
|
740 | 733 | |||||||
|
Dilutive
effect of Employee stock
|
|||||||||
|
options
|
- | 1 | |||||||
|
Adjusted
weighted-average shares
|
|||||||||
|
outstanding,
diluted
|
740 | 734 | |||||||
|
NET
INCOME (LOSS) PER SHARE:
|
|||||||||
|
Basic
|
$ | (.12 | ) | $ | .05 | ||||
|
Diluted
|
$ | (.12 | ) | $ | .05 | ||||
5. FINANCIAL
DERIVATIVE INSTRUMENTS
Fuel
Contracts
Airline
operators are inherently dependent upon energy to operate and, therefore, are
impacted by changes in jet fuel prices. Jet fuel and oil (including
related taxes) consumed during the three months ended March 31, 2009 and 2008,
represented approximately 29 percent and 33 percent of the Company’s operating
expenses, respectively. The Company’s operating expenses have been extremely
volatile in recent years due to dramatic increases and declines in energy
prices. The Company endeavors to acquire jet fuel at the lowest
possible cost and to reduce volatility in operating expenses. 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 used financial derivative instruments for both short-term and
long-term time frames, and typically uses a mixture of purchased call options,
collar structures (which include both a purchased call option and a sold put
option), and fixed price swap agreements in its portfolio. Generally,
when prices are lower, the Company prefers to use fixed price swap agreements
and purchased call options. However, when prices are higher, the
Company uses more collar structures due to the high cost of purchased call
options and the increased risk associated with fixed price
swaps. Although the use of collar structures can reduce the overall
cost of hedging, these instruments carry more risk than purchased call options
in that the Company could end up in a liability position when the collar
structure settles. With the use of purchased call options, there is
no risk of the Company being in a liability position at settlement.
During
most of 2008, when energy prices were generally rising, the Company had a more
significant hedge volume position related to 2009 through
2013. However, as a result of the dramatic decline in energy prices
during the fourth quarter of 2008, the Company significantly reduced its net
hedge volumes related to these years. In late first quarter 2009, the
Company began adding to its hedge related to 2009 and 2010, primarily with
purchased call options with above current market strike prices as of March 31,
2009. The following table provides information about the Company’s
volume of fuel hedging for the first quarter of 2009, and its portfolio as of
March 31, 2009, for future periods. These hedge volumes are strictly
from an “economic” standpoint and thus do not reflect whether the hedges
qualified or will qualify for special hedge accounting as defined in SFAS
133. The Company defines its “economic” hedge as the total volume of
fuel derivative contracts held, including the net impact of positions that have
been effectively “settled” through offsetting positions, regardless of whether
those contracts qualify for hedge accounting as defined in SFAS
133.
|
Fuel
hedged as
|
Approximate
%
|
|||||||
|
of
March 31, 2009
|
of
jet fuel
|
|||||||
|
Period
(by year)
|
(gallons
in millions)
|
consumption
|
||||||
|
2009
|
408 | 29 | % * | |||||
|
2010
|
383 | 27 | % * | |||||
|
2011
|
85 | 6 | % * | |||||
|
2012
|
93 | 7 | % * | |||||
|
2013
|
98 | 7 | % * | |||||
|
Period
(by quarter for 2009)
|
||||||||
|
First
quarter 2009
|
15 | 4 | % | |||||
|
Second
quarter 2009
|
150 | 41 | % * | |||||
|
Third
quarter 2009
|
122 | 33 | % * | |||||
|
Fourth
quarter 2009
|
121 | 35 | % * | |||||
|
*
Forecasted
|
||||||||
Upon
proper qualification, the Company accounts for its fuel derivative instruments
as cash flow hedges, as defined in SFAS 133. Under SFAS 133, all
derivatives designated as hedges that meet certain requirements are granted
special hedge accounting treatment. Generally, utilizing the special
hedge accounting, all periodic changes in fair value of the derivatives
designated as hedges that are considered to be effective, as defined, are
recorded in "Accumulated other comprehensive income (loss)” (“AOCI”) until the
underlying jet fuel is consumed. See Note 6 for further information
on “AOCI.” The Company is exposed to the risk that periodic changes
will not be effective, as defined, or that the derivatives will no longer
qualify for special hedge accounting. Ineffectiveness, as defined,
results when the change in the 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 are not effective, that ineffectiveness is
recorded to “Other (gains) losses, net” in the statement of
operations. 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) losses, net” in the statement of
operations in the period of the change; however, in accordance with SFAS 133,
any amounts previously recorded to “AOCI” would remain there until such time as
the original forecasted transaction occurs, then would be reclassified to “Fuel
and oil” expense. In a situation where it becomes probable that a
hedged forecasted transaction will not occur, any gains and/or losses that have
been recorded to “AOCI” would be required to be immediately reclassified into
earnings. The Company did not have any such situations occur for the
three months ended March 31, 2009 or 2008.
Ineffectiveness
is inherent in hedging jet fuel with derivative positions based in other crude
oil related commodities. Due to the volatility in markets for crude
oil and related products, the Company is unable to predict the amount of
ineffectiveness each period, including the loss of hedge accounting, which could
be determined on a derivative by derivative basis or in the aggregate for a
specific commodity. This may result, and has resulted, in increased
volatility in the Company’s financial results. Factors that have and
may continue to lead to ineffectiveness and unrealized gains and losses on
derivative contracts include: the significant fluctuation in energy prices, the
number of derivative positions the Company holds, significant weather events
that have affected refinery capacity and the production of refined products, and
the volatility of the different types of products the Company uses in
hedging. The number of instances in which the Company has
discontinued hedge accounting for specific hedges and for specific refined
products, such as unleaded gasoline, has increased recently, primarily due to
these reasons. However, even though these derivatives may not qualify
for SFAS 133 special hedge accounting, the Company continues to hold the
instruments as it believes they continue to afford the Company the opportunity
to minimize jet fuel costs.
SFAS 133
is a complex accounting standard with stringent requirements, including the
documentation of a Company hedging strategy, statistical analysis to qualify a
commodity for hedge accounting both on a historical and a prospective basis, and
strict contemporaneous documentation that is required at the time each hedge is
designated by the Company. As required by SFAS 133, the Company
assesses the effectiveness of each of its individual hedges on a quarterly
basis. The Company also examines the effectiveness of its entire
hedging program on a quarterly basis utilizing statistical
analysis. This analysis involves utilizing regression and other
statistical analyses that compare changes in the price of jet fuel to changes in
the prices of the commodities used for hedging purposes.
All cash
flows associated with purchasing and selling derivatives are classified as
operating cash flows in the unaudited Condensed Consolidated Statement of Cash
Flows. The following table presents the location of all assets and
liabilities associated with the Company’s hedging instruments within the
unaudited Condensed Consolidated Balance Sheet (in millions):
|
Asset
Derivatives
|
Liability
Derivatives
|
||||||||||||||||
|
Balance
Sheet Location
|
Fair
Value at 3/31/09
|
Fair
Value at 12/31/08
|
Fair
Value at 3/31/09
|
Fair
Value at 12/31/08
|
|||||||||||||
|
Derivatives
designated as hedging
|
|||||||||||||||||
|
instruments
under SFAS 133
|
|||||||||||||||||
|
Fuel
derivative contracts (gross)*
|
Accrued
liabilities
|
$ | - | $ | 94 | $ | 15 | $ | 19 | ||||||||
|
Fuel
derivative contracts (gross)*
|
Other
deferred liabilities
|
19 | 40 | 197 | 522 | ||||||||||||
|
Interest
rate derivative contracts
|
Other
assets
|
79 | 83 | - | - | ||||||||||||
|
Interest
rate derivative contracts
|
Other
deferred liabilities
|
- | - | 4 | 3 | ||||||||||||
|
Total
derivatives designated as hedging
|
|||||||||||||||||
|
instruments
under SFAS 133
|
$ | 98 | $ | 217 | $ | 216 | $ | 544 | |||||||||
|
Derivatives
not designated as hedging
|
|||||||||||||||||
|
instruments
under SFAS 133
|
|||||||||||||||||
|
Fuel
derivative contracts (gross)*
|
Accrued
liabilities
|
$ | 441 | $ | 387 | $ | 635 | $ | 708 | ||||||||
|
Fuel
derivative contracts (gross)*
|
Other
deferred liabilities
|
255 | 266 | 799 | 530 | ||||||||||||
|
Total
derivatives not designated as
|
|||||||||||||||||
|
hedging
instruments under SFAS 133
|
$ | 696 | $ | 653 | $ | 1,434 | $ | 1,238 | |||||||||
|
Total
derivatives
|
$ | 794 | $ | 870 | $ | 1,650 | $ | 1,782 | |||||||||
|
*
Does not include the impact of cash collateral deposits provided to
counterparties. See discussion
|
|||||||||||||||||
|
of
credit risk and collateral following in this Note.
|
|||||||||||||||||
In
addition, the Company also had the following amounts associated with fuel
derivative instruments and hedging activities in its unaudited Condensed
Consolidated Balance Sheet (in millions):
|
Balance
Sheet
|
March
31,
|
December
31,
|
|||||||
|
Location
|
2009
|
2008
|
|||||||
|
Cash
collateral deposits provided
|
Offset
against Other
|
||||||||
|
to
counterparty
|
deferred
liabilities
|
300 | 240 | ||||||
|
Due
to third parties for settled fuel contracts
|
Accrued
liabilities
|
22 | 16 | ||||||
|
Net
unrealized losses from fuel
|
Accumulated
other
|
||||||||
|
hedges,
net of tax
|
comprehensive
loss
|
888 | 946 | ||||||
The
following tables present the impact of derivative instruments and their location
within the unaudited Condensed Consolidated Statement of Operations (in
millions):
|
Derivatives
in SFAS 133 Cash Flow Hedging Relationships
|
||||||||||||||||||||||||
|
Amount
of (Gain) Loss Recognized in AOCI on Derivative (Effective
Portion)
|
Amount
of (Gain) Loss Reclassified from AOCI into Income (Effective
Portion)(a)
|
Amount
of (Gain) Loss Recognized in Income on Derivatives (ineffective portion)
(b)
|
||||||||||||||||||||||
|
Three
months ended March 31,
|
Three
months ended March 31,
|
Three
months ended March 31,
|
||||||||||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
2009
|
2008
|
|||||||||||||||||||
|
Fuel
derivative
|
||||||||||||||||||||||||
|
contracts
|
$ | 52 | * | $ | (430 | ) * | $ | 110 | * | $ | (170 | ) * | $ | 16 | $ | 7 | ||||||||
|
Interest
rate
|
||||||||||||||||||||||||
|
derivatives
|
(5 | ) * | - | - | - | - | - | |||||||||||||||||
|
Total
|
$ | 47 | $ | (430 | ) | $ | 110 | $ | (170 | ) | $ | 16 | $ | 7 | ||||||||||
|
* Net
of tax
|
||||||||||||||||||||||||
|
(a)
Amounts related to fuel derivative contracts and interest rate derivatives
are included in
|
||||||||||||||||||||||||
|
Fuel
and oil and Interest expense, respectively.
|
||||||||||||||||||||||||
|
(b)
Amounts are included in Other (gains) losses, net.
|
||||||||||||||||||||||||
|
Derivatives
not in SFAS 133 Cash Flow Hedging Relationships
|
||||
|
Amount
of (Gain) Loss Recognized in Income on Derivatives
|
||||
|
Three
months ended March 31,
|
Location
of (Gain) Loss Recognized in Income
|
|||
|
2009
|
2008
|
on
Derivatives
|
||
|
Fuel
derivative contracts
|
$(27)
|
$16
|
Other
(gains) losses,
net
|
|
In
addition, the Company also recorded expense associated with premiums paid for
fuel derivative contracts that settled/expired during the three months ended
March 31, 2009 and 2008, respectively, of $32 million and $14
million. These amounts are excluded from the Company’s measurement of
effectiveness for related hedges.
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. Included in the Company’s total net unrealized losses from
fuel hedges as of March 31, 2009, are approximately $360 million in net
unrealized losses that are expected to be realized in earnings during the twelve
months following March 31, 2009. In addition, as of March 31, 2009,
the Company had already recognized cumulative net losses due to ineffectiveness
and derivatives that do not qualify for hedge accounting totaling $10 million,
net of taxes. These gains were recognized in the three months ended
March 31, 2009, and prior periods, and are reflected in “Retained earnings” as
of March 31, 2009, but the underlying derivative instruments will not
expire/settle until subsequent periods of 2009 or future periods.
Interest
rate swaps
The
Company is party to interest rate swap agreements related to its $385 million
6.5% senior unsecured notes due 2012, its $350 million 5.25% senior unsecured
notes due 2014, its $300 million 5.125% senior unsecured notes due 2017, and its
$100 million 7.375% senior unsecured debentures due 2027. The primary
objective for the Company’s use of these interest rate hedges is to better match
the repricing of its assets and liabilities. 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 payments based on the fixed stated rate of the notes every six
months until the date the notes become due. These interest rate swap
agreements qualify as fair value hedges, as defined by SFAS 133. In
addition, these interest rate swap agreements qualify for the “shortcut” method
of accounting for hedges, as defined by SFAS 133. Under the
“shortcut” method, the hedges are assumed to be perfectly effective, and, thus,
there is no ineffectiveness to be recorded in earnings.
The
Company also entered into an interest rate swap agreement concurrent with its
entry into a twelve-year, $600 million floating-rate Term Loan Agreement during
2008. Under this swap agreement, which is accounted for as a cash
flow hedge, the interest rate on the term loan is effectively fixed for its
entire term at 5.223 percent and ineffectiveness is required to be measured each
reporting period. The fair values of the interest rate swap
agreements, which are adjusted regularly, have been aggregated by counterparty
for classification in the unaudited Condensed Consolidated Balance
Sheet.
Credit
risk and collateral
The
Company’s credit exposure related to fuel derivative instruments is represented
by the fair value of contracts with a net positive fair value to the Company at
the reporting date. At such times, these outstanding instruments
expose the Company to credit loss in the event of nonperformance by the
counterparties to the agreements. However, the Company has not
experienced any significant credit loss as a result of counterparty
nonperformance in the past. To manage credit risk, the Company
selects and will periodically review counterparties based on credit ratings,
limits its exposure to a single counterparty, and monitors the market position
of the program and its relative market position with each
counterparty. At March 31, 2009, the Company had agreements with
eight 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. Based on the Company’s current agreement with one of these
counterparties, cash deposits are required to be posted whenever the net fair
value of derivatives associated with that counterparty exceed a specific
threshold. If this threshold is exceeded, cash is either posted by
the counterparty if the value of derivatives is an asset to the Company, or
posted by the Company if the value of derivatives is a liability to the
Company. Under this agreement, as amended, until January 1, 2010, if
the Company becomes obligated to post collateral for obligations in amounts of
up to $300 million and in excess of $700 million, the Company is required to
post cash collateral; however, if the Company becomes obligated to post
collateral for obligations in amounts between $300 million and $700 million, the
Company has pledged 20 of its Boeing 737-700 aircraft as collateral in lieu of
cash. At March 31, 2009, the fair value of fuel derivative
instruments with this counterparty was a net liability of $355 million, and the
Company had posted $300 million in cash collateral deposits with the
counterparty, with the remaining $55 million secured by specified
aircraft. If the fair value of fuel derivative instruments with this
counterparty were in a net asset position, the counterparty is required to post
cash collateral to the Company on a dollar-for-dollar basis for amounts in
excess of $40 million. This agreement does not contain any triggers
that would require additional cash to be posted by the Company outside of
further changes in the fair value of the fuel derivative instruments held with
the counterparty. However, if the fair value of fuel derivative
instruments with this counterparty were in a net asset position, and the
counterparty’s credit rating were to be lowered to specified levels, the
counterparty could be required to post cash collateral to the Company on a
dollar-for-dollar basis related to the first $40 million of assets
held.
On March
27, 2009, the Company entered into a fuel hedging agreement with a second
counterparty that replaced an existing fuel hedging agreement with that
counterparty. Under the previous agreement, the Company became
obligated to post cash or letters of credit as security for fuel derivative
liabilities upon a noninvestment grade credit rating. Under the new
agreement, the Company is obligated to post collateral related to fuel
derivative liabilities as follows: (i) if the obligation is up to
$125 million, the Company posts cash collateral, (ii) if the obligation is
between $125 million and $625 million, the Company has pledged Boeing 737-700
aircraft, and (iii) if the obligation exceeds $625 million, the Company must
post cash or letters of credit as collateral. The Company pledged 29
of its Boeing 737-700 aircraft to cover the collateral posting band in clause
(ii). Although no cash collateral had been provided to this
counterparty as of March 31, 2009, the Company did post $125 million in cash
collateral deposits to this counterparty in April 2009 upon the effective date
of the agreement. The agreement also provides for the counterparty to
post cash collateral to the Company on a dollar-for-dollar basis for any net
positive fair value of fuel derivative instruments in excess of $150 million
held by the Company from that counterparty. This agreement does not
contain any triggers that would require additional cash to be posted by the
Company outside of further changes in the fair value of the fuel derivative
instruments held with the counterparty. However, if the fair value of
fuel derivative instruments with this counterparty were in a net asset position,
and the counterparty’s credit rating were to be lowered to specified levels, the
counterparty would be required to post cash collateral to the Company on a
dollar-for-dollar basis related to the first $150 million of assets
held.
As of
March 31, 2009, other than described above, the Company did not have any fuel
hedging agreements with counterparties in which cash collateral is required to
be posted based on the Company’s current investment grade credit
rating. However, one additional fuel hedging agreement contains a
provision whereby each party has the right to terminate and settle all
outstanding fuel contracts if the other party’s credit rating falls below
investment grade. Upon this occurrence, the party in a net liability
position could subsequently be required to post cash collateral if a mutual
alternative agreement could not be reached. At March 31, 2009, the
Company’s estimated fair value of fuel derivative contracts with this
counterparty was a liability of $188 million, including $73 million that will
settle by the end of 2009.
As a
result of recent modifications made to the fuel hedging agreements with
counterparties, the Company has significantly reduced its exposure to future
cash collateral requirements. As an example, even if market prices
for the commodities used in the Company’s fuel hedging activities were to
decrease by 50 percent from current market prices, given the Company’s current
fuel hedge portfolio and its investment grade credit rating, it would not have
to provide additional cash collateral to its current
counterparties.
As
discussed in Note 1, the Company has adopted the provisions of FIN
39-1. FIN 39-1 requires an entity to select a policy of how it
records the offset rights to reclaim cash collateral associated with the related
derivative fair value of the assets or liabilities of such derivative
instruments. Entities may either select a “net” or a “gross”
presentation. The Company has elected to present its cash collateral
utilizing a net presentation, in which cash collateral amounts held or provided
have been netted against the fair value of outstanding derivative
instruments. The Company’s policy differs depending on whether its
derivative instruments are in a net asset position or a net liability
position. If its fuel derivative instruments are in a net asset
position with a counterparty, cash collateral amounts held are first netted
against current derivative amounts (those that will settle during the twelve
months following the balance sheet date) associated with that counterparty until
that balance is zero, and then any remainder would be applied against the fair
value of noncurrent outstanding derivative instruments (those that will settle
beyond one year following the balance sheet date.) If its fuel
derivative instruments are in a net liability position with a counterparty, cash
collateral amounts provided are first netted against noncurrent derivative
amounts associated with that counterparty until that balance is zero, and then
any remainder would be applied against the fair value of current outstanding
derivative instruments. At March 31, 2009, the $300 million in cash
collateral deposits posted with a counterparty under its bilateral collateral
provisions has been netted against noncurrent fuel derivative instruments within
“Other deferred liabilities” in the unaudited Condensed Consolidated Balance
Sheet.
6. COMPREHENSIVE
INCOME (LOSS)
Comprehensive
income (loss) included changes in the fair value of certain financial derivative
instruments, which qualify for hedge accounting, and unrealized gains and losses
on certain investments. The differences between net income (loss) and
comprehensive income (loss) for the three month periods ended March 31, 2009 and
2008, were as follows:
|
Three
months ended March 31,
|
|||||||||
|
(In
millions)
|
2009
|
2008
|
|||||||
|
Net
income (loss)
|
$ | (91 | ) | $ | 34 | ||||
|
Unrealized
gain (loss) on derivative instruments,
|
|||||||||
|
net
of deferred taxes of $36 and ($151)
|
58 | 260 | |||||||
|
Other,
net of deferred taxes of $3 and $6
|
4 | (9 | ) | ||||||
|
Total
other comprehensive income
|
62 | 251 | |||||||
|
Comprehensive
income (loss)
|
$ | (29 | ) | $ | 285 | ||||
A
rollforward of the amounts included in “AOCI,” net of taxes, is shown
below:
|
Accumulated
|
||||||||||||
|
Fuel
|
other
|
|||||||||||
|
hedge
|
comprehensive
|
|||||||||||
|
(In
millions)
|
derivatives
|
Other
|
income
(loss)
|
|||||||||
|
Balance
at December 31, 2008
|
$ | (946 | ) | $ | (38 | ) | $ | (984 | ) | |||
|
2009
changes in value
|
(52 | ) | 4 | (48 | ) | |||||||
|
Reclassification
to earnings
|
110 | - | 110 | |||||||||
|
Balance
at March 31, 2009
|
$ | (888 | ) | $ | (34 | ) | $ | (922 | ) | |||
7. ACCRUED
LIABILITIES
|
March
31,
|
December
31,
|
|||||||
|
(In
millions)
|
2009
|
2008
|
||||||
|
Retirement
Plans
|
$ | 85 | $ | 86 | ||||
|
Aircraft
Rentals
|
98 | 118 | ||||||
|
Vacation
Pay
|
178 | 175 | ||||||
|
Advances
and deposits
|
20 | 23 | ||||||
|
Fuel
derivative contracts
|
213 | 246 | ||||||
|
Deferred
income taxes
|
67 | 36 | ||||||
|
Workers
compensation
|
123 | 122 | ||||||
|
Other
|
232 | 206 | ||||||
|
Accrued
liabilities
|
$ | 1,016 | $ | 1,012 | ||||
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)
|
2009
|
2008
|
|||||||
|
Service
cost
|
$ | 3 | $ | 3 | |||||
|
Interest
cost
|
1 | 1 | |||||||
|
Net
periodic postretirement benefit cost
|
$ | 4 | $ | 4 | |||||
9. SALE-LEASEBACK
TRANSACTIONS
In
December 2008, the Company entered into a two tranche sale and leaseback
transaction with a third party aircraft lessor for the sale and leaseback of ten
of the Company's Boeing 737-700 aircraft. Under the first tranche of the
transaction, which closed on December 23, 2008, the Company sold five of its
Boeing 737-700 aircraft for a total of approximately $173 million and
immediately leased the aircraft back for 12 years. Under the second
tranche of the transaction, which closed on January 8, 2009, the Company sold
five of its Boeing 737-700 aircraft for a total of approximately $173 million
and immediately leased the aircraft back for 16 years. These sale and
leasebacks resulted in a deferred gain of $21 million, which will be amortized
over the respective terms of the leases.
All of
the leases from these sale-leasebacks are accounted for as operating
leases. Under the terms of the lease agreements, the Company will
continue to operate and maintain the aircraft. Payments under the
lease agreements will be reset every six months based on changes in the
six-month LIBOR rate. The lease agreements contain standard termination events,
including termination upon a breach of the Company's obligations to make rental
payments and upon any other material breach of the Company's obligations under
the leases, and standard maintenance and return condition provisions. Upon a
termination of the lease upon a breach by the Company, the Company would be
liable for standard contractual damages, possibly including damages suffered by
the lessor in connection with remarketing the aircraft or while the aircraft is
not leased to another party.
10. CONTINGENCIES
On March
6, 2008, the Federal Aviation Administration (the “FAA”) 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 accrued the proposed fine as an
operating expense in first quarter 2008. On March 2, 2009, the FAA
and the Company agreed to settle the matter, and other pending and
potential regulatory compliance matters, for $7.5 million.
Approximately one-third of this amount was paid in first quarter
2009, and the remainder will be paid in equal installments in 2010 and
2011. The Company also agreed, among other things, to improve
FAA access to information about its maintenance and engineering activities and
make certain changes to its maintenance and engineering functions. Failure
to perform these obligations could result in additional fines of up to a
maximum of $7.5 million. The agreement did not contain any finding
of violation or admission of wrongdoing by the Company.
In
connection with the above incident, during the first quarter and early second
quarter of 2008, the Company was 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 FAA 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. Also in connection with the above incident,
during the first quarter and early second quarter of 2008, the Company received
four letters from 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 an alleged breach of
fiduciary duties owed by them to the Company. In August 2008, Carbon
County Employees Retirement System and Mark Cristello filed a related
Shareholder derivative action in Texas state court naming certain directors and
officers of the Company as individual defendants and the Company as a nominal
defendant. The derivative action claims breach of fiduciary duty and
seeks recovery by the Company of alleged monetary damages sustained as a result
of the purported breach of fiduciary duty, as well as costs of the
action. A Special Committee appointed by the Independent Directors of
the Company is currently evaluating the Shareholder 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 (IRS).
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.
During
2008, the City of Dallas approved the Love Field Modernization Program, an
estimated $519 million project to reconstruct Dallas Love Field with modern,
convenient air travel facilities. Pursuant to a Program Development
Agreement with the City of Dallas, Southwest is managing this project, and
initial construction is expected to commence during late 2009, with completion
scheduled for October 2014. Bonds will be issued at a later date by
the Love Field Airport Modernization Corporation (a “local government
corporation” under Texas law formed by the City of Dallas) that will provide
funding for this project, with repayment of the bonds being made through
recurring ground rents, fees, and other revenues collected by the
airport.
11. FAIR
VALUE MEASUREMENTS
The
Company adopted SFAS No. 157, “Fair Value Measurements” (SFAS 157) as of
January 1, 2008. 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. FASB Staff Position 157-2, “Effective Date of FASB
Statement No. 157,” applies to nonfinancial assets and nonfinancial liabilities
and was effective January 1, 2009. The adoption of this standard had
no impact on the Company in first quarter 2009.
As of
March 31, 2009, the Company held certain items that are required to be measured
at fair value on a recurring basis. These included cash equivalents,
short-term investments, certain noncurrent investments, interest rate derivative
contracts, fuel derivative contracts, and available-for-sale
securities. Cash equivalents consist of short-term, highly liquid,
income-producing investments, all of which have maturities of 90 days or less,
including money market funds, U.S. Government obligations, and obligations of
U.S. Government backed agencies. Short-term investments consist of
short-term, highly liquid, income-producing investments, which have maturities
of greater than 90 days but less than one year, including U.S. Government
obligations, obligations of U.S. Government backed agencies, and certain
non-taxable auction rate securities. Derivative instruments are
related to the Company’s attempts to hedge fuel costs and interest
rates. Noncurrent investments consist of auction rate securities
collateralized by student loan portfolios, which are guaranteed by the U.S.
Government. Other available-for-sale securities primarily consist of
investments associated with the Company’s Excess Benefit Plan.
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 financial institutions that trade
these contracts. In situations where the Company obtains inputs via
quotes from financial institutions, it verifies the reasonableness of these
quotes via similar quotes from another financial institution as of each date for
which financial statements are prepared. The Company also considers
counterparty credit risk and its own credit risk in its determination of all
estimated fair values. 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 used to determine
the fair value of option contracts are unobservable (principally implied
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 used 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.
All of
the Company’s auction rate security instruments are reflected at estimated fair
value in the unaudited Condensed Consolidated Balance Sheet. At March
31, 2009, approximately $109 million of these instruments are classified as
available for sale securities and $83 million are classified as trading
securities. The $83 million classified as trading securities are subject to an
agreement the Company entered into in December 2008, as discussed
below. The current portion of these securities, totaling $10 million,
are included in “Short-term investments,” and the noncurrent portion, totaling
$73 million, are included in “Other assets” in the unaudited Condensed
Consolidated Balance Sheet. In periods when an auction process
successfully takes place every 30-35 days, quoted market prices would be readily
available, which would qualify as Level 1 under SFAS 157. However,
due to events in credit markets beginning during first quarter 2008, the auction
events for most of these instruments failed, and, therefore, the Company has
subsequently determined the estimated fair values of these securities utilizing
a discounted cash flow analysis or other type of valuation model. In
addition, during fourth quarter 2008, the Company performed a valuation of a
selected number of auction rate security instruments and considered these
valuations in determining estimated fair values of other similar instruments
within its portfolio. The Company’s 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 estimates of the next time the security is expected to have a successful
auction or return to full par value. These securities were also
compared, when possible, to other securities not owned by the Company, but with
similar characteristics.
In
association with this estimate of fair value, the Company has recorded a
temporary unrealized decline in fair value of $11 million, with an offsetting
entry to “AOCI.” 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 these auction rate securities held by the
Company are almost entirely backed by the U.S. Government. In
addition, for the $109 million in instruments classified as available for sale,
these auction rate securities represented approximately five percent of the
Company’s total cash, cash equivalent, and investment balance at March 31, 2009,
which it believes allows it sufficient time for the securities to return to full
value. For the $83 million in instruments classified as trading
securities, the Company is party to an agreement with the counterparty that
allows the Company to put the instruments back to the counterparty at full par
value in June 2010. In conjunction with this agreement, the Company
has applied the provisions of SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities” to this put option. Part of this
agreement also contains a line of credit in which the Company holds an $83
million loan that is secured by the auction rate security instruments from that
counterparty. Both the put option and the instruments are being
marked to market value through earnings each period; however, these adjustments
offset and had minimal impact on net earnings impact for first quarter
2009. At the time of the first failed auctions during first quarter
2008, the Company held a total of $463 million in securities. Since
that time, the Company has been able to sell $260 million of these instruments
at par value in addition to the $83 million subject to the agreement to be
settled at par in June 2010.
During
first quarter 2009, the Company also entered into a $46 million line of credit
agreement with another counterparty secured by approximately $92 million (par
value) of its remaining auction rate security instruments purchased through that
counterparty. This agreement allows the Company the ability to draw
against the line of credit secured by the auction rate security instruments from
that counterparty. As of March 31, 2009, the Company had no
borrowings against that available line of credit. The Company remains
in discussions with its other counterparties to determine whether mutually
agreeable decisions can be reached regarding the effective repurchase of its
remaining securities. The Company has continued 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 temporary write-downs, would
be recorded to “AOCI.” If the Company determines that any future
valuation adjustment was other than temporary, it would record a charge to
earnings as appropriate.
The
following items are measured at fair value on a recurring basis subject to the
disclosure requirements of SFAS 157 at March 31, 2009:
|
Fair Value Measurements at Reporting Date
Using
|
||||||||||||||||
|
Quoted
Prices in
|
Significant
|
|||||||||||||||
|
Active
Markets for
|
Significant
Other
|
Unobservable
|
||||||||||||||
|
Identical
Assets
|
Observable
Inputs
|
Inputs
|
||||||||||||||
|
Description
|
March 31, 2009
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
|
Assets
|
(in
millions)
|
|||||||||||||||
|
Cash
equivalents
|
$ | 1,145 | $ | 1,145 | $ | - | $ | - | ||||||||
|
Short-term
investments
|
989 | 959 | - | 30 | ||||||||||||
|
Noncurrent
investments (a)
|
162 | - | - | 162 | ||||||||||||
|
Interest
rate derivatives
|
75 | - | 75 | - | ||||||||||||
|
Fuel
derivatives (b)
|
715 | - | 348 | 367 | ||||||||||||
|
Other
available-for-sale securities
|
29 | 21 | - | 8 | ||||||||||||
|
Total
assets
|
$ | 3,115 | $ | 2,125 | $ | 423 | $ | 567 | ||||||||
|
Liabilities
|
||||||||||||||||
|
Fuel
derivatives (b)
|
$ | (1,646 | ) | $ | (498 | ) | $ | (1,148 | ) | |||||||
|
(a)
Included in "Other assets" in the unaudited Condensed Consolidated Balance
Sheet.
|
||||||||||||||||
|
(b)
In the unaudited Condensed Consolidated Balance Sheet, amounts are
presented as a net liability, and are also
|
||||||||||||||||
|
net
of $300 million in cash collateral provided to
counterparties.
|
||||||||||||||||
The
following table presents the Company’s activity for assets measured at fair
value on a recurring basis using significant unobservable inputs (Level 3) as
defined in SFAS 157 for the three months ended March 31, 2009:
|
Fair Value Measurements Using
Significant
|
|||||||||||||||||
|
Unobservable Inputs (Level
3)
|
|||||||||||||||||
|
Fuel
|
Auction
Rate
|
Other
|
|||||||||||||||
|
(in
millions)
|
Derivatives
|
Securities (a)
|
Securities
|
Total
|
|||||||||||||
|
Balance
at December 31, 2008
|
$ | (864 | ) | $ | 200 | $ | 8 | $ | (656 | ) | |||||||
|
Total
gains or (losses) (realized or unrealized)
|
|||||||||||||||||
|
Included
in earnings
|
(32 | ) | - | - | (32 | ) | |||||||||||
|
Included
in other comprehensive income
|
(84 | ) | - | - | (84 | ) | |||||||||||
|
Purchases
and settlements (net)
|
199 | (8 | ) | - | 191 | ||||||||||||
|
Balance
at March 31, 2009
|
$ | (781 | ) | $ | 192 |
(b)
|
$ | 8 | $ | (581 | ) | ||||||
|
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 March 31, 2009
|
$ | (10 | ) | $ | - | $ | - | $ | (10 | ) | |||||||
|
(a)
Includes those classified as short-term investments and noncurrent
investments.
|
|||||||||||||||||
|
(b)
Includes $83 classified as trading securities.
|
|||||||||||||||||
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 derivative contracts, as defined in SFAS 133, including amounts
that settled in the current period (realized), and amounts that will settle in
future periods (unrealized), is recorded in earnings immediately, as a component
of “Other (gains) losses, net.” See Note 5 for further information on
SFAS 133 and hedging.
Gains and
losses (realized and unrealized) included in earnings related to other
investments for the three months ended March 31, 2009, are reported in “Other
operating expenses.”
12. TAX
RATE
The
Company’s effective tax rate was 15.3 percent in first quarter
2009. This low rate in first quarter 2009 was impacted by the
Company’s lower expected earnings for 2009 and the related impact that permanent
tax differences have on these projections.
13. SUBSEQUENT
EVENTS
On April
2, 2009, the Company documented and closed the first tranche of what is expected
to be a two tranche sale and leaseback transaction with a third party aircraft
lessor for the sale and leaseback of a total of six of the Company's Boeing
737-700 aircraft. On that date, the Company sold three of its Boeing
737-700 aircraft for a total of approximately $105 million and immediately
leased the aircraft back for approximately 12 years. This sale and leaseback
resulted in a deferred gain of $8 million, which will be amortized over the
respective terms of the leases. Under the second tranche of the
transaction, which is expected to close in second quarter 2009, the Company will
sell an additional three of its Boeing 737-700 aircraft for approximately the
same amount and terms as in the first tranche.
On April
16, 2009, the Company announced Freedom ’09, a voluntary early retirement
program offered to eligible Employees, in which the Company will offer cash
bonuses, medical/dental coverage for a specified period of time, and travel
privileges based on work group and years of service. Virtually all of
the Company’s Employees hired before March 31, 2008 are eligible to participate
in the program. Participants’ last day of work is expected to fall
between July 15, 2009 and April 15, 2010, based on the operational needs of
particular work locations and departments, which is to be
determined. The Company does not have a target or expectation for the
number of Employees expected to accept the package.
The
Company expects to determine the accounting for charges incurred with Freedom
‘09 and be able to estimate the cost of termination benefits in second quarter
2009. Depending on the number of eligible Employees who accept the
offer, it may be necessary to replace a portion of the positions with newly
hired Employees to meet operational demands. Some of the positions
will not need to be filled based on the Company’s recent capacity
reductions. The purpose of this voluntary initiative and other
initiatives is to reduce headcount in conjunction with the Company’s current
plans to reduce its capacity by five percent in 2009 and to help reduce
costs.
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, 2009 and 2008 are as
follows:
|
Three
months ended March 31,
|
||||||||||||
|
2009
|
2008
|
Change
|
||||||||||
|
Revenue
passengers carried
|
19,759,690 | 21,504,821 | (8.1 | )% | ||||||||
|
Enplaned
passengers
|
23,049,990 | 24,708,615 | (6.7 | )% | ||||||||
|
Revenue
passenger miles (RPMs) (000s)
|
16,891,629 | 17,592,159 | (4.0 | )% | ||||||||
|
Available
seat miles (ASMs) (000s)
|
24,171,675 | 25,193,437 | (4.1 | )% | ||||||||
|
Load
factor
|
69.9 | % | 69.8 | % |
0.1
|
pts | ||||||
|
Average
length of passenger haul (miles)
|
855 | 818 | 4.5 | % | ||||||||
|
Average
aircraft stage length (miles)
|
635 | 627 | 1.3 | % | ||||||||
|
Trips
flown
|
279,135 | 294,790 | (5.3 | )% | ||||||||
|
Average
passenger fare
|
$113.97 | $112.24 | 1.5 | % | ||||||||
|
Passenger
revenue yield per RPM (cents)
|
13.33 | 13.72 | (2.8 | )% | ||||||||
|
Operating
revenue yield per ASM (cents)
|
9.75 | 10.04 | (2.9 | )% | ||||||||
|
Operating
expenses per ASM (cents)
|
9.96 | 9.69 | 2.8 | % | ||||||||
|
Fuel
costs per gallon, including fuel tax
|
$1.99 | $2.13 | (6.6 | )% | ||||||||
|
Fuel
consumed, in gallons (millions)
|
349 | 373 | (6.4 | )% | ||||||||
|
Full-time
equivalent Employees at period-end
|
35,512 | 34,793 | 2.1 | % | ||||||||
|
Size
of fleet at period-end
|
539 | 527 | 2.3 | % | ||||||||
|
*
Headcount is defined as "Active" fulltime equivalent Employees for both
periods presented.
|
||||||||||||
Material
Changes in Results of Operations
Summary
Southwest
recorded a first quarter 2009 net loss of $91 million, or $.12 loss per share,
diluted, versus the Company’s first quarter 2008 net income of $34 million, or
$.05 per share, diluted. The net loss in first quarter 2009 was
primarily due to a decline in demand for domestic air travel as a result of the
current ongoing U.S. recession. Although the Company, as well as most
other airlines, reduced capacity versus the prior year, demand was weak,
resulting in a significant increase in discounting of seats and a reduction in
full-fare demand. This resulted in a 2.7 percent decrease in
passenger revenue yield per available seat mile (ASM). This result
was exacerbated by the year-over-year impact relating to the timing of the
Easter holiday—Easter fell in March of 2008, thereby providing a boost to first
quarter 2008 revenues, but falls in April of the current year, which will
provide a benefit to second quarter 2009. The Company’s overall 6.8
percent year-over-year decrease in operating revenues more than offset savings
realized as a result of lower jet fuel prices versus first quarter
2008. The Company’s average jet fuel cost per gallon (including
related fuel taxes) decreased 6.6 percent compared to first quarter 2008,
inclusive of gains and/or losses from fuel contract settlements and related SFAS
133 adjustments included in “Fuel and oil” expense. See Note 5 to the
unaudited condensed consolidated financial statements for further information on
the Company’s hedging activities and accounting associated with derivative
instruments. For first quarter 2009, the Company had an operating
loss of $50 million compared to first quarter 2008 operating income of $88
million.
Despite
the ongoing U.S. recession and reduction in demand for air travel, the Company
is continuing to push forward with its strategy to grow revenues. The
Company has differentiated itself from most other domestic carriers with its
aggressive promotion of its No Hidden Fees, Low Fare brand. The
Company also continues to add new markets, including Minneapolis-St. Paul (in
March 2009), New York’s LaGuardia airport (in June 2009), and Boston’s Logan
International airport (in August 2009). Although the Company does not
plan to grow its fleet in 2009, it is able to add flights to these new markets
through a continual flight schedule optimization, which involves trimming
unproductive and less popular flights and reallocating capacity to fund market
growth opportunities such as Denver and the aforementioned
cities. Other potential revenue initiatives include codeshare
agreements with Canadian carrier WestJet and Mexican carrier Volaris, and the
Company’s current ongoing test of wireless internet connectivity (“Wi-Fi”)
aboard its aircraft. The Company and WestJet plan to announce
codeshare flight schedules and additional features regarding the relationship by
late 2009. The Company and Volaris plan to announce codeshare flight
schedules and additional features regarding the relationship by early
2010. Certain details of these alliances are subject to approvals by
both the U.S. and Canadian/Mexican governments. The Company is also
continuing to consider codeshare opportunities with other
carriers. The Company currently has Wi-Fi installed on four of its
Boeing 737 aircraft, and expects to soon make a decision regarding plans to
offer this service aboard a larger portion of its fleet.
On the
cost side, the Company remains diligent in its efforts to control expenses and
remain a low-cost leader in the industry. On April 16, 2009, the
Company announced an early retirement option available for the vast majority of
its Employees. This voluntary separation program provides cash
bonuses, health care coverage for a specified period of time, and certain
extended flight privileges to eligible Employees who elect early retirement
under the program. The Company also has recently reached agreement
regarding many of its collective-bargaining agreements which are currently
amendable. During the first quarter of 2009, the Company’s Ramp,
Operations, Provisioning, and Freight Agents and its Mechanics voted to ratify
their agreements. The Company’s Flight Attendants and Pilots will
vote on their tentative agreements in second quarter 2009. These
contracts contain modest raises and improved benefits for the Company’s
productive Employees, but also contain provisions that should result in
efficiency improvements that could boost the Company’s bottom
line. The Company has also significantly reduced planned capital
spending by approximately $1.4 billion for 2009 and 2010 combined from what was
planned at the beginning of 2008, by deferring aircraft deliveries, accelerating
aircraft retirements, and suspending plans to grow capacity.
In first
quarter 2009, the Company received three new Boeing 737-700s and retired one
Boeing 737-300 aircraft. The Company has ten additional deliveries of
new Boeing 737-700s scheduled during the remainder of 2009, but also plans to
sell, retire and/or return from lease 14 of its existing Boeing 737 aircraft
during the remainder of 2009. Overall, the Company currently expects
to end 2009 with 535 aircraft, which is a net reduction of two aircraft for the
year, and to fly approximately five percent fewer ASMs than it flew in
2008. Based on current plans, the Company expects its second quarter
2009 ASM capacity to decrease approximately three percent versus second quarter
2008. The Company believes this cautious strategy will enable it to
match flights with expected demand in the current economic
environment. However, the Company believes it has retained the
flexibility to enable it to begin growing again once economic conditions
improve.
Comparison
of three months ended March 31, 2009, to three months ended March 31,
2008
Revenues
Consolidated operating revenues
decreased by $173 million, or 6.8 percent, primarily due to a $162 million, or
6.7 percent, decrease in Passenger revenues. Approximately 60 percent
of the overall decrease in Passenger revenues was due to the 4.1 percent
reduction in capacity (ASMs) versus the prior year. The remainder of
the Passenger revenue decrease was primarily due to a 2.8 percent decrease in
Passenger yield per Revenue Passenger Mile (RPM yield), as full fare bookings
are down versus the prior year and the Company increased the amount of fare
discounting and fare sales in response to the decline in demand for air travel
amid current domestic economic conditions. As a result of the
Company’s fare discounting efforts and overall reduction in ASM capacity, load
factors were slightly higher than first quarter 2008 levels, and represented a
record for the first quarter of any year in the Company’s
history. The overall decline in operating revenues combined with the
lower capacity led to a 2.9 percent decline in operating revenue yield per ASM
(unit revenue).
Based on the Company’s recent actions
to reduce fares, current revenue and booking trends, and based on the Company’s
and its competitors’ announced capacity reductions for second quarter 2009
versus second quarter 2008, the Company currently expects continued higher load
factors versus the prior year, but at lower passenger revenue
yields. Second quarter 2009 will benefit from the Easter holiday, but
based on current revenue and booking trends, the Company expects another decline
in operating unit revenues for second quarter 2009 versus second quarter
2008.
Consolidated freight revenues decreased
by $4 million, or 11.8 percent, primarily due to fewer shipments as a result of
the ongoing worldwide recession. The Company expects a comparable
decrease in consolidated freight revenues for second quarter 2009 compared to
second quarter 2008. Other revenues decreased by $7 million, or 8.5
percent, compared to first quarter 2008. The majority of the decrease
was primarily due to lower commissions earned from programs the Company sponsors
with certain business partners, such as the Company sponsored co-branded Visa
card. The Company expects Other revenues for second quarter 2009 to
decrease versus second quarter 2008, also due to lower commissions earned from
business partners.
Operating
expenses
Consolidated operating expenses for
first quarter 2009 decreased $35 million, or 1.4 percent, compared to first
quarter 2008, versus a 4.1 percent decrease in capacity compared to first
quarter 2008. Historically, except for changes in the price of fuel,
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 2009 and first quarter 2008 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
|
|||||||||||||||
|
2009
|
2008
|
Change
|
Change
|
||||||||||||||
|
Salaries,
wages, and benefits
|
3.46 | 3.17 | .29 | 9.1 | |||||||||||||
|
Fuel
and oil
|
2.89 | 3.17 | (.28 | ) | (8.8 | ) | |||||||||||
|
Maintenance
materials
|
|||||||||||||||||
|
and
repairs
|
.76 | .57 | .19 | 33.3 | |||||||||||||
|
Aircraft
rentals
|
.19 | .15 | .04 | 26.7 | |||||||||||||
|
Landing
fees and other rentals
|
.69 | .68 | .01 | 1.5 | |||||||||||||
|
Depreciation
|
.62 | .58 | .04 | 6.9 | |||||||||||||
|
Other
operating expenses
|
1.35 | 1.37 | (.02 | ) | (1.5 | ) | |||||||||||
|
Total
|
9.96 | 9.69 | .27 | 2.8 | |||||||||||||
Operating expenses per ASM for the
three months ended March 31, 2009, were 9.96 cents, a 2.8 percent increase
compared to 9.69 cents for first quarter 2008. The majority of this
increase primarily was due to higher wages, as a result of higher wage
rates. In addition, the decline in capacity versus first quarter 2008
has caused the Company’s fixed costs to be spread over a smaller quantity of
ASMs. Mostly offsetting these increases, however, was a reduction in
fuel costs, as the Company’s average cost per gallon of fuel decreased 6.6
percent versus the prior year, net of hedging. On a dollar basis, the
majority of the decrease was due to a $102 million decline in Fuel and
oil. Approximately half of this decrease was due to a lower fuel cost
per gallon and half was due to the reduction in fuel
consumption. Partially offsetting this decrease were a $41 million
increase in Maintenance materials and repairs and a $36 million increase in
Salaries, wages, and benefits. Based on current unit operating cost
trends, the Company expects second quarter 2009 unit costs, excluding fuel and
any charges associated with the Company's voluntary retirement program, to be in
line with first quarter 2009. See Note 13 to the unaudited condensed
consolidated financial statements for more information on Freedom
'09.
Salaries, wages, and benefits expense
per ASM for the three months ended March 31, 2009, increased 9.1 percent
compared to first quarter 2008, and on a dollar basis increased $36
million. These increases primarily were due to wage rate
increases. These rate increases were a result of both completed and
ongoing labor contract negotiations with various unionized Employee workgroups
and rate increases associated with promotions and increased seniority of
existing Employees. This increase was partially offset by a decrease
in profitsharing expense versus first quarter 2008. The Company’s
profitsharing contributions are based on income before taxes, primarily
excluding unrealized gains and losses from fuel derivative contracts; therefore,
profitsharing expense for first quarter 2009 was zero, versus $13 million in
first quarter 2008. Based on current trends and considering ongoing labor
negotiations, the Company expects second quarter 2009 salaries, wages, and
benefits expense per ASM, excluding any potential charges associated with the
Company's voluntary retirement program, to decline from first quarter 2009's
3.46 cents per ASM.
The
Company’s Mechanics, totaling approximately 1,700 Employees, are subject to an
agreement between the Company and the Aircraft Mechanics Fraternal Association
(“AMFA”). During first quarter 2009, the Company’s Mechanics ratified
a new agreement that extends to 2012.
The Company’s Pilots, totaling
approximately 5,600 Employees, are subject to an agreement between the Company
and the Southwest Airlines Pilots’ Association (“SWAPA”), which became amendable
during September 2006. During first quarter 2009, the Company and
SWAPA came to a tentative agreement on a new contract extending to
2011. The tentative agreement is expected to be voted on by SWAPA
membership during second quarter 2009.
The
Company’s Flight Attendants, totaling approximately 9,300 Employees, are subject
to an agreement between the Company and the Transportation Workers of America,
AFL-CIO Local 556 (“TWU 556”), which became amendable in June
2008. During first quarter 2009, the Company and TWU 556 came to a
tentative agreement on a new contract extending to 2012. The
tentative agreement is expected to be voted on by TWU 556 membership during
second quarter 2009.
The
Company’s Ramp, Operations, Provisioning, and Freight Agents, totaling
approximately 7,100 Employees, are subject to an agreement between the Company
and the Transportation Workers of America, AFL-CIO Local 555 (“TWU 555”), which
became amendable in July 2008. During first quarter 2009, the Company
and TWU 555 came to a tentative agreement on a new contract that will become
amendable in 2011. The tentative agreement was approved by TWU 555
membership during first quarter 2009.
Fuel and
oil expense for the three months ended March 31, 2009, decreased $102 million,
and on a per ASM basis decreased 8.8 percent, primarily due to lower average
prices, excluding the impact of hedging. Excluding hedging, but
including related fuel taxes in both years, the Company’s average fuel cost per
gallon in first quarter 2009 was $1.57 versus $2.91 in first quarter
2008. However, the Company had a worse performance from its fuel
hedging program in first quarter 2009 versus the same prior year
period. As a result of these positions, and the significant decrease
in physical prices for crude oil, jet fuel, and related products compared to
first quarter 2008, the Company had hedging losses reflected in Fuel and oil
expense totaling $146 million, while first quarter 2008 hedging gains recorded
in Fuel and oil expense were $291 million. Including the
effects of hedging activities, the Company’s average fuel cost per gallon in
first quarter 2009 was $1.99, which was 6.6 percent lower than first quarter
2008.
As of April 15, 2009, for second
quarter 2009, the Company primarily has “above-market” purchased call option
instruments in place and has increased its fuel hedge position to approximately
50 percent of its expected fuel consumption, the majority of which effectively
cap prices at approximately $66 per barrel of crude oil. Since these
instruments are “above-market,” they do not provide any cash benefit to the
Company unless average market crude oil prices for second quarter exceed the
call option price of the instrument. Prior to 2009, the Company had
more derivative instruments in place related to expected 2009 through 2013 fuel
consumption. However, in fourth quarter 2008, the Company entered
into offsetting positions related to the majority of these hedges, effectively
fixing some losses associated with these instruments. At that time,
the associated hedges, as defined in Statement of Financial Accounting Standards
No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended (SFAS 133),
were undesignated, and any amounts previously held in “AOCI” will remain until
the underlying contracts settle in future periods. The Company’s
current “hedge” position for second quarter 2009 excludes these previously
undesignated fuel contracts.
As a result of these previously fixed
losses, the Company expects to pay higher than market prices for fuel for these
future periods associated with the “sold” instruments. In addition,
as a result of previous hedges that have been “undesignated” as defined in SFAS
133, the Company has significant amounts “frozen” in AOCI that will be
recognized in earnings in future periods when the underlying fuel derivative
contracts settle. As discussed in Note 6 to the unaudited condensed
consolidated financial statements, the Company has deferred losses in AOCI of
$888 million, net of tax, related to fuel derivative contracts. The
estimated fair market value (as of March 31, 2009) of the Company’s net fuel
derivative contracts for the remainder of 2009 through 2013 reflects a net
liability of approximately $631 million, including the effect of $300 million in
cash collateral that had been provided to a counterparty as of March 31, 2009,
which has been netted against the Company’s liability in the unaudited Condensed
Consolidated Balance Sheet. The following table displays the Company’s
estimated fair value of remaining fuel derivative contracts (excluding the $300
million in cash collateral provided to a counterparty) as well as the amount of
deferred losses in AOCI at March 31, 2009, and the expected future periods in
which these items are expected to settle and/or be recognized in earnings (in
millions):
|
Fair
value
|
Amount
of
|
|||||||
|
(liability)
of fuel
|
(losses)
deferred
|
|||||||
|
derivative
contracts
|
in
AOCI at March 31,
|
|||||||
|
Year
|
at
March 31, 2009
|
2009
(net of tax)
|
||||||
|
2009
|
$ | (156 | ) | $ | (250 | ) | ||
|
2010
|
$ | (213 | ) | $ | (245 | ) | ||
|
2011
|
$ | (251 | ) | $ | (160 | ) | ||
|
2012
|
$ | (165 | ) | $ | (118 | ) | ||
|
2013
|
$ | (146 | ) | $ | (115 | ) | ||
|
Total
|
$ | (931 | ) | $ | (888 | ) | ||
Based on
this liability at March 31, 2009 (and precluding any other subsequent changes to
the fuel hedge portfolio), the Company’s jet fuel costs per gallon are expected
to exceed market (or unhedged) prices by approximately $.15 to $.16 in
2009 and 2010, $.19 in 2011, $.12 in 2012, and $.10 in 2013. These
estimates are based on expected future cash settlements from fuel derivatives,
but exclude any SFAS 133 impact associated with the ineffectiveness of fuel
hedges or fuel derivatives that are marked to market value because they do not
qualify for special hedge accounting. See Note 5 to the unaudited
condensed consolidated financial statements for further
information. Based on this derivative position and market prices as
of April 14, 2009, the Company is currently estimating its second quarter 2009
jet fuel cost per gallon to be in the $1.75 range, excluding the effects of any
ineffectiveness from the Company’s fuel hedging program.
The
Company has also continued its efforts to conserve fuel and, by the end of 2009,
expects to complete the installation of Aviation Partners Boeing Blended
Winglets on a significant number of its 737-300 aircraft (all 737-700 aircraft
have already been equipped with winglets). This and other fuel
conservation efforts resulted in an approximate 2.7 percent decrease in the
Company’s fuel burn rate per ASM for first quarter 2009 versus first quarter
2008.
Maintenance materials and repairs for
the three months ended March 31, 2009, increased $41 million or 28.7 percent on
a dollar basis compared to first quarter 2008, and increased 33.3 percent on a
per-ASM basis compared to first quarter 2008. On both a dollar and a
per-ASM basis, the increases compared to first quarter 2008 were due to higher
engine costs related to the Company’s 737-700 aircraft. For the first
quarter of 2008, these aircraft engines had been accounted for on a time and
materials basis, and there were relatively few repair events for these engines
during that period. This was due to the fact that the 737-700 is the
newest aircraft type in the Company’s fleet, and there were not yet a
significant number of engines on these aircraft that were due for their first
major overhaul. In June 2008, the Company transitioned to a new
engine repair agreement for these aircraft and expense is now based on flight
hours associated with 737-700 engines. The expense for 737-700
engines recognized in the first quarter of 2009 associated with the current
agreement significantly exceeded the expense recognized in first quarter 2008,
when repairs were still being accounted for on a time and materials
basis. Considering the new agreement, the Company expects Maintenance
materials and repairs per ASM for second quarter 2009 to increase slightly from
the .76 cents per ASM experienced in first quarter 2009, based on currently
scheduled airframe maintenance events and projected engine hours
flown.
Aircraft rentals per ASM for the three
months ended March 31, 2009, increased 26.7 percent compared to first quarter
2008, and, on a dollar basis, increased $7 million. Both of these
increases primarily were due to the Company’s recent sale and leaseback
transactions involving a total of ten Boeing 737-700 aircraft. See
Note 9 to the unaudited condensed consolidated financial statements for further
information. As a result of these transactions and additional sale
and leaseback transactions that were executed in April 2009 or will be executed
later in second quarter 2009, the Company expects aircraft rentals per ASM in
second quarter 2009 to approximate the .19 cents experienced during first
quarter 2009.
Landing
fees and other rentals for the three months ended March 31, 2009, decreased $5
million on a dollar basis, and on a per ASM basis was effectively flat compared
to first quarter 2008. The majority of the decrease on a dollar basis
primarily was due to credits received in first quarter 2009 as a result of
airports’ audits of prior periods versus audit settlement charges paid to
airports in first quarter 2008. Excluding these credits and charges
from both years, Landing fees and other rentals were higher both on a dollar
basis and a per ASM basis in first quarter 2009, primarily due to higher space
rentals in airports as a result of higher rates charged by those airports for
gate and terminal space. A portion of these higher rates charged by
airports are due to the fact that other airlines reduced capacity at a faster
pace than the Company, resulting in the Company incurring a higher percentage of
total airport-related costs. As a consequence, the Company currently
also expects Landing fees and other rentals per ASM in second quarter 2009 to be
higher than the .69 cents per ASM recorded in first quarter 2009, primarily due
to the fact that the Company does not expect to receive a comparable amount of
audit settlement credits from airports that were received in first quarter
2009.
Depreciation expense for the three
months ended March 31, 2009, increased by $5 million on a dollar basis compared
to first quarter 2008, and increased 6.9 percent on a per-ASM
basis. The increase on a dollar basis primarily was due to the
Company’s net addition of 12 Boeing 737s to its fleet over the past twelve
months. This included the purchase of 17 new Boeing 737-700s from
Boeing, net of five 737-300s returned from lease. In addition, the
Company executed sale and leasebacks of ten 737-700 aircraft. See
Note 9 to the unaudited condensed consolidated financial
statements. The increase on a per-ASM basis primarily was due to the
increase in the Company’s fleet size combined with a decrease in ASMs as a
result of the Company’s decision to slow its growth given current economic
conditions. For second quarter 2009, the Company expects Depreciation
expense per ASM to decline slightly versus first quarter 2009’s .62 cents as a
result of recent sale and leaseback transactions.
Other operating expenses per ASM for
the three months ended March 31, 2009, decreased 1.5 percent compared to first
quarter 2008, and on a dollar basis, decreased $17 million. On both a
per ASM basis and a dollar basis, the decrease was related to a decline in bad
debts related to revenues from credit card sales. For second quarter
2009, the Company currently expects Other operating expenses per ASM to be
higher than first quarter 2009’s 1.35 cents.
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, 2009. 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 for the three months
ended March 31, 2009, increased $16 million, or 57.1 percent, compared to first
quarter 2008, primarily due to the Company’s borrowing under its $600 million
term loan in May 2008, its borrowing of $400 million of the available $600
million under its revolving credit facility in October 2008, and the Company’s
December 2008 issuance of $400 million of secured notes. As a result
of these past transactions, the Company also expects higher year-over-year
interest expense for second quarter 2009.
Capitalized interest for the three
months ended March 31, 2009, decreased $2 million, or 25.0 percent, compared to
the same prior year period primarily due to a decline in both interest rates and
a decrease in progress payment balances for scheduled future aircraft
deliveries.
Interest income for the three months
ended March 31, 2009, decreased by $3 million, or 42.9 percent, compared to the
same prior year period, primarily due to a decrease in rates earned on invested
cash and short-term investments. In first quarter 2008, the Company’s
cash and cash equivalents and short-term investments included a significant
amount of collateral deposits received from a counterparty of the Company’s fuel
derivative instruments. Although these amounts were not restricted in
any way, the Company was required to remit the investment earnings from these
amounts back to the counterparty. See Item 3 of Part I for further
information on 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, 2009 and
2008:
|
Three
months ended March 31,
|
|||||||||
|
(In
millions)
|
2009
|
2008
|
|||||||
|
Mark-to-market
impact from fuel contracts settling in future
|
|||||||||
|
periods
- included in Other (gains) losses, net
|
$ | (10 | ) | $ | 7 | ||||
|
Ineffectiveness
from fuel hedges settling in future periods -
|
|||||||||
|
included
in Other (gains) losses, net
|
15 | - | |||||||
|
Realized
ineffectiveness and mark-to-market (gains) or
|
|||||||||
|
losses
- included in Other (gains) losses, net
|
(15 | ) | 16 | ||||||
|
Premium
cost of fuel contracts included in Other (gains) losses,
net
|
32 | 14 | |||||||
|
Other
|
1 | 1 | |||||||
| $ | 23 | $ | 38 | ||||||
Based on
the Company’s current fuel derivative contracts position, 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), the Company expects expense of approximately $36 million relating to
these items in second quarter 2009.
The Company’s effective tax rate was
15.3 percent in first quarter 2009 compared to 8.9 percent in first quarter
2008. The low rate in first quarter 2008 was impacted by a state of
Illinois tax law reversal during first quarter 2008 that resulted in a $12
million ($.01 per share, diluted) reduction to state deferred tax
liabilities. The rate in first quarter 2009 was impacted by the
Company’s lower expected earnings for 2009 and the related impact that permanent
tax differences have on these projections.
Liquidity
and Capital Resources
Net cash provided by operating
activities was $286 million for the three months ended March 31, 2009, compared
to $964 million provided by operating activities in the same prior year
period. The operating cash flows for first quarter 2008 were largely
impacted by fluctuations in counterparty deposits associated with the Company’s
fuel hedging program. For the three months ended March 31, 2008,
there was an increase in counterparty deposits of $570 million due to the large
increase 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. For first quarter 2009, cash flows from operating activities
were also impacted by a change in Air traffic liability, which increased from
$963 million at December 31, 2008, to $1.3 billion at March 31, 2009, as a
result of seasonal bookings for future travel, and a $150 million increase due
to the impact of noncash depreciation and amortization. In the same
prior year period, there was a $267 million increase in Air traffic
liability. Net cash provided by operating activities is primarily
used to finance capital expenditures and provide working capital.
Net cash
flows used in investing activities during the three months ended March 31, 2009,
totaled $638 million compared to $126 million used in the same prior year
period. Investing activities for the first three months of 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 and noncurrent
investments. During the three months ended March 31, 2009, the
Company’s short-term and noncurrent investments increased by a net $553 million,
versus a net decrease of $238 million during the same prior year
period.
Net cash
provided by financing activities during the three months ended March 31, 2009,
was $129 million compared to $69 million used in financing activities for the
same period in 2008. During the three months ended March 31, 2009,
the Company raised approximately $173 million from a sale and leaseback
transaction involving five of the Company’s 737-700 aircraft. These
inflows were partially offset by $35 million in payments of debt and capital
lease obligations. During the three months ended March 31, 2008, the
majority of cash used in financing activities was in the Company’s repurchase of
$54 million of its Common Stock, representing a total of 4.4 million
shares.
The
Company has a “well-known seasoned issuer” universal shelf registration
statement, effective April 3, 2009, to register an indeterminate amount of
debt or equity securities for future sales. The Company intends to use the
proceeds from any future securities sales off this shelf for general corporate
purposes. The Company has not issued any securities under this shelf
registration statement to date.
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 2009, the
Company purchased three new 737-700 aircraft from Boeing and is scheduled to
receive ten more 737-700 aircraft from Boeing during the remainder of
2009. The Company also retired one of its older leased 737-300
aircraft during the first three months of 2009. The Company also
completed the sale and leaseback of five of its previously owned 737-700
aircraft during first quarter 2009, the sale and leaseback of three 737-700s on
April 2, 2009, and has committed to another three sale and leasebacks later
during second quarter 2009. However, these transactions have no
impact on the Company’s future aircraft commitments with Boeing. See
Notes 9 and 13 to the unaudited condensed Consolidated Financial Statements for
further information on these transactions. Based on recent economic
events and announced industry capacity reductions, the Company continues to
evaluate its plans with regards to planned aircraft retirements and future
deliveries from Boeing. The Company currently plans to reduce its
fleet by 14 additional aircraft during the remainder of 2009 through a
combination of lease returns, aircraft sales, and/or retirements, resulting in a
fleet totaling 535 Boeing 737 aircraft as of December 31, 2009. As of
April 16, 2009, 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
|
|||||||||||||
|
2009
|
13 | - | - | 13 | * | |||||||||||
|
2010
|
10 | - | - | 10 | ||||||||||||
|
2011
|
10 | 10 | - | 20 | ||||||||||||
|
2012
|
13 | 10 | - | 23 | ||||||||||||
|
2013
|
19 | 4 | - | 23 | ||||||||||||
|
2014
|
13 | 7 | - | 20 | ||||||||||||
|
2015
|
14 | 3 | - | 17 | ||||||||||||
|
2016
|
12 | 11 | - | 23 | ||||||||||||
|
2017
|
- | 17 | - | 17 | ||||||||||||
|
Through
2018
|
- | - | 54 | 54 | ||||||||||||
|
Total
|
104 | 62 | 54 | 220 | ||||||||||||
|
*
Currently plan to reduce fleet by 15 aircraft, bringing 2009 to a
net
|
||||||||||||||||
|
reduction
of two aircraft.
|
||||||||||||||||
The following table details information
on the 539 aircraft in the Company’s fleet as of March 31, 2009:
|
Average
|
Number
|
Number
|
Number
|
||
|
737
Type
|
Seats
|
Age
(Yrs)
|
of
Aircraft
|
Owned
|
Leased
|
|
-300
|
137
|
17.7
|
184
|
112
|
72
|
|
-500
|
122
|
17.9
|
25
|
16
|
9
|
|
-700
|
137
|
5.5
|
330
|
316
|
14
|
|
TOTALS
|
10.2
|
539
|
444
|
95
|
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: $340 million
remaining in 2009, $344 million in 2010, $446 million in 2011, $562 million in
2012, $632 million in 2013, $508 million in 2014, and $692 million
thereafter.
During October 2008, the Company
elected to access $400 million of the available $600 million under its revolving
credit facility. The Company plans to use this borrowing for general
corporate purposes and was done in order to enhance the Company’s liquidity as a
result of the current instability of the credit markets. The Company
has various options available to meet its capital and operating commitments,
including cash on hand and short-term investments at March 31, 2009, of $2.1
billion, internally generated funds, and $200 million remaining under the
Company’s $600 million revolving credit facility. As discussed in
Note 13 to the unaudited condensed consolidated financial statements, on April
2, 2009, the Company executed sale and leaseback transactions involving three of
its aircraft that generated $105 million in proceeds, and has agreed to another
similar sale and leaseback transaction to be finalized later in second quarter
2009. The Company will also consider other various borrowing or
leasing options to supplement cash requirements as necessary.
During 2008, the City of Dallas
approved the Love Field Modernization Program, an estimated $519 million project
to reconstruct Dallas Love Field with modern, convenient air travel
facilities. Pursuant to a Program Development Agreement with the City
of Dallas, Southwest is managing this project, and initial construction is
expected to commence during late 2009, with completion scheduled for October
2014. Bonds will be issued at a later date by the Love Field Airport
Modernization Corporation (a “local government corporation” under Texas law
formed by the City of Dallas) that will provide funding for this project, with
repayment of the bonds being made through recurring ground rents, fees, and
other revenues collected by the airport.
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 the current economic environment.
Fair
value measurements
As discussed in Note 11 to the
unaudited condensed consolidated financial statements, the Company uses the
provisions of Statement of Financial Accounting Standards No. 157 (SFAS 157) in
determining the fair value of certain assets and liabilities. As
defined in SFAS 157, the Company has determined that it uses unobservable (Level
3) inputs in determining the fair value of its auction rate security
investments, valued at $192 million, a portion of its fuel derivative contracts,
which totaled a net liability of $781 million, and $8 million in other
investments, at March 31, 2009.
All of the Company’s auction rate
security instruments are reflected at estimated fair value in the unaudited
Condensed Consolidated Balance Sheet. At March 31, 2009,
approximately $109 million of these instruments are classified as available for
sale securities and $83 million are classified as trading
securities. In early 2008 and 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 have qualified as Level 1 under SFAS
157. However, due to events in credit markets beginning 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, 2009. In addition, the Company has previously
obtained an independent valuation of a selected number of auction rate security
instruments and has considered these valuations in determining estimated fair
values of other similar instruments within its portfolio. The
Company’s 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 estimates of the next time the
security is expected to have a successful auction or return to full par
value. These securities were also compared, when possible, to other
securities not owned by the Company, but with similar
characteristics. Due to these events, the Company reclassified these
instruments as Level 3 during first quarter 2008.
In association with this estimate of
fair value, the Company has recorded a temporary unrealized decline in fair
value of $11 million, with an offsetting entry to “Accumulated other
comprehensive income (loss).” Given the quality and backing of the
Company’s auction rate securities held, the fact that the Company has not yet
recorded a loss on the sale of any of these instruments, and the fact that it
has been able to periodically sell instruments in the auction process, it
believes it can continue to account for the estimated reduction in fair value of
its remaining securities as temporary. These conclusions will also
continue to be evaluated and challenged in subsequent periods. 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, for the $109 million in instruments classified as available for sale,
these auction rate securities represented approximately five percent of the
Company’s total cash, cash equivalent, and investment balance at March 31, 2009,
which it believes allows it sufficient time for the securities to return to full
value. For the $83 million in instruments classified as trading
securities, the Company has entered into an agreement with the counterparty that
allows the Company to put the instruments back to the counterparty at full par
value in June 2010. As part of this agreement, the Company has
entered into a line of credit in which it currently holds an $83 million loan
that is secured by the auction rate security instruments from that
counterparty. At the time of the first failed auctions during first
quarter 2008, the Company held a total of $463 million in
securities. Since that time, the Company has been able to sell $260
million of these instruments at par value, in addition to the $83 million
subject to the agreement to be sold at par in June 2010. The Company
is also in discussions with other counterparties to determine whether mutually
agreeable decisions can be reached regarding the effective repurchase of its
remaining securities.
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 SFAS 157, the Company has
categorized these option contracts as Level 3.
As discussed 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 of cash flow hedges that are
considered to be effective, as defined, are offset within “Accumulated other
comprehensive income (loss)” 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 (or the Company) to provide cash collateral when the fair values of fuel
derivatives with a single party exceed 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.
Forward-looking
statements
Some
statements in this Form 10-Q 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 related to the Company’s (i) growth strategies and
expectations; (ii) revenue and cost-cutting initiatives; (iii) expectations for
future results of operations; (iv) expectations regarding liquidity, including
anticipated needs for, and sources of, funds; (v) plans and expectations for
managing risk associated with changing jet fuel prices; and (vi) expectations
and intentions relating to outstanding litigation. While management
believes 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)
|
continued
unfavorable economic conditions, which could continue to impact the demand
for air travel and the Company’s ability to adjust
fares;
|
|
(ii)
|
the
price and availability of aircraft fuel and any changes in the Company’s
fuel hedging strategies and
positions;
|
|
(iii)
|
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;
|
|
(iv)
|
continued
instability of the credit, capital, and energy markets, which could result
in future pressure on credit ratings and could also negatively impact (a)
the Company’s ability to obtain financing on acceptable terms, (b) the
Company’s liquidity generally, and (c) the availability and cost of
insurance;
|
|
(v)
|
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;
|
|
(vi)
|
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;
|
|
(vii)
|
the
Company’s dependence on third party arrangements to assist with
implementation of certain of its
initiatives;
|
|
(viii)
|
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;
|
|
(ix)
|
competitor
capacity and load factors; and
|
|
(x)
|
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, 2008.
|
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 uses financial derivative instruments to hedge its
exposure to material increases in jet fuel prices. At March 31, 2009,
the estimated fair value of outstanding contracts was a liability of $931
million.
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,
2009, the Company had agreements with eight 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, 2009, the Company had
provided $300 million in fuel derivative related cash collateral deposits under
these bilateral collateral provisions to a counterparty, but did not hold any
cash collateral deposits from any of its counterparties as of that
date. These collateral deposits are netted against the fair value of
the Company’s noncurrent derivative contracts in Other deferred liabilities in
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.
On March
27, 2009, the Company entered into a fuel hedging agreement with a second
counterparty that replaced an existing fuel hedging agreement with that
counterparty. Under the previous agreement, the Company became
obligated to post cash or letters of credit as security for fuel derivative
liabilities upon a noninvestment grade credit rating. Under the new
agreement, the Company is obligated to post collateral related to fuel
derivative liabilities as follows: (i) if the obligation is up to
$125 million, the Company posts cash collateral, (ii) if the obligation is
between $125 million and $625 million, the Company has pledged Boeing 737-700
aircraft, and (iii) if the obligation exceeds $625 million, the Company must
post cash or letters of credit as collateral. The Company pledged 29
of its Boeing 737-700 aircraft to cover the collateral posting band in clause
(ii). Although no cash collateral had been provided to this
counterparty as of March 31, 2009, the Company did post $125 million in cash
collateral deposits to this counterparty in April 2009 upon the effective date
of the agreement.
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, 2008, and Note 5 to the unaudited
condensed consolidated financial statements in this Form 10-Q 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,
2009. 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, 2009, at the reasonable
assurance level.
Changes
in Internal Control over Financial Reporting
In first
quarter 2009, the Company ascertained that it had incorrectly interpreted the
applicability of the provisions of FIN 39-1 to the balance sheet presentation of
cash collateral deposits associated with the Company’s fuel derivative
instruments. The Company determined that the impact of this error was
not material to its financial statements and disclosures taken as a whole, and
decided to apply FIN 39-1 prospectively beginning with this first quarter 2009
Form 10-Q. The Company has made a reclassification adjustment to
retrospectively apply FIN 39-1 to its comparative December 31, 2008, unaudited
Condensed Consolidated Balance Sheet included in this first quarter 2009 Form
10-Q. The Company has made related retrospective adjustments to items
within the unaudited Condensed Consolidated Statement of Cash Flows for the
three months ended March 31, 2008; however, these adjustments have no net impact
on “Net cash provided by operating activities,” or earnings as previously
reported for such period. The Company’s internal controls over
financial reporting were designed to protect against errors of interpretation,
and the Company believes the set of internal controls in place were designed to
reasonably ensure new or changed financial reporting requirements are identified
and interpreted. The Company evaluated the error it identified and
concluded it had a significant deficiency, but not a material weakness, in its
internal control over financial reporting. As a result of the error,
the Company has changed its internal controls around the identification and
interpretation of new financial reporting and accounting standards and
guidance. The Company has strengthened its processes to include
detailed consideration not only of standards and guidance deemed to be
applicable to the Company, but also to include further consideration of
standards and guidance initially deemed to be inapplicable. In
addition to the financial reporting department’s regular review and discussion
of new accounting guidance, such guidance, including guidance believed to be
inapplicable, is now also discussed with members of the Company’s Disclosure
Committee, who are provided with a description of the reasons why the guidance
is believed not to be applicable. Management has concluded that the
above changes to its internal controls over financial reporting, implemented in
first quarter 2009, correct the significant deficiency.
During
first quarter 2009, the Company implemented a new reservations and ticketing
system which resulted in a material change in a component of the Company's
internal control over financial reporting. Pre-implementation
testing was conducted by management to ensure that internal controls surrounding
the implementation process and the application itself were properly designed to
prevent material financial statement errors. The Company's
management has determined that the internal controls and procedures related to
the financial reporting of ticket sales, exchanges and refunds in the
new system are effective as of the end of the period covered by this
report.
Except as
noted above, 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, 2009, 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 FAA 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 accrued the proposed fine as an operating
expense in first quarter 2008. On March 2, 2009, the FAA and the
Company agreed to settle the matter, and other pending and potential
regulatory compliance matters, for $7.5 million. Approximately
one-third of this amount was paid in first quarter 2009, and the
remainder will be paid in equal installments in 2010 and 2011. The
Company also agreed, among other things, to improve FAA access to
information about its maintenance and engineering activities and make certain
changes to its maintenance and engineering functions. Failure to perform
these obligations could result in additional fines of up to a maximum of
$7.5 million. The agreement did not contain any finding of violation
or admission of wrongdoing by the Company.
In
connection with the above incident, during the first quarter and early second
quarter of 2008, the Company was 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 FAA 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. Also in connection with the above incident,
during the first quarter and early second quarter of 2008, the Company received
four letters from 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 an alleged breach of
fiduciary duties owed by them to the Company. In August 2008, Carbon
County Employees Retirement System and Mark Cristello filed a related
Shareholder derivative action in Texas state court naming certain directors and
officers of the Company as individual defendants and the Company as a nominal
defendant. The derivative action claims breach of fiduciary duty and
seeks recovery by the Company of alleged monetary damages sustained as a result
of the purported breach of fiduciary duty, as well as costs of the
action. A Special Committee appointed by the Independent Directors of
the Company is currently evaluating the Shareholder 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 (IRS).
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, 2008.
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
(a) Recent Sales of
Unregistered Securities
During
the first quarter of 2009, Herbert D. Kelleher, Chairman Emeritus of the
Company, exercised options to purchase unregistered shares of Southwest Airlines
Co. Common Stock from the Company as follows:
|
Aggregate
|
|||
|
Number
of
|
Option
exercise
|
proceeds
to
|
|
|
shares
purchased
|
price
per share
|
Date
of exercise
|
the
Company
|
|
45,000
|
$1.00
|
3/17/2009
|
$45,000
|
The
issuance of the above shares to Mr. Kelleher was exempt from the registration
under the Securities Act of 1933, as amended (the “Act”), pursuant to the
provision of Section 4(2) of the Act because, among other things, of the limited
number of participants in such transactions and the agreement and representation
of Mr. Kelleher that he was acquiring such securities for investment and not
with a view to distribution thereof. The issuance of such shares was
not underwritten.
Item 3. Defaults upon Senior
Securities
None
Item 4. Submission of Matters to a Vote of
Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
|
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)); Articles of Amendment
to
|
||
|
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, 2007 (File No. 1-7259)).
|
||
|
3.2
|
Amended
and Restated Bylaws of Southwest, effective January 15,
|
|
|
2009
(incorporated by reference to Exhibit 3.1 to Southwest’s Current
Report
|
||
|
on
Form 8-K dated January 15, 2009 (File
No. 1-7259)).
|
||
|
10.1
|
Supplemental
Agreement No. 62 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
||
|
10.2
|
Supplemental
Agreement No. 63 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
17, 2009
|
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 (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 January 15,
|
|
|
2009
(incorporated by reference to Exhibit 3.1 to Southwest’s Current
Report
|
||
|
on
Form 8-K dated January 15, 2009 (File
No. 1-7259)).
|
||
|
10.1
|
Supplemental
Agreement No. 62 to Purchase Agreement No. 1810,
|
|
|
dated
January 19, 1994, between The Boeing Company and Southwest
(1)
|
||
|
10.2
|
Supplemental
Agreement No. 63 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.
33