CONSOLIDATED FINANCIAL STATEMENTS
Published on February 25, 1997
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, 1996, 1995, AND 1994
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
SEE ACCOMPANYING NOTES.
SOUTHWEST AIRLINES CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
SEE ACCOMPANYING NOTES.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION Southwest Airlines Co. (Southwest) is a major domestic
airline that provides shorthaul, high frequency, point-to-point, low-fare
service. The consolidated financial statements include the accounts of
Southwest and its wholly owned subsidiaries (the Company). All significant
intercompany balances and transactions have been eliminated. The preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the amounts reported in the financial statements and accompanying notes. Actual
results could differ from these estimates. Certain prior year amounts have been
reclassified for comparison purposes.
CASH AND CASH EQUIVALENTS Cash equivalents consist of certificates of deposit
and investment grade commercial paper issued by major corporations and
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 12 to 20 years for flight equipment
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 Company'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. In
accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of", the Company records impairment losses on long-lived assets
used in operations when events and circumstances indicate that the assets might
be impaired and the undiscounted cash flows to be generated by those assets are
less than the carrying amounts of those assets.
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 and amortized over the estimated period 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 transportation is
provided. Tickets sold but not yet used are included in "Air traffic
liability", which includes estimates that are evaluated and adjusted
periodically. Any adjustments resulting therefrom are included in results of
operations for the periods in which the evaluations are completed.
FREQUENT FLYER AWARDS The Company accrues the estimated incremental cost of
providing free travel awards earned under its Rapid Rewards frequent flyer
program.
ADVERTISING The Company expenses the production costs of advertising as
incurred. Advertising expense for the years ended December 31, 1996, 1995, and
1994 was $109,136,000, $92,087,000, and $79,475,000, respectively.
STOCK-BASED EMPLOYEE COMPENSATION Pursuant to Statement of Financial Accounting
Standards No. 123 (SFAS 123) "Accounting for Stock-Based Compensation", the
Company accounts for stock-based compensation plans utilizing the provisions of
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock
Issued to Employees" and related Interpretations because, as discussed in Note
7, the alternative fair value accounting provided for under SFAS 123 requires
use of option valuation models that were not developed for use in valuing
employee stock options.
2. COMMITMENTS
The Company's contractual purchase commitments consist primarily of scheduled
aircraft acquisitions. Timing of payments pursuant to contractual commitments
was affected favorably by third quarter 1995 amendments to certain aircraft
purchase contracts, which modified future progress payment schedules. Fifteen
737-300 and four 737-700 aircraft are scheduled for delivery in 1997. Sixteen
- -700s are scheduled for delivery in 1998, 16 in 1999, 15 in 2000, and 12 in
2001. In addition, the Company has options to purchase up to sixty-seven -700s
during 1998-2004. 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 -700s delivered subsequent to 1999. Aggregate funding needed for these
commitments is approximately $1,960.1 million, subject to adjustments for
inflation, due as follows: $515.1 million in 1997,
$420.0 million in 1998, $502.2 million in 1999, $318.3 million in 2000, and
$204.5 million in 2001.
The Company has historically used jet fuel and heating oil fixed price swap
arrangements to hedge its exposure to price fluctuations on an insignificant
percent of its annual fuel requirements. As of December 31, 1996, the Company
had no open swap agreements, although the hedging program has not been
discontinued. As of December 31, 1995, the Company had a heating oil swap
agreement with a broker-dealer to exchange monthly payments on a notional
quantity of 1,050,000 gallons during May 1996. Under the swap agreement, the
Company paid or received the difference between the daily average heating oil
price and a fixed price of $.46 per gallon.
The Company's principal hedging program utilizes the purchase of crude oil call
options at a nominal premium and at volumes of up to 30 percent of its annual
fuel requirements.
Gains and losses on hedging transactions are recorded as adjustments to fuel
expense and have been insignificant. Any such future 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.
3. ACCRUED LIABILITIES
(in thousands)
4. LONG-TERM DEBT
(in thousands)
On March 7, 1995, the Company issued $100 million of senior unsecured 8% Notes
due March 1, 2005. Interest is payable semi-annually on March 1 and September
1. The Notes are not redeemable prior to maturity.
On September 9, 1992, the Company 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 prior to maturity.
The fair values, based on quoted market prices, of these Notes at December 31,
1996, were as follows (in thousands):
In addition to the credit facilities described above, Southwest has an
unsecured Bank Credit Agreement with a group of banks that permits Southwest to
borrow through December 14, 1999 on a revolving credit basis up to $460
million. Interest rates on borrowings under the Credit Agreement can be, at the
option of Southwest, the agent bank's prime rate, 0.275% over LIBOR, or 0.50%
over domestic certificate of deposit rates. The commitment fee is 0.125% per
annum. There were no outstanding borrowings under this agreement at December
31, 1996 or 1995.
5. LEASES
Total rental expense for operating leases charged to operations in 1996, 1995,
and 1994 was $280,389,000, $247,033,000, and $198,987,000, respectively. The
majority of the Company's terminal operations space, as well as 106 aircraft,
were under operating leases at December 31, 1996. The amounts applicable to
capital leases included in property and equipment were (in thousands):
1996 1995
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[S]
Flight equipment __________________ $226,677 $223,844
Less accumulated amortization _____ 111,815 101,641
---------------------------
$114,862 $122,203
===========================
Future minimum lease payments under capital leases and noncancelable operating
leases with initial or remaining terms in excess of one year at December 31,
1996 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 lessor's defined
cost of the aircraft.
6. COMMON STOCK
At December 31, 1996, the Company had common stock reserved for issuance
pursuant to Employee stock benefit plans (35,257,962 shares) and upon exercise
of rights (180,370,052 shares) pursuant to the Common Stock Rights Agreement ,
as amended (Agreement).
Effective July 18, 1996, the Company amended and restated the Agreement. The
principal purpose of the amendment and restatement was to extend the Agreement
by 10 years. 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 15 percent of the common stock has been acquired by a
person or group. If the Company is acquired, 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, 2006.
7. STOCK PLANS
At December 31, 1996, the Company had six stock-based compensation plans and
other stock options outstanding, which are described below. The Company applies
APB 25 and related Interpretations in accounting for its stock-based
compensation. Accordingly, no compensation cost is recognized for its fixed
option plans and its stock purchase plan because the exercise price of the
Company's Employee stock options equals the market price of the underlying
stock on the date of the grant. Compensation cost charged against income for
other options outstanding was $649,778, $564,251, and $451,400 for 1996, 1995,
and 1994, respectively.
The Company has five fixed option plans. Under the 1991 Incentive Stock Option
Plan, the Company may grant options to key Employees for up to 9,000,000 shares
of common stock. Under the 1991 Non-Qualified Stock Option Plan, the Company
may grant options to key Employees and non-employee directors for up to 750,000
shares of common stock. All options granted under these plans have ten-year
maximum terms and vest and become fully exercisable at the end of three, five,
or ten years of continued employment, depending upon the grant type.
Under the 1995 Southwest Airlines Pilots' Association Non-Qualified Stock
Option Plan (SWAPA Plan), the Company may grant
options to Pilots for up to 18,000,000 shares of common stock. An initial grant
of approximately 14,500,000 shares was made on January 12, 1995 at an option
price of $20.00 per share. Options granted under the initial grant vest in ten
annual increments of ten percent. On September 1 of each year of the agreement,
beginning September 1, 1996, additional options will be granted to Pilots that
become eligible during that year. Additional options granted on September 1,
1996 vest in eight annual increments of 12.5 percent. Options under both grants
must be exercised prior to January 31, 2007, or within a specified time upon
retirement or termination. In the event that the Southwest Airlines Pilots'
Association exercises its option to make the collective bargaining agreement
amendable on September 1, 1999, any unexercised options will be canceled on
December 1, 1999.
Under the 1996 Incentive Stock Option Plan, the Company may grant options to
key Employees for up to 6,000,000 shares of common stock. Under the 1996
Non-Qualified Stock Option Plan, the Company may grant options to key Employees
and non-employee directors for up to 575,000 shares of common stock. All
options granted under these plans have ten-year terms and vest and become fully
exercisable at the end of three, five, or ten years of continued employment,
depending upon the grant type.
Under all fixed option plans, the exercise price of each option equals the
market price of the Company's stock on the date of grant, except that under the
SWAPA Plan, for additional options granted each September 1, eligible Pilots
will be required to pay a purchase price equal to 105 percent of the fair value
of such stock on the date of the grant.
A summary of the status of the Company's five fixed option plans as of December
31, 1996, 1995, and 1994, and changes during the years ending on those dates is
presented below:
*Includes 1991 Incentive Stock Option Plan. No options have been
granted under the 1996 Incentive Stock Option Plan.
**Includes 1991 Non-Qualified Stock Option Plan and SWAPA Plan. No
options have been granted under the 1996 Non-Qualified Stock Option
Plan.
The following table summarizes information about fixed stock options
outstanding under the fixed option plans at December 31, 1996:
The Company has granted options to purchase the Company's common stock related
to employment contracts with the Company's president and chief executive
officer. These options have terms of ten years from the date of grant or ten
years from the date exercisable, depending upon the grant. The options vest and
become fully exercisable over three or four years. In 1996, the Company granted
144,395 options with an exercise price of $1.00 per share and 500,000 options
with an exercise price of $23.50 per share related to the 1996 employment
agreement. None of the 1996 options granted were exercised in 1996, however,
128,879 were exercisable as of December 31, 1996. At December 31, 1996, 1995,
and 1994, 1,897,898, 1,422,253, and 1,489,753 total options were outstanding.
Exercise prices range from $1.00 to $23.50 per share. Options for 168,750,
67,500, and 15,000 shares were exercised in 1996, 1995, and 1994, respectively.
Under the 1991 Employee Stock Purchase Plan (ESPP), the Company is authorized
to issue up to a balance of 1,183,236 shares of common stock to Employees of
the Company at a price equal to 90 percent 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 309,446 shares in
1996, 388,339 shares in 1995, and 290,054 shares in 1994 at average prices of
$23.05, $19.18, and $24.98, respectively.
Pro forma information regarding net income and net income per share is required
by SFAS 123, and has been determined as if the Company had accounted for its
employee stock-based compensation plans and other stock options under the fair
value method of that SFAS. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants under the fixed option
plans in 1996 and 1995, respectively: dividend yield of .16% and .21%; expected
volatility of 35.4% and 36.9%; risk-free interest rate of 5.9% and 7.8%; and
expected lives of 5.0 years for both periods. Assumptions for the stock options
granted in 1996 to the Company's president and chief executive officer were the
same as for the fixed option plans except for the weighted average expected
lives of 8.0 years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's Employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its Employee stock options.
For purposes of pro forma disclosures the estimated fair value of stock-based
compensation plans and other options is amortized to expense primarily over the
vesting period. The Company's pro forma net income and net income per share is
as follows (in thousands except per share amounts):
The effects of applying SFAS 123 for providing pro forma disclosures during the
initial phase-in period may not be representative of the effects on reported
net income for future years.
The weighted-average fair value of options granted under the five fixed option
plans during 1996 and 1995 was $10.17 and $8.42, respectively, for the
incentive plans, $9.24 and $7.97, respectively, for the SWAPA Plan, and $10.17
and $8.42,
respectively, for other non-qualified plans. The weighted average fair value of
options granted in 1996 to the Company's president and chief executive officer
(no options were granted in 1995) was $13.98. The weighted-average fair value
of each purchase right under the ESPP granted in 1996 and 1995, which is equal
to the ten percent discount from the market value of the common stock at the
end of each purchase period, was $2.56 and $2.15, respectively.
8. 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 1996, 1995, and 1994, was $59,927,000, $54,033,000, and
$52,782,000, respectively.
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 1996, 1995 and
1994 were $35,125,000, $28,954,000, and $19,817,000, respectively.
9. INCOME TAXES
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, 1996 and 1995 are as
follows (in thousands):
The provision for income taxes is comprised of the following (in thousands):
Southwest has received examination reports from the Internal Revenue Service
proposing certain adjustments to Southwest's income tax returns for 1987
through 1991. 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 income taxes differed from the federal
income tax statutory rate for the following reasons (in thousands):
1996 1995 1994
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Tax at statutory
U.S. tax rates ___ $119,477 $106,799 $104,833
Nondeductible items 5,168 4,488 3,689
State income taxes,
net of federal
benefit __________ 9,072 8,784 9,177
Other, net _________ 308 2,443 2,493
________ ________ ________
Total income tax $134,025 $122,514 $120,192
provision __________ ======== ======== ========
10. 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
(151,840,187 in 1996, 148,850,512 in 1995 and 147,305,374 in 1994). 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 is not material.