pre14a
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No. )
Filed by the Registrant þ
Filed by a Party other than the Registrant o
Check the appropriate box:
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Preliminary Proxy Statement |
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Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2)) |
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Definitive Proxy Statement |
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Soliciting Material Pursuant to §240.14a-12 |
Southwest Airlines Co.
(Name of Registrant as Specified In Its Charter)
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
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SOUTHWEST AIRLINES
CO.
NOTICE OF ANNUAL MEETING OF
SHAREHOLDERS
Wednesday, May 16,
2007
To the Shareholders:
The Annual Meeting of the Shareholders of Southwest Airlines Co.
(the Company or Southwest) will be held
at its corporate headquarters, 2702 Love Field Drive, Dallas,
Texas on Wednesday, May 16, 2007, at 10:00 a.m., local
time, for the following purposes:
(1) to elect ten Directors;
(2) to approve an amendment to the Companys Articles
of Incorporation to eliminate supermajority voting requirements;
(3) to approve the Companys 2007 Equity Incentive
Plan;
(4) to ratify the selection of Ernst & Young LLP
as the Companys independent auditors for the fiscal year
ending December 31, 2007;
(5) to consider and vote on a Shareholder proposal to adopt
a simple majority vote with respect to certain matters, if the
proposal is presented at the meeting; and
(6) to transact such other business as may properly come
before such meeting.
March 21, 2007 is the date of record for determining
Shareholders entitled to receive notice of and to vote at the
Annual Meeting.
Our Annual Meeting will be broadcast live on the Internet. To
listen to the broadcast, log on to www.southwest.com
at 10:00 a.m., CDT, on May 16, 2007.
We have made our 2006 Annual Report to Shareholders available to
you on the Internet at www.southwest.com (click on
About SWA, Investor Relations,
Annual Reports).
If you do not have Internet access and you would like a copy of
our 2006 Annual Report to Shareholders, you may request one from
Investor Relations, Southwest Airlines Co., P.O. Box 36611,
Dallas, Texas 75235. Additionally, the Companys Annual
Report on
Form 10-K
as filed with the Securities and Exchange Commission, but
excluding exhibits, is attached to this Proxy Statement as
Appendix D.
By Order of the Board of Directors,
Colleen C. Barrett
President and Secretary
April , 2007
YOUR VOTE IS IMPORTANT. PLEASE SIGN AND RETURN THE
ENCLOSED PROXY IN THE ENCLOSED ENVELOPE TO ENSURE THAT YOUR
SHARES ARE REPRESENTED AT THE MEETING. YOU MAY ALSO VOTE
VIA TELEPHONE OR INTERNET AS DESCRIBED IN THE ENCLOSED PROXY.
Southwest
Airlines Co.
P.O. Box 36611
Dallas, Texas
75235-1611
(214) 792-4000
PROXY
STATEMENT
SOLICITATION
AND REVOCABILITY OF PROXIES; VOTING
The enclosed proxy is solicited by and on behalf of the Board of
Directors of the Company for use at the Annual Meeting of
Shareholders to be held on May 16, 2007, at
10:00 a.m., local time, at the Companys corporate
headquarters, 2702 Love Field Drive, Dallas, Texas, or any
adjournment thereof. The Company will pay the cost of
solicitation. In addition to solicitation by mail, solicitation
of proxies may be made personally or by telephone by the
Companys regular Employees, and arrangements will be made
with brokerage houses or other custodians nominees and
fiduciaries to send proxies and proxy material to their
principals. In addition, the Company has hired Georgeson Inc. to
distribute and solicit proxies for a fee of $15,000 plus
reasonable expenses. The proxy statement and form of proxy were
first mailed to Shareholders of the Company on or about
April , 2007.
The enclosed proxy, even though executed and returned, may be
revoked at any time prior to the voting of the proxy by the
subsequent execution and submission of a revised proxy, by
written notice to the Secretary of the Company, or by voting in
person at the meeting. All Shareholders of record can vote by
completing and returning the enclosed proxy card. All
Shareholders of record can also vote by touch-tone telephone
from the United States, using the toll-free number on the proxy
card, or by the Internet, using the instructions on the proxy
card. If you have shares held by a broker, bank, or other
nominee as a custodian, you are a street name
holder. In such case, you may instruct your nominee to
vote your shares by following instructions that the nominee
provides for you. You may also vote by telephone or the Internet
if your nominee makes these methods available, in which case the
nominee will enclose the instructions with the proxy statement.
Shares represented by proxy will be voted at the meeting.
An automated system administered by the Companys transfer
agent will tabulate the votes. If your shares are held in street
name, your nominee will ask for instructions on how you want
your shares to be voted. If you provide instructions, your
shares will be voted as you direct. If you do not provide
instructions, your nominee will vote your shares only with
respect to proposals as to which it has discretion to vote. For
all other proposals, the broker cannot vote your shares at all,
which is referred to as a broker non-vote.
Abstentions and broker non-votes are each included in the
determination of the number of shares present and voting for
purposes of determining the presence or absence of a quorum for
the transaction of business. Neither abstentions nor broker
non-votes are counted as voted either for or against a proposal.
Except as otherwise stated herein, provided a quorum is present,
the affirmative vote of the holders of a majority of the shares
entitled to vote on, and voted for or against, a matter is
required to approve the matter.
In some cases, only one proxy statement is being delivered to
multiple Shareholders sharing an address unless the Company has
received contrary instructions from one or more of the
Shareholders. Upon written or oral request, the Company will
deliver a separate copy of the proxy statement to a Shareholder
at a shared address to which a single copy of the proxy
statement was delivered. A Shareholder can notify the Company at
the above address that it wishes to receive a separate copy of
the proxy statement in the future, or, alternatively, that it
wishes to receive a single copy of the materials instead of
multiple copies.
PROPOSAL 1
ELECTION OF DIRECTORS
At the Annual Meeting of Shareholders, ten Directors are to be
elected for one-year terms expiring in 2008. Provided a quorum
is present at the Annual Meeting, a plurality of the votes cast
in person or by proxy by the holders of shares entitled to vote
is required to elect Directors.
The persons named in the enclosed proxy have been selected as a
proxy committee by the Directors of the Company, and it is the
intention of the proxy committee that, unless otherwise directed
therein, proxies will be voted for the election of the nominees
listed below. Although the Directors of the Company do not
contemplate that any of the nominees will be unable to serve, if
such a situation arises prior to the meeting, the proxy
committee will act in accordance with its best judgment.
The following sets forth certain information for each nominee
for Director of the Company, as of January 1, 2007.
Governor William P. Hobby, a director since 1990, will retire at
the Annual Meeting. There are no family relationships between
any of the Directors or between any of the Directors and
executive officers of the Company.
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Name
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Director Since
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Age
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Colleen C. Barrett
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2001
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62
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David W. Biegler
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2006
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60
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Louis E. Caldera
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2003
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50
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C. Webb Crockett
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1994
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72
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William H. Cunningham
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2000
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62
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Travis C. Johnson
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1978
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70
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Herbert D. Kelleher
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1967
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75
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Gary C. Kelly
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2004
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51
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Nancy B. Loeffler
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2003
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60
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John T. Montford
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2002
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63
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Colleen C. Barrett has been President of the Company
since June 19, 2001, at which time she was also named to
the Board of Directors. Prior to that time, Ms. Barrett was
Executive Vice President Customers from 1990 to 2001
and Vice President Administration from 1986 to 1990.
Ms. Barrett has been Secretary of the Company since March
1978. Ms. Barrett is a Director of J.C. Penney Company, Inc.
David W. Biegler has been Chairman of Estrella Energy
L.P., a company engaged in natural gas transportation and
processing, since September 2003. He retired as Vice Chairman of
TXU Corporation at the end of 2001, having served TXU
Corporation as President and Chief Operating Officer from 1997
until 2001. He previously served as Chairman, President, and CEO
of ENSERCH Corporation from 1993 to 1997. Mr. Biegler is
also a director of Dynegy Inc., a company engaged in power
generation, Trinity Industries, Inc., a diversified industrial
company providing products and services for the transportation,
industrial, and construction sectors, and Austin Industries, a
company engaged in construction.
Louis E. Caldera has served as a Professor of Law at The
University of New Mexico since August 2003. He served as
President of the University of New Mexico from August 2003
through February 2006. He was the Vice Chancellor for University
Advancement and President, CSU Foundation, at The California
State University from June 2001 until June 2003. He was the
Secretary of the Army in the Clinton Administration from July
1998 until January 2001. Mr. Caldera previously served as
the Managing Director and Chief Operating Officer for the
Corporation for National and Community Service, a federal
grant-making agency, from September 1997 to June 1998. He served
as a member of the California State Legislature from 1992 to
1997, representing the 46th Assembly District (Los
Angeles). Mr. Caldera is a Director of Belo Corp. and
IndyMac Bancorp, Inc.
C. Webb Crockett has been an attorney in the
Phoenix, Arizona law firm of Fennemore Craig for more than the
past five years and is a non-equity director in such firm.
Fennemore Craig performed services for the Company in 2006 and
will do so in 2007.
2
William H. Cunningham, Ph.D., holds the James L.
Bayless Chair for Free Enterprise at the University of Texas at
Austin Red McCombs School of Business. Dr. Cunningham was
the Chancellor of the University of Texas System from 1992 to
June 2000. He is a Director of the following publicly traded
companies: Lincoln National Corporation, Introgen Therapeutics,
Inc., LIN TV Corp., and Hayes Lemmerz International, Inc.
He is a disinterested Director of John Hancock Mutual Funds and
John Hancock Funds II and III.
Travis C. Johnson was a partner in the law firm of
Johnson & Bowen for more than five years prior to 2001.
Since January 2001, Mr. Johnson has practiced law as Travis
Johnson, Attorney at Law. Mr. Johnson served as a Director
of J.P. Morgan Chase Bank El Paso from
1984 until 2005 and was Founder and Chairman of the Board, Texas
Commerce Bank Border City from 1971 until 1987. He
is a former County Judge and served as a member of the
University of Houston Board of Regents for 12 years.
Mr. Johnson currently serves as Vice Chairman of the Board
of Directors of the El Paso Museum of Art Foundation.
Herbert D. Kelleher has been Chairman of the Board of the
Company since March 29, 1978. Mr. Kelleher became
interim President and Chief Executive Officer of the Company in
September 1981, and assumed those offices on a permanent basis
in February 1982, relinquishing those titles on June 19,
2001. In January 2007, Mr. Kelleher was named to the board
of the Federal Reserve Bank of Dallas for a one-year term.
Gary C. Kelly has been Vice Chairman of the Board of
Directors and Chief Executive Officer of the Company since
July 15, 2004. Prior to that time, Mr. Kelly was
Executive Vice President Chief Financial Officer
from 2001 to 2004, and Vice President Finance and
Chief Financial Officer from 1989 to 2001. Mr. Kelly joined
the Company in 1986 as its Controller.
Nancy B. Loeffler, a long-time advocate of volunteerism,
currently serves as Vice-Chairman of the University of Texas
M.D. Anderson Cancer Center Board of Visitors and on the Board
of Regents at St. Marys University, The South Texas
Community Foundation, the National Cowgirl Museum and Hall of
Fame, the Vice Presidents Residence Foundation in
Washington, D.C., and the Capitol Advisory Committee for
Texas Lutheran University. She also serves as co-chairman of the
Blanton Museum of Art located on the University of Texas campus.
The Loeffler Group LLP and the law firm of Loeffler Tuggey
Pauerstein Rosenthal LLP have performed services for the Company
in the past and will do so in 2007. Nancy Loefflers
husband is a member of the law firm of Loeffler Tuggey
Pauerstein Rosenthal LLP and The Loeffler Group LLP.
John T. Montford has been Senior Vice
President Western Region Legislative and Regulatory
Affairs for AT&T Services, Inc., a global provider of
telecommunications products and services, since November 2005.
Between September 2001 and October 2005, Mr. Montford
served as Senior Vice President of Governmental and External
Affairs for SBC Communications, Inc. Prior to September 2001,
Mr. Montford served as Chancellor of the Texas Tech
University System from 1996 to 2001. Mr. Montford served in
the Texas Senate from 1983 to 1996. He served as both Chairman
of the Senate Finance Committee and Chairman of the Senate State
Affairs Committee. He is a Director of Fleetwood Enterprises,
Inc. In 2002, he was named Chancellor Emeritus of the Texas Tech
University System. He is a former elected District Attorney.
Corporate
Governance
General
The Board of Directors has adopted Corporate Governance
Guidelines to set forth its policies concerning overall
governance practices. The Corporate Governance Guidelines
require that a majority of the members of the Companys
Board of Directors satisfy the independence requirements set
forth in the rules of the New York Stock Exchange. The
Companys Board has determined that each of its current
Directors, other than Messrs. Kelleher and Kelly and
Ms. Barrett and Ms. Loeffler, meets these independence
requirements. In addition, the Board determined that the two
members of the Board who retired in May 2006, Rollin W. King and
June M. Morris, met these independence requirements.
The Board of Directors held six meetings during 2006, and
otherwise acted by unanimous consent. Each Director attended at
least 75 percent of the total of the Board and Committee
meetings that he or she was obligated to attend. Additionally,
it is the Boards policy that every Director and nominee
for Director should make every
3
effort to attend the Companys annual meeting of
Shareholders. All but one of the Companys Directors
attended the 2006 annual meeting.
The Corporate Governance Guidelines also require the
Boards non-management Directors to meet at regularly
scheduled executive sessions without management Directors.
During 2006, they had five such meetings. Currently,
Dr. Cunningham, Chairman of the Audit Committee, serves as
the presiding Director for executive sessions of non-management
Directors. Shareholders of the Company may contact the Board of
Directors by mail addressed as follows: Board of Directors,
c/o Southwest Airlines Co., Attn. William H. Cunningham, P.
O. Box 36611, Dallas, Texas 75235.
The Board of Directors has appointed Audit, Compensation,
Executive, and Nominating and Corporate Governance Committees
and has adopted charters for the Audit, Compensation, and
Nominating and Corporate Governance Committees. Copies of the
Corporate Governance Guidelines and each of these committee
charters, as well as the Companys Code of Ethics, are
available on the Companys website,
www.southwest.com. Shareholders can obtain
copies of these documents upon written request to Investor
Relations, P.O. Box 36611, Dallas, Texas 75235.
Committees
of the Board
Audit Committee. The Audit Committee
consists of Messrs. Cunningham (Chairman), Biegler,
Caldera, Hobby (retiring), Johnson, and Montford. The Board of
Directors of the Company has determined that all of the members
of the Audit Committee are independent, as that term
is used under applicable rules of the New York Stock Exchange.
The Board has also determined that at least one of the members
of the Audit Committee, Dr. Cunningham, satisfies the
criteria adopted by the Securities and Exchange Commission to
serve as the audit committee financial expert on the
Committee. The Audit Committee held five meetings during 2006.
Pursuant to the Audit Committee Charter, the Audit Committee is
responsible for the appointment, compensation, retention, and
oversight of the work of Southwests independent auditors.
Its principal functions are to give additional assurance that
financial information is accurate and timely and that it
includes all appropriate disclosures; to ascertain the existence
of an effective accounting and internal control system; to
pre-approve all services provided by the independent auditors;
to review and discuss related party transactions with management
and the independent auditors; and to oversee the entire audit
function, both independent and internal.
Compensation Committee. The Compensation
Committee consists of Messrs. Hobby (Chairman,
retiring), Biegler, and Crockett. The Board of Directors of the
Company has determined that all of the members of the
Compensation Committee are independent, as that term
is used under applicable rules of the New York Stock Exchange.
The Compensation Committee held three meetings during 2006, and
otherwise acted by unanimous consent.
Pursuant to the Compensation Committee Charter, the Compensation
Committee (i) reviews and approves corporate goals and
objectives relevant to the compensation of the Chief Executive
Officer, (ii) evaluates the Chief Executive Officers
performance in light of those goals and objectives, and
(iii) determines and approves the Chief Executive
Officers compensation level based on this evaluation. With
the advice of the Chairman of the Board and the Chief Executive
Officer, the Compensation Committee also conducts an annual
review of the compensation of other senior executives and makes
recommendations to the Board with respect to non-CEO
compensation and incentive compensation plans that are subject
to Board approval. The Compensation Committee also reviews and
approves all stock-based compensation arrangements for Employees
of the Company (including executive officers) and makes
recommendations to the Board with respect to equity-based plans
that are subject to Board approval. The Companys processes
and procedures for the consideration and determination of
executive officer compensation (as well as the Chief Executive
Officers role in such determinations) are discussed
further below under Compensation Discussion and
Analysis. To the extent permitted by applicable law and
regulations, the Compensation Committee has the power to
delegate its authority and duties to subcommittees or individual
members of the Committee, as it deems appropriate.
With the approval of the Chairman of the Compensation Committee,
the Company retained Longnecker and Associates in 2004 to
provide guidance to the Compensation Committee in connection
with the Companys employment contracts with the Chief
Executive Officer, Chairman of the Board, and President of the
Company.
4
Longnecker and Associates was retained due to its longstanding
history with the Company and its resulting understanding of the
Companys compensation practices and philosophies, in
particular with respect to the Companys employment
contracts. From time to time, the Company, through its human
resources department, also retains other consultants in
connection with the design of compensation plans and programs
that may impact executive officer compensation. As part of the
review of the Companys compensation practices discussed
below under Compensation Discussion and Analysis,
the Company requested input from Mercer Human Resource
Consulting, ISS Corporate Services, Inc., and Georgeson Inc.
As discussed further below, the Nominating and Corporate
Governance Committee is responsible for reviewing the
compensation and benefits for non-Employee Directors.
Executive Committee. The Executive
Committee consists of Messrs. Kelleher (Chairman),
Cunningham, and Johnson, and was appointed to assist the Board
in carrying out its duties. The Executive Committee has
authority to act for the Board on most matters during the
intervals between Board meetings. The Executive Committee held
one meeting during 2006.
Nominating and Corporate Governance
Committee. The Nominating and Corporate
Governance Committee consists of Messrs. Montford
(Chairman), Caldera, Crockett, Hobby (retiring), and Johnson.
The Board of Directors of the Company has determined that all of
the members of the Nominating and Corporate Governance Committee
are independent, as that term is used under
applicable rules of the New York Stock Exchange. The Nominating
and Corporate Governance Committee held two meetings during
2006. Pursuant to its charter, the Nominating and Corporate
Governance Committee reviews possible candidates for Board
membership and recommends a slate of nominees, and develops and
recommends to the Board corporate governance principles
applicable to the Company. In addition, pursuant to its charter,
as well as the Corporate Governance Guidelines, the Nominating
and Corporate Governance Committee, with the advice of the
Chairman of the Board and the Chief Executive Officer, is
required to conduct an annual review of compensation for the
non-management members of the Board and for recommending to the
Board any appropriate changes thereto. The compensation should
be an appropriate mix of cash and Company equity-related
compensation considering the Companys unique culture. The
Committee will consider nominees submitted by Shareholders,
provided nominations are submitted in accordance with the
Companys Bylaws. Director nominations are discussed
further below under Other Matters Notice
Requirements.
Board
Qualifications
The qualifications to be considered by the Nominating and
Corporate Governance Committee in nominating Board members are
set forth in the Corporate Governance Guidelines. Members of the
Board of Directors of Southwest Airlines Co. should possess the
highest personal and professional ethics, integrity, and values.
They must possess practical wisdom, mature judgment, and be
committed to the best longterm interests of the Companys
Employees, Customers, and Shareholders. Directors must be
willing to devote sufficient time to fulfill their
responsibilities and be willing to serve on the Board for an
extended period of time. While there is no specific limitation
on service on other Boards, the Committee will take into
consideration the nature and time involved in a Directors
service on other boards in evaluating the suitability of that
Director. In addition, the Board will consider a number of
factors in the nomination or appointment of new Board members,
including finance, marketing, government, education, and other
professional experience or knowledge relevant to the success of
the Company in todays business environment. The Board will
also take into consideration factors such as diversity and
independence (for non-management Directors) in the appointment
of future Board members. The Board evaluates each Director in
the context of the Board as a whole, with the objective of
recommending a group that can best serve the longterm interests
of the Companys Employees, Customers, and Shareholders. In
the case of current Directors being considered for renomination,
the Board considers the Directors past attendance at Board
and Committee meetings and participation in and contributions to
such meetings and Board activities. The Companys Bylaws
provide for a mandatory retirement age of 75 for members of the
Board of Directors. The Chairman of the Board is exempted from
the mandatory retirement provisions of the Bylaws.
5
Certain
Relationships and Related Transactions, and Director
Independence
Pursuant to its charter, the Audit Committee of the Board is
required to review and discuss related person transactions with
management and the independent auditors. In addition, the
Company distributes Director and Officer Questionnaires at least
annually, pursuant to which all Directors and executive officers
of the Company are requested to disclose any direct or indirect
interest that they may have in transactions with the Company.
The Questionnaire further requires that these responses be
updated to the extent circumstances change. The Board has taken
these responses into account in making its independence
determinations. In particular, in 2007, the Board evaluated the
following relationships: (i) Mr. Crocketts
status as an attorney and non-equity director in a law firm that
performs services for the Company and
(ii) Mr. Montfords status as an officer of
AT&T Services, Inc., which does business with the Company.
The Board determined that neither of such indirect relationships
was material either to the Company or to the executive officer.
6
VOTING
SECURITIES AND PRINCIPAL SHAREHOLDERS
At the close of business on March 21, 2007, the record date
of those entitled to notice of and to vote at the meeting, there
were
outstanding shares
of Common Stock, $1.00 par value, each share of which is
entitled to one vote.
Certain
Beneficial Owners
The following table sets forth information with respect to
persons who, to the Companys knowledge, beneficially own
more than 5 percent of the Common Stock of the Company.
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Amount and Nature
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of Beneficial
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Percent of
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Name and Address of Beneficial Owner
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Ownership(1)
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Class(1)
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Capital Research and Management
Company
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87,298,480
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(2)
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11.0
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%
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333 South Hope Street
Los Angeles, CA 90071
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T. Rowe Price Associates,
Inc.
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61,582,772
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(3)
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7.7
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%
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100 E. Pratt Street
Baltimore, MD 21202
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PRIMECAP Management Company
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47,699,925
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(4)
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6.0
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%
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225 South Lake
Avenue, #400
Pasadena, CA 91101
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The Growth Fund of America,
Inc.
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44,962,877
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(5)
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5.7
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%
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333 South Hope Street
Los Angeles, CA 90071
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Shares, percentages, and other information are based on
information contained in Schedules 13G filed with the Securities
and Exchange Commission with respect to beneficial ownership at
December 31, 2006. |
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(2) |
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As of December 31, 2006, Capital Research and Management
Company reported sole voting power with respect to
18,005,300 shares and sole dispositive power with respect
to 87,298,480 shares, but disclaimed beneficial ownership
of any shares of Common Stock. |
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(3) |
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As of December 31, 2006, T. Rowe Price Associates, Inc.
reported sole voting power with respect to
16,253,757 shares and sole dispositive power with respect
to 61,280,172 shares. These securities are owned by various
individual and institutional investors which T. Rowe Price
Associates, Inc. serves as investment adviser with power to
direct investments
and/or sole
power to vote the securities. For purposes of the reporting
requirements of the Securities Exchange Act of 1934, T. Rowe
Price Associates is deemed to be a beneficial owner of such
securities; however, T. Rowe Price Associates expressly
disclaims that it is, in fact, the beneficial owner of such
securities. |
|
(4) |
|
As of December 31, 2006, PRIMECAP Management Company
reported sole voting power with respect to
12,648,650 shares and sole dispositive power with respect
to 47,699,925 shares. |
|
(5) |
|
As of December 31, 2006, The Growth Fund of America, Inc.
reported sole voting power with respect to all
44,962,877 shares. The Growth Fund of America, Inc. is an
investment company registered under the Investment Company Act
of 1940, which is advised by Capital Research and Management
Company. |
7
Management
The following table sets forth as of December 31, 2006,
certain information regarding the beneficial ownership of Common
Stock by the Directors, each of the executive officers of the
Company named in the Summary Compensation Table, and by all
executive officers and Directors, as a group.
|
|
|
|
|
|
|
|
|
|
|
Amount and Nature
|
|
|
|
|
|
|
of Beneficial
|
|
|
Percent of
|
|
Name of Beneficial Owner
|
|
Ownership(1)(2)
|
|
|
Class(2)
|
|
|
Colleen C. Barrett(3)
|
|
|
583,328
|
|
|
|
*
|
|
David W. Biegler(4)
|
|
|
9,707
|
|
|
|
*
|
|
Louis E. Caldera(5)
|
|
|
4,500
|
|
|
|
*
|
|
C. Webb Crockett(6)
|
|
|
25,975
|
|
|
|
*
|
|
William H. Cunningham(7)
|
|
|
23,000
|
|
|
|
*
|
|
William P. Hobby(8)
|
|
|
6,681
|
|
|
|
*
|
|
Travis C. Johnson
|
|
|
207,413
|
|
|
|
*
|
|
Herbert D. Kelleher(9)
|
|
|
4,984,237
|
|
|
|
*
|
|
Gary C. Kelly(10)
|
|
|
528,077
|
|
|
|
*
|
|
Nancy B. Loeffler(11)
|
|
|
5,550
|
|
|
|
*
|
|
John T. Montford(12)
|
|
|
9,700
|
|
|
|
*
|
|
Laura Wright(13)
|
|
|
183,505
|
|
|
|
*
|
|
Ron Ricks(14)
|
|
|
230,575
|
|
|
|
*
|
|
Executive Officers and Directors
as a Group (17 persons)(15)
|
|
|
7,060,793
|
|
|
|
*
|
|
|
|
|
* |
|
Less than 1% |
|
(1) |
|
Unless otherwise indicated, beneficial owners have sole rather
than shared voting and investment power respecting their shares,
other than shared rights created under joint tenancy or marital
property laws as between the Companys Directors and
executive officers and their respective spouses, if any. |
|
(2) |
|
The number of shares beneficially owned includes shares that
each beneficial owner and the group had the right to acquire
within 60 days pursuant to stock options, whether or not
such options were
in-the-money.
Because data is as of December 31, 2006, it does not
reflect any transactions, including any option exercises, that
may have occurred subsequent to such date. |
|
(3) |
|
Includes 1,474 shares held for Ms. Barretts
account under the Companys profit sharing plan, with
respect to which she has the right to direct the voting, and
539,489 shares that Ms. Barrett had the right to
acquire within 60 days pursuant to stock options. |
|
(4) |
|
Held by spouse. |
|
(5) |
|
Includes 4,500 shares that Mr. Caldera had the right
to acquire within 60 days pursuant to stock options. |
|
(6) |
|
Includes 7,500 shares held in a family trust. |
|
(7) |
|
Includes 15,000 shares that Dr. Cunningham had the
right to acquire within 60 days pursuant to stock options. |
|
(8) |
|
Held by testamentary trusts of which Governor Hobby is a
co-trustee. |
|
(9) |
|
Includes 838,039 shares that Mr. Kelleher had the
right to acquire within 60 days pursuant to stock options
and 304,380 shares held by a family limited liability
company in which Mr. Kellehers wife has a beneficial
interest. Mr. Kelleher disclaims any beneficial interest in
the limited liability company shares. |
|
(10) |
|
Includes 391,576 shares that Mr. Kelly had the right
to acquire within 60 days pursuant to stock options.
Mr. Kellys shares of Common Stock are pledged in
connection with a margin account. |
|
(11) |
|
Includes 4,500 shares that Ms. Loeffler had the right
to acquire within 60 days pursuant to stock options. |
|
(12) |
|
Includes 7,000 shares that Mr. Montford had the right
to acquire within 60 days pursuant to stock options. |
(footnotes continue on next
page)
8
|
|
|
(13) |
|
Includes 9,380 shares held for Ms. Wrights
account under the Companys profit sharing plan, with
respect to which she has the right to direct the voting, and
146,120 shares that Ms. Wright had the right to
acquire within 60 days pursuant to stock options. |
|
(14) |
|
Includes 180,575 shares that Mr. Ricks had the right
to acquire within 60 days pursuant to stock options. |
|
(15) |
|
In addition to amounts disclosed in footnotes (3) through (14),
includes 4,346 shares held for the accounts of executive
officers under the Companys profit sharing plan with
respect to which such persons have the right to direct voting,
and 239,191 shares that such executives had the right to
acquire within 60 days pursuant to stock options. All
information with respect to the profit sharing plan is based on
a statement dated December 31, 2006. |
9
COMPENSATION
OF EXECUTIVE OFFICERS
The following table discloses compensation earned for services
performed by the Companys Chief Executive Officer and
Chief Financial Officer and the three remaining most highly paid
executive officers during the year ended December 31, 2006.
These executives will be referred to as the named
executive officers.
Summary
Compensation Table
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Qualified
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option
|
|
|
Compensation
|
|
|
All Other
|
|
|
|
|
|
|
|
|
|
Salary
|
|
|
Bonus
|
|
|
Awards
|
|
|
Earnings
|
|
|
Compensation
|
|
|
Total
|
|
Name and Principal Position
|
|
Year
|
|
|
($)
|
|
|
($)(1)
|
|
|
($)(2)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
Herbert D. Kelleher
|
|
|
2006
|
|
|
$
|
450,000
|
|
|
$
|
332,000
|
|
|
$
|
428,740
|
|
|
$
|
36,905
|
(3)
|
|
$
|
117,355
|
(4)
|
|
$
|
1,365,000
|
|
Chairman of the Board
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Colleen C. Barrett
|
|
|
2006
|
|
|
$
|
362,487
|
|
|
$
|
483,000
|
|
|
$
|
321,555
|
|
|
$
|
5,565
|
(3)
|
|
$
|
84,328
|
(5)
|
|
$
|
1,256,935
|
|
President and Secretary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gary C. Kelly
|
|
|
2006
|
|
|
$
|
416,860
|
|
|
$
|
462,000
|
|
|
$
|
429,862
|
|
|
$
|
620
|
(3)
|
|
$
|
96,541
|
(6)
|
|
$
|
1,405,883
|
|
Chief Executive Officer and Vice
Chairman of the Board
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Laura Wright
|
|
|
2006
|
|
|
$
|
271,413
|
|
|
$
|
200,000
|
|
|
$
|
160,082
|
|
|
|
|
|
|
$
|
32,490
|
(7)
|
|
$
|
663,985
|
|
Sr. Vice President
Chief Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ron Ricks
|
|
|
2006
|
|
|
$
|
286,986
|
|
|
$
|
340,000
|
|
|
$
|
158,581
|
|
|
|
|
|
|
$
|
36,937
|
(8)
|
|
$
|
822,505
|
|
Executive Vice
President Law, Airports, and Public Affairs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Reflects bonuses paid in January 2007 in respect of performance
for 2006. Bonuses paid in January 2006 to the named executive
officers in respect of service for 2005 were as follows:
Mr. Kelleher $277,000;
Ms. Barrett $439,000;
Mr. Kelly $385,000; Ms. Wright
$165,000; and Mr. Ricks $283,200. |
|
(2) |
|
Reflects the dollar amount recognized for financial statement
reporting purposes for the fiscal year ended December 31,
2006, in accordance with Statement of Financial Accounting
Standards No. 123R, Share-Based Payments
(SFAS 123R), with respect to stock options.
Amounts therefore include expense related to stock options
granted in and prior to fiscal 2006, as applicable. Assumptions
used in calculating these amounts are included in Note 13
to the Companys financial statements included in its
Annual Report on
Form 10-K
for the fiscal year ended December 31, 2006. |
|
(3) |
|
Consists of above-market earnings on deferred compensation
provided pursuant to the executives employment contract,
which is discussed below under Employment and Other
Contracts; Potential Payments Upon Termination or
Change-In-Control. |
|
(4) |
|
Consists of (i) Company contributions to the Companys
profit sharing plan of $17,490; (ii) Company matching
contributions to the Southwest Airlines Co. 401(k) Plan of
$16,060; (iii) Company contributions in the amount of
$44,857 to Mr. Kellehers deferred compensation
arrangement in accordance with the terms of his employment
contract; (iv) positive space travel for Mr. Kelleher
on Southwest Airlines; (v) life, accidental death, and
long-term disability insurance premiums; (vi) medical and
dental reimbursements for Mr. Kelleher and his spouse; and
(vii) a business expense reimbursements allowance.
Perquisites are valued based on the
out-of-pocket
cost to the Company, except that the value attributed to travel
on Southwest Airlines is based on the average passenger fare for
all Southwest flights during 2006 and assumes the executive took
the place of a paying passenger who otherwise would have used
the seat. |
|
(5) |
|
Consists of (i) Company contributions to the Companys
profit sharing plan of $17,490; (ii) Company matching
contributions to the Southwest Airlines Co. 401(k) Plan of
$16,060; and (iii) Company contributions in the amount of
$50,778 to Ms. Barretts deferred compensation
arrangement in accordance with the terms of her employment
contract. |
10
|
|
|
(6) |
|
Consists of (i) Company contributions to the Companys
profit sharing plan of $17,490; (ii) Company matching
contributions to the Southwest Airlines Co. 401(k) Plan of
$16,060; (iii) Company contributions in the amount of
$50,808 to Mr. Kellys deferred compensation
arrangement in accordance with the terms of his employment
contract; (iv) positive space travel for Mr. Kelly and
his family on Southwest Airlines; (v) life, accidental
death, and long-term disability insurance premiums; and
(vi) medical and dental reimbursements for Mr. Kelly
and his family. Perquisites are valued based on the
out-of-pocket
cost to the Company, except that the value attributed to travel
on Southwest Airlines is based on the average passenger fare for
all Southwest flights during 2006 and assumes the executive took
the place of a paying passenger who otherwise would have used
the seat. |
|
(7) |
|
Consists of (i) Company contributions to the Companys
profit sharing plan of $17,490; and (ii) Company matching
contributions to the Southwest Airlines Co. 401(k) Plan of
$15,000. |
|
(8) |
|
Consists of (i) Company contributions to the Companys
profit sharing plan of $17,490; (ii) Company contributions
to the Southwest Airlines Excess Benefit Plan of $3,387; and
(iii) Company matching contributions to the Southwest
Airlines Co. 401(k) Plan of $16,060. |
Mr. Kelleher, Ms. Barrett, and Mr. Kelly receive
their compensation in large part pursuant to the terms of their
employment contracts, which are discussed in detail below under
Employment and Other Contracts; Potential Payments Upon
Termination or
Change-in-Control.
In addition, the amount of executive salary and bonus in
proportion to total compensation is discussed in detail below
under Compensation Discussion and Analysis.
Amounts included in All Other Compensation for the
individuals named above in respect of the Companys profit
sharing plan and Southwest Airlines Co. 401(k) Plan are
determined on the same basis as the calculation used for all
Southwest Airlines Co. Employees.
11
Grants of
Plan-Based Awards in Last Fiscal Year
The following table provides information on grants of plan-based
awards in 2006 to the named individuals.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option Awards:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
Exercise Price of
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
|
|
|
Option Awards
|
|
|
Closing Price on
|
|
|
Grant Date Fair
|
|
|
|
|
|
|
Underlying Options
|
|
|
($/Sh)
|
|
|
Grant Date ($/Sh)
|
|
|
Value of
|
|
Name
|
|
Grant Date
|
|
|
(#)
|
|
|
(1)
|
|
|
(1)
|
|
|
Option Awards($)
|
|
|
Herbert D. Kelleher
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Colleen C. Barrett
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gary C. Kelly
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Laura Wright
|
|
|
03/17/06
|
|
|
|
4,583
|
(2)
|
|
$
|
17.53
|
|
|
$
|
17.60
|
|
|
$
|
25,719
|
|
|
|
|
03/17/06
|
|
|
|
35,417
|
(3)
|
|
$
|
17.53
|
|
|
$
|
17.60
|
|
|
$
|
200,616
|
|
Ron Ricks
|
|
|
03/17/06
|
|
|
|
5,471
|
(2)
|
|
$
|
17.53
|
|
|
$
|
17.60
|
|
|
$
|
30,702
|
|
|
|
|
03/17/06
|
|
|
|
34,529
|
(4)
|
|
$
|
17.53
|
|
|
$
|
17.60
|
|
|
$
|
195,586
|
|
|
|
|
(1) |
|
Reflects awards of stock options. In accordance with the terms
of the stock option plan under which all stock options were
granted, fair market value was determined based on the mean
between the highest and lowest quoted selling prices of the
Companys Common Stock on the date of grant of an option,
as reported by the New York Stock Exchange. |
|
(2) |
|
These options were granted to the named executive officers at
the fair market value of the Companys Common Stock on the
date of grant and are exercisable on December 31, 2008 with
respect to all of the shares covered thereby. |
|
(3) |
|
These options were granted to Ms. Wright at the fair market
value of the Companys Common Stock on the date of grant
and are exercisable as follows: 13,334 on December 31,
2006, 13,333 on December 31, 2007, and 8,750 on
December 31, 2008. |
|
(4) |
|
These options were granted to Mr. Ricks at the fair market
value of the Companys Common Stock on the date of grant
and are exercisable as follows: 13,334 on December 31,
2006, 13,333 on December 31, 2007, and 7,862 on
December 31, 2008. |
The factors supporting the Compensation Committees
determinations with respect to the plan-based awards are
discussed below under Compensation Discussion and
Analysis.
12
Outstanding
Equity Awards at Fiscal Year-end
The following table provides information regarding stock options
held by the named executive officers as of December 31,
2006. Stock options are the only type of equity award that has
been granted to the named executive officers.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option Awards
|
|
|
|
Number of Securities
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Underlying
|
|
|
Underlying
|
|
|
|
|
|
|
|
|
|
Unexercised
|
|
|
Unexercised
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
Options
|
|
|
Option Exercise
|
|
|
|
|
|
|
(#)
|
|
|
(#)
|
|
|
Price
|
|
|
Option Expiration
|
|
Name
|
|
Exercisable
|
|
|
Unexercisable
|
|
|
($)
|
|
|
Date
|
|
|
Herbert D. Kelleher
|
|
|
7,597
|
|
|
|
|
|
|
$
|
7.27
|
|
|
|
01/01/2008
|
|
|
|
|
10,465
|
|
|
|
|
|
|
$
|
10.11
|
|
|
|
01/01/2009
|
|
|
|
|
12,713
|
|
|
|
|
|
|
$
|
10.88
|
|
|
|
01/01/2010
|
|
|
|
|
8,570
|
|
|
|
|
|
|
$
|
22.80
|
|
|
|
12/31/2010
|
|
|
|
|
35,282
|
|
|
|
|
|
|
$
|
1.00
|
|
|
|
01/01/2011
|
|
|
|
|
35,281
|
|
|
|
|
|
|
$
|
1.00
|
|
|
|
01/01/2012
|
|
|
|
|
35,281
|
|
|
|
|
|
|
$
|
1.00
|
|
|
|
01/01/2013
|
|
|
|
|
150,000
|
|
|
|
|
|
|
$
|
22.35
|
|
|
|
01/01/2011
|
|
|
|
|
150,000
|
|
|
|
|
|
|
$
|
22.35
|
|
|
|
01/01/2012
|
|
|
|
|
150,000
|
|
|
|
|
|
|
$
|
22.35
|
|
|
|
01/01/2013
|
|
|
|
|
8,570
|
|
|
|
|
|
|
$
|
18.73
|
|
|
|
01/01/2012
|
|
|
|
|
8,570
|
|
|
|
|
|
|
$
|
14.03
|
|
|
|
01/02/2013
|
|
|
|
|
8,570
|
|
|
|
|
|
|
$
|
15.91
|
|
|
|
01/05/2014
|
|
|
|
|
200,000
|
|
|
|
|
|
|
$
|
14.95
|
|
|
|
07/15/2014
|
|
|
|
|
8,570
|
|
|
|
|
|
|
$
|
14.25
|
|
|
|
01/20/2015
|
|
|
|
|
8,570
|
|
|
|
|
|
|
$
|
16.43
|
|
|
|
12/31/2015
|
|
Colleen C. Barrett
|
|
|
56,829
|
|
|
|
|
|
|
$
|
4.30
|
|
|
|
01/24/2007
|
|
|
|
|
3,798
|
|
|
|
|
|
|
$
|
7.27
|
|
|
|
01/01/2008
|
|
|
|
|
48,020
|
|
|
|
|
|
|
$
|
7.87
|
|
|
|
01/23/2008
|
|
|
|
|
5,484
|
|
|
|
|
|
|
$
|
10.11
|
|
|
|
01/01/2009
|
|
|
|
|
36,471
|
|
|
|
|
|
|
$
|
11.72
|
|
|
|
01/22/2009
|
|
|
|
|
4,977
|
|
|
|
|
|
|
$
|
10.88
|
|
|
|
01/01/2010
|
|
|
|
|
21,843
|
|
|
|
|
|
|
$
|
10.35
|
|
|
|
01/19/2010
|
|
|
|
|
5,790
|
|
|
|
|
|
|
$
|
22.80
|
|
|
|
12/31/2010
|
|
|
|
|
22,050
|
|
|
|
|
|
|
$
|
21.30
|
|
|
|
02/15/2011
|
|
|
|
|
150,000
|
|
|
|
|
|
|
$
|
17.11
|
|
|
|
06/19/2011
|
|
|
|
|
7,663
|
|
|
|
|
|
|
$
|
18.73
|
|
|
|
01/01/2012
|
|
|
|
|
8,336
|
|
|
|
|
|
|
$
|
14.03
|
|
|
|
01/02/2013
|
|
|
|
|
7,262
|
|
|
|
|
|
|
$
|
15.91
|
|
|
|
01/05/2014
|
|
|
|
|
150,000
|
|
|
|
|
|
|
$
|
14.95
|
|
|
|
07/15/2014
|
|
|
|
|
6,309
|
|
|
|
|
|
|
$
|
14.25
|
|
|
|
01/20/2015
|
|
|
|
|
4,657
|
|
|
|
|
|
|
$
|
16.43
|
|
|
|
12/31/2015
|
|
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option Awards
|
|
|
|
Number of Securities
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Underlying
|
|
|
Underlying
|
|
|
|
|
|
|
|
|
|
Unexercised
|
|
|
Unexercised
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
Options
|
|
|
Option Exercise
|
|
|
|
|
|
|
(#)
|
|
|
(#)
|
|
|
Price
|
|
|
Option Expiration
|
|
Name
|
|
Exercisable
|
|
|
Unexercisable
|
|
|
($)
|
|
|
Date
|
|
|
Gary C. Kelly
|
|
|
905
|
|
|
|
|
|
|
$
|
7.27
|
|
|
|
01/01/2008
|
|
|
|
|
33,739
|
|
|
|
|
|
|
$
|
7.87
|
|
|
|
01/23/2008
|
|
|
|
|
5,261
|
|
|
|
|
|
|
$
|
10.11
|
|
|
|
01/01/2009
|
|
|
|
|
29,252
|
|
|
|
|
|
|
$
|
11.72
|
|
|
|
01/22/2009
|
|
|
|
|
6,687
|
|
|
|
|
|
|
$
|
10.88
|
|
|
|
01/01/2010
|
|
|
|
|
21,001
|
|
|
|
|
|
|
$
|
10.35
|
|
|
|
01/19/2010
|
|
|
|
|
5,313
|
|
|
|
|
|
|
$
|
22.80
|
|
|
|
12/31/2010
|
|
|
|
|
15,000
|
|
|
|
|
|
|
$
|
21.30
|
|
|
|
02/15/2011
|
|
|
|
|
2,700
|
|
|
|
3,800
|
(1)
|
|
$
|
17.11
|
|
|
|
06/19/2011
|
|
|
|
|
4,348
|
|
|
|
|
|
|
$
|
18.73
|
|
|
|
01/01/2012
|
|
|
|
|
17,250
|
|
|
|
|
|
|
$
|
17.78
|
|
|
|
01/18/2012
|
|
|
|
|
4,151
|
|
|
|
|
|
|
$
|
14.03
|
|
|
|
01/02/2013
|
|
|
|
|
21,000
|
|
|
|
|
|
|
$
|
13.19
|
|
|
|
01/23/2013
|
|
|
|
|
4,352
|
|
|
|
|
|
|
$
|
15.91
|
|
|
|
01/05/2014
|
|
|
|
|
30,000
|
|
|
|
|
|
|
$
|
15.51
|
|
|
|
01/23/2014
|
|
|
|
|
180,000
|
|
|
|
|
|
|
$
|
14.95
|
|
|
|
07/15/2014
|
|
|
|
|
4,322
|
|
|
|
|
|
|
$
|
14.25
|
|
|
|
01/20/2015
|
|
|
|
|
6,295
|
|
|
|
|
|
|
$
|
16.43
|
|
|
|
12/31/2015
|
|
Laura Wright
|
|
|
473
|
|
|
|
|
|
|
$
|
7.27
|
|
|
|
01/01/2008
|
|
|
|
|
6,458
|
|
|
|
|
|
|
$
|
7.87
|
|
|
|
01/23/2008
|
|
|
|
|
36,225
|
|
|
|
7,380
|
(2)
|
|
$
|
8.20
|
|
|
|
09/01/2008
|
|
|
|
|
170
|
|
|
|
|
|
|
$
|
10.11
|
|
|
|
01/01/2009
|
|
|
|
|
4,500
|
|
|
|
|
|
|
$
|
11.72
|
|
|
|
01/22/2009
|
|
|
|
|
650
|
|
|
|
|
|
|
$
|
10.88
|
|
|
|
01/01/2010
|
|
|
|
|
6,000
|
|
|
|
|
|
|
$
|
10.35
|
|
|
|
01/19/2010
|
|
|
|
|
969
|
|
|
|
|
|
|
$
|
22.80
|
|
|
|
12/31/2010
|
|
|
|
|
4,400
|
|
|
|
|
|
|
$
|
21.30
|
|
|
|
02/15/2011
|
|
|
|
|
2,700
|
|
|
|
3,800
|
(1)
|
|
$
|
17.11
|
|
|
|
06/19/2011
|
|
|
|
|
719
|
|
|
|
|
|
|
$
|
18.73
|
|
|
|
01/01/2012
|
|
|
|
|
5,060
|
|
|
|
|
|
|
$
|
17.78
|
|
|
|
01/18/2012
|
|
|
|
|
553
|
|
|
|
|
|
|
$
|
14.03
|
|
|
|
01/02/2013
|
|
|
|
|
7,500
|
|
|
|
|
|
|
$
|
13.19
|
|
|
|
01/23/2013
|
|
|
|
|
1,114
|
|
|
|
|
|
|
$
|
15.91
|
|
|
|
01/05/2014
|
|
|
|
|
12,000
|
|
|
|
|
|
|
$
|
15.51
|
|
|
|
01/23/2014
|
|
|
|
|
432
|
|
|
|
2,688
|
(3)
|
|
$
|
14.75
|
|
|
|
09/01/2014
|
|
|
|
|
10,180
|
|
|
|
4,600
|
(4)
|
|
$
|
14.25
|
|
|
|
01/20/2015
|
|
|
|
|
28,083
|
|
|
|
13,333
|
(5)
|
|
$
|
16.43
|
|
|
|
12/31/2015
|
|
|
|
|
13,334
|
|
|
|
26,666
|
(6)
|
|
$
|
17.53
|
|
|
|
03/17/2016
|
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option Awards
|
|
|
|
Number of Securities
|
|
|
Number of Securities
|
|
|
|
|
|
|
|
|
|
Underlying
|
|
|
Underlying
|
|
|
|
|
|
|
|
|
|
Unexercised
|
|
|
Unexercised
|
|
|
|
|
|
|
|
|
|
Options
|
|
|
Options
|
|
|
Option Exercise
|
|
|
|
|
|
|
(#)
|
|
|
(#)
|
|
|
Price
|
|
|
Option Expiration
|
|
Name
|
|
Exercisable
|
|
|
Unexercisable
|
|
|
($)
|
|
|
Date
|
|
|
Ron Ricks
|
|
|
3,869
|
|
|
|
|
|
|
$
|
7.87
|
|
|
|
01/23/2008
|
|
|
|
|
9,754
|
|
|
|
|
|
|
$
|
11.72
|
|
|
|
01/22/2009
|
|
|
|
|
15,926
|
|
|
|
|
|
|
$
|
10.35
|
|
|
|
01/19/2010
|
|
|
|
|
3,915
|
|
|
|
|
|
|
$
|
22.80
|
|
|
|
12/31/2010
|
|
|
|
|
14,500
|
|
|
|
|
|
|
$
|
21.30
|
|
|
|
02/15/2011
|
|
|
|
|
3,916
|
|
|
|
|
|
|
$
|
18.73
|
|
|
|
01/01/2012
|
|
|
|
|
15,950
|
|
|
|
|
|
|
$
|
17.78
|
|
|
|
01/18/2012
|
|
|
|
|
3,916
|
|
|
|
|
|
|
$
|
14.33
|
|
|
|
01/07/2013
|
|
|
|
|
17,545
|
|
|
|
|
|
|
$
|
13.19
|
|
|
|
01/23/2013
|
|
|
|
|
3,084
|
|
|
|
|
|
|
$
|
15.91
|
|
|
|
01/05/2014
|
|
|
|
|
20,000
|
|
|
|
|
|
|
$
|
15.51
|
|
|
|
01/23/2014
|
|
|
|
|
415
|
|
|
|
2,585
|
(7)
|
|
$
|
14.75
|
|
|
|
09/01/2014
|
|
|
|
|
17,732
|
|
|
|
7,333
|
(8)
|
|
$
|
14.25
|
|
|
|
01/20/2015
|
|
|
|
|
29,386
|
|
|
|
13,333
|
(5)
|
|
$
|
16.43
|
|
|
|
12/31/2015
|
|
|
|
|
13,334
|
|
|
|
26,666
|
(6)
|
|
$
|
17.53
|
|
|
|
03/17/2016
|
|
|
|
|
(1) |
|
The remaining options are exercisable as follows: 800 on
June 19, 2007; 900 on June 19, 2008; 1,000 on
June 19, 2009; and 1,100 on June 19, 2010. |
|
(2) |
|
All 7,380 options are exercisable on September 1, 2007. |
|
(3) |
|
The remaining options are exercisable as follows: 240 on
September 1, 2007; 288 on September 1, 2008; 336 on
September 1, 2009; 384 on September 1, 2010; 432 on
September 1, 2011; 480 on September 1, 2012; and 528
on September 1, 2013. |
|
(4) |
|
All 4,600 options became exercisable on January 20, 2007. |
|
(5) |
|
All 13,333 options become exercisable on December 31, 2007. |
|
(6) |
|
The remaining options are exercisable as follows: 13,333 on
December 31, 2007 and 13,333 on December 31, 2008. |
|
(7) |
|
The remaining options are exercisable as follows: 231 on
September 1, 2007; 277 on September 1, 2008; 323 on
September 1, 2009; 369 on September 1, 2010; 415 on
September 1, 2011; 462 on September 1, 2012; and 508
on September 1, 2013. |
|
(8) |
|
All 7,333 options became exercisable on January 20, 2007. |
In an effort to bridge the perceived gap between the lower level
of cash compensation for Company officers as compared to their
peers and to provide a longterm incentive for future performance
that aligns officers interests with Shareholders in
general, the Company has historically relied on stock options.
Typically, officers (and other Southwest leaders) receive large
grants upon appointment to office and annual merit grants. Many
of these grants had a 10 year term and vested over the life
of the options. In addition, officers (and other Southwest
leaders) received an annual grant equal to 5% of the number of
shares held by the Employee at December 31 of the given
year, to the extent such shares were obtained as the result of
option exercises.
15
Option
Exercises in Last Fiscal Year
The following table provides information regarding stock options
exercised, and the value realized upon exercise, by the named
executive officers during 2006.
|
|
|
|
|
|
|
|
|
|
|
Option Awards
|
|
|
Numbers of Shares
|
|
|
|
|
Acquired on Exercise
|
|
Value Realized on Exercise
|
Name
|
|
(#)
|
|
($)(1)
|
|
Herbert D. Kelleher
|
|
|
7,595
|
|
|
$
|
81,874
|
|
Colleen C. Barrett
|
|
|
1,268
|
|
|
$
|
13,669
|
|
Gary C. Kelly
|
|
|
28,594
|
|
|
$
|
329,884
|
|
Laura Wright
|
|
|
|
|
|
|
|
|
Ron Ricks
|
|
|
8,564
|
|
|
$
|
102,939
|
|
|
|
|
(1) |
|
Amounts reflect the difference between the exercise price of the
stock option and the market price of the underlying Common Stock
at the time of exercise. |
Nonqualified
Deferred Compensation in Last Fiscal Year
The Company maintains a profit sharing plan pursuant to which
the Company annually contributes a percentage of its profits to
the accounts of eligible Employees. The profit sharing plan is a
qualified deferred compensation plan. In conjunction with
the profit sharing plan, the Company maintains an excess benefit
plan, which is a nonqualified deferred compensation plan and
which is available to all Employees. At the Employees
election, the Company makes contributions to the accounts of
participants in the excess plan to the extent such amounts
cannot be contributed to the profit sharing plan due to
contribution limits established by the Internal Revenue Code.
The Company has also established nonqualified deferred
compensation arrangements with Mr. Kelleher,
Ms. Barrett, and Mr. Kelly as part of their employment
contracts. Pursuant to these arrangements, the Company makes
contributions to their accounts to the extent such amounts
cannot be contributed to the profit sharing plan due to
contribution limits and compensation limits established by the
Internal Revenue Code.
The profit sharing plan allows plan participants to invest all
or a portion of their accounts in investment funds selected by
the plan administrator, including the Companys Common
Stock. The excess benefit plan provides that plan participants
may elect to have their accounts credited with earnings
determined by reference to the earnings of investment options
selected by the plan administrator, but not Company stock.
Participants in the profit sharing and excess benefit plans are
generally entitled to a distribution of their accounts upon
separation from service with the Company.
The deferred compensation arrangements with Mr. Kelleher,
Ms. Barrett, and Mr. Kelly provide that amounts
credited to their accounts will accrue simple interest at a rate
of 10 percent annually, compounded annually on the accrued
and unpaid balance of the deferred compensation credited to
their accounts as of the preceding December 31. Deferred
compensation is payable at the rate of $100,000 per
calendar year, commencing with the calendar year following the
year in which (i) the executive attains a specified age
(76, in the case of Mr. Kelleher, and 65, in the case of
Ms. Barrett and Mr. Kelly) or (ii) the
executives employment terminates, whichever occurs later.
16
The following table provides information regarding nonqualified
deferred compensation for the named executive officers for 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonqualified Deferred Compensation
|
|
|
|
|
|
|
|
|
|
|
Aggregate
|
|
|
|
|
|
|
Executive
|
|
Southwest
|
|
Aggregate
|
|
Withdrawals/
|
|
|
|
|
|
|
Contributions
|
|
Contributions
|
|
Earnings
|
|
Distributions
|
|
Aggregate
|
|
|
|
|
in Last
|
|
in Last
|
|
in Last
|
|
in Last
|
|
Balance at
|
|
|
|
|
Fiscal Year
|
|
Fiscal Year
|
|
Fiscal Year
|
|
Fiscal Year
|
|
December 31,
|
Name
|
|
Plan
|
|
($)
|
|
($)(1)
|
|
($)
|
|
($)
|
|
2006(1)
|
|
Herbert D. Kelleher
|
|
Employment
Contract
|
|
|
|
|
|
$
|
44,857
|
|
|
$
|
103,086
|
(2)
|
|
|
|
|
|
$
|
1,171,962
|
|
Colleen C. Barrett
|
|
Employment
Contract
|
|
|
|
|
|
$
|
50,778
|
|
|
$
|
15,545
|
(3)
|
|
|
|
|
|
$
|
211,090
|
|
|
|
Excess
Benefit Plan
|
|
|
|
|
|
|
|
|
|
$
|
3,314
|
|
|
|
|
|
|
$
|
50,256
|
|
Gary C. Kelly
|
|
Employment
Contract
|
|
|
|
|
|
$
|
50,808
|
|
|
$
|
1,733
|
(4)
|
|
|
|
|
|
$
|
58,360
|
|
|
|
Excess
Benefit Plan
|
|
|
|
|
|
|
|
|
|
$
|
3,139
|
|
|
|
|
|
|
$
|
47,601
|
|
Laura Wright
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ron Ricks
|
|
Excess
Benefit Plan
|
|
|
|
|
|
$
|
3,387
|
|
|
$
|
5,037
|
|
|
|
|
|
|
$
|
38,680
|
|
|
|
|
(1) |
|
Southwest contributions reflect amounts earned for performance
during 2006. Because profit sharing contributions are not
calculated until after year-end, these amounts were not actually
contributed to the executives account during 2006 and are
therefore not included in the aggregate balance at
December 31, 2006. |
|
(2) |
|
Includes the $36,905 disclosed in the Non-Qualified
Deferred Compensation Earnings column of the Summary
Compensation Table. |
|
(3) |
|
Includes the $5,565 disclosed in the Non-Qualified
Deferred Compensation Earnings column of the Summary
Compensation Table. |
|
(4) |
|
Includes the $620 disclosed in the Non-Qualified Deferred
Compensation Earnings column of the Summary Compensation
Table. |
Employment
and Other Contracts; Potential Payments Upon Termination or
Change-in-Control
Employment Contracts with Mr. Kelleher, Mr. Kelly,
and Ms. Barrett. The Company entered into a
three-year employment contract with Herbert D. Kelleher,
effective as of July 15, 2004. Mr. Kellehers
contract provides for an annual base salary of $450,000 for the
year ending July 14, 2007, and discretionary performance
bonuses to be paid in cash at the times and in the amounts
determined by the Board. Pursuant to his contract,
Mr. Kelleher is also entitled to reimbursement for medical
and dental expenses incurred by him and by his spouse and family
and deferred compensation in an amount equal to any Company
contributions that would otherwise have been made on behalf of
Mr. Kelleher to the Companys profit sharing plan, but
that exceed the limits established by the Internal Revenue Code
for qualified plans. Such deferred compensation bears interest
at 10 percent. Mr. Kelleher has the right to terminate
his employment contract within 60 days after the occurrence
of a Change of Control of the Company, as defined below. In the
event Mr. Kelleher so terminates his employment, his
employment contract provides for a lump sum severance payment
equal to his unpaid base salary for the remaining term of the
contract plus $750,000. Had such an event occurred as of
December 31, 2006, Mr. Kelleher would have been
entitled to a lump sum payment of $993,750.
The Company entered into a three-year employment contract with
Gary C. Kelly, effective as of July 15, 2004.
Mr. Kellys contract provides for an annual base
salary of $424,065 for the year ending July 15, 2007, and
discretionary performance bonuses to be paid in cash at the
times and in the amounts determined by the Board. Pursuant to
his contract, Mr. Kelly is also entitled to reimbursement
for medical and dental expenses incurred by him, his spouse, and
his children and deferred compensation in an amount equal to any
Company contributions that
17
would otherwise have been made on behalf of Mr. Kelly to
the Companys profit sharing plan, but that exceed the
limits established by the Internal Revenue Code for qualified
plans. Such deferred compensation bears interest at
10 percent. Mr. Kelly has the right to terminate his
employment contract within 60 days after the occurrence of
a Change of Control of the Company, as defined below. In the
event Mr. Kelly so terminates his employment, the
employment contract provides for a lump sum severance payment
equal to Mr. Kellys unpaid base salary for the
remaining term of his employment contract plus $750,000. Had
such an event occurred as of December 31, 2006,
Mr. Kelly would have been entitled to a lump sum payment of
$979,702.
The Company entered into a three-year employment contract with
Colleen C. Barrett, effective as of July 15, 2004.
Ms. Barretts contract provides for an annual base
salary of $368,752 for the year ending July 15, 2007, and
discretionary performance bonuses paid in cash at the times and
in the amounts determined by the Board. Pursuant to her
contract, Ms. Barrett is also entitled to reimbursement for
her medical and dental expenses and deferred compensation in an
amount equal to any Company contributions that would otherwise
have been made on behalf of Ms. Barrett to the
Companys profit sharing plan, but that exceed the limits
established by the Internal Revenue Code for qualified plans.
Such deferred compensation bears interest at 10 percent.
Ms. Barrett has the right to terminate her employment
contract within 60 days after the occurrence of a Change of
Control of the Company, as defined below. In the event
Ms. Barrett so terminates her employment, the employment
contract provides for a lump sum severance payment equal to
Ms. Barretts unpaid base salary for the remaining
term of her employment contract plus $750,000. Had such an event
occurred as of December 31, 2006, Ms. Barrett would
have been entitled to a lump sum payment of $949,741.
Mr. Kelleher, Mr. Kelly, and Ms. Barrett would
not be entitled to any special compensation or benefits in the
event of termination of employment for any reason other than a
Change of Control, with the exception of termination due to
disability resulting from a job-related cause. In such event,
pursuant to their employment contracts, they would be entitled
to receive regular installments of their base salary in effect
at the time of termination of employment for the remainder of
the term of their agreements. Had such an event occurred as of
December 31, 2006, Mr. Kelleher, Mr. Kelly, and
Ms. Barrett would have been entitled to $243,750, $229,702,
and $199,741, respectively.
For purposes of the foregoing agreements, as well as the
Executive Service Recognition Plan discussed below, a Change of
Control is generally deemed to occur in the event that a third
party acquires 20 percent or more of the Companys
voting securities or a majority of the Directors of the Company
are replaced as a result of a tender offer or merger, sale of
assets or contested election.
Executive Service Recognition Plan. In 1987,
The Board of Directors of the Company established an Executive
Service Recognition Plan to permit the Company to continue to
attract and retain well-qualified executive personnel and to
assure both the Company of continuity of management and its
executives of continued employment in the event of any actual or
threatened change of control of the Company. As contemplated by
the Executive Service Recognition Plan, the Company has entered
into employment agreements with Ms. Wright and
Mr. Ricks. The terms of these employment agreements would
be invoked only in the event of a Change of Control, and these
executives would not be entitled to any special compensation or
benefits in the event of termination of employment for any
reason other than a Change of Control. Under the terms of these
agreements, the executives must remain in the employment of the
Company for one year after a Change of Control has occurred (the
Employment Year). While employed pursuant to these
agreements, the executives would be entitled to a base salary in
an amount at least equal to the highest salary received by the
executives during the preceding
12-month
period. In addition, the executives would be entitled to an
annual bonus in an amount at least equal to the highest bonus
(the Change of Control Bonus Amount) paid or payable
to the executive in respect of either of the two fiscal years
immediately prior to the fiscal year in which the Change of
Control occurs. If, during the Employment Year, the
executives employment were to be terminated other than for
cause or the executive were to resign for good reason (each as
defined in the agreement), then the executive would be entitled
a lump sum payment equal to:
(a) a pro rated bonus, which would be based on the annual
bonus paid to the executive for the last full fiscal year of the
Company prior to the fiscal year in which the date of
termination occurs;
(b) the executives annual base salary in effect at
the time of notice of termination;
18
(c) the Change of Control Bonus Amount paid to the
executive for the last full fiscal year of the Company (being
the year in which the Change of Control has occurred, but not
the date of termination of employment), or, if no such bonus
shall have been paid, the Change of Control Amount that would
have been payable to the executive for the then current fiscal
year (being the year in which the date of termination of
employment occurs).
Had such an event occurred as of December 31, 2006,
Mr. Ricks and Ms. Wright would have been entitled to
$886,400 and $630,000, respectively.
In addition to the amounts discussed above, in the event of
termination of their employment for any reason other than cause,
each of the named executive officers would be eligible to
participate in any non-contract retiree medical benefit plan or
program that the Company may then make available to its retirees
generally on the same terms as other retirees. In addition, the
executives would be entitled to the amounts credited to their
accounts pursuant to the Companys qualified 401(k) and
profit sharing plans, as well as nonqualified deferred
compensation amounts credited to their accounts pursuant to the
Companys excess benefit plan
and/or their
employment agreements (as applicable), each as disclosed in more
detail above under the heading Nonqualified Deferred
Compensation in Last Fiscal Year.
Change of Control Severance Pay Plan. The
Board of Directors established in 1988 a Change of Control
Severance Pay Plan (the Severance Pay Plan) to
provide for severance payments to qualified Employees whose
employment with the Company terminates due to certain conditions
created by a change in control of the Company (as defined in the
Severance Pay Plan). All Employees of the Company are
participants in the Severance Pay Plan except any officer
participating in the Executive Service Recognition Plan and all
other Employees who are beneficiaries of an enforceable contract
with the Company providing for severance payments in the event
of a reduction in force or furlough (collective bargaining
agreements). Generally, the Severance Pay Plan provides for
severance payments, based upon the Employees salary and
years of service with the Company, in the event the Employee is
terminated, other than for cause (as defined in the Severance
Pay Plan), death, voluntary retirement or total and permanent
disability, within one year of a change in control.
The Employee would also remain eligible for a
12-month
extension of coverage under each welfare benefit
plan of the Company, including medical, dental, etc., as in
effect immediately prior to any change in control. For purposes
of the Severance Pay Plan, a change in control is
deemed to have occurred if 20 percent or more of the combined
voting power of the Companys outstanding voting securities
ordinarily having the right to vote for Directors shall have
been acquired by a third person or a change in the makeup of the
Board of Directors shall have occurred under certain
circumstances described in the Severance Pay Plan.
19
Directors
Compensation
The following table provides information regarding compensation
earned by the Directors during the year ended December 31,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fees Earned
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
or Paid
|
|
|
|
|
|
|
|
|
All Other
|
|
|
|
|
|
|
in Cash
|
|
|
Stock Awards
|
|
|
Option Awards
|
|
|
Compensation
|
|
|
Total
|
|
Name(1)
|
|
($)(2)
|
|
|
($)(4)
|
|
|
($)(5)
|
|
|
($)
|
|
|
($)
|
|
|
David W. Biegler
|
|
$
|
24,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
24,693
|
|
Louis E. Caldera
|
|
$
|
46,859
|
|
|
$
|
9,825
|
|
|
$
|
6,706
|
|
|
|
|
|
|
$
|
63,390
|
|
C. Webb Crockett
|
|
$
|
43,274
|
|
|
$
|
8,160
|
|
|
|
|
|
|
|
|
|
|
$
|
51,434
|
|
William H. Cunningham
|
|
$
|
59,347
|
|
|
$
|
8,160
|
|
|
|
|
|
|
|
|
|
|
$
|
67,507
|
|
William P. Hobby
|
|
$
|
48,875
|
|
|
$
|
8,160
|
|
|
|
|
|
|
|
|
|
|
$
|
57,035
|
|
Travis C. Johnson
|
|
$
|
53,459
|
|
|
$
|
8,160
|
|
|
|
|
|
|
|
|
|
|
$
|
61,619
|
|
Nancy B. Loeffler
|
|
$
|
34,354
|
|
|
$
|
9,825
|
|
|
$
|
6,706
|
|
|
|
|
|
|
$
|
50,885
|
|
John T. Montford
|
|
$
|
50,650
|
|
|
$
|
8,993
|
|
|
$
|
8,347
|
|
|
|
|
|
|
$
|
67,990
|
|
Rollin M. King(3)
|
|
$
|
21,042
|
|
|
$
|
12,660
|
|
|
|
|
|
|
$
|
75,000
|
|
|
$
|
108,702
|
|
June Morris(3)
|
|
$
|
27,587
|
|
|
$
|
12,660
|
|
|
|
|
|
|
$
|
75,000
|
|
|
$
|
115,247
|
|
|
|
|
(1) |
|
Directors who also serve as executive officers of the Company do
not receive compensation other than for their services as an
executive officer. Such Directors are therefore not included in
this table. |
|
(2) |
|
Reflects amounts earned for performance during 2006, whether or
not paid during 2006. Therefore, the retainer fees discussed
below have been allocated to 2006, as appropriate. |
|
(3) |
|
Reflects payments to Mr. King and Ms. Morris in
connection with their retirement from the Board in May 2006.
They each also received $61,950 in connection with the payout of
performance shares. The related expense is reflected in the
Stock Awards column. These payments are discussed in
more detail below. |
|
(4) |
|
Reflects the dollar amount recognized as a liability for
financial statement reporting purposes for the fiscal year ended
December 31, 2006, in accordance with SFAS 123R with
respect to performance shares granted under the Companys
Outside Director Incentive Plan. Amounts therefore include
expense related to awards granted in and prior to fiscal 2006,
as applicable. These awards are discussed in Note 13 to the
Companys financial statements included in its Annual
Report on
Form 10-K
for the fiscal year ended December 31, 2006. The aggregate
number of Performance Shares outstanding at December 31,
2006 for each of the Directors was as follows:
Mr. Biegler 0; Mr. Caldera
2,250; Mr. Crockett 3,750;
Dr. Cunningham 3,750; Governor
Hobby 3,750; Mr. Johnson 3,750;
Ms. Loeffler 2,250;
Mr. Montford 3,000; Mr. King
0; and Ms. Morris 0. Performance Shares were
the only type of Stock Awards held by these Directors at fiscal
year end. |
|
(5) |
|
These Directors were not granted any Option Awards during fiscal
2006. The aggregate number of shares underlying stock options
outstanding at fiscal year end for each of the Directors was as
follows: Mr. Biegler 0;
Mr. Caldera 10,000;
Mr. Crockett 0; Dr. Cunningham
15,000; Governor Hobby 0;
Mr. Johnson 0; Ms. Loeffler
10,000; and Mr. Montford 10,000. Stock options
were the only type of Option Awards held by these Directors at
December 31, 2006. |
Directors fees are paid on an annual basis in May of each
year. Each Director of the Company who is not an Employee of the
Company was paid $13,125 for his or her services as a Director
during the
12-month
period ending May 2006. These fees were increased to $13,780 for
services during the
12-month
period ending May 2007 and will be increased to $14,260 for
services during the
12-month
period ending May 2008. During 2006, the Board of Directors held
six meetings and otherwise acted by unanimous consent. In
addition, these Directors received $3,360 for attendance at each
meeting of the Board of Directors during the
12-month
period ending May 2006. These fees were increased to $3,525 for
meetings during the
12-month
period ending May 2007 and will be increased to $3,650 for
meetings during the
12-month
period ending May 2008. Committee members received $1,750 for
attendance at each Committee meeting during the
12-month
period ending May 2006. This fee was increased to $1,835 for
20
meetings during the
12-month
period ending May 2007 and will be increased to $1,900 for
meetings during the
12-month
period ending May 2008. Members of the Executive Committee,
other than Mr. Kelleher, received an additional $6,400 for
their services on such Committee during the
12-month
period ended May 2006. This fee was increased to $6,720 for
services during the
12-month
period ended May 2007 and will be increased to $6,955 for the
12-month
period ending May 2008. The Chairmen of the Audit, Compensation,
and Nominating and Corporate Governance Committees received
annual fees of $7,100, $3,675, and $3,675 respectively, for
their service as Chairs of such Committees during the
12-month
period ended May 2006. These fees were increased to $9,000,
$3,860, and $3,860, respectively, for the
12-month
period ending May 2007 and will be increased to $9,320, $4,000,
and $4,000, respectively, for the
12-month
period ending May 2008. Officers of the Company receive no
additional remuneration for serving as Directors or on
Committees of the Board.
In 2001, the Board adopted the Southwest Airlines Co. Outside
Director Incentive Plan. The purpose of the plan is to align
more closely the interests of the non-Employee Directors with
those of the Companys Shareholders and to provide the
non-Employee Directors with retirement income. To accomplish
this purpose, the plan compensates each non-Employee Director
based on the performance of the Companys Common Stock and
defers the receipt of such compensation until after the
non-Employee Director ceases to be a Director of the Company.
Pursuant to the plan, on the date of the 2002 Annual Meeting of
Shareholders, the Company granted 750 non-transferable
Performance Shares to each non-Employee Director who had served
as a Director since at least May 2001. Thereafter, on the date
of each Annual Meeting of Shareholders, the Company granted 750
Performance Shares to each non-Employee Director who served
since the previous Annual Meeting. Beginning with the May 2007
Annual Meeting of Shareholders, this will be increased to 1,000
Performance Shares. A Performance Share is a unit of value equal
to the Fair Market Value of a share of Southwest Common Stock,
based on the average closing sale price of the Common Stock as
reported on the New York Stock Exchange. On the
30th calendar day following the date on which a
non-Employee Director ceases to serve as a Director of the
Company for any reason, Southwest will pay to such non-Employee
Director an amount equal to the Fair Market Value of the Common
Stock during the 30 days preceding such last date of
service multiplied by the number of Performance Shares then held
by such Director. The plan contains provisions contemplating
adjustments on changes in capitalization of the Company.
Upon retirement from the Board of Directors, a Director who has
served at least five years as of the date of retirement will
receive $35,000 and a Director who has served at least ten years
will receive $75,000.
21
COMPENSATION
DISCUSSION AND ANALYSIS
The Salary Administration Program for Southwests
non-contract people will be administered in a manner that
promotes the attainment by Southwest of reasonable profits on a
consistent basis in order to preserve job protection and
security for such non-contract people; that promotes and rewards
productivity and dedication to the success of Southwest as the
collective embodiment of all of its people; that accomplishes
internal equity among its people; and that responds
pragmatically to the actual influence of external market
forces.
Southwest
Airlines Co.
Salary Administration Manual
The above principles are applied to all Southwest Employees who
are not subject to collective bargaining agreements
(non-contract Employees), including executive officers. The
Compensation Committee of the Board of Directors reviews the
compensation of Southwests executive officers on an annual
basis. The Committee considers the total compensation (both
salary and incentives), as well as the recommendation of the
Companys Chief Executive Officer, in establishing each
element of compensation. Mr. Kelleher, Mr. Kelly, and
Ms. Barrett have employment contracts with the Company,
which are discussed in detail above under Employment and
Other Contracts; Potential Payments Upon Termination or
Change-in-Control.
At current cash compensation levels, the Committee does not
expect Internal Revenue Service regulations regarding maximum
deductibility of executive compensation to have any application
to the Company.
The Companys 1996 Incentive Stock Option Plan and 1996
Non-Qualified Stock Option Plan have both expired. In light of
the unavailability of shares for future option grants to
management under these plans, as well as the change in
accounting for equity grants to Employees, the Company has
recently undertaken a review of its compensation practices for
management. The Compensation Committee of the Board of Directors
has participated in this review, taking into consideration the
Companys operating results, compensation practices of
comparable businesses, labor relations, and the Companys
egalitarian culture. Approximately 82% of the Companys
Employees are subject to collective bargaining agreements, and
the relationship between executive pay and pay rates for
contract Employees is an important consideration for the
Committee. As a result of this review, the Compensation
Committee, working together with the Companys Chief
Executive Officer, has continued the philosophy indicated above,
implemented in the manner described below.
The principal elements of compensation for Southwests
executive officers are the following:
Base Salary. As a general rule, base
salary for the executive officers of Southwest falls below the
salaries for comparable positions in comparably sized companies
and other airlines. The Committee bases this determination on
comparative compensation studies for similarly situated
businesses; its impression of the prevailing business climate;
and the advice of the Companys Chief Executive Officer.
This approach is used to mitigate the myriad of risks inherent
in the airline business, culminating in earnings volatility.
Annual salary increases, if any, for executive officers as a
group are not more, on a percentage basis, than those received
by other non-contract Employees.
Annual Incentive Bonus. Officers of the
Company are eligible for annual incentive bonuses. For the 2006
bonus, paid in January 2007, the Committee first considered the
Companys profitability in 2006, which increased 38%
(economic), then the performance of each individual, his or her
level of responsibility within the Company, the longevity in
office of each officer, and each officers performance as a
team member. No mathematical weighing formulae were applied with
respect to any factors. In evaluating an individuals
performance, the Committee relied on the recommendation of the
Chief Executive Officer, whose recommendation is based on his
own perception of such officers performance. For 2006
compensation, the Company did not utilize defined performance
targets in establishing compensation, nor did it employ minimum,
targeted, or maximum amounts of bonuses or total compensation
levels for the individual executive officers, and the final
determination of compensation was subjective. Variable cash
bonuses are used to help make up the difference between
officers salaries and the market for their services,
consistent with the Companys earnings results.
For 2007, it is intended that salary plus bonus for each officer
will provide total cash compensation for the Companys top
performers approximating median (average) market rates for
similar positions, based on
22
information provided to the Committee by outside consultants or
the Companys own human resource professionals. It is also
intended that the annual bonus program will continue to provide
an opportunity for part of total compensation to fluctuate based
on individual performance and Company profitability.
Longterm Incentives. In an effort to
bridge the perceived gap between the lower levels of cash
compensation for Company officers as compared to their peers and
to provide a longterm incentive for future performance that
aligns officers interests with Shareholders in general,
the Company adopted its 1996 Incentive Stock Option Plan and
1996 Non-Qualified Stock Option Plan (the 1996
Plans). The number of options initially granted to an
officer, as compared to other Southwest Employees, was dependent
on the length of service with the Company and individual levels
of performance and responsibility. Subsequent grants have been
based on levels of individual performance. With respect to all
options granted, the precise number of shares was determined on
a subjective basis. All grants under the 1996 Plans were at
current market value, vesting over a number of years, dependent
on continued employment. Each grant was made based upon the
individuals compensation package for that year, without
reference to previous grants.
Each of the 1996 Plans expired prior to April 2006. With this in
mind, the Committee authorized the issuance of options to
officers in March 2006, with vesting dates that were comparable
to those that would have been in effect had the options been
granted in December 2006 in accordance with past practice.
Subject to Shareholder approval at the 2007 Annual Meeting, and
based on the Committees recommendation, the Board has
adopted the Companys 2007 Equity Incentive Plan (the
2007 Plan). As discussed further under
Proposal 3 Approval of the Companys
2007 Equity Incentive Plan, the 2007 Plan gives the
Committee flexibility to grant stock options, restricted stock,
or restricted stock units. The objectives of the 2007 Plan are
to provide a vehicle to encourage retention of our best Leaders,
to pay our Leaders competitively, near the middle of the market
for total compensation in cases of outstanding Company and
individual performance, and to provide a tool to attract future
Employees in a tight labor market. If the 2007 Plan is not
approved by Shareholders, it is the Committees intention
to recommend the adoption of a longterm incentive plan for
management that mirrors the characteristics of an equity plan,
but that does not require Shareholder approval, such as a
phantom stock plan.
CEO Employment Contract. Effective as
of July 15, 2004, Southwest entered into a three-year
employment contract with Mr. Kelly pursuant to which
Mr. Kelly serves as Chief Executive Officer of the Company,
and, so long as he is on the Board of Directors, Vice Chairman
of the Board. Mr. Kellys employment contract is
discussed in more detail above under the heading
Employment and Other Contracts; Potential Payments Upon
Termination or
Change-in-Control.
Pursuant to his employment contract, Mr. Kellys
annual base salary for the year ending July 15, 2006 was
$411,714 and for the year ending July 15, 2007 is $424,065.
In addition, in July 2004, Mr. Kelly was granted fair
market value options to purchase 180,000 shares of
Southwest Common Stock with one-third vested immediately and the
balance vesting in increments of one-third on each of
July 15, 2005 and July 15, 2006. Mr. Kelly
received no stock option grants in 2006.
The Committee relied on information supplied by an independent
consultant in determining that Mr. Kellys cash
compensation for the three-year period covered by his employment
contract was significantly below the market midpoint for
comparable positions at the time in question. The options
granted to Mr. Kelly, in accordance with Company practice,
were designed to make up at least a portion of the difference
between his cash compensation and that received by others in
comparable positions, dependent on successful performance by the
Company as reflected in the price of its stock.
The number of options granted to Mr. Kelly was based on the
Committees review of compensation for similarly situated
individuals in the transportation industry and the
Committees perception of his expected future contributions
to Southwests performance over the three-year term of his
contract. The Committee did not consider the amount and value of
other options granted to Mr. Kelly in the past, as those
options were granted in connection with earlier compensation
packages. The Company has no target ownership levels for Company
equity holdings by executives.
Pursuant to his employment contract, Mr. Kelly is entitled
to a performance bonus at the discretion of the Board of
Directors. The bonus paid to Mr. Kelly in January 2007 in
respect of his performance in 2006 was $462,000, an increase of
20% over the previous years amount of $385,000 (as
compared to Company profitability,
23
which increased 38% (economic)). In fixing Mr. Kellys
bonus, the Committee considered the factors indicated above for
bonuses for all Officers of Southwest Airlines.
Executive officers participate in the Companys profit
sharing plan, excess benefit plan, and 401(k) plan, which are
available to all Southwest Employees on the same basis. Officers
of the Company, and their spouses, are eligible for unlimited,
positive space travel on Southwest. Beyond such travel benefits,
Southwest makes little use of perquisites for executive officers.
COMPENSATION COMMITTEE
William P. Hobby, Chair
C. Webb Crockett
David Biegler
AUDIT
COMMITTEE REPORT
The Audit Committee has reviewed and discussed the audited
financial statements of the Company for the year ended
December 31, 2006 (the Audited Financial
Statements) with management. In addition, we have
discussed with Ernst & Young LLP, the independent
auditing firm for the Company, the matters required by
Codification of Statements on Auditing Standards No. 61, as
amended by Statement on Auditing Standards No. 90, Audit
Committee Communications.
The Committee also has received the written disclosures and the
letter from Ernst & Young required by Independence
Standards Board Standard No. 1, and we have discussed with
that firm its independence from the Company and the
compatibility of its provision of services other than auditing
services with such independence. We also have discussed with
management of the Company and the auditing firm such other
matters and received such assurances from them, as we deemed
appropriate.
Based on the foregoing review and discussions and relying
thereon, we have recommended to the Companys Board of
Directors the inclusion of the Audited Financial Statements in
the Companys Annual Report for the year ended
December 31, 2006 and in the Companys Annual Report
on
Form 10-K.
AUDIT COMMITTEE
William H. Cunningham, Chair
David Biegler
Louis Caldera
William P. Hobby
Travis Johnson
John T. Montford
COMPENSATION
COMMITTEE REPORT
The Compensation Committee has reviewed and discussed the
Compensation Discussion and Analysis contained in this Proxy
Statement with Southwest management. Based on such review and
discussions and relying thereon, we have recommended to the
Companys Board of Directors that the Compensation
Discussion and Analysis contained in this Proxy Statement be
included in the Companys Annual Report on
Form 10-K
for the year ended December 31, 2006 and in this Proxy
Statement.
COMPENSATION COMMITTEE
William P. Hobby, Chair
David Biegler
C. Webb Crockett
24
PROPOSAL 2
APPROVAL OF THE AMENDMENT TO THE COMPANYS ARTICLES OF
INCORPORATION TO
ELIMINATE SUPERMAJORITY VOTING REQUIREMENTS
The Board of Directors recommends that the Companys
Restated Articles of Incorporation, as amended (the
Articles), be amended to remove the supermajority
voting requirements found in the Articles. Article Nine of
the Articles currently requires, subject to certain exceptions,
a supermajority vote for the following actions:
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Any merger or consolidation of the Company or any of its
subsidiaries with or into any other corporation;
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Any sale, lease, exchange or other disposition of all or
substantially all of the property and assets of the Company or
any of its subsidiaries to or with any other corporation, person
or other entity;
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Any sale, lease, exchange or other disposition to the Company or
any of its subsidiaries of any assets, cash, securities or other
property of any other corporation, person or other entity in
exchange for securities of the Company or any of its
subsidiaries; or
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Any amendment to Article Nine of the Articles.
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At the 2006 Annual Meeting of Shareholders, the Shareholders
approved, by a substantial margin, a Shareholder proposal
requesting that simple majority voting be required on all
matters for which Shareholders vote. The stated purpose of the
proposal was to eliminate all supermajority voting requirements
from the Companys Articles of Incorporation and Bylaws.
The Board of Directors continues to believe, as it has stated in
prior years in response to similar proposals, that these
supermajority voting requirements provide some protection
against self-interested actions by one or a few holders of a
large number of shares of Common Stock, and encourage persons
making unsolicited bids for Southwest Airlines to negotiate with
the Board. Although the proposal made at the 2006 Annual Meeting
was not binding, given the size of the vote in support of the
proposal, the Board of Directors and its Nominating and
Corporate Governance Committee have reexamined the arguments for
and against supermajority voting provisions and concluded that
it is in the best interests of the Companys Shareholders
to allow the Shareholders the opportunity to vote on an
amendment to the Articles to remove all supermajority voting
requirements from the Articles. The Board has also recently
amended the Companys Bylaws to remove the supermajority
provisions found in the Bylaws.
Accordingly, the Board has approved and submits to the
Shareholders for their approval an amendment to the Articles to
remove Article Nine of the Articles, a copy of which is
attached to this Proxy Statement as Appendix A.
Vote
Required for Approval
Article Nine of the Articles currently requires the
affirmative vote of 80% of all classes of stock of the Company
entitled to vote thereon to amend, alter, change or repeal any
of the provisions of Article Nine.
If the amendment to the Articles is approved, articles of
amendment to the Companys Articles deleting
Article Nine will be executed and filed in accordance with
Texas law.
The Board recommends a vote FOR the approval of the
Amendment to the Companys Articles of Incorporation to
Eliminate Supermajority Voting Requirements
PROPOSAL 3
APPROVAL OF THE COMPANYS 2007 EQUITY INCENTIVE
PLAN
The Board of Directors adopted the 2007 Equity Incentive Plan
(the Plan) on March 15, 2007, subject to
approval by the Companys Shareholders. If approved by the
Shareholders of the Company at the meeting, the Plan will become
effective immediately. No awards will be granted under the Plan
unless and until Shareholder approval is received.
As discussed in more detail above under Compensation
Discussion and Analysis, the objectives of the Plan are to
provide a vehicle to encourage retention of the Companys
best Leaders, to pay its Leaders competitively, near the middle
of the market for total compensation in cases of outstanding
Company and individual performance, and
25
to provide a tool to attract future Employees in a tight labor
market. The Company has historically granted stock options to
maintain adequate compensation for members of Company management
as compared to their peers. While the Company believes that
stock options have been an effective retention vehicle
historically, in light of recent changes in accounting for
equity grants to Employees, the Company deems it advisable to
provide for increased flexibility in its equity grant practices
going forward. Therefore, in addition to stock options, the Plan
provides for grants of restricted shares of Common Stock and
restricted stock units. In addition, the Plan has been designed
to allow (to the extent deemed necessary and advisable) each of
these types of awards to satisfy the performance-based
compensation exception to the $1 million limitation on the
Companys deduction with respect to compensation of certain
executives, as specified by Section 162(m) of the Internal
Revenue Code.
Summary
of the Plan
The following is a brief summary of the Plan and should be read
in conjunction with, and is qualified in its entirety by
reference to, the complete text of the Plan, which is attached
to this Proxy Statement as Appendix B.
Administration
The Plan must be administered by the Board or by a committee
appointed by the Board consisting of at least two members of the
Board. The Board or committee, as applicable, will be referred
to as the committee. With respect to any award that
is intended to satisfy the requirements of
Rule 16b-3
under the Securities Exchange Act of 1934, as amended, the
committee must consist of at least such number of Directors as
is required from time to time by such rule, and each committee
member must satisfy the qualification requirements of such rule.
With respect to any award that is intended to satisfy the
performance-based compensation exception provided for under
Section 162(m) of the Internal Revenue Code, the committee
must consist of at least such number of Directors as is required
from time to time to satisfy such exception, and each committee
member must satisfy the qualification requirements of the
exception. To the extent required under the rules of the stock
exchange or automated quotation system on which the
Companys Common Stock is listed for trading or is quoted,
each member of the committee must satisfy any
independence requirements of such exchange or
quotation system. Subject to certain limitations, the committee
may delegate some or all of its authority under the Plan to one
or more members of the committee or to one or more officers of
the Company.
The committee will have the power to interpret the Plan, to
establish rules and regulations relating to the Plan, and to
make all other determinations necessary or advisable for
administering the Plan. The Plan does not permit the repricing
of options or the granting of discounted awards, and no awards
may be granted under the Plan after ten years from the date of
the Plans adoption by the Shareholders.
Eligibility
and Plan Benefits
Any Employee of the Company or its affiliates and any Director
who is not an Employee (a non-Employee Director) is
eligible to participate in the Plan; however, only Employees of
the Company or its subsidiaries are eligible to receive
incentive stock options. Other than with respect to automatic
formula grants to non-Employee Directors (which are discussed
below), the selection of participants in the Plan and the number
and type of awards to be granted to any individual is within the
discretion of the committee.
Limits
on Awards Under the Plan
The maximum number of shares of Common Stock that may be issued
under the Plan with respect to all types of awards in the
aggregate may not exceed 6,000,000; provided that no more than
2,400,000 of the 6,000,000 shares may be issued pursuant to
restricted stock and restricted stock unit awards, collectively.
For example, (i) if the Company were to issue
2,400,000 shares of Common Stock pursuant to restricted
stock and/or
restricted stock unit awards, 3,600,000 shares would remain
available for issuance pursuant to stock options only; or
(ii) if the Company were to issue 5,500,000 shares of
Common Stock pursuant to stock options, 500,000 shares
would remain available for restricted stock, restricted stock
unit awards,
and/or stock
options. During the ten-year term of the Plan, the maximum
number of shares of Common Stock with respect to which awards
may be granted under the Plan to any participant will be
450,000. To the extent an award lapses or the rights of its
holder terminate, any shares of
26
Common Stock subject to such award will again be available for
grant under the Plan. Unless earlier terminated by action of the
Board, the Plan will terminate on the date that is ten years
from the date of its approval by Shareholders. Any outstanding
awards at such time will nonetheless expire in accordance with
their terms.
Stock
Options
Stock options granted under the Plan may be either
incentive stock options, within the meaning of
Section 422 of the Internal Revenue Code, or non-qualified
stock options, as determined by the committee. With the
exception of automatic grants to non-Employee Directors (which
are discussed below), the committee has the power to determine
the exercise price, vesting schedule (including any performance
measures, if applicable), and term of any stock option, as well
as any other terms that are not inconsistent with the purposes
and provisions of the Plan; provided that (i) no stock
option may have a term of longer than ten years (five years in
the case of an incentive stock option granted to a
10 percent Shareholder), and (ii) the per share
exercise price of any stock option cannot be less than 100% of
the fair market value of a share of Common Stock on the date of
grant (110% of the fair market value in the case of an incentive
stock option granted to a 10 percent Shareholder, as
calculated pursuant to the rules of the Internal Revenue Code).
The Plan provides for automatic grants of stock options to new
non-Employee Directors. Similar to the Companys
1996 Non-Qualified Stock Option Plan, which expired in
2005, the proposed Plans formula provides that each
individual who becomes a non-Employee Director after adoption of
the Plan and who has not previously been granted stock options
under any other plan of the Company will receive, on the date of
his or her initial appointment or election to the Board, a
non-qualified stock option to purchase 10,000 shares of
Common Stock at a price equal to 100 percent of the fair
market value of the Common Stock on such date. In addition, the
proposed Plan provides that each individual who became a
non-Employee Director prior to adoption of the Plan and who has
not previously been granted stock options under any plan of the
Company will, on the date of the 2007 Annual Meeting of
Shareholders of the Company, be granted a stock option to
purchase 8,000 shares of Common Stock at a price equal to
100 percent of the fair market value of the Common Stock on
such date. (This provision is applicable to Mr. Biegler,
who is the only current Director not to have received stock
options, due to the expiration of the Companys stock
option plans prior to his election to the Board. In January
2007, Mr. Biegler also received a one-time grant of
2,000 shares of phantom stock in an effort to equalize his
equity grants with those of other Directors who have received
options to purchase 10,000 shares of Common Stock.) Formula
grants under the Plan will have a ten-year term and will become
exercisable with respect to one-third of the shares covered
thereby annually, beginning on the first anniversary of the date
of grant.
An options exercise price may be paid (i) in cash,
(ii) in shares of Common Stock (in the discretion of the
committee), (iii) through a cashless exercise, or
(iv) in any other manner permitted by the committee. The
closing price of a share of the Companys Common Stock on
March , 2007, was
$ .
In the event of the termination of a Plan participants
service with the Company, any of the participants stock
options that have not vested as of the date of termination will
automatically become null and void on the date of termination.
The vested portion of the participants outstanding stock
options will become null and void on the date that is earliest
to occur of the following (i) the date of the
participants termination of service for cause;
(ii) the expiration of two years following the date of
termination of a participants employment if the
participant is not also a Director; (iii) the expiration of
five years following the date of termination of a
Directors service with the Board of Directors of the
Company; (iv) the expiration of such period of time or the
occurrence of such event as the committee in its discretion may
provide in the participants stock option agreement; and
(v) the expiration of ten years from the date of grant of
the participants stock option.
Restricted
Stock and Restricted Stock Units
Restricted stock is an award of Common Stock that is granted
subject to restrictions that are established by the committee. A
restricted stock unit is a right to receive a share of Common
Stock in the future, subject to terms and conditions that are
established by the committee. Restricted stock and restricted
stock units granted under the Plan will be subject to a vesting
schedule, which may include specified performance goals or other
criteria that the committee determines must be satisfied in
order to remove any restrictions with respect to such award;
provided that
27
(i) in no event may restricted stock or restricted stock
units with a vesting schedule based on the passing of time have
(or be accelerated to have) a vesting schedule of less than
three years from the date of grant; and (ii) in no event
may restricted stock or restricted stock units with a vesting
schedule based on the achievement of a performance measure vest
(or be accelerated to vest) in under one year from the date of
grant. In the event of the termination of a Plan
participants service with the Company, any of the
participants restricted stock or restricted stock units
that have not vested as of the date of termination will be
forfeited. Shares of restricted stock will be registered in the
participants name or otherwise credited to the participant
as of the date of grant, but will remain held by the Company for
the account of the participant (and will not be transferable)
until they have vested; however, a holder of restricted stock
will have the right (to the extent applicable) to vote and to
receive dividends or other distributions made or paid with
respect to shares of Common Stock generally. A holder of
restricted stock units will have not have these rights until the
units have vested. Upon vesting, the participant will be
entitled to receive one share of Common Stock for each
restricted stock unit that has vested. If a participants
service with the Company terminates for any reason, any of the
participants unvested shares of restricted stock and
unvested restricted stock units will be forfeited as of the date
of such event.
Performance
Goals
The committee may condition the grant, vesting,
and/or
exercisability of any award upon the attainment of one or more
performance targets related to one or more performance measures
over a performance period. Awards that are not intended to
satisfy the performance-based compensation exception to the
deduction limitation set forth in Section 162(m) of the
Internal Revenue Code may be based on the achievement of such
goals and be subject to such terms, conditions, and restrictions
as the committee shall determine. Awards that are intended to
satisfy the performance-based compensation exception based on
the satisfaction of one or more performance measures must be
conditioned on specified levels of one or more of the following:
(1) the earnings or earnings per share of the Company or of
any business unit of the Company designated by the committee;
(2) the net operating margin of the Company or of any
business unit of the Company designated by the committee;
(3) the cash flow return on investment of the Company or
any business unit of the Company designated by the committee;
(4) the earnings before interest, taxes, depreciation,
and/or
amortization of the Company or any business unit of the Company
designated by the committee; (5) the return on
shareholders equity achieved by the Company; (6) the
total shareholders return achieved by the Company;
(7) any of the foregoing calculated on an economic
basis; (8) the price of a share of Common Stock;
(9) the Companys market share; (10) the market
share of a business unit of the Company designated by the
committee; (11) the Companys sales; (12) the
sales of a business unit of the Company designated by the
committee; (13) the economic value added; or (14) any
combination of the foregoing. A measure that is calculated on an
economic basis is a measure that is adjusted (to the
extent consistent with Section 162(m) of the Code) to
reflect the impact of special items, which are reflected from
time to time in the Companys published financials. Special
items are material nonrecurring adjustments deemed appropriate
to exclude by the committee and may include, without limitation,
(a) unrealized gains or losses and other items that are
recorded by the Company as a result of Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended;
(b) impairment and other non-cash charges including the
impact of changes in accounting principles or estimates or other
unusual, infrequent non-cash items; and (c) other items not
considered to be representative of the Companys ongoing
operations.
A performance period must be established within ninety days
after the beginning of such period; provided that (i) the
performance target is substantially uncertain at such time and
(ii) no more than 25% of the overall performance period has
elapsed. The committee may adjust performance measures for
specified significant extraordinary items or events, to the
extent consistent with Section 162(m) of the Internal
Revenue Code.
Prior to the payment of any award that has been conditioned upon
achievement of a performance goal that is intended to qualify
for the performance-based compensation exception provided for
under Section 162(m) of the Internal Revenue Code, the
committee must certify whether the performance target(s) have
been achieved. The committee will have the discretion to reduce
any award.
28
Adjustments
In the event of a subdivision or consolidation of shares of the
Companys Common Stock or the payment of a stock dividend
on the Common Stock without receipt of consideration by the
Company, (i) the number of shares of Common Stock with
respect to which an outstanding award may thereafter be
exercised or satisfied, as applicable, will, in the event of an
increase in the number of outstanding shares, be proportionately
increased, and the exercise price per share (if applicable) will
be proportionately reduced; and (ii) the number of shares
of Common Stock with respect to which an outstanding award may
thereafter be exercised or satisfied, as applicable, will, in
the event of a reduction in the number of outstanding shares, be
proportionately reduced, and the exercise price per share (if
applicable) will be proportionately increased. In the event of
any such change in the outstanding Common Stock, the aggregate
number of shares available under the Plan may be appropriately
adjusted by the committee.
In the event the Company recapitalizes or otherwise changes its
capital structure, the number and class of shares of Common
Stock covered by an outstanding award will be adjusted so that
such award will thereafter cover the number and class of shares
of stock and securities to which a participant would have been
entitled pursuant to the terms of the recapitalization if,
immediately prior to such recapitalization, the participant had
been the holder of record of the number of shares of Common
Stock then covered by such award. If the Company is not to be
the surviving entity in any merger or consolidation (or survives
only as a subsidiary of an entity other than a previously
wholly-owned subsidiary of the Company), or if the Company is to
be dissolved or liquidated, then, unless a surviving corporation
assumes or substitutes new awards for awards then outstanding
under the Plan, (i) all unvested options then outstanding
will be accelerated and will become exercisable in full, and all
restrictions
and/or
performance measures with respect to any award will be deemed to
be satisfied, on or before a date fixed by the Company prior to
the effective date of such merger or consolidation or such
dissolution or liquidation, and (ii) upon such effective
date, awards will expire.
Transfer
Restrictions
The rights of a participant with respect to any award will not
be transferable by the participant other than by will or the
laws of descent or distribution.
Amendment
and Termination
The Board in its discretion may amend or terminate the Plan at
any time; provided that no change in the Plan may be made that
would impair the rights of a participant with respect to an
award theretofore granted without the consent of the
Participant; and provided, further, that no amendment may be
made without approval of the Shareholders of the Company if such
approval is required under applicable law or by the requirements
of any exchange or automated quotation system upon which the
Common Stock is listed for trading or quoted.
Summary
of Certain Federal Income Tax Consequences
The following discussion is intended as a general summary of the
federal income tax consequences associated with the grant and
exercise of stock options. This summary does not purport to be
complete and does not address any applicable state or local tax
law.
Non-Qualified
Stock Options
In general, no taxable income is realized by a participant upon
the grant of a non-qualified stock option, and no deduction is
then available to the Company. Upon exercise of a non-qualified
stock option, the excess of the fair market value of the shares
on the date of exercise over the exercise price will be
includable in the gross income of the participant as ordinary
income. The amount includable in the gross income of the
participant will also be deductible by the Company. The tax
basis of the shares acquired by the participant will be equal to
the exercise price plus the amount includable in the gross
income of the participant as ordinary income. When a participant
disposes of shares acquired upon exercise of a non-qualified
stock option, any amount realized in excess of the tax basis of
the shares generally will be treated as a capital gain; if the
amount realized is less than such tax basis, the difference will
be treated as a capital loss. Any capital gain or capital loss
will be long-term or short-term, depending on whether the shares
have been held for more than one year; the holding period
commences upon exercise of the non-qualified
29
stock option. Certain additional rules may apply if the exercise
price of a non-qualified stock option is paid in shares or other
securities previously owned by the participant.
Incentive
Stock Options
In general, no taxable income is realized by a participant and
no deduction is available to the Company upon either the grant
or exercise of an incentive stock option. If a participant holds
the shares acquired upon the exercise of an incentive stock
option for more than one year after the transfer of the shares
upon exercise of the incentive stock option and at least two
years from the date of the grant of the incentive stock option
(the ISO Holding Period), the difference between the
exercise price and the amount realized upon a subsequent sale of
the shares will be treated as a long-term capital gain or loss
and no deduction will be available to the Company. If the shares
acquired upon exercise of an incentive stock option are disposed
of before the expiration of the ISO Holding Period, the
participant will realize ordinary income and the Company will be
entitled to a deduction on the portion of the gain, if any,
equal to the excess of the fair market value of the shares on
the date of exercise over the incentive stock option exercise
price (or, if less, the excess of the amount realized on the
disposition over the tax basis of the shares); any further gain,
or any loss, from such disposition will be taxable as a
long-term or short-term capital gain or loss, depending upon
whether the shares have been held for more than one year.
Certain additional rules may apply if the exercise price of an
incentive stock option is paid in shares or other securities
previously owned by the participant.
The excess of the fair market value (at the time of exercise) of
the shares acquired upon the exercise of an incentive stock
option over the exercise price of such stock option may
constitute an adjustment to taxable income for purposes of the
alternative minimum tax. Special rules for computing alternative
minimum taxable income also may apply in certain cases where
there are subsequent sales of shares in disqualifying
dispositions and to determine the basis of the shares for
purposes of computing alternative minimum taxable income on a
subsequent sale of the shares.
Vote
Required for Approval
Provided a quorum is present at the Annual Meeting, approval of
Proposal 3 requires the affirmative vote of a majority of
the shares entitled to vote on, and voted for or against, the
proposal.
The Board recommends a vote FOR the approval of the
Companys 2007 Equity Incentive Plan.
PROPOSAL 4
RATIFICATION OF SELECTION OF AUDITOR
Shareholder ratification of the selection of Ernst &
Young LLP as the Companys independent auditors is not
required by our Bylaws or otherwise. However, the Board of
Directors is submitting the selection of Ernst & Young
to the Shareholders for ratification as a matter of good
corporate practice. If the Shareholders fail to ratify the
selection, the Audit Committee and Board of Directors will
reconsider whether or not to retain Ernst & Young. Even
if the selection is ratified, the Board of Directors, in its
discretion, may direct the selection of a different independent
accounting firm at any time during the year if the Board of
Directors believes that this change would be in the best
interests of the Company and its Shareholders.
The Board recommends a vote FOR the ratification of the
selection of Ernst & Young LLP as the independent
auditor of the Company.
30
RELATIONSHIP
WITH INDEPENDENT AUDITORS
The firm of Ernst & Young LLP, independent auditors,
has been selected by the Board of Directors to serve as the
Companys auditors for the fiscal year ending
December 31, 2007. Ernst & Young LLP has served as
the Companys auditors since the inception of the Company.
A representative of Ernst & Young LLP is expected to be
present at the Annual Meeting in order to make a statement if he
so desires and to respond to appropriate questions.
The following table sets forth the various fees for services
provided to the Company by Ernst & Young in 2006 and
2005:
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Audit-
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Related
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Tax
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All Other
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Year
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Audit Fees(1)
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Fees(2)
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Fees(3)
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Fees(4)
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Total Fees
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2006
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$
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1,063,000
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$
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181,700
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$
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42,123
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|
|
$
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6,000
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|
|
$
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1,292,823
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2005
|
|
$
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969,000
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|
|
$
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259,849
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|
$
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50,482
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|
$
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6,000
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$
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1,285,331
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(1) |
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Includes fees for the annual audit and quarterly reviews, SEC
registration statements, accounting and financial reporting
consultations and research work regarding Generally Accepted
Accounting Principles, passenger facility charge audits, and the
attestation of managements 2006 Report on Internal
Controls. |
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(2) |
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Includes fees for audits of benefit plans and wholly owned
captive insurance company. |
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(3) |
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Includes services for tax compliance, tax advice, and tax
planning. |
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(4) |
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Consists of fees for other products and services. |
A copy of the Audit Committees Audit and Non-Audit
Services Preapproval Policy is attached to this Proxy Statement
as Appendix C. All of the services rendered by the
independent auditor during 2006 were pre-approved by the Audit
Committee, or by its Chairman pursuant to his delegated
authority.
31
SHAREHOLDER
PROPOSAL
ADOPT SIMPLE MAJORITY VOTE
(PROPOSAL 5)
RESOLVED: Comprehensive Commitment to Adopt Simple
Majority Vote. Shareholders recommend that our Board take each
step necessary for adoption of a simple majority vote to apply
to the greatest extent possible. This includes using all means
in our Boards power such as corresponding special company
solicitations and
one-on-one
management contacts with major shareholders to obtain the
majority vote required for formal adoption of this proposal
topic.
This proposal is not intended to unnecessarily limit our
Boards judgment in crafting the requested change to the
fullest extent feasible in accordance with applicable laws and
existing governance documents.
This topic won our 77% yes-vote at our 2006 annual meeting. At
least one proxy advisory service has recommend a no-vote for
directors who do not adopt a shareholder proposal after it wins
one majority vote. This topic also won a 66% yes-vote average at
20 major companies in 2006. The Council of Institutional
Investors www.cii.org formally recommends adoption of
this proposal topic.
Our current rule allows a small minority to frustrate the will
of our shareholder majority. For example, in requiring an
80%-vote to make certain key governance changes, if our vote is
an overwhelming 79%-yes and only 1%-no only 1% could
force their will on our 79%-majority.
It is important to take one step forward and support this
proposal since our 2006 governance standards were not
impeccable. For instance in 2006 it was reported (and certain
concerns are noted):
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The Corporate Library (TCL)
http://www.thecorporatelibrary.com/ an independent
research firm rated our company D in corporate
governance.
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Two of our long-tenured directors (16 and 39 years) were on
our key Audit Committee Independence concern.
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Two directors had
non-director
links to our company Independence concern.
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Two of our newer directors held between zero to 1600 shares
each of our inexpensive stock Commitment concern.
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Our full board met only 6-times in a year.
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We had 3 directors over age 70 Succession
concern.
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And our directors can be re-elected with one yes-vote from our
700 million shares under plurality voting.
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Additionally:
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We would have to marshal an awesome 80% shareholder vote to make
certain improvements in our bylaws Entrenchment
concern.
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Cumulative voting was not allowed.
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Our current CEO had tenure of less than
2-years,
while our former CEO remained as Chairman. This was a situation
which could have undermined and weakened our CEOs
leadership.
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The Corporate Library added: The mounting pressures of
ever-increasing competition seem likely to take their toll on
what little remains of the original Southwest vision. Failing a
major overhaul, this is a board and
company that appears now in serious decline, and
weve downgraded our rating accordingly, from an overall B
to an overall D.
The above status shows there is room for improvement and
reinforces the reason to take one step forward now and vote yes
for simple majority vote.
Adopt Simple Majority Vote
Yes on Proposal 5
32
BOARD OF
DIRECTORS POSITION AGAINST THIS PROPOSAL
Your Directors recommend a vote AGAINST the adoption of
this Shareholder Proposal for the following reasons:
We believe the Shareholder Proposal will be substantially
implemented by our Company Proposal No. 2 contained in
this Proxy Statement. By virtue of Company
Proposal No. 2, we are proposing for Shareholder
approval an amendment of our Restated Articles of Incorporation
(the Articles) to delete the supermajority
provisions currently found in the Articles. As discussed in
Company Proposal No. 2, the Board of Directors earlier
this year took the additional step of amending the
Companys Bylaws to remove the supermajority voting
provisions previously existing in the Bylaws. Shareholder
approval was not required for the amendment to the Bylaws.
Although the Shareholder is aware of the actions taken by the
Company to address the issues raised by the Shareholder
Proposal, and although the Shareholder Proposal itself states
that, [t]his proposal is not intended to unnecessarily
limit our Boards judgment in crafting the requested
change, the Shareholder has not withdrawn his Shareholder
Proposal. We oppose the Shareholder Proposal because we believe
it will be substantially implemented by Company
Proposal No. 2. Additionally, the Shareholder Proposal
is so vague and confusing that its implementation by the Company
could subject us to claims we had failed to give full effect to
its intent. We therefore oppose the Shareholder Proposal for the
following specific reasons:
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Uncertainty of Action Being
Requested. The Company Proposal requests that
a specific action be undertaken namely, amendment of
the Companys Articles to remove the supermajority
provisions currently found in the Articles. By contrast, the
Shareholder Proposal is unclear as to specific actions but
instead calls for the Company to take each step
necessary... to the greatest extent possible. Arguably,
this might include actions such as reincorporating to
jurisdictions (such as Delaware) which do not have provisions
such as those contained in the Texas statutes which require a
greater-than-majority
vote in certain circumstances or adopting additional charter or
Bylaw provisions to the extent that these actions would further
assure the implementation of a majority vote standard. Adoption
of the Shareholder Proposal could subject the Company to claims
that filing the amendment to its Articles was insufficient to
meet the greatest extent possible standard of the
Shareholder Proposal.
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Overbroad Scope of Application. The
Company Proposal relates to the specific amendment of our
Articles to remove the supermajority voting requirement for
certain actions. The Shareholder Proposal seems to relate to any
issue that can be subject to Shareholder vote, again by
proposing simple majority vote be implemented to the
greatest extent possible. Adoption of the Shareholder
Proposal would impose an
across-the-board,
one-size-fits-all majority-vote requirement in relation to
matters the Company voluntarily elects to submit to Shareholder
vote, though no law or stock exchange regulation required it to
do so and notwithstanding the possibility that a different
voting standard might be, in light of facts or circumstances
then existing, in the best interests of the Company or its
Shareholders.
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No Clear Definition of a
Majority. The Shareholder
Proposal provides no definition or reference in its use of the
term simple majority. It may be referring to
(i) a majority of outstanding shares, (ii) a majority
of shares represented at the meeting, (iii) a majority of
shares voting on a particular matter, or (iv) some other
calculation. Thus, however the Company interpreted the
Shareholder Proposal when implementing it, the Company could be
subject to claims it had misinterpreted the intent of the
Shareholder Proposal.
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Therefore, the Board of Directors recommends a
vote AGAINST this Shareholder Proposal. Proxies solicited
by the Board of Directors will be so voted unless Shareholders
specify a different choice.
33
OTHER
MATTERS
Notice
Requirements
To permit the Company and its Shareholders to deal with
Shareholder proposals in an informed and orderly manner, the
Bylaws establish an advance notice procedure with regard to the
nomination (other than by or at the direction of the Board of
Directors) of candidates for election to the Board of Directors
and with regard to certain matters to be brought before an
Annual Meeting of Shareholders. In general, under the Bylaws
written notice must be received by the Secretary of the Company
not less than 60 days nor more than 90 days prior to
the meeting and must contain certain specified information
concerning the person to be nominated or the matters to be
brought before the meeting as well as the Shareholder submitting
the proposal. Pursuant to the Companys Bylaws, a
Shareholder may nominate a person or persons for election to the
Board by providing written notice to the Secretary of the
Company not less than 60 and not more than 90 days prior to
the meeting. The notice must contain (i) as to each
nominee, all information required to be disclosed in
solicitations of proxies for election of Directors pursuant to
Regulation 14A under the Securities Exchange Act of 1934,
(ii) the name and address of the Shareholder giving the
notice, and (iii) the number of shares of the Company
beneficially owned by the Shareholder giving the notice. If we
do not receive notice of your proposal
before ,
2008, it will be considered untimely and we may
properly use our discretionary authority to vote for or against
the proposal. A copy of the applicable Bylaw provisions may be
obtained, without charge, upon written request to the Secretary
of the Company at the address set forth on page 1 of this
Proxy Statement.
In addition, any Shareholder who wishes to submit a proposal for
inclusion in the Companys Proxy Statement and proxy
relating to the 2008 Annual Meeting of Shareholders must forward
such proposal to the Secretary of the Company, at the address
indicated on page 1 of this Proxy Statement, so that the
Secretary receives it no later than December ,
2007.
Section 16(a)
Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities and Exchange Act of 1934,
as amended, requires the Companys executive officers and
Directors to file reports of ownership and changes in ownership
of Company Common Stock with the Securities and Exchange
Commission and the New York Stock Exchange. Due to the
Companys administrative error, one filing related to the
automatic grant of Governor Hobbys Performance Shares in
2006 was late.
Discretionary
Authority
In the event a quorum is present at the meeting but sufficient
votes to approve any of the items proposed by the Board of
Directors have not been received, the persons named as proxies
may propose one or more adjournments of the meeting to permit
further solicitation of proxies. A Shareholder vote may be taken
on one or more of the proposals in this Proxy Statement prior to
such adjournment if sufficient proxies have been received and it
is otherwise appropriate. Any adjournment will require the
affirmative vote of the holders of a majority of those shares of
Common Stock represented at the meeting in person or by proxy.
If a quorum is present, the persons named as proxies will vote
these proxies which they have been authorized to vote on any
other business properly before the meeting in favor of such an
adjournment.
The Board of Directors does not know of any other matters that
are to be presented for action at the meeting. However, if other
matters properly come before the meeting, it is intended that
the enclosed proxy will be voted in accordance with the judgment
of the persons voting the proxy.
By Order of the Board of Directors,
Herbert D. Kelleher
Chairman of the Board
April , 2007
34
TO: Participants in the Southwest Airlines Co. ProfitSharing
Plan (the Plan)
The accompanying Notice of Annual Meeting of Shareholders and
Proxy Statement relate to shares of Common Stock of Southwest
Airlines Co. held by the Trustee for your profit sharing
account, as well as any shares you may own in your own name.
Under the Plan, each participant has the right to direct the
voting of stock credited to his or her account. In addition, you
and the other participants are entitled to direct the voting of
stock credited to the accounts of participants who do not give
voting instructions.
The Trustee is required to vote the shares held for your account
in accordance with your instructions. If you wish to instruct
the Trustee on the vote of shares held for your account, you
should vote via telephone or the Internet, or complete and sign
the form enclosed and return it in the addressed, postage-free
envelope by May 14, 2007.
If you do not vote by May 14, 2007, the Plan provides that
the Trustee will vote your shares in the same proportions as the
shares for which the Trustee receives voting instructions from
other participants.
35
APPENDIX A
Articles
of Amendment to the Articles of Incorporation
of
Southwest Airlines Co.
ARTICLE ONE
Southwest Airlines Co., a Texas corporation (the
Corporation), pursuant to the provisions of the
Texas Business Corporation Act, hereby adopts these Articles of
Amendment to its Articles of Incorporation.
ARTICLE TWO
ARTICLE NINE is hereby deleted in its entirety and replaced
with the following:
[Intentionally Omitted]
ARTICLE THREE
The amendment made by these Articles of Amendment was duly
adopted by the shareholders of the Corporation on May 16,
2007.
ARTICLE FOUR
The number of shares outstanding on the record date for such
shareholders meeting
was
and the number of shares entitled to vote on such amendment
was .
A total
of shares
were voted for the amendment
and shares
were voted against the amendment. This Amendment has been
approved in the manner required by the Texas Business
Corporation Act and the constituent documents of the Corporation.
IN WITNESS THEREOF, the Corporation has caused these Articles of
Amendment to be executed
this
day
of ,
2007.
SOUTHWEST AIRLINES CO.
Laura H. Wright, Senior Vice President-Finance
and Chief Financial Officer
A-1
Appendix B
SOUTHWEST
AIRLINES CO.
2007
EQUITY INCENTIVE PLAN
I. PURPOSE
The purpose of the SOUTHWEST AIRLINES CO. 2007 EQUITY
INCENTIVE PLAN (the Plan) is to secure for the
Company the benefits of the additional incentive inherent in the
ownership of its Common Stock by Directors and selected key
Employees of the Company and its Affiliates who are important to
the success and the growth of the Company and its Affiliates,
and to help the Company and its Affiliates secure and retain the
services of such Directors and key Employees.
II. DEFINITIONS
The following definitions shall be applicable throughout the
Plan, unless specifically modified by any provision of the Plan:
(a) Affiliate means any corporation,
partnership, limited liability company or partnership,
association, trust, or other organization which, directly or
indirectly, controls, is controlled by, or is under common
control with, the Company. For purposes of the preceding
sentence, control (including, with correlative
meanings, the terms controlled by and under
common control with), as used with respect to any entity
or organization, shall mean the possession, directly or
indirectly, of the power (i) to vote more than
50 percent of the securities having ordinary voting power
for the election of directors of the controlled entity or
organization; or (ii) to direct or cause the direction of
the management and policies of the controlled entity or
organization, whether through the ownership of voting securities
or by contract or otherwise.
(b) Agreement means an agreement,
certificate, or other documentation (in each case, whether in
written, electronic, or other format) governing the grant of an
Award under the Plan, which shall contain terms and conditions
not inconsistent with the Plan and which shall incorporate the
Plan by reference.
(c) Award means, individually or
collectively, any Option, Restricted Stock Award, Restricted
Stock Unit, or Performance Award.
(d) Board means the Board of Directors
of the Company.
(e) Code means the Internal Revenue Code
of 1986, as amended. Reference in the Plan to any section of the
Code shall be deemed to include any amendments or successor
provisions to such section and any regulations under such
section.
(f) Committee means the committee(s)
appointed by the Board to administer the Plan, in accordance
with Section IV(a) of the Plan.
(g) Common Stock means the common stock,
par value $1.00 per share, of the Company, or any security
into which such common stock may be changed by reason of any
transaction or event of the type described in Section XI of
the Plan.
(h) Company means Southwest Airlines
Co., a Texas corporation.
(i) Director means an individual who is
a member of the Board.
(j) Employee means any person (including
a Director) in an employment relationship with the Company or
any Affiliate.
(k) Exchange Act means the Securities
Exchange Act of 1934, as amended.
(l) Fair Market Value means, as of any
specified date, unless otherwise determined by the Committee,
the closing price of the Common Stock as reported by the primary
national stock exchange on which such stock is listed. If no
sale shall have been made on that day, or if the Common Stock is
not listed on a national exchange at that time, fair market
value will be determined by the Committee in such manner as it
deems
B-1
appropriate including, without limitation, by reference to the
last preceding date on which the price of the Common Stock is
reported by a national stock exchange or, if the Common Stock is
traded over the counter at the time a determination of its fair
market value is required to be made hereunder, by reference to
the average between the reported high and low or closing bid and
asked prices of the Common Stock on the most recent date on
which the Common Stock was publicly traded.
(m) Incentive Stock Option means an
incentive stock option within the meaning of Section 422 of
the Code.
(n) Non-Employee Director means a member
of the Board who is not an Employee of the Company or any of its
Affiliates.
(o) Non-Qualified Stock Option means any
Option that does not qualify as an Incentive Stock Option.
(p) Option means a right granted to a
Participant under Section VII of the Plan to purchase
shares of Common Stock at such time and price, and subject to
such other terms, conditions, and restrictions, as are set forth
in the Plan and in the applicable Agreement. Options may be
Incentive Stock Options or Non-Qualified Stock Options.
(q) Participant means an Employee or
Director who has been granted an Award under the Plan.
(r) Performance Award means an Award
that includes performance measures in accordance with
Section X of the Plan.
(s) Plan means the Southwest Airlines
Co. 2007 Equity Incentive Plan, as amended from time to time.
(t) Restricted Stock Award means an
Award of Common Stock granted under Section VIII of the
Plan that is subject to the restrictions set forth in such
Section and to such other terms, conditions, and restrictions as
are set forth in the Plan and in the applicable Agreement.
(u) Restricted Stock Unit means a right
granted under Section IX of the Plan to receive a share of
Common Stock in the future, subject to such terms, conditions,
and restrictions as are set forth in the Plan and in the
applicable Agreement.
(v) Rule 16b-3
means
Rule 16b-3
promulgated under the Exchange Act, as such may be amended from
time to time, and any successor rule, regulation, or statute
fulfilling the same or a similar function.
(w) Section 162(m) means
Section 162(m) of the Code and the regulations promulgated
thereunder from time to time.
(x) Section 162(m) Exception means
the exception under Section 162(m) for qualified
performance-based compensation.
III. EFFECTIVE
DATE AND DURATION OF THE PLAN
The Plan shall become effective upon the date of its approval by
the Shareholders of the Company. No Awards may be granted under
the Plan after ten years from the date the Plan is adopted by
the Board. The Plan shall remain in effect until all Options
granted under the Plan have been exercised or have expired, all
Restricted Stock Awards and Restricted Stock Units granted under
the Plan have vested or been forfeited, and all Performance
Awards have been satisfied or have expired.
IV. ADMINISTRATION
(a) Composition of Committee. The
Plan shall be administered by the Board or by a committee of,
and appointed by, the Board that shall be comprised of at least
two members of the Board; provided that, (i) with
respect to any Award that is intended to satisfy the
requirements of
Rule 16b-3,
such committee shall consist of at least such number of
Directors as is required from time to time by
Rule 16b-3,
and each such committee member shall satisfy the qualification
requirements of such rule; (ii) with respect to any Award
that is intended to satisfy the requirements of the
Section 162(m) Exception, such committee shall consist of
at least such number of Directors as is required
B-2
from time to time to satisfy the Section 162(m) Exception,
and each such committee member shall satisfy the qualification
requirements of such exception; and (iii) to the extent
required under the rules of any stock exchange or automated
quotation system on which the Common Stock is listed for trading
or quoted, each member of such committee shall satisfy any
independence or other requirements of such exchange
or quotation system; provided, however, that if any such
committee member is found not to have met the qualification
requirements set forth in clauses (i) and/or
(ii) above, any actions taken or Awards granted by such
committee shall not be invalidated by such failure to so
qualify. Subject to (i) the limitations set forth in this
Section IV and (ii) any limitations set forth in the
Texas Business Corporation Act, as well as any other laws,
rules, or regulations that may apply from time to time, the
Committee shall have the authority to delegate some or all of
its authority under the Plan to one or more members of the
Committee or to one or more officers of the Company.
(b) Powers. Subject to the express
provisions of the Plan, the Committee shall have authority, in
its discretion, to determine the individuals who will receive an
Award, the time or times when such Award shall be made, the type
of Award that shall be made, and the number of shares of Common
Stock to be subject to each Award. In making its determinations,
the Committee shall take into account the nature of the services
rendered by the respective individuals, their present
responsibility level, performance, and potential contribution to
the Companys success, any other Awards received by them,
and such other factors as the Committee in its sole discretion
shall deem relevant. Subject to the express provisions of the
Plan, the Committee shall have the power to interpret the Plan
and the respective Agreements hereunder, to establish rules and
regulations relating to the Plan, and to make all other
determinations necessary or advisable for administering the
Plan. The Committee may correct any defect, supply any omission,
or reconcile any inconsistency in the Plan or in any Agreement
relating to an Award in the manner and to the extent it shall
deem expedient to carry it into effect. The Committee shall have
the authority to amend the terms of any outstanding Award or to
waive any condition or restriction applicable to any Award in
any manner that is not inconsistent with the terms of the Plan;
provided, however, that no amendment may
materially impair the rights of the holder thereof without the
holders consent. The determinations of the Committee on
the matters referred to in this Section IV shall be
conclusive.
With respect to any restriction in the Plan, or to which any
Award is subject, that is based on the requirements of
Rule 16b-3,
Section 422 of the Code, the Section 162(m) Exception,
the rules of any exchange upon which the Companys
securities are listed or automated quotation system upon which
the Companys securities are quoted, or any other
applicable law, rule, or restriction, to the extent that any
such restriction is no longer required, the Committee shall have
the sole discretion and authority to grant Awards that are not
subject to such restriction
and/or to
waive any such restriction with respect to outstanding Awards.
V. SHARES SUBJECT
TO THE PLAN
Subject to adjustment in accordance with Section XI below,
the maximum number of shares of Common Stock that may be issued
under the Plan with respect to all types of Awards in the
aggregate shall not exceed 6,000,000; provided that no
more than 2,400,000 of the 6,000,000 shares shall be issued
pursuant to Restricted Stock and Restricted Stock Unit Awards,
collectively. (For example, (i) if the Company were to
issue 2,400,000 shares of Common Stock pursuant to
Restricted Stock
and/or
Restricted Stock Unit Awards, 3,600,000 shares would remain
available for issuance pursuant to Option Awards only, and no
shares would remain available for Restricted Stock or Restricted
Stock Unit Awards; or (ii) if the Company were to issue
5,500,000 shares of Common Stock pursuant to Option Awards,
500,000 shares would remain available for Restricted Stock,
Restricted Stock Unit and/or Option Awards.) To the extent
that an Award lapses or the rights of its holder terminate, any
shares of Common Stock subject to such Award shall again be
available for the grant of an Award under the Plan.
Notwithstanding any provision in the Plan to the contrary,
subject to adjustment in accordance with Section XI below,
the maximum number of shares of Common Stock with respect to
which Awards may be granted in the aggregate to any Participant
during the term of the Plan shall not exceed 450,000.
The stock to be offered pursuant to the grant of an Award may be
authorized but unissued Common Stock, Common Stock previously
issued and outstanding and reacquired by the Company, or both.
Any of such shares that remain unissued and that are not subject
to outstanding Awards at the termination of the Plan shall cease
to be
B-3
subject to the Plan but, until termination of the Plan, the
Company shall at all times make available a sufficient number of
shares to meet the requirements of the Plan.
VI. ELIGIBILITY
Awards may be granted only to persons who, at the time of grant,
are Employees or Directors; provided that Awards of
Incentive Stock Options may only be granted to Employees of the
Company or any parent or subsidiary corporation in accordance
with Section VII(e) below.
VII. STOCK
OPTIONS
(a) Grants of Stock Options
Generally. The Committee may from time to
time grant Options on the terms and conditions set forth in the
Plan and on such other terms and conditions as are not
inconsistent with the purposes and provisions of the Plan as the
Committee, in its discretion, may from time to time determine.
(b) Automatic Grants of Options to Non-Employee
Directors. Each individual who becomes a
Non-Employee Director after adoption of this Plan and who has
not previously been granted Options under this or any other plan
of the Company shall, on the date of his or her initial
appointment or election to the Board, be granted a Non-Qualified
Stock Option to purchase 10,000 shares of Common Stock at a
price equal to 100 percent of the Fair Market Value of the
Common Stock on such date. Each individual who became a
Non-Employee Director prior to adoption of this Plan and who has
not previously been granted Options under any plan of the
Company shall, on the date of the 2007 Annual Meeting of
Shareholders of the Company, be granted an Option to purchase
8,000 shares of Common Stock at a price equal to
100 percent of the Fair Market Value of the Common Stock on
such date. Subject to Section VII(g) below, Options granted
to Non-Employee Directors pursuant to this Section VII(b)
shall have a term of ten years and shall become exercisable with
respect to one-third of the shares covered thereby annually,
beginning on the first anniversary of the date of grant.
(c) Option Period. Subject to
Section VII(b) above (regarding automatic grants to
Non-Employee Directors), the term of each Option shall be as
specified by the Committee at the date of grant of such Option,
but in no event shall an Option be exercisable after the
expiration of ten years from the date of its grant.
(d) Exercisability of
Options. Subject to Section VII(b) above
(regarding automatic grants to Non-Employee Directors), an
Option shall be exercisable in whole or in such installments and
at such times as are determined by the Committee.
(e) Special Limitations on Incentive Stock
Options. The maximum number of shares of
Common Stock that may be issued under the Plan with respect to
Incentive Stock Options shall be 6,000,000, subject to the
following limitations. An Incentive Stock Option may be granted
only to an individual who is employed by the Company or any
parent or subsidiary corporation (as defined in Section 424
of the Code) at the time the Option is granted. To the extent
that the aggregate Fair Market Value (determined at the time an
Incentive Stock Option is granted) of the Common Stock with
respect to which Incentive Stock Options are exercisable for the
first time by an individual during any calendar year under all
incentive stock option plans of the Company and its parent and
subsidiary corporations exceeds $100,000, such Incentive Stock
Options shall be treated as Non-Qualified Stock Options. No
Incentive Stock Option shall be granted to an individual if, at
the time the Option is granted, such individual owns stock
possessing more than 10 percent of the total combined
voting power of all classes of stock of the Company or of its
parent or subsidiary corporations, within the meaning of
Section 422(b)(6) of the Code, unless (i) at the time
such Option is granted the option price is at least
110 percent of the Fair Market Value of the Common Stock
subject to the Option and (ii) such Option by its terms is
not exercisable after the expiration of five years from the date
of grant.
(f) Option Exercise Price and Payment of Exercise
Price. The exercise price of an Option shall
be determined by the Committee but, subject to adjustment as
provided in Section XI, such exercise price shall not be
less than the Fair Market Value of a share of Common Stock on
the date such Option is granted. The exercise price may be paid
as follows: (i) in cash; (ii) in the discretion of the
Committee, in shares of Common Stock (provided that the
Committee may require that such shares have been held by the
Participant for a specified period
B-4
time); (iii) by delivery (including by fax or electronic
means in accordance with the procedures determined by the
Committee) to the Company or its designated agent of an
irrevocable Option exercise notice together with irrevocable
instructions from the Participant to a broker or dealer,
reasonably acceptable to the Company, to sell certain shares of
Common Stock purchased upon exercise of an Option or to pledge
such shares as collateral for a loan and promptly deliver to the
Company the amount of sale or loan proceeds necessary to pay the
exercise price for the Option (provided that, with
respect to such a cashless exercise, the Option shall be deemed
exercised on the date of sale of the shares of Common Stock
received upon exercise);
and/or
(iv) in any other form of valid consideration that is
acceptable to the Committee in its sole discretion.
(g) Rights Upon Termination of
Service. Subject to Section VII(e) above
(regarding Incentive Stock Options), in the event of the
termination of a Participants service with the Company or
any Affiliate, such Participants Options that have not
vested as of the date of termination shall automatically and
without notice terminate and become null and void at
4:00 p.m., Eastern Time, on the date of termination. The
vested portion of the Participants outstanding Options
shall thereafter automatically and without notice terminate and
become null and void at 4:00 p.m., Eastern Time, on the
date that is the earliest to occur of the following (the
Option Termination Date):
(i) The date of the Participants termination of
service with the Company or an Affiliate for cause, including
breach by the Participant of an employment agreement with the
Company or an Affiliate or the Participants commission of
a felony or misdemeanor (whether or not prosecuted) against the
Company or an Affiliate;
(ii) The expiration of two years following the date of
termination of a Participants employment with the Company
or an Affiliate if such Participant is not also a Director of
the Company;
(iii) The expiration of five years following the date of
termination of a Directors service with the Board;
(iv) The expiration of such period of time or the
occurrence of such event as the Committee in its discretion may
provide in the Participants Option Agreement;
(v) The expiration of ten years from the date of grant of
such Option.
Upon the occurrence of any event described in this
Section VII(g), any Participant who desires to exercise an
Option prior to the Option Termination Date shall be required to
provide notice of exercise to the Company prior to the close of
trading on the New York Stock Exchange on the Option Termination
Date.
(h) Restrictions on Repricing of
Options. Subject to Section XI below,
the Committee may not reprice Options for any reason.
(i) Shareholder Rights and
Privileges. A Participant shall have no right
to receive dividends, vote, or otherwise exercise the privileges
and rights of a Shareholder with respect to an unexercised
Option. The Participant shall be entitled to all the privileges
and rights of a Shareholder only with respect to such shares of
Common Stock as have been purchased under the Option and for
which shares of Common Stock have been registered in the
Participants name or otherwise credited to the Participant.
(j) Option Agreements. Options
granted under the Plan shall be evidenced by an Option Agreement
in such form and containing such provisions not inconsistent
with the provisions of the Plan as the Committee from time to
time shall approve, including, without limitation, (i) the
number of Options granted; (ii) the date of grant;
(iii) the option exercise price; (iv) whether such
Options are Incentive Stock Options or Non-Qualified Stock
Options; (v) the period during which such Options may be
exercised and any vesting schedule applicable to such Options,
including any applicable performance measures (as set forth in
Section X); (vi) the effect of termination of
employment or service on the exercisability of the Options; and
(vii) any other terms that the Committee deems appropriate.
B-5
VIII. RESTRICTED
STOCK AWARDS
(a) Grants of Restricted
Stock. The Committee may from time to time
grant shares of Restricted Stock on the terms and conditions set
forth in the Plan and on such other terms and conditions as are
not inconsistent with the purposes and provisions of the Plan as
the Committee, in its discretion, may from time to time
determine.
(b) Vesting of Restricted
Stock. Shares of Common Stock that are the
subject of a Restricted Stock Award shall be subject to
restrictions on disposition by the Participant and an obligation
of the Participant to forfeit and surrender the shares to the
Company under certain circumstances, as determined by the
Committee. The Committee shall establish the vesting schedule
applicable to each Restricted Stock Award, provided that
(i) in no event shall any Restricted Stock Award that
has a vesting schedule based on the passing of time have (or be
accelerated such that it has) a vesting schedule of less than
three years from the date of grant, and no more than
331/3
percent of any such Award shall vest on each anniversary of the
date of grant; and (ii) in no event shall any Restricted
Stock Award that is a Performance Award vest (or be accelerated
such that it vests) in under one year from the date of grant.
The Committee may provide that the shares will vest upon
(i) the Participants continued employment with the
Company for a specified period of time; (ii) the attainment
of one or more performance measures established by the
Committee, as set forth in Section X; (iii) the
occurrence of any event or the satisfaction of any other
condition specified by the Committee in its sole discretion; or
(iv) a combination of any of the foregoing.
(c) Rights and Restrictions Governing Restricted
Stock. Common Stock awarded pursuant to a
Restricted Stock Award shall be registered in the
Participants name or otherwise credited to the
Participant. Unless provided otherwise in a Restricted Stock
Agreement, the Participant shall have the right to receive
dividends or other distributions with respect to shares of
Common Stock subject to a Restricted Stock Award, to
vote Common Stock subject thereto, and to enjoy all other
Shareholder rights, except that (i) the Participant shall
not be entitled to delivery of unrestricted shares until all
conditions to vesting have been satisfied; (ii) the
Participant may not sell, transfer, pledge, assign, exchange,
hypothecate, or otherwise encumber or dispose of the shares
until all conditions to vesting have been satisfied; and
(iii) a breach of the terms and conditions established by
the Committee pursuant to the Restricted Stock Agreement shall
cause a forfeiture of the Restricted Stock.
(d) Payment for Restricted
Stock. The Committee shall determine the
amount and form of any payment for Common Stock received
pursuant to a Restricted Stock Award, provided that, in
the absence of such a determination, a Participant shall not be
required to make any payment for Common Stock received pursuant
to a Restricted Stock Award, except to the extent otherwise
required by law.
(e) Rights Upon Termination of
Service. In the event of the termination of a
Participants service with the Company or any Affiliate,
any of such Participants shares of Restricted Stock that
have not vested as of the date of termination shall
automatically and without notice be forfeited at 4:00 p.m.,
Eastern Time, on the date of termination.
(f) Restricted Stock
Agreements. Each Restricted Stock Award shall
be evidenced by a Restricted Stock Agreement in such form and
containing such provisions not inconsistent with the provisions
of the Plan as the Committee from time to time shall approve,
including, without limitation, (i) the number of shares of
Restricted Stock granted; (ii) the date of grant;
(iii) the price, if any, to be paid by the Participant for
such Restricted Stock; (iv) the vesting schedule applicable
to such Restricted Stock, including any applicable performance
measures (as set forth in Section X) or other
restrictions; (v) the effect of termination of service on
the vesting of the Restricted Stock; and (vi) any other
terms that the Committee deems appropriate.
IX. RESTRICTED
STOCK UNITS
(a) Grants of Restricted Stock
Units. The Committee may from time to time
grant Restricted Stock Units on the terms and conditions set
forth in the Plan and on such other terms and conditions as are
not inconsistent with the purposes and provisions of the Plan as
the Committee, in its discretion, may from time to time
determine.
(b) Vesting of Restricted Stock
Units. The Committee shall establish the
vesting schedule applicable to each Restricted Stock Unit Award;
provided that (i) in no event shall any Restricted
Stock Unit Award that has a vesting schedule based on the
passing of time have (or be accelerated such that is has) a
vesting schedule of less than three
B-6
years from the date of grant, and no more than
331/3
percent of any such Award shall vest (or be accelerated such
that it vests) on each anniversary of the date of grant; and
(ii) in no event shall any Restricted Stock Award that is a
Performance Award vest in under one year from the date of grant.
The Committee may provide that the Restricted Stock Units will
vest upon (i) the Participants continued employment
with the Company for a specified period of time; (ii) the
attainment of one or more performance measures established by
the Committee, as set forth in Section X; (iii) the
occurrence of any event or the satisfaction of any other
condition specified by the Committee in its sole discretion; or
(iv) a combination of any of the foregoing.
(c) Settlement of Restricted Stock
Units. On the date on which Restricted Stock
Units vest (or at such other time or times as the Committee may
provide), the holder of such Restricted Stock Units shall be
entitled to receive one share of Common Stock for each
Restricted Stock Unit that has vested. In such event, the
applicable number of shares of Common Stock shall be registered
in the Participants name or otherwise credited to the
Participant.
(d) Shareholder Rights and
Privileges. A Participant shall have no right
to receive dividends, vote, or otherwise exercise the privileges
and rights of a Shareholder with respect to outstanding
Restricted Stock Units granted pursuant to this Section. The
Participant shall be entitled to all of the privileges and
rights of a Shareholder only with respect to such shares of
Common Stock as have been issued pursuant to a Restricted Stock
Unit Award and that have been registered in the
Participants name or otherwise credited to the Participant.
(e) Rights Upon Termination of
Service. In the event of the termination of a
Participants service with the Company or any Affiliate,
any of such Participants Restricted Stock Units that have
not vested as of the date of termination shall automatically and
without notice be forfeited at 4:00 p.m., Eastern Time, on
the date of termination.
(f) Restricted Stock Unit Award
Agreements. Each Restricted Stock Unit
granted pursuant to this Section IX shall be evidenced by
an Agreement in such form and containing such provisions not
inconsistent with the provisions of the Plan as the Committee
from time to time shall approve, including, without limitation,
(i) the number of Restricted Stock Units granted;
(ii) the date of grant; (iii) the price, if any, to be
paid by the Participant in connection with such Restricted Stock
Units; (iv) the vesting schedule applicable to such
Restricted Stock Units, including any applicable performance
measures (as set forth in Section X) or other
restrictions; (v) the effect of termination of service on
the vesting of the Restricted Stock Units; and (vi) any
other terms that the Committee deems appropriate.
X. PERFORMANCE
AWARDS
The grant, vesting,
and/or
exercisability of any Award may, in the Committees sole
discretion, be conditioned, in whole or in part, on the
attainment of performance targets related to one or more
performance measures over a performance period, in which case,
such Award shall constitute a Performance Award under the Plan.
(a) Performance
Measures. (i) Performance Awards that
are not intended to qualify for the Section 162(m)
Exception may be based on the achievement of such goals and be
subject to such terms, conditions, and restrictions as the
Committee shall determine.
(ii) Performance Awards that are intended to qualify for
the Section 162(m) Exception based on the satisfaction of
one or more performance measures shall be conditioned upon the
achievement during a specified performance period of specified
levels of one or more of the measures listed below. The
Committee shall establish the performance measures applicable to
such performance either (i) prior to the beginning of the
performance period or (ii) within 90 days after the
beginning of the performance period if the outcome of the
performance targets is substantially uncertain at the time such
targets are established, but not later than the date on which
25 percent of the performance period has elapsed; provided
such measures may be made subject to adjustment for specified
significant extraordinary items or events to the extent
consistent with Section 162(m) of the Code. The performance
measures established by the Committee may be based upon
(1) the earnings or earnings per share of the Company or of
any business unit of the Company designated by the Committee;
(2) the net operating margin of the Company or of any
business unit of the Company designated by the Committee;
(3) the cash flow return on investment of the Company or
any business unit of the Company designated by the Committee;
(4) the earnings before interest, taxes, depreciation,
and/or
amortization of the Company or any business unit of the Company
designated by the
B-7
Committee; (5) the return on shareholders equity
achieved by the Company; (6) the total shareholders
return achieved by the Company; (7) any of the foregoing
calculated on an economic basis; (8) the price
of a share of Common Stock; (9) the Companys market
share; (10) the market share of a business unit of the
Company designated by the Committee; (11) the
Companys sales; (12) the sales of a business unit of
the Company designated by the Committee; (13) the economic
value added; or (14) any combination of the foregoing. A
measure that is calculated on an economic basis is a
measure that is adjusted (to the extent consistent with
Section 162(m) of the Code) to reflect the impact of
special items, which items are reflected from time to time in
the Companys published financials. Special items are
material nonrecurring adjustments deemed appropriate to exclude
by the Committee and may include, without limitation,
(a) unrealized gains or losses and other items that are
recorded by the Company as a result of Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended;
(b) impairment and other non-cash charges including the
impact of changes in accounting principles or estimates or other
unusual, infrequent non-cash items; and (c) other items not
considered to be representative of the Companys ongoing
operations.
(b) Determination of Awards. To
the extent the Committee intends for Awards to qualify for the
Section 162(m) Exception, prior to the Participants
receipt of shares of Common Stock pursuant to such Awards (or
prior to receipt of the Awards themselves, if applicable), the
Committee shall certify whether the performance targets and
measure(s) related to such Awards have been achieved. The
Committee, in its sole discretion, may provide for a reduction
in a Participants Performance Award during the performance
period.
XI. RECAPITALIZATION
OR REORGANIZATION
(a) No Effect on Right or
Power. The existence of the Plan and the
Awards granted hereunder shall not affect in any way the right
or power of the Board or the Shareholders of the Company to make
or authorize (i) any adjustment, recapitalization,
reorganization, or other change in the Companys or any
Affiliates capital structure or its business;
(ii) any merger or consolidation of the Company or any
Affiliate; (iii) any issue of debt or equity securities
ahead of or affecting Common Stock or the rights thereof;
(iv) the dissolution or liquidation of the Company or any
Affiliate; (v) any sale, lease, exchange, or other
disposition of all or any part of the Companys or any
Affiliates assets or business; or (vi) any other
corporate act or proceeding.
(b) Subdivision or Consolidation of Shares; Stock
Dividends. The shares with respect to which
Awards may be granted are shares of Common Stock as presently
constituted, but if, and whenever, prior to the expiration of an
Award theretofore granted, the Company shall effect a
subdivision or consolidation of shares of Common Stock or the
payment of a stock dividend on Common Stock without receipt of
consideration by the Company, the number of shares of Common
Stock with respect to which such Award may thereafter be
exercised or satisfied, as applicable, (i) in the event of
an increase in the number of outstanding shares, shall be
proportionately increased, and the exercise price per share (if
applicable) shall be proportionately reduced; and (ii) in
the event of a reduction in the number of outstanding shares,
shall be proportionately reduced, and the exercise price per
share (if applicable) shall be proportionately increased. In the
event of any such change in the outstanding Common Stock, the
aggregate number of shares available under the Plan may be
appropriately adjusted by the Committee, whose determination
shall be conclusive.
(c) Recapitalizations and Corporate
Changes. If the Company recapitalizes or
otherwise changes its capital structure (a
recapitalization), the number and class of shares of
Common Stock covered by an Award theretofore granted shall be
adjusted so that such Award shall thereafter cover the number
and class of shares of stock and securities to which the
Participant would have been entitled pursuant to the terms of
the recapitalization if, immediately prior to such
recapitalization, the Participant had been the holder of record
of the number of shares of Common Stock then covered by such
Award. If the Company shall not be the surviving entity in any
merger or consolidation (or survives only as a subsidiary of an
entity other than a previously wholly-owned subsidiary of the
Company), or if the Company is to be dissolved or liquidated,
then, unless a surviving corporation assumes or substitutes new
Awards for Awards then outstanding hereunder, (i) all
unvested Options then outstanding shall be accelerated and shall
become exercisable in full, and all restrictions
and/or
performance measures with respect to any Award shall be deemed
to be satisfied, on or before a date fixed by the Company prior
to the effective date of
B-8
such merger or consolidation or such dissolution or liquidation;
and (ii) upon such effective date, Awards shall expire.
(d) Awards and Rights in Substitution for Awards
Granted by Other Employers. Awards may be
granted under the Plan from time to time in substitution for
Awards held by individuals providing services to corporations or
other entities who become Employees or Directors as a result of
a merger or consolidation or other business transaction with the
Company or any Affiliate.
(e) Shareholder Action. Any
adjustment provided for in the above Subsections shall be
subject to any required Shareholder action.
(f) No Adjustments Unless Otherwise
Provided. Except as hereinbefore expressly
provided, the issuance by the Company of shares of stock of any
class or securities convertible into shares of stock of any
class for property, labor, or services, upon direct sale, upon
the exercise of rights or warrants to subscribe therefor, or
upon conversion of shares or obligations of the Company
convertible into such shares or other securities, and in any
case whether or not for fair value, shall not affect, and no
adjustment by reason thereof shall be made with respect to, the
number of shares of Common Stock subject to Awards theretofore
granted or the exercise price per share, if applicable.
XII. AMENDMENT
AND TERMINATION OF THE PLAN
The Board in its discretion may terminate the Plan at any time
with respect to any shares of Common Stock for which Awards have
not theretofore been granted. In addition, the Board shall have
the right to alter or amend the Plan or any part thereof from
time to time; provided that no change in the Plan may be
made that would impair the rights of a Participant with respect
to an Award theretofore granted without the consent of the
Participant; and provided, further, that no amendment
shall be made without approval of the Shareholders of the
Company if such approval is required under applicable law or by
the requirements of any exchange or automated quotation system
upon which the Common Stock is listed for trading or quoted.
XIII. MISCELLANEOUS
(a) No Right to An Award. Neither
the adoption of the Plan nor any action of the Board or of the
Committee shall be deemed to give any individual any right to be
granted an Award nor any other rights hereunder except as may be
evidenced by an Award Agreement, and then only to the extent and
on the terms and conditions expressly set forth therein. The
Plan shall be unfunded. The Company shall not be required to
establish any special or separate fund or to make any other
segregation of funds or assets to assure the performance of its
obligations with respect to any Award.
(b) No Employment/Board Membership Rights
Conferred. Nothing contained in the Plan
shall (i) confer upon any Employee any right with respect
to continuation of an employment relationship with the Company
or any Affiliate or (ii) interfere in any way with the
right of the Company or any Affiliate to terminate his or her
employment relationship at any time. Nothing contained in the
Plan shall confer upon any Director any right with respect to
continuation of membership on the Board.
(c) Other Laws; Withholding. By
accepting any shares of Common Stock issued pursuant to an Award
granted under the Plan, the Participant thereby represents and
warrants to the Company that the purchase or receipt of such
shares shall be for investment and not with a view to
distribution; provided that such representation and
warranty shall be inoperative if, in the opinion of counsel to
the Company, a proposed sale or distribution of such shares is
pursuant to an applicable effective registration statement under
the Securities Act of 1933, as amended, or is, without such
representation and warranty, exempt from registration under such
Act. The Company shall not be obligated to issue any Common
Stock pursuant to any Award granted under the Plan at any time
when the requirements of any securities exchange upon which the
Companys securities shall then be listed have not been met
or when the shares covered by such Award have not been
registered under the Securities Act of 1933, as amended, and
such other state and federal laws, rules, and regulations as the
Company or the Committee deem applicable and, in the opinion of
legal counsel for the Company, there is no exemption from the
registration requirements of such laws, rules, and regulations
available for the issuance and sale of such shares. The Company
may (i) endorse an
B-9
appropriate legend referring to the foregoing restrictions upon
the certificate or certificates representing any shares of
Common Stock issued or transferred pursuant to any Award granted
under this Plan; or (ii) otherwise note such restrictions
with respect to Common Stock that is not certificated. No
fractional shares of Common Stock shall be delivered, nor shall
any cash in lieu of fractional shares be paid. The Company shall
have the right to deduct in connection with all Awards any taxes
required by law to be withheld and to require any payments
required to enable it to satisfy its withholding obligations.
This authority shall include the authority to withhold or
receive Common Stock or other property and to make cash payments
in respect thereof in satisfaction of a Participants tax
obligations, either on a mandatory or elective basis in the
discretion of the Committee. The Committee, in its sole
discretion, may require, as a condition to the exercise of any
Option or delivery of any shares of Common Stock, that an
additional amount be paid in cash equal to the amount of any
taxes owed as a result of such exercise or delivery.
(d) No Restriction on Corporate
Action. Nothing contained in the Plan shall
be construed to prevent the Company or any Affiliate from taking
any action that is deemed by the Company or such Affiliate to be
appropriate or in its best interest, whether or not such action
would have an adverse effect on the Plan or any Award made under
the Plan. No Participant, beneficiary, or other person shall
have any claim against the Company or any Affiliate as a result
of any such action.
(e) Restrictions on Transfer. No
Award granted under this Plan or any right evidenced thereby
shall be transferable by the Participant other than by will or
the laws of descent and distribution, and any Options shall be
exercisable during the Participants lifetime only by such
Participant or the Participants guardian or legal
representative.
(f) Governing Law. The Plan
shall be governed by, and construed in accordance with, the laws
of the State of Texas, without regard to conflicts of laws
principles thereof.
B-10
APPENDIX C
Southwest Airlines Co.
Audit and Non-Audit Services Preapproval Policy
Adopted March 20, 2003
I. Purpose
Under the Sarbanes-Oxley Act of 2002 (the Act) and
the rules of the Securities and Exchange Commission (the
SEC), the Audit Committee of the Board of Directors
is responsible for the appointment, compensation, and oversight
of the work of the independent auditor. The Audit Committee is
required to pre-approve the audit and non-audit services
performed by the independent auditor in order to assure that
they do not impair the auditors independence from the
Company. Accordingly, the Audit Committee has adopted, and the
Board of Directors of Southwest Airlines Co. (the
Company or Southwest) has ratified, this
Audit and Non-Audit Services Preapproval Policy (the
Policy), which sets forth the procedures and the
conditions pursuant to which services proposed to be performed
by the independent auditor may be preapproved.
The SECs rules provide that proposed services may be
preapproved without consideration of specific
case-by-case
services by the Audit Committee (general
preapproval) or may require the specific preapproval of
the Audit Committee (specific preapproval). The
Audit Committee believes that the combination of these two
approaches in this Policy will result in an effective and
efficient procedure to pre-approve services performed by the
independent auditor. Accordingly, unless a type of service has
received general preapproval, it will require specific
preapproval by the Audit Committee if it is to be provided by
the independent auditor. Any proposed services exceeding
preapproved cost levels or budgeted amounts will also require
specific preapproval by the Audit Committee.
For each preapproval, the Audit Committee will consider whether
the services are consistent with the SECs rules on auditor
independence. The Audit Committee will also consider whether the
independent auditor is best positioned to provide the most
effective and efficient service, for reasons such as its
familiarity with the Companys business, people, culture,
accounting systems, risk profile and other factors, and whether
the service might enhance the Companys ability to manage
or control risk or improve audit quality. All such factors will
be considered as a whole, and no one factor will necessarily be
determinative.
The independent auditor has reviewed this Policy and believes
that implementation of the policy will not adversely affect the
auditors independence.
II. Delegation
The Act and the SECs rules permit the Audit Committee to
delegate preapproval authority to one or more of its members.
The member to whom such authority is delegated must report, for
informational purposes only, any preapproval decisions to the
Audit Committee at its next scheduled meeting.
III. Audit
Services
The annual Audit services engagement terms and fees will be
subject to the specific preapproval of the Audit Committee. The
Audit Committee will monitor the Audit services engagement as
necessary, but no less than on a quarterly basis, and will also
approve, if necessary, any changes in terms, conditions and fees.
In addition to the annual Audit services engagement approved by
the Audit Committee, the Audit Committee may grant preapproval
to other Audit services, which are those services that only the
independent auditor reasonably can provide. Other Audit services
may include services associated with SEC registration statements
or other documents issued in connection with securities
offerings.
C-1
IV. Audit-related
Services
Audit-related services are assurance and related services that
are reasonably related to the performance of the audit or review
of the Companys financial statements or that are
traditionally performed by the independent auditor. Because the
Audit Committee believes that the provision of Audit-related
services does not impair the independence of the auditor and is
consistent with the SECs rules on auditor independence,
the Audit Committee may grant general preapproval to
Audit-related services. Audit-related services include, among
others, due diligence services pertaining to potential business
acquisitions/dispositions; accounting consultations related to
accounting, financial reporting or disclosure matters not
classified as Audit services; assistance with
understanding and implementing new accounting and financial
reporting guidance from rulemaking authorities; financial audits
of Employee benefit plans;
agreed-upon
or expanded audit procedures related to accounting
and/or
billing records required to respond to or comply with financial,
accounting or regulatory reporting matters; and assistance with
internal control reporting requirements.
V. Tax
Services
The Audit Committee believes that the independent auditor can
provide Tax services to the Company such as tax compliance, tax
planning and tax advice without impairing the auditors
independence, and the SEC has stated that the independent
auditor may provide such services. The Audit Committee believes
it may grant general preapproval to those Tax services that have
historically been provided by the auditor, that the Audit
Committee has reviewed and believes would not impair the
independence of the auditor, and that are consistent with the
SECs rules on auditor independence. The Audit Committee
will not permit the retention of the independent auditor in
connection with a transaction initially recommended by the
independent auditor, the sole business purpose of which may be
tax avoidance and the tax treatment of which may not be
supported in the Internal Revenue Code and related regulations.
The Audit Committee will consult with the Chief Financial
Officer or Vice President Finance to determine that
the tax planning and reporting positions are consistent with
this policy.
The Audit Committee must preapprove tax services to be provided
by the independent auditor to any Executive Officer or Director
of the Company, in his or her individual capacity, where such
services are paid for by the Company.
VI. All
Other Services
The Audit Committee believes, based on the SECs rules
prohibiting the independent auditor from providing specific
non-audit services, that other types of non-audit services are
permitted. Accordingly, the Audit Committee believes it may
grant general preapproval to those permissible non-audit
services classified as All Other services that it believes are
routine and recurring services, would not impair the
independence of the auditor, and are consistent with the
SECs rules on auditor independence.
A list of the SECs prohibited non-audit services is
attached to this policy as Exhibit 1. The SECs rules
and relevant guidance should be consulted to determine the
precise definitions of these services and the applicability of
exceptions to certain of the prohibitions.
VII. Preapproval
Fee Levels or Budgeted Amounts
Preapproval fee levels for all services to be provided by the
independent auditor will be established by the Audit Committee.
Any proposed services exceeding these levels or amounts will
require specific preapproval by the Audit Committee. The Audit
Committee is mindful of the overall relationship of fees for
audit and non-audit services in determining whether to
pre-approve any such services.
VIII. Procedures
All requests or applications for services to be provided by the
independent auditor that do not require specific approval by the
Audit Committee will be submitted to the Chief Financial Officer
or Vice President Finance and
C-2
must include a detailed description of the services to be
rendered. The Vice President Finance will determine
whether such services are included within the list of services
that have received the general preapproval of the Audit
Committee. The Audit Committee will be informed on a timely
basis of any such services rendered by the independent auditor.
Requests or applications to provide services that require
specific approval by the Audit Committee will be submitted to
the Audit Committee by both the independent auditor and the Vice
President Finance and must include a joint statement
as to whether, in their view, the request or application is
consistent with the SECs rules on auditor independence.
C-3
Exhibit 1
Prohibited
Non-Audit Services
|
|
|
|
|
Bookkeeping or other services related to the accounting records
or financial statements of the audit client
|
|
|
|
Financial information systems design and implementation
|
|
|
|
Appraisal or valuation services, fairness opinions or
contribution-in-kind
reports
|
|
|
|
Actuarial services
|
|
|
|
Internal audit outsourcing services
|
|
|
|
Management functions
|
|
|
|
Human resources
|
|
|
|
Broker-dealer, investment adviser or investment banking services
|
|
|
|
Legal services
|
|
|
|
Expert services unrelated to the audit
|
C-4
APPENDIX D
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
|
|
|
(Mark One)
|
|
|
þ
|
|
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
For the fiscal year ended
December 31, 2006
|
or
|
o
|
|
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
(State or other
jurisdiction of
incorporation or organization)
|
|
74-1563240
(I.R.S. Employer
Identification No.)
|
P.O. Box 36611
Dallas, Texas
(Address of principal
executive offices)
|
|
75235-1611
(Zip
Code)
|
Registrants telephone number, including area code:
(214) 792-4000
Securities registered pursuant to Section 12(b) of the
Act:
|
|
|
Title of Each Class
|
|
Name of Each Exchange on Which Registered
|
Common Stock ($1.00 par value)
|
|
New York Stock Exchange, Inc.
|
Securities registered pursuant to Section 12(g) of the
Act:
None
Indicate by check mark whether the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act.
Yes þ No o
Indicate by check mark whether the registrant is not required to
file reports pursuant to Section 13 or Section 15(d)
of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act.
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
The aggregate market value of the Common Stock held by
non-affiliates of the registrant was approximately
$12,811,246,960, computed by reference to the closing sale price
of the Common Stock on the New York Stock Exchange on
June 30, 2006, the last trading day of the
registrants most recently completed second fiscal quarter.
Number of shares of Common Stock outstanding as of the close of
business on January 29, 2007: 788,431,522 shares
DOCUMENTS
INCORPORATED BY REFERENCE
Portions of the Proxy Statement for our Annual Meeting of
Shareholders to be held May 16, 2007 are incorporated into
Part III of this
Form 10-K.
D-1
PART I
Overview
Southwest Airlines Co. is a major passenger airline that
provides scheduled air transportation in the United States.
Based on the most recent data available from the Department of
Transportation, Southwest Airlines is the largest carrier in the
United States, as measured by originating passengers boarded and
scheduled domestic departures. Southwest was incorporated in
Texas in 1967 and commenced Customer Service on June 18,
1971, with three Boeing 737 aircraft serving three Texas
cities Dallas, Houston, and San Antonio. At
year-end 2006, Southwest operated 481 Boeing 737 aircraft and
provided service to 63 cities in 32 states throughout
the United States. During 2006, the Company began service to
Denver, Colorado, and Washington Dulles International Airport.
The terms Southwest, the Company,
we, us, and similar terms refer to
Southwest Airlines Co. and its subsidiaries.
Southwest focuses principally on
point-to-point,
rather than
hub-and-spoke,
service, providing its markets with frequent, conveniently timed
flights and low fares. At December 31, 2006, Southwest
served 397 nonstop city pairs. Historically, Southwest has
served predominantly short-haul routes, with high frequencies.
In recent years, the Company has complemented this service with
more medium to long-haul routes, including transcontinental
service.
One of Southwests primary competitive strengths is its low
operating costs. Southwest has the lowest costs, adjusted for
stage length, on a seat mile basis, of all the major airlines.
Among the factors that contribute to its low cost structure are
a single aircraft type, an efficient, high-utilization,
point-to-point
route structure, and hardworking, innovative, and highly
productive Employees.
The business of the Company is somewhat seasonal. Quarterly
operating income and, to a lesser extent, revenues tend to be
lower in the first quarter (January 1 -
March 31) and fourth quarter (October 1 -
December 31) of most years.
Southwests annual report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
and amendments to those reports that are filed with or furnished
to the SEC, are accessible free of charge at www.southwest.com
as soon as reasonably practicable after they are electronically
filed with, or furnished to, the SEC.
Fuel
The cost of fuel is an item that has significant impact on the
Companys results of operations. The Companys average
cost of jet fuel, net of hedging gains and excluding fuel taxes,
over the past five years was as follows:
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Cost
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Average Cost
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Percent of
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Year
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(Millions)
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Per Gallon
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Operating Expenses
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2002
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$
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762
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$
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.68
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14.7
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%
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2003
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$
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830
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$
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.72
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14.9
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%
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2004
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$
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1,000
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$
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.83
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16.3
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%
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2005
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$
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1,341
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$
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1.03
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19.6
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%
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2006
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$
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2,138
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$
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1.53
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26.2
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%
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From October 1, 2006 through December 31, 2006, the
average cost per gallon was $1.55. Fuel costs and
Southwests fuel hedging activities are discussed in more
detail below under Risk Factors and
Managements Discussion and Analysis of Financial
Condition and Results of Operations.
Regulation
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Department of Transportation. The Department
of Transportation (DOT) has significant regulatory
jurisdiction over passenger airlines. To provide passenger
transportation in the United States, a domestic airline is
required to hold a certificate of public convenience and
necessity issued by the DOT. A certificate is unlimited in
duration and generally permits the Company to operate among any
points within the United States, its territories and
possessions. The DOT may revoke a certificate, in whole or in
part, for intentional failure to comply with federal aviation
statutes, regulations, orders, or the terms of the certificate
itself. The DOT also has jurisdiction over certain economic and
consumer protection matters such as advertising, denied boarding
compensation, baggage liability, and access for persons with
disabilities. The DOT may impose civil penalties on air carriers
for violations of its regulations in these areas.
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Wright Amendment. The International Air
Transportation Competition Act of 1979, as amended (the
Act), includes restrictions on the provision of air
transportation to and from Dallas Love Field. The applicable
portion of the Act, commonly known as the Wright
Amendment, as it affects Southwests scheduled
service, has prohibited carrying nonstop and through passengers
on commercial flights between Dallas Love
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D-3
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Field and all states outside of Texas, with the exception of the
states of Alabama, Arkansas, Kansas, Louisiana, Mississippi,
Missouri, New Mexico, and Oklahoma, which will be referred to as
Wright Amendment States. Flights between Dallas Love
Field and the Wright Amendment States have been permitted only
when an airline has not offered or provided any through service
or ticketing with another air carrier at Dallas Love Field and
has not offered service to or from any point that was outside of
a Wright Amendment State. The Wright Amendment does not restrict
flights operated with aircraft having 56 or fewer passenger
seats. In addition, the Wright Amendment does not restrict
Southwests intrastate Texas flights or its air service
from points other than Dallas Love Field.
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In the third quarter of 2006, Southwest entered into an
agreement with the City of Dallas, the City of Fort Worth,
American Airlines, Inc., and the DFW International Airport
Board. Pursuant to this agreement, the five parties sought
enactment of legislation to amend the Act. On October 13,
2006, Congress responded by passing the Wright Amendment Reform
Act of 2006 (the Reform Act), which provides for,
among other things, (1) substantial repeal of the Wright
Amendment in 2014, (2) immediate repeal of through service
and ticketing restrictions, so that Customers can purchase a
single ticket between Dallas Love Field and any
U.S. destination (while still requiring the Customers
flight to make a stop in a Wright Amendment State), and
(3) reduction of the maximum number of gates available for
commercial air service at Dallas Love Field from 32 to 20.
Southwest currently uses 14 gates at Dallas Love Field. Pursuant
to the Reform Act and local agreements with the City of Dallas
with respect to gates, Southwest can expand scheduled service
from Dallas Love Field and intends to do so.
Safety and Health. The Company and its
third-party maintenance providers are subject to the
jurisdiction of the Federal Aviation Administration
(FAA) with respect to the Companys aircraft
maintenance and operations, including equipment, ground
facilities, dispatch, communications, flight training personnel,
and other matters affecting air safety. To ensure compliance
with its regulations, the FAA requires airlines to obtain
operating, airworthiness, and other certificates, which are
subject to suspension or revocation for cause. The Company has
obtained such certificates. In addition, pursuant to FAA
regulations, the Company has established, and the FAA has
approved, the Companys operations specifications and a
maintenance program for the Companys aircraft, ranging
from frequent routine inspections to major overhauls. The FAA,
acting through its own powers or through the appropriate
U.S. Attorney, also has the power to bring proceedings for
the imposition and collection of fines for violation of the
Federal Air Regulations.
The Company is subject to various other federal, state, and
local laws and regulations relating to occupational safety and
health, including Occupational Safety and Health Administration
and Food and Drug Administration regulations.
Security. Pursuant to the Aviation and
Transportation Security Act (the Aviation Security
Act), the Transportation Security Administration
(TSA), a division of the Department of Homeland
Security, is responsible for certain civil aviation security
matters. The Aviation Security Act mandated, among other things,
improved flight deck security, deployment of federal air
marshals onboard flights, improved airport perimeter access
security, airline crew security training, enhanced security
screening of passengers, baggage, cargo, mail, employees, and
vendors, enhanced training and qualifications of security
screening personnel, additional provision of passenger data to
U.S. Customs, and enhanced background checks. Under the
Aviation Security Act, substantially all security screeners at
airports are federal employees, and significant other elements
of airline and airport security are overseen and performed by
federal employees, including federal security managers, federal
law enforcement officers, and federal air marshals. Under the
Aviation Security Act, funding for passenger security is
provided in part by a $2.50 per enplanement security fee,
subject to a maximum of $5.00 per one-way trip. The
Aviation Security Act also allows the TSA to assess an Aviation
Security Infrastructure Fee on each airline up to the total
amount spent by that airline on passenger and property screening
in calendar year 2000. Southwest was assessed a fee, and
recorded expense, totaling approximately $50 million in
each of 2005 and 2006 (of which approximately $24 million
in each year is being contested by Southwest). Like the FAA, the
TSA may impose and collect fines for violations of its
regulations.
Enhanced security measures have had, and will continue to have,
a significant impact on the airport experience for passengers.
While these security requirements have not impacted aircraft
utilization, they have impacted our business. In particular, the
third quarter of 2006 presented challenges to the airline
industry due to new security measures mandated by the TSA, as a
result
D-4
of a terrorist plot uncovered by authorities in London. The
stringent new rules, mostly regarding the types of liquid items
that can be carried onboard the aircraft, had a negative impact
on air travel beginning in mid-August, especially on shorthaul
routes and with business travelers. Although the TSA has relaxed
some of the requirements for carryon luggage, the Company is not
able to predict the ongoing impact, if any, that these security
changes will have on passenger revenues, both in the shortterm
and the longterm.
The Company has invested significantly in facilities, equipment,
and technology to process Customers efficiently and restore the
airport experience. The Companys Automated Boarding Passes
and E-Ticket
Check-In self service kiosks, which the Company has implemented
in all airports it serves, have reduced the number of lines in
which a Customer must wait. The Company has also installed gate
readers at all of its airports to improve the boarding
reconciliation process and offers baggage checkin through
E-Ticket
Check-In kiosks at certain airport locations, as well as
Internet checkin and transfer boarding passes at the time of
checkin.
Environmental. The Airport Noise and Capacity
Act of 1990 gives airport operators the right, under certain
circumstances, to implement local noise abatement programs, so
long as they do not unreasonably interfere with interstate or
foreign commerce or the national air transportation system. Some
airports, including San Diego and Orange County, California
have established airport restrictions to limit noise, including
restrictions on aircraft types to be used, and limits on the
number of hourly or daily operations or the time of such
operations. In some instances, these restrictions have caused
curtailments in service or increases in operating costs, and
such restrictions could limit the ability of Southwest to expand
its operations at the affected airports. Local authorities at
other airports may consider adopting similar noise regulations,
but such regulations are subject to the provisions of the
Airport Noise and Capacity Act of 1990 and regulations
promulgated thereunder.
Operations at John Wayne Airport, Orange County, California, are
governed by the Airports Phase 2 Commercial Airline
Access Plan and Regulation (the Plan). Pursuant to
the Plan, each airline is allocated total annual seat capacity
to be operated at the airport, subject to renewal/reallocation
on an annual basis. Service at this airport may be adjusted
annually to meet these requirements.
The Company is subject to various other federal, state, and
local laws and regulations relating to the protection of the
environment, including the discharge or disposal of materials
such as chemicals, hazardous waste, and aircraft deicing fluid.
Regulatory developments pertaining to such things as control of
engine exhaust emissions from ground support equipment and
prevention of leaks from underground aircraft fueling systems
could increase operating costs in the airline industry. The
Company does not believe, however, that such environmental
regulatory developments will have a material impact on the
Companys capital expenditures or otherwise adversely
affect its operations, operating costs, or competitive position.
Additionally, in conjunction with airport authorities, other
airlines, and state and local environmental regulatory agencies,
the Company is undertaking voluntary investigation or
remediation of soil or groundwater contamination at several
airport sites. The Company does not believe that any
environmental liability associated with such sites will have a
material adverse effect on the Companys operations, costs,
or profitability.
Customer Service Commitment. From time to
time, the airline transportation industry has been faced with
possible legislation dealing with certain Customer Service
practices. As a compromise with Congress, the industry, working
with the Air Transport Association, has responded by adopting
and filing with the DOT written plans disclosing how it would
commit to improving performance. Southwest Airlines
Customer Service Commitment is a comprehensive plan which
embodies the Mission Statement of Southwest Airlines: dedication
to the highest quality of Customer Service delivered with a
sense of warmth, friendliness, individual pride, and Company
Spirit. The Customer Service Commitment can be reviewed by
clicking on About Southwest at
www.southwest.com. The DOT and Congress monitor the
industrys plans, and there can be no assurance that
legislation or regulations will not be proposed in the future to
regulate airline Customer Service practices.
Operations
and Marketing
Operating Strategies. Southwest focuses
principally on
point-to-point,
rather than
hub-and-spoke,
service, providing its markets with frequent, conveniently timed
flights and low fares. Southwests average aircraft trip
stage length in 2006 was 622 miles with an average duration
of approximately 1.7 hours, as compared to an average
aircraft trip stage length of 607 miles and an average
duration of approximately 1.7 hours in 2005. Examples of
markets offering frequent daily flights are: Dallas to Houston
Hobby, 30 weekday roundtrips; Phoenix to Las Vegas,
19 weekday roundtrips; and Los Angeles International to
Oakland, 22 weekday
D-5
roundtrips. Southwest complements these high-frequency shorthaul
routes with longhaul nonstop service between markets such as
Baltimore and Los Angeles, Phoenix and Tampa Bay, Las Vegas and
Orlando, and Houston and Oakland.
Most major U.S. airlines have adopted the
hub-and-spoke
system, which concentrates most of an airlines operations
at a limited number of hub cities and serves most other
destinations in the system by providing one-stop or connecting
service through the hub. Southwest focuses on nonstop, not
connecting, traffic over its
point-to-point
route system. The
point-to-point
route system, as compared to
hub-and-spoke,
allows for more direct nonstop routings for our Customers and,
therefore, minimizes connections, delays, and total trip time.
As a result, approximately 79 percent of the Companys
Customers fly nonstop.
Southwest serves many conveniently located secondary or downtown
airports such as Dallas Love Field, Houston Hobby, Chicago
Midway, Baltimore-Washington International, Burbank, Manchester,
Oakland, San Jose, Providence,
Ft. Lauderdale/Hollywood, and Long Island Islip airports,
which are typically less congested than other airlines hub
airports. This operating strategy enables the Company to achieve
high asset utilization because aircraft can be scheduled to
minimize the amount of time they are at the gate (currently
approximately 25 minutes). This in turn reduces the number of
aircraft and gate facilities that would otherwise be required.
The Company is also able to simplify scheduling, maintenance,
flight operations, and training activities by operating only one
aircraft type, the Boeing 737. All of these strategies enhance
the Companys ability to sustain high Employee productivity
and reliable ontime performance.
Introduction of Codesharing. In first quarter
2005, Southwest began its first codeshare arrangement, with ATA
Airlines. Under its codeshare arrangement with ATA, Southwest
may market and sell tickets for certain flights on ATA that are
identified by Southwests designator code (for example,
WN Flight 123). Conversely, ATA may market and sell
tickets under its code designator (TZ) for certain flights on
Southwest Airlines. Any flight bearing a Southwest code
designator that is operated by ATA is disclosed in
Southwests reservations systems and on the Customers
flight itinerary, boarding pass, and ticket, if a paper ticket
is issued. As a result of the ATA codeshare, Southwests
Customers are able to purchase single ticket service on
Southwest connecting to ATAs service to Hawaii, New
Yorks LaGuardia Airport, and Washington Reagan National
Airport. Also, members of Southwests and ATAs
respective frequent flier programs are able to earn and redeem
awards in the other carriers program. Finally, beginning
in 2006, Southwest began selling ATA-only service at
www.southwest.com. Other than the ATA arrangement, Southwest
does not interline or offer joint fares with other airlines, nor
does Southwest have any marketing or commuter feeder
relationships with other carriers.
Simplified Fare Structure. Southwest employs a
relatively simple fare structure, featuring low, unrestricted,
unlimited, everyday coach fares, as well as even lower fares
available on a restricted basis. As of November 1, 2006,
the Companys highest non-codeshare, oneway unrestricted
walkup fare offered was $319 for any flight. Even lower walkup
fares are available on Southwests short and medium haul
flights.
Ticketless Travel. Southwest was the first
major airline to introduce a Ticketless travel option,
eliminating the need to print and then process a paper ticket
altogether, and the first to offer Ticketless travel through the
Companys home page on the Internet, at
www.southwest.com. For the year ended December 31,
2006, more than 94 percent of Southwests Customers
chose the Ticketless travel option and over 70 percent of
Southwests passenger revenues came through its Internet
site, which has become a vital part of the Companys
distribution strategy. The Company has not paid commissions to
travel agents for sales since December 15, 2003.
Competition
The airline industry is highly competitive. We believe the
principal competitive factors in the industry are:
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Fares
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Customer Service
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Costs
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Frequency and convenience of scheduling
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Frequent flyer benefits
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Efficiency and productivity, including effective selection and
use of aircraft
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We currently compete with other airlines on all of our routes,
some of which airlines have larger fleets and some of which
airlines may have wider name recognition in some markets.
Certain major U.S. airlines have established marketing or
codesharing alliances with each other, including Northwest
Airlines/Continental Airlines/Delta Air Lines; American
Airlines/Alaska
D-6
Airlines; and United Airlines/US Airways. These alliances are
more extensive than ours and enable the carriers to expand their
destinations and marketing opportunities. The Company is also
subject to varying degrees of competition from surface
transportation in its shorthaul markets, particularly the
private automobile. In shorthaul air services that compete with
surface transportation, price is a competitive factor, but
frequency and convenience of scheduling, facilities,
transportation safety and security procedures, and Customer
Service are also of great importance to many passengers.
The competitive landscape for airlines has changed significantly
over the last few years. Following the terrorist attacks on
September 11, 2001, the airline industry, as a whole,
incurred substantial losses through 2005. The war in Iraq and
significant increases in the cost of fuel have exacerbated
industry challenges. As a result, a number of carriers have
sought relief from financial obligations in bankruptcy,
including UAL Corporation, the parent of United Airlines; ATA
Airlines; US Airways; Northwest Airlines Corporation, the parent
of Northwest Airlines; and Delta Air Lines. UAL Corporation and
ATA Airlines emerged from bankruptcy in 2006.
US Airways emergence from bankruptcy in 2005
culminated in its merger with America West Airlines in September
of that year. Northwest Airlines Corporation and Delta Air Lines
remain under the protection of bankruptcy proceedings. Other,
smaller carriers have ceased operations entirely. In addition,
post-9/11, many carriers shrank capacity, grounded their most
inefficient aircraft, cut back on unprofitable service, and
furloughed employees. Reorganization in bankruptcy has allowed
carriers to decrease operating costs through renegotiated labor,
supply, and financing contracts. As a result of those events, as
well as actions taken by some carriers outside of bankruptcy,
differentials in cost structures between traditional
hub-and-spoke
carriers and low cost carriers have significantly diminished.
Nevertheless, throughout this entire time period, Southwest has
continued to maintain its cost advantage, improve Employee
productivity, pursue steady, controlled growth, and provide
outstanding Service to its Customers. The factors discussed
above have, however, led to more intense competition in the
airline industry generally. Some carriers reported profitable
results in one or more quarters in 2006 for the first time since
9/11.
The re-emerging competitiveness of some of the larger carriers,
such as United, US Airways, and American, has put pressure on
smaller carriers such as AirTran Airways, JetBlue, and Frontier.
AirTran Airways and JetBlue have announced scaled back growth
plans, and many carriers have expressed interest in industry
consolidation. For example, US Airways is pursuing a merger with
Delta Air Lines, and AirTran Airways has recently announced an
unsolicited offer for Midwest Airlines. The Company cannot
predict the timing or extent of any such consolidation or its
impact (either positive or negative) on the Companys
operations or results of operations.
Insurance
The Company carries insurance of types customary in the airline
industry and at amounts deemed adequate to protect the Company
and its property and to comply both with federal regulations and
certain of the Companys credit and lease agreements. The
policies principally provide coverage for public and passenger
liability, property damage, cargo and baggage liability, loss or
damage to aircraft, engines, and spare parts, and workers
compensation.
Following the terrorist attacks, commercial aviation insurers
significantly increased the premiums and reduced the amount of
war-risk coverage available to commercial carriers. The federal
Homeland Security Act of 2002 requires the federal government to
provide third party, passenger, and hull war-risk insurance
coverage to commercial carriers through a period of time that
has now been extended to August 31, 2007. The Company is
unable to predict whether the government will extend this
insurance coverage past August 31, 2007, whether
alternative commercial insurance with comparable coverage will
become available at reasonable premiums, and what impact this
will have on the Companys ongoing operations or future
financial performance.
Frequent
Flyer Awards
Southwests frequent flyer program, Rapid Rewards, is based
on trips flown rather than mileage. Rapid Rewards Customers earn
a credit for each one-way trip flown or two credits for each
roundtrip flown. Rapid Rewards Customers can also receive
credits by using the services of non-airline partners, which
include car rental agencies, hotels, telecommunication
companies, and credit card partners, including the Southwest
Airlines
Chase®
Visa card. Rapid Rewards offers two types of travel awards. The
Rapid Rewards Award Ticket (Award Ticket) offers one
free roundtrip award valid to any destination available on
Southwest after the accumulation of 16 credits. The Rapid
Rewards Companion Pass (Companion Pass) is granted
for flying 50 roundtrips (or 100 one-way trips) on
Southwest or earning 100 credits within a consecutive
twelve-month period. The Companion Pass offers unlimited free
roundtrip
D-7
travel to any destination available on Southwest for a
designated companion of the qualifying Rapid Rewards member. For
the designated companion to use this pass, the Rapid Rewards
member must purchase a ticket or use an Award Ticket.
Additionally, the Rapid Rewards member and designated companion
must travel together on the same flight.
Award Tickets and Companion Passes are automatically generated
when earned by the Customer rather than allowing the Customer to
bank credits indefinitely. Award Tickets are valid for
12 months after issuance. Award Tickets issued before
February 10, 2006 have no seat restrictions, but are
subject to published Black out dates. Effective
February 10, 2006, systemwide Black out dates
for Award Tickets were eliminated, but Award Tickets are subject
to seat restrictions. Companion travel has no seat restrictions
or Black out dates.
The Company also sells credits to business partners including
credit card companies, hotels, telecommunication companies, and
car rental agencies. These credits may be redeemed for Award
Tickets having the same program characteristics as those earned
by flying. Southwests codeshare agreement with ATA
Airlines offers Customers of each airline the opportunity to
earn and redeem frequent flier award credits on the other.
Customers redeemed approximately 2.7 million,
2.6 million, and 2.5 million Award Tickets and flights
on Companion Passes during 2006, 2005, and 2004, respectively.
The amount of free travel award usage as a percentage of total
Southwest revenue passengers carried was 6.4 percent in
2006, 6.6 percent in 2005, and 7.1 percent in 2004.
The number of fully earned Award Tickets and partially earned
awards outstanding at December 31, 2006 was approximately
10.1 million, of which approximately 81 percent were
partially earned awards. The number of fully earned Award
Tickets and partially earned awards outstanding at
December 31, 2005 was approximately 6.8 million, of
which approximately 78 percent were partially earned
awards. However, due to the expected expiration of a portion of
credits making up partial awards, not all of them will
eventually turn into useable Award Tickets. Also, not all Award
Tickets will be redeemed for future travel. Since the inception
of Rapid Rewards in 1987, approximately 14 percent of all
fully earned Award Tickets have expired without being used. The
number of Companion Passes for Southwest outstanding at
December 31, 2006 and 2005 was approximately 58,000 and
60,000, respectively. The Company currently estimates that an
average of 3 to 4 trips will be redeemed per outstanding
Companion Pass.
The Company accounts for its frequent flyer program obligations
by recording a liability for the estimated incremental cost of
flight awards the Company expects to be redeemed. The estimated
incremental cost includes direct passenger costs such as fuel,
food, and other operational costs, but does not include any
contribution to overhead or profit. Revenue from the sale of
credits to business partners and associated with future travel
is deferred and recognized when the ultimate free travel award
is flown or the credits expire unused. The liability for free
travel awards earned but not used at December 31, 2006 and
2005 was not material.
Employees
At December 31, 2006, Southwest had 32,664 active
Employees, consisting of 12,954 flight, 2,056 maintenance,
13,446 ground, Customer, and fleet service and 4,208 management,
accounting, marketing, and clerical personnel.
D-8
Southwest has ten collective bargaining agreements, which
agreements covered approximately 82 percent of
Southwests Employees as of December 31, 2006. Our
relations with labor unions are governed by the Railway Labor
Act (the RLA), which establishes the right of
airline employees to organize and bargain collectively. Under
the RLA, a collective bargaining agreement between an airline
and a labor union generally does not expire, but instead becomes
amendable as of a stated date. If either party wants to modify
the terms of such agreement, it must notify the other party in
the manner required by the RLA
and/or
described in the agreement. After receipt of such notice, the
parties must meet for direct negotiations, and, if no agreement
is reached, either party may request the National Mediation
Board (the NMB) to appoint a federal mediator. If no
agreement is reached in mediation, the NMB may determine that an
impasse exists and offer binding arbitration to the parties. If
either party rejects binding arbitration, a
30-day
cooling off period begins. At the end of this
30-day
period, the parties may engage in self-help, unless
a Presidential Emergency Board is established to investigate and
report on the disputes. The appointment of a Presidential
Emergency Board maintains the status quo for an
additional 60 days. If the parties do not reach agreement
during this period, the parties may then engage in
self-help. Self-help includes, among
other things, a strike by the union or the airlines
imposition of any or all of its proposed amendments and the
hiring of new employees to replace any striking workers. The
following table sets forth the Companys Employee groups
and collective bargaining status:
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Employee Group
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|
Represented by
|
|
Agreement Amendable in
|
|
Pilots
|
|
Southwest Airlines Pilots
Association
|
|
Currently in negotiation
|
Flight Attendants
|
|
Transportation Workers of America,
AFL-CIO (TWU)
|
|
June 2008
|
Ramp, Operations, Provisioning,
and Freight Agents
|
|
TWU
|
|
July 2008
|
Stock Clerks
|
|
International Brotherhood of
Teamsters (Teamsters)
|
|
August 2008
|
Mechanics
|
|
Aircraft Mechanics Fraternal
Association (AMFA)
|
|
August 2008
|
Customer Service and Reservations
Agents
|
|
International Association of
Machinists and Aerospace Workers, AFL-CIO
|
|
November 2008
|
Aircraft Appearance Technicians
|
|
AMFA
|
|
February 2009
|
Flight Dispatchers
|
|
Southwest Airlines Employee
Association
|
|
December 2009
|
Flight Simulator Technicians
|
|
Teamsters
|
|
November 2011
|
Flight/Ground School
Instructors
and Flight Crew Training Instructors
|
|
Southwest Airlines Professional
Instructors Association
|
|
January 2013
|
In addition to the other information contained in this
Form 10-K,
the following risk factors should be considered carefully in
evaluating Southwests business. The Companys
business, financial condition, or results of operations could be
materially adversely affected by any of these risks. Additional
risks not presently known to the Company or that the Company
currently deems immaterial may also impair its business and
operations.
|
|
|
Southwests
business is dependent on the price and availability of aircraft
fuel. Continued periods of high fuel costs
and/or
significant disruptions in the supply of fuel, could adversely
affect our results of operations.
|
Airline operators are inherently dependent upon energy to
operate and, therefore, are impacted by changes in jet fuel
prices. The cost of fuel, which was at an historically high
level over the last two years, is largely unpredictable and has
a significant impact on the Companys results of
operations. Jet fuel and oil consumed for fiscal 2006 and 2005
represented approximately 26 percent and 20 percent of
Southwests operating expenses, respectively. Fuel
availability, as well as pricing, is also
D-9
impacted by political and economic factors. We do not currently
anticipate a significant reduction in fuel availability;
however, it is difficult to predict the future availability of
jet fuel due to the following, among other, factors: dependency
on foreign imports of crude oil and the potential for
hostilities or other conflicts in oil producing areas; limited
refining capacity; and the possibility of changes in
governmental policies on jet fuel production, transportation,
and marketing. Significant disruptions in the supply of aircraft
fuel could have a negative impact on the Companys
operations and results of operations.
Due to the competitive nature of the airline industry, the
Companys ability to increase fares is limited, and it is
not certain that future fuel cost increases can be covered by
increasing fares. From time to time the Company enters into fuel
derivative contracts to protect against rising fuel costs.
Changes in the Companys overall fuel hedging strategy, the
ability of the commodities used in fuel hedging (principally
crude oil, heating oil, and unleaded gasoline) to qualify for
special hedge accounting, and the effectiveness of the
Companys fuel hedges pursuant to highly complex accounting
rules, are all significant factors impacting the Companys
results of operations. For more information on Southwests
fuel hedging arrangements, see Managements
Discussion and Analysis of Financial Condition and Results of
Operations, and Note 10 to the Consolidated Financial
Statements.
|
|
|
Southwests
business is labor-intensive; we could be adversely affected if
we are unable to maintain satisfactory relations with any
unionized or other Employee work group.
|
The airline business is labor intensive. Wages, salaries, and
benefits represented approximately 37 percent of the
Companys operating expenses for the year ended
December 31, 2006. In addition, as of December 31,
2006, approximately 82 percent of the Companys
Employees were represented for collective bargaining purposes by
labor unions. The Companys Ramp, Operations, Provisioning,
and Freight Agents are subject to an agreement with the
Transport Workers Union of America, AFL-CIO (TWU),
which becomes amendable on June 30, 2008. However, under
certain conditions, TWU could elect to give notice to the
Company by June 1, 2007, of its desire to make the
agreement amendable on June 30, 2007. During second quarter
2006, TWU membership voted to not make the contract amendable on
June 30, 2007. The Company is unable to predict whether
future votes between now and June 2007 would result in the same
outcome. The Companys Pilots are subject to an agreement
with the Southwest Airlines Pilots Association
(SWAPA), which became amendable during September
2006. The Company and SWAPA recently began discussions on a new
agreement. Although, historically, the Companys
relationships with its Employees have been good, the following
items could have a significant impact on the Companys
results of operations: results of labor contract negotiations,
employee hiring and retention rates, pay rates, outsourcing
costs, the impact of work rules, and costs for health care.
|
|
|
Southwests
business is affected by many changing economic and other
conditions beyond its control.
|
Our business, and the airline industry in general, is
particularly impacted by changes in economic and other
conditions that are largely outside of our control, including,
among others:
|
|
|
|
|
Actual or potential changes in international, national,
regional, and local economic, business, and financial
conditions, including recession, inflation, interest rate
increases, war, terrorist attacks, and political instability;
|
|
|
|
Changes in consumer preferences, perceptions, spending patterns,
or demographic trends;
|
|
|
|
Actual or potential disruptions in the air traffic control
system;
|
|
|
|
Increases in costs of safety, security, and environmental
measures; and
|
|
|
|
Weather and natural disasters.
|
Because expenses of a flight do not vary significantly with the
number of passengers carried, a relatively small change in the
number of passengers can have a disproportionate effect on an
airlines operating and financial results. Therefore, any
general reduction in airline passenger traffic as a result of
any of these factors could adversely affect our business,
financial condition, and results of operations.
|
|
|
Southwest
relies on technology to operate its business, and any failure of
these systems could harm the Company.
|
Southwest is increasingly dependent on automated systems and
technology to operate its business, enhance Customer Service and
back office support systems, and increase Employee productivity,
including the Companys computerized airline reservation
system, flight operations systems, telecommunication systems,
website at www.southwest.com, Automated Boarding Passes
D-10
system, and the
E-Ticket
Check-In self service kiosks. Any disruptions in these systems
due to internal failures of technology or large-scale external
interruptions in technology infrastructure, such as power,
telecommunications, or the internet, could result in the loss of
revenue or important data, increase the Companys expenses,
and generally harm the Companys business. In addition, our
growth strategies may be dependent on our ability to effectively
implement technology advancements.
|
|
|
The
travel industry continues to face on-going security concerns and
cost burdens; further threatened or actual terrorist attacks, or
other hostilities, could significantly harm our industry and our
business.
|
The attacks of September 11, 2001, materially impacted, and
continue to impact, air travel and the results of operations for
Southwest and the airline industry generally. The Department of
Homeland Security and the TSA have implemented numerous security
measures that affect airline operations and costs. Substantially
all security screeners at airports are now federal employees,
and significant other elements of airline and airport security
are now overseen and performed by federal employees, including
federal security managers, federal law enforcement officers, and
federal air marshals. Enhanced security procedures, including
enhanced security screening of passengers, baggage, cargo, mail,
employees, and vendors, introduced at airports since the
terrorist attacks of September 11 have increased costs to
airlines and have from time to time impacted demand for air
travel.
Additional terrorist attacks, even if not made directly on the
airline industry, or the fear of such attacks or other
hostilities (including elevated national threat warnings or
selective cancellation or redirection of flights due to terror
threats) could have a further significant negative impact on
Southwest and the airline industry. The war in Iraq further
decreased demand for air travel during the first half of 2003,
and additional international hostilities could potentially have
a material adverse impact on the Companys results of
operations.
|
|
|
Airport
capacity constraints and air traffic control inefficiencies
could limit the Companys growth; changes in or additional
governmental regulation could increase the Companys
operating costs or otherwise limit the Companys ability to
conduct business.
|
Almost all commercial service airports are owned
and/or
operated by units of local or state government. Airlines are
largely dependent on these governmental entities to provide
adequate airport facilities and capacity at an affordable cost.
Similarly, the federal government singularly controls all
U.S. airspace, and airlines are completely dependent on the
FAA to operate that airspace in a safe, efficient, and
affordable manner. As discussed above, under
Business Regulation, airlines are also
subject to other extensive regulatory requirements. These
requirements often impose substantial costs on airlines. Our
results of operations may be affected by changes in law and
future actions taken by governmental agencies having
jurisdiction over our operations, including:
|
|
|
|
|
Increases in airport rates and charges;
|
|
|
|
Limitations on airport gate capacity or other use of airport
facilities;
|
|
|
|
Increases in taxes;
|
|
|
|
Changes in the law that affect the services that can be offered
by airlines in particular markets and at particular airports;
|
|
|
|
Restrictions on competitive practices;
|
|
|
|
The adoption of regulations that impact customer service
standards, such as security standards; and
|
|
|
|
The adoption of more restrictive locally-imposed noise
restrictions.
|
|
|
|
The
airline industry is intensely competitive.
|
As discussed in more detail above under
Business Competition, the airline
industry is extremely competitive. Southwests competitors
include other major domestic airlines, as well as regional and
new entrant airlines, and other forms of transportation,
including rail and private automobiles. The Companys
revenues are sensitive to the actions of other carriers in the
areas of capacity, pricing, scheduling, codesharing, and
promotions.
|
|
|
Southwests
low cost structure is one of its primary competitive advantages,
and many factors could affect the Companys ability to
control its costs.
|
Factors affecting the Companys ability to control its
costs include the price and availability of fuel, results of
Employee labor contract negotiations, Employee hiring and
retention rates, costs for health care, capacity decisions by
the Company and its competitors, unscheduled required aircraft
airframe or engine repairs, regulatory requirements,
availability of capital markets, and future financing decisions
made by the Company.
D-11
Item 1B. Unresolved
Staff Comments
None.
Item 2. Properties
Aircraft
Southwest operated a total of 481 Boeing 737 aircraft as of
December 31, 2006, of which 84 and 9 were under operating
and capital leases, respectively. The remaining 388 aircraft
were owned.
The following table details information on the 481 aircraft in
the Companys fleet as of December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Age
|
|
|
Number of
|
|
|
Number
|
|
|
Number
|
|
737 Type
|
|
Seats
|
|
|
(Yrs)
|
|
|
Aircraft
|
|
|
Owned
|
|
|
Leased
|
|
|
-300
|
|
|
137
|
|
|
|
15.7
|
|
|
|
194
|
|
|
|
112
|
|
|
|
82
|
|
-500
|
|
|
122
|
|
|
|
15.7
|
|
|
|
25
|
|
|
|
16
|
|
|
|
9
|
|
-700
|
|
|
137
|
|
|
|
4.0
|
|
|
|
262
|
|
|
|
260
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
|
|
|
|
9.3
|
|
|
|
481
|
|
|
|
388
|
|
|
|
93
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In total, at December 31, 2006, the Company had firm
orders, options and purchase rights for the purchase of Boeing
737 aircraft as follows:
Firm
Orders, Options and Purchase Rights for Boeing
737-700
Aircraft
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Delivery Year
|
|
Firm Orders
|
|
|
Options
|
|
|
Purchase Rights
|
|
|
Total
|
|
|
2007
|
|
|
37
|
|
|
|
|
|
|
|
|
|
|
|
37
|
|
2008
|
|
|
30
|
|
|
|
4
|
|
|
|
|
|
|
|
34
|
|
2009
|
|
|
18
|
|
|
|
18
|
|
|
|
|
|
|
|
36
|
|
2010
|
|
|
10
|
|
|
|
32
|
|
|
|
|
|
|
|
42
|
|
2011
|
|
|
10
|
|
|
|
30
|
|
|
|
|
|
|
|
40
|
|
2012
|
|
|
10
|
|
|
|
30
|
|
|
|
|
|
|
|
40
|
|
2008-2014
|
|
|
|
|
|
|
|
|
|
|
54
|
|
|
|
54
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
115
|
|
|
|
114
|
|
|
|
54
|
|
|
|
283
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ground
Facilities and Services
Southwest leases terminal passenger service facilities at each
of the airports it serves, to which it has added various
leasehold improvements. The Company leases land on a long-term
basis for its maintenance centers located at Dallas Love Field,
Houston Hobby, Phoenix Sky Harbor, and Chicago Midway, its
training center near Dallas Love Field, which houses seven 737
simulators, and its corporate headquarters, also located near
Dallas Love Field. The maintenance, training center, and
corporate headquarters buildings on these sites were built and
are owned by Southwest. At December 31, 2006, the Company
operated six reservation centers. The reservation centers
located in Chicago, Albuquerque, and Oklahoma City occupy leased
space. The Company owns its Houston, Phoenix, and
San Antonio reservation centers.
Southwest has entered into a concession agreement with the Town
of Islip, New York, which gives Southwest the right to
construct, furnish, occupy, and maintain a new concourse at the
airport. Phase I of this project, which began operations in
August 2004, includes four gates. Phase II of the project,
which includes an additional four gates, was completed in
November 2006. The entire new concourse is now the property of
the Town of Islip. In return for constructing the new concourse,
Southwest is receiving fixed-rent abatements for a total of
25 years; however, the Company is still be required to pay
variable rents for common use areas and manage the new concourse.
The Company performs substantially all line maintenance on its
aircraft and provides ground support services at most of the
airports it serves. However, the Company has arrangements with
certain aircraft maintenance firms for major component
inspections and repairs for its airframes and engines, which
comprise the majority of the Companys annual aircraft
maintenance costs.
D-12
Item 3. Legal
Proceedings
On December 8, 2005, Southwest Airlines Flight 1248 was
involved in an accident at Chicago Midway Airport while the
aircraft, a Boeing
737-700, was
landing. The aircraft overran the runway onto a roadway and
collided with an automobile. Several occupants of the vehicles
involved in the accident were injured, one fatally. The Company
continues to cooperate fully with all federal, state, and local
regulatory and investigatory agencies to determine the cause of
this accident. The Company is currently unable to predict the
amount of claims, if any, relating to this accident which may
ultimately be made against it and how those claims might be
resolved. At this time, the Company has no reason to believe
that the costs to defend any claims and any potential liability
exposure will not be covered by the insurance maintained by the
Company. Consequently, the Company does not expect any
litigation arising from the accident involving Flight 1248 to
have a material adverse affect on the financial position or
results of operations of the Company.
The Company is subject to various legal proceedings and claims
arising in the ordinary course of business, including, but not
limited to, examinations by the Internal Revenue Service (IRS).
The IRS regularly examines the Companys federal income tax
returns and, in the course of those examinations, proposes
adjustments to the Companys federal income tax liability
reported on such returns. It is the Companys practice to
vigorously contest those proposed adjustments that it deems
lacking merit. The Companys management does not expect the
outcome in any of its currently ongoing legal proceedings or the
outcome of any proposed adjustments presented to date by the
IRS, individually or collectively, will have a material adverse
effect on the Companys financial condition, results of
operations, or cash flows.
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
None to be reported.
EXECUTIVE
OFFICERS OF THE REGISTRANT
The executive officers of Southwest, their positions, and their
respective ages (as of January 1, 2007) are as follows:
|
|
|
|
|
|
|
Name
|
|
Position
|
|
Age
|
|
|
Herbert D. Kelleher
|
|
Chairman of the Board
|
|
|
75
|
|
Gary C. Kelly
|
|
Vice Chairman of the Board and
Chief Executive Officer
|
|
|
51
|
|
Colleen C. Barrett
|
|
President and Secretary
|
|
|
62
|
|
Robert E. Jordan
|
|
Executive Vice
President Strategy, Procurement, and Technology
|
|
|
46
|
|
Michael G. Van de Ven
|
|
Executive Vice
President Aircraft Operations
|
|
|
45
|
|
Ron Ricks
|
|
Executive Vice
President Law, Airports and Public Affairs
|
|
|
57
|
|
Laura H. Wright
|
|
Senior Vice President
Finance and Chief Financial Officer
|
|
|
46
|
|
Executive officers are elected annually at the first meeting of
Southwests Board of Directors following the annual meeting
of Shareholders or appointed by the Chief Executive Officer
pursuant to Board authorization. Each of the above individuals
has worked for Southwest Airlines Co. for more than the past
five years.
D-13
PART II
|
|
Item 5.
|
Market
for Registrants Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities
|
Southwests common stock is listed on the New York Stock
Exchange and is traded under the symbol LUV. The high and low
sales prices of the common stock on the Composite Tape and the
quarterly dividends per share paid on the common stock were:
|
|
|
|
|
|
|
|
|
|
|
|
|
Period
|
|
Dividend
|
|
|
High
|
|
|
Low
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
1st Quarter
|
|
$
|
0.00450
|
|
|
$
|
18.10
|
|
|
$
|
15.51
|
|
2nd Quarter
|
|
|
0.00450
|
|
|
|
18.20
|
|
|
|
15.10
|
|
3rd Quarter
|
|
|
0.00450
|
|
|
|
18.20
|
|
|
|
15.66
|
|
4th Quarter
|
|
|
0.00450
|
|
|
|
17.03
|
|
|
|
14.61
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
1st Quarter
|
|
$
|
0.00450
|
|
|
$
|
16.45
|
|
|
$
|
13.60
|
|
2nd Quarter
|
|
|
0.00450
|
|
|
|
15.50
|
|
|
|
13.56
|
|
3rd Quarter
|
|
|
0.00450
|
|
|
|
14.85
|
|
|
|
13.05
|
|
4th Quarter
|
|
|
0.00450
|
|
|
|
16.95
|
|
|
|
14.54
|
|
As of December 31, 2006, there were 11,055 holders of
record of the Companys common stock.
The following table presents information with respect to
purchases of Common Stock of the Company made during the three
months ended December 31, 2006 by the Company, or any
affiliated purchaser, of the Company, as defined in
Rule 10b-18(a)(3)
under the Exchange Act.
Issuer
Purchases of Equity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maximum Number (or
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate Dollar
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Value) of Shares
|
|
|
|
|
|
|
|
|
|
Shares Purchased as
|
|
|
that May Yet Be
|
|
|
|
|
|
|
|
|
|
Part of Publicly
|
|
|
Purchased Under the
|
|
|
|
Total Number of
|
|
|
Average Price Paid
|
|
|
Announced Plans or
|
|
|
Plans or Programs
|
|
Period
|
|
Shares Purchased
|
|
|
per Share
|
|
|
Programs(1)
|
|
|
(1)
|
|
|
October 1, 2006 through
October 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 1, 2006 through
November 30, 2006
|
|
|
2,649,200
|
|
|
$
|
15.92
|
|
|
|
2,649,200
|
|
|
$
|
357,811,822
|
|
December 1, 2006 through
December 31, 2006
|
|
|
10,053,800
|
|
|
$
|
15.70
|
|
|
|
10,053,800
|
|
|
$
|
199,747,357
|
|
|
|
|
(1) |
|
On November 16, 2006, the Company publicly announced that
its Board of Directors had authorized a share repurchase program
to acquire up to $400 million of the Companys Common
Stock. |
D-14
Performance
Graph
The following Performance Graph and related information shall
not be deemed soliciting material or to be
filed with the Securities and Exchange Commission,
nor shall such information be incorporated by reference into any
future filing under the Securities Act of 1933 or Securities
Exchange Act of 1934, each as amended, except to the extent that
the Company specifically incorporates it by reference into such
filing.
The following table compares total Shareholder returns for the
Company over the last five years to the Standard and Poors
500 Stock Index and the AMEX Airline Index assuming a $100
investment made on December 31, 2001. Each of the three
measures of cumulative total return assumes reinvestment of
dividends. The stock performance shown on the graph below is not
necessarily indicative of future price performance.
COMPARISON
OF FIVE YEAR CUMULATIVE TOTAL RETURN
AMONG SOUTHWEST AIRLINES CO., S&P 500 INDEX,
AND AMEX AIRLINE INDEX
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12/31/01
|
|
|
12/31/02
|
|
|
12/31/03
|
|
|
12/31/04
|
|
|
12/31/05
|
|
|
12/31/06
|
Southwest Airlines
|
|
|
$
|
100
|
|
|
|
$
|
75
|
|
|
|
$
|
88
|
|
|
|
$
|
88
|
|
|
|
$
|
89
|
|
|
|
$
|
83
|
|
S&P 500
|
|
|
$
|
100
|
|
|
|
$
|
78
|
|
|
|
$
|
100
|
|
|
|
$
|
111
|
|
|
|
$
|
117
|
|
|
|
$
|
135
|
|
AMEX Airline
|
|
|
$
|
100
|
|
|
|
$
|
44
|
|
|
|
$
|
70
|
|
|
|
$
|
69
|
|
|
|
$
|
62
|
|
|
|
$
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
D-15
Securities
Authorized for Issuance under Equity Compensation
Plans
The following table provides information as of December 31,
2006, regarding compensation plans (including individual
compensation arrangements) under which equity securities of
Southwest are authorized for issuance.
Equity
Compensation Plan Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities Remaining
|
|
|
|
Number of Securities to be
|
|
|
Weighted-Average
|
|
|
Available for Future Issuance Under
|
|
|
|
Issued upon Exercise of
|
|
|
Exercise Price of
|
|
|
Equity Compensation Plans
|
|
|
|
Outstanding Options,
|
|
|
Outstanding Options,
|
|
|
(Excluding Securities
|
|
|
|
Warrants, and Rights
|
|
|
Warrants, and Rights*
|
|
|
Reflected in Column (a))
|
|
Plan Category
|
|
(a)
|
|
|
(b)
|
|
|
(c)
|
|
|
|
(In thousands)
|
|
|
|
|
|
(In thousands)
|
|
|
Equity Compensation Plans Approved
by Security Holders
|
|
|
27,299
|
|
|
$
|
15.40
|
|
|
|
4,303
|
|
Equity Compensation Plans not
Approved by Security Holders
|
|
|
85,689
|
|
|
$
|
15.79
|
|
|
|
30,840
|
|
Total
|
|
|
112,988
|
|
|
$
|
15.70
|
|
|
|
35,143
|
|
|
|
|
* |
|
As adjusted for stock splits. |
See Note 13 to the Consolidated Financial Statements for
information regarding the material features of the above plans.
Each of the above plans provides that the number of shares with
respect to which options may be granted, and the number of
shares of Common Stock subject to an outstanding option, shall
be proportionately adjusted in the event of a subdivision or
consolidation of shares or the payment of a stock dividend on
Common Stock, and the purchase price per share of outstanding
options shall be proportionately revised.
D-16
|
|
Item 6.
|
Selected
Financial Data
|
The following financial information for the five years ended
December 31, 2006, has been derived from the Companys
Consolidated Financial Statements. This information should be
read in conjunction with the Consolidated Financial Statements
and related notes thereto included elsewhere herein.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(in millions, except per share amounts)
|
|
|
Financial Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
$
|
9,086
|
|
|
$
|
7,584
|
|
|
$
|
6,530
|
|
|
$
|
5,937
|
|
|
$
|
5,522
|
|
Operating expenses
|
|
|
8,152
|
|
|
|
6,859
|
|
|
|
6,126
|
|
|
|
5,558
|
|
|
|
5,181
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
934
|
|
|
|
725
|
|
|
|
404
|
|
|
|
379
|
|
|
|
341
|
|
Other expenses (income) net
|
|
|
144
|
|
|
|
(54
|
)
|
|
|
65
|
|
|
|
(225
|
)
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
790
|
|
|
|
779
|
|
|
|
339
|
|
|
|
604
|
|
|
|
317
|
|
Provision for income taxes
|
|
|
291
|
|
|
|
295
|
|
|
|
124
|
|
|
|
232
|
|
|
|
129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
499
|
|
|
$
|
484
|
|
|
$
|
215
|
|
|
$
|
372
|
|
|
$
|
188
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share, basic
|
|
$
|
.63
|
|
|
$
|
.61
|
|
|
$
|
.27
|
|
|
$
|
.48
|
|
|
$
|
.24
|
|
Net income per share, diluted
|
|
$
|
.61
|
|
|
$
|
.60
|
|
|
$
|
.27
|
|
|
$
|
.46
|
|
|
$
|
.23
|
|
Cash dividends per common share
|
|
$
|
.0180
|
|
|
$
|
.0180
|
|
|
$
|
.0180
|
|
|
$
|
.0180
|
|
|
$
|
.0180
|
|
Total assets at period-end
|
|
$
|
13,460
|
|
|
$
|
14,003
|
|
|
$
|
11,137
|
|
|
$
|
9,693
|
|
|
$
|
8,766
|
|
Long-term obligations at period-end
|
|
$
|
1,567
|
|
|
$
|
1,394
|
|
|
$
|
1,700
|
|
|
$
|
1,332
|
|
|
$
|
1,553
|
|
Stockholders equity at
period-end
|
|
$
|
6,449
|
|
|
$
|
6,675
|
|
|
$
|
5,527
|
|
|
$
|
5,029
|
|
|
$
|
4,374
|
|
Operating Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue passengers carried
|
|
|
83,814,823
|
|
|
|
77,693,875
|
|
|
|
70,902,773
|
|
|
|
65,673,945
|
|
|
|
63,045,988
|
|
Enplaned passengers
|
|
|
96,276,907
|
|
|
|
88,379,900
|
|
|
|
81,066,038
|
|
|
|
74,719,340
|
|
|
|
72,462,123
|
|
Revenue passenger miles (RPMs)
(000s)
|
|
|
67,691,289
|
|
|
|
60,223,100
|
|
|
|
53,418,353
|
|
|
|
47,943,066
|
|
|
|
45,391,903
|
|
Available seat miles (ASMs) (000s)
|
|
|
92,663,023
|
|
|
|
85,172,795
|
|
|
|
76,861,296
|
|
|
|
71,790,425
|
|
|
|
68,886,546
|
|
Load factor(1)
|
|
|
73.1
|
%
|
|
|
70.7
|
%
|
|
|
69.5
|
%
|
|
|
66.8
|
%
|
|
|
65.9
|
%
|
Average length of passenger haul
(miles)
|
|
|
808
|
|
|
|
775
|
|
|
|
753
|
|
|
|
730
|
|
|
|
720
|
|
Average stage length (miles)
|
|
|
622
|
|
|
|
607
|
|
|
|
576
|
|
|
|
558
|
|
|
|
537
|
|
Trips flown
|
|
|
1,092,331
|
|
|
|
1,028,639
|
|
|
|
981,591
|
|
|
|
949,882
|
|
|
|
947,331
|
|
Average passenger fare
|
|
$
|
104.40
|
|
|
$
|
93.68
|
|
|
$
|
88.57
|
|
|
$
|
87.42
|
|
|
$
|
84.72
|
|
Passenger revenue yield per RPM
|
|
|
12.93
|
¢
|
|
|
12.09
|
¢
|
|
|
11.76
|
¢
|
|
|
11.97
|
¢
|
|
|
11.77
|
¢
|
Operating revenue yield per ASM
|
|
|
9.81
|
¢
|
|
|
8.90
|
¢
|
|
|
8.50
|
¢
|
|
|
8.27
|
¢
|
|
|
8.02
|
¢
|
Operating expenses per ASM
|
|
|
8.80
|
¢
|
|
|
8.05
|
¢
|
|
|
7.97
|
¢
|
|
|
7.74
|
¢
|
|
|
7.52
|
¢
|
Operating expenses per ASM,
excluding fuel
|
|
|
6.49
|
¢
|
|
|
6.48
|
¢
|
|
|
6.67
|
¢
|
|
|
6.59
|
¢
|
|
|
6.41
|
¢
|
Fuel cost per gallon (average)
|
|
$
|
1.53
|
|
|
$
|
1.03
|
|
|
$
|
.83
|
|
|
$
|
.72
|
|
|
$
|
.68
|
|
Number of Employees at year-end
|
|
|
32,664
|
|
|
|
31,729
|
|
|
|
31,011
|
|
|
|
32,847
|
|
|
|
33,705
|
|
Size of fleet at year-end(2)
|
|
|
481
|
|
|
|
445
|
|
|
|
417
|
|
|
|
388
|
|
|
|
375
|
|
|
|
|
(1) |
|
Revenue passenger miles divided by available seat miles. |
|
(2) |
|
Includes leased aircraft. |
D-17
|
|
Item 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Year in
Review
Southwest recorded a profit of $499 million in 2006, an
increase of $15 million, or 3.1 percent, compared to
the Companys 2005 net income of $484 million.
Although the airline industry as a whole in 2006 was expected to
report its first collective profit since 2000, Southwests
string of consecutive profitable years has now reached 34, and
the Company also extended its number of consecutive profitable
quarters to 63, both of which are unmatched in the industry.
Southwests 2006 operating income was $934 million, an
increase of $209 million, or 28.8 percent, compared to
2005. The increase in operating income was driven primarily by
strong revenues, especially during the first half of the year,
and effective cost control measures. As a result of the
extensive restructuring in the U.S. airline industry in
2004 and 2005, several carriers reduced domestic capacity,
resulting in fare increases and higher load factors for many
airlines in 2006. In fact, Southwests 2006 load factor of
73.1 percent was a company record. The Company modestly
raised its fares over the course of the year, resulting in an
increase in passenger revenue yield per RPM (passenger revenues
divided by revenue passenger miles) of 6.9 percent compared
to 2005. Unit revenue (total revenue divided by available seat
miles) also increased a healthy 10.2 percent compared to
2005 levels, as a result of the higher load factor and higher
RPM yield.
The Companys 2006 CASM (cost per available seat mile) was
basically flat compared to 2005, excluding fuel. This was
primarily a result of the Companys continued focus on
controlling non-fuel costs and attempting to offset wage rate
and benefit increases through productivity and efficiency
improvements. In addition, the Companys headcount per
aircraft at December 31, 2006 was 68, which was an
improvement versus a year-ago level of 71. Furthermore, from the
end of 2003 to the end of 2006, the Companys headcount per
aircraft decreased 20.0 percent, as the number of Employees
remained virtually flat despite the net addition of 93 aircraft
during that three year period. Including fuel expense, 2006 CASM
increased 9.3 percent compared to 2005, primarily due to
the 48.5 percent increase in the Companys fuel cost
per gallon, including the effects of hedging.
Significant events for Southwest
and/or the
airline industry during 2006 included:
* The Wright Amendment Reform Act of 2006 immediately lifted
through-ticketing restrictions, so that Customers could purchase
a single one-stop ticket between Dallas Love Field and any
Southwest destination beyond the nine Wright Amendment states
(to which nonstop Love Field service is permitted), and will
eventually eliminate substantially all restrictions associated
with the Wright Amendment in 2014. This Act also reduced the
maximum number of available gates for commercial air service at
Love Field from 32 to 20, of which the Company will
ultimately lease 16. Dallas Love Field is a significant
destination for Southwest as well as the location of the
Companys headquarters.
* The Department of Transportation announced that for
August, September, and October 2006, Southwest carried the most
passengers of any U.S. airline.
* Southwest began service to two new
destinations Denver, Colorado and Washington Dulles
in northern Virginia.
* During 2006, Southwest was authorized by its Board of
Directors to repurchase a total of $1.0 billion of its
outstanding common stock. For the year ended December 31,
2006, the Company repurchased 49.1 million shares for
$800 million.
* The Transportation Security Administration (TSA) mandated
new security measures as a result of a terrorist plot uncovered
by authorities in London. The stringent new rules, mostly
regarding the types of liquid items that can be carried onboard
the aircraft, had a negative impact on air travel beginning in
mid-August, especially on shorthaul routes and with business
travelers. The Company estimated it lost more than
$40 million in passenger revenue in August and September
related to the security threat and these new restrictions.
* The price of jet fuel continued to be a significant
factor for Southwest and other airlines. Despite the
Companys industry-leading fuel hedging program, which
resulted in cash savings of $675 million in 2006, the
Companys jet fuel cost per gallon still increased by
48.5 percent compared to 2005.
* The Company added 36
737-700
aircraft in 2006, bringing its fleet to 481 Boeing 737s at
December 31, 2006.
As the Company experienced in 2006, it must continue to overcome
higher jet fuel prices to grow profits. Based on current and
projected energy prices for 2007 and expected growth plans, the
Company
D-18
believes expenditures for jet fuel could increase between
$400 million and $500 million compared to 2006, even
including the effects of fuel derivative contracts the Company
has in place as of January 2007. The Companys fuel
derivative contracts in place for 2007 provide protection for
nearly 95 percent of the Companys expected jet fuel
consumption at an average price of approximately $50 per
barrel of crude oil. The Company once again hopes to overcome
the impact of higher anticipated 2007 fuel prices and other cost
pressures through improved revenues and continued focus on
non-fuel costs.
As Southwest moves into 2007, the Company believes its low-cost
competitive advantage, protective fuel hedging position,
excellent Employees, and strong balance sheet will allow
Southwest to respond quickly to potential industry consolidation
and to favorable market opportunities. The Company plans to add
37 new
737-700
aircraft to its fleet in 2007, resulting in a net available seat
mile (ASM) capacity increase of approximately eight percent.
Based on these deliveries, the Companys fleet will total
518 737s by the end of 2007.
Results
of Operations
The Companys consolidated net income for 2006 was
$499 million ($.61 per share, diluted), as compared to
2005 net income of $484 million ($.60 per share,
diluted), an increase of $15 million, or 3.1 percent.
Operating income for 2006 was $934 million, an increase of
$209 million, or 28.8 percent, compared to 2005. The
2006 increase in operating income was primarily due to higher
revenues from the Companys fleet growth, improved load
factors, and higher fares, which more than offset a significant
increase in the cost of jet fuel. The Company believes operating
income provides a better indication of the Companys
financial performance for both 2006 and 2005 than does net
income. This is due to the fact that, generally, certain gains
and losses, recorded in accordance with Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended
(SFAS 133), that relate to fuel derivatives expiring in
future periods, are included in Other (gains)
losses, which is below the operating income line, in both
periods. In 2006, these adjustments, which are related to the
ineffectiveness of hedges and the loss of hedge accounting for
certain fuel derivatives and are included in Other (gains)
losses, totaled net losses of $101 million. For 2005,
these adjustments totaled net gains of $110 million.
Consolidated operating revenues increased $1.5 billion, or
19.8 percent, primarily due to a $1.5 billion, or
20.2 percent, increase in passenger revenues. The increase
in passenger revenues primarily was due to an increase in
capacity, an increase in RPM yield, and an increase in load
factor. Approximately 45 percent of the increase in
passenger revenue was due to the Companys 8.8 percent
increase in available seat miles compared to 2005. The Company
increased available seat miles as a result of the addition of 36
aircraft (all
737-700
aircraft). Approximately 35 percent of the increase in
passenger revenue was due to the 6.9 percent increase in
passenger yields. Average passenger fares increased
11.4 percent compared to 2005, primarily due to less fare
discounting because of the strong demand for air travel coupled
with the availability of fewer seats as a result of industrywide
domestic capacity reductions. The remainder of the passenger
revenue increase primarily was due to the 2.4 point increase in
the Companys load factor compared to 2005. The
73.1 percent load factor for 2006 represented the highest
annual load factor in the Companys history.
The airline revenue environment changed significantly from the
first half of 2006 to the second half of the year. The Company
believes this was due to both reduced demand related to domestic
economic factors, as well as the effects of the increased
carryon baggage restrictions put in place following the
terrorist plot uncovered by London authorities in August 2006.
The airline revenue environment regained some momentum during
late fourth quarter 2006, and, despite growing capacity
10 percent during the quarter, the Company achieved a
record load factor of 70.2 percent at healthy yields, which
resulted in a steady unit revenue growth rate of
4.2 percent. Based upon traffic and bookings to date, the
Company expects 2007 first quarter unit revenue growth to exceed
first quarter 2006s 9.15 cents per ASM.
Consolidated freight revenues increased slightly versus 2005. An
$18 million, or 17.1 percent, increase in freight and
cargo revenues, primarily as a result of higher rates charged,
was almost entirely offset by lower mail revenues. The lower
mail revenues were primarily due to the Companys decision
to discontinue carrying mail for the U.S. Postal Service
effective as of the end of second quarter 2006. Due to this
mid-year decision in 2006, the Company expects a
year-over-year
decrease in freight revenue for the first half of 2007.
Other revenues increased $30 million, or
17.4 percent, compared to 2005, primarily from higher
commissions earned from programs the Company sponsors with
certain business partners, such as the Company sponsored
Chase®
Visa
D-19
card. The Company expects a similar increase in first quarter
2007, also due to higher commissions earned.
Operating
Expenses
Consolidated operating expenses for 2006 increased
$1.3 billion, or 18.9 percent, compared to the
8.8 percent increase in capacity. To a large extent,
changes in operating expenses for airlines are driven by changes
in capacity, or ASMs. The following presents Southwests
operating expenses per ASM for 2006 and 2005 followed by
explanations of these changes on a per-ASM basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
|
Percent
|
|
|
|
2006
|
|
|
2005
|
|
|
(Decrease)
|
|
|
Change
|
|
|
Salaries, wages, and benefits
|
|
|
3.29
|
¢
|
|
|
3.27
|
¢
|
|
|
.02
|
¢
|
|
|
.6
|
%
|
Fuel and oil
|
|
|
2.31
|
|
|
|
1.58
|
|
|
|
.73
|
|
|
|
46.2
|
|
Maintenance materials and repairs
|
|
|
.51
|
|
|
|
.52
|
|
|
|
(.01
|
)
|
|
|
(1.9
|
)
|
Aircraft rentals
|
|
|
.17
|
|
|
|
.19
|
|
|
|
(.02
|
)
|
|
|
(10.5
|
)
|
Landing fees and other rentals
|
|
|
.53
|
|
|
|
.53
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
.56
|
|
|
|
.55
|
|
|
|
.01
|
|
|
|
1.8
|
|
Other
|
|
|
1.43
|
|
|
|
1.41
|
|
|
|
.02
|
|
|
|
1.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
8.80
|
¢
|
|
|
8.05
|
¢
|
|
|
.75
|
¢
|
|
|
9.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses per ASM increased 9.3 percent to 8.80
cents, primarily due to an increase in jet fuel prices, net of
gains from the Companys fuel hedging program. The
Companys average cost per gallon of fuel increased
48.5 percent versus the prior year. Excluding fuel,
year-over-year
CASM was basically flat with 2005. Based on current cost trends,
the Company expects first quarter 2007 unit costs,
excluding fuel, to increase from 2006s full year figure of
6.49 cents.
Salaries, wages, and benefits expense per ASM increased
.6 percent compared to 2005, primarily due to an increase
in average wage rates, mostly offset by productivity efforts
that have enabled the Company to grow overall headcount at a
rate that is less than the growth in ASMs. The Companys
headcount at December 31, 2006, was 2.9 percent higher
than at December 31, 2005, despite the 8.8 growth in
available seat miles. The Company expects a similar performance
for salaries, wages, and benefits per ASM in first quarter 2007
versus first quarter 2006, due to higher wage rates partially
offset by a reduction in share-based compensation expense.
The Companys Ramp, Operations, Provisioning, and Freight
Agents are subject to an agreement with the Transport Workers
Union of America, AFL-CIO (TWU), which becomes
amendable on June 30, 2008. However, under certain
conditions, TWU could elect to give notice to the Company by
June 1, 2007, of its desire to make the agreement amendable
on June 30, 2007. During second quarter 2006, TWU
membership voted to not make the contract amendable on
June 30, 2007. The Company is unable to predict whether
future votes between now and June 2007 would result in the same
outcome.
The Companys Pilots are subject to an agreement with the
Southwest Airlines Pilots Association (SWAPA),
which became amendable during September, 2006. The Company and
SWAPA recently began discussions on a new agreement.
Fuel and oil expense per ASM increased 46.2 percent, net of
hedging gains, primarily due to a significant increase in the
average jet fuel cost per gallon. Although the Companys
fuel hedge position was not as strong as the position the
Company held in 2005, the Companys hedging program still
resulted in the realization of $675 million in cash
settlements during 2006. These settlements resulted in a 2006
reduction to Fuel and oil expense of $634 million. However,
even with this hedge position, the Companys jet fuel cost
per gallon increased 48.5 percent versus 2005. The average
cost per gallon of jet fuel in 2006 was $1.53 compared to $1.03
in 2005, excluding fuel-related taxes and net of hedging gains.
See Note 10 to the Consolidated Financial Statements. The
increase in fuel prices was partially offset by steps the
Company has taken to improve the fuel efficiency of its
aircraft, including the addition of blended winglets to all of
the Companys
737-700
aircraft. The Company has also announced it will install blended
winglets on a significant number of its
737-300
aircraft, beginning in first quarter 2007.
D-20
The Company has benefited from the recent decline in energy
prices and is currently 100 percent protected with fuel
derivative instruments for its first quarter 2007 jet fuel
purchase requirements. These instruments are at an average crude
oil equivalent price of $50 per barrel, and the majority of
these positions effectively perform like option
contracts allowing the Company to benefit in most
cases from energy price decreases. Based on this protection and
current market conditions, the Company expects its first quarter
2007 jet fuel cost per gallon to be in the $1.65 to $1.70 range,
excluding the impact of any hedge ineffectiveness and
derivatives that do not qualify for hedge accounting as defined
in SFAS 133. As of mid-January 2007, the Company had fuel
derivative contracts in place for approximately 95 percent
of its expected fuel consumption for the remainder of 2007 at
approximately $50 per barrel; 65 percent in 2008 at
approximately $49 per barrel; over 50 percent in 2009 at
approximately $51 per barrel; over 25 percent in 2010
at $63 per barrel; approximately 15 percent in 2011 at
$64 per barrel, and 15 percent in 2012 at $63 per
barrel.
Maintenance materials and repairs per ASM decreased
1.9 percent compared to 2005, primarily due to a decrease
in repair events for aircraft engines. Based on the number of
scheduled repair events for both engines and airframes in first
quarter 2007, the Company expects an increase in maintenance
materials and repairs per ASM compared to the 2006 figure of 51
cents.
Aircraft rentals per ASM decreased 10.5 percent. The
Companys 8.8 percent increase in ASMs was generated
by the 36 aircraft the Company acquired during 2006, all of
which were purchased. The number of aircraft on operating lease
remained the same. The Company currently expects a similar
year-over-year
comparison for first quarter 2007.
Landing fees and other rentals per ASM was flat compared to
2005. The Company currently expects a
year-over-year
increase in landing fees and other rentals per ASM for first
quarter 2007 primarily due to higher rates paid for airport
space.
Depreciation expense per ASM increased 1.8 percent,
primarily due to an increase in depreciation expense per ASM
from 36 new
737-700
aircraft purchased during 2006 and the resulting higher
percentage of owned aircraft. The Company currently expects a
similar
year-over-year
comparison for first quarter 2007.
Other operating expenses per ASM increased 1.4 percent
compared to 2005, primarily due to an increase in
revenue-related costs, such as credit card processing fees, from
the Companys 20.2 percent increase in passenger
revenues. The Company currently expects a similar
year-over-year
comparison for first quarter 2007.
Other expenses (income) included interest expense,
capitalized interest, interest income, and other gains and
losses. Interest expense increased by $6 million, or
4.9 percent, primarily due to an increase in floating
interest rates. This was partially offset by the Companys
repayment of $607 million in debt during 2006. The majority
of the Companys long-term debt is at floating rates. In
addition, the Company issued $300 million in senior
unsecured notes during December 2006. Excluding the effect of
any new debt offerings the Company may execute during 2007, the
Company expects a reduction in interest expense compared to
2006, primarily due to a lower average debt balance. See
Note 7 to the Consolidated Financial Statements for more
information. Capitalized interest increased $12 million, or
30.8 percent, compared to 2005 due to higher 2006 progress
payment balances for scheduled future aircraft deliveries as
well as higher interest rates. Interest income increased
$37 million, or 78.7 percent, primarily due to an
increase in rates earned on cash and investments.
During 2006, the Company recognized approximately
$52 million of expense related to amounts excluded from the
Companys measurements of hedge effectiveness (i.e., the
premium cost of fuel derivative option contracts.) Also during
2006, the Company recognized approximately $101 million of
additional expense in Other (gains) losses, net,
related to the ineffectiveness of its hedges and the loss of
hedge accounting for certain contracts. In the second half of
2006, both current and forward prices for the commodities
Southwest uses for hedging jet fuel fell significantly,
resulting in a reduction in the unrealized gains the Company had
experienced in prior periods. Of this additional expense,
approximately $42 million was unrealized,
mark-to-market
changes in the fair value of derivatives due to the
discontinuation of hedge accounting for certain contracts that
will settle in future periods; approximately $39 million
was ineffectiveness associated with the change in value of
hedges designated for future periods; and $20 million was
ineffectiveness and
mark-to-market
losses related to the change in value of contracts that settled
during 2006. See Note 10 to the consolidated financial
statements for further information on the Companys hedging
activities. For 2005, the Company recognized approximately
$35 million of expense related to amounts excluded from the
Companys measurements of hedge effectiveness and
$110 million in
D-21
additional income related to the ineffectiveness of its hedges
and unrealized
mark-to-market
changes in the fair value of certain derivative contracts.
The provision for income taxes, as a percentage of income before
taxes, decreased to 36.8 percent in 2006 from
37.9 percent in 2005. The decrease in the 2006 rate was
primarily due to a $9 million reduction related to a
revision in the State of Texas franchise tax law enacted during
2006. The Company currently expects its 2007 effective rate to
be approximately 38 percent.
The Companys consolidated net income for 2005 was
$484 million ($.60 per share, diluted), as compared to
2004 net income of $215 million ($.27 per share,
diluted), an increase of $269 million, or
125.1 percent. Operating income for 2005 was
$725 million, an increase of $321 million, or
79.5 percent, compared to 2004. The increase in operating
income was primarily due to higher revenues from the
Companys fleet growth, improved load factors, and higher
fares, which more than offset a significant increase in the cost
of jet fuel. The larger percentage increase in net income
compared to operating income primarily was due to variability in
Other (gains) losses, due to unrealized 2005 gains
resulting from the Companys fuel hedging activities, in
accordance with SFAS 133.
Consolidated operating revenues increased $1.1 billion, or
16.1 percent, primarily due to a $1.0 billion, or
15.9 percent, increase in passenger revenues. The increase
in passenger revenues primarily was due to an increase in
capacity, an increase in RPM yield, and an increase in load
factor. Holding other factors constant (such as yields and load
factor), almost 70 percent of the increase in passenger
revenue was due to the Companys 10.8 percent increase
in available seat miles compared to 2004. The Company increased
available seat miles as a result of the net addition of 28
aircraft (33 new
737-700
aircraft net of five
737-200
aircraft retirements). Approximately 18 percent of the
increase in passenger revenue was due to the 2.8 percent
increase in passenger yields. Average passenger fares increased
5.8 percent compared to 2004, primarily due to less fare
discounting because of the strong demand for air travel coupled
with the availability of fewer seats from industrywide domestic
capacity reductions. The remainder of the passenger revenue
increase primarily was due to the 1.2 point increase in the
Companys load factor compared to 2004.
Consolidated freight revenues increased $16 million, or
13.7 percent. Approximately 65 percent of the increase
was due to an increase in freight and cargo revenues, primarily
due to higher rates charged on shipments. The remaining
35 percent of the increase was due to higher mail revenues.
The U.S. Postal Service periodically reallocates the amount
of mail business given to commercial and freight air carriers
and, during 2005, shifted more business to commercial carriers.
Other revenues increased $39 million, or 29.3 percent,
compared to 2004. Approximately 35 percent of the increase
was from commissions earned from programs the Company sponsors
with certain business partners, such as the Company sponsored
Chase®
Visa card. An additional 35 percent of the increase was due
to an increase in excess baggage charges, as the Company
modified its fee policy related to the weight of checked baggage
during second quarter 2005. Among other changes, the limit at
which baggage charges apply was reduced to 50 pounds per checked
bag.
D-22
Consolidated operating expenses for 2005 increased
$733 million, or 12.0 percent, compared to the
10.8 percent increase in capacity. To a large extent,
changes in operating expenses for airlines are driven by changes
in capacity, or ASMs. The following presents Southwests
operating expenses per ASM for 2005 and 2004 followed by
explanations of these changes on a per-ASM basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
|
Percent
|
|
|
|
2005
|
|
|
2004
|
|
|
(Decrease)
|
|
|
Change
|
|
|
Salaries, wages, and benefits
|
|
|
3.27
|
¢
|
|
|
3.35
|
¢
|
|
|
(.08
|
)¢
|
|
|
(2.4
|
)%
|
Fuel and oil
|
|
|
1.58
|
|
|
|
1.30
|
|
|
|
.28
|
|
|
|
21.5
|
|
Maintenance materials and repairs
|
|
|
.52
|
|
|
|
.61
|
|
|
|
(.09
|
)
|
|
|
(14.8
|
)
|
Aircraft rentals
|
|
|
.19
|
|
|
|
.23
|
|
|
|
(.04
|
)
|
|
|
(17.4
|
)
|
Landing fees and other rentals
|
|
|
.53
|
|
|
|
.53
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
.55
|
|
|
|
.56
|
|
|
|
(.01
|
)
|
|
|
(1.8
|
)
|
Other
|
|
|
1.41
|
|
|
|
1.39
|
|
|
|
.02
|
|
|
|
1.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
8.05
|
¢
|
|
|
7.97
|
¢
|
|
|
.08
|
¢
|
|
|
1.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses per ASM increased 1.0 percent to 8.05
cents, primarily due to an increase in jet fuel prices, net of
hedging gains. The Company was able to hold flat or reduce unit
costs in every cost category, except fuel expense and other
operating expense, through a variety of cost reduction and
productivity efforts. These efforts, however, were entirely
offset by the significant increase in the cost of fuel.
Excluding fuel, CASM was 2.8 percent lower than 2004, at
6.48 cents.
Salaries, wages, and benefits expense per ASM decreased
2.4 percent compared to 2004, primarily due to a reduction
in share-based compensation expense, the majority of which is
due to stock-options granted by the Company. As a result of the
timing of grants in prior years and their related vesting
provisions, share-based compensation expense decreased from
$135 million in 2004 to $80 million in 2005. Excluding
the impact of share-based compensation expense, salaries, wages,
and benefits decreased slightly due to productivity efforts that
enabled the Company to grow overall headcount at a rate that was
less than the growth in ASMs. This decrease was partially offset
by higher average wage rates, and higher profitsharing expense
associated with the Companys higher earnings.
Fuel and oil expense per ASM increased 21.5 percent,
primarily due to a 24.8 percent increase in the average jet
fuel cost per gallon, net of hedging gains. The average cost per
gallon of jet fuel in 2005 was $1.03 compared to 82.8 cents in
2004, excluding fuel-related taxes and net of hedging gains. The
Companys 2005 and 2004 average jet fuel costs are net of
approximately $892 million and $455 million in gains
from hedging activities, respectively. See Note 10 to the
Consolidated Financial Statements. The increase in fuel prices
was partially offset by steps the Company took to improve the
fuel efficiency of its aircraft. These steps primarily included
the addition of blended winglets to all of the Companys
737-700
aircraft, and the upgrade of certain engine components on many
aircraft. The Company estimates that these and other efficiency
gains saved the Company approximately $70 million during
2005, at average unhedged market jet fuel prices.
Maintenance materials and repairs per ASM decreased
14.8 percent compared to 2004, primarily due to a decrease
in repair events for aircraft engines.
Aircraft rentals per ASM decreased 17.4 percent. Of the 33
aircraft the Company acquired during 2005, all are owned. In
addition, during 2005, the Company renegotiated the leases on
four aircraft, and, as a result, reclassified these aircraft
from operating leases to capital leases. These transactions
increased the Companys percentage of aircraft owned or on
capital lease to 81 percent at December 31, 2005, from
79 percent at December 31, 2004.
Depreciation expense per ASM decreased 1.8 percent. An
increase in depreciation expense per ASM from 33 new
737-700
aircraft purchased during 2005 and the higher percentage of
owned aircraft, was more than offset by lower expense associated
with the Companys retirement of its
737-200
fleet and all
737-200
remaining spare parts by the end of January 2005.
Other operating expenses per ASM increased 1.4 percent
compared to 2004. Approximately 75 percent of the increase
related to higher 2005 security fees in the form of a
$24 million retroactive assessment the Company received
from the Transportation Security Administration in January 2006.
The remainder of the increase
D-23
primarily related to higher fuel taxes as a result of the
substantial increase in fuel prices compared to 2004.
Other expenses (income) included interest expense,
capitalized interest, interest income, and other gains and
losses. Interest expense increased by $34 million, or
38.6 percent, primarily due to an increase in floating
interest rates. The majority of the Companys long-term
debt is at floating rates. See Note 10 to the Consolidated
Financial Statements for more information. Capitalized interest
was flat compared to 2004 as lower 2005 progress payment
balances for scheduled future aircraft deliveries were offset by
higher interest rates. Interest income increased
$26 million, or 123.8 percent, primarily due to an
increase in rates earned on cash and investments. Other
(gains) losses, net primarily includes amounts recorded in
accordance with SFAS 133. See Note 10 to the
Consolidated Financial Statements for more information on the
Companys hedging activities. During 2005, the Company
recognized approximately $35 million of expense related to
amounts excluded from the Companys measurements of hedge
effectiveness. Also during 2005, the Company recognized
approximately $110 million of additional income in
Other (gains) losses, net, related to the
ineffectiveness of its hedges and the loss of hedge accounting
for certain contracts. Of this additional income, approximately
$77 million was unrealized,
mark-to-market
changes in the fair value of derivatives due to the
discontinuation of hedge accounting for certain contracts that
will settle in future periods, approximately $9 million was
unrealized ineffectiveness associated with hedges designated for
future periods, and $24 million was ineffectiveness and
mark-to-market
gains related to contracts that settled during 2005. For 2004,
the Company recognized approximately $24 million of expense
related to amounts excluded from the Companys measurements
of hedge effectiveness and $13 million in expense related
to the ineffectiveness of its hedges and unrealized
mark-to-market
changes in the fair value of certain derivative contracts.
The provision for income taxes, as a percentage of income before
taxes, increased to 37.9 percent in 2005 from
36.5 percent in 2004. The 2004 rate was favorably impacted
by an adjustment related to the ultimate resolution of an
airline industry-wide issue regarding the tax treatment of
certain aircraft engine maintenance costs, and lower state
income taxes.
Liquidity
and Capital Resources
Net cash provided by operating activities was $1.4 billion
in 2006 compared to $2.1 billion in 2005. For the Company,
operating cash inflows primarily are derived from providing air
transportation for Customers. The vast majority of tickets are
purchased prior to the day on which travel is provided and, in
some cases, several months before the anticipated travel date.
Operating cash outflows primarily are related to the recurring
expenses of operating the airline. The operating cash flows in
both years were significantly impacted by fluctuations in
counterparty deposits associated with the Companys fuel
hedging program (counterparty deposits are reflected as an
increase to Cash and a corresponding increase to Accrued
liabilities.) There was a decrease in counterparty deposits of
$410 million for 2006, versus an increase of
$620 million during 2005. The decrease in these deposits
during 2006 was due to the decline in fair value of the
Companys fuel derivative portfolio from December 31,
2005 to December 31, 2006, especially during the second
half of the year. The increase during 2005 was primarily due to
a large increase in the fair value of the Companys fuel
derivative instruments, as a result of escalating energy prices
during 2005. Cash flows from operating activities for 2006 were
also driven by the $499 million in net income, plus noncash
depreciation and amortization expense of $515 million. For
further information on the Companys hedging program and
counterparty deposits, see Note 10 to the Consolidated
Financial Statements, and Item 7A. Qualitative and
Quantitative Disclosures about Market Risk, respectively. Cash
generated in 2006 and in 2005 was used primarily to finance
aircraft-related capital expenditures and to provide working
capital.
Net cash flows used in investing activities in 2006 totaled
$1.5 billion compared to $1.1 billion in 2005.
Investing activities in both years primarily consisted of
payments for new
737-700
aircraft delivered to the Company and progress payments for
future aircraft deliveries. The Company purchased 34 new
737-700
aircraft and two previously owned
737-700
aircraft in 2006 versus the purchase of 33 new
737-700s in
2005. In addition, progress payments for future deliveries were
higher in 2006 than 2005. See Note 4 to the Consolidated
Financial Statements. Investing activities for 2006 were also
reduced by $117 million related to a change in the balance
of the Companys short-term investments, namely auction
rate securities.
Net cash used in financing activities was $801 million in
2006, primarily from the repurchase of $800 million of
common stock and the repayment of $607 million
D-24
in debt. The Company repurchased a total of 49 million
shares of outstanding common stock during 2006 as a result of
three buyback programs authorized by the Companys Board of
Directors. These uses were partially offset by the issuance of
$300 million senior unsecured 5.75% notes in December
2006 and $260 million in proceeds from exercises of
Employee stock options. During 2005, the Company generated a net
$260 million from financing activities primarily from the
issuance of $300 million senior unsecured 5.125% notes
in February 2005, and proceeds of $132 million from
exercises of Employee stock options. These were partially offset
by the redemption of the Companys $100 million senior
unsecured 8% notes in March 2005 and the repurchase of
$55 million of common stock. See Note 7 to the
Consolidated Financial Statements for more information on the
issuance and redemption of long-term debt.
The Company has various options available to meet its 2007
capital and operating commitments, including cash on hand and
short-term investments at December 31, 2006, totaling
$1.8 billion, internally generated funds, and a
$600 million bank revolving line of credit. In addition,
the Company will also consider various borrowing or leasing
options to maximize earnings and supplement cash requirements.
The Company believes it has access to a wide variety of
financing arrangements because of its excellent credit ratings,
unencumbered assets, modest leverage, and consistent
profitability. The Company currently has outstanding shelf
registrations for the issuance of up to $1.0 billion in
public debt securities and pass through certificates, which it
may utilize for aircraft financings or other purposes in the
future. The Company may issue a portion of these securities in
2007, primarily to fund current fleet growth plans or to take
advantage of certain strategic growth opportunities if they were
to arise.
Off-Balance
Sheet Arrangements, Contractual Obligations, and Contingent
Liabilities and Commitments
Southwest has contractual obligations and commitments primarily
with regard to future purchases of aircraft, payment of debt,
and lease arrangements. The Company received 36,
737-700
aircraft in 2006 34 of which were new aircraft from
Boeing, and two of which were pre-owned and purchased from a
third party. As of December 31, 2006, the Company had
exercised all remaining options for aircraft to be delivered in
2007, and has firm orders for 37
737-700
aircraft in 2007, 30 in 2008, 18 in 2009, and ten each in
2010-2012.
The Company also had options for four
737-700
aircraft in 2008, 18 in 2009, 32 in 2010, and 30 each in 2011
and 2012. Southwest also has an additional 54 purchase rights
for 737-700
aircraft for the years 2008 through 2014. The Company has the
option to substitute
737-600s or
-800s for the -700s. This option is applicable to aircraft
ordered from the manufacturer and must be exercised
18 months prior to the contractual delivery date.
The leasing of aircraft effectively provides flexibility to the
Company as a source of financing. Although the Company is
responsible for all maintenance, insurance, and expense
associated with operating the aircraft, and retains the risk of
loss for leased aircraft, it has not made any guarantees to the
lessors regarding the residual value (or market value) of the
aircraft at the end of the lease terms. The Company operates 93
aircraft leased from third parties, of which 84 are operating
leases. As prescribed by GAAP, assets and obligations under
operating leases are not included in the Companys
Consolidated Balance Sheet. Disclosure of the contractual
obligations associated with the Companys leased aircraft
are included below as well as in Note 8 to the Consolidated
Financial Statements.
The Company is required to provide standby letters of credit to
support certain obligations that arise in the ordinary course of
business. Although the letters of credit are an off-balance
sheet item, the majority of obligations to which they relate are
reflected as liabilities in the Consolidated Balance Sheet.
Outstanding letters of credit totaled $211 million at
December 31, 2006.
D-25
The following table aggregates the Companys material
expected contractual obligations and commitments as of
December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations by Period
|
|
|
|
|
|
|
2008
|
|
|
2010
|
|
|
Beyond
|
|
|
|
|
Contractual Obligations
|
|
2007
|
|
|
- 2009
|
|
|
- 2011
|
|
|
2011
|
|
|
Total
|
|
|
|
(In millions)
|
|
|
Long-term debt(1)
|
|
$
|
111
|
|
|
$
|
25
|
|
|
$
|
29
|
|
|
$
|
1,507
|
|
|
$
|
1,672
|
|
Interest commitments(2)
|
|
|
45
|
|
|
|
80
|
|
|
|
80
|
|
|
|
277
|
|
|
|
482
|
|
Capital lease commitments(3)
|
|
|
16
|
|
|
|
32
|
|
|
|
27
|
|
|
|
|
|
|
|
75
|
|
Operating lease commitments
|
|
|
360
|
|
|
|
598
|
|
|
|
453
|
|
|
|
1,000
|
|
|
|
2,411
|
|
Aircraft purchase commitments(4)
|
|
|
1,004
|
|
|
|
1,225
|
|
|
|
656
|
|
|
|
184
|
|
|
|
3,069
|
|
Other purchase commitments
|
|
|
34
|
|
|
|
47
|
|
|
|
26
|
|
|
|
|
|
|
|
107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations
|
|
$
|
1,570
|
|
|
$
|
2,007
|
|
|
$
|
1,271
|
|
|
$
|
2,968
|
|
|
$
|
7,816
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes current maturities, but excludes amounts associated
with interest rate swap agreements |
|
(2) |
|
Related to fixed-rate debt |
|
(3) |
|
Includes amounts classified as interest |
|
(4) |
|
Firm orders from the manufacturer |
There were no outstanding borrowings under the revolving credit
facility at December 31, 2006. See Note 6 to the
Consolidated Financial Statements for more information on the
Companys revolving credit facility.
In January 2004, the Companys Board of Directors
authorized the repurchase of up to $300 million of the
Companys common stock, utilizing present and anticipated
proceeds from the exercise of Employee stock options.
Repurchases were made in accordance with applicable securities
laws in the open market or in private transactions from time to
time, depending on market conditions. This program was completed
during first quarter 2005, resulting in the total repurchase of
approximately 20.9 million of the Companys common
shares.
In 2006, the Companys Board of Directors authorized three
separate programs for the repurchase of up to a total of
$1.0 billion of the Companys Common Stock
$300 million authorized in January 2006, $300 million
authorized in May 2006, and $400 million authorized in
November 2006. Repurchases have been made in accordance with
applicable securities laws in the open market or in private
transactions from time to time, depending on market conditions.
Through December 31, 2006, these programs resulted in the
repurchase of a total of 49.1 million shares for
$800 million.
Critical
Accounting Policies and Estimates
The Companys Consolidated Financial Statements have been
prepared in accordance with U.S. GAAP (GAAP). The
Companys significant accounting policies are described in
Note 1 to the Consolidated Financial Statements. The
preparation of financial statements in accordance with GAAP
requires the Companys management to make estimates and
assumptions that affect the amounts reported in the Consolidated
Financial Statements and accompanying footnotes. The
Companys estimates and assumptions are based on historical
experience and changes in the business environment. However,
actual results may differ from estimates under different
conditions, sometimes materially. Critical accounting policies
and estimates are defined as those that are both most important
to the portrayal of the Companys financial condition and
results and require managements most subjective judgments.
The Companys most critical accounting policies and
estimates are described below.
As described in Note 1 to the Consolidated Financial
Statements, tickets sold for passenger air travel are initially
deferred as Air traffic liability. Passenger revenue
is recognized and air traffic liability is reduced when the
service is provided (i.e., when the flight takes place).
Air traffic liability represents tickets sold for
future travel dates and estimated future refunds and exchanges
of tickets sold for past travel dates. The balance in Air
traffic liability fluctuates throughout the year based on
seasonal travel patterns and fare sale activity. The
Companys Air traffic liability balance at
December 31, 2006 was $799 million, compared to
$649 million as of December 31, 2005.
D-26
Estimating the amount of tickets that will be refunded,
exchanged, or forfeited involves some level of subjectivity and
judgment. The majority of the Companys tickets sold are
nonrefundable, which is the primary source of forfeited tickets.
According to the Companys Contract of
Carriage, tickets (whether refundable or nonrefundable)
that are sold but not flown on the travel date can be reused for
another flight, up to a year from the date of sale, or can be
refunded (if the ticket is refundable). A small percentage of
tickets (or partial tickets) expire unused. Fully refundable
tickets are rarely forfeited. Air traffic liability
includes an estimate of the amount of future refunds and
exchanges, net of forfeitures, for all unused tickets once the
flight date has passed. These estimates are based on historical
experience over many years. The Company and members of the
airline industry have consistently applied this accounting
method to estimate revenue from forfeited tickets at the date of
travel. Estimated future refunds and exchanges included in the
air traffic liability account are constantly evaluated based on
subsequent refund and exchange activity to validate the accuracy
of the Companys estimates with respect to forfeited
tickets. Holding other factors constant, a ten-percent change in
the Companys estimate of the amount of refunded,
exchanged, or forfeited tickets for 2006 would have resulted in
a $16 million, or .2%, change in Passenger revenues
recognized for that period.
Events and circumstances outside of historical fare sale
activity or historical Customer travel patterns, as noted, can
result in actual refunds, exchanges, or forfeited tickets
differing significantly from estimates. The Company evaluates
its estimates within a narrow range of acceptable amounts. If
actual refunds, exchanges, or forfeiture experience results in
an amount outside of this range, estimates and assumptions are
reviewed and adjustments to Air traffic liability
and to Passenger revenue are recorded, as necessary.
Additional factors that may affect estimated refunds and
exchanges include, but may not be limited to, the Companys
refund and exchange policy, the mix of refundable and
nonrefundable fares, and promotional fare activity. The
Companys estimation techniques have been consistently
applied from year to year; however, as with any estimates,
actual refund, exchange, and forfeiture activity may vary from
estimated amounts. No material adjustments were recorded for
years 2004, 2005, or 2006.
The Company believes it is unlikely that materially different
estimates for future refunds, exchanges, and forfeited tickets
would be reported based on other reasonable assumptions or
conditions suggested by actual historical experience and other
data available at the time estimates were made.
|
|
|
Accounting
for Long-Lived Assets
|
As of December 31, 2006, the Company had approximately
$13.9 billion (at cost) of long-lived assets, including
$11.8 billion (at cost) in flight equipment and related
assets. Flight equipment primarily relates to the 397 Boeing 737
aircraft in the Companys fleet at December 31, 2006,
which are either owned or on capital lease. The remaining 84
Boeing 737 aircraft in the Companys fleet at
December 31, 2006, are on operating lease. In accounting
for long-lived assets, the Company must make estimates about the
expected useful lives of the assets, the expected residual
values of the assets, and the potential for impairment based on
the fair value of the assets and the cash flows they generate.
The following table shows a breakdown of the Companys
long-lived asset groups along with information about estimated
useful lives and residual values of these groups:
|
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
Residual
|
|
|
Estimated Useful Life
|
|
value
|
|
Aircraft and engines
|
|
23 to 25 years
|
|
15%
|
Aircraft parts
|
|
Fleet life
|
|
4%
|
Ground property and equipment
|
|
5 to 30 years
|
|
0%-10%
|
Leasehold improvements
|
|
5 years or lease term
|
|
0%
|
In estimating the lives and expected residual values of its
aircraft, the Company primarily has relied upon actual
experience with the same or similar aircraft types and
recommendations from Boeing, the manufacturer of the
Companys aircraft. Aircraft estimated useful lives are
based on the number of cycles flown (one take-off
and landing). The Company has made a conversion of cycles into
years based on both its historical and anticipated future
utilization of the aircraft. Subsequent revisions to these
estimates, which can be significant, could be caused by changes
to the Companys maintenance program, changes in
utilization of the aircraft (actual cycles during a given period
of time), governmental regulations on aging aircraft, and
changing market prices of new and used aircraft of the same or
similar types. The Company evaluates its estimates and
assumptions each reporting period and, when warranted, adjusts
these estimates and assumptions. Generally, these adjustments
are accounted for on a prospective basis through depreciation
and amortization expense, as required by GAAP.
D-27
When appropriate, the Company evaluates its long-lived assets
for impairment. Factors that would indicate potential impairment
may include, but are not limited to, significant decreases in
the market value of the long-lived asset(s), a significant
change in the long-lived assets physical condition, and
operating or cash flow losses associated with the use of the
long-lived asset. While the airline industry as a whole has
experienced many of these indicators, Southwest has continued to
operate all of its aircraft, generate positive cash flow, and
produce profits. Consequently, the Company has not identified
any impairments related to its existing aircraft fleet. The
Company will continue to monitor its long-lived assets and the
airline operating environment.
The Company believes it unlikely that materially different
estimates for expected lives, expected residual values, and
impairment evaluations would be made or reported based on other
reasonable assumptions or conditions suggested by actual
historical experience and other data available at the time
estimates were made.
|
|
|
Financial
Derivative Instruments
|
The Company utilizes financial derivative instruments primarily
to manage its risk associated with changing jet fuel prices, and
accounts for them under Statement of Financial Accounting
Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended
(SFAS 133). See Qualitative and Quantitative
Disclosures about Market Risk for more information on
these risk management activities and see Note 10 to the
Consolidated Financial Statements for more information on
SFAS 133, the Companys fuel hedging program, and
financial derivative instruments.
SFAS 133 requires that all derivatives be marked to market
(fair value) and recorded on the Consolidated Balance Sheet. At
December 31, 2006, the Company was a party to over 480
financial derivative instruments, related to its fuel hedging
program, for year 2007 and beyond. The fair value of the
Companys fuel hedging financial derivative instruments
recorded on the Companys Consolidated Balance Sheet as of
December 31, 2006, was $999 million, compared to
$1.7 billion at December 31, 2005. The large decrease
in fair value primarily was due to the decrease in energy prices
in the second half of 2006, as well as the expiration of
approximately $675 million in fuel derivative instruments
that related to 2006, net of new derivative instruments the
Company added for future years. Changes in the fair values of
these instruments can vary dramatically, as was evident during
both 2005 and 2006, based on changes in the underlying commodity
prices. Market price changes can be driven by factors such as
supply and demand, inventory levels, weather events, refinery
capacity, political agendas, and general economic conditions,
among other items. The financial derivative instruments utilized
by the Company primarily are a combination of collars, purchased
call options, and fixed price swap agreements. The Company does
not purchase or hold any derivative instruments for trading
purposes.
The Company enters into financial derivative instruments with
third party institutions in
over-the-counter
markets. Since the majority of the Companys financial
derivative instruments are not traded on a market exchange, the
Company estimates their fair values. Depending on the type of
instrument, the values are determined by the use of present
value methods or standard option value models with assumptions
about commodity prices based on those observed in underlying
markets. Also, since there is not a reliable forward market for
jet fuel, the Company must estimate the future prices of jet
fuel in order to measure the effectiveness of the hedging
instruments in offsetting changes to those prices, as required
by SFAS 133. Forward jet fuel prices are estimated through
the observation of similar commodity futures prices (such as
crude oil, heating oil, and unleaded gasoline) and adjusted
based on historical variations to those like commodities.
Fair values for financial derivative instruments and forward jet
fuel prices are both estimated prior to the time that the
financial derivative instruments settle, and the time that jet
fuel is purchased and consumed, respectively. However, once
settlement of the financial derivative instruments occurs and
the hedged jet fuel is purchased and consumed, all values and
prices are known and are recognized in the financial statements.
In recent years, because of increased volatility in energy
markets, the Companys estimates have materially differed
from actual results, resulting in increased volatility in the
Companys periodic financial results.
Estimating the fair value of these fuel derivative instruments
and forward prices for jet fuel will also result in changes in
their values from period to period and thus determine how they
are accounted for under SFAS 133. To the extent that the
change in the estimated fair value of a fuel derivative
instrument differs from the change in the estimated price of the
associated jet fuel to be purchased, both on a cumulative and a
period-to-period
basis, ineffectiveness of the fuel hedge can result, as defined
by SFAS 133. This could result in the immediate recording
of noncash charges or income, representing the change in the
fair value of the derivative, even though the derivative
instrument may not expire until a future period.
D-28
Likewise, if a derivative contract ceases to qualify for hedge
accounting, the changes in the fair value of the derivative
instrument is recorded every period to Other gains and
losses in the income statement in the period of the change.
Ineffectiveness is inherent in hedging jet fuel with derivative
positions based in other crude oil related commodities,
especially given the magnitude of the current fair market value
of the Companys fuel derivatives and the recent volatility
in the prices of refined products. Due to the volatility in
markets for crude oil and related products, the Company is
unable to predict the amount of ineffectiveness each period,
including the loss of hedge accounting, which could be
determined on a derivative by derivative basis or in the
aggregate. This may result, and has resulted, in increased
volatility in the Companys financial statements. The
significant increase in the amount of hedge ineffectiveness and
unrealized gains and losses on the change in value of derivative
contracts settling in future periods recorded during recent
periods has been due to a number of factors. These factors
include: the significant fluctuation in energy prices, the
number of derivative positions the Company holds, significant
weather events that have affected refinery capacity and the
production of refined products, and the volatility of the
different types of products the Company uses for protection. The
number of instances in which the Company has discontinued hedge
accounting for specific hedges and for specific refined
products, such as unleaded gasoline, has increased recently,
primarily due to these reasons. In these cases, the Company has
determined that the hedges will not regain effectiveness in the
time period remaining until settlement and therefore must
discontinue special hedge accounting, as defined by
SFAS 133. When this happens, any changes in fair value of
the derivative instruments are marked to market through earnings
in the period of change. As the fair value of the Companys
hedge positions increases in amount, there is a higher degree of
probability that there will be continued variability recorded in
the income statement and that the amount of hedge
ineffectiveness and unrealized gains or losses recorded in
future periods will be material. This is primarily due to the
fact that small differences in the correlation of crude oil
related products are leveraged over large dollar volumes.
SFAS 133 is a complex accounting standard with stringent
requirements, including the documentation of a Company hedging
strategy, statistical analysis to qualify a commodity for hedge
accounting both on a historical and a prospective basis, and
strict contemporaneous documentation that is required at the
time each hedge is designated by the Company. As required by
SFAS 133, the Company assesses the effectiveness of each of
its individual hedges on a quarterly basis. The Company also
examines the effectiveness of its entire hedging program on a
quarterly basis utilizing statistical analysis. This analysis
involves utilizing regression and other statistical analyses
that compare changes in the price of jet fuel to changes in the
prices of the commodities used for hedging purposes.
The Company continually looks for better and more accurate
methodologies in forecasting future cash flows relating to its
jet fuel hedging program. These estimates are used in the
measurement of effectiveness for the Companys fuel hedges,
as required by SFAS 133. During first quarter 2006, the
Company did revise its method for forecasting future cash flows.
Previously, the Company had estimated future cash flows using
actual market forward prices of like commodities and adjusting
for historical differences from the Companys actual jet
fuel purchase prices. The Companys new methodology
utilizes a statistical-based regression equation with data from
market forward prices of like commodities. This equation is then
adjusted for certain items, such as transportation costs, that
are stated in the Companys fuel purchasing contracts with
its vendors. This change to the Companys methodology for
estimating future cash flows (i.e., jet fuel prices) was applied
prospectively, in accordance with the Companys
interpretation of SFAS 133. The Company believes that this
change for estimating future cash flows will result in more
effective hedges over the long-term.
The Company also utilizes financial derivative instruments in
the form of interest rate swap agreements. The primary objective
for the Companys use of interest rate hedges is to reduce
the volatility of net interest income by better matching the
repricing of its assets and liabilities. During 2003, the
Company entered into interest rate swap agreements relating to
its $385 million 6.5% senior unsecured notes due 2012,
and $375 million 5.496%
Class A-2
pass-through certificates due 2006. The interest rate swap
associated with the $375 million 5.496%
Class A-2
pass-through certificates expired on the date the certificates
were repaid in fourth quarter 2006. The floating rate paid under
the swap associated with the $385 million 6.5% senior
unsecured notes due 2012 sets in arrears. The Company pays the
London InterBank Offered Rate (LIBOR) plus a margin every six
months and receives 6.5% every six months on a notional amount
of $385 million until 2012. The average floating rate paid
under this agreement during 2006 is estimated to be
7.63 percent based on actual and forward rates at
December 31, 2006.
D-29
The Company is also party to an interest rate swap agreement
relating to its $350 million 5.25% senior unsecured
notes due 2014, in which the floating rate is set at the
beginning of each six month period. Under this agreement, the
Company pays LIBOR plus a margin every six months and receives
5.25% every six months on a notional amount of $350 million
until 2014. The average floating rate paid under this agreement
during 2006 was 5.69 percent.
The Companys interest rate swap agreements qualify as fair
value hedges, as defined by SFAS 133. In addition, these
interest rate swap agreements qualify for the
shortcut method of accounting for hedges, as defined
by SFAS 133. Under the shortcut method, the
hedges are assumed to be perfectly effective, and, thus, there
is no ineffectiveness to be recorded in earnings. The fair value
of the interest rate swap agreements, which are adjusted
regularly, are recorded in the Consolidated Balance Sheet, as
necessary, with a corresponding adjustment to the carrying value
of the long-term debt. The fair value of the interest rate swap
agreements, excluding accrued interest, at December 31,
2006, was a liability of approximately $30 million. The
comparable fair value of these same agreements at
December 31, 2005, was a liability of $31 million. The
long-term portion of these amounts are recorded in Other
deferred liabilities in the Consolidated Balance Sheet for
each respective year. In accordance with fair value hedging, the
offsetting entry is an adjustment to decrease the carrying value
of long-term debt. See Note 10 to the Consolidated
Financial Statements.
The Company believes it is unlikely that materially different
estimates for the fair value of financial derivative
instruments, and forward jet fuel prices, would be made or
reported based on other reasonable assumptions or conditions
suggested by actual historical experience and other data
available at the time estimates were made.
The Company has share-based compensation plans covering the
majority of its Employee groups, including plans adopted via
collective bargaining, a plan covering the Companys Board
of Directors, and plans related to employment contracts with one
Executive Officer of the Company. Prior to January 1, 2006,
the Company accounted for stock-based compensation utilizing the
intrinsic value method in accordance with the provisions of
Accounting Principles Board Opinion No. 25 (APB 25),
Accounting for Stock Issued to Employees and related
Interpretations. Accordingly, no compensation expense was
recognized for fixed option plans because the exercise prices of
Employee stock options equaled or exceeded the market prices of
the underlying stock on the dates of grant. However, prior to
adoption of SFAS 123R, share-based compensation had been
included in pro forma disclosures in the financial statement
footnotes for periods prior to 2006.
Effective January 1, 2006, the Company adopted the fair
value recognition provisions of SFAS No. 123R,
Share-Based Payment using the modified retrospective
transition method. Among other items, SFAS 123R eliminates
the use of APB 25 and the intrinsic value method of
accounting, and requires companies to recognize the cost of
Employee services received in exchange for awards of equity
instruments, based on the grant date fair value of those awards,
in the financial statements.
Under the modified retrospective method, compensation cost is
recognized in the financial statements beginning with the
effective date, based on the requirements of SFAS 123R for
all share-based payments granted after that date, and based on
the requirements of SFAS 123 for all unvested awards
granted prior to the effective date of SFAS 123R. In
addition, results for prior periods have been retroactively
adjusted utilizing the pro forma disclosures in those prior
financial statements, except as noted. As part of this revision,
the Company recorded cumulative share-based compensation expense
of $409 million for the period
1995-2005,
resulting in a reduction to Retained earnings in the
accompanying Consolidated Balance Sheet as of December 31,
2005. This adjustment, along with the creation of a net Deferred
income tax asset in the amount of $130 million, resulted in
an offsetting increase to Capital in excess of par value in the
amount of $539 million in the accompanying Consolidated
Balance Sheet as of December 31, 2005. The Deferred tax
asset represents the portion of the cumulative expense related
to stock options that will result in a future tax deduction.
The Company estimates the fair value of stock option awards on
the date of grant utilizing a modified Black-Scholes option
pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of short-term
traded options that have no vesting restrictions and are fully
transferable. However, certain assumptions used in the
Black-Scholes model, such as expected term, can be adjusted to
incorporate the unique characteristics of the Companys
stock option awards. Option valuation models require the input
of somewhat subjective assumptions including expected stock
price volatility and expected term. For 2005 and 2006, the
Company has relied on observations of both historical volatility
trends, implied future volatility
D-30
observations as determined by independent third parties, and
implied volatility from traded options on the Companys
stock. For both 2006 and 2005 stock option grants, the Company
utilized expected volatility based on the expected life of the
option, but within a range of 25% to 27%. Prior to 2005, the
Company relied exclusively on historical volatility as an input
for determining the estimated fair value of stock options. In
determining the expected term of the option grants, the Company
has observed the actual terms of prior grants with similar
characteristics, the actual vesting schedule of the grant, and
assessed the expected risk tolerance of different optionee
groups.
Other assumptions required for estimating fair value with the
Black-Scholes model are the expected risk-free interest rate and
expected dividend yield of the Companys stock. The
risk-free interest rates used were actual U.S. Treasury
zero-coupon rates for bonds matching the expected term of the
option on the date of grant. The expected dividend yield of the
Companys common stock over the expected term of the option
on the date of grant was estimated based on the Companys
current dividend yield, and adjusted for anticipated future
changes.
Vesting terms for the Companys stock option plans differ
based on the type of grant made and the group to which the
options are granted. For grants made to Employees under
collective bargaining plans, vesting has ranged in length from
immediate vesting to vesting periods in accordance with the
period covered by the respective collective bargaining
agreement. For Other Employee Plans, options vest
and become fully exercisable over three, five, or ten years of
continued employment, depending upon the grant type. For grants
in any of the Companys plans that are subject to graded
vesting over a service period, the Company recognizes expense on
a straight-line basis over the requisite service period for the
entire award. None of the Companys grants include
performance-based or market-based vesting conditions, as defined.
As of December 31, 2006, the Company has $74 million
in remaining unrecognized compensation cost related to past
grants of stock options, which is expected to be recognized over
a weighted-average period of 1.9 years. The total
recognition period for the remaining unrecognized compensation
cost is approximately ten years; however, the majority of this
cost will be recognized over the next two years, in accordance
with vesting provisions. Over 80 percent of net
unrecognized amount at December 31, 2006, related to
options granted prior to the adoption of SFAS 123R on
January 1, 2006. In addition, the vast majority of the
$80 million in share-based compensation expense reflected
in the Consolidated Statement of Income for the year ended
December 31, 2006, was related to options granted prior to
the adoption of SFAS 123R. Based on Employee stock options
expected to vest during 2007, the number of options eligible to
be granted in future periods and the Companys expectation
of future grants, the Company expects the expense related to
share-based compensation to decrease significantly during 2007
compared to 2006 expense.
The Company believes it is unlikely that materially different
estimates for the assumptions used in estimating the fair value
of stock options granted would be made based on the conditions
suggested by actual historical experience and other data
available at the time estimates were made.
Forward-Looking
Statements
Some statements in this
Form 10-K
(or otherwise made by the Company or on the Companys
behalf from time to time in other reports, filings with the
Securities and Exchange Commission, news releases, conferences,
World Wide Web postings or otherwise) which are not historical
facts, may be forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as
amended, Section 21E of the Securities Exchange Act of
1934, and the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are based on, and include statements
about, Southwests estimates, expectations, beliefs,
intentions or strategies for the future, and the assumptions
underlying these forward-looking statements. Specific
forward-looking statements can be identified by the fact that
they do not relate strictly to historical or current facts and
include, without limitation, words such as
anticipates, believes,
estimates, expects, intends,
forecasts, may, will,
should, and similar expressions. Forward-looking
statements are not guarantees of future performance and involve
risks and uncertainties that are difficult to predict.
Therefore, actual results may differ materially from what is
expressed in or indicated by Southwests forward-looking
statements or from historical experience or the Companys
present expectations. Factors that could cause these differences
include, but are not limited to, those set forth under
Item 1A Risk Factors.
Caution should be taken not to place undue reliance on the
Companys forward-looking statements, which represent the
Companys views only as of the date this report is filed.
The Company undertakes no obligation to update publicly or
revise any forward-looking statement,
D-31
whether as a result of new information, future events, or
otherwise.
|
|
Item 7A.
|
Qualitative
and Quantitative Disclosures About Market Risk
|
Southwest has interest rate risk in its floating rate debt
obligations and interest rate swaps, and has commodity price
risk in jet fuel required to operate its aircraft fleet. The
Company purchases jet fuel at prevailing market prices, but
seeks to manage market risk through execution of a documented
hedging strategy. Southwest has market sensitive instruments in
the form of fixed rate debt instruments and financial derivative
instruments used to hedge its exposure to jet fuel price
increases. The Company also operates 93 aircraft under operating
and capital leases. However, leases are not considered market
sensitive financial instruments and, therefore, are not included
in the interest rate sensitivity analysis below. Commitments
related to leases are disclosed in Note 8 to the
Consolidated Financial Statements. The Company does not purchase
or hold any derivative financial instruments for trading
purposes. See Note 10 to the Consolidated Financial
Statements for information on the Companys accounting for
its hedging program and for further details on the
Companys financial derivative instruments.
The Company utilizes financial derivative instruments, on both a
short-term and a long-term basis, as a form of insurance against
significant increases in fuel prices. The Company believes there
is significant risk in not hedging against the possibility of
such fuel price increases. The Company expects to consume
approximately 1.5 billion gallons of jet fuel in 2007.
Based on this usage, a change in jet fuel prices of just one
cent per gallon would impact the Companys Fuel and
oil expense by approximately $15 million per year,
excluding any impact of the Companys derivative
instruments.
The fair values of outstanding financial derivative instruments
related to the Companys jet fuel market price risk at
December 31, 2006, were net assets of $999 million.
The current portion of these financial derivative instruments,
or $369 million, is classified as Fuel derivative
contracts in the Consolidated Balance Sheet. The long-term
portion of these financial derivative instruments, or
$630 million, is included in Other assets. The
fair values of the derivative instruments, depending on the type
of instrument, were determined by use of present value methods
or standard option value models with assumptions about commodity
prices based on those observed in underlying markets. An
immediate ten-percent increase or decrease in underlying
fuel-related commodity prices from the December 31, 2006,
prices would correspondingly change the fair value of the
commodity derivative instruments in place by up to
$480 million. Changes in the related commodity derivative
instrument cash flows may change by more or less than this
amount based upon further fluctuations in futures prices as well
as related income tax effects. This sensitivity analysis uses
industry standard valuation models and holds all inputs constant
at December 31, 2006, levels, except underlying futures
prices.
Outstanding financial derivative instruments expose the Company
to credit loss in the event of nonperformance by the
counterparties to the agreements. However, the Company does not
expect any of the counterparties to fail to meet their
obligations. The credit exposure related to these financial
instruments is represented by the fair value of contracts with a
positive fair value at the reporting date. To manage credit
risk, the Company selects and will periodically review
counterparties based on credit ratings, limits its exposure to a
single counterparty, and monitors the market position of the
program and its relative market position with each counterparty.
At December 31, 2006, the Company had agreements with eight
counterparties containing early termination rights
and/or
bilateral collateral provisions whereby security is required if
market risk exposure exceeds a specified threshold amount or
credit ratings fall below certain levels. At December 31,
2006, the Company held $540 million in cash collateral
deposits under these bilateral collateral provisions. These
collateral deposits serve to decrease, but not totally
eliminate, the credit risk associated with the Companys
hedging program. The deposits are included in Accrued
liabilities on the Consolidated Balance Sheet. See also
Note 10 to the Consolidated Financial Statements.
The vast majority of the Companys assets are aircraft,
which are long-lived. The Companys strategy is to maintain
a conservative balance sheet and grow capacity steadily and
profitably. While the Company uses financial leverage, it has
maintained a strong balance sheet and an A credit
rating on its senior unsecured fixed-rate debt with
Standard & Poors and Fitch ratings agencies, and
a Baa1 credit rating with Moodys rating
agency. The Companys 1999 and 2004 French Credit
Agreements do not give rise to significant fair value risk but
do give rise to interest rate risk because these borrowings are
floating-rate debt. In addition, as disclosed in Note 10 to
the Consolidated Financial Statements, the Company has
D-32
converted certain of its long-term debt to floating rate debt by
entering into interest rate swap agreements. This includes the
Companys $385 million 6.5% senior unsecured
notes due 2012 and the $350 million 5.25% senior
unsecured notes due 2014. Although there is interest rate risk
associated with these floating rate borrowings, the risk for the
1999 and 2004 French Credit Agreements is somewhat mitigated by
the fact that the Company may prepay this debt under certain
conditions. See Notes 6 and 7 to the Consolidated Financial
Statements for more information on the material terms of the
Companys short-term and long-term debt.
Excluding the $385 million 6.5% senior unsecured
notes, and the $350 million 5.25% senior unsecured
notes that were converted to a floating rate as previously
noted, the Company had outstanding senior unsecured notes
totaling $800 million at December 31, 2006. These
senior unsecured notes currently have a weighted-average
maturity of 10.2 years at fixed rates averaging
5.98 percent at December 31, 2006, which is comparable
to average rates prevailing for similar debt instruments over
the last ten years. The carrying value of the Companys
floating rate debt totaled $843 million, and this debt had
a weighted-average maturity of 7.0 years at floating rates
averaging 6.74 percent for the twelve months ended
December 31, 2006. In total, the Companys fixed rate
debt and floating rate debt represented 7.4 percent and
7.8 percent, respectively, of total noncurrent assets at
December 31, 2006.
The Company also has some risk associated with changing interest
rates due to the short-term nature of its invested cash, which
totaled $1.4 billion, and short-term investments, which
totaled $369 million, at December 31, 2006. The
Company invests available cash in certificates of deposit,
highly rated money market instruments, investment grade
commercial paper, auction rate securities, and other highly
rated financial instruments. Because of the short-term nature of
these investments, the returns earned parallel closely with
short-term floating interest rates. The Company has not
undertaken any additional actions to cover interest rate market
risk and is not a party to any other material market interest
rate risk management activities.
A hypothetical ten percent change in market interest rates as of
December 31, 2006, would not have a material affect on the
fair value of the Companys fixed rate debt instruments.
See Note 10 to the Consolidated Financial Statements for
further information on the fair value of the Companys
financial instruments. A change in market interest rates could,
however, have a corresponding effect on the Companys
earnings and cash flows associated with its floating rate debt,
invested cash, and short-term investments because of the
floating-rate nature of these items. Assuming floating market
rates in effect as of December 31, 2006, were held constant
throughout a
12-month
period, a hypothetical ten percent change in those rates would
correspondingly change the Companys net earnings and cash
flows associated with these items by less than $3 million.
Utilizing these assumptions and considering the Companys
cash balance, short-term investments, and floating-rate debt
outstanding at December 31, 2006, an increase in rates
would have a net positive effect on the Companys earnings
and cash flows, while a decrease in rates would have a net
negative effect on the Companys earnings and cash flows.
However, a ten percent change in market rates would not impact
the Companys earnings or cash flow associated with the
Companys publicly traded fixed-rate debt.
The Company is also subject to various financial covenants
included in its credit card transaction processing agreement,
the revolving credit facility, and outstanding debt agreements.
Covenants include the maintenance of minimum credit ratings. For
the revolving credit facility, the Company shall also maintain,
at all times, a Coverage Ratio, as defined in the agreement, of
not less than 1.25 to 1.0. The Company met or exceeded the
minimum standards set forth in these agreements as of
December 31, 2006. However, if conditions change and the
Company fails to meet the minimum standards set forth in the
agreements, it could reduce the availability of cash under the
agreements or increase the costs to keep these agreements intact
as written.
D-33
Item 8. Financial
Statements and Supplementary Data
SOUTHWEST
AIRLINES CO.
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(In millions, except share data)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,390
|
|
|
$
|
2,280
|
|
Short-term investments
|
|
|
369
|
|
|
|
251
|
|
Accounts and other receivables
|
|
|
241
|
|
|
|
258
|
|
Inventories of parts and supplies,
at cost
|
|
|
181
|
|
|
|
150
|
|
Fuel derivative contracts
|
|
|
369
|
|
|
|
641
|
|
Prepaid expenses and other current
assets
|
|
|
51
|
|
|
|
40
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
2,601
|
|
|
|
3,620
|
|
Property and equipment, at cost:
|
|
|
|
|
|
|
|
|
Flight equipment
|
|
|
11,769
|
|
|
|
10,592
|
|
Ground property and equipment
|
|
|
1,356
|
|
|
|
1,256
|
|
Deposits on flight equipment
purchase contracts
|
|
|
734
|
|
|
|
660
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,859
|
|
|
|
12,508
|
|
Less allowance for depreciation
and amortization
|
|
|
3,765
|
|
|
|
3,296
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,094
|
|
|
|
9,212
|
|
Other assets
|
|
|
765
|
|
|
|
1,171
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
13,460
|
|
|
$
|
14,003
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
STOCKHOLDERS
EQUITY
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
643
|
|
|
$
|
524
|
|
Accrued liabilities
|
|
|
1,323
|
|
|
|
2,074
|
|
Air traffic liability
|
|
|
799
|
|
|
|
649
|
|
Current maturities of long-term
debt
|
|
|
122
|
|
|
|
601
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
2,887
|
|
|
|
3,848
|
|
Long-term debt less current
maturities
|
|
|
1,567
|
|
|
|
1,394
|
|
Deferred income taxes
|
|
|
2,104
|
|
|
|
1,681
|
|
Deferred gains from sale and
leaseback of aircraft
|
|
|
120
|
|
|
|
136
|
|
Other deferred liabilities
|
|
|
333
|
|
|
|
269
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Common stock, $1.00 par
value: 2,000,000,000 shares authorized; 807,611,634 and
801,641,645 shares issued in 2006 and 2005, respectively
|
|
|
808
|
|
|
|
802
|
|
Capital in excess of par value
|
|
|
1,142
|
|
|
|
963
|
|
Retained earnings
|
|
|
4,307
|
|
|
|
4,018
|
|
Accumulated other comprehensive
income
|
|
|
582
|
|
|
|
892
|
|
Treasury stock, at cost:
24,302,215 shares in 2006
|
|
|
(390
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
6,449
|
|
|
|
6,675
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
13,460
|
|
|
$
|
14,003
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
D-34
SOUTHWEST
AIRLINES CO.
CONSOLIDATED STATEMENT OF INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
(In millions, except
|
|
|
|
per share amounts)
|
|
|
OPERATING REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Passenger
|
|
$
|
8,750
|
|
|
$
|
7,279
|
|
|
$
|
6,280
|
|
Freight
|
|
|
134
|
|
|
|
133
|
|
|
|
117
|
|
Other
|
|
|
202
|
|
|
|
172
|
|
|
|
133
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
9,086
|
|
|
|
7,584
|
|
|
|
6,530
|
|
OPERATING EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries, wages, and benefits
|
|
|
3,052
|
|
|
|
2,782
|
|
|
|
2,578
|
|
Fuel and oil
|
|
|
2,138
|
|
|
|
1,341
|
|
|
|
1,000
|
|
Maintenance materials and repairs
|
|
|
468
|
|
|
|
446
|
|
|
|
472
|
|
Aircraft rentals
|
|
|
158
|
|
|
|
163
|
|
|
|
179
|
|
Landing fees and other rentals
|
|
|
495
|
|
|
|
454
|
|
|
|
408
|
|
Depreciation and amortization
|
|
|
515
|
|
|
|
469
|
|
|
|
431
|
|
Other operating expenses
|
|
|
1,326
|
|
|
|
1,204
|
|
|
|
1,058
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
8,152
|
|
|
|
6,859
|
|
|
|
6,126
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING INCOME
|
|
|
934
|
|
|
|
725
|
|
|
|
404
|
|
OTHER EXPENSES
(INCOME):
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
128
|
|
|
|
122
|
|
|
|
88
|
|
Capitalized interest
|
|
|
(51
|
)
|
|
|
(39
|
)
|
|
|
(39
|
)
|
Interest income
|
|
|
(84
|
)
|
|
|
(47
|
)
|
|
|
(21
|
)
|
Other (gains) losses, net
|
|
|
151
|
|
|
|
(90
|
)
|
|
|
37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses (income)
|
|
|
144
|
|
|
|
(54
|
)
|
|
|
65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE INCOME
TAXES
|
|
|
790
|
|
|
|
779
|
|
|
|
339
|
|
PROVISION FOR INCOME
TAXES
|
|
|
291
|
|
|
|
295
|
|
|
|
124
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$
|
499
|
|
|
$
|
484
|
|
|
$
|
215
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME PER SHARE,
BASIC
|
|
$
|
.63
|
|
|
$
|
.61
|
|
|
$
|
.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME PER SHARE,
DILUTED
|
|
$
|
.61
|
|
|
$
|
.60
|
|
|
$
|
.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
D-35
SOUTHWEST
AIRLINES CO.
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, 2006, 2005, and 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital in
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
Excess of
|
|
|
Retained
|
|
|
Comprehensive
|
|
|
Treasury
|
|
|
|
|
|
|
Stock
|
|
|
Par Value
|
|
|
Earnings
|
|
|
Income (Loss)
|
|
|
Stock
|
|
|
Total
|
|
|
|
(In millions, except per share amounts)
|
|
|
Balance at December 31, 2003
|
|
$
|
789
|
|
|
$
|
612
|
|
|
$
|
3,506
|
|
|
$
|
122
|
|
|
$
|
|
|
|
$
|
5,029
|
|
Purchase of shares of treasury
stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(246
|
)
|
|
|
(246
|
)
|
Issuance of common and treasury
stock pursuant to Employee stock plans
|
|
|
1
|
|
|
|
7
|
|
|
|
(93
|
)
|
|
|
|
|
|
|
175
|
|
|
|
90
|
|
Tax benefit of options exercised
|
|
|
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23
|
|
Share-based compensation
|
|
|
|
|
|
|
135
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
135
|
|
Cash dividends, $.018 per
share
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
|
|
|
|
|
|
|
|
|
|
(14
|
)
|
Comprehensive income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
215
|
|
|
|
|
|
|
|
|
|
|
|
215
|
|
Unrealized gain on derivative
instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
293
|
|
|
|
|
|
|
|
293
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004
|
|
$
|
790
|
|
|
$
|
777
|
|
|
$
|
3,614
|
|
|
$
|
417
|
|
|
$
|
(71
|
)
|
|
$
|
5,527
|
|
Purchase of shares of treasury
stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55
|
)
|
|
|
(55
|
)
|
Issuance of common and treasury
stock pursuant to Employee stock plans
|
|
|
12
|
|
|
|
59
|
|
|
|
(66
|
)
|
|
|
|
|
|
|
126
|
|
|
|
131
|
|
Tax benefit of options exercised
|
|
|
|
|
|
|
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
47
|
|
Share-based compensation
|
|
|
|
|
|
|
80
|
|
|
|
|
|
|
|
|
|
|
|
|
|