10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 14, 2001
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file No. 1-7259
SOUTHWEST AIRLINES CO.
(Exact name of registrant as specified in its charter)
TEXAS 74-1563240
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. BOX 36611, DALLAS, TEXAS 75235-1611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 792-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock outstanding as of the close of
business on November 9, 2001:
765,345,132
1
SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
SOUTHWEST AIRLINES CO.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
See accompanying notes.
2
SOUTHWEST AIRLINES CO.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
See accompanying notes.
3
SOUTHWEST AIRLINES CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
See accompanying notes.
4
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) 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 condensed
consolidated financial statements for the interim periods ended September 30,
2001 and 2000 include all adjustments (which include only normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods. The Condensed Consolidated
Balance Sheet as of December 31, 2000 has been derived from the Company's
audited financial statements as of that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. Operating results for the three and nine
months ended September 30, 2001 are not necessarily indicative of the results
that may be expected for the year ended December 31, 2001. 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, 2000.
2. Dividends - During the three months ended September 30, 2001, June
30, 2001 and March 31, 2001, dividends of $.0045 per share were declared on the
764.0 million, 762.7 million and 760.7 million shares of common stock then
outstanding, respectively. During the three months ended September 30, 2000,
June 30, 2000 and March 31, 2000, dividends of $.0037 per share were declared on
the 749.4 million, 746.5 million and 745.7 million shares of common stock then
outstanding, respectively.
3. Common stock - On January 18, 2001, the Company's Board of Directors
declared a three-for-two stock split, distributing 253.9 million shares on
February 15, 2001. All share and per share data presented in the accompanying
unaudited condensed consolidated financial statements and notes thereto have
been restated for the stock split.
4. Reclassifications - Certain prior year amounts have been
reclassified to conform to the current year presentation.
5
5. Net income per share - The following table sets forth the
computation of basic and diluted net income per share (in thousands except per
share amounts) (unaudited):
6. Accounting changes - Effective January 1, 2001, the Company adopted
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended (SFAS 133). SFAS 133 requires the
Company to record all financial derivative instruments on its balance sheet at
fair value. Derivatives that are not designated as hedges must be adjusted to
fair value through income. If the derivative is designated as a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives that are
considered to be effective, as defined, either offset the change in fair value
of the hedged assets, liabilities, or firm commitments through earnings or are
recorded in accumulated other comprehensive income until the hedged item is
recorded in earnings. Any portion of a change in a derivative's fair value that
is considered to be ineffective, as defined, is recorded immediately in Other
(gains) losses, net in the Condensed Consolidated Statement of Income. Any
portion of a change in a derivative's fair value that the Company elects to
exclude from its measurement of effectiveness is required to be recorded
immediately in earnings.
6
Airline operators are inherently dependent upon energy to operate and,
therefore, are impacted by changes in jet fuel prices. The Company endeavors to
acquire jet fuel at the lowest prevailing prices possible. Because jet fuel is
not traded on an organized futures exchange, liquidity for hedging is limited.
However, the Company has found that both crude oil and heating oil contracts are
effective commodities for hedging jet fuel. The Company has financial derivative
instruments in the form of the types of hedges it utilizes to decrease its
exposure to jet fuel price increases. The Company does not purchase or hold any
derivative financial instruments for trading purposes.
The Company utilizes financial derivative instruments for both short-term and
long-term time frames when it appears the Company can take advantage of market
conditions. At September 30, 2001, the Company had a mixture of purchased call
options, collar structures, and fixed price swap agreements in place to hedge
approximately 80 percent of its remaining 2001 total anticipated jet fuel
requirements, approximately 50 percent of its 2002 total anticipated jet fuel
requirements, and small portions of its 2003-2005 total anticipated jet fuel
requirements. As of September 30, 2001, nearly all of the Company's remaining
2001 hedges, and the majority of its 2002 hedges, are effectively heating
oil-based positions. All other remaining hedge positions are crude oil-based.
The Company accounts for its fuel hedge derivative instruments as cash flow
hedges, as defined. Upon adoption of SFAS 133, the Company recorded the fair
value of its fuel derivative instruments in the Condensed Consolidated Balance
Sheet and a deferred gain of $46.1 million, net of tax, in accumulated other
comprehensive income. The portion of the transition adjustment in "Accumulated
other comprehensive income" that was recognized in earnings during third quarter
2001 was a gain of $9.2 million, net of tax. During third quarter 2001, the
Company recognized approximately $4.4 million as a net expense in Other (gains)
losses, net, related to the ineffectiveness of its hedges, in the Condensed
Consolidated Statement of Income. During third quarter 2001, the Company
recognized approximately $504,000 of net expense, related to amounts excluded
from the Company's measurements of hedge effectiveness, in Other (gains) losses,
net in the Condensed Consolidated Statement of Income. The current year adoption
of SFAS 133 has resulted in more volatility in the Company's financial
statements than in the past.
Effective January 1, 2000, the Company adopted Staff Accounting Bulletin 101
(SAB 101) issued by the Securities and Exchange Commission in December 1999. As
a result of adopting SAB 101, the Company changed the way it recognizes revenue
from the sale of flight segment credits to companies participating in its Rapid
Rewards frequent flyer program. Prior to the issuance of SAB 101, the Company
recorded revenue to "Other revenue" when flight segment credits were sold,
consistent with most other major airlines. Beginning January 1, 2000, the
Company recognizes "Passenger revenue" when free travel awards resulting from
the flight segment credits sold are earned and flown or credits expire unused.
Due to this change, the Company recorded a cumulative effect charge in first
quarter 2000 of $22.1 million (net of income taxes of $14.0 million) or $.03 per
share, basic and diluted.
7
7. Comprehensive income - Comprehensive income includes changes in the
fair value of certain financial derivative instruments, which qualify for hedge
accounting, and unrealized gains and losses on certain investments. For the
three and nine months ended September 30, 2001, comprehensive income totaled
$120.4 million and $449.0 million, respectively. The difference between net
income and comprehensive income for the three and nine months ended September
30, 2001 is as follows (in thousands):
As of September 30, 2001, the Company had approximately $2.6 million in
unrealized gains, net of tax, in accumulated other comprehensive income related
to fuel hedges. Included in this total are approximately $5.7 million in net
unrealized gains that are expected to be realized in earnings over the twelve
months following September 30, 2001. Upon the adoption of SFAS 133 on January 1,
2001, the Company recorded unrealized fuel hedge gains of $46.1 million, net of
tax, of which approximately $45.1 million were expected to be realized in
earnings over the twelve months following January 1, 2001.
A rollforward of the amounts included in Accumulated other comprehensive income,
net of taxes, is shown below (in thousands):
8. September 11, 2001 Terrorist Attacks - On September 11, 2001,
terrorists hijacked and used two American Airlines, Inc. aircraft and two United
Air Lines, Inc. aircraft in terrorist attacks on the United States (terrorist
attacks). As a result of these terrorist attacks, the Federal Aviation
Administration (FAA) immediately suspended all commercial airline flights on the
morning of September 11. The Company resumed flight activity on September 14 and
was operating its normal pre-September 11 flight schedule by September 18, 2001.
From September 11 until the Company resumed flight operations on September 14,
Southwest cancelled approximately 9,000 flights. Although flight operations were
suspended, the Company continued to incur nearly all of its normal operating
expenses (with the exception of certain direct trip-related expenditures such as
fuel, landing fees, etc.). Once the Company resumed operations, load factors and
yields were severely impacted, along with increased ticket refund activity.
8
The Company incurred total operating losses of approximately $25 million during
the time our operations were suspended. As a result of reduced load factors and
yields after the terrorist attacks once operations were resumed, the Company
continued to incur operating losses through the end of third quarter 2001 of
approximately $95 million. Although load factors have returned to somewhat
normal levels by the end of October 2001, yields have continued to be
significantly below prior year levels. The Company expects this trend to
continue for the forseeable future due primarily to aggressive fare discounting
within the industry.
On September 22, 2001, President Bush signed into law the Air Transportation
Safety and System Stabilization Act (Act). The Act provides for up to $5 billion
in cash grants to qualifying U.S. airlines and freight carriers to compensate
for direct and incremental losses, as defined in the Act, associated with the
terrorist attacks. The Act also provides for other items such as protection
against certain insurance coverage increases, delaying payments of excise taxes,
and certain protections against lawsuits for the airlines directly involved in
the attacks.
In response to the decrease in demand for air travel since the terrorist
attacks, the Company has also modified its schedule for future aircraft
deliveries and the timing of its future capital expenditure commitments. See
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources for further discussion of the
Company's long-term commitments for aircraft.
In accordance with generally accepted accounting principles, consolidated net
income for third quarter 2001 included approximately $169.0 million in "Other
gains" that the Company recognized from grants under the Act and special pre-tax
charges of approximately $58.0 million arising from the terrorist attacks. The
$169.0 million gain recognized in third quarter 2001 was the Company's estimate
of its direct and incremental losses, as defined in the Act, incurred in third
quarter 2001 as a result of the terrorist attacks. Special charges arising from
the terrorist attacks resulted from or include refunds of nonrefundable fares,
provisions for uncollectible accounts, write-downs of various assets due to
impairment, and estimated charges for the deferral of Boeing 737 aircraft firm
orders and options
9. Credit facility - In September 2001, the Company borrowed the full
$475 million available under its unsecured revolving credit line with a group of
banks. Borrowings under the credit line bear interest at six-month LIBOR plus
15.5 basis points and amounts are repayable on or before May 6, 2002. The
Company intends to repay the borrowings in full prior to the due date with
either cash on hand or proceeds from issuance of long-term debt securities. The
full $475 million is classified as Current maturities of long-term debt in the
Condensed Consolidated Balance Sheet.
10. Recently issued accounting standards - On August 16, 2001, the
Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards SFAS No. 143, "Accounting for Asset Retirement
Obligations", which is effective for financial statements issued for fiscal
years beginning after June 15, 2002. The pronouncement addresses the recognition
and re-measurement of obligations associated with the retirement of tangible
long-lived assets. On October 3, 2001, the FASB issued SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets", which is effective for
financial statements issued for fiscal years beginning after December 15, 2001.
SFAS 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of", and applies to all
long-lived assets (including discontinued operations). The Company is currently
reviewing these statements but does not expect them to have a material impact on
future financial statements or results of operations.
9
11. Subsequent events - On October 30, 2001, the Company issued $614.3
million Pass Through Certificates consisting of $150.0 million 5.1% Class A-1
certificates, $375.0 million 5.5% Class A-2 certificates, and $89.3 million 6.1%
Class B certificates. A separate trust was established for each class of
certificates. The trusts used the proceeds from the sale of certificates to
acquire equipment notes, which were issued by Southwest on a full recourse
basis. Payments on the equipment notes held in each trust will be passed through
to the holders of certificates of such trust. The equipment notes were issued
for each of 29 Boeing 737-700 aircraft owned by Southwest and are secured by the
mortgage on such aircraft. Interest on the equipment notes held for the
certificates is payable semiannually, beginning May 1, 2002. Principal payments
on the equipment notes held for the Class A-1 certificates are due semiannually
beginning May 1, 2002. The entire principal of the equipment notes for the Class
A-2 and Class B certificates are scheduled for payment on November 1, 2006.
Southwest will use the proceeds from the issuance of the equipment notes for
general corporate purposes, including, among other possible uses, repayment of
the $475 million of borrowings outstanding under Southwest's bank credit
facility and accrued interest thereon.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
COMPARATIVE CONSOLIDATED OPERATING STATISTICS
Relevant operating statistics for the three and nine months ended
September 30, 2001 and 2000 follow:
SOUTHWEST AIRLINES CO.
COMPARATIVE CONSOLIDATED
OPERATING STATISTICS
Operating expenses per ASM for the three and nine months ended
September 30, 2001 and 2000 are as follows (in cents except percent change):
11
MATERIAL CHANGES IN RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2001 TO THREE MONTHS
ENDED SEPTEMBER 30, 2000
Consolidated net income for third quarter 2001 was $151.0 million ($.19
per share, diluted), as compared to third quarter 2000 net income of $184.3
million ($.23 per share, diluted), a decrease of 18.1 percent. The prior year's
net income per share amounts have been restated for the 2001 three-for-two stock
split (see Note 3 to the unaudited Condensed Consolidated Financial Statements).
Operating income was $93.0 million, a decrease of 69.0 percent compared to 2000.
In accordance with generally accepted accounting principles, consolidated net
income for third quarter 2001 included approximately $169.0 million in "Other
gains" that the Company recognized from grants under the Act and special pre-tax
charges of approximately $58.0 million arising from the terrorist attacks. See
Note 8 to the unaudited Condensed Consolidated Financial Statements. Excluding
the gain and special charges, third quarter 2001 net income was $82.8 million,
or $.10 per share, diluted.
Consolidated operating revenues decreased 9.7 percent due primarily to
a 9.6 percent decrease in passenger revenues. The decrease in passenger revenues
was a direct result of the September 11, 2001 terrorist attacks. The Company's
combined July and August passenger revenues were approximately 4.5 percent
higher than the same period in 2000. However, September 2001 passenger revenues
were 41.3 percent lower than September 2000, including an adjustment to decrease
revenues further as a result of refunds of nonrefundable fares previously
estimated to expire. The adjustment was necessary as a result of the Company's
relaxation of its normal refund policy rules following the terrorist attacks.
Third quarter 2001 capacity, as measured by ASMs, increased 6.4 percent. The
increase in ASMs resulted primarily from the addition of 24 aircraft since third
quarter 2000, which represents a 7.2 percent increase in the Company's fleet
size. The increase in fleet size was partially offset by the Company's
cancellation of approximately 9,000 flights from September 11 through September
17, as a result of the terrorist attacks. The third quarter 2001 load factor was
69.1 percent, a decrease of 2.5 points compared to 2000. The Company experienced
a 1.8 percent decrease in revenue passengers carried, a 2.7 percent increase in
RPMs, and a 12.0 percent decrease in passenger revenue yield per RPM (passenger
yield). For the period July 1, 2001 until the terrorist attacks, Southwest's
load factor was 74.6 percent, or 1.1 points above the year ago period. The
Company's passenger revenue per available seat mile (RASM) was $.0870, or 7.1
percent below the year ago period. After the September 11 attacks and resuming
service on September 14, Southwest's load factor was 45.4 percent through
September 30, or 19.4 points below the year ago period. The Company's RASM for
this same period was $.0484, or 44.5 percent below the year ago period.
The Company's load factor for October 2001 was 63.7 percent, down 6.3
points compared to the October 2000 load factor of 70.0 percent. The load factor
for the two-week period ended November 11, 2001 was 60.5 percent, down 6.7
points compared to the same period in 2000. Likewise, RASM for the two-week
period ended November 11, 2001 was an estimated $.0669, compared to $.0879
during the comparable prior year period. Passenger yield for this same two-week
period was an estimated $.1105 in 2001 compared to $.1307 in 2000. Weak air
travel conditions have spawned aggressive fare sales and the Company expects
yields per RPM to be well below year ago levels for the foreseeable future.
Without consideration of the federal grants the Company expects to recognize in
fourth quarter 2001, the Company is unable to predict whether or not it will be
profitable for fourth quarter 2001. However, barring any unforeseen events, we
expect to be profitable for full year 2001. (The immediately preceding two
sentences are forward-looking statements that involve uncertainties that could
result in actual results differing materially from expected results. Some
significant factors include, but may not be limited to, additional incidents
that could cause the public to question the safety and/or efficiency of air
travel, competitive pressure such as fare sales and capacity changes by other
carriers, general economic conditions, and variations in advance booking
trends.)
12
As a result of the terrorist attacks and weak economic conditions
throughout third quarter 2001, consolidated freight revenues decreased 25.5
percent. Combined July and August freight revenues were approximately 13.0
percent lower than the same period in 2000. However, September 2001 freight
revenues were 49.5 percent lower than September 2000. Subsequent to the
resumption of service after the terrorist attacks, the U.S. Postal Service made
a decision to divert more of its mail shipments to freight carriers from
commercial airlines. Additionally, the FAA instituted significantly heightened
security rules for commercial airlines carrying freight following the terrorist
attacks. As a result of these recent developments, the Company expects
year-over-year declines in freight revenues to continue throughout the near
term. (The immediately preceding sentence is a forward-looking statement that
involves uncertainties that could result in actual results differing materially
from expected results. Some significant factors include, but may not be limited
to, decisions by major freight customers on how they allocate freight deliveries
among different types of carriers, general economic conditions, etc.) Other
revenues increased 3.2 percent due primarily to an increase in commissions
earned from programs the Company sponsors with certain business partners, such
as the Company sponsored First USA Visa card. That increase was partially offset
by a decline in charter revenues as a result of the terrorist attacks.
Operating expenses per ASM were $.0762, a 1.0 percent decrease compared
to $.0770 for 2000. Excluding fuel expense, operating expenses per ASM increased
.2 percent to $.0644. Due to the Company's approximately 9,000 flight
cancellations as a result of the terrorist attacks, several of the operating
expense captions in the Condensed Consolidated Statements of Income that are
measured as a percentage of ASMs were impacted. However, the captions that
typically fluctuate with actual flight activity, such as fuel and landing fees,
were not materially affected on a per ASM basis.
As a result of the terrorist attacks, the Company put into effect a
number of measures to control costs. The Company has deferred nonessential
capital spending, cut nonessential operating expenses, and has temporarily
suspended its fleet growth plans. Excluding fuel, it is difficult to accurately
predict fourth quarter 2001 unit costs, especially with respect to potential
increases in airport, security, and insurance costs. Were it not for these cost
risks, the Company would project an overall decline in fourth quarter 2001 unit
costs. (The immediately preceding sentence is a forward-looking statement which
involves uncertainties that could result in actual results differing materially
from expected results. Some significant factors include, but may not be limited
to, wage and productivity pressures, new or additional security regulations,
capacity decisions made by competitors, and general economic conditions.)
Salaries, wages, and benefits per ASM increased 7.9 percent. The
increase was due primarily to the approximately 9,000 trips the Company was
forced to cancel as a result of the September 11, 2001 terrorist attacks. All
salaries, wages, and benefits normally incurred by the Company were paid during
the time operations were suspended, but there were no corresponding ASMs.
Employee retirement plans expense per ASM decreased 40.0 percent, due
primarily to the decrease in Company earnings available for profitsharing.
Fuel and oil expense per ASM decreased 7.1 percent due to a 5.8 percent
decrease in the average jet fuel cost per gallon compared to 2000. The average
jet fuel cost per gallon in third quarter 2001 was $.6984 compared to $.7412 in
third quarter 2000, including the effects of hedging activities. The Company's
third quarter 2001 average jet fuel cost is net of approximately $23.5 million
in "effective" hedging gains, as defined. See Note 6 to the Condensed
Consolidated Financial Statements. The Company's third quarter 2000
13
average jet fuel cost is net of approximately $43.1 million in gains from
hedging activities. As of September 30, 2001, the Company had hedges in place
for approximately 80 percent of its anticipated jet fuel requirements for the
remainder of 2001. Including estimated hedging gains and considering current
market prices and the continued effectiveness of the Company's fuel hedges, we
are forecasting our fourth quarter 2001 average fuel price per gallon to be
below third quarter 2001's average fuel cost per gallon of $.6984. The majority
of the Company's near term hedge positions are in the form of option contracts,
which should enable the Company to benefit to a large extent from a decline in
jet fuel prices. However, the Company's overall fuel hedging strategy could
result in the Company not fully benefiting from certain jet fuel price declines.
(The immediately preceding three sentences are forward-looking statements, which
involve uncertainties that could result in actual results differing materially
from expected results. Such uncertainties include, but may not be limited to,
the largely unpredictable levels of jet fuel prices, the continued effectiveness
of the Company's fuel hedges, and changes in the Company's overall fuel hedging
strategy.)
Maintenance materials and repairs per ASM decreased 3.1 percent due to
a decrease in engine repair expense per ASM. This decrease was due primarily to
the Company's capacity growth exceeding the increase in expense. Virtually all
the Company's third quarter capacity growth versus the prior year was
accomplished with new aircraft, most of which have not yet begun to incur any
meaningful engine repair costs. The Company expects fourth quarter 2001
maintenance materials and repairs per ASM to be in line with third quarter 2001
expense. (The immediately preceding sentence is a forward-looking statement
involving uncertainties that could result in actual results differing materially
from expected results. Such uncertainties include, but may not be limited to,
any unscheduled required aircraft airframe or engine repairs and regulatory
requirements.)
Agency commissions per ASM decreased 48.1 percent. Approximately 80
percent of the decrease was due to a change in the Company's commission rate
policy and mix of commissionable revenues, and approximately 20 percent of the
decrease was associated with the overall decline in revenues. Effective January
1, 2001, the Company reduced the commission rate paid to travel agents from ten
percent to eight percent for Ticketless bookings, and from ten percent to five
percent for paper ticket bookings. The percentage of commissionable revenues
decreased from approximately 29 percent in third quarter 2000 to approximately
23 percent in third quarter 2001. The Company recently announced that effective
October 15, 2001, we are reducing the commission paid to travel agents to five
percent (with no cap), regardless of the type of ticket sold. Due to these
commission policy changes in 2001, we expect agency commissions to show further
year-over-year decreases in fourth quarter 2001 on a per-ASM basis. (The
immediately preceding sentence is a forward-looking statement involving
uncertainties that could result in actual results differing materially from
expected results. Such uncertainties include, but may not be limited to, changes
in consumer ticket purchasing habits.)
Aircraft rentals per ASM decreased 6.3 percent compared to third
quarter 2000 due to a lower percentage of the aircraft fleet being leased.
Approximately 26.3 percent of the Company's aircraft fleet was under operating
lease at September 30, 2001, compared to 28.1 percent at September 30, 2000.
Landing fees and other rentals per ASM increased 8.9 percent primarily
as a result of the Company's expansion of facilities in several airports. This
increase was partially offset by a decrease in landing fees expense per ASM from
credits the Company received from airports in third quarter 2001
14
from audits of prior periods. As a result of the September 11 terrorist attacks,
most major airlines have reduced their flight schedules and/or have retired
aircraft early due to the decrease in demand for air travel. Since Southwest has
not reduced the number of flights it offers, the Company expects that the
airport costs it shares with other airlines on the basis of flights offered or
passengers carried, such as landing fees, will increase on a per ASM basis in
future periods, including fourth quarter 2001. (The immediately preceding
sentence is a forward-looking statement involving uncertainties that could
result in actual results differing materially from expected results. Such
uncertainties include, but may not be limited to, changes in competitors flight
schedules, demand for air travel, etc.)
Depreciation expense per ASM increased 6.4 percent due primarily to a
higher percentage of owned aircraft. All of the 24 aircraft added to the
Company's fleet over the past twelve months have been purchased. This has
increased the Company's percentage of aircraft owned or on capital lease from
71.9 percent at September 30, 2000 to 73.7 percent at September 30, 2001.
Other operating expenses per ASM increased 7.0 percent. The increase
was due primarily to charges incurred to write down the value of certain assets
the Company determined had been impaired due to depressed market values for
aircraft and related parts and equipment as a result of the terrorist attacks
and their impact on the airline industry. Excluding these charges, Other
operating expense per ASM would have increased slightly due to the ASMs lost
when operations were temporarily suspended as a result of the terrorist attacks.
Interest expense decreased 18.3 percent due primarily to the July 2001
redemption of $100 million notes. However, the Company expects fourth quarter
2001 interest expense to increase compared to third quarter 2001 expense as a
result of recent financing transactions as discussed in Note 9 and Note 11 to
the unaudited Condensed Consolidated Financial Statements. (The immediately
preceding sentence is a forward-looking statement involving uncertainties that
could result in actual results differing materially from expected results. Such
uncertainties include, but may not be limited to, subsequent financing decisions
made by the Company.) Capitalized interest decreased 13.7 percent due primarily
to a reduction in progress payment balances for future aircraft deliveries.
Interest income decreased 11.7 percent as higher invested cash balances were
more than offset by a decrease in rates earned on investments. Other gains in
third quarter 2001 resulted primarily from $169.0 million recognized as the
Company's share of government grant funds from the Act related to third quarter
2001. The Company received the majority of these funds in third quarter 2001 and
expects to receive the remaining portion of its share in fourth quarter 2001. If
direct and incremental losses, as defined in the Act, continue, as expected
currently, Southwest will recognize gains from additional grants of up to
approximately $120 million during fourth quarter 2001. (The immediately
preceding two sentences are forward-looking statements involving uncertainties
that could result in actual results differing materially from expected results.
Such uncertainties include, but may not be limited to, subsequent modifications
or amendments to the Act, changes in the government's expected schedule of
distributing grant funds, the Company's operating performance improving to the
point where it would not qualify to receive its full estimated remaining share
of grant funds, etc.)
15
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2001 TO NINE MONTHS ENDED
SEPTEMBER 30, 2000
Consolidated net income for the nine months ended September 30, 2001
was $447.6 million ($.55 per share, diluted), as compared to 2000 net income,
before the cumulative effect of change in accounting principle, of $470.6
million ($.60 per share, diluted), a decrease of 4.9 percent. The prior year's
net income per share amounts have been restated for the 2001 three-for-two stock
split (see Note 3 to the unaudited Condensed Consolidated Financial Statements).
Excluding the grant and special charges related to the terrorist attacks, net
income for the nine months ended September 30, 2001, was $379.5 million ($.47
per share, diluted). The cumulative effect of change in accounting principle for
the nine months ended September 30, 2000 was $22.1 million, net of taxes of
$14.0 million (see Note 6 to the unaudited Condensed Consolidated Financial
Statements). Net income and diluted net income per share, after the cumulative
change in accounting principle, for the nine months ended September 30, 2000
were $448.4 million and $.57, respectively. Operating income for the nine months
ended September 30, 2001 was $594.0 million, a decrease of 22.9 percent compared
to 2000.
Consolidated operating revenues increased 3.2 percent due primarily to
a 3.3 percent increase in passenger revenues. The increase in passenger revenues
primarily resulted from the Company's increased capacity, but was partially
offset by a decrease of 3.8 percent in passenger yield due to aggressive fare
discounting by the Company and airline industry in general. The Company
experienced a 4.3 percent increase in revenue passengers carried, a 7.4 percent
increase in RPMs, and a 9.9 percent increase in ASMs. The Company's load factor
for the nine months ended September 30, 2001, was 69.4 percent, or 1.6 points
below the same prior year period. The increase in ASMs resulted primarily from
the net addition of 24 aircraft since third quarter 2000, which represents a 7.2
percent increase in the Company's fleet size.
As a result of weak economic conditions throughout 2001, consolidated
freight revenues decreased 13.9 percent. There were decreases in both the number
of freight shipments and revenue per shipment. Other revenues increased 25.0
percent due primarily to an increase in commissions earned from programs the
Company sponsors with certain business partners, such as the Company sponsored
First USA Visa card.
Operating expenses per ASM were $.0766, compared to $.0772 for 2000.
Excluding fuel expense, operating expenses per ASM increased .3 percent to
$.0641.
Salaries, wages, and benefits per ASM increased 4.6 percent.
Approximately 52 percent of the increase in salaries and wages primarily was
from increases in headcount and wage rates, while approximately 48 percent of
the increase was due to an escalation in health benefits costs.
Employee retirement plans expense per ASM decreased 19.5 percent, due
primarily to the decrease in Company earnings available for profitsharing.
Fuel and oil expense per ASM decreased 5.3 percent due to a 4.5 percent
decrease in the average jet fuel cost per gallon compared to 2000. The average
jet fuel cost per gallon for the nine months ended September 30, 2001 was $.7440
compared to $.7793 in 2000, including the effects of hedging activities. The
Company's 2001 average jet fuel cost is net of approximately $68.4 million in
"effective" hedging gains, as defined. See Note 6 to the unaudited Condensed
Consolidated Financial Statements. The Company's 2000 average jet fuel cost is
net of approximately $49.4 million in gains from hedging activities.
16
Maintenance materials and repairs per ASM decreased 1.6 percent. A
decrease in engine repair expense per ASM was partially offset by an increase in
airframe inspection and repairs expense per ASM. The decrease in engine repair
expense per ASM was due primarily to the Company's capacity growth exceeding the
increase in expense. Virtually all the Company's 2001 capacity growth was
accomplished with new aircraft, most of which have not yet begun to incur any
meaningful engine repair costs. The increase in airframe inspection and repairs
was primarily a result of more of these repairs being outsourced than in the
prior year due to a larger amount of this type of work than the Company could
perform with internal headcount and facilities.
Agency commissions per ASM decreased 37.0 percent due primarily to a
change in the Company's commission rate policy effective January 1, 2001. The
Company reduced the commission rate paid to travel agents from ten percent to
eight percent for Ticketless bookings, and from ten percent to five percent for
paper ticket bookings. The percentage of commissionable revenues decreased from
approximately 29 percent in 2000 to approximately 25 percent in 2001.
Aircraft rentals per ASM decreased 9.1 percent due to a lower
percentage of the aircraft fleet being leased.
Landing fees and other rentals per ASM increased 2.2 percent primarily
as a result of an increase in other rentals partially offset by a decrease in
landing fees. The increase in other rentals is due primarily to the Company's
expansion of facilities in several airports.
Depreciation expense per ASM increased 4.3 percent due primarily to a
higher percentage of the aircraft fleet being owned.
Other operating expenses per ASM increased 6.3 percent primarily from
small increases in several areas that had previously been postponed as part of a
prior year cost reduction effort.
Interest expense decreased 8.4 percent due primarily to the July 2001
redemption of $100 million notes. Capitalized interest decreased 14.5 percent
due primarily to a reduction in progress payment balances for future aircraft
deliveries. Interest income increased 2.1 percent as an increase in invested
cash balances was partially offset by a decrease in rates earned on investments.
Other gains in 2001 resulted primarily from the Company's share of government
grant funds from the Act that were determined to be related to direct and
incremental losses incurred in third quarter 2001 as a result of the terrorist
attacks.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $1.25 billion for the
nine months ended September 30, 2001 and $1.505 billion for the 12 months then
ended. In addition, the Company accessed its $475 million bank credit facility
in September 2001 following the terrorist attacks. See Note 9 to the unaudited
Condensed Consolidated Financial Statements. Cash generated for the 12 months
ended September 30, 2001 was primarily used to finance aircraft-related capital
expenditures and provide working capital. See Note 11 to the Condensed
Consolidated Financial Statements for subsequent events involving liquidity in
fourth quarter 2001.
17
During the 12 months ended September 30, 2001, net capital expenditures
were $1.002 billion, which primarily related to the purchase of 24 new 737-700
aircraft, and progress payments for future aircraft deliveries.
The Company's contractual commitments consist primarily of scheduled
aircraft acquisitions. As a result of the September 11, 2001 terrorist attacks,
the Company was able to modify its future aircraft delivery dates. As of
November 13, 2001, the Company has no new aircraft deliveries scheduled for the
remainder of 2001, 11 737-700s scheduled for delivery in 2002, 21 in 2003, 23 in
2004, 24 in 2005, 22 in 2006, 25 in 2007, and 6 in 2008. The Company also has a
total of 87 purchase options for new 737-700 aircraft for years 2003 through
2008 as follows: 13 in 2004, 20 in 2005, 20 in 2006, 9 in 2007, and 25 in 2008.
In total, Southwest's firm orders, options, and purchase rights through 2012
have remained unchanged at 436 aircraft. The Company has the option, which must
be exercised two years prior to the contractual delivery date, to substitute
737-600s or 737-800s for the 737-700s scheduled subsequent to 2002. Based on
these recent modifications, aggregate funding needed for fixed commitments at
November 13, 2001, was approximately $3.650 billion due as follows: $2 million
in 2001; $322 million in 2002; $687 million in 2003; $670 million in 2004;
$706 million in 2005; and $1.263 billion thereafter.
The Company has various options available to meet its capital and
operating commitments, including cash on hand at September 30, 2001 of $1.49
billion and internally generated funds. In addition, the Company will also
consider various borrowing or leasing options to maximize earnings and
supplement cash requirements.
On October 11, 2001, the Company filed a registration statement on Form
S-3 covering an additional $1.0 billion principal amount of unsecured debt
securities and pass through certificates which may be publicly offered from time
to time. The registration statement was declared effective by the SEC on October
15, 2001. Subsequent to the Company's issuance of $614.3 million Pass Through
Certificates on October 30, 2001, as discussed in Note 11 to the unaudited
Condensed Consolidated Financial Statements, the Company has outstanding shelf
registrations for the issuance of an additional $704.5 million in public debt
securities and pass through certificates. The Company could utilize these to pay
down short-term borrowings and/or finance aircraft during 2001 and 2002.
In July 2001, the Company redeemed $100 million of senior unsecured
9.4% Notes originally issued in 1991.
The Company recently began new service to Norfolk International Airport
in Norfolk, Virginia. Service began on October 7, 2001, with daily nonstop
flights from Baltimore/Washington, Jacksonville, Las Vegas, and Orlando, plus
direct or connecting service from 32 other cities.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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,
2000 and Note 6 to the unaudited Condensed Consolidated Financial Statements.
18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company received a statutory notice of deficiency from the Internal
Revenue Service (IRS) in July 1995 in which the IRS proposed to
disallow deductions claimed by the Company on its federal income tax
returns for the taxable years 1989 through 1991 for the costs of
certain aircraft inspection and maintenance procedures. In response to
the statutory notice of deficiency, the Company filed a petition in the
United States Tax Court on October 30, 1997, seeking a determination
that the IRS erred in disallowing the deductions claimed by the Company
and there is no deficiency in the Company's tax liability for the
taxable years in issue. On December 21, 2000, the national office of
the IRS published a revenue ruling in which it concluded that aircraft
inspection and maintenance is currently deductible as an ordinary and
necessary business expense. In accordance with the revenue ruling, the
IRS conceded the proposed adjustments to the deductions claimed by the
Company for aircraft inspection and maintenance expense, and on June 1,
2001, a decision was entered by the Tax Court holding that there is no
deficiency in income tax for the taxable years 1989 through 1991.
The IRS similarly proposed to disallow deductions claimed by the
Company on its federal income tax returns for the taxable years 1992
through 1994 for the costs of certain aircraft inspection and
maintenance expenses. Although the examination of such returns has not
been finally concluded, the IRS has advised the Company that it will
concede the proposed adjustments to the deductions claimed for these
aircraft inspection and maintenance expenses. Management believes the
final resolution of this controversy will not have a material adverse
effect upon the financial position or results of operations of the
Company.
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
19
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit 10.1 Supplemental Agreements No. 15, 16, 17, 18
and 19 to Purchase Agreement No. 1810, dated
January 19, 1994 between The Boeing Company
and Southwest.
Exhibit 10.2 Aircraft Acquisition and Sale Agreement
dated as of November 13, 2001 among The Amor
Trust, Wilmington Trust Company, Wells Fargo
Bank Northwest, National Association and
Southwest.
Exhibit 10.3 Purchase Agreement Assignment dated as of
November 13, 2001 between The Amor Trust and
Southwest.
b) Reports on Form 8-K
On October 3, 2001, Southwest filed a Current Report on Form
8-K for the purpose of filing the Company's October 3, 2001
press release reporting September 2001 traffic results as
Exhibit 99.1.
On October 29, 2001, Southwest filed a Current Report on Form
8-K to file, under Item 7-Financial Statements and Exhibits,
certain documents related to its Registration Statement on
Form S-3 (File No. 333-71392).
20
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.
November 14, 2001 By /s/ Gary C. Kelly
---------------------------
Gary C. Kelly
Executive Vice President -
Chief Financial Officer
(Principal Financial and
Accounting Officer)
21
INDEX TO EXHIBITS