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 March 31, 1997 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) (214) 792-4000 (Registrant's telephone number, including area code) 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 May 12, 1997: 145,583,242 SOUTHWEST AIRLINES CO. FORM 10-Q Part I - FINANCIAL INFORMATION Item 1. Financial Statements Southwest Airlines Co. CONDENSED CONSOLIDATED BALANCE SHEET (in thousands) (unaudited) <TABLE> <CAPTION> March 31, 1997 December 31, 1996 <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $652,412 $581,841 Accounts receivable 84,493 73,440 Inventories of parts and supplies 50,171 51,094 Deferred income taxes 11,796 11,560 Prepaid expenses and other 24,245 33,055 Total current assets 823,117 750,990 Property and equipment: Flight equipment 3,543,020 3,435,304 Ground property and equipment 538,358 523,958 Deposits on flight equipment purchase contracts 188,924 198,366 4,270,302 4,157,628 Less allowance for depreciation 1,240,253 1,188,405 3,030,049 2,969,223 Other assets 4,079 3,266 $3,857,245 $3,723,479 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $143,718 $214,232 Accrued liabilities 397,821 380,747 Air traffic liability 184,178 158,098 Income taxes payable 17,517 - Current maturities of long-term debt 18,192 12,327 Total current liabilities 761,426 765,404 Long-term debt less current maturities 739,188 650,226 Deferred income taxes 358,013 349,987 Deferred gains from sale and leaseback of aircraft 270,281 274,891 Other deferred liabilities 28,465 34,659 Stockholders' equity: Common stock 145,415 145,112 Capital in excess of par value 183,632 181,650 Retained earnings 1,370,825 1,321,550 Total stockholders' equity 1,699,872 1,648,312 $3,857,245 $3,723,479 </TABLE> See accompanying notes. Southwest Airlines Co. CONDENSED CONSOLIDATED STATEMENT OF INCOME (in thousands except per share amounts) (unaudited) <TABLE> <CAPTION> Three months ended March 31, 1997 1996 <S> <C> <C> Operating revenues: Passenger $849,106 $741,100 Freight 21,354 18,980 Other 16,635 12,449 Total operating revenues 887,095 772,529 Operating expenses: Salaries, wages, and benefits 265,794 237,365 Fuel and oil 134,075 103,867 Maintenance materials and repairs 57,238 62,199 Agency commissions 37,092 31,826 Aircraft rentals 50,382 44,997 Landing fees and other rentals 49,011 45,443 Depreciation 48,386 44,014 Other operating expenses 157,914 145,425 Total operating expenses 799,892 715,136 Operating income 87,203 57,393 Other expenses (income): Interest expense 15,225 14,902 Capitalized interest (4,422) (6,904) Interest income (7,962) (4,053) Nonoperating (gains) losses, net 961 (1,323) Total other expenses 3,802 2,622 Income before income taxes 83,401 54,771 Provision for income taxes 32,527 21,771 Net income $50,874 $33,000 Weighted average common and common equivalent shares outstanding 150,448 152,403 Net income per common and common equivalent share $.34 $.22 </TABLE> See accompanying notes. Southwest Airlines Co. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (unaudited) <TABLE> <CAPTION> Three months ended March 31, 1997 1996 <S> <C> <C> Net cash provided by operating activities $ 93,511 $141,715 Cash flows from investing activities: Net purchases of property and equipment (115,850) (132,354) Cash flows from financing activities: Issuance of long-term debt 98,764 - Payment of long-term debt and capital lease obligations (4,944) (6,558) Payment of cash dividends (3,195) (3,029) Proceeds from Employee stock plans 2,285 7,543 Net cash provided by (used in) financing activities 92,910 (2,044) Net increase in cash and cash equivalents 70,571 7,317 Cash and cash equivalents at beginning of period 581,841 317,363 Cash and cash equivalents at end of period $652,412 $324,680 Cash payments for: Interest, net of amount capitalized $20,827 $17,434 Income taxes $215 $396 </TABLE> See accompanying notes. SOUTHWEST AIRLINES CO. Notes to Condensed Consolidated Financial Statements 1. Basis of presentation - The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles for complete financial statements. The condensed consolidated financial statements for the interim periods ended March 31, 1997 and 1996 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. Operating results for the three months ended March 31, 1997 are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. 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, 1996. 2. Dividends - During the three-month period ended March 31, 1997, $.01155 per share in dividends were declared on the 145,335,143 shares of common stock then outstanding. During the three-month period ended March 31, 1996, $.011 per share in dividends were declared on the 144,452,894 shares of common stock then outstanding. 3. Long-term debt - During February 1997, the Company issued $100 million of senior unsecured 7 3/8% Debentures due March 1, 2027. Interest on the Debentures is payable semi- annually on March 1 and September 1, commencing September 1, 1997. The Debentures may be redeemed, at the option of the Company, in whole at any time or in part from time to time, at a redemption price equal to the greater of the principal amount of the Debentures plus accrued interest at the date of redemption or the sum of the present values of the remaining scheduled payments of principal of the Debentures and interest thereon discounted to the date of redemption plus accrued interest at the date of redemption. 4. Recently issued accounting standard - In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share, which is required to be adopted on December 31, 1997. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating primary earnings per share, the dilutive effect of stock options will be excluded. The impact of Statement 128 on the calculation of primary and fully diluted earnings per share for the first quarter ended March 31, 1997 and March 31, 1996 is not expected to be material. 5. Reclassifications - Certain prior year amounts have been reclassified for comparison purposes. Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition Comparative Consolidated Operating Statistics Relevant operating statistics for the three-month periods ended March 31, 1997 and 1996 are as follows: <TABLE> <CAPTION> Three months ended March 31, 1997 1996 Change <S> <C> <C> <C> Revenue passengers carried 12,046,184 11,405,237 5.6% Revenue passenger miles (RPMs) (000s) 6,533,046 5,837,118 11.9% Available seat miles (ASMs) (000s) 10,517,635 9,641,403 9.1% Load factor 62.1% 60.5% 1.6 pts. Average length of passenger haul 542 512 5.9% Trips flown 190,205 179,105 6.2% Average passenger fare $70.49 $64.98 8.5% Passenger revenue yield per RPM $.1300 $.1270 2.4% Operating revenue yield per ASM $.0843 $.0801 5.2% Operating expenses per ASM $.0761 $.0742 2.6% Average fuel cost per gallon $.7145 $.5913 20.8% Number of employees at period-end 23,544 20,804 13.2% Size of fleet at period-end 246 229 7.4% </TABLE> Material Changes in Results of Operations Consolidated net income for the first quarter ended March 31, 1997 was $50.9 million ($.34 per share), as compared to first quarter 1996 net income of $33.0 million ($.22 per share), an increase of 54.2%. The increase in earnings was principally due to increased passenger revenues resulting from year-over-year increases in revenue passenger miles (RPMs) and passenger revenue yield per RPM. First quarter 1997 consolidated operating revenues increased 14.8 percent compared to first quarter 1996 primarily due to a 14.6 percent increase in passenger revenues. The increase in passenger revenues resulted from an 11.9 percent increase in RPMs coupled with a 2.4 percent increase in yield per RPM. While RPMs in first quarter 1997 increased 11.9 percent, available seat miles (ASMs) increased 9.1 percent resulting in a load factor of 62.1 percent versus 60.5 percent for the first three months of 1996. The increase in ASMs resulted primarily from the net addition of 17 aircraft since first quarter 1996. The load factor for April 1997 was 60.8 percent, compared to the April 1996 load factor of 64.7 percent. Management believes the lower load factor for April 1997 was due to the 1997 Easter holiday falling in March rather than April as it did in 1996, coupled with modest fare increases in February 1997. Although load factor trends have improved since the Easter holiday and bookings for the remainder of the second quarter, at this point, are good, we do not expect to match the load factor performance of second quarter 1996. Additionally, the March 1997 reimposition of the ten percent federal excise tax may adversely impact revenue growth during second quarter 1997 versus second quarter 1996, which was not subject to any federal excise tax. (The immediately preceding two sentences are forward-looking statements which involve uncertainties that could result in actual results differing materially from expected results. Some significant factors include, but may not be limited to, competitive pressure such as fare sales and capacity changes by other carriers, general economic conditions, and variations in advance booking trends.) Consolidated freight revenues increased 12.5 percent in the first quarter of 1997 as compared to the same period in 1996, due to increased capacity, as well as an increase in United States mail services. Other revenues increased 33.6 percent in first quarter 1997, primarily due to increased revenues from the sale of frequent flyer credits to participating partners in the Rapid Rewards program. Operating expenses per ASM for first quarter 1997 increased 2.6 percent to $.0761, compared to $.0742 for first quarter 1996, primarily due to higher jet fuel prices and a $6.4 million increase in Profitsharing and Employee savings plan contributions, partially offset by lower aircraft engine overhaul costs. Southwest Airlines Co. Operating Expenses per ASM (in cents except percent change) <TABLE> <CAPTION> Three months ended March 31, Increase Percent 1997 1996 (decrease) change <S> <C> <C> <C> <C> Salaries, wages, and benefits 2.30 2.28 .02 .9 Employee profitsharing and savings plans .23 .19 .04 21.1 Fuel and oil 1.28 1.08 .20 18.5 Maintenance materials and repairs .54 .64 (.10) (15.6) Agency commissions .35 .33 .02 6.1 Aircraft rentals .48 .47 .01 2.1 Landing fees and other rentals .47 .47 - - Depreciation .46 .45 .01 2.2 Other operating expenses 1.50 1.51 (.01) (.7) Total 7.61 7.42 .19 2.6 </TABLE> The Company's flight attendants are subject to an agreement with the Transport Workers Union of America, AFL-CIO (TWU), which became amendable May 31, 1996. Southwest is currently in negotiations with TWU to amend the contract. Profitsharing and Employee savings plan expenses per ASM increased 21.1 percent from first quarter 1996 to first quarter 1997, primarily due to higher earnings available for profitsharing in 1997. Fuel and oil expense per ASM increased 18.5 percent in first quarter 1997 due to a 20.8 percent increase in the average jet fuel cost per gallon from the same period in 1996. The average price paid for jet fuel in first quarter 1997 was $.7145 per gallon, compared to $.5913 per gallon in first quarter 1996. Since the end of first quarter 1997, fuel prices have averaged approximately $.62 per gallon. Maintenance materials and repairs per ASM decreased 15.6 percent for the three months ended March 31, 1997 as compared to the corresponding period of the prior year. The decrease was primarily due to performing fewer aircraft engine overhauls in first quarter 1997. Agency commissions per ASM increased 6.1 percent for the first quarter of 1997 as compared to the first quarter of 1996, primarily due to increased passenger revenues. First quarter 1997 agency commissions as a percentage of revenue were flat year over year. Aircraft rentals per ASM increased 2.1 percent for first quarter 1997 as compared to first quarter 1996 due to the sale- leaseback of ten aircraft in second and third quarter 1996. Depreciation expense per ASM increased 2.2 percent for first quarter 1997 as compared to first quarter 1996 due to owned aircraft representing a higher percentage of the total fleet. Other expense (income) for the first quarter 1997 included interest expense, capitalized interest, interest income, and nonoperating gains and losses. Interest expense increased slightly in the first quarter 1997 due to the February issuance of $100 million of senior unsecured 7 3/8% Debentures due March 1, 2027. Capitalized interest decreased $2.5 million in first quarter 1997 as a result of certain amendments to aircraft purchase contracts that deferred the timing of advance payments. Interest income increased $3.9 million in first quarter 1997 due to higher invested cash balances. Material Changes in Financial Condition Net cash provided by operating activities was $93.5 million for the three months ended March 31, 1997 and $567.0 million for the 12 months then ended. This cash was primarily used to finance aircraft-related capital expenditures and provide working capital. During the 12 months ended March 31, 1997, net capital expenditures were $660.9 million, which primarily related to the purchase of one previously leased 737-200 and 20 new 737-300 aircraft, of which six were subsequently sold and leased back, and progress payments for future aircraft deliveries. The Company opened service to Jacksonville, Florida on January 15, 1997 and recently announced expansion to Jackson, Mississippi beginning August 1997. As of March 31, 1997, the Company had authority from its Board of Directors to purchase up to 2,500,000 shares of its common stock from time to time on the open market. No shares have been purchased since 1990. The Company's contractual commitments consist primarily of scheduled aircraft acquisitions. Twelve 737-300s are scheduled for delivery in the remainder of 1997. Four 737-700s are scheduled for delivery in 1997, 21 in 1998, 16 in 1999, 15 in 2000, and 12 in 2001. In addition, the Company has options to purchase up to sixty-seven 737-700s during 1998-2004. The Company has the option, which must be exercised two years prior to the contractual delivery date, to substitute 737-600s or 737-800s for the 737-700s delivered subsequent to 1999. Aggregate funding needed for these commitments was approximately $2,015.4 million at March 31, 1997 due as follows: $457.7 million in 1997; $533.0 million in 1998; $502.3 million in 1999; $318.1 million in 2000; and $204.3 million in 2001. The Company has various options available to meet its capital and operating commitments, including cash on hand at March 31, 1997 of $652.4 million, internally generated funds, and a revolving credit line with a group of banks, which has recently been increased to $475 million (none of which had been drawn at March 31, 1997). In addition, the Company will also consider various borrowing or leasing options to maximize earnings and supplement cash requirements. PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company 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 made with which it does not agree. The industry's difference with the IRS involves complex issues of law and fact which 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. This forward-looking statement is based on management's current understanding of the relevant law and facts; it is subject to various contingencies including the views of legal counsel, changes in the IRS' position, the potential cost and risk associated with litigation and the actions of the IRS, judges and juries. Item 2. Changes in Securities Recent Sales of Unregistered Securities The Company re-employed Herbert D. Kelleher, effective as of January 1, 1996, as President and Chief Executive Officer under a five-year Employment Contract. Pursuant to this Contract, Mr. Kelleher was granted nonstatutory options to purchase, subject to his employment for four years, 144,395 shares at a purchase price of $23.50 per share, representing the composite tape closing sales price of the Common Stock on the New York Stock Exchange on January 2, 1996. One-fifth of the options are not subject to vesting and may be exercised at any time as to the underlying shares. Provided Mr. Kelleher remains in the continuous, full-time employ of the Company, the balance of the options will become exercisable in cumulative increments of one-fifth of the underlying shares each January 1 beginning January 1, 1997; provided that in the event of a change of control of the Company all of the options become immediately exercisable. Each of the options will expire ten years after it becomes exercisable. The options are not transferable by Mr. Kelleher other than by will or the laws of descent and distribution, and are exercisable during Mr. Kelleher's lifetime only by him. During the first quarter of 1997, Mr. Kelleher exercised unregistered options to purchase Southwest Common Stock as follows: <TABLE> <CAPTION> Number of Shares Date of Purchased Exercise Price Exercise <C> <C> <C> 123,750 $1.00 1/14/97 33,750 $4.8889 1/14/97 </TABLE> The issuance of the above options and shares to Mr. Kelleher were deemed exempt from the registration provisions of the Securities Act of 1933, as amended (the "Act"), by reason of 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 certificates representing the shares issued to Mr. Kelleher contain a legend to the effect that such shares are not registered under the Act and may not be transferred except pursuant to a registration statement which has become effective under the Act or to an exemption from such registration. 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 and Reports on Form 8-K a) Exhibits (11.1) Computation of Earnings Per Share (27) Financial Data Schedule b) Reports on Form 8-K The Company filed the following Reports on Form 8-K during the quarter: - Form 8-K dated February 24, 1997 for the purpose of filing certain exhibits, including financial statements, in connection with the issuance of $100,000,000 senior unsecured debentures due March 1, 2027. - Form 8-K dated February 27, 1997 for the purpose of filing the Terms Agreement and Form of Global Security as exhibits in connection with the issuance of $100,000,000 senior unsecured debentures due March 1, 2027. 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. <TABLE> <S> <C> May 14, 1997 /s/ Gary C. Kelly Date Gary C. Kelly Vice President - Finance and Chief Financial Officer (Principal Financial and Accounting Officer </TABLE> INDEX TO EXHIBITS Exhibit Number Exhibit (11.1) Computation of Earnings Per Share (27) Financial Data Schedule