CONSOLIDATED FINANCIAL STATEMENTS
Published on February 27, 1995
EXHIBIT 99.1
SOUTHWEST AIRLINES CO.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
SEE ACCOMPANYING NOTES.
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
SEE ACCOMPANYING NOTES.
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1994, 1993, AND 1992
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
SEE ACCOMPANYING NOTES.
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
SEE ACCOMPANYING NOTES.
SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1994.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation The consolidated financial statements include the
accounts of Southwest Airlines Co. (Southwest) and its wholly owned
subsidiaries (the Company). All significant intercompany balances and
transactions have been eliminated. Certain prior year amounts have been
reclassified for comparison purposes.
Cash and cash equivalents Cash equivalents consist of investment grade
commercial paper issued by major financial institutions that are highly liquid
and have original maturity dates of three months or less. Cash and cash
equivalents are carried at cost, which approximates market value.
Inventories Inventories of flight equipment expendable parts, materials,
and supplies are carried at average cost. These items are charged to expense
when issued for use.
Property and equipment Depreciation is provided by the straight-line method
to residual values over periods ranging from 15 to 20 years for flight
equipment (see Note 3) and 3 to 30 years for ground property and equipment.
Property under capital leases and related obligations are recorded at an amount
equal to the present value of future minimum lease payments computed on the
basis of the lessee's incremental borrowing rate or, when known, the interest
rate implicit in the lease. Amortization of property under capital leases is on
a straight-line basis over the lease term and is included in depreciation
expense.
Aircraft and engine maintenance The cost of engine overhauls and routine
maintenance costs for aircraft and engine maintenance are charged to
maintenance expense as incurred. Scheduled airframe overhaul costs are
capitalized at amounts not to exceed the fair market value of the related
aircraft and amortized over the estimated periods benefited, presently 8 years.
Modifications that significantly enhance the operating performance or extend
the useful lives of aircraft or engines are capitalized and amortized over the
remaining life of the asset.
Revenue recognition Passenger revenue is recognized when the
transportation is provided. Tickets sold but not yet used are included in "Air
traffic liability."
Frequent flyer awards The Company accrues the estimated incremental cost of
providing free travel awards earned under its Company Club Frequent Flyer
program.
Advertising The Company expenses the production costs of advertising as
incurred. Advertising expense for the years ended December 31, 1994, 1993 and
1992 was $79,475,000, $55,344,000, and $42,068,000, respectively.
2. ACQUISITION
On December 31, 1993, Southwest exchanged 3,574,656 newly issued shares of its
common stock for all of the outstanding stock of Morris Air Corporation
(Morris), a low-fare commercial/charter air carrier based in Salt Lake City.
The acquisition was accounted for as a pooling of interests and, accordingly,
the Company's consolidated financial statements were restated to include the
accounts and operations of Morris for all periods prior to the acquisition.
Prior to 1993, Morris was treated as an S-Corporation for federal and state
income tax purposes under applicable provisions of the Internal Revenue Code
and various state tax laws. Therefore, no provision for income taxes was made
prior to 1993. Morris made regular cash distributions to its shareholders
sufficient to meet their tax liabilities. Upon termination of S-Corporation
status on December 31, 1992, the undistributed S-Corporation retained earnings
were reclassified to capital in excess of par value. Additionally, Morris
established $3,032,000 of deferred income taxes for the cumulative differences
in the timing of reporting certain items for financial statement and income tax
purposes. These deferred taxes related primarily to depreciation. The
establishment of deferred taxes was offset by a reduction of capital in excess
of par value.
Merger expenses of $10,803,000 relating to the merger of Southwest and Morris
have been included in 1993 operating expenses as required for financial
reporting purposes; however, these expenses have been separately reported as
"merger expenses" to reflect the impact of the nonrecurring expenses on
operating results. Included in these one-time costs resulting from the merger
were $1,900,000 of various professional fees; $4,703,000 for disposal of
duplicate or incompatible property and equipment; and $4,200,000 for Employee
relocation and severance costs related to elimination of duplicate or
incompatible operations. During 1994, the integration of Morris into Southwest
was substantially completed, including the disposal of incompatible property
and equipment and settlement of Employee relocation and severance costs.
3. ACCOUNTING CHANGES
Income Taxes Effective January 1, 1993, the Company adopted Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
109). As a result of adopting SFAS 109, the Company recorded deferred tax
assets of $6,977,000 and reduced deferred tax liabilities by $9,048,000 at
January 1, 1993, which resulted in an increase to the Company's 1993 net income
of $16,025,000 ($.11 per share) for the cumulative effect of the accounting
change.
Postretirement Benefits Effective January 1, 1993, the Company adopted
Statement of Financial Accounting Standards No. 106, "Employers' Accounting
for Postretirement Benefits Other Than Pensions" (SFAS 106). The cumulative
effect of this change in accounting method at January 1, 1993 reduced 1993 net
income by $766,000 (net of benefit from income taxes of $469,000) or $.01 per
share. The effect of adopting SFAS 106 on 1993 income before cumulative effect
of accounting changes was not material.
Scheduled Airframe Overhauls Prior to January 1, 1992, the Company
expensed scheduled airframe overhaul costs as incurred. This practice was
adopted at a time when costs were relatively constant from year to year and
consistent with the growth of the fleet.
Given the significant growth of the Company's fleet and the Company's 1991
modification of its airframe overhaul maintenance program with the Federal
Aviation Administration (FAA), Southwest changed its method of accounting for
scheduled airframe overhauls costs from the direct expense method to that of
capitalizing and amortizing the costs over the periods benefited. The Company
believes this method is preferable because it results in charges to expense
that are consistent with the growth in the fleet; improves financial reporting;
and better matches revenues and expenses.
For the year ended December 31, 1992, the Company recognized approximately
$6,900,000 in amortization of airframe overhaul expense. Had the direct
expense method been used to provide for scheduled airframe overhaul costs
during the year ended December 31, 1992, income before cumulative effect of
accounting change would have been reduced by approximately $9,800,000 (net of
provision for income taxes and profitsharing of approximately $8,800,000), or
approximately $.07 per share.
This change in accounting principle had the effect of a one-time adjustment
increasing net income for the year ended December 31, 1992 by approximately
$12,538,000 (net of provision for income taxes and profitsharing of
approximately $11,500,000).
Change in Accounting Estimate Effective January 1, 1992, the Company
revised the estimated useful lives of its 737-200 aircraft from 15 years to
15-19 years. This change was the result of the Company's assessment of the
remaining useful lives of its 737-200 aircraft following the recent
promulgation of rules by the FAA for the phase out of Stage 2 aircraft by
December 31, 1999. The effect of this change was to reduce depreciation expense
approximately $3,680,000, or $.03 per share, for the year ended December 31,
1992.
4. COMMITMENTS
The Company's contractual purchase commitments consist primarily of scheduled
aircraft acquisitions. Twenty-five 737-300 aircraft are scheduled for delivery
in 1995, 18 in 1996, and ten in 1997. Four 737-700s are scheduled for delivery
in 1997, 16 in 1998, 16 in 1999, 15 in 2000, and 12 in 2001. In addition, the
Company has options to purchase up to eleven 737-300s in 1997 and up to sixty-
three 737-700s during 1998-2004. The Company has the option, which must be
exercised two years prior to the contractual delivery date, to substitute
737-400s or 737-500s for the 737-300s to be delivered during 1997 and 737-600S
or 737-800S for the 737-700s delivered subsequent to 1999. Aggregate funding
needed for these commitments was approximately $3,042.7 million, subject to
adjustments for inflation, due as follows: $602.6 million in 1995, $489.5
million in 1996, $447.8 million in 1997, $445.4 million in 1998, $452.9 million
in 1999, $366.0 million in 2000, and $238.5 million in 2001. In addition, the
Company has an agreement in principle to lease two used 737-300 aircraft in
1995.
The Company uses jet fuel fixed price swap arrangements to hedge its exposure
to price fluctuations on approximately 5 percent of its annual fuel
requirements. As of December 31, 1994, the Company had jet fuel swap agreements
with broker-dealers to exchange monthly payments on notional quantities
amounting to 2,100,000 gallons per month, over the ensuing three months. Under
the swap agreements, the Company pays or receives the difference between the
daily average jet fuel price and a fixed price of approximately $.518 per
gallon. Gains and losses on such transactions are recorded as adjustments to
fuel expense and have been insignificant. Although the agreements expose the
Company to credit loss in the event of nonperformance by the other parties to
the agreements, the Company does not anticipate such nonperformance.
5. ACCRUED LIABILITIES
(in thousands)
6. LONG-TERM DEBT
(in thousands)
On March 1, 1993, the Company redeemed the $100 million in senior unsecured 9%
Notes due March 1, 1996 issued in March 1986. The Notes were redeemed at par
plus accrued interest.
On September 9, 1992, Southwest issued $100 million of senior unsecured 7 7/8%
Notes due September 1, 2007. Interest is payable semi-annually on March 1 and
September 1. The Notes are not redeemable prior to maturity.
During 1991, the Company issued $100 million of senior unsecured 9 1/4% Notes,
$100 million of senior unsecured 9.4% Notes, and $100 million of senior
unsecured 8 3/4% Notes due February 15, 1998, July 1, 2001, and October
15,2003, respectively. Interest on the Notes is payable semi-annually. The
Notes are not redeemable by the Company prior to maturity.
The fair values, based on quoted market prices, of these Notes at December 31,
1994, were as follows (in thousands):
In 1992, certain Convertible Subordinated Debentures issued by Southwest
Airlines Eurofinance N.V. were redeemed. The principal amount of $35,000,000
was converted into 1,370,902 shares (unadjusted for the 1993 and 1992 stock
splits) of Southwest's common stock at the conversion price of $25.53 per
share. The conversion was primarily a noncash transaction and, therefore, was
excluded from the Statement of Cash Flows.
In addition to the credit facilities described above, Southwest has an
unsecured Bank Credit Agreement with a group of domestic banks that permits
Southwest to borrow through December 14, 1996 on a revolving credit basis up to
$300 million. Interest rates on borrowings under the Credit Agreement can be,
at the option of Southwest, the agent bank's prime rate, .30% over LIBOR, or
.50% over domestic certificate of deposit rates. The commitment fee is 0.1875%
per annum. There were no outstanding borrowings under this agreement at
December 31, 1994, 1993, or 1992.
7. LEASES
Total rental expense for operating leases charged to operations in 1994, 1993,
and 1992 was $198,987,000, $167,303,000, and $125,835,000, respectively. The
majority of the Company's terminal operations space, as well as 89 aircraft,
were under operating leases. The amounts applicable to capital leases included
in property and equipment were (in thousands):
Future minimum lease payments under capital leases and noncancelable operating
leases, with initial or remaining terms in excess of one year, at December 31,
1994, were (in thousands):
The aircraft leases can generally be renewed at rates, based on fair market
value at the end of the lease term, for one to five years. Most aircraft leases
have purchase options at or near the end of the lease term at fair market
value, but generally not to exceed a stated percentage of the defined lessor's
cost of the aircraft.
8. COMMON STOCK
At December 31, 1994, the Company had common stock reserved for issuance
pursuant to Employee stock benefit plans (12,009,293 shares) and upon exercise
of rights pursuant to the Common Stock Rights Agreement (Agreement), as amended
(155,265,088 shares).
Pursuant to the Agreement, each outstanding share of the Company's common stock
is accompanied by one common share purchase right (Right). Each Right entitles
its holder to purchase one share of common stock at an exercise price of $16.67
and is exercisable only in the event of a proposed takeover, as defined by the
Agreement. The Company may redeem the Rights at $.0111 per Right prior to the
time that 20 percent of the common stock has been acquired by a person or
group. If the Company is acquired or if certain self- dealing transactions
occur, as defined in the Agreement, each Right will entitle its holder to
purchase for $16.67 that number of the acquiring company's or the Company's
common shares, as provided in the Agreement, having a market value of two times
the exercise price of the Right. The Rights will expire no later than July 30,
1996.
On May 19, 1993, the Company's Board of Directors declared a three-for-two
stock split, distributing 46,325,147 shares on July 15, 1993. On May 20, 1992,
the Company's Board of Directors declared a two-for-one stock split,
distributing 46,180,531 shares on July 15, 1992.
In February 1992, the Company sold 2,500,000 shares (unadjusted for the
subsequent 1993 and 1992 stock splits) of its common stock (2,327,892 new
shares and 172,108 shares from treasury) in a public offering. Net proceeds
from the sale of approximately $86,946,000 were added to the working capital of
the Company for general corporate purposes, including the acquisition of
aircraft and related equipment.
9. STOCK PLANS
In May 1991, the Company's stockholders approved the Incentive Stock Option
Plan and the Non-Qualified Stock Option Plan. Under the Incentive Stock Option
Plan, options to purchase a maximum of 9,000,000 shares of Southwest Common
Stock may be granted to key Employees. Under the Non-Qualified Stock Option
Plan, options to purchase up to 750,000 shares of Southwest Common Stock may be
granted to key Employees and non-employee directors. Under each plan, the
option price per share may not be less than the fair market value of a share on
the date the option is granted and the maximum term of an option may not exceed
10 years.
Information regarding the stock option plans is summarized below:
* Includes 108,113 pre-split shares and 36,115 post-split shares, of
which 5,476 pre-split shares and 72 post-split shares were issued from
treasury.
** Includes 12,740 pre-split shares and 75,700 post-split shares.
The exercise price of outstanding options ranged from $6.02 to $37.44 in 1994,
$6.02 to $19.71 in 1993, and $6.02 to $12.06 in 1992.
In 1991, the Company's stockholders also approved the Employee Stock Purchase
Plan that provides for the sale of common stock to Employees of the Company at
a price equal to 90% of the market value at the end of each purchase period.
Common stock purchases are paid for through periodic payroll deductions.
Participants under the plan received 290,054 shares in 1994, 182,459 shares
(59,442 pre-split shares and 93,296 post-split shares) in 1993 and 166,436
shares in 1992 at average prices of $24.98, $25.25, and $12.89, respectively.
At December 31, 1994, 1993, and 1992, 1,489,753, 1,504,752, and 1,512,252
options to purchase the Company's common stock were also outstanding related to
employment contracts with the Company's president and chief executive officer.
Exercise prices range from $1.00 to $11.33 per share. Options for 15,000
shares, 7,500 shares (5,000 pre-split shares, of which 968 shares were issued
from treasury), and 22,500 shares were exercised in 1994, 1993, and 1992,
respectively.
Effective January 12, 1995, the Company adopted, pursuant to a collective
bargaining agreement between the Company and the Southwest Airlines Pilots'
Association (SWAPA), the 1995 SWAPA Non-Qualified Stock Option Plan (SWAPA
Plan). Under the terms of the SWAPA Plan, 18,000,000 common shares have been
reserved for issuance. An initial grant of approximately 14.5 million shares
was made on the effective date at an option price of $20.00 per share. On
September 1 of each year of the agreement, commencing September 1, 1996,
additional options will be granted to pilots that became eligible during that
year at an option price equal to the fair market value of the common stock of
the Company on the date of grant plus 5 percent. Options vest in ten annual
increments of 10 percent and must be exercised prior to January 31, 2007, or
within a specified time upon retirement or termination. In the event that SWAPA
exercises its option to make the collective bargaining agreement amendable on
or before September 1, 1999, any unexercised options will be canceled on
December 1, 1999.
10. EMPLOYEE PROFITSHARING AND SAVINGS PLANS
Substantially all of Southwest's Employees are members of the Southwest
Airlines Co. Profitsharing Plan (the Plan). Total profitsharing expense charged
to operations in 1994, 1993, and 1992 was $52,782,000, $44,959,000, and
$26,363,000, respectively. The Company also elected to contribute $3,605,000 in
1992 as a result of an accounting change (see Note 3).
The Company sponsors Employee savings plans under Section 401(k) of the
Internal Revenue Code. The plans cover substantially all full-time Employees.
The amount of matching contributions varies by Employee group. Company
contributions generally vest over five years with credit for prior years'
service granted. Company matching contributions expensed in 1994, 1993, and
1992 were $19,817,000, $13,986,000, and $11,611,000, respectively.
11. INCOME TAXES
Effective January 1, 1993, the Company changed its method of accounting for
income taxes from the deferred method to the liability method as required by
SFAS 109 (see Note 3).
Under SFAS 109, deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. The
components of deferred tax assets and liabilities at December 31, 1994 and
1993, are as follows (in thousands):
In August 1993, the Revenue Reconciliation Act of 1993 (the "1993 Act") was
enacted, which contains numerous provision changes including an increase in the
federal corporate income tax rate from 34 percent to 35 percent effective
January 1, 1993. As a result, the Company recognized approximately $4.0 million
of additional expense related to deferred tax liabilities existing on January
1, 1993.
The provision for income taxes before the cumulative effect of accounting
changes is comprised of the following (in thousands):
The components of the provision for deferred income taxes as reported under the
previous method of accounting for the year ended December 31, 1992, were as
follows (in thousands):
In January 1994, Southwest received an examination report from the Internal
Revenue Service proposing certain adjustments to Southwest's income tax returns
for 1987 and 1988. The adjustments relate to certain types of aircraft
financings consummated by Southwest, as well as other members of the aviation
industry during that time period. Southwest intends to vigorously protest the
adjustments proposed with which it does not agree.
The industry's difference with the IRS involves complex issues of law and fact
that are likely to take a substantial period of time to resolve. Management
believes that final resolution of such protest will not have a materially
adverse effect upon the results of operations of Southwest.
The effective tax rate on income before cumulative effect of accounting changes
differed from the federal income tax statutory rate for the following reasons:
12. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Net income per common and common equivalent share is computed based on the
weighted average number of common and common equivalent shares outstanding
(147,305,374 in 1994, 147,144,568 in 1993, and 142,945,890 in 1992). Fully
diluted earnings per share have not been presented as the fully dilutive effect
of shares issuable upon the exercise of options under the Company's Stock
Option Plans, or conversion of Convertible Subordinated Debentures is
anti-dilutive or is not material.