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.  )

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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 21, 2008

 

To the Shareholders:

 

The Annual Meeting of the Shareholders of Southwest Airlines Co. (the “Company” or “Southwest”) will be held at the Company’s corporate headquarters located at 2702 Love Field Drive, Dallas, Texas on Wednesday, May 21, 2008, at 10:00 a.m., Central Daylight Time, for the following purposes:

 

(1)   to elect eight Directors;

 

 

March 25, 2008, is the date of record for determining Shareholders entitled to receive notice of and to vote at the Annual Meeting or any adjournment or postponement thereof.

 

The 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., Central Daylight Time, on May 21, 2008.

 

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.

 

By Order of the Board of Directors,

 

Colleen C. Barrett
President and Secretary

 

April 17, 2008

 

 

Table of Contents

 

 

Southwest Airlines Co.
P.O. Box 36611
Dallas, Texas 75235-1611
(214) 792-4000

 

PROXY STATEMENT

FOR

ANNUAL MEETING OF SHAREHOLDERS

 

To be Held May 21, 2008

 

 

This proxy statement is being furnished in connection with the solicitation of proxies by and on behalf of the Board of Directors of Southwest Airlines Co. for use at the Annual Meeting of Shareholders of the Company to be held on May 21, 2008, at 10:00 a.m., Central Daylight Time, at the Company’s corporate headquarters located at 2702 Love Field Drive, Dallas, Texas, or at such other time and place to which the meeting may be adjourned. The approximate date on which this proxy statement and accompanying proxy are first being sent or given to Shareholders is April 17, 2008.

 

A representative from Wells Fargo Shareowner Services, the Company’s transfer agent, will tabulate votes and serve as Inspector of Election for the meeting. If you are a Shareholder of record, which means that you hold shares that are registered by the Company’s transfer agent in your own name, you can vote by completing and returning the enclosed proxy card. You can also vote by touch-tone telephone from the United States, using the number on the proxy card, or through the Internet, using the instructions on the proxy card. Shares represented by proxy will be voted at the meeting and may be revoked at any time prior to the time at which they are voted by (i) timely submitting a valid, later-dated proxy; (ii) delivering a written notice of revocation to the Secretary of the Company; or (iii) voting in person at the meeting.

 

If you have shares held by a broker (or a bank or other nominee as custodian), you are a “street name” holder. In such case, your broker will ask for instructions on how you want your shares voted on your behalf. You may instruct your broker on how to vote your shares by completing the voting instruction card the broker provides for you. You may also vote by telephone or through the Internet if your broker makes these methods available, in which case the broker will enclose applicable instructions with the proxy statement. If you provide voting instructions to your broker, your shares will be voted as you direct. If you do not provide instructions, pursuant to the rules of the New York Stock Exchange, your broker can vote your shares only with respect to proposals as to which it has discretion to vote under such rules. For any 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 at the meeting; however, neither abstentions nor broker non-votes are counted as voted either for or against a proposal. If you do not provide voting instructions to your broker, your broker will be entitled to vote your shares in its discretion with respect to Proposal 1 (Election of Directors) and Proposal 2 (Ratification of Selection of Independent Auditor), but will not be able to vote your shares on any of the Shareholder proposals and your vote will be counted as a “broker non-vote” on those proposals. As the beneficial owner of shares, you are invited to attend the meeting. Please note, however, that if you are a beneficial owner, you may not vote your shares in person at the meeting unless you obtain a “legal proxy” from the record holder that holds your shares.

 

The presence at the meeting, in person or by proxy, of the holders of a majority of the shares of the Company’s common stock entitled to vote at the meeting is necessary to constitute a quorum. Shareholders of record at the close of business on March 25, 2008, are entitled to vote at the meeting. As of that date, the

Company had issued and outstanding 731,551,915 shares of common stock. Each share is entitled to one vote with respect to each matter to be voted on at the meeting.

 

In some cases, only one copy of the Company’s proxy statement/annual report to Shareholders 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 promptly deliver a separate copy of these documents to a Shareholder at a shared address to which a single copy has been delivered. A Shareholder can notify the Company at the address or phone number indicated on the first page of this proxy statement if the Shareholder wishes to receive separate copies in the future. Shareholders sharing an address who are currently receiving multiple copies may also notify the Company at such address or phone number if they wish to receive only a single copy.

 

The Company will pay the costs of solicitation of proxies by the Board. In addition to solicitation by mail, solicitation of proxies may be made personally or by telephone by the Company’s 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.

 

At the Annual Meeting of Shareholders, eight Directors are to be elected for one-year terms expiring in 2009. Provided a quorum is present at the meeting, a plurality of the votes cast in person or by proxy by the holders of shares entitled to vote in the election of Directors is required to elect Directors.

 

The persons named in the enclosed proxy have been selected as a proxy committee by the Board of Directors, 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 it is not contemplated 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. Each of the nominees has indicated his or her willingness to serve as a member of the Board of Directors, if elected.

 

The following sets forth certain information for each nominee for Director of the Company. Mr. Kelleher and Ms. Barrett are stepping down from their membership on the Board of Directors at the Annual Meeting.

 

 

 

 

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, Austin Industries, a company engaged in construction, Animal Health International, Inc., a company engaged in selling and distributing animal health products, and Guaranty Financial Group Inc., a financial services company.

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 A. H. Belo Corporation 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 2007 and will do so in 2008.

 

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., Hicks Acquisition Company I, Inc., and Hayes Lemmerz International, Inc. He is a disinterested Director of John Hancock Mutual Funds.

 

Travis C. Johnson has practiced law as Travis Johnson, Attorney at Law, since January 2001. Prior to such time, Mr. Johnson was a partner in the law firm of Johnson & Bowen. 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.

 

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 Chair-Elect of the University of Texas M.D. Anderson Cancer Center Board of Visitors and on the Board of Regents at St. Mary’s University, the National Cowgirl Museum and Hall of Fame, the Vice President’s Residence Foundation in Washington, D.C., and the Capitol Advisory Committee for Texas Lutheran University. She also serves on the Board of the Blanton Museum of Fine Art located on the University of Texas campus.

 

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.

 

The Board recommends a vote FOR the election of each of the nominees for Director named above. Proxies solicited by the Board of Directors will be so voted unless Shareholders specify a different choice.

 

The business of the Company is managed under the direction of the Board of Directors. Pursuant to the requirements of the New York Stock Exchange, a majority of the members of the Board must be independent, as defined by NYSE rules. The Board of Directors meets on a regularly scheduled basis to review significant developments affecting the Company, to act on matters requiring approval by the Board, and to otherwise fulfill its responsibilities. The Board of Directors has adopted Corporate Governance Guidelines to further its goal of providing effective governance of the Company’s business for the longterm benefit of the Company’s Shareholders, Employees, and Customers. These guidelines set forth policies concerning overall governance practices for the Company, including the following:

 

 

The Company’s Corporate Governance Guidelines, along with its Code of Ethics and the charters for its Audit, Compensation, and Nominating and Corporate Governance Committees, are available on the Company’s website, www.southwest.com. Shareholders can obtain copies of these documents upon written request to Investor Relations, Southwest Airlines Co., P.O. Box 36611, Dallas, Texas 75235.

 

The Company’s Nominating and Corporate Governance Committee is responsible for establishing and reviewing the criteria for Board membership, as set forth in the Company’s Corporate Governance Guidelines. The Corporate Governance Guidelines require that members of the Board (i) possess the highest personal and professional ethics, integrity, and values; (ii) possess practical wisdom and mature judgment; (iii) be committed to the best longterm interests of the Company’s Employees, Customers, and Shareholders; (iv) be willing to devote sufficient time to fulfill their responsibilities; and (v) be willing to serve on the Board for an extended period of time. The Corporate Governance Guidelines also require the following factors to be considered in connection with the nomination or appointment of new Board members: (i) finance, marketing, government, education, and other professional experience or knowledge relevant to the success of the Company in today’s business environment; (ii) diversity and independence (for non-management Directors); and (iii) in the case of current Directors being considered for renomination, a Director’s past attendance at Board and Committee meetings and participation in and contributions to such meetings. Each individual is evaluated in the context of the Board as a whole, with the objective of recommending to Shareholders a group that can best serve the longterm interests of the Company’s Employees, Customers, and Shareholders. There is no specific limit on a Board member’s service on other boards; however, the Corporate Governance Guidelines require that the nature and time involved in a Director’s service on other boards be considered in connection with the evaluation of the suitability of that Director. The Company’s Bylaws provide for a mandatory retirement age of 75 for members of the Board. The Chairman of the Board is exempted from this requirement.

 

The Board of Directors held six meetings during 2007 and otherwise acted by unanimous written consent. During 2007, each Director attended at least 75 percent of the total number of Board meetings and applicable Committee meetings held during the period for which he or she served as Director. Additionally, it is the Board’s policy that every Director and nominee for Director should make every effort to attend the Company’s

Annual Meeting of Shareholders. All of the Company’s current Directors attended the 2007 Annual Meeting of Shareholders.

 

Pursuant to the Company’s Corporate Governance Guidelines, the independent members of the Board of Directors are required to meet at regularly scheduled executive sessions without management participation. Currently, Dr. Cunningham, Chairman of the Audit Committee, serves as the presiding Director for these executive sessions. Shareholders and any other interested parties may communicate directly with any or all of the independent or other members of the Board by writing to such Directors, c/o Southwest Airlines Co., Attn. Dr. William H. Cunningham, P. O. Box 36611, Dallas, Texas 75235.

 

The Board has established standing Audit, Compensation, Executive, and Nominating and Corporate Governance Committees to assist it with fulfilling its obligations. Set forth below is a description of the membership and principal functions of each Committee.

 

Audit Committee.  The Audit Committee consists of Messrs. Cunningham (Chairman), Biegler, Caldera, Johnson, and Montford. The Board has determined that all of the members of the Audit Committee are “independent,” as that term is used under applicable rules of the NYSE. 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 an “audit committee financial expert” for the Committee. The functions of the Audit Committee include assisting the Board in its oversight of (i) the integrity of the Company’s financial statements, (ii) the Company’s compliance with legal and regulatory requirements, (iii) the independent auditor’s qualification and independence, and (iv) the performance of the Company’s internal audit function and independent auditors. The Audit Committee held five meetings during 2007.

 

Compensation Committee.  The Compensation Committee consists of Messrs. Biegler (Chairman), Caldera, and Montford. The Board of Directors of the Company has determined that each of the members of the Compensation Committee is (i) an “independent director,” under the NYSE’s rules; (ii) a “non-employee director” under Rule 16b-3 of the Securities Exchange Act of 1934, as amended; and (iii) an “outside director” under Section 162(m) of the Internal Revenue Code of 1986, as amended. The functions of the Compensation Committee include (i) reviewing and approving corporate goals and objectives relevant to the compensation of the Chief Executive Officer; (ii) evaluating the Chief Executive Officer’s performance in light of those goals and objectives; (iii) determining and approving the Chief Executive Officer’s compensation level based on the Committee’s evaluation; (iv) with the advice of the Chairman of the Board and the Chief Executive Officer, conducting an annual review of the compensation of senior executives; and (v) reviewing and approving all stock-based compensation arrangements for Employees of the Company (including executive officers), and making recommendations to the Board with respect to non-CEO executive officer compensation, and incentive compensation and equity-based plans that are subject to Board approval. The Company’s processes and procedures for the consideration and determination of executive officer compensation (as well as management’s role in such determinations) are discussed further below under “Compensation of Executive Officers — 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 to individual members of the Committee, as it deems appropriate. The Compensation Committee held five meetings during 2007 and otherwise acted by unanimous written consent.

 

As discussed further under “Compensation of Executive Officers — Compensation Discussion and Analysis,” the Compensation Committee has from time to time used information provided by outside consultants to assist it with its compensation decisions. In particular, during 2007, with the approval of the Compensation Committee, the Company continued to engage Mercer Human Resource Consulting in connection with the design of its equity compensation plan and to obtain a better understanding of the Company’s compensation practices relative to its peers. The Company also engaged Longnecker and Associates to obtain data for the Compensation Committee to use in connection with the Company’s employment contracts with

the Chief Executive Officer, Executive Chairman of the Board, and President of the Company. These consultants were not hired for the purpose of making formal recommendations or determinations; rather, they were hired as a resource for providing comparative market information to management and the Compensation Committee. Management uses consultant information to assist it with evaluating and designing overall compensation programs and to develop additional analyses and recommendations for the Compensation Committee. The Committee in turn reviews the consultants’ data and the Company’s resulting analyses and recommendations.

 

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), Crockett, Cunningham, and Johnson, and was established 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 acted once by unanimous written consent during 2007 and otherwise met informally at various times throughout the year.

 

Nominating and Corporate Governance Committee.  The Nominating and Corporate Governance Committee consists of Messrs. Montford (Chairman), Crockett, and Johnson. The Board of Directors has determined that all of the members of the Nominating and Corporate Governance Committee are “independent,” as that term is used under the rules of the NYSE. The functions of the Nominating and Corporate Governance Committee include (i) developing and recommending to the Board Corporate Governance Guidelines applicable to the Company; (ii) reviewing potential candidates for Board membership in accordance with the criteria set forth in the Company’s Corporate Governance Guidelines, as discussed above; and (iii) recommending a slate of nominees for the Board. The Nominating and Corporate Governance Committee will also consider nominees submitted by Shareholders based on the criteria set forth in the Company’s Corporate Governance Guidelines, provided that such nominations are submitted in accordance with the Company’s Bylaws. Director nominations are discussed further below under “Other Matters — Submission of Shareholder Proposals.” The Nominating and Corporate Governance Committee, with the advice of the Chairman of the Board and the Chief Executive Officer, is also required to conduct an annual review of compensation for the non-management members of the Board and to recommend to the Board any appropriate changes thereto. The Nominating and Corporate Governance Committee held three meetings during 2007.

 

Review, Approval, or Ratification of Transactions with Related Persons; Director Independence Determinations.  The Company does not have a formal written policy with respect to the review, approval, or ratification of transactions with related persons, but has established procedures to identify these transactions and bring them to the attention of the Board for consideration. These procedures include formal written questionnaires to Directors and executive officers and written procedures followed by the Company’s Internal Audit Department to identify related person transactions.

 

The Company requires that all of its Directors and executive officers complete an annual questionnaire that requires them to identify and describe any transactions that they or their respective related parties may have with the Company, whether or not material. Separately, the Company’s Internal Audit Department analyzes accounts payable records to search for payments involving (i) the Company’s Directors and executive officers, (ii) known relatives of the Company’s Directors and executive officers, and (iii) companies and organizations with which the Directors and executive officers are associated. The Company also requires each non-Employee Director to complete an additional questionnaire that is designed to elicit all information that should be considered to ensure that the Company satisfies the NYSE’s requirement that a majority of its Board members be independent, within the meaning of the NYSE’s rules. Relevant information regarding Directors is then provided to the Nominating and Corporate Governance Committee, which is responsible for evaluating the qualifications of Board nominees, including independence, and for making recommendations to the Board regarding (i) nominations for Board membership; and (ii) individual qualifications for committee membership, taking into account various additional regulatory requirements that specifically apply to the different Board

committees, including independence requirements. In making its recommendations to the Board, the Nominating and Corporate Governance Committee considers the following regulatory guidance: (i) Item 404(a) of Regulation S-K of the Securities Act of 1933, as amended (Transactions with Related Persons); (ii) Statement of Financial Accounting Standard No. 57 (Related Party Disclosures); and (iii) the NYSE’s governance standards related to independence determinations. Based on the foregoing, most recently, the Nominating and Corporate Governance Committee presented its findings to the Board in January 2008, and the Board determined that the following Directors are independent under applicable NYSE standards: David W. Biegler, Louis E. Caldera, C. Webb Crockett, William H. Cunningham, Travis C. Johnson, and John T. Montford. In addition, the Board determined that Governor William P. Hobby, who retired from the Board in May 2007, was independent.

 

In making the foregoing determinations, the Board considered the Company’s transactions with entities with which Mr. Crockett and Mr. Montford are associated. Mr. Crockett serves as a non-equity director for Fennemore Craig, a law firm that performs services for the Company, and Mr. Montford serves as an officer for AT&T Services, Inc., which does business with the Company. The Board concluded that Mr. Crockett does not have a direct or indirect material interest in the Company’s transactions with Fennemore Craig because (i) Mr. Crockett’s status with such law firm is that of a non-equity director, and, as such, he does not share in the profits of the firm, nor does he have any voting power with respect to the firm; and (ii) the annual fees paid by the Company to such law firm are not material, either to the firm or to the Company. The Board determined that Mr. Montford does not have a direct or indirect material interest in the Company’s transactions with AT&T based on (i) the extremely indirect nature of the interest and the resulting insignificance of such transaction to Mr. Montford, (ii) the ordinary course nature of the services provided, and (iii) the immateriality of the amount involved to either the Company or AT&T. The Board made its materiality determinations taking into account applicable rules of both the NYSE and the SEC.

 

Transactions with Related Persons Since the Beginning of Fiscal 2007.  The spouse of Board member Nancy Loeffler (i) is Chairman and Senior Partner of The Loeffler Group LLP, a law firm that performed services for the Company during 2007 and continues to perform services for the Company during 2008; and (ii) was, during 2007, a member of the law firm of Loeffler Tuggey Pauerstein Rosenthal LLP, which also performed services for the Company during 2007. During 2007, the Company paid these firms a combined amount of $240,000. The Loeffler Group LLP continues to perform services for the Company pursuant to a $20,000 per month retainer. The Board reviewed Ms. Loeffler’s qualifications and this relationship at the time it first nominated her for Board membership. The Audit Committee most recently reviewed, discussed, and confirmed its continued comfort with this relationship in January 2008.

 

Ongoing Reporting Obligations with Respect to Related Person Transactions.  In order to provide an ongoing mechanism for monitoring related person transactions and Board member independence, each Board member and executive officer of the Company is required to sign an acknowledgement that he or she will promptly inform the Company of any new information that should be considered by the Board subsequent to the Director’s or executive officer’s completion of its annual questionnaire(s).

 

At the close of business on March 25, 2008, the record date for determining Shareholders entitled to notice of and to vote at the meeting, there were outstanding 731,551,915 shares of common stock, $1.00 par value, each share of which is entitled to one vote.

 

The following table sets forth information with respect to persons who, to the Company’s knowledge, beneficially own more than 5 percent of the common stock of the Company.

 

 

 

 

The following table sets forth, as of February 29, 2008, certain information regarding the beneficial ownership of common stock by each of the members of the Company’s Board of Directors, each of the executive officers of the Company named in the Summary Compensation Table, and all executive officers and Directors, as a group.

 

 

 

 

Compensation Objectives

 

The Company’s compensation program seeks to promote and reward productivity and dedication to the overall success of the Company, with an overarching objective of preserving job security. Therefore, the Company’s overall business objective of attaining reasonable profits on a consistent basis weighs heavily in the Company’s compensation determinations, and the Company believes in responding pragmatically to the actual influences of external market forces.

 

The Company’s compensation objectives apply equally to executive and non-executive Employees. Because approximately 82 percent of the Company’s Employees are subject to collective bargaining agreements that govern their compensation structure, these negotiated compensation arrangements factor significantly into the Company’s overall compensation decisions.

 

References to the “named executive officers” include the following officers whose compensation information is detailed in the tables following this Compensation Discussion and Analysis: (i) the Executive Chairman of the Board, (ii) the Chief Executive Officer and Vice Chairman of the Board, (iii) the President and Corporate Secretary, (iv) the Executive Vice President — Law, Airports, and Public Affairs, and (v) the Senior Vice President — Finance and Chief Financial Officer.

 

Elements of Compensation Program

 

The Company’s compensation program consists of the following elements:

 

incentive and reward to all Employees because the plan is based on overall Company profitability. Therefore, it effectively serves as a bonus component for the Company’s Employees at all levels. The Company considers the value of its retirement plans when establishing salary and bonus elements and amounts.

 

 

Role of Compensation Consultants and Benchmarking

 

The Company has historically compensated Employees based on seniority and internal equity and, to a lesser extent, job title and market value. In addition, the Company has historically placed a great deal of emphasis on equity compensation at all Employee levels, including the executive level, which is evidenced by the numbers included in the “Outstanding Equity Awards at Fiscal 2007 Year-End” table. However, by April 2006, all of the Company’s existing stock option plans for non-contract Employees (Employees not subject to collective bargaining agreements) had expired. In anticipation of the expiration of these plans, as well as legislative, regulatory, and accounting developments, the Company commenced a review of its option program in 2005. With the approval of the Compensation Committee, the Company retained the services of Mercer Human Resource Consulting to assist the Company in developing a longterm incentive strategy. Mercer was asked to analyze the advantages and disadvantages of various longterm incentive vehicles with respect to (i) cost, (ii) Shareholder alignment, (iii) Employee attraction/retention value, (iv) Employee perceived value, and (v) communication and administration. Mercer also focused the Company on anticipated institutional investor concerns regarding the dilutive impact of continuing such a broad-based option program, as well as the cost of continuing such a broad-based program versus the perceived value of the options. The Company worked with Mercer on this project from 2005 until 2007 when the Company submitted a new equity compensation plan for approval by Shareholders.

 

Mercer’s engagement included an analysis of total compensation levels for a group of 17 benchmark positions (which included, among others, the positions of Vice Chairman and Chief Executive Officer, President and Secretary, and Senior Vice President — Finance and Chief Financial Officer). The positions were chosen because of Mercer’s ability to find what it considered to be good matches for these positions in the marketplace. Mercer provided this data in order to demonstrate alternatives to the Company’s heavy emphasis on stock options by helping the Company gain perspective on pay mix generally, as well as the Company’s current positioning relative to the market. The analysis provided a high level view of pay levels and mix. The

peer group used consisted of the following 13 companies in the airline industry, which were determined by Mercer based on Mercer’s access to relevant data:

 

 

As an additional reference point, Mercer also provided data that was generally available with respect to comparable positions in other industries. The Mercer data at that time indicated that base salaries and total annual compensation for the Company’s officers on average were below median, with the Chief Executive Officer and Chief Financial Officer in the lowest quartile, compared to market. Therefore, the Company and the Compensation Committee continued in 2006 and 2007 to work on developing a new equity compensation plan that might enable the Company to increase its overall executive compensation package through longterm incentives. However, in response to institutional investor concerns with dilution, the Company requested fewer shares for approval than it deemed necessary to accomplish this objective. The Company used Mercer’s data, as well as input from ISS Corporate Services, Inc. and Georgeson Inc., to design a new equity compensation plan for recommendation to the Compensation Committee and the full Board. In 2007, the Company submitted, and received Shareholder approval for, a new equity compensation plan. In addition, taking the scope of the new plan into consideration, the Company obtained another report from Mercer to again evaluate the competitiveness of the compensation levels for the Company’s top executives (which included, among others, the positions of Vice Chairman and Chief Executive Officer, President and Secretary, Executive Vice President — Law, Airports, and Public Affairs, and Senior Vice President — Finance and Chief Financial Officer). Mercer updated its peer group comparison to included a review of overall pay practices for the following group of ten airlines, which were more closely related in size to the Company:

 

 

Mercer focused its analysis on the programs at the top six of these carriers (based on revenues). Mercer’s review covered all key components of these carriers’ compensation, including base salary, actual and target bonus, total annual compensation, longterm incentives, and total direct compensation. The analysis compared the Company’s executives to executives in similar positions at these airlines and, where deemed appropriate (and where information was generally available to Mercer), to similar positions in companies in general industry.

 

The Mercer information was then presented to the Compensation Committee, which did not target named executive officer compensation against the peer companies; rather, the Committee used (and continues to use) the information to assist it with evaluating the fairness of its executive compensation levels generally. Therefore, the Committee uses comparative information as a point of reference, rather than as a determinative factor, and the Committee has discretion in determining the nature and extent of its use. Although the Company and the Compensation Committee believe that comparative information is helpful in assessing the overall fairness of its compensation program, the Company and the Compensation Committee also believe that compensation must be internally consistent and equitable in order to achieve the Company’s corporate objectives. Therefore, as discussed in more detail below, although the Compensation Committee believes the Mercer data would have supported significant increases in compensation for the named executive officers, the Committee did not use such information to automatically adjust the named executive officers’ compensation.

In addition to Mercer, the Company has also obtained advice from Longnecker and Associates with respect to its employment contracts for close to two decades. Therefore, with the permission of the Chairman of the Compensation Committee, Longnecker was also engaged to provide comparative information specifically relating to the Company’s entry into employment agreements with the Chief Executive Officer, Executive Chairman of the Board, and President in 2004 and 2007. As with the Mercer studies, the Committee used this information as a point of reference, not as a determinative factor. Each of these executive officers volunteered to take less in terms of cash compensation than would have been supported by the Longnecker data.

 

Role of Executives in Determining Compensation

 

On a bi-annual basis, the Company’s human resources department considers market competitiveness, individual performance, internal equity, and Company performance in evaluating the compensation of its officers, including the named executive officers. The human resources department, along with members of the Company’s finance department, work with the Chief Executive Officer and the Executive Chairman of the Board to (i) design and develop compensation programs, (ii) recommend changes to existing plans and programs, (iii) prepare analyses and other briefing materials to assist the Compensation Committee in making its decisions, and (iv) implement the decisions of the Compensation Committee. At the Compensation Committee’s request, the Chief Executive Officer reviews with the Compensation Committee the performance of the other executives. The Compensation Committee gives considerable weight to the Chief Executive Officer’s evaluation because of his ability to directly observe on a day-to-day basis each officer’s performance and contributions. For the same reasons, the Compensation Committee considers the Chairman of the Board’s evaluation of the Chief Executive Officer’s performance. The Compensation Committee also considers the analyses and briefing materials prepared by the Company’s human resources department. Although the Compensation Committee considers and values all of the foregoing input, it is not obligated to accept management’s recommendations with respect to executive compensation.

 

Relative Compensation of Executive Officers

 

Overall compensation levels for the Company’s named executive officers reflect the nature and level of their respective roles and the scope of their responsibilities. In addition, tenure has historically factored into compensation levels. Mr. Kelleher and Ms. Barrett have been employed by the Company since 1978, Mr. Kelly and Mr. Ricks since 1986, and Ms. Wright since 1988. Although the Compensation Committee does not believe there are substantial differences in compensation for its named executive officers, the Committee does believe it is appropriate for the Chief Executive Officer, the Executive Chairman of the Board, and the President of the Company (the “Principal Officers”) to receive the highest compensation in the Company because of their leading roles and the higher market value associated with those roles.

 

Significance of Employment Agreements

 

The Board and the Compensation Committee also believe continuity of senior leadership is of significant importance. Therefore, the Company has historically entered into employment contracts with the individuals holding the Principal Officer roles. As a result, the Company entered into employment contracts with Mr. Kelly, Mr. Kelleher, and Ms. Barrett, effective as of July 15, 2007, which contracts succeeded the Company’s prior employment contracts with these individuals dated July 15, 2004. Mr. Kelleher’s and Ms. Barrett’s employment contracts are scheduled to expire in July 2013, and Mr. Kelly’s contract is scheduled to expire in February 2011. The general structure of these agreements has remained the same since Mr. Kelleher’s second employment contract with the Company in 1982. The Company, the Committee, and the Principal Officers believe that retaining the structure of these employment contracts saves the Company time that would otherwise be spent in structuring new forms of agreements. The consistent structure of the contracts also reflects the fact that the Principal Officers have not requested new or more generous compensation structures over the years.

 

The difference in duration in the Principal Officer contracts reflects the differences in the ongoing roles among these executives. Mr. Kelleher and Ms. Barrett have decided to step down from their roles as officers

and members of the Board in 2008. The Company’s entry into employment contracts with Mr. Kelleher and Ms. Barrett therefore reflect the strong desire of the Company, its Board, and the Compensation Committee to continue to retain the services of these individuals as Employees notwithstanding their desire to step down from their executive and Board positions. These agreements also reflect the Company’s and the Committee’s perception from its Employees, investors, and Customers that continuity and a smooth transition are important considerations for the Company’s operations. Therefore, as is discussed further below, these agreements generally provide for consistent compensation for a relatively long term. Mr. Kelly’s contract provides for his continued employment as Chief Executive Officer and service as Vice Chairman of the Board (for so long as he is elected as such) for a flat salary for its term, unless otherwise changed by the Compensation Committee. Given the nature of Mr. Kelly’s roles, the Compensation Committee and Mr. Kelly deem it advisable to provide for a review of the terms of his contract on a more frequent basis. The Company believes that the structure of the Principal Officers’ employment contracts is fair (i) to the executives, (ii) to the Company, and (iii) in comparison to the compensation of other executives and Employees generally, given the key roles and responsibilities of these officers.

 

Determination of 2007 Executive Compensation

 

The Company’s compensation elements and the relative compensation of each of its named executive officers are discussed below.

 

Salary.  As discussed above, the salaries for the Principal Officers were established pursuant to the terms of their individually negotiated employment contracts, which provide for increases, if any, to occur in July of each year. Pursuant to their contracts, Mr. Kelly and Ms. Barrett received an approximate 3 percent increase in salary for the period from July 2006 to July 2007. Mr. Kelleher’s contract did not provide for any increase. These increases reflected the executives’ willingness to accept percentage increases at or below the increases of non-contract Employees generally, consistent with the Company’s objective of internal equity. In addition, each of the Principal Officers elected not to receive an increase in July 2007 when they entered into their new employment contracts. Although the Committee believes that Mercer’s information would have supported increases in July 2007, the Company’s profitability has suffered from a challenging economic environment, including significant increases in fuel costs, slowing economic growth, and increases in labor costs. This decision demonstrates the commitment of the Principal Officers to the longterm prosperity of the Company and is consistent with the Company’s philosophy of responding pragmatically to external forces that impact the Company’s profitability. It also evidences their support of the Company’s focus on internal equity over external equity.

 

The salary levels of Ms. Wright and Mr. Ricks reflect, in part, the length of their service with the Company, as the Company’s historic regular annual salary increases were generally applied on the same percentage basis for all non-contract Employees. Therefore, Employees, including officers, who have had a longer tenure at the Company generally have higher salaries that reflect their longterm service. Ms. Wright’s and Mr. Ricks’ salaries also reflect the fact that the Compensation Committee believes that the nature and scope of their responsibilities justify payment of salaries at least at the current levels. Like the Principal Officers, Mr. Ricks and Ms. Wright received an approximate 3 percent increase in base salary during 2007, which was below the average increase for the remainder of the Company’s Employees. The basis for this decision was to evidence the Company’s objective of internal equity. Mr. Ricks and Ms. Wright also volunteered to maintain their 2007 salary levels for 2008.

 

Bonus.  Officers of the Company were eligible to receive annual incentive bonuses for 2007. The Compensation Committee believes this is a necessary element of compensation to attract and retain executives, given its typical use in the market in which the Company competes for executive talent, and given that base salaries are well below market median.

 

In determining bonus amounts for 2007, the Compensation Committee’s primary consideration was the Company’s profitability. Therefore, bonus amounts were granted generally based on Company, as opposed to individual, performance, provided that the executive was deemed to be a valuable contributor to the collective effort. In determining profitability for this purpose, the Company considered net income minus special items,

such as (i) certain items that are recorded as a result of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”); and (ii) other special items management believes it is necessary to exclude in order to provide management and Shareholders the ability to measure and monitor the Company’s performance on a consistent economic basis. Items calculated on an “economic” basis consist of gains or losses for derivative instruments that settle in the applicable period, but that will be recognized in a future period in the Company’s GAAP results. The items excluded from economic results primarily include ineffectiveness, as defined by SFAS 133, for future period instruments, and changes in market value for future period derivatives that no longer qualify for special hedge accounting, as defined in SFAS 133. For 2007, other special items included (i) a charge related to a voluntary early retirement program offered by the Company; (ii) a change in the Illinois state income tax law that resulted in an increase in income taxes during 2007, but that has already been reversed in 2008 due to a reversal in such law; and (iii) a change in Texas state law related to franchise taxes. Because these items do not in fact reflect the Company’s actual operations during 2007 or the Company’s ongoing operations, neither management nor the Compensation Committee believes they are a meaningful indicator of the Company’s ongoing performance.

 

The Compensation Committee determined to award bonuses to the named executive officers for 2007 to reward them for the Company’s 35th year of consecutive profitability, an accomplishment that is unmatched in the airline industry. In addition to profitability, the Compensation Committee considered (i) the below-market salaries of the named executive officers, (ii) the agreement of these officers to maintain their 2007 salary level for 2008, and (iii) the following accomplishments of the Company during 2007:

 

 

The Compensation Committee believed that the collective accomplishments above could not have been achieved without the collective efforts of each of the named executive officers. The Committee deemed it necessary to incentivize and reward these officers for their collective contribution to overall company performance and thereby also incentivize them to continue their collective efforts. In addition, although the Company’s profitability was negatively impacted by the difficult economic conditions discussed above, the primary factor impacting the Company’s profitability during 2007 was the significant increase in fuel costs, which costs were a factor beyond the Company’s and the executives’ control. Despite the increase in fuel costs, the Company was able to earn $727 million (on a cash basis, before profitsharing and income taxes) from the expiration/settlement of fuel derivative instruments that the Company had previously entered into to protect against jet fuel price increases. The Compensation Committee believes it appropriate to reward the Chief Executive Officer in particular for his forethought in developing the Company’s hedging program and the positive results of such program. In determining bonus levels, the Committee therefore took into

consideration all of these achievements; however, bonuses were not increased from 2006 amounts, reflecting the Company’s overall profitability results.

 

Equity.  As noted above, because the Company does not have as many shares available under its equity plans as it has historically, it has re-evaluated the use of equity throughout the organization. The Company is therefore currently using options on a much more limited basis, primarily for those positions with respect to which the Company believes they are the most efficient way to attract and retain Employees. Therefore, each of the named executive officers has received options under the Company’s new 2007 Equity Incentive Plan.

 

During 2007, the Principal Officers each received option grants pursuant to the negotiated terms of their employment contracts. The Compensation Committee approved the grants at the same time it approved the remainder of the terms of the employment contracts, which was subsequent to the Company’s release of earnings for the second quarter of 2007. The terms of these grants are discussed in more detail below under “Grants of Plan-Based Awards in Fiscal 2007.” These grants reflect the Committee’s perception of the Principal Officers’ expected future contributions to Southwest’s performance during the term of the agreements, which was necessarily balanced by the decreased pool of shares available to Employees generally (as compared to shares available under the Company’s prior stock option plans). The Committee believed that equity grants were particularly important given the ongoing salary levels provided for by the Principal Officers’ employment contracts and their bonus levels for 2007. Mr. Ricks and Ms. Wright did not receive option grants during 2007, as the Company was continuing to evaluate how to effectively use its limited number of shares on an ongoing basis.

 

In 2008, the Compensation Committee formally implemented a plan to consider discretionary option grants to its Leadership Group in February of each year. The Compensation Committee chose the month of February because of its occurrence after the release of the Company’s year-end earnings in accordance with the Company’s policy not to grant options at a time at which it is in possession of material non-public information. The February grant date is subject to adjustment should the scheduled timing coincide with the Company’s possession of material non-public information. In addition, subject to this requirement, the Compensation Committee may grant options at other times in connection with executive employment arrangements. In February 2008, Mr. Ricks and Ms. Wright received grants of options to purchase 80,000 and 65,000 shares of common stock, respectively. In determining the amount of these grants, the Compensation Committee took into account (i) their amenability to maintaining their 2007 salary for 2008, (ii) their bonus levels for 2007, and (iii) the Compensation Committee’s resulting desire to have some mechanism to make their overall compensation packages more competitive. In determining the number of shares to be granted, the Committee balanced its desire to increase the executives’ overall compensation potential with the number of shares that would be available for other Employees. In addition, after assessing the available pool of shares for Employees generally, the Compensation Committee determined that it had sufficient shares to grant options to purchase an additional 150,000 shares of common stock to Mr. Kelly in February 2008 in an attempt to bring his total compensation closer to market median.

 

Deferred Compensation.  The Company offers traditional 401(k) plans to all of its Employees. In addition, the Company offers a profit sharing plan to all of its Employees, which reflects the Company’s objective to promote and reward productivity and dedication to the overall success of the Company. The Southwest Airlines Co. ProfitSharing Plan has been in effect since January 1, 1973, and provides for an annual Company contribution to Employee accounts equal to a uniform percentage of each Employee’s compensation up to an amount that is cumulatively equal to 15 percent of the Company’s operating profit, as defined, for the year. Therefore, it effectively serves as a bonus component for the Company’s Employees at all levels.

 

In connection with the Company’s qualified plans, the Company maintains the Southwest Airlines Co. 2005 Excess Benefit Plan, a nonqualified excess benefit plan. Amounts are contributed to this plan that cannot be contributed to the qualified plans due to contribution limits established by the Internal Revenue Code. The Company also maintains two additional nonqualified deferred compensation plans that are available only to pilots pursuant to the terms of their collective bargaining agreement.

 

The Principal Officers also have separate deferred compensation arrangements available to them under their employment contracts. Pursuant to these contracts, the Company credits to the Principal Officers’

accounts an amount equal to any Company contributions that would otherwise have been made on behalf of these executives to the Company’s qualified plans but that exceed the limits established by the Internal Revenue Code for qualified plans. Such deferred compensation bears interest at 10 percent, the interest rate established in 1982 when the first such arrangement was put into place with respect to Mr. Kelleher. The Company believes that its nonqualified deferred compensation plans, as they apply to the named executive officers, are appropriate because they are a standard benefit commonly offered at peer companies and also because the named executive officers receive below median salaries.

 

Change of Control Arrangements.  The Company offers protection to its Employees in the event of their termination of employment following a change of control, through the following: (i) the Company’s employment contracts with the Principal Officers, (ii) the Company’s Executive Service Recognition Plan for the Company’s other officers, and (iii) the Company’s Change of Control Severance Pay Plan for the remainder of the Company’s Employees who are not beneficiaries of an enforceable contract with the Company providing for severance payments in the event of a reduction in force or furlough. These arrangements have been in place in their current form since the 1980s and do not have any significant impact on the rest of the Company’s current compensation elements because the likelihood of their implementation is deemed to be remote.

 

As discussed further below under “Potential Payments Upon Termination or Change-in-Control,” in the event of a change of control of the Company: (i) the Company’s Principal Officers would continue to be employed pursuant to the terms of their employment contracts; and (ii) Mr. Ricks and Ms. Wright would continue to be employed for one year pursuant to the Company’s Executive Service Recognition Plan. In each case, the named executive officers would receive compensation consistent with their compensation prior to the change of control and would not receive any incremental benefit (with the exception of potential option acceleration, as discussed further below). Pursuant to these arrangements, the Principal Officers have the right to terminate their employment contracts within 60 days after the occurrence of the change of control, and Mr. Ricks and Ms. Wright have the right to resign if circumstances give rise to “good reason.” In these events, or in the event an officer under the Executive Service Recognition Plan is terminated by the Company other than for cause, the officers would be entitled to lump sum payments. Each of the Principal Officers would receive an identical $750,000 lump sum amount in addition to their accrued benefits, reflecting the Company’s focus on internal equity and collective efforts in the face of challenges. These lump sum payment amounts have remained the same since 1988. The lump sum amounts for the other named executive officers would be based on their historical compensation levels. The Compensation Committee believes that the differences between these arrangements and the arrangements of the Principal Officers are consistent with market conditions and the Company’s overall compensation philosophy. The Company believes the provision of these arrangements is appropriate generally as these arrangements serve to (i) continue to attract and retain well qualified executive personnel and (ii) enhance the retention of the Company’s officers to carry on the Company’s business as usual in the event of any real or rumored possibilities of a change of control of the Company. In particular, the Principal Officer arrangements are intended to assure that, should the Company receive proposals from third parties with respect to its future, these key officers can, without being influenced by the uncertainties of their own situations, (i) assess such proposals, (ii) formulate an objective opinion as to whether or not such proposals would be in the best interests of the Company and its Shareholders, and (iii) take any other action regarding such proposals as the Board might determine to be appropriate.

 

Pursuant to the terms of the Company’s option plans, if the Company is not 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 and the surviving corporation refuses to assume or substitute new options for currently outstanding Company options, all outstanding options will fully vest and will be exercisable until a date fixed by the Company, which date must be prior to the effective date of the merger, consolidation, dissolution, or liquidation.

 

The Compensation Committee continues to believe that all of the foregoing arrangements serve a valid purpose, particularly in light of continuing potential for consolidation in the airline industry.

Perquisites and Other Benefits.  The named executive officers, like the Company’s other Employees, participate in various Employee benefit plans, including medical and dental care plans; life, accidental death and dismemberment and disability insurance; and vacation and sick time. In addition, all Employees receive flight benefits on Southwest and certain other airlines. Officers have the following additional benefits available to them: (i) Company paid premiums for business travel accident insurance, (ii) Company paid premiums for a portion of their life and long-term disability insurance coverage, and (iii) Company paid physicals and tax return preparation. In addition: (i) officers are eligible to fly positive space, (ii) pursuant to their employment contracts, the Principal Officers are entitled to reimbursement of medical and dental expenses, and (iii) Mr. Kelly receives $10,000 per year to be applied to supplemental insurance. Further, through July 2007, Mr. Kelleher received $2,000 per month for the purpose of covering business expenses, which was treated as compensation to him for tax purposes and is therefore included in the Summary Compensation Table. The Compensation Committee believes these minimal additional benefits are justified given the time and level of effort that is expected of the Company’s officers.

 

Accounting and Tax Considerations

 

Section 162(m) of the Internal Revenue Code generally limits to $1,000,000 the federal tax deductibility of compensation paid to a named executive officer, including compensation received upon exercise of stock options. Section 162(m) provides an exception to such limitation for certain performance-based compensation. The Company’s 2007 Equity Incentive Plan has been designed to satisfy the conditions of such exception to the extent necessary, feasible, and in the best interests of the Company.

 

Overall, the Compensation Committee seeks to balance its objective of ensuring an effective compensation package for the named executive officers with the need to maximize the immediate deductibility of compensation. However, the Committee does have the discretion to design and use compensation elements that may not be deductible under Section 162(m). During 2007, all amounts paid to the named executive officers were deductible.

 

During 2007, the Company and the Compensation Committee also addressed the final regulations that were enacted under Section 409A of the Internal Revenue Code. These regulations impacted Compensation Committee decisions with respect to the Principal Officers’ employment contracts, as well as the Company’s nonqualified deferred compensation arrangements.

 

The Company specifically considered changes to accounting for equity compensation in evaluating its overall compensation program in 2007 and in designing its 2007 Equity Incentive Plan. In particular, the Company balanced the costs of its equity program versus the perceived value. In addition, reflecting the impacts of Statement of Financial Accounting Standards No. 123R, “Share-Based Payments” (“SFAS 123R”), the Company’s 2007 Equity Incentive Plan provides for the grant of restricted stock and restricted stock units in addition to the options traditionally used by the Company.

 

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis contained in this Proxy Statement with the Company’s management. Based on such review and discussions and relying thereon, we have recommended to the Company’s Board of Directors that the Compensation Discussion and Analysis contained in this Proxy Statement be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 and in this Proxy Statement.

 

COMPENSATION COMMITTEE

 

David W. Biegler, Chair
Louis E. Caldera
John T. Montford

 

The following table discloses compensation earned for services performed by the named executive officers during the years ended December 31, 2007 and 2006.

 

 

 

 

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 above under “Compensation Discussion and Analysis” and below under “Nonqualified Deferred Compensation in Fiscal 2007” and “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 above under “Compensation Discussion and Analysis.”

 

The following table provides information on grants of plan-based awards to the named executive officers in 2007.

 

 

 

 

The material factors underlying the information disclosed in the table above and in the Summary Compensation Table are described above under “Compensation Discussion and Analysis.”

 

The following table provides information regarding stock options held by the named executive officers as of December 31, 2007. Stock options are the only type of equity award that has been granted to the named executive officers.

 

 

 

The following table provides information regarding stock options exercised, and the value realized upon exercise, by the named executive officers during 2007.

 

 

 

 

The Company maintains the Southwest Airlines Co. ProfitSharing Plan pursuant to which the Company annually contributes a percentage of its profits to the accounts of eligible Employees. The ProfitSharing Plan is a qualified deferred compensation plan. The Company also maintains qualified 401(k) plans for its Employees. In conjunction with these plans, the Company maintains the Southwest Airlines Co. 2005 Excess Benefit Plan, which is a nonqualified deferred compensation plan that is available to all Employees. The Company makes contributions to the accounts of participants in the Excess Benefit Plan to the extent such amounts cannot be contributed to the qualified plans due to contribution limits established by the Internal Revenue Code. The Company has also established individual nonqualified deferred compensation arrangements for Mr. Kelleher, Ms. Barrett, and Mr. Kelly as part of the Company’s employment contracts with these executives discussed above under “Compensation Discussion and Analysis.” Pursuant to these arrangements, the Company makes contributions to their accounts to the extent such amounts cannot be contributed to the qualified plans due to contribution limits and compensation limits established by the Internal Revenue Code.

 

The ProfitSharing Plan allows participants to invest all or a portion of their accounts in investment funds selected by the plan administrator, including the Company’s 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 Company’s ProfitSharing Plan and Excess Benefit Plan are generally entitled to a distribution of their accounts upon separation from service with the Company.

 

The individual 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 $200,000 per calendar year, commencing with the calendar year following the year in which (i) the executive attains a specified age (82, in the case of Mr. Kelleher, 68, in the case of Ms. Barrett, and 65, in the case of Mr. Kelly) or (ii) the executive’s employment terminates, whichever occurs later. The following table provides information regarding nonqualified deferred compensation for the named executive officers for 2007.

 

 

 

 

 

Pursuant to the terms of their employment contracts, Mr. Kelleher, Mr. Kelly, and Ms. Barrett have the right to terminate their employment contracts within 60 days after the occurrence of a change of control of the Company. In such event, their employment contracts provide for a lump sum severance payment equal to their unpaid base salary for the remaining term of the contract plus $750,000. 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 on account of any disabling illness resulting from a job-related cause. A disabling illness is defined to include any emotional or mental disorder, physical disease, or injury as a result of which the executive is, for a continuous period of 90 days, unable to perform his or her duties under the employment contract. If the executive’s employment is terminated by the Company due to disability resulting from a job-related cause (after an additional 90 day notice period during which the executive has not recovered), the executive is entitled to receive regular installments of his or her base salary in effect at the time of termination of employment for the remainder of the term of the employment contract. The structure of these agreements has been in place since 1982, and the $750,000 lump sum amount has been in place since 1988. As discussed above, the change of control provisions for these individuals are intended to assure that, should the Company receive proposals from third parties with respect to its future, these key officers can, without being influenced by the uncertainties of their own situations, (i) assess such proposals, (ii) formulate an objective opinion as to whether or not such proposals would be in the best interests of the Company and its Shareholders, and (iii) take any other action regarding such proposals as the Board might determine to be appropriate. For purposes of these 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 Company’s 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.

 

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 and key 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 Mr. Ricks and Ms. Wright. The Principal Officers are not participants in this plan due to the provisions contained in their employment contracts. The terms of the employment agreements with Mr. Ricks and Ms. Wright would be invoked only in the event of a change of control, and these executives are not entitled to any special compensation or benefits in the event of termination of employment for any reason other than a termination of employment subsequent to a change of control. Under the terms of these agreements, Mr. Ricks and Ms. Wright must remain in the employment of the Company for one year after the occurrence of a change of control (the “Employment Year”). In such event, they would be entitled to a base salary in an amount at least equal to the highest salary received by them during the preceding 12-month period. In addition, they 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 them 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 executive’s employment were to be terminated other than for cause or the executive were to resign for good reason, then the executive would be entitled a lump sum payment equal to:

 

 

 

termination of employment), or, if no such bonus has been paid, the Change of Control Bonus 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 has occurred).

 

“Good reason” is generally defined as the assignment to the executive of duties inconsistent with the executive’s duties prior to the change of control or a failure of the Company to abide by the provisions of the executive’s agreement.

 

Incremental amounts receivable by the named executive officers pursuant to the arrangements discussed above are set forth in the table below.

 

 

Pursuant to the terms of the Company’s option plans, if the Company is not 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 and if the surviving corporation refuses to assume or substitute new options for currently outstanding Company options, all outstanding options will fully vest and will be exercisable until a date fixed by the Company, which date must be prior to the effective date of the merger, consolidation, dissolution, or liquidation. Therefore, to the extent these amounts are payable, they will be payable prior to the effective date of a change of control and therefore will not be payable at the same time as the amounts above. The following table sets forth the estimated benefits to the named executive officers in the event the surviving corporation refuses to assume or substitute new options for the named executive officer’s outstanding options.

 

 

 

 

In addition to the amounts discussed above, in the event of termination of their employment for any reason other than for 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 Company’s qualified retirement plans, as well as nonqualified deferred compensation amounts credited to their accounts pursuant to the Company’s Excess Benefit Plan and/or their employment contracts (as applicable), each as disclosed in more detail above under the heading “Nonqualified Deferred Compensation in Fiscal 2007.”

 

The following table provides information regarding compensation earned by the Directors during the year ended December 31, 2007:

 

 

 

 

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 $13,780 for his or her services as a Director during the 12-month period ended May 2007. These fees were increased to $14,260 for services during the 12-month period ending May 2008 and will be increased to $14,760 for services during the 12-month period ending May 2009. In addition, these Directors received $3,525 for attendance at each meeting of the Board of Directors during the 12-month period ended May 2007. These fees were increased to $3,650 for meetings during the 12-month period ending May 2008 and will be increased to $3,780 for meetings during the 12-month period ending May 2009. Committee members received $1,835 for attendance at each Committee meeting during the 12-month period ended May 2007. This fee was increased to $1,900 for meetings during the 12-month period ending May 2008 and will be increased to $1,970 for meetings during the 12-month period ending May 2009. Members of the Executive Committee, other than Mr. Kelleher, received an additional $6,720 for their services on such Committee during the 12-month period ended May 2007. This fee was increased to $6,955 for services during the 12-month period ending May 2008 and will be increased to $7,200 for the 12-month period ending May 2009. The Chairmen of the Audit, Compensation, and Nominating and Corporate Governance Committees received annual retainer fees of $9,000, $3,860, and $3,860 respectively, for their service as Chairs of such Committees during the 12-month period ended May 2007. These fees were increased to $9,320, $4,000, and $4,000, respectively, for the 12-month period ending May 2008 and will be increased to $9,650, $4,140, and $4,140, respectively, for the 12-month period ending May 2009. Officers of the Company receive no additional compensation for their services on the Board.

 

Southwest Airlines Co. Outside Director Incentive Plan.  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 Company’s 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 Company’s 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 was increased to 1,000 performance shares. A performance share is a unit of value equal to the fair market value of a share of the Company’s common stock, based on the average closing sale price of the common stock as reported on the NYSE. 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, such non-Employee Director is entitled to an amount equal to the average fair market value of the common stock during the 30 days preceding such Director’s 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.

 

Southwest Airlines Co. Severance Plan for Directors.  In 2000, the Board of Directors adopted the Southwest Airlines Co. Severance Plan for Directors. Pursuant to this plan, upon retirement from the Board of Directors, a Director who has served at least five years as of the date of retirement is entitled to a cash payment of $35,000, and a Director who has served at least ten years is entitled to a cash payment of $75,000.

 

The Audit Committee has reviewed and discussed the audited financial statements of the Company for the year ended December 31, 2007, with management. In addition, we have discussed with Ernst & Young LLP, the independent auditing firm for the Company, the matters required to be discussed by the Statement on Auditing Standards No. 61 (Communication with Audit Committees), as amended by Statement on Auditing Standards No. 90 (Audit Committee Communications).

 

The Audit Committee also has received the written disclosures and the letter from Ernst & Young required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), 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 have deemed appropriate.

 

Based on the foregoing review and discussions and relying thereon, we have recommended to the Company’s Board of Directors that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

 

AUDIT COMMITTEE

 

William H. Cunningham, Chair
David W. Biegler
Louis E. Caldera
Travis C. Johnson
John T. Montford

 

Shareholder ratification of the selection of Ernst & Young LLP as the Company’s 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 and its Audit Committee, in their discretion, may direct the selection of a different independent accounting firm at any time during the year if the Board of Directors believes this change would be in the best interests of the Company and its Shareholders.

 

The affirmative vote of the holders of a majority of the shares entitled to vote on, and voted for or against, this proposal is required to approve this proposal.

 

The Board recommends a vote FOR the ratification of the selection of Ernst & Young LLP as the independent auditor for the Company. Proxies solicited by the Board of Directors will be so voted unless Shareholders specify a different choice.

 

The firm of Ernst & Young LLP, independent auditors, has been selected by the Board of Directors to serve as the Company’s auditors for the fiscal year ending December 31, 2008. Ernst & Young LLP has served as the Company’s 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 2007 and 2006:

 

 

 

 

A copy of the Audit Committee’s Audit and Non-Audit Services Preapproval Policy is attached to this Proxy Statement as Appendix A. All of the services rendered by the independent auditor during 2007 were pre-approved by the Audit Committee, or by its Chairman pursuant to his delegated authority.

 

The Company has been notified by Mr. John Chevedden that he intends to present the following proposal for consideration at the Annual Meeting. This proposal will be voted on if it is properly presented at the Annual Meeting. The Company will provide to any Shareholder, promptly upon receipt of the Shareholder’s written or oral request, the name and address of the proponent of this proposal and the number of shares of the Company’s common stock held by the proponent of this proposal.

 

3 — Directors to be Elected by Majority Vote Bylaw

 

Resolved: Shareholders request that our company adopt a bylaw specifying that the election of our directors shall be decided by a majority of the votes cast, with a plurality vote standard used in those director elections in which the number of nominees exceeds the number of directors to be elected.

 

This proposal will give shareholders a meaningful role in director elections. A majority vote standard would require that a nominee receive a majority of the votes cast in order to be elected. Under our current plurality vote standard, a nominee for the board can be elected with as little as a single affirmative vote, even if a substantial majority of the votes cast are “withheld” from the nominee.

 

More than one-hundred (122) shareholder proposals on this topic won an impressive 49% average yes-vote in 2007. The Council of Institutional Investors www.cii.org, whose members have $3 trillion invested, recommends adoption of this proposal topic. The Council sent letters asking the 1,500 largest U.S. companies to comply with the Council’s policy and adopt this topic. Leading proxy advisory firms also recommended voting for this proposal topic.

 

John Chevedden, Redondo Beach, Calif., said that the merits of this proposal should also be considered in the context of our company’s overall corporate governance structure and individual director performance. For instance in 2007 the following structure and performance issues were identified:

Mr. Kelly			22	%
Mr. Kelleher			23	%
Ms. Barrett			24	%
Ms. Loeffler			25	%
Mr. Crockett			39	%

1) Cumulative voting.

2) Act by written consent.

3) Elect any director by a majority vote.

 

Additionally:

The above concerns shows there is room for improvement and reinforces the reason to take one step forward now and encourage our board to respond positively to this proposal:

 

Directors to be Elected by Majority Vote Bylaw –
Yes on 3

 

 

 

 

BOARD OF DIRECTORS POSITION AGAINST PROPOSAL 3

 

Your Directors recommend a vote AGAINST the adoption of this Shareholder Proposal for the following reasons:

 

The Company’s Directors are currently elected by a “plurality” vote, which means that, with respect to the number of available Board memberships, the nominees who receive the greatest number of votes are elected. Proposal 3 asks the Company’s Board to amend the Company’s bylaws to change the standard in uncontested elections to a majority vote standard. The Board believes the plurality vote standard, which is the default standard under Texas law (the law of the Company’s state of incorporation), continues to be the best standard for electing Directors. In particular, the Board believes a change in standard is unnecessary and could in fact lead to unintended and undesirable consequences.

 

The Board believes this proposal is unnecessary given the numerous steps taken by the Board to ensure quality nominees and the historic voting record in favor of Director nominees. Director nominees are evaluated and recommended for election by the Nominating and Corporate Governance Committee, which is comprised solely of independent, non-Employee Directors. The Nominating and Corporate Governance Committee is required to take into consideration the criteria for Board membership set forth in the Company’s Corporate Governance Guidelines. These guidelines are designed to identify and allow the Committee to propose Director nominees (including Shareholder nominees) who will serve the best interests of the Company and its Shareholders. The Board believes it is important to balance the proponent’s concerns with respect to matters such as age, independence, and tenure on the Board against the significant benefits associated with retaining Board members who have tremendous institutional knowledge of the Company’s operations and its industry. Reflecting the strength of the Company’s current process, the Company’s nominees have always easily received a majority vote. Therefore, there has never been a Shareholder meeting at which a majority vote standard would have impacted the outcome of the election.

 

The Board also believes this proposal may not achieve its desired intent. While the concept of majority voting for the election of Directors may initially appear straightforward and democratic, the Board believes the majority vote standard recommended by this proposal would likely result in unintended consequences, as the proposal may not in fact achieve the proponent’s goal of electing Directors by a majority vote and removing those Directors who do not receive a majority vote. For example, if a non-incumbent nominee in an uncontested election fails to receive a majority vote for election, the result will be a vacancy on the Board that will be filled by the remaining members of the Board, not Shareholders. In the event that an incumbent Director in an uncontested election fails to receive a majority vote for re-election, under Texas law and the Company’s bylaws, that Director, although not elected by the Shareholders, nonetheless remains on the Board indefinitely as a “holdover” until (i) the election of a successor at a subsequent Shareholder meeting or (ii) the Director’s resignation. A resignation results in either a smaller Board or in a vacancy being filled by the Board, not the Shareholders. The Board does not believe that these results are beneficial to Shareholders, nor do they improve accountability.

 

In addition to the above considerations, the Board believes you should be aware of a rule change that has been proposed by the NYSE. Under current NYSE rules, a Shareholder who holds shares through a broker (or other custodian) is asked to provide instructions to the broker as to how to vote the shares; however, in the event instructions are not provided, the broker is entitled to vote the shares on the account holder’s behalf. Under the NYSE’s proposed rule, brokers would no longer be able to vote shares for which they have not received voting instructions. Therefore, it is likely that fewer votes would be cast, as it is not unusual for a large number of Shareholders to fail to give voting instructions. When combined with this proposal, the

NYSE’s proposed rule could cause unintended consequences. Because the standard for Director election under this proposal is a majority of the votes cast, a single-issue activist would need to mobilize only a minority of the Company’s Shareholders to achieve “NO” votes from a majority of the votes cast. As a result, a minority of the Company’s shares outstanding could act to defeat a Director’s election. Single issue shareholder activists have a history of mounting “vote no” campaigns to signal displeasure with various matters and to send a message to the Board. Under a majority vote standard, these types of campaigns can have real consequences. The Board believes it is unlikely Shareholders generally want the consequence of a single-issue message to be the actual failure to elect a particular Director or group of Directors, particularly given that the current plurality vote standard allows Shareholders to nonetheless register dissatisfaction by means of a “withhold” vote for one or more Directors. The Board asks that Shareholders not underestimate the impact of a significant “withhold” vote. The Board understands the importance of examining the reasons for the dissatisfaction. The Board also believes it is important, though, to have the opportunity to determine whether such a vote is intended merely to send a message to the Board or whether the purpose is in fact to remove a Director from the Board.

 

Active Shareholder participation in a well-designed process for the election of Directors is important to the Company. In fact, the Board responded to Shareholder action regarding the election of Directors in 2005 when it approved the amendment of the Company’s Bylaws to eliminate a classified Board structure. Prior to such time, Directors were elected for a three-year term. As a result of the Board’s responsive action, all Directors are now subject to election or re-election by the Shareholders every year. The Board also responded to the request of Shareholders last year when it amended its Articles of Incorporation and Bylaws to eliminate super-majority provisions.

 

The Board recognizes that there continues to be discussion among governance experts and others on whether requiring majority voting in the election of Directors is a worthy and workable goal and on how best to address the concerns raised by a majority vote standard. The Board respectfully suggests, however, that, in view of the consistency of the Company’s performance and the Company’s record of responsiveness to Shareholder concerns, there is no urgency to adopt this proposal. In particular, the Board urges caution in light of the NYSE’s proposed rule change. The Board will continue to monitor developments with respect to the majority voting standard and the NYSE’s proposed rule and will carefully consider whether changes to the Company’s current voting system are appropriate and in the best interests of the Shareholders and the Company.

 

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.

 

The Company has been notified by the office of Mr. William C. Thompson, Jr., Comptroller of the City of New York, on behalf of the New York City Employees’ Retirement System, the New York City Teachers’ Retirement System, the New York City Police Pension Fund, the New York City Fire Department Pension Fund, and the New York City Board of Education Retirement System (collectively, the “Systems”), that the Systems intend to present the following proposal for consideration at the Annual Meeting. This proposal will be voted on if it is properly presented at the Annual Meeting. The Company will provide to any Shareholder, promptly upon receipt of the Shareholder’s written or oral request, the name and address of each proponent of this proposal and the number of shares of the Company’s common stock held by each proponent of this proposal.

INDEPENDENT COMPENSATION COMMITTEE

 

CREATION OF AN INDEPENDENT COMPENSATION COMMITTEE

 

Submitted by William C. Thompson, Comptroller, City of New York, on behalf of
the Boards of Trustees of the New York City Pension Funds

 

WHEREAS, we believe the primary role of the Compensation Committee (the “Committee”) is structuring executive pay and evaluating executive performance. Critical to performing these functions is setting key compensation policies and evaluating them annually; setting justifiable performance criteria and challenging performance benchmarks, retaining experts when needed to assist with the process and substance of the Committee’s work; and ensuring full and accurate disclosure of the scope of compensation;

 

NOW THEREFORE, BE IT RESOLVED, the shareholders request the Board to amend the Committee charter to specify that the Committee be composed solely of independent directors as defined below. The charter should also specify (a) how to select a new independent Committee member if a current member ceases to be independent during the time between annual meetings of shareholders; and (b) that compliance with the policy is excused if no independent director is available and willing to serve on the Committee.

 

BE IT FURTHER RESOLVED, for the purpose of this proposal an independent director is someone whose only nontrivial professional, familial or financial connection to the corporation, its chairman or its executive officers is his/her directorship, and who also:

 

(1) is not, or has not been employed by the corporation, or employed by, or a director of, an affiliate; and

 

(2) whose relative is not, or in the past 5 years, has not been employed by the corporation, or employed by, or a director of, an affiliate, and

 

(3) complies with Sections (b)-(h) of the Council of Institutional Investors Definition of Director Independence as found on its website:

http://www.cii.org/policies/ind_dir_defn.htm

 

 

 

 

BOARD OF DIRECTORS POSITION AGAINST PROPOSAL 4

 

Your Directors recommend a vote AGAINST the adoption of this Shareholder Proposal for the following reasons:

 

The Board recognizes the importance of having a Compensation Committee composed of members who are free to exercise independent judgment in making executive compensation decisions. Members of the Company’s Compensation Committee not only meet the independence criteria set forth in the rules established by the NYSE, they also satisfy the independence standards set forth in Rule 16b-3 of the Exchange Act and Section 162(m) of the Internal Revenue Code. In addition, the Board believes that all members currently satisfy the requirements set forth in this proposal. The Board therefore believes no meaningful additional measure of Board independence would be accomplished through adoption of the requirements set forth in this proposal. Instead, the Board believes additional restrictions on Compensation Committee membership could impair the Company’s ability to recruit individuals who hold other attributes that are also critical to effective service on the Compensation Committee.

 

To have an effective Board and Compensation Committee, the Company must recruit individuals with a variety of talents, experience, knowledge, and professional skills. In addition to being free to exercise independent judgment in making executive compensation decisions, members of the Compensation Committee must also have the background and business expertise necessary to address compensation issues and analyze executive performance on an informed basis. The Board believes the members of the Board and its Compensation Committee benefit the Company’s Shareholders with their expertise and varied business experience and provide an ability to view the Company and its compensation from a broad perspective. While independent judgment in the Boardroom is essential, the Board believes it is inadvisable for the Board to risk

sacrificing the experience and wisdom of future potential members of the Board and of the Compensation Committee who might not meet this proposal’s independence standards.

 

The independence criteria established by the NYSE are based on the recommendations of the Corporate Accountability and Listing Standards Committee appointed by the NYSE and are the result of extensive research, input, and analysis. The Board therefore believes the existing independence requirements adequately foster the exercise of independent judgment by members of the Compensation Committee in making executive compensation decisions. Since the members of the Compensation Committee already meet these existing independence requirements, the Board believes the proposal would only serve to add unnecessary restrictions without providing any significant additional benefits.

 

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.

 

The Company has been notified by Calvert Asset Management Company, Inc., Domini Social Investments LLC, and Clean Yield Asset Management (on behalf of the Walter and Conny Lindley Donations Trust) that they intend to present the following proposal for consideration at the Annual Meeting. This proposal will be voted on if it is properly presented at the Annual Meeting. The Company will provide to any Shareholder, upon receipt of the Shareholder’s written or oral request, the name and address of each proponent of this proposal and the number of shares of the Company’s common stock held by each proponent of this proposal.

 

Southwest Airlines Co. - 2008

 

Whereas:

 

Investors increasingly seek disclosure of companies’ social and environmental practices in the belief that they impact shareholder value. Many investors believe companies that are good employers, environmental stewards, and corporate citizens are more likely to generate stronger financial returns, better respond to emerging issues, and enjoy long-term business success.

 

Mainstream financial companies are also increasingly recognizing the links between sustainability performance and shareholder value. According to research consultant Innovest, major investment firms including ABN-AMRO, Schroders, T. Rowe Price, and Legg Mason subscribe to information on companies’ social and environmental practices to help make investment decisions.

 

Globally over 2,300 companies issued reports on sustainability issues in 2006 (www.corporateregister.com). An earlier study found more than half of the global Fortune 250 issue such reports (KPMG International Survey of Corporate Responsibility Reporting 2005).

 

Unfortunately, the majority of US domestic airlines lag behind their global industry peers on sustainability reporting, especially regarding key aviation issues such as climate change. British Airways and Air France-KLM have taken leadership roles in these areas through the publication of comprehensive sustainability reports that address their company’s impacts on the environment, employee safety, labor relations, and customer safety.

 

Commercial aviation is estimated to contribute between 2-3% of total anthropogenic CO2 emissions to the atmosphere. Furthermore, the commercial aviation industry continues to grow at an unprecedented rate. According to the Air Transport Association’s 2007 Economic Report, US airlines posted a 2.4% growth in passenger traffic between 2005 and 2006. The recent action by European regulators to include airlines as part of the EU Emissions Trading Scheme underscores the importance of the airline industry in GHG reduction efforts.

Since 2003, Southwest Airlines has demonstrated a steady growth across most of its operating data (i.e. load factor, revenue passenger miles, trips flown, etc.). Given the industry’s large social and environmental footprint, we feel it is imperative that Southwest develop clear policies and programs that address the impacts of its operations on the environment and on society.

 

RESOLVED:  Shareholders request that the Board of Directors prepare a sustainability report describing corporate strategies to reduce greenhouse gas emissions and addressing other environmental and social impacts such as waste management and recycling, as well as employee and product safety. The report, prepared at reasonable cost and omitting proprietary information, should be published by October 2008.

 

SUPPORTING STATEMENT:

The report should include the company’s definition of sustainability and a company-wide review of company policies, practices, and metrics related to long-term social and environmental sustainability.

 

We recommend that Southwest use the Global Reporting Initiative’s Sustainability Reporting Guidelines (“the Guidelines”) to prepare the report. The Global Reporting Initiative (www.globalreporting.org) is an international organization developed with representatives from the business, environmental, human rights and labor communities. The Guidelines provide guidance on report content, including performance on direct economic impacts, environmental, labor practices and decent work conditions, human rights, society, and product responsibility. The Guidelines provide a flexible reporting system that allows the omission of content that is not relevant to company operations.

 

 

 

 

BOARD OF DIRECTORS POSITION AGAINST PROPOSAL 5

 

Your Directors recommend a vote AGAINST the adoption of this Shareholder Proposal for the following reasons:

 

Since its inception, the Company has focused on the longterm sustainability of its business and believes this focus has had a direct impact on the Company’s ability to remain profitable. In particular, the Company believes its efforts towards fuel conservation and efficiency have not only helped the Company achieve its goal of getting Customers to their destination as directly and cost effectively as possible, it has also helped the Company to reduce air emissions associated with the Company’s industry. The Company has not openly publicized its performance in this area because it has been an inherent part of the Company’s culture and business approach. The Company does, however, recognize that sustainability is a prominent issue in today’s world and that its Customers, Employees, and Shareholders desire to have a better understanding of the manner in which the Company addresses sustainability issues. Therefore, in March 2008, the Company published its first Environmental Stewardship Report, which details the Company’s efforts with respect to the following:

 

 

In addition to the Environmental Stewardship Report, the Company has published the following documents, which have already codified the Company’s culture of conducting business in a socially responsible manner in accordance with applicable governmental environmental, safety, and health requirements: (i) Southwest Airlines Social Responsibility Statement; (ii) Southwest Airlines Code of Ethics; (iii) Southwest Airlines Policy Concerning Harassment, Sexual Harassment, or Discrimination; (iv) Southwest Airlines Customer Service Commitment; and (v) Southwest Airlines Goals for Success.

 

The Board believes the foregoing documents provide a significant portion of the information requested by the proponents. In particular, the Board believes the Environmental Stewardship Report provides information regarding the areas that present the most concern with respect to the airline industry. The Company is nonetheless continuing to look into the advisability of preparing a more expansive report, but deems it advisable to take the time and effort to adequately assess the financial and human resources that would be required to expand the report into various additional areas. The Board intends to weigh the additional use of financial and human resources against the degree of benefit that would be obtained by the Company’s stakeholders from the additional information. The Board therefore believes prudence dictates that Shareholders not approve this proposal at this time.

 

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.

 

To permit the Company and its Shareholders to deal with Shareholder proposals in an informed and orderly manner, the Company’s 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 other 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. If less than 30 days’ notice or prior public disclosure of the date of the meeting is given or made to Shareholders, written notice must be received not later than the close of business on the tenth day following the day on which such notice of the date of the Annual Meeting is mailed or such public disclosure is made. Any Shareholder proposal or nomination 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. Any notice relating to a Shareholder nomination of a person or persons for election to the Board 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. Based on a 2009 Annual Meeting date corresponding to this year’s Annual Meeting date (and assuming a 30 day notice or public disclosure of such Annual Meeting date), if the Company does not receive notice of a proposal before March 22, 2009, it will be considered “untimely” and the proxy committee may properly use its 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 Company’s Proxy Statement and proxy relating to the 2009 Annual Meeting of Shareholders must forward such proposal to the Secretary of the Company, at the address indicated on the first page of this Proxy Statement, so that the Secretary receives it no later than December 18, 2008.

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s executive officers, Directors, and persons who beneficially own more than ten percent of the Company’s common stock to file reports of ownership and changes in ownership of Company common stock with the SEC and the NYSE. These persons are also required by SEC regulation to furnish the Company with copies of all such reports they file. To the Company’s knowledge, based solely on its review of its copies of such reports, or written representations from such persons, the Company believes that all filing requirements applicable to its Directors, executive officers, and beneficial owners of more than ten percent of the Company’s common stock have been satisfied.

 

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 the proxies 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 17, 2008

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 ProfitSharing account, as well as any shares you may own in your own name.

 

Under the Plan, each participant has the right to direct the Trustee to vote stock credited to his or her account. If you do not direct the Trustee to vote stock credited to your account, the Plan provides that the Trustee will vote your shares in the same proportion as the shares for which the Trustee receives voting instructions from other participants.

 

The Trustee is required to vote the shares held for your account in accordance with your instructions or, if you do not provide instructions, in accordance with the Plan. 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 19, 2008.

 

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 auditor’s 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 SEC’s 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 SEC’s 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 Company’s business, people, culture, accounting systems, risk profile and other factors, and whether the service might enhance the Company’s 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 auditor’s independence.

 

II.  Delegation

 

The Act and the SEC’s 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.

 

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 Company’s 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 SEC’s 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 auditor’s 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 SEC’s 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 SEC’s 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 SEC’s rules on auditor independence.

 

A list of the SEC’s prohibited non-audit services is attached to this policy as Exhibit 1. The SEC’s 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 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 SEC’s rules on auditor independence.

Exhibit 1

 

Prohibited Non-Audit Services

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission File No. 1-7259

Southwest Airlines Co.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(214) 792-4000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if 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 if 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 registrant’s 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.  þ

 

Indicate by check mark if 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. (Check one):

 

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o     

 

Indicate by check mark if 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 $11,172,660,474, computed by reference to the closing sale price of the common stock on the New York Stock Exchange on June 29, 2007, the last trading day of the registrant’s most recently completed second fiscal quarter.

 

Number of shares of common stock outstanding as of the close of business on January 30, 2008: 735,665,898 shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement for the Company’s Annual Meeting of Shareholders to be held May 21, 2008 are incorporated into Part III of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS

 

 

 

 

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 U.S. Department of Transportation (“DOT”), Southwest is the largest air carrier in the United States, as measured by the number of originating passengers boarded and the number of scheduled domestic departures. Southwest commenced Customer Service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities — Dallas, Houston, and San Antonio. As of December 31, 2007, Southwest operated 520 Boeing 737 aircraft and provided service to 64 cities in 32 states throughout the United States. In 2007, Southwest recommenced service to San Francisco International Airport.

 

Southwest focuses principally on point-to-point, rather than hub-and-spoke, service, providing its markets with frequent, conveniently timed flights and low fares. As of December 31, 2007, Southwest served 411 nonstop city pairs. Historically, Southwest has served predominantly short-haul routes, with high frequencies. In recent years, Southwest has complemented this service with more medium to long-haul routes, including transcontinental service.

 

Southwest has a low cost structure, enabling it to charge low fares. Adjusted for stage length, Southwest has lower unit costs, on average, than most major network carriers. Southwest’s low cost advantage is facilitated by reliance upon a single aircraft type, an operationally efficient route structure, and highly productive Employees.

 

Fuel Cost Impact and Related Growth Plans and Initiatives

 

Fuel prices can have a significant impact on Southwest’s profitability. From October 1, 2007 through December 31, 2007, the average cost per gallon for jet fuel was $1.87. Southwest’s average cost of jet fuel, net of hedging gains and excluding fuel taxes, over the past five years was as follows:

 

 

Fuel costs, coupled with evidence of slowing economic growth and the impact of labor costs, led to the Company’s decision in 2007 to slow capacity growth through a combination of schedule adjustments and fleet changes. The Company has been working on optimizing its flight schedule by reducing frequency on less profitable routes and reallocating capacity to potentially more rewarding markets. This in turn has allowed the Company to reduce the number of aircraft it will add to its fleet in 2008. As discussed further below under “Properties,” the Company has also adjusted its aircraft deliveries from Boeing.

 

In addition to schedule adjustments, the Company has developed several initiatives designed to enhance Customer Service and to help offset increasing costs through improving future revenues. These initiatives include, among others:

 

 

The Company’s initiatives are discussed in more detail below under “Operating Strategies and Marketing.” Fuel costs and Southwest’s fuel hedging activities are discussed in more detail below under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Regulation

 

The airline industry is regulated heavily, especially by the federal government. Examples of such regulation include:

 

Economic and Operational Regulation