10-Q 1 final3q0010q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2000 OR ____TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________ Commission file No. 1-7259 SOUTHWEST AIRLINES CO. (Exact name of registrant as specified in its charter) TEXAS 74-1563240 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) P.O. Box 36611, Dallas, Texas 75235-1611 (Address of principal executive offices) (Zip Code) (214) 792-4000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Number of shares of Common Stock outstanding as of the close of business on October 26, 2000: 501,851,494 SOUTHWEST AIRLINES CO. FORM 10-Q Part I - FINANCIAL INFORMATION Item 1. Financial Statements Southwest Airlines Co. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) (unaudited)
September 30, 2000 December 31, 1999 ASSETS Current assets: Cash and cash equivalents $ 580,608 $ 418,819 Accounts receivable 121,049 73,448 Inventories of parts and supplies 82,053 65,152 Deferred income taxes 21,831 20,929 Prepaid expenses and other current assets 54,331 52,657 Total current assets 859,872 631,005 Property and equipment: Flight equipment 6,465,137 5,768,506 Ground property and equipment 768,989 742,230 Deposits on flight equipment purchase contracts 401,795 338,229 7,635,921 6,848,965 Less allowance for depreciation 2,067,430 1,840,799 5,568,491 5,008,166 Other assets 19,294 12,942 $ 6,447,657 $ 5,652,113 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 213,065 $ 156,755 Accrued liabilities 543,088 538,896 Air traffic liability 478,566 256,942 Income taxes payable 40,526 - Current maturities of long-term debt 108,655 7,873 Total current liabilities 1,383,900 960,466 Long-term debt less current maturities 762,612 871,717 Deferred income taxes 802,213 692,342 Deferred gains from sale and leaseback of aircraft 211,317 222,700 Other deferred liabilities 77,095 69,100 Stockholders' equity: Common stock 507,897 505,005 Capital in excess of par value 42,103 35,436 Retained earnings 2,781,941 2,385,854 Treasury stock, at cost (121,421) (90,507) Total stockholders' equity 3,210,520 2,835,788 $ 6,447,657 $ 5,652,113 See accompanying notes.
Southwest Airlines Co. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) (unaudited)
Three months ended Nine months ended Sept. 30, Sept. 30, 2000 1999 2000 1999 OPERATING REVENUES: Passenger $ 1,429,838 $ 1,189,470 $ 4,045,681 $ 3,401,111 Freight 27,925 25,273 82,959 75,552 Other 21,071 20,423 53,516 54,506 Total operating revenues 1,478,834 1,235,166 4,182,156 3,531,169 OPERATING EXPENSES: Salaries, wages, and benefits 436,776 375,524 1,240,512 1,088,109 Fuel and oil 194,531 142,624 589,210 331,274 Maintenance materials and repairs 99,442 100,037 283,318 274,673 Agency commissions 41,525 39,222 120,051 118,504 Aircraft rentals 49,609 49,835 147,979 149,539 Landing fees and other rentals 69,421 62,547 199,422 181,238 Depreciation 71,511 63,808 206,732 180,136 Other operating expenses 215,910 195,106 624,857 580,285 Total operating expenses 1,178,725 1,028,703 3,412,081 2,903,758 OPERATING INCOME 300,109 206,463 770,075 627,411 OTHER EXPENSES (INCOME): Interest expense 17,464 13,254 52,129 39,936 Capitalized interest (7,030) (8,337) (20,936) (24,430) Interest income (11,609) (6,465) (28,769) (18,838) Other (gains) losses, net 211 62 (260) 10,094 Total other expenses (income) (964) (1,486) 2,164 6,762 INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 301,073 207,949 767,911 620,649 PROVISION FOR INCOME TAXES 116,775 80,971 297,348 240,067 NET INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 184,298 126,978 470,563 380,582 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (net of income taxes of $14.0 million) - - 22,131 - NET INCOME $ 184,298 $ 126,978 $ 448,432 $ 380,582 NET INCOME PER SHARE, BASIC BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ .37 $ .25 $ .94 $ .76 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE - - .04 - NET INCOME PER SHARE, BASIC $ .37 $ .25 $ .90 $ .76 NET INCOME PER SHARE, DILUTED BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ .35 $ .24 $ .89 $ .71 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE - - .04 - NET INCOME PER SHARE, DILUTED $ .35 $ .24 $ .85 $ .71 WEIGHTED AVERAGE SHARES OUTSTANDING: Basic 499,099 504,214 497,855 502,978 Diluted 531,032 535,772 528,705 536,929 See accompanying notes.
Southwest Airlines Co. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Nine months ended Sept. 30, 2000 1999 NET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,043,134 $ 782,468 INVESTING ACTIVITIES: Net purchases of property and equipment (799,507) (902,441) FINANCING ACTIVITIES: Payments of long-term debt and capital lease obligations (8,618) (11,278) Payments of cash dividends (10,978) (10,842) Proceeds from Employee stock plans 46,431 30,695 Repurchases of common stock (108,673) (425) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (81,838) 8,150 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 161,789 (111,823) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 418,819 378,511 CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 580,608 $ 266,688 CASH PAYMENTS FOR: Interest, net of amount capitalized $ 32,414 $ 22,735 Income taxes $ 113,782 $ 103,627 See accompanying notes.
SOUTHWEST AIRLINES CO. Notes to Condensed Consolidated Financial Statements (unaudited) 1. Basis of presentation - The accompanying unaudited condensed consolidated financial statements of Southwest Airlines Co. (Company) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The condensed consolidated financial statements for the interim periods ended September 30, 2000 and 1999 include all adjustments (which include only normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods. Operating results for the three and nine month periods ended September 30, 2000 are not necessarily indicative of the results that may be expected for the year ended December 31, 2000. For further information, refer to the consolidated financial statements and footnotes thereto included in the Southwest Airlines Co. Annual Report on Form 10-K for the year ended December 31, 1999. 2. Dividends - During the three month periods ended September 30, 2000, June 30, 2000, and March 31, 2000, dividends of $.0055 per share were declared on the 499.6 million, 497.7 million, and 497.1 million shares of common stock then outstanding, respectively. During the three month periods ended September 30, 1999 and June 30, 1999, dividends of $.0055 per share were declared on the 504.1 million and 503.6 million shares of common stock then outstanding, respectively. During the three month period ended March 31, 1999, dividends of $.005 per share were declared on the 501.9 million shares of common stock then outstanding. 3. Reclassifications - Certain prior year amounts have been reclassified to conform to the current year presentation. Most notably, this includes the reclassification of $14.7 million and $46.9 million for the three months and nine months ended September 30, 1999, respectively, of "Other revenue" to "Passenger revenue" as a result of the change in accounting principle effective January 1, 2000. See Note 5 for further information. 4. Net income per share - The following table sets forth the computation of basic and diluted net income per share (in thousands except per share amounts):
Three months ended Nine months ended Sept 30, Sept 30, 2000 1999 2000 1999 NUMERATOR: Net income before cumulative effect of change in accounting principle $ 184,298 $ 126,978 $ 470,563 $ 380,582 Cumulative effect of change in accounting principle - - 22,131 - Net income available to common stockholders $ 184,298 $ 126,978 $ 448,432 $ 380,582 DENOMINATOR: Weighted-average shares outstanding, basic 499,099 504,214 497,855 502,978 Dilutive effect of Employee stock options 31,933 31,558 30,850 33,951 Adjusted weighted- average shares outstanding, diluted 531,032 535,772 528,705 536,929 NET INCOME PER SHARE: Basic, before cumulative effect of change in accounting principle $ .37 $ .25 $ .94 $ .76 Cumulative effect of change in accounting principle - - .04 - Basic $ .37 $ .25 $ .90 $ .76 Diluted, before cumulative effect of change in accounting principle $ .35 $ .24 $ .89 $ .71 Cumulative effect of change in accounting principle - - .04 - Diluted $ .35 $ .24 $ .85 $ .71
5. Accounting Change - Effective January 1, 2000, the Company adopted Staff Accounting Bulletin 101 (SAB 101) issued by the Securities and Exchange Commission in December 1999. As a result of adopting SAB 101, the Company changed the way it recognizes revenue from the sale of flight segment credits to companies participating in its Rapid Rewards frequent flyer program. Prior to the issuance of SAB 101, the Company recorded revenue to "Other revenue" when flight segment credits were sold, consistent with most other major airlines. Beginning January 1, 2000, the Company recognizes "Passenger revenue" when free travel awards are earned and flown. Due to this change, the Company recorded a cumulative adjustment in first quarter 2000 of $22.1 million (net of income taxes of $14.0 million) or $.04 per share, basic and diluted. The third quarter 2000 impact of adopting SAB 101 was to reduce net income by $1.8 million. Excluding the impact of the change, basic and diluted net income per share for third quarter 2000 would have been $.37 and $.35, respectively. The Company also reclassified for comparison purposes the revenue reported in prior periods related to the sale of flight segment credits from "Other revenue" to "Passenger revenue." 6. Recently issued accounting standards - In 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities. In 1999, the FASB issued SFAS 137, which delayed the effective date of SFAS 133 by one year. In June 2000, the FASB issued SFAS 138, which further amended SFAS 133. SFAS 133 is required to be adopted in years beginning after June 15, 2000. The Company expects to adopt SFAS 133 effective January 1, 2001. SFAS 133 will require the Company to record all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will be either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recorded in other comprehensive income until the hedged item is recorded in earnings. The ineffective portion of a derivative's change in fair value will be immediately recorded in earnings. The Company currently believes it will have all appropriate documentation in place as required by SFAS 133 and will be ready to complete the transition to SFAS 133 on January 1, 2001. The Company currently intends to account for its fuel hedge derivative instruments as cash flow hedges, as defined. Although the fair value of the Company's derivative instruments fluctuates daily, as of September 30, 2000, the Company has estimated the fair value of its off-balance sheet fuel hedge derivative instruments for periods subsequent to January 1, 2001 to be approximately $140 million. Under SFAS 133, this amount would have to be recorded as an asset on the Company's balance sheet. The Company believes the majority of the offset to this balance sheet adjustment would be an increase to other comprehensive income, a component of stockholders equity. Any difference between these amounts would be recorded as a cumulative effect of accounting adjustment on the Company's statement of income. The cumulative effect adjustment would represent any ineffectiveness from the Company's hedge positions, including items such as changes in time value that can be excluded in tests of effectiveness. The Company believes, upon the adoption of SFAS 133, more volatility may be incurred in its financial statements than in the past. Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition Comparative Consolidated Operating Statistics Relevant operating statistics for the three and nine months ended September 30, 2000 and 1999 are as follows:
Three months ended Nine months ended Sept. 30, Sept. 30, 2000 1999 * Change 2000 1999 * Change Revenue passengers carried 16,500,662 14,932,022 10.5% 47,391,379 42,682,403 11.0% Revenue passenger miles (RPMs) (000s) 10,968,076 9,611,325 14.1% 31,376,044 27,128,823 15.7% Available seat miles (ASMs) (000s) 15,310,348 13,620,008 12.4% 44,209,075 38,960,801 13.5% Load factor 71.6% 70.6% 1.0pts. 71.0% 69.6% 1.4pts. Average length of passenger haul (miles) 665 644 3.3% 662 636 4.1% Trips flown 229,710 216,761 6.0% 671,968 629,336 6.8% Average passenger fare $86.65 $79.66 8.8% $85.37 $79.68 7.1% Passenger revenue yield per RPM (cents) 13.04 12.38 5.3% 12.89 12.54 2.8% Operating revenue yield per ASM (cents) 9.66 9.07 6.5% 9.46 9.06 4.4% Operating expenses per ASM (cents) 7.70 7.55 2.0% 7.72 7.45 3.6% Operating expenses per ASM, excluding fuel (cents) 6.43 6.51 (1.2)% 6.39 6.60 (3.2)% Fuel costs per gallon, excluding fuel taxes (cents) 74.12 58.36 27.0% 77.93 47.72 63.3% Number of Employees at period-end 28,321 27,164 4.3% 28,321 27,164 4.3% Size of fleet at period-end 334 306 9.2% 334 306 9.2% * Average passenger fare and passenger revenue yield per RPM have been restated for comparison purposes to reflect the reclassifications related to the change in accounting principle.
Operating expenses per ASM for the three and nine months ended September 30, 2000 and 1999 are as follows (in cents except percent change):
Three months ended Nine months ended Sept. 30, Sept. 30, Percent Percent 2000 1999 Change 2000 1999 Change Salaries, wages, and benefits 2.40 2.38 .8 2.40 2.40 - Employee profit- sharing and savings plans .45 .38 18.4 .41 .40 2.5 Fuel and oil 1.27 1.05 21.0 1.33 .85 56.5 Maintenance materials and repairs .65 .73 (11.0) .64 .70 (8.6) Agency commissions .27 .29 (6.9) .27 .30 (10.0) Aircraft rentals .32 .37 (13.5) .33 .38 (13.2) Landing fees and other rentals .45 .46 (2.2) .45 .47 (4.3) Depreciation .47 .47 - .47 .46 2.2 Other operating expenses 1.42 1.42 - 1.42 1.49 (4.7) Total 7.70 7.55 2.0 7.72 7.45 3.6
Material Changes in Results of Operations Comparison of Three Months Ended September 30, 2000 to Three Months Ended September 30, 1999 Consolidated net income for the third quarter ended September 30, 2000 was $184.3 million, an increase of 45.1 percent compared to 1999. Diluted net income per share was $.35 compared to $.24 in 1999. Operating income for third quarter 2000 was $300.1 million, an increase of 45.4 percent compared to 1999. Third quarter 2000 consolidated operating revenues increased 19.7 percent primarily due to a 20.2 percent increase in passenger revenues. The increase in passenger revenues primarily resulted from the Company's increased capacity, strong demand for commercial air travel, and excellent revenue management. The Company also benefited due to operational difficulties experienced by several airline competitors. Although the Company cannot precisely quantify this benefit, we believe the basic demand for our low fare service remained strong for third quarter 2000. The Company experienced a 10.5 percent increase in revenue passengers carried, a 14.1 percent increase in RPMs, and a 5.3 percent increase in passenger revenue yield per RPM (passenger yield). The increase in passenger yield is primarily due to an 8.8 percent increase in average passenger fare, partially offset by a 3.3 percent increase in average length of passenger haul. The increase in RPMs exceeded the 12.4 percent increase in ASMs resulting in a load factor of 71.6 percent, or 1.0 points above third quarter 1999. The increase in ASMs resulted primarily from the net addition of 28 aircraft since third quarter 1999, which represents a 9.2 percent increase in the Company's fleet size. Thus far, load factors in October have exceeded those experienced in October 1999. Bookings for November and December are also good and we presently anticipate positive year over year unit revenue comparisons again in fourth quarter 2000. (The immediately preceding two sentences are forward-looking statements, which involve uncertainties that could result in actual results differing materially from expected results. Some significant factors include, but may not be limited to, competitive pressure such as fare sales and capacity changes by other carriers, general economic conditions, and variations in advance booking trends.) Consolidated freight revenues increased 10.5 percent primarily due to an increase in capacity. Other revenues, which consist primarily of charter revenues, increased 3.2 percent. This increase was less than the Company's increase in capacity primarily due to the Company's decision to use more of its aircraft to satisfy the strong demand for scheduled service and, therefore, make fewer aircraft available for charters. Operating expenses per ASM increased 2.0 percent to $.0770, compared to $.0755 for third quarter 1999, primarily due to an increase in average jet fuel prices. The average fuel cost per gallon was 27.0 percent higher than third quarter 1999's average cost per gallon. Excluding fuel expense, operating expenses per ASM decreased 1.2 percent. As detailed below, the Company has hedges in place for all of its anticipated fuel consumption in fourth quarter 2000 at prices well below market prices as of October 25, 2000. Including estimated hedging gains and taking into account current market prices, we are forecasting our fourth quarter 2000 average fuel cost to be in the $.80 range per gallon, which would exceed fourth quarter 1999's average cost of $.67 per gallon. Excluding fuel, the Company expects slightly lower unit costs in fourth quarter 2000 versus 1999. (The immediately preceding two sentences are forward-looking statements which involve uncertainties that could result in actual results differing materially from expected results. Such uncertainties include, but may not be limited to, the largely unpredictable levels of jet fuel prices and the Company's ability to control its non-fuel costs.) Salaries, wages, and benefits per ASM increased slightly as an increase in average wage rates was partially offset by an increase in productivity in several of the Company's operational areas. Profitsharing and Employee savings plan expenses per ASM increased 18.4 percent, primarily due to the increase in Company earnings available for profitsharing. Fuel and oil expense per ASM increased 21.0 percent due to a 27.0 percent increase in the average jet fuel cost per gallon compared to 1999. The average price paid for jet fuel in third quarter 2000 was $.7412 per gallon compared to $.5836 in 1999, including the effects of hedging activities. The Company's third quarter 2000 and 1999 average jet fuel prices are net of approximately $43.1 million and $2.5 million in gains from hedging activities, respectively. As of October 25, 2000, the Company had crude oil and/or heating oil hedge positions in place for 2000 and 2001 as follows:
Type Average underlying Approximate percentage of hedge price of crude oil of expected jet fuel Period instrument hedge (per barrel) requirements hedged Fourth Quarter swaps $22.47 70% 2000 options/other $23.25 30% Total 100% First Quarter swaps $22.27 56% 2001 options/other $25.00 24% Total 80% Second Quarter swaps $21.73 60% 2001 options/other $24.44 20% Total 80% Third Quarter swaps $21.64 50% 2001 options/other $22.15 30% Total 80% Fourth Quarter swaps $21.85 51% 2001 options/other $20.00 29% Total 80%
As of October 25, 2000, the unrealized gains from these hedging activities were $64.6 million for fourth quarter 2000 and approximately $133.4 million for all of 2001. The majority of the Company's crude oil hedge positions in the above table have been converted to heating oil hedges. Heating oil prices have historically correlated more closely with jet fuel prices than has the price of crude oil. Despite these hedge positions, the Company is expecting higher average net jet fuel cost per gallon for fourth quarter 2000 compared to fourth quarter 1999. The Company's fuel hedging strategy could result in the Company not fully benefiting from lower jet fuel prices should crude oil and/or heating oil prices decline below prices implicit in the hedge instruments. (The immediately preceding two sentences are forward-looking statements, which involve uncertainties that could result in actual results differing materially from expected results. Such uncertainties include, but may not be limited to, the largely unpredictable levels of jet fuel prices.) Maintenance materials and repairs per ASM decreased 11.0 percent primarily due to a decrease in engine maintenance related to its 737-200 aircraft fleet, as 1999 was an unusually high period for engine maintenance on these aircraft. The engines on these aircraft are not covered by the Company's "power-by-the-hour" maintenance contract with General Electric Engine Services, Inc.; therefore, repairs are expensed on a time and materials basis. These engine repairs represented approximately 59 percent of the total decrease, while a decrease in airframe inspections and repairs per ASM represented approximately 16 percent of the total decrease. The Company also expects maintenance materials and repairs expense per ASM to be lower in fourth quarter 2000 than the comparable 1999 period due to a decrease in scheduled engine maintenance on 737-200 aircraft, although not as much of a decrease as third quarter 2000. (The immediately preceding sentence is a forward-looking statement that involves uncertainties that could result in actual results differing materially from expected results. Such uncertainties include, but may not be limited to any unanticipated required aircraft airframe or engine repairs.) Agency commissions per ASM decreased 6.9 percent, primarily due to an increase in direct sales. In third quarter 2000, approximately 30 percent of the Company's revenues were attributable to direct bookings through the Company's Internet site compared to approximately 20 percent in the same prior year period. The increase in Internet revenues contributed to the Company's percentage of commissionable revenues decreasing from 33.0 percent in 1999 to 29.0 percent in 2000. Aircraft rentals per ASM decreased 13.5 percent due to a lower percentage of the aircraft fleet being leased. Landing fees and other rentals per ASM decreased 2.2 percent primarily as a result of a decrease in landing fees per ASM of 6.5 percent, partially offset by a slight increase in other rentals. Although landing fees declined on a per ASM basis, they were basically flat on a per trip basis. The growth in ASMs exceeded the trip growth primarily due to an increase in the average distance per aircraft trip flown. Other expenses (income) include interest expense, capitalized interest, interest income, and other gains and losses. Interest expense increased approximately 31.8 percent due primarily to the Company's issuance of $256 million of long-term debt in fourth quarter 1999. Capitalized interest decreased 15.7 percent primarily as a result of lower 2000 progress payment balances for scheduled future aircraft deliveries compared to 1999 and lower interest rates. Interest income increased 79.6 percent primarily due to higher invested cash balances. Comparison of Nine Months Ended September 30, 2000 to Nine Months Ended September 30, 1999 Consolidated net income before the cumulative effect of change in accounting principle for the nine months ended September 30, 2000 was $470.6 million ($.89 per share, diluted), an increase of 23.6 percent compared to 1999. The cumulative effect of change in accounting principle for 2000 was $22.1 million, net of taxes of $14.0 million (see Note 5 to the unaudited Condensed Consolidated Financial Statements). Net income, after the cumulative change in accounting principle, for 2000 was $448.4 million. Diluted net income per share, after consideration of the accounting change, was $.85 compared to $.71 in 1999. Operating income was $770.1 million, an increase of 22.7 percent compared to 1999. Consolidated operating revenues increased 18.4 percent primarily due to a 19.0 percent increase in passenger revenues. The increase in passenger revenues primarily resulted from the Company's increased capacity, strong demand for commercial air travel, and excellent revenue management. The Company experienced an 11.0 percent increase in revenue passengers carried, a 15.7 percent increase in RPMs, and a 2.8 percent increase in passenger revenue yield per RPM (passenger yield). The increase in passenger yield is primarily due to a 7.1 percent increase in average passenger fare, partially offset by a 4.1 percent increase in average length of passenger haul. The increase in RPMs exceeded a 13.5 percent increase in ASMs resulting in a load factor of 71.0 percent, or 1.4 points above the same prior year period. The increase in ASMs resulted primarily from the net addition of 28 aircraft since third quarter 1999, which represents a 9.2 percent increase in the Company's fleet size. Consolidated freight revenues increased 9.8 percent primarily due to an increase in capacity. Other revenues decreased 1.8 percent primarily due to a decrease in commercial charter revenue. The Company had less aircraft devoted to its charter business compared to 1999 due to the strong demand for scheduled passenger service. Operating expenses per ASM increased 3.6 percent to $.0772, compared to $.0745 for 1999, primarily due to a significant increase in average jet fuel prices. The average fuel cost per gallon was 63.3 percent higher than the same 1999 period. Excluding fuel expense, operating expenses per ASM decreased 3.2 percent. Salaries, wages, and benefits per ASM were flat, as increases in productivity were offset by increases in average wage rates and in Employee benefit costs, primarily health care and workers' compensation expenses. Profitsharing and Employee savings plan expenses per ASM increased primarily due to the increase in Company earnings available for profitsharing. Fuel and oil expense per ASM increased 56.5 percent due to a 63.3 percent increase in the average jet fuel cost per gallon compared to 1999. The average price paid for jet fuel in 2000 was $.7793 per gallon compared to $.4772 in 1999, including the effects of hedging activities. The Company's 2000 and 1999 average jet fuel prices are net of approximately $49.4 million and $10.2 million in gains from hedging activities, respectively. See comparison of third quarter 2000 to third quarter 1999 for a schedule of the Company's fuel hedging positions for the remainder of 2000 and for 2001. Maintenance materials and repairs per ASM decreased 8.6 percent primarily because of a decrease in engine maintenance related to the Company's 737-200 aircraft fleet as 1999 was an unusually high period for engine maintenance on these aircraft. The engines on these aircraft are not covered by the Company's "power-by-the-hour" maintenance contract with General Electric Engine Services, Inc.; therefore, repairs are expensed on a time and materials basis. These engine repairs represented approximately 63 percent of the total decrease, while a decrease in airframe inspections and repairs per ASM represented approximately 34 percent of the total decrease. Agency commissions per ASM decreased 10.0 percent, primarily due to an increase in direct sales. More than 29 percent of the Company's 2000 revenues were attributable to direct bookings through the Company's Internet site compared to approximately 17 percent in the same prior year period. The increase in Internet revenues contributed to the Company's percentage of commissionable revenues decreasing from 34.8 percent in 1999 to 29.7 percent in 2000. Aircraft rentals per ASM decreased 13.2 percent due to a lower percentage of the aircraft fleet being leased. Landing fees and other rentals per ASM decreased 4.3 percent primarily as a result of a decrease in landing fees per ASM of 6.7 percent, partially offset by a slight increase in other rentals. Although landing fees declined on a per ASM basis, they were basically flat on a per trip basis. The growth in ASMs exceeded the trip growth primarily due to an increase in the average distance per aircraft trip flown. Depreciation expense per ASM increased 2.2 percent primarily due to a higher percentage of owned aircraft. Of the 35 aircraft added to the Company's fleet over the past twelve months, 34 have been purchased. This, combined with the retirement of 7 leased aircraft, has increased the Company's percentage of aircraft owned or on capital lease from 67 percent at September 30, 1999 to 72 percent at September 30, 2000. Other operating expenses per ASM decreased 4.7 percent primarily due to Company-wide cost reduction efforts in areas such as supplies, advertising, optional training, communication costs, etc. Other expenses (income) include interest expense, capitalized interest, interest income, and other gains and losses. Interest expense increased 30.5 percent due primarily to the Company's issuance of $256 million of long-term debt in fourth quarter 1999. Capitalized interest decreased 14.3 percent primarily as a result of lower 2000 progress payment balances for scheduled future aircraft deliveries compared to 1999 and lower interest rates. Interest income increased 52.7 percent primarily due to higher invested cash balances. Other losses in 1999 resulted primarily from a write-down associated with the consolidation of certain software development projects. Liquidity and Capital Resources Net cash provided by operating activities was $1,043.1 million for the nine months ended September 30, 2000 and $1,262.4 million for the 12 months then ended. Also, during fourth quarter 1999, additional funds of $256 million were generated through the issuance of floating rate long-term debt from two separate financing transactions. Cash generated for the 12 months ended September 30, 2000 was primarily used to finance aircraft-related capital expenditures, provide working capital, and to repurchase approximately $199.2 million of the Company's outstanding common stock. The Company began this repurchase program during third quarter 1999. Through September 30, 2000, the program resulted in the repurchase of approximately 12.2 million shares at an average cost of $16.28 per share. During the 12 months ended September 30, 2000, net capital expenditures were $1,064.9 million, which primarily related to the purchase of 31 new 737-700 aircraft, one used 737-700 aircraft, two used 737-300 aircraft, and progress payments for future aircraft deliveries. The Company's contractual commitments consist primarily of scheduled aircraft acquisitions. As of September 30, 2000, 10 737- 700s are scheduled for delivery in the remainder of 2000, 21 in 2001, 31 in 2002, 13 in 2003, 29 in 2004, and 52 during the period 2005 to 2007. In addition, the Company has options to purchase up to 87 737- 700s during 2003-2008 and purchase rights for up to 217 additional aircraft during 2007-2012. The Company has the option, which must be exercised two years prior to the contractual delivery date, to substitute 737-600s or 737-800s for the 737-700s scheduled subsequent to 2001. Aggregate funding needed for fixed commitments at September 30, 2000 was approximately $4,488 million due as follows: $266 million in 2000; $749 million in 2001; $912 million in 2002; $472 million in 2003; $641 million in 2004; and $1,448 million thereafter. The Company has various options available to meet its capital and operating commitments, including cash on hand at September 30, 2000 of $580.6 million, internally generated funds, and a revolving credit line with a group of banks of up to $475 million (none of which had been drawn at September 30, 2000). In addition, the Company will also consider various borrowing or leasing options to maximize earnings and supplement cash requirements. The Company currently has outstanding shelf registrations for the issuance of $318.8 million in public debt securities which it may utilize for aircraft financing and general corporate purposes during 2000 and 2001. The Company began new service to Buffalo, New York, on October 8, 2000, with daily nonstop service to Baltimore/Washington, Las Vegas, Phoenix, and Orlando. The Company recently announced new service to West Palm Beach, Florida, beginning January 21, 2001, with daily nonstop service to Baltimore/Washington, Nashville, Tampa Bay, and Orlando. Item 3. Quantitative and Qualitative Disclosures About Market Risk See Item 7A. Quantitative and Qualitative Disclosures About Market Risk in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company received a notice of deficiency from the Internal Revenue Service (IRS) in which it proposed to defer deductions claimed by the Company on its federal income tax returns for the taxable years 1989 through 1991 for the costs of certain aircraft inspection and maintenance procedures. In defense of the notice of deficiency, the Company filed a petition in the United States Tax Court on October 30, 1997, seeking a determination that the IRS erred in disallowing the deductions claimed by the Company and that there is no deficiency in the Company's tax liability for the taxable years in issue. The notice of deficiency received by the Company stemmed from an industry-wide challenge by the IRS of the long standing practice of currently expensing aircraft inspection and maintenance costs, and similar adjustments have been proposed by the IRS to the tax returns of numerous other members of the airline industry. In response to this challenge, the Air Transport Association of America, the airline industry's trade association, since late 1996 has been in discussions with the Treasury Department and the national office of the IRS regarding the issuance of published guidance confirming the industry's practice of expensing the subject inspection and maintenance costs. Approximately one month ago, counsel for the Company and the IRS jointly advised the Tax Court that the IRS expects to publish guidance favorable to the airline industry by early November 2000. Following the publication of the guidance, counsel for the Company and the IRS will attempt to resolve the controversy without the necessity of further litigation. Management believes that the final resolution of this controversy will not have a materially adverse effect upon the financial position and results of operations of the Company. Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K a) Exhibits (10.1) Supplemental Agreements No. 11, 12, 13 and 14 to Purchase Agreement No. 1810, dated January 19, 1994 between the Boeing Company and Southwest (27) Financial Data Schedule b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHWEST AIRLINES CO. November 2, 2000 /s/ Gary C. Kelly Date Gary C. Kelly Vice President - Finance and Chief Financial Officer (Principal Financial and Accounting Officer)