Southwest Airlines

SOUTHWEST AIRLINES CO.
2017 ANNUAL REPORT TO SHAREHOLDERS

To our Shareholders:

I am very pleased to report another strong year of earnings in 2017. It marked our

45th consecutive year of profitability, unmatched by any competitor in the U.S. airline
industry. Despite an unprecedented string of hurricanes, earthquakes, and wildfires, our
2017 results compared admirably to 2016’s record results. Our stock price (LUV) ended
the year 2017 at $65.45, an approximate 30 percent increase from the prior year and an
approximate 540 percent increase over the last five years. Both periods led the industry
and, in fact, placed us first against all industrials in the S&P 500 Index and ninth in the
overall S&P 500 for the five years ended 2017.

Our 2017 net income was a record $3.5 billion, or $5.79 per diluted share. These
results include a $1.4 billion reduction in our deferred income tax expense resulting from
the Tax Cuts and Jobs Act. Excluding this and other special items1, our 2017 net income
was $2.1 billion, or $3.50 per diluted share, compared with $2.4 billion, or $3.75 per
diluted share in 2016.

Total operating revenues were a record $21.2 billion, up 3.7 percent versus a

year ago. Available seat mile (ASM) capacity increased 3.6 percent, resulting in a slight
increase in revenue per ASM (RASM), year-over-year. This reflects a more stable
revenue yield environment than what we experienced the previous 24 months; however,
the fare environment remains vigorous.

It was another successful year for our Commercial group, and they made
significant progress in strengthening Southwest’s revenue-generating capabilities and
reach. First, we successfully deployed our new reservation system in May 2017.
Beginning in 2018, we estimate the new system will drive incremental improvements in
pre-tax results of $200 million, escalating to $500 million by 2020; however, we
experienced a reduction in revenues of approximately $80 million in 2017 in connection
with the transition from the old to the new system.

Second, we launched service to several new destinations including Cincinnati,

Ohio; Grand Cayman; and Turks & Caicos. And, we announced our commitment to begin
selling Southwest flights to Hawaii in 2018.

Finally, after three years of construction, we opened a brand new international

concourse at Ft. Lauderdale-Hollywood International Airport and launched international
service to Belize; Cancun, Mexico; Grand Cayman; Montego Bay, Jamaica; and San
Jose, Costa Rica.

1 See Note Regarding Use of Non-GAAP Financial Measures and related reconciliations included in the accompanying
Form 10-K for the fiscal year ended December 31, 2017, for additional information on special items.

Operating expenses increased 5.9 percent to $17.7 billion, or 2.3 percent per
available seat mile, year-over-year. Jet fuel costs (economic) were up 4.2 percent to
$2.00 per gallon from a year ago2, while fuel efficiency3 improved a welcome 1.1 percent.

We also had several notable achievements in the Operations group in 2017. We

began flying Boeing’s new 737 MAX 8 aircraft on October 1 of last year, which we believe
is the best narrow-body airplane of comparable size in the world. We are pleased with the
initial performance and are realizing over 13 percent less fuel consumed per mile along
with a 40 percent reduction in noise, as compared with the prior generation 737-800.
We ended 2017 with 13 of the new MAX 8 aircraft. Coincident with that historic milestone,
we simplified our fleet for operational and financial purposes by completing the early
retirement of our remaining 62 Boeing 737-300 (Classic) aircraft in September 2017. The
effect of that was a $96 million charge in 2017, but we expect to receive economic
benefits through year 2020 of an estimated $200 million stemming from lower fuel,
maintenance, repairs, and out-of-service costs.

Our ontime performance was 78.7 percent for the year, a satisfactory performance

given the challenging weather environment but still below our goal of over 80 percent.
Our baggage handling continued to be superb (and improved). Most importantly, and for
the 23rd time in the last 27 years, we were first in the U.S. Department of Transportation’s
category of fewest Customer complaints4. All in all, a very satisfactory performance from
our Operations groups’ perspective.

Our cash flow from operations was $3.9 billion, and our free cash flow5 was
$1.8 billion. Our strengthened financial position earned us an upgrade in our investment-
grade credit rating to A3 with Moody’s Investors Service and BBB+ with Standard & Poor’s.
We continue to target debt-to-total-capital (including off-balance sheet aircraft leases) in
the low to mid-30 percent range. Our liquidity remained strong with $3.3 billion in year-end
cash and short-term investments, plus our fully-available $1.0 billion bank line of credit.
We returned $1.9 billion to Shareholders in 2017, through $274 million in dividends and
$1.6 billion in share repurchases. In May 2017, in recognition of our exceptionally strong
results, our Board of Directors authorized a $2.0 billion share repurchase program and
increased the quarterly dividend by 25 percent to $.125 per share.

Once again, we are off to a solid start to the year. With corporate income tax

reform passed through Congress and signed by the President late last year, we expect
our effective income tax rate to drop to between 23 and 23.5 percent. That is expected to
result in a significant boost to earnings and cash flow, compared with 2017, all else being
equal. It is a welcome change 1) for our country, as it makes us more competitive around
the world; 2) for our transportation sector, as it levels the federal income tax “playing field”
among industries; and 3) for Southwest Airlines as the largest cash taxpayer in the

2 See Note Regarding Use of Non-GAAP Financial Measures and related reconciliations included in the accompanying
Form 10-K for the fiscal year ended December 31, 2017, for additional information on economic fuel costs.
3 Calculated as available seat miles produced per fuel gallon consumed.
4 Source: Air Travel Consumer Reports. Rankings based on complaints filed with the U.S. Department of Transportation per
100,000 passengers enplaned.
5 Free cash flow is calculated as operating cash flows of $3.9 billion less capital expenditures of $2.1 billion less assets
constructed for others of $126 million plus reimbursements for assets constructed for others of $126 million.

U.S. airline industry. Beyond income tax reform, we continue to hope for regulatory
reform and air traffic control modernization. We were disappointed with Congress’s
recent decision to table air traffic control reform as this was the only viable path forward
to modernization; however, we will continue our efforts to work with the Federal Aviation
Administration and Members of Congress to achieve the air traffic control efficiencies we
so desperately need.

U.S. domestic economic growth seems stable, and the 2017 tax reform should

provide a further boost. Energy prices are stable at moderate prices, and travel demand
remains strong in a competitive environment. We currently plan to grow our 2018 ASM
capacity in the low five percent range, year-over-year. We ended the year 2017 with
706 aircraft in our all-Boeing 737 fleet. We are focused on restoring our fleet to its
previous size prior to retiring the 737 Classic fleet, and then growing to approximately
750 aircraft at year-end 2018. Expansion to Hawaii from California is our near-term
priority, along with consolidating our Central Michigan operations in Detroit by closing
our Flint operation.

The year 2017 brought to a close a significant transformation of Southwest’s
Customer Experience, beginning with a new boarding process in 2007, to an all-new
Rapid Rewards program in 2011, to an all-new reservation system in 2017, to name just
a few. This year, 2018, is the first in a decade where we do not have planned a major
deployment. So, in addition to readying ourselves for Hawaii service, we are focused on
the basics: 1) the Reliability of our Operation; 2) the Hospitality of our Customer Service;
and 3) the perpetuation of low operating costs. That is not to say we are done with
innovation and change. New technologies will continue to be deployed, and improvements
will continue to be enthusiastically pursued. More than anything, 2018 is a time for us to
perfect the changes that have been implemented over the last decade and harvest the
benefits from these significant investments.

Southwest is stronger than ever, and we are positioned better than ever, to

compete in a very competitive airline environment. I am extremely grateful to all of our
superb Employees, without whom, there would be no Southwest. They have built a great
Company, and for the 24th consecutive year, landed us in the Top 10 of FORTUNE’s list
of World’s Most Admired Companies: #8.

Please join me in thanking all 56,110 Employees for their hard work, Hospitality,

can-do spirits, and exceptional results!

Sincerely,

Gary C. Kelly
Chairman and Chief Executive Officer
March 23, 2018

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
Í

‘

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2017
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from

to

Commission File No. 1-7259

Southwest Airlines Co.
(Exact name of registrant as specified in its charter)

TEXAS
(State or other jurisdiction of
incorporation or organization)
P.O. Box 36611
Dallas, Texas
(Address of principal executive offices)

74-1563240
(IRS Employer
Identification No.)

75235-1611
(Zip Code)

Registrant’s telephone number, including area code: (214) 792-4000

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

Title of Each Class

Common Stock ($1.00 par value)

Name of Each Exchange on Which Registered

New York Stock Exchange

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 Í No ‘
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 ‘ No Í
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 Í No ‘

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes Í No ‘

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. ‘

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting
company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and
“emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer Í Accelerated filer ‘ Non-accelerated filer ‘ Smaller reporting company ‘ Emerging growth company ‘
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for

complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ‘

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ‘ No Í
The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $37,211,057,645 computed by
reference to the closing sale price of the common stock on the New York Stock Exchange on June 30, 2017, 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 February 5, 2018: 587,950,973 shares

Portions of the Definitive Proxy Statement for the Company’s Annual Meeting of Shareholders to be held May 16, 2018, are incorporated

into Part III of this Annual Report on Form 10-K.

DOCUMENTS INCORPORATED BY REFERENCE

Business

Item 1.
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Item 3.
Item 4. Mine Safety Disclosures

Properties
Legal Proceedings

TABLE OF CONTENTS

PART I

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of

Equity Securities
Selected Financial Data

Item 6.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources
Off-Balance Sheet Arrangements, Contractual Obligations, and Contingent Liabilities and
Commitments
Critical Accounting Policies and Estimates

Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8.

Financial Statements and Supplementary Data
Southwest Airlines Co. Consolidated Balance Sheet
Southwest Airlines Co. Consolidated Statement of Income
Southwest Airlines Co. Consolidated Statement of Comprehensive Income
Southwest Airlines Co. Consolidated Statement of Stockholders’ Equity
Southwest Airlines Co. Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

Item 9.
Item 9A. Controls and Procedures
Item 9B. Other Information

PART III

Item 10. Directors, Executive Officers, and Corporate Governance
Item 11. Executive Compensation
Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters

Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14.

Principal Accounting Fees and Services

Item 15. Exhibits and Financial Statement Schedules
Item 16.
Signatures

Form 10-K Summary

PART IV

1
23
32
32
33
35

38
41
43
61

64
67
75
81
81
82
83
84
85
86
130
130
131

132
132

132
133
133

134
141
142

Item 1.

Business

Company Overview

PART I

Southwest Airlines Co. (the “Company” or “Southwest”) operates Southwest Airlines, a major
passenger airline that provides scheduled air transportation in the United States and near-international
markets. For the 45th consecutive year, the Company was profitable, earning $3.5 billion in net
income.

Southwest commenced service on June 18, 1971, with three Boeing 737 aircraft serving three Texas
cities: Dallas, Houston, and San Antonio. At December 31, 2017, Southwest operated a total of 706
Boeing 737 aircraft and served 100 destinations in 40 states,
the
Commonwealth of Puerto Rico, and ten near-international countries: Mexico, Jamaica, The Bahamas,
Aruba, Dominican Republic, Costa Rica, Belize, Cuba, the Cayman Islands, and Turks and Caicos.

the District of Columbia,

The Company expanded its international footprint during 2017, with the commencement of service to
Owen Roberts International Airport in Grand Cayman and Providenciales International Airport in
Turks and Caicos, both from Fort Lauderdale-Hollywood International Airport. The Company also
commenced service to Cincinnati/Northern Kentucky International Airport
in 2017, giving the
Company’s Customers access to a full complement of the top 50 markets across the 48 contiguous
United States.

to requisite governmental approvals,

During 2017, the Company announced plans to begin selling tickets in 2018 for service to Hawaii,
subject
from the Federal Aviation
Administration (“FAA”) for Extended Operations (“ETOPS”), a regulatory requirement to operate
between the U.S. mainland and the Hawaiian Islands. The Company further announced its decision to
cease service at Bishop International Airport in Flint, Michigan, with the last day of service on June 6,
2018. In January 2018, the Company announced its intent to begin service at a new commercial aircraft
facility at Paine Field in Everett, Washington, scheduled to be completed in 2018.

including approval

In 2017, the Company completed its deployment of a new single reservation system, the largest
technology project in the Company’s history. The new reservation system was designed to improve
flight scheduling and inventory management, enable revenue enhancements, support additional
international growth, and enable other foundational and operational capabilities.

Further, in 2017, the Company became the first airline in North America to offer scheduled service
utilizing Boeing’s new, more fuel efficient, 737 MAX 8 aircraft. The Company also retired its
remaining Boeing 737-300 aircraft.

Based on the most recent data available from the U.S. Department of Transportation (the “DOT”), as
of September 30, 2017, Southwest was the largest domestic air carrier in the United States, as
measured by the number of domestic originating passengers boarded.

Industry

The airline industry has historically been an extremely volatile industry subject
challenges. Among other things,

it has been cyclical, energy intensive,

to numerous
labor intensive, capital

1

intensive, technology intensive, highly regulated, heavily taxed, and extremely competitive. The airline
industry has also been particularly susceptible to detrimental events such as acts of terrorism, poor
weather, and natural disasters.

The U.S. airline industry benefited from modest economic growth during 2017 and was further aided
by a relatively stable fuel environment. In recent years, the U.S. airline industry, including Southwest,
has increased available seat miles (also referred to as “capacity,” an available seat mile is one seat,
empty or full, flown one mile and is a measure of space available to carry passengers in a given
period), and has increased the number of seats per trip (or “gauge”) through slimline seat retrofits and
the use of larger aircraft. Strategic capacity increases are expected to continue in 2018.

In 2017, the airline industry continued to be impacted by the significant growth of “Ultra-Low Cost
Carriers” (“ULCCs”). ULCCs offer “unbundled” service offerings, which enable them to appeal to
price-sensitive travelers through promotion to consumers of an extremely low relative base fare for a
seat, while separately charging for related services and products. In response, certain major U.S.
airlines (sometimes referred to as “legacy” or “network” carriers) have introduced new fare products,
such as a “Basic Economy” product. The Basic Economy product provides for a lower base fare to
compete with a ULCC base fare, but includes significant additional restrictions on amenities such as
seat assignments (including restrictions on group and family seating), order of boarding, checked
baggage and use of overhead bin space, flight changes and refunds, and eligibility for upgrades. Also
in response to ULCC pricing, some legacy carriers have removed their fare floors for certain routes,
leading to lower fares across the industry. Conversely, some legacy carriers offer a “Premium
Economy” fare that targets consumers willing to pay extra for additional amenities such as more
favorable seating options in segmented aircraft.

Company Operations

Route Structure

Southwest principally provides point-to-point service, rather than the “hub-and-spoke” service
provided by most major U.S. airlines. The hub-and-spoke system concentrates most of an airline’s
operations at a limited number of central hub cities and serves most other destinations in the system by
providing one-stop or connecting service through a hub. By not concentrating operations through one
or more central transfer points, Southwest’s point-to-point route structure has allowed for more direct
nonstop routing than hub-and-spoke service. Approximately 76 percent of the Company’s Customers
flew nonstop during 2017, and, as of December 31, 2017, Southwest served 675 nonstop city pairs.

Southwest’s point-to-point service has also enabled it to provide its markets with frequent, conveniently
timed flights and low fares. For example, Southwest currently offers 19 weekday roundtrips between
Dallas Love Field and Houston Hobby, 12 weekday roundtrips between Burbank and Oakland, 12
weekday roundtrips between San Diego and San Jose, eight weekday roundtrips between Denver and
Chicago Midway, and 10 weekday roundtrips between Los Angeles International and Las Vegas.

Southwest complements its high-frequency short-haul routes with long-haul nonstop service between
markets such as Los Angeles and Nashville, Las Vegas and Orlando, San Diego and Baltimore,
the Company
Houston and New York LaGuardia, and Oakland and Baltimore. During 2017,
introduced the Boeing 737 Max 8 to its fleet and continued to incorporate the Boeing 737-800 aircraft
into its fleet, both of which offer significantly more Customer seating capacity than the Company’s

2

other aircraft. This has enabled the Company to more economically serve long-haul routes, as well as
high-demand, slot-controlled, and gate-restricted airports, by adding seats for such routes without
increasing the number of flights (a “slot” is the right of an air carrier, pursuant to regulations of the
FAA, to operate a takeoff or landing at a specific time at certain airports). For 2017, the Company’s
average aircraft trip stage length was 754 miles, with an average duration of approximately 2.0 hours,
as compared with an average aircraft trip stage length of 760 miles and an average duration of
approximately 2.0 hours in 2016.

The Company continued its focus on California in 2017, and continues to invest significant resources
to solidify its leadership position in California, including the planned addition of new domestic and
international destination options and flights for California Customers, as well as additional marketing
programs, loyalty incentives, and local outreach efforts designed to retain, engage, and acquire
Customers. Based on the most recent data available from the DOT, for the year ending October 31,
2017, Southwest carried more domestic Revenue Passengers to, from, and within California than any
other airline.

The Company ended 2017 with international service to 14 destinations through 16 international
gateway cities within the 48 contiguous United States. During 2017, the Company commenced
international service out of Oakland, San Diego, Nashville, and St. Louis. In addition, the Company
announced commencement in 2018 of international service out of Indianapolis, San Jose, Sacramento,
Columbus, New Orleans, Pittsburgh, and Raleigh-Durham. The Company has also concentrated its
service to Cuba in Havana and ceased operations during 2017 to Varadero and Santa Clara, Cuba.

In 2017, to further support its near-international operations, the Company opened a new five-gate
international concourse at Fort Lauderdale-Hollywood International Airport (FLL). The Company
expanded its international flight schedule for South Florida to a total of nine international nonstop
destinations including Montego Bay, Jamaica; Belize City, Belize; Cancun, Mexico; Grand Cayman;
Havana, Cuba; Nassau, The Bahamas; San Jose, Costa Rica; Punta Cana, Dominican Republic; and
Turks and Caicos. Additional information regarding the Company’s involvement with construction of
the new concourse at FLL is provided below under “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial
Statements.

Approximately $595 million, approximately $383 million, and approximately $287 million of the
Company’s operating revenues in 2017, 2016, and 2015, respectively, were attributable to foreign
operations. The remainder of the Company’s operating revenues, approximately $20.6 billion,
approximately $20.0 billion, and approximately $19.5 billion in 2017, 2016, and 2015, respectively,
were attributable to domestic operations. The Company’s assets are not allocated to a geographic area
because the Company’s tangible assets primarily consist of flight equipment, the majority of which are
interchangeable and are deployed systemwide, with no individual aircraft dedicated to any specific
route or region.

Cost Structure

A key component of the Company’s business strategy is its focus on cost discipline and profitably
charging competitively low fares. Adjusted for stage length, the Company has lower unit costs, on
average, than the majority of major domestic carriers. The Company’s strategy includes the use of a
single aircraft
the Company’s operationally efficient point-to-point route
structure, and its highly productive Employees. Southwest’s use of a single aircraft type allows for

the Boeing 737,

type,

3

simplified scheduling, maintenance,
and training activities. Southwest’s
flight operations,
point-to-point route structure includes service to and from many secondary or downtown airports such
as Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International,
Burbank, Manchester, Oakland, San Jose, Providence, and Ft. Lauderdale-Hollywood. These
conveniently located airports are typically less congested than other airlines’ hub airports, which has
contributed to Southwest’s ability to achieve high asset utilization because aircraft can be scheduled to
minimize the amount of time they are on the ground. This, in turn, has reduced the number of aircraft
and gate facilities that would otherwise be required and allows for high Employee productivity (lower
headcount per aircraft).

The Company’s focus on controlling costs also includes a continued commitment
to pursuing,
implementing, and enhancing initiatives to reduce fuel consumption and improve fuel efficiency. Fuel
and oil expense remained the Company’s second largest operating cost in 2017. Although 2017 fuel
prices were moderately higher than 2016 fuel prices, as evidenced by the table below, energy prices
can fluctuate significantly in a relatively short amount of time. The table below shows the Company’s
average cost of jet fuel for each year beginning in 2003 and during each quarter of 2017.

Year

2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
First Quarter 2017
Second Quarter 2017
Third Quarter 2017
Fourth Quarter 2017

Cost
(Millions)

Average
Cost Per
Gallon

Percentage of
Operating
Expenses

$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$

920 $
1,106 $
1,470 $
2,284 $
2,690 $
3,713 $
3,044 $
3,620 $
5,644 $
6,120 $
5,763 $
5,293 $
3,616 $
3,647 $
3,940 $
922 $
990 $
1,003 $
1,025 $

0.80
0.92
1.13
1.64
1.80
2.44
2.12
2.51
3.19
3.30
3.16
2.93
1.90
1.82
1.92
1.89
1.84
1.92
2.04

16.5%
18.1%
21.4%
28.0%
29.7%
35.1%
30.2%
32.6%
37.7%
37.2%
35.1%
32.3%
23.0%
21.9%
22.3%
21.8%
22.0%
22.6%
22.8%

The Company focuses on reducing fuel consumption and improving fuel efficiency through fleet
modernization and other fuel initiatives. For example, during 2017, the Company continued to replace
its older aircraft with newer aircraft that are less maintenance intensive and more fuel efficient. The
Company retired all remaining Boeing 737-300 aircraft from its fleet in September 2017 and began
scheduled service with its first Boeing 737 MAX 8 aircraft in October 2017. The Boeing 737 MAX 8
is expected to significantly reduce fuel use and CO2 emissions, as compared with the Company’s other
aircraft. The Company ended 2017 with 13 Boeing 737 MAX 8 aircraft in its fleet. The Company’s

4

fleet composition and delivery schedules are discussed in more detail below under “Properties -
Aircraft.” The Company has also undertaken a number of other fuel conservation initiatives which are
discussed in detail under “Regulation - Environmental Regulation.”

To illustrate the results of the Company’s efforts to reduce fuel consumption and improve fuel
efficiency, the table below sets forth the Company’s available seat miles produced per fuel gallon
consumed over the last five years:

2017

Year ended December 31,
2015

2014

2016

2013

Available seat miles per fuel

gallon consumed

75.2

74.4

73.9

72.8

71.7

The Company also enters into fuel derivative contracts to manage its risk associated with significant
increases in fuel prices. The Company’s fuel hedging activities, as well as the risks associated with
high and/or volatile fuel prices, are discussed in more detail below under “Risk Factors,”
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note
10 to the Consolidated Financial Statements.

Salaries, wages, and benefits expense constituted approximately 41 percent of the Company’s
operating expenses during 2017 and was the Company’s largest operating cost. The Company’s ability
to control labor costs is limited by the terms of its collective-bargaining agreements, and increased
labor costs have negatively impacted the Company’s low-cost competitive position. The Company’s
labor costs, and risks associated therewith, are discussed in more detail below under “Risk Factors”
and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Fare Structure

General

Southwest offers a relatively simple fare structure that features competitive fares and product benefits,
including unrestricted fares as well as lower fares available on a restricted basis. Southwest fare
products include three major categories: “Wanna Get Away®,” “Anytime,” and “Business Select®,”
with the goal of making it easier for Customers to choose the fare they prefer. All fare products include
the privilege of two free checked bags (weight and size limits apply), complimentary soft drinks and
snacks, as well as free live and on-demand television where available. In addition, regardless of the
fare product, Southwest does not charge fees for changes to flight reservations although fare
differences may apply.

•

•

“Wanna Get Away” fares are generally the lowest fares and are typically subject to advance
purchase requirements. They are nonrefundable, but, subject to Southwest’s No Show Policy,
funds may be applied to future travel on Southwest.

“Anytime” fares are, subject to Southwest’s No Show Policy, refundable if canceled, or
funds may be applied towards future travel on Southwest. A change or modification to a
flight reservation will result in the fare becoming nonrefundable. In addition, if this fare is
purchased with nonrefundable funds, then the flight would be nonrefundable if canceled.
Anytime fares also include a higher frequent flyer point multiplier under Southwest’s Rapid
Rewards® frequent flyer program compared with “Wanna Get Away” fares. The Company’s
frequent flyer program is discussed below under “Rapid Rewards Frequent Flyer Program.”

5

•

“Business Select” fares are, subject to Southwest’s No Show Policy, refundable if canceled,
or funds may be applied towards future travel on Southwest. A change or modification to a
flight reservation will result in the fare becoming nonrefundable. In addition, if this fare is
purchased with nonrefundable funds, then the flight would be nonrefundable if canceled.
Upgrading to “Business Select” from another fare type will result in the fare becoming
nonrefundable. Business Select fares also include additional perks such as priority boarding
with a boarding position in the first 15 boarding positions within boarding group “A,” the
highest frequent flyer point multiplier of all Southwest fare products, “Fly By®” priority
security and/or ticket counter access in participating airports, and one complimentary adult
beverage coupon for the day of travel (for Customers of legal drinking age).

Southwest’s No Show Policy applies if a Customer does not change or cancel a flight segment at least
ten minutes prior to scheduled departure and the Customer does not travel on the scheduled flight. In
such event, subject to certain exceptions, all segments associated with the reservation will be canceled,
and (i) with respect to a “Wanna Get Away” fare, unused funds will be forfeited; and (ii) with respect
to an “Anytime” or “Business Select” fare, unused funds will be held as travel credit for future travel
by the Customer on Southwest.

Ancillary Services

The Company offers ancillary services such as Southwest’s EarlyBird Check-In® and transportation of
pets and unaccompanied minors,
in accordance with Southwest’s respective policies. EarlyBird
Check-In provides Customers with automatic check-in and an assigned boarding position before
general boarding positions become available, thereby improving Customers’ seat selection options
(priority boarding privileges are already a benefit of being an “A-List” tier member under the
Company’s Rapid Rewards Frequent Flyer Program). Southwest’s Pet Policy provides Customers an
opportunity to bring a small cat or dog into the aircraft cabin. Southwest also has an unaccompanied
minor travel policy to address the administrative costs and the extra care necessary to safely transport
these Customers.

When available, Southwest also sells Upgraded Boarding at the airport. These are open priority
boarding positions in the first 15 positions in its “A” boarding group.

Southwest has inflight satellite-based WiFi equipped on all of its aircraft. During 2017, Southwest
upgraded its WiFi product to increase onboard bandwidth and refreshed its inflight entertainment
portal and television options. Southwest’s onboard entertainment options on WiFi-enabled aircraft for
viewing on Customers’ personal wireless devices include free access to Southwest’s live and
on-demand television product (although free live TV may not be available onboard international flights
due to licensing restrictions). The refreshed television product currently consists of nearly 20 live
channels and up to 75 on-demand recorded episodes from popular television series. Southwest also
provides movies-on-demand and offers a Messaging-only option, including all WiFi-enabled stops and
connections. The Messaging service allows access to iMessage and pre-downloaded apps for Viber and
WhatsApp. Customers do not have to purchase WiFi to access television offerings, movies-on-demand,
or the Messaging-only service.

Rapid Rewards Frequent Flyer Program

Southwest’s Rapid Rewards frequent flyer program enables program members (“Members”) to earn
points for every dollar spent on Southwest fares. The amount of points earned under the program is

6

based on the fare and fare class purchased, with higher fare products (e.g., Business Select) earning
more points than lower fare products (e.g., Wanna Get Away). Each fare class is associated with a
points earning multiplier, and points for flights are calculated by multiplying the fare for the flight by
the fare class multiplier. Likewise, the amount of points required to be redeemed for a flight is based
on the fare and fare class purchased. Under the program (i) Members are able to redeem their points for
every available seat, every day, on every flight, with no blackout dates; and (ii) points do not expire so
long as the Member has points-earning activity during the most recent 24 months.

Under the program, Members continue to accumulate points until the time they decide to redeem them.
As a result,
the program provides Members significant flexibility and options for earning and
redeeming rewards. For example, Members can earn more points (and/or achieve tiered status such as
A-List and Companion Pass faster) by purchasing higher fare tickets. Members also have significant
flexibility in redeeming points, such as the opportunity to book in advance to take advantage of a lower
fare (including many fare sales) ticket by redeeming fewer points or by being able to redeem more
points and book at the last minute if seats are still available for sale. Members can also earn points
through qualifying purchases with Rapid Rewards Partners (which include, for example, car rental
agencies, hotels, restaurants, and retailers), as well as by using Southwest’s co-branded Chase® Visa
credit card. In addition, holders of Southwest’s co-branded Chase Visa credit card are able to redeem
their points for items other than travel on Southwest, such as international flights on other airlines,
cruises, hotel stays, rental cars, gift cards, event tickets, and more. In addition to earning points for
revenue flights and qualifying purchases with Rapid Rewards Partners, Members also have the ability
to purchase, gift, and transfer points, as well as the ability to donate points to selected charities.

Southwest’s Rapid Rewards frequent flyer program features tier and Companion Pass programs for the
most active Members, including “A-List” and “A-List Preferred” status. Both A-List and A-List
Preferred Members enjoy benefits such as “Fly By®” priority check-in and security lane access, where
available, as well as dedicated phone lines, standby priority, and an earnings bonus on eligible revenue
flights (25 percent for A-List and 100 percent for A-List Preferred). In addition, A-List Preferred
Members enjoy free inflight WiFi on equipped flights. Members who attain A-List or A-List Preferred
status receive priority boarding privileges for an entire year. When these Customers purchase travel at
least 36 hours prior to flight time, they receive the best boarding pass number available (generally, an
“A” boarding pass). During the day of travel, if an A-List or A-List Preferred Member’s plans change,
they have free same-day standby privileges, which allow them to fly on earlier flights between the same
city pairs if space is available. Members who fly 100 qualifying one-way flights or earn 110,000
qualifying points in a calendar year automatically receive a Companion Pass, which provides for
unlimited travel free of airline charges (does not include taxes and fees from $5.60 one-way). The
Companion Pass is valid for the remainder of the calendar year in which status was earned and for the
following full calendar year to any destination available on Southwest for a designated companion of the
qualifying Member. The Member and designated companion must travel together on the same flight.

Southwest’s Rapid Rewards frequent flyer program has been designed to drive more revenue by
(i) bringing in new Customers, including new Members, as well as new holders of Southwest’s
co-branded Chase Visa credit card;
from existing Customers; and
(iii) strengthening the Company’s Rapid Rewards hotel, rental car, credit card, and retail partnerships.

increasing business

(ii)

For the Company’s 2017 consolidated results, Customers of Southwest redeemed approximately
9.6 million flight awards, accounting for approximately 13.8 percent of revenue passenger miles flown.
For the Company’s 2016 consolidated results, Customers of Southwest redeemed approximately

7

8.3 million flight awards, accounting for approximately 12.7 percent of revenue passenger miles flown.
For the Company’s 2015 consolidated results, Customers of Southwest redeemed approximately
7.3 million flight awards, accounting for approximately 12.0 percent of revenue passenger miles flown.
The Company’s accounting policies with respect to its frequent flyer programs are discussed in more
detail in Note 1 to the Consolidated Financial Statements.

Digital Customer Platforms including Southwest.com

The Company offers a suite of digital platforms to support Customers’ needs across the travel journey
including Southwest.com®, mobile.southwest.com, an iOS app, an Android app, an email subscription
service, and push notifications. The Company also offers Swabiz.com, a website tailored for business
Customers that offers businesses shared stored company credit cards, company activity reporting, and
centralized traveler management. These digital tools are designed to help make the Customer’s
experience personal and intuitive with features such as recognizing the Customer’s location to provide
relevant deals, remembering recent searches to make it easy to get to trips of interest, offering a
calendar view to find the best date to travel for the lowest fare, and providing a “My Account” section
to provide a detailed view into a Customer’s travel and loyalty activity.

The Company’s digital assets are also used to highlight points of differentiation between Southwest
and other air carriers, as well as provide information on the Company’s fare and ancillary products. In
addition, Southwest.com and Swabiz.com are available in a translated Spanish version, which provides
Customers who prefer to transact in Spanish the same level of Customer Service provided by the
English versions of the websites. Both sites meet Web Content Accessibility Guidelines (2.0, Level
AA) in order to provide an optimal experience for Customers with accessibility needs.

The Company continues to invest to broaden and improve these digital assets. In 2017, the Company
launched enhanced Customer experiences on the desktop application for Car Bookings, Viewing Flight
Reservations, and Flight Checkin, which were all launched on a new modern architecture that is
expected to be used for additional enhancements in the future. The Company continues to invest in
growing mobile applications, such as adding the ability to buy EarlyBird within the booking path,
offering buttons to view Inflight Drinks and Entertainment options while flying, building mobile
redesigning the apps’
friendly versions of Special Offers, simplifying the checkout process,
homepages, and adding targeting capabilities to better match Customers with relevant information.

For the year ended December 31, 2017, approximately 80 percent of the Company’s Passenger
revenues originated from its websites (including revenues from Swabiz.com).

Marketing

During 2017, the Company continued to aggressively market and benefit from Southwest’s points of
the Company’s TransfarencySM campaign
differentiation from its competitors. For example,
emphasizes Southwest’s approach to treating Customers fairly, honestly, and respectfully, with its low
fares and no unexpected bag fees, change fees, or hidden fees.

Southwest continues to be the only major U.S. airline that offers to all ticketed Customers up to two
checked bags that fly free (weight and size limits apply). Through both its national and local marketing
campaigns, Southwest has continued to aggressively promote this point of differentiation from its
competitors with its “Bags Fly Free®” message. The Company believes its decision not to charge for
first and second checked bags, as reinforced by the Company’s related marketing, has driven an
increase in the Company’s market share and a resulting net increase in revenues.

8

Southwest is also the only major U.S. airline that does not charge a fee on any of its fares for a
Customer change in flight reservations. The Company has continued to incorporate this key point of
differentiation in its marketing campaigns. The campaigns highlight the importance to Southwest of
Customer Service by showing that Southwest understands plans can change and therefore does not
charge a change fee. While a Customer may pay a difference in airfare, the Customer will not be
charged a change fee on top of any difference in airfare.

Also unlike many of its competitors, Southwest does not impose additional fees for items such as seat
selection, snacks, curb-side check-in, and telephone reservations. In addition, Southwest allows each
ticketed Customer to check one stroller and one car seat free of charge, in addition to the two free
checked bags.

The Company also continues to promote all of the many other reasons to fly Southwest such as its low
fares, network size, Customer Service, free live television offerings, and its Rapid Rewards frequent
flyer program.

The Company’s visual expression of its brand - Heart - is a part of the Company’s aircraft livery,
airport experience, and logo, and symbolizes the Company’s care, trust, and belief in providing
exceptional Hospitality, and its Employees’ dedication to connecting Customers with what is important
in their lives. The Company’s 737-800 and 737 MAX 8 aircraft include a Heart cabin interior, which
gives Southwest Customers a look and feel of the future, with bold blue seats and additional seat width
and legroom, an adjustable headrest, enhanced back comfort, and extra room for personal belongings.
In addition, in 2017, the Company launched the final major element of its Heart brand refresh when
front-line Employees began wearing Employee-designed uniforms that highlight the Company’s red
and blue Heart brand.

Technology Initiatives

The Company has committed significant resources to technology improvements in support of its
ongoing operations and initiatives. In 2017,
the Company completed a multi-year initiative to
completely transition its reservation system to the Amadeus Altéa Passenger Service System. The new
reservation system, which represented the single largest technology project in the Company’s history,
was designed to improve flight
scheduling and inventory management, enable operational
enhancements to manage flight disruptions, such as those caused by extreme weather conditions,
enable revenue enhancements, further schedule optimization, support additional international growth,
and enable other foundational and operational capabilities.

The Company continues to invest significantly in technology resources including, among others, the
Company’s systems related to (i) aircraft maintenance record keeping, (ii) flight planning and
scheduling, (iii) crew scheduling, and (iv) technical operations.

Regulation

The airline industry is heavily regulated, especially by the federal government, and there are a
significant number of governmental agencies and legislative bodies that have the ability to directly or
indirectly affect the Company and/or the airline industry financially and/or operationally. Examples of
regulations affecting the Company and/or
these
governmental agencies and legislative bodies, are discussed below.

imposed by several of

the airline industry,

9

Economic and Operational Regulation

Consumer Protection Regulation by the U.S. Department of Transportation

The DOT regulates economic operating authority for air carriers and consumer protection for airline
passengers. The FAA, a sub-agency of the DOT, regulates aviation safety. The DOT may impose civil
penalties on air carriers for violating its regulations.

To provide passenger transportation in the United States, a domestic airline is required to hold both a
Certificate of Public Convenience & Necessity from the DOT and an Air Carrier Operating Certificate
from the FAA. A Certificate of Public Convenience & Necessity is unlimited in duration, and the
Company’s certificate generally permits it to operate among any points within the United States and its
territories and possessions. Additional DOT authority, in the form of a certificate or exemption from
certificate requirements, is required for a U.S. airline to serve foreign destinations either with its own
aircraft or via code-sharing with another airline. Exemptions granted by the DOT to serve international
markets are generally limited in duration and are subject to periodic renewal requirements. The DOT
also has jurisdiction over international tariffs and pricing in certain markets. The DOT may revoke a
certificate or exemption, in whole or in part, for intentional failure to comply with federal aviation
statutes, regulations, orders, or the terms of the certificate itself.

The DOT’s consumer protection and enforcement activities relate to areas such as unfair and deceptive
practices and unfair competition by air carriers, deceptive airline advertising (concerning, e.g., fares,
ontime performance, schedules, and code-sharing), and violations of rules concerning denied boarding
compensation, ticket refunds, and baggage liability requirements. The DOT is also charged with
prohibiting discrimination by airlines against consumers on the basis of race, religion, national origin,
sex, or ancestry.

Under the above-described authority, the DOT has adopted so-called “Passenger Protection Rules,”
which address a wide variety of matters, including flight delays on the tarmac, chronically delayed
flights, denied boarding compensation, and advertising of airfares, among others. Under the Passenger
Protection Rules, U.S. passenger airlines are required to adopt contingency plans that include the
following: (i) assurances that no domestic flight will remain on the airport tarmac for more than three
hours before beginning to return to the gate and that no international flight will remain on the tarmac at
a U.S. airport for more than four hours before beginning to return to the gate, unless the
pilot-in-command determines there is a safety-related or security-related impediment to deplaning
passengers, or air traffic control advises the pilot-in-command that returning to the gate or permitting
passengers to disembark elsewhere would significantly disrupt airport operations; (ii) an assurance that
air carriers will provide adequate food and potable drinking water no later than two hours after the
aircraft leaves the gate (in the case of departure) or touches down (in the case of arrival) if the aircraft
remains on the tarmac, unless the pilot-in-command determines that safety or security considerations
preclude such service; and (iii) an assurance of operable lavatories, as well as adequate medical
attention, if needed. Air carriers are required to publish their contingency plans on their websites.

The Passenger Protection Rules also subject airlines to potential DOT enforcement action for unfair
and deceptive practices in the event of chronically delayed domestic flights (i.e., domestic flights that
operate at least ten times a month and arrive more than 30 minutes late more than 50 percent of the
time during that month). In addition, airlines are required to (i) display ontime performance on their
websites; (ii) adopt customer service plans, publish those plans on their website, and audit their own

10

compliance with their plans; (iii) designate an employee to monitor the performance of their flights;
(iv) provide information to passengers on how to file complaints; and (v) respond in a timely and
substantive fashion to consumer complaints.

The Passenger Protection Rules also require airlines to (i) pay up to $1,350 in compensation to each
passenger denied boarding involuntarily from an oversold flight; (ii) refund any checked bag fee for
permanently lost luggage; (iii) prominently disclose all potential fees for optional ancillary services on
their websites; and (iv) refund passenger fees paid for ancillary services if a flight cancels or oversells
and a passenger is unable to take advantage of such services.

The Passenger Protection Rules also require that (i) advertised airfares include all government-
mandated taxes and fees; (ii) passengers be allowed to either hold a reservation for up to 24 hours
without making a payment or cancel a paid reservation without penalty for 24 hours after the
reservation is made, as long as the reservation is made at least seven days in advance of travel;
(iii) fares may not increase after purchase; (iv) baggage fees must be disclosed to the passenger at the
time of booking; (v) the same baggage allowances and fees must apply throughout a passenger’s trip;
(vi) baggage fees must be disclosed on e-ticket confirmations; and (vii) passengers must be promptly
notified in the event of delays of more than 30 minutes or if there is a cancellation or diversion of their
flight.

In November 2016, the DOT finalized an additional “Passenger Protection Rule.” The new rule is
intended to enhance the performance quality information collected by the DOT and made available to
the public. The DOT removed the assumption that every passenger checks a bag, and now calculates
mishandled bags per overall checked bags, rather than per enplaned passengers. The new rule also
expands the pool of air carriers that must report performance data to the DOT’s Bureau of
Transportation Statistics by requiring reporting air carriers to include data for their domestic scheduled
flights operated by their code-share partners.

The DOT has expressed its intent to aggressively investigate alleged violations of its consumer
protection rules. Airlines that violate any DOT regulation are subject to potential fines of up to $32,140
per occurrence.

The Company is also monitoring other potential rulemakings that could impact its business. The DOT
is preparing a proposed rule for the purpose of improving accessibility of lavatories on single-aisle
aircraft and of in-flight entertainment. The proposed rule may require both short-term and long-term
measures be taken to fully address the challenges persons with mobility impairments face when
traveling on single-aisle aircraft, including the eventual requirement that accessible lavatories be
available for individuals who use wheelchairs. The future proposed rule is also expected to address the
improvement of accessibility of in-flight entertainment by requiring certain movies and shows
displayed on such aircraft to be captioned to provide access to deaf and hard of hearing passengers. In
addition, audio described entertainment would be available to enable people who are blind to listen to
the visual narration of movies and shows.

The DOT is also preparing a proposed rule to consider, among other things, (i) whether carriers should
be required to supply in-flight medical oxygen for a fee to passengers who require it to access air
transportation; and (ii) whether to broaden the scope of passengers with disabilities who must be
afforded seats with extra leg room, and whether carriers should be required to provide seating
accommodations with extra leg room in all classes of service. Additionally, the DOT is preparing a

11

proposed rule that would address the definition of a service animal to reduce the likelihood of
passengers falsely claiming that their pets are service animals.

Aviation Taxes and Fees

The statutory authority for the federal government to collect most types of aviation taxes, which are
used, in part, to finance programs administered by the FAA, must be periodically reauthorized by the
U.S. Congress. In 2012, Congress adopted the FAA Modernization and Reform Act of 2012, which
extended most commercial aviation taxes through September 30, 2015. In September 2015, in July
2016, and again in September 2017, Congress extended the expiration date, which is currently
March 31, 2018. Congress is expected to try to enact a new FAA reauthorization bill in 2018, which
may make substantive changes with respect to aviation taxes (including, possibly, an increase in
airport-assessed Passenger Facility Charges (“PFCs”)) and/or FAA offices and programs that are
financed through aviation tax revenue. Congress must either adopt a new FAA reauthorization bill or
pass a “status quo” extension by March 31, 2018; otherwise, a lapse in the statutory authority could
affect the airlines’ and passengers’ respective tax burdens, as well as impact the FAA’s ability to fund
airport grants and regulate the airline industry.

In addition to FAA-related taxes, there are additional federal taxes related to the U.S. Department of
Homeland Security. These taxes do not need to be reauthorized periodically. Congress has set the
Transportation Security Fee paid by passengers at $5.60 per one-way passenger trip. In addition,
inbound international passengers are subject to immigration and customs fees that are indexed to
inflation. These fees are used to support the operations of U.S. Customs and Border Protection
(“CBP”). Finally, the U.S. Department of Agriculture’s Animal and Plant Health Inspection Service
imposes a per-passenger agriculture inspection fee of $5.00 and a per-commercial aircraft fee of
$225.00.

In 2018, the Company expects to benefit from the comprehensive U.S. tax reform legislation enacted
by Congress in late 2017, which includes, among other items, a reduced federal corporate tax rate. At
the same time, the legislation eliminates certain tax deductions and preferences. These changes not
only impact the Company directly, but could impact the U.S. economy as a whole, including consumer
demand.

Finally, the annual congressional budget process is another legislative vehicle in which new aviation
taxes or regulations may be imposed. Congress is expected to approve an “omnibus” or comprehensive
appropriations package for federal fiscal year 2018 in early 2018. This legislation will fund the federal
government - including the DOT, the FAA, the Transportation Security Administration (the “TSA”),
and CBP - through October 1, 2018. Passage of this legislation could result in an increase in the
maximum PFC and/or new mandates on the DOT to begin or complete rulemakings related to airline
consumer protection. By the summer of 2018, the House and Senate Appropriations Committees will
start to work on the federal fiscal year 2019 appropriations bills, which could address many of the same
issues and may be completed by the end of calendar year 2018.

Operational, Safety, and Health Regulation

The FAA has the authority to regulate safety aspects of civil aviation operations. Specifically, the
Company and its third-party service providers are subject to the jurisdiction of the FAA with respect to
aircraft maintenance and operations, including equipment, ground facilities, dispatch, communications,
flight training personnel, and other matters affecting air safety. The FAA, acting through its own

12

powers or through the appropriate U.S. Attorney, has the power to bring proceedings for the imposition
and collection of fines for violation of the FAA regulations.

The FAA requires airlines to obtain and maintain an Air Carrier Operating Certificate, as well as other
certificates, approvals, and authorities. These certificates, approvals, and authorities are subject to
suspension or revocation for cause.

The FAA has rules in effect with respect to flight, duty, and rest regulations. Among other things, the
rules require a ten hour minimum rest period prior to a pilot’s flight duty period; mandate that a pilot
must have an opportunity for eight hours of uninterrupted sleep within the rest period; and impose pilot
“flight time” and “duty time” limitations based upon report times, the number of scheduled flight
segments, and other operational factors. The rules affect the Company’s staffing flexibility, which
could impact the Company’s operational performance, costs, and Customer Experience.

In addition to its role as safety regulator, the FAA also operates the nation’s air traffic control system
and has continued its lengthy and ongoing effort to implement a multi-faceted, air traffic control
modernization program called “NextGen.” The Air Traffic Organization (“ATO”) is the operational
arm of the FAA. The ATO is responsible for providing safe and efficient air navigation services to all
of the United States and large portions of the Atlantic and Pacific Oceans and the Gulf of Mexico. The
Company is subject to any operational changes imposed by the FAA/ATO as they relate to the
“NextGen” program, as well as the day-to-day management of the air traffic control system.

The FAA reauthorization bill and annual appropriations legislation discussed above under “Aviation
Taxes and Fees” could include provisions impacting future FAA safety-related activities and ATO
operations in 2018 and beyond. For instance, a key issue for congressional consideration in the FAA
reauthorization process is whether to create a private, not-for-profit corporation to replace the ATO in
its day-to-day management of the air traffic control system and its implementation of the NextGen
modernization program. Under the legislation, the FAA would retain its authority to regulate aviation
safety. Regardless of the outcome of this legislative effort, it is not expected to impact air traffic
control operations or the NextGen program in 2018 as any reform measure is expected to take several
years to implement.

During 2017, the Company announced plans to begin selling tickets in 2018 for service to Hawaii,
subject to requisite governmental approvals, including authorization from the FAA for ETOPS, a
regulatory requirement to operate between the U.S. mainland and the Hawaiian Islands. In January
2018, the Company submitted a formal request, along with supporting application materials, to the
FAA for authorization to conduct ETOPS using Boeing 737-800 aircraft.

The Company is subject to various other federal, state, and local laws and regulations relating to
occupational safety and health, including Occupational Safety and Health Administration and Food and
Drug Administration regulations.

Security Regulation

Pursuant to the Aviation and Transportation Security Act (“ATSA”), the Transportation Security
Administration, a division of the U.S. Department of Homeland Security, is responsible for certain
civil aviation security matters. ATSA and subsequent TSA regulations and procedures implementing
ATSA address, among other things, (i) flight deck security; (ii) the use of federal air marshals onboard
flights; (iii) airport perimeter access security; (iv) airline crew security training; (v) security screening

13

of passengers, baggage, cargo, mail, employees, and vendors; (vi) training and qualifications of
security screening personnel; (vii) provision of passenger data to CBP; and (viii) background checks.

Under ATSA, substantially all security officers at airports are federal employees, and significant other
elements of airline and airport security are overseen and performed by federal employees, including
federal security managers, federal law enforcement officers, and federal air marshals. TSA personnel
and TSA-mandated security procedures can affect the Company’s operations, costs, and Customer
experience. For example, as part of its security measures, the TSA regulates the types of liquid items
that can be carried onboard aircraft. In addition, as part of its Secure Flight program, the TSA requires
airlines to collect a passenger’s full name (as it appears on a government-issued ID), date of birth,
gender, and Redress Number (if applicable). Airlines must transmit this information to Secure Flight,
which uses the information to perform matching against terrorist watch lists. After matching passenger
information against the watch lists, Secure Flight transmits the matching results back to airlines. This
serves to identify individuals for enhanced security screening and to prevent individuals on watch lists
from boarding an aircraft. It also helps prevent the misidentification of passengers who have names
similar to individuals on watch lists. The TSA has also implemented enhanced security procedures as
part of its enhanced, multi-layer approach to airport security, including physical pat down procedures,
at security checkpoints. Such enhanced security procedures have raised privacy concerns by some air
travelers, and have caused delays at screening checkpoints.

The Company, in conjunction with the TSA, participates in TSA PreCheck™, a pre-screening initiative
that allows a select group of low risk passengers to move through security checkpoints with greater
efficiency and ease when traveling. Eligible passengers may use dedicated screening lanes at certain
airports the Company serves for screening benefits, which include leaving on shoes, light outerwear,
and belts, as well as leaving laptops and permitted liquids in carryon bags. A similar CBP-administered
program, Global Entry®, allows expedited clearance for pre-approved, low-risk international travelers
upon arrival in the United States.

The Company also participates in the TSA Known Crewmember® program, which is a risk-based screening
system that enables TSA security officers to positively verify the identity and employment status of flight-
crew members. The program expedites flight crew member access to sterile areas of airports.

The Company works collaboratively with foreign national governments and airports to provide risk-
based security measures at international departure locations.

In 2017, the Department of Homeland Security granted the Company designation coverage under the
Support Anti-Terrorism by Fostering Effective Technologies Act of 2002 (the “SAFETY Act”) for a
five year term. The designation is based on certain safety and security procedures put in place by the
Company to date related to the protection of its Employees, Customers, and assets from terrorists and
other criminal activities. The designation coverage affords the Company certain limitations of liability
for claims arising out of an “act of terrorism,” as defined under the SAFETY Act.

The Company has also made significant investments to address the effect of security regulations,
including investments in facilities, equipment, and technology to process Customers, checked baggage,
and cargo efficiently; however, the Company is not able to predict the impact, if any, that various
security measures or the lack of TSA resources at certain airports will have on Passenger revenues and
the Company’s costs, either in the short-term or the long-term.

14

Environmental Regulation

The Company is subject to various federal laws and regulations relating to the protection of the
environment, including the Clean Air Act, the Resource Conservation and Recovery Act, the Clean
Water Act,
the Safe Drinking Water Act, and the Comprehensive Environmental Response,
Compensation and Liability Act, as well as state and local laws and regulations. These laws and
regulations govern aircraft drinking water, emissions, storm water discharges from operations, and the
disposal of materials such as jet fuel, chemicals, hazardous waste, and aircraft deicing fluid.

Additionally, in conjunction with airport authorities, other airlines, and state and local environmental
regulatory agencies, the Company, as a normal course of business, undertakes voluntary investigation
or remediation of soil or groundwater contamination at various airport sites. The Company does not
believe that any environmental liability associated with these airport sites will have a material adverse
effect on the Company’s operations, costs, or profitability, nor has it experienced any such liability in
the past that has had a material adverse effect on its operations, costs, or profitability.

Further regulatory developments pertaining to the control of engine exhaust emissions from ground
support equipment could increase operating costs in the airline industry. The Company does not
believe, however, that pending environmental regulatory developments in this area will have a material
effect on the Company’s capital expenditures or otherwise materially adversely affect its operations,
operating costs, or competitive position.

The federal government, as well as several state and local governments, the governments of other
countries, and the United Nations’ International Civil Aviation Organization (“ICAO”) are considering
legislative and regulatory proposals and voluntary measures to address climate change by reducing green-
house gas emissions. At the federal level, in July 2016, the Environmental Protection Agency (the
“EPA”) issued a final endangerment finding for greenhouse gas emissions from certain types of aircraft
engines, which the agency determined contribute to the pollution that causes climate change and
endangers public health and the environment. Following this endangerment finding, per the federal Clean
Air Act, the EPA is required to promulgate new regulations for controlling greenhouse gas emissions
from aircraft, including potential new carbon-efficiency standards on aircraft and engine manufacturers.

The EPA’s endangerment finding preceded adoption by the ICAO Assembly of a new “global market-
based measure” framework in an effort to control carbon dioxide emissions from international aviation.
The focal point of this framework is a future carbon offsetting system on aircraft operators designed to
cap the growth of emissions related to international aviation emissions. Details of this system are
expected to be further developed in 2018 and, assuming the U.S. Government remains committed to
the ICAO framework agreement and adopts terms for implementing it into U.S. law, this system is
scheduled to be phased-in beginning in 2021. Regardless of the method of regulation, policy changes
with regard to climate change are possible, which could significantly increase operating costs in the
airline industry and, as a result, adversely affect operations.

In addition to climate change, aircraft noise continues to be an environmental focus, especially as the
FAA implements new flight procedures as part of its NextGen airspace modernization program
discussed above. The Airport Noise and Capacity Act of 1990 gives airport operators the right, under
local noise abatement programs, provided they do not
certain circumstances,
unreasonably interfere with interstate or foreign commerce or the national air transportation system.
Some airports have established airport restrictions to limit noise, including restrictions on aircraft types

to implement

15

to be used and limits on the number of hourly or daily operations or the time of operations. These types
of restrictions can cause curtailments in service or increases in operating costs and can limit the ability
of air carriers to expand operations at the affected airports.

At the federal level, the FAA is considering changes to enhance community engagement when
developing new flight procedures, and there is a possibility that Congress may enact legislation in 2018
to address local noise concerns at one or more commercial airports in the United States, via either the
FAA reauthorization or annual appropriations process. In 2017, the FAA published a final rule
adopting the ICAO noise standard for future new type design aircraft submitted for certification after
December 31, 2017, for large aircraft. This standard does not affect the Company’s in-service fleet, nor
does it require that manufacturers who produce existing types, such as the Boeing 737, meet the
standard as they continue to produce those types in the future.

The Company remains steadfast in its desire to pursue, implement, and enhance initiatives that will
reduce fuel consumption and improve fuel efficiency. During 2017, the Company benefited from the
introduction of the Boeing 737 MAX 8 aircraft to the Company’s fleet and the retirement of the
Company’s Classic aircraft. In addition, over the years, the Company has undertaken a number of other
fuel conservation and carbon emission reduction initiatives such as the following:

•

•

•

•

•

•

•

•

•

•

•

•

•

installation of blended winglets, which reduce drag and increase fuel efficiency, on all
aircraft in the Company’s fleet;

upgrading of the Company’s 737-800 fleet with newly designed, split scimitar winglets;

periodic engine washes;

use of electric ground power for aircraft air and power at the gate and for ground support
equipment at select locations;

deployment of auto-throttle and vertical navigation to maintain optimum cruising speeds;

implementation of engine start procedures to support the Company’s single engine taxi
procedures;

adjustment of the timing of auxiliary power unit starts on originating flights to reduce
auxiliary power unit usage;

implementation of fuel planning initiatives to safely reduce loading of excess fuel;

aircraft cabin interior retrofitting to reduce weight;

reduction of aircraft engine idle speed while on the ground, which also increases engine life;

galley refreshes with dry goods weight reduction;

Company optimized routes (flying the best wind routes to take advantage of tailwinds or to
minimize headwinds);

improvements in flight planning algorithms to better match the Company’s aircraft flight
management system (and thereby enabling the Company to fly at
the most efficient
altitudes);

16

•

•

substitution of Pilot and Flight Attendant flight bags with lighter Electronic Flight Bag
tablets; and

implementation of Real Time Descent Winds (automatic uplinking of up-to-date wind data to
the aircraft allowing crews to time the descent to minimize thrust inputs).

The Company has also participated in Required Navigation Performance (“RNP”) operations as part of
the FAA’s Performance Based Navigation program, which is intended to modernize the U.S. air traffic
control system by addressing limitations on air transportation capacity and making more safe and
efficient use of airspace. RNP combines the capabilities of advanced aircraft avionics, Global
Positioning System (“GPS”) satellite navigation (instead of less precise ground-based navigation), and
new flight procedures to (i) enable aircraft to carry navigation capabilities rather than relying on
airports; (ii) improve operational capabilities by opening up many new and more direct airport
approach paths to produce safer and more efficient flight patterns; and (iii) conserve fuel and reduce
carbon emissions. Since its first use of RNP in 2011, Southwest has conducted approximately 58,000
RNP approaches, including over 19,000 in 2017. Southwest must rely on RNP approaches published
by the FAA, and the rate of introduction and utilization of RNP approaches continues to be slower than
expected, with fuel efficient RNP approaches currently available at only 50 of Southwest’s airports. In
addition, even at airports with approved RNP approaches, the clearance required from air traffic
controllers to perform RNP approaches is sometimes not granted. Southwest continues to work with
the FAA to develop and seek more use of RNP approaches and to evolve air traffic control rules to
support greater utilization of RNP.

As part of its commitment to corporate sustainability, the Company has published the Southwest One
ReportTM describing the Company’s sustainability strategies, which include the foregoing and other
efforts to reduce greenhouse gas emissions and address other environmental matters such as energy
and water conservation, waste minimization, and recycling. Information contained in the Southwest
One Report is not incorporated by reference into, and does not constitute a part of, this Form 10-K.

International Regulation

All international air service is subject to certain U.S. federal requirements and approvals, as well as the
regulatory requirements of the appropriate authorities of the foreign countries involved. The Company
has obtained the necessary economic authority from the DOT, as well as approvals required by the
FAA and applicable foreign government entities, to conduct operations, under certain circumstances, to
points outside of the continental United States currently served by the Company. Certain international
authorities and approvals held by the Company are subject to periodic renewal requirements. The
Company requests extensions of such authorities and approvals when and as appropriate. To the extent
the Company seeks to serve additional foreign destinations in the future, or to renew its authority to
serve certain routes, it may be required to obtain necessary authority from the DOT and/or approvals
from the FAA, as well as any applicable foreign government entity.

Certain international route authorities are governed by bilateral air transportation agreements between
the United States and foreign countries. Changes in U.S. or foreign government aviation policies could
result in the alteration or termination of such agreements, diminish the value of the Company’s existing
international authorities, present barriers to renewing existing or securing new authorities, or otherwise
affect the Company’s international operations. In particular, there is still a degree of uncertainty about
the future of scheduled commercial flight operations between the United States and Cuba as a result of

17

changes in diplomatic relations between the two governments, as well as travel and trade restrictions
implemented by the U.S. government in 2017. There are also capacity limitations at certain airports in
Mexico and the Caribbean, which could impact future service levels. In general, bilateral agreements
between the United States and foreign countries the Company currently serves, or may serve in the
future, may be subject
to renegotiation or reinterpretation from time to time. While the U.S.
government has negotiated “open skies” agreements with many countries, which allow for unrestricted
access between the United States and respective foreign destinations, agreements with other countries
may restrict the Company’s entry and/or growth opportunities.

The CBP is the federal agency of the U.S. Department of Homeland Security charged with facilitating
international trade, collecting import duties, and enforcing U.S. regulations with respect to trade,
customs, and immigration. As the Company expands its international flight offerings, CBP and its
requirements and resources will also become increasingly important considerations to the Company.
For instance, with the exception of flights from a small number of foreign “preclearance” locations,
arriving international flights may only land at CBP-designated airports, and CBP officers must be
those airports to effectively process and inspect arriving
present and in sufficient quantities at
international passengers and cargo. Thus, CBP personnel and CBP-mandated procedures can affect the
Company’s operations, costs, and Customer experience. The Company has made and expects to
continue to make significant investments in facilities, equipment, and technologies at certain airports in
order to improve the Customer experience and to assist CBP with its inspection and processing duties;
however, the Company is not able to predict the impact, if any, that various CBP measures or the lack
of CBP resources will have on Company revenues and costs, either in the short-term or the long-term.

Insurance

The Company carries insurance of types customary in the airline industry and in amounts the Company
deems adequate to protect the Company and its property and to comply both with federal regulations
and certain of the Company’s credit and lease agreements. The policies principally provide coverage
for public and passenger liability, property damage, cargo and baggage liability, loss or damage to
aircraft, engines, and spare parts, and workers’ compensation. In addition, the Company carries a
cyber-security insurance policy with regards to data protection and business interruption associated
with both security breaches from malicious parties and from certain system failures.

Although the Company has been able to purchase aviation, property, liability, and professional
insurance via the commercial insurance marketplace, available commercial insurance could be more
expensive in the future and/or have material differences in coverage than insurance that has historically
been provided and may not be adequate to protect the Company’s risk of loss from future events,
including acts of terrorism. Further, available cyber-security insurance with regards to data protection
and business interruption could be more expensive in the future and/or have material differences in
coverage than insurance that has historically been provided and may not be adequate to protect the
Company’s risk of loss.

Competition

Competition within the airline industry is intense and highly unpredictable, and Southwest currently
competes with other airlines on virtually all of its scheduled routes. As a result of moderately improved
economic conditions and an increased focus by airlines on costs, the airline industry has become
increasingly competitive in recent years with a healthier financial condition and improved profitability.

18

Key competitive factors within the airline industry include (i) pricing and cost structure; (ii) routes,
frequent flyer programs, and schedules; and (iii) customer service, operational reliability, and amenities.
Southwest also competes for customers with other forms of transportation, as well as alternatives to
travel. In recent years, the majority of domestic airline service has been provided by Southwest and the
other largest major U.S. airlines, including American Airlines, Delta Air Lines, and United Airlines. The
DOT defines major U.S. airlines as those airlines with annual revenues of at least $1 billion; there are
currently 14 passenger airlines offering scheduled service, including Southwest, that meet this standard.

Pricing and Cost Structure

Pricing is a significant competitive factor in the airline industry, and the availability of fare information
on the Internet allows travelers to easily compare fares and identify competitor promotions and
discounts. During 2017, the Company experienced additional competitive challenges associated with
industry changes from both a fare level and product offering perspective. As discussed above under
“Business - Industry,” legacy carrier offerings ranged from a “Basic Economy” fare product, designed
to compete with ULCC fares, to a “Premium Economy” product, targeted to appeal to customers
willing to pay a premium for additional amenities. Also in response to ULCC pricing, some legacy
carriers have removed their fare floors for certain routes, leading to lower fares across the industry.
These changes have put increased pressure on the industry’s fare environment and have created a
challenging revenue environment.

Pricing can be driven by a variety of factors. For example, airlines often discount fares to drive traffic
in new markets or to stimulate traffic when necessary to improve load factors and/or cash flow. In
addition, multiple airlines have been able to reduce fares because they have been able to lower their
operating costs as a result of reorganization within and outside of bankruptcy. Further, some of the
Company’s competitors have continued to grow and modernize their fleets and expand their networks,
potentially enabling them to better control costs per available seat mile (the average cost to fly an
aircraft seat (empty or full) one mile), which in turn may enable them to lower their fares.

The Company believes its low-cost operating structure continues to provide it with an advantage over
many of its airline competitors by enabling it to continue to charge low fares. However, ULCCs, which
have increased capacity in the Company’s markets, have surpassed the Company’s cost advantage with
larger gauge aircraft, increased seat density, and lower wages. The Company believes it continues to have
a competitive advantage through its differentiation of Southwest from many of its competitors by not
charging additional fees for items such as first and second checked bags for each ticketed Customer,
flight changes, seat selection, snacks, curb-side check-in, and telephone reservations; nevertheless it has
become increasingly difficult for the Company to improve upon its industry cost position.

Routes, Frequent Flyer Programs, and Schedules

The Company also competes with other airlines based on markets served, frequent flyer opportunities,
and flight schedules. Some major airlines have more extensive route structures than Southwest,
including more extensive international networks. In addition, many competitors have entered into
significant commercial relationships with other airlines, such as global alliances, code-sharing, and
capacity purchase agreements, which increase the airlines’ opportunities to expand their route
offerings. An alliance or code-sharing agreement enables an airline to offer flights that are operated by
another airline and also allows the airline’s customers to book travel that includes segments on
different airlines through a single reservation or ticket. As a result, depending on the nature of the

19

specific alliance or code-sharing arrangement, a participating airline may be able to, among other
things, (i) offer its customers access to more destinations than it would be able to serve on its own,
(ii) gain exposure in markets it does not otherwise serve, and (iii) increase the perceived frequency of
its flights on certain routes. Alliance and code-sharing arrangements not only provide additional route
flexibility for participating airlines, they can also allow these airlines to offer their customers more
opportunities to earn and redeem frequent flyer miles or points. A capacity purchase agreement enables
an airline to expand its route structure by paying another airline (e.g., a regional airline with smaller
aircraft) to operate flights on its behalf in markets that it does not, or cannot, serve itself. The Company
continues to evaluate and implement initiatives to better enable itself to offer additional itineraries.

Customer Service, Operational Reliability, and Amenities

Southwest also competes with other airlines with respect to customer service, operational reliability
(such as ontime performance), and passenger amenities. According to statistics published by the DOT,
Southwest consistently ranks at or near the top among domestic carriers in Customer Satisfaction for
ratio. However, carriers are increasingly focusing on
having the lowest Customer complaint
operational reliability as an opportunity to win and retain Customers. In addition, some airlines have
more seating options and associated passenger amenities than does Southwest, including first-class,
business class, and other premium seating and related amenities. New and different types of aircraft
flown by competitors could have operational attributes and passenger amenities that could be
considered more favorable than those associated with the Company’s existing fleet.

Other Forms of Competition

The airline industry is subject to varying degrees of competition from surface transportation by
automobiles, buses, and trains. Inconveniences and delays associated with air travel security measures
can increase surface competition. In addition, surface competition can be significant during economic
downturns when consumers cut back on discretionary spending and fewer choose to fly, or when
gasoline prices are lower, making surface transportation a less expensive option. Because of the
relatively high percentage of short-haul travel provided by Southwest, it is particularly exposed to
competition from surface transportation in these instances. The airline industry is also subject to
competition from alternatives to travel such as videoconferencing and the Internet, which can increase
in the event of travel inconveniences and economic downturns. The Company is subject to the risk that
air travel inconveniences and economic downturns may, in some cases, result in permanent changes to
consumer behavior in favor of surface transportation and electronic communications.

Seasonality

The Company’s business is seasonal. Generally, in most markets the Company serves, demand for air
travel is greater during the summer months, and therefore, revenues in the airline industry tend to be
stronger in the second (April 1 - June 30) and third (July 1 - September 30) quarters of the year than in
the first (January 1 - March 31) and fourth (October 1 - December 31) quarters of the year. As a result,
in many cases, the Company’s results of operations reflect this seasonality. Factors that could alter this
seasonality include, among others, the price of fuel, general economic conditions, extreme or severe
weather and natural disasters, fears of terrorism or war, or changes in the competitive environment.
Therefore, the Company’s quarterly operating results are not necessarily indicative of operating results
for the entire year, and historical operating results in a quarterly or annual period are not necessarily
indicative of future operating results.

20

Employees

At December 31, 2017, the Company had approximately 56,100 active fulltime equivalent Employees,
consisting of approximately 23,600 flight, 3,000 maintenance, 20,000 ground, Customer, and fleet
service, and 9,500 management, technology, finance, marketing, and clerical personnel (associated
with non-operational departments). Approximately 83 percent of these Employees were represented by
labor unions. The Railway Labor Act establishes the right of airline employees to organize and bargain
collectively. Under the Railway Labor Act, collective-bargaining agreements between an airline and a
labor union generally do not expire, but instead become amendable as of an agreed date. By the
amendable date, if either party wishes to modify the terms of the agreement, it must notify the other
party in the manner required by the Railway Labor Act and/or described in the agreement. After receipt
of the notice, the parties must meet for direct negotiations. If no agreement is reached, either party may
request the National Mediation Board to appoint a federal mediator. If no agreement is reached in
mediation,
the National Mediation Board may determine an impasse exists and offer binding
arbitration to the parties. If either party rejects binding arbitration, a 30-day “cooling off” period
begins. At the end of this 30-day period, the parties may engage in “self-help,” unless a Presidential
Emergency Board is established to investigate and report on the dispute. The appointment of a
Presidential Emergency Board maintains the “status quo” for an additional period of time. If the parties
do not reach agreement during this period, the parties may then engage in “self-help.” “Self-help”
includes, among other things, a strike by the union or the airline’s imposition of any or all of its
proposed amendments and the hiring of new employees to replace any striking workers. The following
table sets forth the Company’s Employee groups subject to collective bargaining and the status of their
respective collective-bargaining agreements as of December 31, 2017:

Employee Group

Approximate Number
of Employees

Southwest Pilots

8,600

Southwest Flight Attendants

14,500

Southwest Ramp, Operations,
Provisioning, Freight Agents
Southwest Customer Service
Agents, Customer
Representatives, and Source of
Support Representatives
Southwest Material Specialists
(formerly known as Stock
Clerks)

Southwest Mechanics
Southwest Aircraft
Appearance Technicians
Southwest Facilities
Maintenance Technicians

Southwest Dispatchers
Southwest Flight Simulator
Technicians

Southwest Flight Crew
Training Instructors
Southwest Meteorologists

12,800

7,400

300

2,400

200

40

350

50

120
10

Representatives
Southwest Airlines Pilots’
Association (“SWAPA”)
Transportation Workers of
America, AFL-CIO, Local 556
(“TWU 556”)
Transportation Workers of
America, AFL-CIO, Local 555
(“TWU 555”)

Status of Agreement

Amendable September 2020

Amendable November 2018

Amendable February 2021

International Association of
Machinists and Aerospace
Workers, AFL-CIO (“IAM 142”)

Amendable December 2018

International Brotherhood of
Teamsters, Local 19 (“IBT 19”)
Aircraft Mechanics Fraternal
Association (“AMFA”)

In negotiations

In negotiations

AMFA

Amendable November 2020

AMFA
Transportation Workers of
America, AFL-CIO, Local 550
(“TWU 550”)
International Brotherhood of
Teamsters (“IBT”)
Transportation Workers of
America, AFL-CIO, Local 557
(“TWU 557”)
TWU 550

Amendable November 2022

Amendable June 2019

Amendable May 2019

Amendable January 2020
Amendable June 2019

21

Additional Information About the Company

The Company was incorporated in Texas in 1967. The following documents are available free of
the Company’s annual report on
charge through the Company’s website, www.southwest.com:
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to
those reports that are filed with or furnished to the Securities and Exchange Commission (“SEC”)
pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934. These materials are made
available through the Company’s website as soon as reasonably practicable after they are electronically
filed with, or furnished to, the SEC. In addition to its reports filed or furnished with the SEC, the
Company publicly discloses material information from time to time in its press releases, at annual
meetings of Shareholders, in publicly accessible conferences and Investor presentations, and through
its website (principally in its Press Room and Investor Relations pages). References to the Company’s
website in this Form 10-K are provided as a convenience and do not constitute, and should not be
deemed, an incorporation by reference of the information contained on, or available through, the
website, and such information should not be considered part of this Form 10-K.

22

DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION

This Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking
statements are based on, and include statements about, the Company’s estimates, expectations, beliefs,
intentions, and strategies for the future, and the assumptions underlying these forward-looking
statements. Specific forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts and include, without limitation, words such as “anticipates,”
“believes,” “estimates,” “expects,” “intends,” “may,” “will,” “would,” “could,” “should,” “projects,”
“plans,” “goal,” and similar expressions. Although management believes these forward-looking
statements are reasonable as and when made, forward-looking statements are not guarantees of future
performance and involve risks and uncertainties that are difficult to predict. Therefore, actual results
may differ materially from what is expressed in or indicated by the Company’s forward-looking
statements or from historical experience or the Company’s present expectations. Known material risk
factors that could cause these differences are set forth below under “Risk Factors.” Additional risks or
uncertainties (i) that are not currently known to the Company, (ii) that the Company currently deems to
be immaterial, or (iii) that could apply to any company, could also materially adversely affect the
Company’s business, financial condition, or future results.

Caution should be taken not to place undue reliance on the Company’s forward-looking statements,
which represent the Company’s views only as of the date this Form 10-K is filed. The Company
undertakes no obligation to update publicly or revise any forward-looking statement, whether as a
result of new information, future events, or otherwise.

Item 1A.

Risk Factors

The airline industry is particularly sensitive to changes in economic conditions; in the event of
unfavorable economic conditions or economic uncertainty, the Company’s results of operations
could be negatively affected, which could require the Company to adjust its business strategies.

to relatively high fixed costs and highly variable and
The airline industry, which is subject
unpredictable demand,
is particularly sensitive to changes in economic conditions. Historically,
unfavorable U.S. economic conditions have driven changes in travel patterns and have resulted in
reduced spending for both leisure and business travel. For some consumers, leisure travel is a
discretionary expense, and short-haul travelers, in particular, have the option to replace air travel with
surface travel. Businesses are able to forego air travel by using communication alternatives such as
videoconferencing and the Internet or may be more likely to purchase less expensive tickets to reduce
costs, which can result in a decrease in average revenue per seat. Unfavorable economic conditions,
when low fares are often used to stimulate traffic, have also historically hampered the ability of airlines
to raise fares to counteract any increases in fuel, labor, and other costs. Although the U.S. economy has
experienced modest economic growth over the course of the past several years, any continuing or
future U.S. or global economic uncertainty could negatively affect the Company’s results of operations
and could cause the Company to adjust its business strategies.

23

The Company’s business can be significantly impacted by high and/or volatile fuel prices, and
the Company’s operations are subject to disruption in the event of any delayed supply of fuel;
therefore, the Company’s strategic plans and future profitability are likely to be impacted by the
Company’s ability to effectively address fuel price increases and fuel price volatility and
availability.

fuel and oil

Airlines are inherently dependent upon energy to operate, and jet
represented
approximately 22 percent of the Company’s operating expenses for 2017. Although 2017 fuel prices
were moderately higher than 2016 fuel prices, as discussed above under “Business - Cost Structure,”
the cost of fuel can be extremely volatile and unpredictable, and even a small change in market fuel
prices can significantly affect profitability. Furthermore, volatility in fuel prices can be due to many
external factors that are beyond the Company’s control. For example, fuel prices can be impacted by
political and economic factors, such as (i) dependency on foreign imports of crude oil and the potential
for hostilities or other conflicts in oil producing areas; (ii) limited domestic refining or pipeline
capacity due to weather, natural disasters, or other factors; (iii) worldwide demand for fuel, particularly
in developing countries, which can result in inflated energy prices; (iv) changes in U.S. governmental
policies on fuel production, transportation, taxes, and marketing; and (v) changes in currency exchange
rates.

The Company’s ability to effectively address fuel price increases could be limited by factors such as its
historical low-fare reputation, the portion of its Customer base that purchases travel for leisure
purposes, the competitive nature of the airline industry generally, and the risk that higher fares will
drive a decrease in demand. The Company attempts to manage its risk associated with volatile jet fuel
prices by utilizing over-the-counter fuel derivative instruments to hedge a portion of its future jet fuel
purchases. However, energy prices can fluctuate significantly in a relatively short amount of time.
Because the Company uses a variety of different derivative instruments at different price points, the
Company is subject to the risk that the fuel derivatives it uses will not provide adequate protection
against significant increases in fuel prices and could in fact result in hedging losses, and the Company
effectively paying higher than market prices for fuel,
thus creating additional volatility in the
Company’s earnings. The Company is also subject to the risk that cash collateral may be required to be
posted to fuel hedge counterparties, which could have a significant impact on the Company’s financial
position and liquidity.

In addition, the Company is subject to the risk that its fuel derivatives will not be effective or that they
will no longer qualify for hedge accounting under applicable accounting standards, which can create
additional earnings volatility. Adjustments in the Company’s overall fuel hedging strategy, as well as
the ability of the commodities used in fuel hedging to qualify for special hedge accounting, are likely
to continue to affect the Company’s results of operations. In addition, there can be no assurance that
the Company will be able to cost-effectively hedge against increases in fuel prices. Also, see Note 2 to
the Consolidated Financial Statements for information on future changes in applicable standards for
hedge accounting.

The Company’s fuel hedging arrangements and the various potential impacts of hedge accounting on
the Company’s financial position, cash flows, and results of operations are discussed in more detail
under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,”
“Quantitative and Qualitative Disclosures About Market Risk,” and in Note 1 and Note 10 to the
Consolidated Financial Statements.

24

The Company is also reliant upon the readily available supply and timely delivery of jet fuel to the
airports that
it serves. A disruption in that supply could present significant challenges to the
Company’s operations and could ultimately cause the cancellation of flights and/or the inability of the
Company to provide service to a particular airport.

The Company’s low-cost structure has historically been one of its primary competitive
advantages, and many factors have affected and could continue to affect the Company’s ability
to control its costs.

The Company’s low-cost structure has historically been one of its primary competitive advantages, as
it has enabled it to offer low fares, drive traffic volume, grow market share, and protect profits. The
Company’s low-cost position has become even more significant with the increased presence of ULCCs
and changes to the legacy fare offerings discussed above; however, it has become increasingly difficult
for the Company to improve upon its industry cost position. For example, labor and fuel costs, as well
as other costs such as regulatory compliance costs, can negatively affect the Company’s ability to
control its costs. Furthermore, the Company has limited control over many of these costs.

Jet fuel and oil constituted approximately 22 percent of the Company’s operating expenses during
2017, and the Company’s ability to control the cost of fuel is subject to the external factors discussed
in the second Risk Factor above.

Salaries, wages, and benefits constituted approximately 41 percent of the Company’s operating
expenses during 2017. The Company’s ability to control labor costs is limited by the terms of its
collective-bargaining agreements, and increased labor costs have negatively impacted the Company’s
low-cost competitive position. As discussed further under “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” the Company’s unionized workforce, which makes up
approximately 83 percent of its Employees, has had pay scale increases as a result of contractual rate
increases. Additionally, the majority of Southwest’s unionized Employees, including its Pilots; Flight
Attendants; Ramp, Operations, Provisioning, and Freight Agents; Aircraft Appearance Technicians;
and Flight Crew Training Instructors, ratified new collective-bargaining agreements during 2016,
which have put pressure on the Company’s low-cost structure. Furthermore, as indicated above under
“Business - Employees,” other Southwest unionized Employees, including its Mechanics and Material
Specialists, are in unions currently in negotiations for labor agreements, which could result
in
additional pressure on the Company’s low-cost structure.

As discussed above under “Business - Regulation,” the airline industry is heavily regulated, and the
Company’s regulatory compliance costs are subject to potentially significant increases from time to
time based on actions by regulatory agencies that are out of the Company’s control. Additionally, the
Company cannot control decisions by other airlines to reduce their capacity. When this occurs, airport
costs are allocated among a fewer number of total flights, which can result in increased landing fees
and other costs for the Company. The Company is also reliant upon third party vendors and service
providers, in particular with respect to its fleet and technology initiatives and performance, and the
Company’s low-cost advantage is also dependent
in part on its ability to obtain and maintain
commercially reasonable terms with those parties.

As discussed above under “Business - Insurance,” the Company carries insurance of types customary
in the airline industry. Although the Company has been able to purchase aviation, property, liability,
and professional insurance via the commercial insurance marketplace, available commercial insurance

25

could be more expensive in the future and/or have material differences in coverage than insurance that
has historically been provided and may not be adequate to protect against the Company’s risk of loss
from future events, including acts of terrorism. Further, available cyber-security insurance with regards
to data protection and business interruption could be more expensive in the future and/or have material
differences in coverage than insurance that has historically been provided and may not be adequate to
protect the Company’s risk of loss. In addition, an accident or other incident involving Southwest
aircraft could result in costs in excess of its related insurance coverage, which costs could be
substantial. Any aircraft accident or other incident, even if fully insured, could also have a material
adverse effect on the public’s perception of the Company.

The Company cannot guarantee it will be able to maintain or improve upon its current level of low-cost
advantage over many of its airline competitors. ULCCs, which have increased capacity in the
Company’s markets, have surpassed the Company’s cost advantage. When competitors grow their
fleets and expand their networks, they are potentially able to better control costs per available seat
mile. In addition, like Southwest, some competitors have added a significant number of new and
different aircraft to their fleets, which could potentially decrease their operating costs through better
fuel efficiencies and lower maintenance costs.

The Company is increasingly dependent on technology to operate its business and continues to
implement substantial changes to its information systems; any failure, disruption, breach, or
delay in implementation of the Company’s information systems could materially adversely affect
its operations.

The Company is increasingly dependent on the use of complex technology and systems to run its
ongoing operations and support its strategic objectives.

Implementation and integration of complex systems and technology presents significant challenges in
terms of costs, human resources, and development of effective internal controls. Implementation and
integration require a balancing between the introduction of new capabilities and the managing of
existing systems, and present the risk of operational or security inadequacy or interruption, which
the Company’s ability to effectively operate its business and/or could
could materially affect
negatively impact
the Company’s results of operations. The Company is also reliant upon the
performance of its third party vendors for timely and effective completion of many of its technology
initiatives and for maintaining adequate information security measures.

In the ordinary course of business, the Company’s systems will continue to require modification and
refinements to address growth and changing business requirements, including requirements related to
international operations. In addition, the Company’s systems may require modification to enable the
Company to comply with changing regulatory requirements. Modifications and refinements to the
Company’s systems have been and are expected to continue to be expensive to implement and can
divert management’s attention from other matters. In addition, the Company’s operations could be
adversely affected, or it could face imposition of regulatory penalties, if it were unable to timely or
effectively modify its systems as necessary or appropriately balance the introduction of new
capabilities with the management of existing systems.

The Company has experienced system interruptions and delays that make its websites and services
unavailable or slow to respond, which can prevent the Company from efficiently processing Customer
transactions or providing services, and these could continue to occur in the future. These system

26

interruptions and delays can reduce the Company’s operating revenues and the attractiveness of its
services, as well as increase the Company’s costs. The Company’s computer and communications
systems and operations could be damaged or interrupted by catastrophic events such as fires, floods,
earthquakes, tornadoes and hurricanes, power loss, computer and telecommunications failures, acts of
war or terrorism, computer viruses, security breaches, and similar events or disruptions. Any of these
events could cause system interruptions, delays, and loss of critical data, and could prevent the
Company from processing Customer transactions or providing services, which could make the
Company’s business and services less attractive and subject the Company to liability. Any of these
events could damage the Company’s reputation and be expensive to remedy.

The Company’s business is labor intensive; therefore, the Company would be adversely affected
if it were unable to maintain satisfactory relations with its Employees or its Employees’
Representatives.

The airline business is labor intensive. Salaries, wages, and benefits represented approximately
41 percent of the Company’s operating expenses for the year ended December 31, 2017. In addition, as
of December 31, 2017, approximately 83 percent of the Company’s Employees were represented for
collective bargaining purposes by labor unions, making the Company particularly exposed in the event
of labor-related job actions. Employment-related issues that have, and continue to,
the
Company’s results of operations, some of which are negotiated items, include hiring/retention rates,
pay rates, outsourcing costs, work rules, health care costs, and retirement benefits.

impact

The Company is currently dependent on single aircraft and engine suppliers, as well as single
suppliers of certain other parts; therefore, the Company would be materially adversely affected
if it were unable to obtain additional equipment or support from any of these suppliers, in the
event of a mechanical or regulatory issue associated with their equipment, or in the event the
pricing and operational attributes of the Company’s equipment become less competitive.

The Company is dependent on Boeing as its sole supplier for aircraft and many of its aircraft parts and
is dependent on other suppliers for certain other aircraft parts. Although the Company is able to
purchase some aircraft from parties other than Boeing, most of its purchases are directly from Boeing.
Therefore, if the Company was unable to acquire additional aircraft from Boeing, or if Boeing was
unable or unwilling to make timely deliveries of aircraft or to provide adequate support for its
products, the Company’s operations would be materially adversely affected. In addition, the Company
would be materially adversely affected in the event of a mechanical or regulatory issue associated with
the Boeing 737 aircraft type, whether as a result of downtime for part or all of the Company’s fleet,
increased maintenance costs, or because of a negative perception by the flying public. The Company
believes, however, that its years of experience with the Boeing 737 aircraft type, as well as the
efficiencies Southwest has historically achieved by operating with a single aircraft type, continue to
outweigh the risks associated with its single aircraft supplier strategy. The Company is also dependent
on sole suppliers for aircraft engines and certain other aircraft parts and would therefore also be
materially adversely affected in the event of the unavailability of, or a mechanical or regulatory issue
associated with, engines and other parts. The Company could also be materially adversely affected if
the pricing or operational attributes of its equipment were to become less competitive.

27

Any failure of the Company to maintain the security of certain Customer-related information
could result in damage to the Company’s reputation and could be costly to remediate.

The Company must receive information related to its Customers in order to run its business, and the
Company’s operations depend upon secure retention and the secure transmission of information over
public networks, including information permitting cashless payments. This information is subject to the
risk of intrusion, tampering, and theft. Although the Company maintains systems to defend against this
from occurring, these systems require ongoing monitoring and updating as technologies change, and
security could be compromised, confidential
information could be misappropriated, or system
disruptions could occur. In the ordinary course of its business, the Company also provides certain
confidential, proprietary, and personal information to third parties. While the Company seeks to obtain
assurances that these third parties will protect this information, there is a risk the security of data held
by third parties could be breached. A compromise of the Company’s security systems could adversely
affect the Company’s reputation and disrupt its operations and could also result in litigation against the
Company or the imposition of penalties. In addition, it could be costly to remediate. Although the
Company has not experienced cyber incidents that are individually, or in the aggregate, material, the
Company has experienced cyber-attacks in the past, which have thus far been mitigated by
preventative, detective, and responsive measures put in place by the Company.

The Company’s results of operations could be adversely impacted if it is unable to grow or to
effectively execute its strategic plans.

Southwest has historically been regarded as a growth airline. However, organic growth remains
challenging because (i) the opportunities for domestic expansion are limited; (ii) the Company’s
international network is relatively small and international expansion presents unique challenges; and
(iii) the Company has faced an increased presence of other low-cost, low-fare carriers. As a result, the
Company is reliant on the success of its revenue strategies to help offset certain increasing costs. The
timely and effective execution of the Company’s strategic plans could be negatively affected by (i) the
Company’s ability to timely and effectively implement, transition, and maintain related information
technology systems and infrastructure; (ii) the Company’s ability to effectively balance its investment
of incremental operating expenses and capital expenditures related to its strategies against the need to
effectively control costs; and (iii) the Company’s dependence on third parties with respect to its
strategic plans.

The airline industry has faced on-going security concerns and related cost burdens; further
threatened or actual terrorist attacks, or other hostilities, could significantly harm the airline
industry and the Company’s operations.

Terrorist attacks or other crimes and hostilities, actual and threatened, have from time to time
materially adversely affected the demand for air travel and also have resulted in increased safety and
security costs for the Company and the airline industry generally. Safety measures create delays and
inconveniences and can,
in particular, reduce the Company’s competitiveness against surface
transportation for short-haul routes. Additional terrorist attacks or other hostilities, even if not made
directly on the airline industry, or the fear of such attacks or other hostilities (including elevated
national threat warnings or selective cancellation or redirection of flights due to terror threats) would
likely have a further significant negative impact on the Company and the airline industry.

28

Airport capacity constraints and air traffic control
inefficiencies have limited and could
continue to limit the Company’s growth; changes in or additional governmental regulation
could increase the Company’s operating costs or otherwise limit the Company’s ability to
conduct business.

Almost all commercial service airports are owned and/or operated by units of local or state
governments. Airlines are largely dependent on these governmental entities to provide adequate airport
facilities and capacity at an affordable cost. Similarly, the federal government singularly controls all
U.S. airspace, and airlines are completely dependent on the FAA operating that airspace in a safe and
efficient manner. The current air traffic control system is mainly radar-based and supported in large
part by antiquated equipment and technologies. The FAA’s protracted transition to a satellite-based air
traffic control system, as well as the implementation of policies and standards that account for the
precision of global positioning system-supported aircraft technologies, could continue to adversely
impact airspace capacity and the overall efficiency of the system, resulting in limited opportunities for
the Company to grow, longer scheduled flight times, increased delays and cancellations, and increased
fuel consumption and aircraft emissions. As discussed above under “Business - Regulation,” airlines
are also subject
to other extensive regulatory requirements. These requirements often impose
substantial costs on airlines. The Company’s strategic plans and results of operations could be
negatively affected by changes in law and future actions taken by domestic and foreign governmental
agencies having jurisdiction over its operations, including, but not limited to:

•

•

•

•

•

•

•

•

•

•

•

•

•

increases in airport rates and charges;

limitations on airport gate capacity or use of other airport facilities such as the 2016 and 2017
reallocation of slots at John Wayne Airport in Orange County, California, which caused the
Company to reduce service at that airport;

limitations on route authorities;

actions and decisions that create difficulties in obtaining access at slot-controlled airports;

actions and decisions that create difficulties in obtaining operating permits and approvals;

changes to environmental regulations;

new or increased taxes or fees;

changes to laws that affect the services that can be offered by airlines in particular markets
and at particular airports;

restrictions on competitive practices;

changes in laws that increase costs for safety, security, compliance, or other Customer
Service standards;

changes in laws that may limit the Company’s ability to enter into fuel derivative contracts to
hedge against increases in fuel prices;

changes in laws that may limit or regulate the Company’s ability to promote the Company’s
business or fares; and

the adoption of more restrictive locally-imposed noise regulations.

29

Because expenses of a flight do not vary significantly with the number of passengers carried, a
relatively small change in the number of passengers can have a disproportionate effect on an airline’s
operating and financial results. Therefore, any general reduction in airline passenger traffic as a result
of any of the factors listed above could adversely affect the Company’s results of operations. In
addition, in instances where the airline industry shrinks, many airport operating costs are essentially
unchanged and must be shared by the remaining operating carriers, which can therefore increase the
Company’s costs.

The airline industry is affected by many conditions that are beyond its control, which can impact
the Company’s business strategies and results of operations.

In addition to the unpredictable economic conditions and fuel costs discussed above, the Company,
like the airline industry in general, is affected by conditions that are largely unforeseeable and outside
of its control, including, among others:

•

•

•

•

•

•

•

adverse weather and natural disasters such as the hurricanes and earthquakes in third quarter
2017, which resulted in approximately $100 million in reduced revenues for the Company as
a result of approximately 5,000 canceled flights;

changes in consumer preferences, perceptions, spending patterns, or demographic trends
(including, without limitation, changes in government travel patterns due to government
shutdowns or sequestration);

actual or potential disruptions in the air traffic control system (including, without limitation,
as a result of potential FAA budget cuts due to government shutdowns or sequestration);

changes in the competitive environment due to industry consolidation, industry bankruptcies,
and other factors;

air traffic congestion and other air traffic control issues;

outbreaks of disease; and

actual or threatened war, terrorist attacks, and political instability.

The airline industry is intensely competitive.

As discussed in more detail above under “Business - Competition,” the airline industry is intensely
competitive. The Company’s primary competitors include other major domestic airlines, as well as
regional and new entrant airlines, surface transportation, and alternatives to transportation such as
videoconferencing and the Internet. The Company’s revenues are sensitive to the actions of other
carriers with respect to pricing, routes, frequent flyer programs, scheduling, capacity, customer service,
operational reliability, comfort and amenities, cost structure, aircraft fleet, and code-sharing and similar
activities.

The Company’s future results will suffer if it does not effectively manage its expanded
international operations and/or Extended Operations (“ETOPS”).

With the expansion of the Company’s international flight offerings, the U.S. Customs and Border
Protection (“CBP”) has become an increasingly important federal agency. CBP personnel and

30

CBP-mandated procedures can affect the Company’s operations, costs, and Customer experience. The
Company has made, and is continuing to make, significant investments in facilities, equipment, and
technologies at certain airports in order to improve the Customer experience and to assist CBP with its
inspection and processing duties; however, the Company is not able to predict the impact, if any, that
various CBP measures or the lack of CBP resources will have on Company revenues and costs, either
in the short-term or the long-term.

in certain international

International flying requires the Company to modify certain processes, as the airport environment is
dramatically different
things,
common-use ticket counters and gate areas, local operating requirements, and cultural preferences. In
addition, international flying exposes the Company to certain foreign currency risks to the extent the
Company chooses to, or is required to, transact in currencies other than the U.S. dollar. To the extent
the Company seeks to serve additional foreign destinations in the future, or to renew its authority to
serve certain routes, it may be required to obtain necessary authority from the DOT and/or approvals
from the FAA, as well as any applicable foreign government entity.

locations with respect

to, among other

The Company’s expansion of its operations into non-U.S. jurisdictions also expands the scope of the
laws to which the Company is subject, both domestically and internationally. In addition, operations in
non-U.S. jurisdictions are in many cases subject to the laws of those jurisdictions rather than U.S. laws.
Laws in some jurisdictions differ in significant respects from those in the United States, and these
differences can affect the Company’s ability to react to changes in its business, and its rights or ability
to enforce rights may be different than would be expected under U.S. laws. Furthermore, enforcement
of laws in some jurisdictions can be inconsistent and unpredictable, which can affect both the
Company’s ability to enforce its rights and to undertake activities that it believes are beneficial to its
business. As a result, the Company’s ability to generate revenue and its expenses in non-U.S.
jurisdictions may differ from what would be expected if U.S.
laws governed these operations.
Although the Company has policies and procedures in place that are designed to promote compliance
with the laws of the jurisdictions in which it operates, a violation by the Company’s Employees,
contractors, or agents or other intermediaries, could nonetheless occur. Any violation (or alleged or
perceived violation), even if prohibited by the Company’s policies, could have an adverse effect on the
Company’s reputation and/or its results of operations.

As discussed above under “Regulation – Operational, Safety, and Health Regulation,” in January 2018,
the Company submitted a formal application to the FAA for authorization to conduct ETOPS using
Boeing 737-800 aircraft, in connection with the Company’s plans to begin service to Hawaii. If the
Company receives FAA authorization and commences ETOPS, the Company will be subject to
additional, ongoing, ETOPS-specific regulatory and procedural requirements, which could add
operational and compliance risks to the Company’s business, including costs associated therewith.

The Company is currently subject to pending litigation, and if judgment were to be rendered
against the Company in the litigation, such judgment could adversely affect the Company’s
operating results.

As discussed below under “Legal Proceedings,” the Company and its AirTran subsidiary are subject to
pending litigation.

Regardless of merit, these litigation matters and any potential future claims against the Company or
AirTran may be both time consuming and disruptive to the Company’s operations and cause significant

31

expense and diversion of management attention. Should the Company or AirTran fail to prevail in
these or other matters, the Company may be faced with significant monetary damages or injunctive
relief that could materially adversely affect its business and might materially affect its financial
condition and operating results.

Item 1B.

Unresolved Staff Comments

None.

Item 2.

Aircraft

Properties

Southwest operated a total of 706 Boeing 737 aircraft as of December 31, 2017, of which 53 and 69
were under operating and capital leases, respectively. The following table details information on the
706 aircraft as of December 31, 2017:

Type

737-700

737-800

737 MAX 8

Totals

Seats

143

175

175

Average
Age
(Yrs)

14

3

—

11

Number of
Aircraft

Number
Owned (a)

Number
Leased

512

181

13

706

397

174

13

584

115

7

—

122

(a) As discussed further in Note 6 to the Consolidated Financial Statements, 203 of the Company’s aircraft were
pledged as collateral as of December 31, 2017, for secured borrowings and/or in the case that the Company
has obligations related to its fuel derivative instruments with counterparties that exceed certain thresholds.

As of December 31, 2017, the Company had firm deliveries and options for Boeing 737-700, 737-800,
737 MAX 7, and 737 MAX 8 aircraft as follows:

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

-800
Firm
Orders

The Boeing Company
MAX 7
Firm
Orders

MAX 8
Firm
Orders

MAX 8
Options

Additional
-700s

Total

26

—

—

—

—

—

—

—

—

—

26

—

7

—

—

—

12

11

—

—

—

30

14

15

25

34

17

22

30

40

—

—

—

—

—

—

14

23

23

36

36

23

4

—

—

—

—

—

—

—

—

—

44

22

25

34

31

57

64

76

36

23

197 (a)

155

4 (b)

412

(a) The Company has flexibility to substitute 737 MAX 7 in lieu of 737 MAX 8 firm orders beginning in 2019.
(b) To be acquired in leases from various third parties.

32

Ground Facilities and Services

Southwest either leases or pays a usage fee for terminal passenger service facilities at each of the
airports it serves, to which various leasehold improvements have been made. The Company leases the
land and/or structures on a long-term basis for its aircraft maintenance centers (located at Dallas Love
Field, Houston Hobby, Phoenix Sky Harbor, Chicago Midway, Hartsfield-Jackson Atlanta
International Airport, and Orlando International Airport) and its main corporate headquarters building,
also located near Dallas Love Field. The Company also leases a warehouse and engine repair facility in
Atlanta.

The Company has commitments associated with various airport improvement projects, including
ongoing construction at Los Angeles International Airport. These projects include the construction of
new facilities and the rebuilding or modernization of existing facilities. Additional
information
regarding these projects is provided below under “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.

The Company owns an additional headquarters building, located across the street from the Company’s
main headquarters building, on land owned by the Company. This energy-efficient, modern building,
called TOPS, houses certain operational and training functions, including its 24-hour operations. In
2016, the Company broke ground on an additional headquarters complex, called the Wings Complex,
consisting of a Leadership Education and Aircrew Development (LEAD) Center (designed to house
flight simulators and classroom space for Pilot training), an additional office building, and a parking
garage. The Wings Complex is scheduled to be completed in 2018 and is also located across the street
from the Company’s main headquarters building on land owned by the Company. The Company began
moving its Boeing 737 flight simulators to the LEAD Center during 2017 and expects to have
15 Boeing 737 flight simulators in the LEAD Center by mid-2018. As of December 31, 2017, the
Company operated seven Customer Support and Services call centers. The centers located in Atlanta,
San Antonio, Chicago, Albuquerque, and Oklahoma City occupy leased space. The Company owns its
Houston and Phoenix centers.

The Company performs substantially all line maintenance on its aircraft and provides ground support
services at most of the airports it serves. However, the Company has arrangements with certain aircraft
maintenance firms for major component inspections and repairs for its airframes and engines, which
comprise the majority of the Company’s annual aircraft maintenance costs.

Item 3.

Legal Proceedings

A complaint alleging violations of federal antitrust laws and seeking certification as a class action was
filed against Delta Air Lines, Inc. and AirTran Holdings, Inc. and its subsidiary AirTran Airways, Inc.
(collectively with AirTran Holdings, Inc., “AirTran”) in the United States District Court for the
Northern District of Georgia in Atlanta on May 22, 2009. The complaint alleged, among other things,
that AirTran attempted to monopolize air travel in violation of Section 2 of the Sherman Act, and
conspired with Delta in imposing $15-per-bag fees for the first item of checked luggage in violation of
Section 1 of the Sherman Act. The initial complaint sought treble damages on behalf of a putative class
of persons or entities in the United States who directly paid Delta and/or AirTran such fees on
domestic flights beginning December 5, 2008. After the filing of the May 2009 complaint, various
other nearly identical complaints also seeking certification as class actions were filed in federal district
courts in Atlanta, Georgia; Orlando, Florida; and Las Vegas, Nevada. All of the cases were

33

consolidated before a single federal district court
judge in Atlanta. A Consolidated Amended
Complaint was filed in the consolidated action on February 1, 2010, which broadened the allegations to
add claims that Delta and AirTran conspired to reduce capacity on competitive routes and to
raise prices in violation of Section 1 of the Sherman Act. In addition to treble damages for the amount
of first baggage fees paid to AirTran and to Delta, the Consolidated Amended Complaint sought
injunctive relief against a broad range of alleged anticompetitive activities, as well as attorneys’
fees. On August 2, 2010, the Court dismissed plaintiffs’ claims that AirTran and Delta had violated
Section 2 of the Sherman Act; the Court let stand the claims of a conspiracy with respect to the
imposition of a first bag fee and the airlines’ capacity and pricing decisions. On June 30, 2010, the
plaintiffs filed a motion to certify a class, which AirTran and Delta opposed. On June 18, 2012, the
parties filed a Stipulation and Order that plaintiffs abandoned their claim that AirTran and Delta
conspired to reduce capacity. On August 31, 2012, AirTran and Delta moved for summary judgment
on all of plaintiffs’ remaining claims. On July 12, 2016, the Court granted plaintiffs’ motion to certify a
class of all persons who paid first bag fees to AirTran or Delta from December 8, 2008 to November 1,
2014 (the date on which AirTran stopped charging first bag fees). Defendants have appealed that
decision. On March 29, 2017, the Court granted defendants’ motion for summary judgment and
dismissed all claims against AirTran. On April 13, 2017, the plaintiffs filed a notice of appeal from the
district court’s judgment, and on April 24, 2017, AirTran filed a conditional notice of cross-appeal to
appeal the Court’s order certifying a class. The appeals of the class certification and summary
judgment orders have been consolidated. The Court has scheduled oral argument for the appeals on
March 7, 2018. AirTran denies all allegations of wrongdoing, including those in the Consolidated
Amended Complaint, and intends to defend vigorously any and all such allegations.

Also, on June 30, 2015, the U.S. Department of Justice (“DOJ”) issued a Civil Investigative Demand
(“CID”) to the Company. The CID seeks information and documents about the Company’s capacity
from January 2010 to the date of the CID including public statements and communications with third
parties about capacity. In June 2015, the Company also received a letter from the Connecticut Attorney
General requesting information about capacity; and on August 21, 2015, the Attorney General of the
State of Ohio issued an investigative demand seeking information and documents about the Company’s
capacity from December 2013 to the date of the CID. The Company is cooperating fully with the DOJ
CID and these two state inquiries.

Further, on July 1, 2015, a complaint was filed in the United States District Court for the Southern
District of New York on behalf of putative classes of consumers alleging collusion among the
Company, American Airlines, Delta Air Lines, and United Airlines to limit capacity and maintain
higher fares in violation of Section 1 of the Sherman Act. Since then, a number of similar class action
complaints were filed in the United States District Courts for the Central District of California, the
Northern District of California, the District of Columbia, the Middle District of Florida, the Southern
District of Florida, the Northern District of Georgia, the Northern District of Illinois, the Southern
District of Indiana, the Eastern District of Louisiana, the District of Minnesota, the District of New
Jersey, the Eastern District of New York, the Southern District of New York, the Middle District of
North Carolina, the District of Oklahoma, the Eastern District of Pennsylvania, the Northern District of
Texas, the District of Vermont, and the Eastern District of Wisconsin. On October 13, 2015, the
Judicial Panel on Multi-District Litigation centralized the cases to the United States District Court in
the District of Columbia. On March 25, 2016, the plaintiffs filed a Consolidated Amended Complaint
in the consolidated cases alleging that the defendants conspired to restrict capacity from 2009 to
present. The plaintiffs seek to bring their claims on behalf of a class of persons who purchased tickets
for domestic airline travel on the defendants’ airlines from July 1, 2011 to present. They seek treble

34

damages, injunctive relief, and attorneys’ fees and expenses. On May 11, 2016, the defendants moved
to dismiss the Consolidated Amended Complaint, and on October 28, 2016, the Court denied this
motion. On December 20, 2017, the Company reached an agreement to settle these cases with a
proposed class of all persons who purchased domestic airline transportation services from July 1, 2011,
to the date of the settlement. The Company agreed to pay $15 million and to provide certain
cooperation with the plaintiffs as set forth in the settlement agreement. The Court granted preliminary
approval of the settlement on January 3, 2018, and it is anticipated that the Court will establish a
schedule for providing notice to the class, for class members to object or opt out, and for a final
fairness hearing. The Company denies all allegations of wrongdoing.

In addition, on July 8, 2015, the Company was named as a defendant in a putative class action filed in
the Federal Court in Canada alleging that the Company, Air Canada, American Airlines, Delta Air
Lines, and United Airlines colluded to restrict capacity and maintain higher fares for Canadian
residents traveling in the United States and for travel between the United States and Canada. Similar
lawsuits were filed in the Supreme Court of British Columbia on July 15, 2015, Court of Queen’s
Bench for Saskatchewan on August 4, 2015, Superior Court of the Province of Quebec on
September 21, 2015, and Ontario Superior Court of Justice on October 6, 2015. In December 2015, the
Company entered into Tolling and Discontinuance agreements with putative class counsel in the
Federal Court, British Columbia, and Ontario proceedings and a discontinuance agreement with
putative class counsel in the Quebec proceeding. The other defendants entered into an agreement with
the same putative class counsel to stay the Federal Court, British Columbia, and Quebec proceedings
and to proceed in Ontario. On June 10, 2016,
the Federal Court granted plaintiffs’ motion to
discontinue that action against the Company without prejudice and stayed the action against the other
defendants. On July 13, 2016, the plaintiff unilaterally discontinued the action against the Company in
British Columbia. On February 14, 2017,
the Quebec Court granted the plaintiff’s motion to
discontinue the Quebec proceeding against the Company and to stay that proceeding against the other
defendants. On March 10, 2017, the Ontario Court granted the plaintiff’s motion to discontinue that
proceeding as to the Company. On September 29, 2017, the Company and the other defendants entered
into a tolling agreement suspending any limitations periods that may apply to possible claims among
them for contribution and indemnity arising from the Canadian litigation. The Saskatchewan claim has
not been served on the Company, and the time for the Company to respond to that complaint has not
yet begun to run. The plaintiff in that case generally seeks damages (including punitive damages in
certain cases), prejudgment interest, disgorgement of any benefits accrued by the defendants as a result
of the allegations, injunctive relief, and attorneys’ fees and other costs. The Company denies all
allegations of wrongdoing and intends to vigorously defend this civil case in Canada. The Company
does not currently serve Canada.

The Company is from time to time subject to various legal proceedings and claims arising in the
ordinary course of business, including, but not limited to, examinations by the Internal Revenue
Service.

The Company’s management does not expect that the outcome in any of its currently ongoing legal
proceedings or the outcome of any proposed adjustments presented to date by the Internal Revenue
Service, individually or collectively, will have a material adverse effect on the Company’s financial
condition, results of operations, or cash flow.

Item 4.

Mine Safety Disclosures

Not applicable.

35

EXECUTIVE OFFICERS OF THE REGISTRANT

The following information regarding the Company’s executive officers is as of February 1, 2018.

Name

Position

Gary C. Kelly

Chairman of the Board & Chief Executive Officer

Thomas M. Nealon

President

Michael G. Van de Ven Chief Operating Officer

Robert E. Jordan

Executive Vice President Corporate Services

Tammy Romo

Executive Vice President & Chief Financial Officer

Andrew M. Watterson

Executive Vice President & Chief Revenue Officer

Gregory D. Wells

Executive Vice President Daily Operations

Mark R. Shaw

Senior Vice President, General Counsel, & Corporate Secretary

Age

62

56

56

57

55

51

59

55

Set forth below is a description of the background of each of the Company’s executive officers.

Gary C. Kelly has served as the Company’s Chairman of the Board since May 2008 and as its Chief
Executive Officer since July 2004. Mr. Kelly also served as President from July 2008 to January 2017,
Executive Vice President & Chief Financial Officer from June 2001 to July 2004, and Vice
President Finance & Chief Financial Officer from 1989 to 2001. Mr. Kelly joined the Company in
1986 as its Controller.

Thomas M. Nealon has served as the Company’s President since January 2017. Mr. Nealon also served
as Executive Vice President Strategy & Innovation from January 2016 to January 2017. Prior to
becoming an executive officer of the Company, Mr. Nealon served on the Company’s Board of
Directors from December 2010 until November 2015. Mr. Nealon has also served as Group Executive
Vice President of J.C. Penney Company, Inc., a retail company, from August 2010 until December
2011. In this role Mr. Nealon was responsible for Strategy,
jcp.com, Information Technology,
Customer Insights, and Digital Ventures. Mr. Nealon also served as J.C. Penney’s Executive Vice
President & Chief Information Officer from September 2006 until August 2010. Prior to joining J.C.
Penney, Mr. Nealon was a partner with The Feld Group, a provider of information technology
consulting services, where he served in a consultant capacity as Senior Vice President & Chief
Information Officer for the Company from 2002 to 2006. Mr. Nealon also served as Chief Information
Officer for Frito-Lay, a division of PepsiCo, Inc., from 1996 to 2000, and in various software
engineering, systems engineering, and management positions for Frito-Lay from 1983 to 1996.

Michael G. Van de Ven has served as the Company’s Chief Operating Officer since May 2008.
Mr. Van de Ven also served as Executive Vice President & Chief Operating Officer from May 2008 to
January 2017, Chief of Operations
from September 2006 to May 2008, Executive Vice
President Aircraft Operations
from November 2005 through August 2006, Senior Vice
President Planning from August 2004 to November 2005, Vice President Financial Planning &
Analysis from 2001 to 2004, Senior Director Financial Planning & Analysis from 2000 to 2001, and
Director Financial Planning & Analysis from 1997 to 2000. Mr. Van de Ven joined the Company in
1993 as its Director Internal Audit.

Robert E. Jordan has served as the Company’s Executive Vice President Corporate Services since July
2017 and as President of AirTran Airways, Inc. since May 2011. Mr. Jordan also served as Executive

36

Vice President & Chief Commercial Officer from September 2011 to July 2017, Executive Vice
President Strategy & Planning
2011, Executive Vice
President Strategy & Technology from September 2006 to May 2008, Senior Vice President Enterprise
Spend Management from August 2004 to September 2006, Vice President Technology from 2002 to
2004, Vice President Purchasing from 2001 to 2002, Controller from 1997 to 2001, Director Revenue
Accounting from 1994 to 1997, and Manager Sales Accounting from 1990 to 1994. Mr. Jordan joined
the Company in 1988 as a programmer.

to September

from May

2008

Tammy Romo has served as the Company’s Executive Vice President & Chief Financial Officer since
July 2015. Ms. Romo also served as Senior Vice President Finance & Chief Financial Officer from
September 2012 to July 2015, Senior Vice President of Planning from February 2010 to September
2012, Vice President of Financial Planning from September 2008 to February 2010, Vice President
Controller from February 2006 to August 2008, Vice President Treasurer from September 2004 to
February 2006, Senior Director of Investor Relations from March 2002 to September 2004, Director of
Investor Relations from December 1994 to March 2002, Manager of Investor Relations from
September 1994 to December 1994, and Manager of Financial Reporting from September 1991 to
September 1994.

Andrew M. Watterson has served as the Company’s Executive Vice President & Chief Revenue Officer
since July 2017. Mr. Watterson also served as Senior Vice President & Chief Revenue Officer from
January 2017 to July 2017, Senior Vice President of Network & Revenue from January 2016 to
January 2017, and as Vice President of Network Planning & Performance from October 2013 to
January 2016. Prior to becoming an officer of the Company, Mr. Watterson served as Vice President of
Planning and Revenue Management at Hawaiian Airlines from May 2011 to October 2013.

Gregory D. Wells has served as the Company’s Executive Vice President Daily Operations since
January 2017. Mr. Wells also served as Senior Vice President Operational Performance from October
2013 to January 2017, Senior Vice President Operations from September 2006 to October 2013, Senior
Vice President Ground Operations from November 2005 to September 2006, Vice President Ground
Operations from September 2004 to November 2005, Vice President Safety, Security, and Flight
Dispatch from October 2001 to September 2004, Director Flight Dispatch from February 1999 to
October 2001, Senior Director Ground Operations from August 1998 to February 1999, and Director
Ground Operations from August 1996 to August 1998. Prior to August 1996, Mr. Wells had various
other operational experience with the Company including as Station Manager in both San Jose and
Phoenix. Mr. Wells has over 35 years of experience with the Company.

Mark R. Shaw has served as the Company’s Senior Vice President, General Counsel, & Corporate
Secretary since July 2015. Mr. Shaw also served as Vice President, General Counsel, & Corporate
Secretary from February 2013 to July 2015 and as Associate General Counsel - Corporate &
Transactions from February 2008 to February 2013. Mr. Shaw joined the Company in 2000 as an
Attorney in the General Counsel Department.

37

PART II

Item 5.
Purchases of Equity Securities

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer

The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) and is traded
under the symbol “LUV.” The following table shows the high and low prices per share of the
Company’s common stock, as reported on the NYSE Composite Tape, and the cash dividends per
share declared on the Company’s common stock.

Period

2017

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

2016

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Dividend

High

Low

$

0.10000 $

59.68 $

0.12500

0.12500

0.12500

62.74

64.39

66.99

$

0.07500 $

45.39 $

0.10000

0.10000

0.10000

48.00

45.00

51.31

48.75

52.89

49.76

52.78

33.96

36.48

35.42

36.91

The Company currently intends to continue declaring dividends on a quarterly basis for the foreseeable
future; however, the Company’s Board of Directors may elect to alter the timing, amount, and payment
of dividends on the basis of operational results, financial condition, cash requirements, future
prospects, and other factors deemed relevant by the Board. As of February 5, 2018, there were
approximately 12,531 holders of record of the Company’s common stock.

38

Stock Performance Graph

The following Performance Graph and related information shall not be deemed “soliciting material”
or “filed” with the Securities and Exchange Commission, nor shall such information be incorporated
by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934.

The following graph compares the cumulative total shareholder return on the Company’s common
stock over the five-year period ended December 31, 2017, with the cumulative total return during such
period of the Standard and Poor’s 500 Stock Index and the NYSE ARCA Airline Index. The
comparison assumes $100 was invested on December 31, 2012, in the Company’s common stock and
in each of the foregoing indices and assumes reinvestment of dividends. The stock performance shown
on the graph below represents historical stock performance and is not necessarily indicative of future
stock price performance.

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN AMONG SOUTHWEST AIRLINES
CO., S&P 500 INDEX, AND NYSE ARCA AIRLINE INDEX

s
r
a
l
l
o
D

-

n
r
u
t
e
R
e
v
i
t
a
l
u
m
u
C

l
a
t
o
T

800

700

600

500

400

300

200

100

0

12/31/12

12/31/13

12/31/14

12/31/15

12/31/16

12/31/17

Period Ending

Southwest Airlines Co.

S&P 500

NYSE ARCA  Airline

Southwest Airlines Co.

S&P 500

NYSE ARCA Airline

12/31/2012 12/31/2013 12/31/2014 12/31/2015 12/31/2016 12/31/2017

$

$

$

100 $

100 $

100 $

185 $

132 $

158 $

418 $

150 $

237 $

428 $

152 $

201 $

500 $

170 $

258 $

661

206

274

39

 
 
 
 
Issuer Repurchases

Period

October 1, 2017 through
October 31, 2017

November 1, 2017 through
November 30, 2017

December 1, 2017 through
December 31, 2017

(a)

(b)

Issuer Purchases of Equity Securities (1)
(c)
Total number of
shares purchased
as part of publicly
announced plans or
programs

Average
price paid
per share

Total
number
of shares
purchased

(d)
Maximum dollar
value of shares that
may yet be purchased
under the plans or
programs

1,206,365 $

— (2)

1,206,365 $

1,700,000,000

670,000 $

— (3)(4)

670,000 $

1,410,017,716

4,280,204 $

— (3)(5)

4,280,204 $

1,350,032,588

Total

6,156,569

6,156,569

(1) On May 17, 2017, the Company’s Board of Directors authorized the repurchase of up to $2.0 billion of the
Company’s common stock. Repurchases are made in accordance with applicable securities laws in open
market, private, or accelerated repurchase transactions from time to time, depending on market conditions,
and may be discontinued at any time.

(2) Under an accelerated share repurchase program entered into by the Company with a third party financial
institution in third quarter 2017 (the “Third Quarter 2017 ASR Program”), the Company paid $300 million
and received an initial delivery of 4,130,592 shares during August 2017, representing an estimated
75 percent of the shares to be purchased by the Company under the Third Quarter 2017 ASR Program
based on a volume-weighted average price of $54.4716 per share, which was the closing price of the
Company’s common stock on the New York Stock Exchange during a calculation period between
August 1, 2017 and August 24, 2017. Final settlement of the Third Quarter 2017 ASR Program occurred in
October 2017 and was determined based generally on a discount to the volume-weighted average price per
share of the Company’s common stock during a calculation period completed in October 2017. Upon
settlement, the third party financial institution delivered 1,206,365 additional shares of the Company’s
common stock to the Company. In total, the average purchase price per share for the 5,336,957 shares
repurchased under the Third Quarter 2017 ASR Program, upon completion of the Third Quarter 2017 ASR
Program in October 2017, was $56.2118.

(3) Under an accelerated share repurchase program entered into by the Company with a third party financial
institution in fourth quarter 2017 (the “Fourth Quarter 2017 ASR Program”),
the Company paid
$250 million in November 2017 and received an initial delivery of 3,323,537 shares during December
2017, representing an estimated 75 percent of the shares to be purchased by the Company under the Fourth
Quarter 2017 ASR Program based on a volume-weighted average price of $56.4158 per share of the
Company’s common stock on the New York Stock Exchange during a calculation period between
November 8, 2017 and December 6, 2017. Final settlement of the Fourth Quarter 2017 ASR Program
occurred in January 2018 and was determined based generally on a discount to the volume-weighted
average price per share of the Company’s common stock during a calculation period completed in January
2018. Upon settlement, the third party financial institution delivered 736,838 additional shares of the
Company’s common stock to the Company. In total, the average purchase price per share for the 4,060,375
shares repurchased under the Fourth Quarter 2017 ASR Program, upon completion of the Fourth Quarter
2017 ASR Program in January 2018, was $61.5707.

(4) During the period from November 29, 2017 through November 30, 2017, the Company repurchased

670,000 shares of its common stock on the open market at an average price of $59.6751 per share.

(5) During the period from December 1, 2017 through December 15, 2017, the Company repurchased 956,667

shares of its common stock on the open market at an average price of $62.7022 per share.

40

Item 6.

Selected Financial Data

The following financial information, for the five years ended December 31, 2017, has been derived
from the Company’s Consolidated Financial Statements. This information should be viewed in
conjunction with the Consolidated Financial Statements and related notes thereto included elsewhere
herein. The Company provides the operating data below because these statistics are commonly used in
the airline industry and, therefore, allow readers to compare the Company’s performance against its
results for prior periods, as well as against the performance of the Company’s peers.

Financial Data (in millions, except per share amounts):

Operating revenues

Operating expenses

Operating income

Other expenses (income) net

Income before taxes

Provision for income taxes

Net income

Net income per share, basic

Net income per share, diluted

Cash dividends per common share

Total assets at period-end

Long-term obligations at period-end

Stockholders’ equity at period-end

Operating Data:

Revenue passengers carried

Enplaned passengers

Year ended December 31,

2017

2016

2015

2014

2013

$

21,171

$

20,425

$

19,820

$

18,605

$

17,656

16,665

15,704

16,380

3,515

264

3,251

(237)

3,488

5.80

5.79

0.4750

25,110

3,320

10,430

$

$

$

$

$

$

$

3,760

213

3,547

1,303

2,244

3.58

3.55

0.3750

23,286

2,821

8,441

$

$

$

$

$

$

$

4,116

637

3,479

1,298

2,181

3.30

3.27

0.2850

21,312

2,541

7,358

$

$

$

$

$

$

$

2,225

409

1,816

680

1,136

1.65

1.64

0.2200

19,723

2,434

6,775

$

$

$

$

$

$

$

$

$

$

$

$

$

$

17,699

16,421

1,278

69

1,209

455

754

1.06

1.05

0.1300

19,177

2,191

7,336

130,256,190

124,719,765

118,171,211

110,496,912

108,075,976

157,677,218

151,740,357

144,574,882

135,767,188

133,155,030

Revenue passenger miles (RPMs) (000s) (a)

129,041,420

124,797,986

117,499,879

108,035,133

104,348,216

Available seat miles (ASMs) (000s) (b)

153,811,072

148,522,051

140,501,409

131,003,957

130,344,072

Load factor (c)

Average length of passenger haul (miles)

Average aircraft stage length (miles)

Trips flown

Seats flown (d)

Seats per trip (e)

83.9%

991

754

84.0%

1,001

760

83.6%

82.5%

80.1%

994

750

978

721

966

703

1,347,893

1,311,149

1,267,358

1,255,502

1,312,785

200,878,967

193,167,695

184,955,094

179,733,055

183,563,527

149.03

147.33

145.94

143.16

Average passenger fare (j)

$

146.95

$

149.09

$

154.85

$

159.80

$

Passenger revenue yield per RPM (cents) (f)(j)

Operating revenue per ASM (cents) (g)

Passenger revenue per ASM (cents) (h)(j)

Operating expenses per ASM (cents) (i)

Operating expenses per ASM, excluding fuel (cents)

Operating expenses per ASM, excluding fuel and

profitsharing (cents)

Fuel costs per gallon, including fuel tax

Fuel costs per gallon, including fuel tax, economic

Fuel consumed, in gallons (millions)

Active fulltime equivalent Employees

Aircraft at end of period

14.83

13.76

12.44

11.48

8.92

14.90

13.75

12.52

11.22

8.76

15.57

13.98

13.02

11.18

8.60

16.34

14.20

13.48

12.50

8.46

8.56

1.92

2.00

$

$

8.37

1.82

1.92

$

$

8.16

1.90

2.07

$

$

8.19

2.93

2.92

$

$

$

$

1,996

53,536

723

1,901

49,583

704

1,801

46,278

665

2,045

56,110

706

41

139.83

154.72

16.02

13.58

12.83

12.60

8.18

8.01

3.16

3.12

1,818

44,381

681

(a) A revenue passenger mile is one paying passenger flown one mile. Also referred to as “traffic,” which is a measure of demand for a

given period.

(b) An available seat mile is one seat (empty or full) flown one mile. Also referred to as “capacity,” which is a measure of the space

available to carry passengers in a given period.

(c) Revenue passenger miles divided by available seat miles.
(d) Seats flown is calculated using total number of seats available by aircraft type multiplied by the total trips flown by the same aircraft

type during a particular period.

(e) Seats per trip is calculated using seats flown divided by trips flown. Also referred to as “gauge.”
(f) Calculated as passenger revenue divided by revenue passenger miles. Also referred to as “yield,” this is the average cost paid by a

paying passenger to fly one mile, which is a measure of revenue production and fares.

(g) Calculated as operating revenues divided by available seat miles. Also referred to as “operating unit revenues” or “RASM,” this is a
measure of operating revenue production based on the total available seat miles flown during a particular period. Year ended 2015
RASM excludes a $172 million one-time special revenue adjustment. Including the special revenue adjustment, RASM would have
been 14.11 cents for the year ended 2015. Additional information regarding this special item is provided in the Note Regarding Use of
Non-GAAP Financial Measures.

(h) Calculated as passenger revenue divided by available seat miles. Also referred to as “passenger unit revenues,” this is a measure of

passenger revenue production based on the total available seat miles flown during a particular period.

(i) Calculated as operating expenses divided by available seat miles. Also referred to as “unit costs” or “cost per available seat mile,” this is

the average cost to fly an aircraft seat (empty or full) one mile, which is a measure of cost efficiencies.

(j) Refer to Note 1 to the Consolidated Financial Statements for additional information regarding the impact from the Company’s July

2015 amended co-branded credit card agreement with Chase Bank USA, N.A.

42

Item 7.
Operations

Management’s Discussion and Analysis of Financial Condition and Results of

YEAR IN REVIEW

For the 45th consecutive year, the Company was profitable, recording GAAP and non-GAAP results
for 2017 and 2016 as noted in the following tables. See Note Regarding Use of Non-GAAP Financial
Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for
additional detail regarding non-GAAP financial measures.

(in millions, except per share amounts)

GAAP

Operating income

Net income
Net income per share, diluted

Non-GAAP

Operating income

Net income

Net income per share, diluted

Year ended
December 31,

2017

2016

Percent
Change

$

$
$

$

$

$

3,515

3,488
5.79

3,455

2,107

3.50

$

$
$

$

$

$

3,760

2,244
3.55

3,957

2,370

3.75

(6.5)

55.4
63.1

(12.7)

(11.1)

(6.7)

Net income for the year ended December 31, 2017, was $3.5 billion, a 55.4 percent increase year-over-
year, or $5.79 per diluted share, and non-GAAP Net income was $2.1 billion, an 11.1 percent decrease
year-over-year, or $3.50 per diluted share. The increase in GAAP Net income was primarily driven by
a $1.4 billion reduction in Provision for income taxes related to the Tax Cuts and Jobs Act legislation
enacted in December 2017, which resulted in a re-measurement of the Company’s deferred tax assets
and liabilities at the new federal corporate tax rate of 21 percent. This non-cash item is excluded from
the Company’s non-GAAP results. Operating income for the year ended December 31, 2017 was
$3.52 billion, a decrease of 6.5 percent year-over-year, and non-GAAP Operating income was
$3.46 billion. The decrease in Operating Income was driven by a 7.7 percent increase in Salaries,
wages, and benefits expense, primarily due to wage rate increases resulting from amended collective-
bargaining agreements reached with multiple unionized workgroups, coupled with an 8.0 percent
increase in Fuel and oil expense, primarily due to increases in market prices. These factors were
partially offset by a 2.9 percent increase in Passenger revenues driven by strong demand for low-fare
air travel and a 3.6 percent year-over-year capacity growth, holding Load factor and Passenger yield
constant. Prior year results included $356 million of contract ratification bonuses accrued in Salaries,
wages, and benefits expense associated with tentative collective-bargaining agreements reached with
multiple unionized workgroups.

For the twelve months ended December 31, 2017, the Company’s earnings performance, combined
with its actions to manage invested capital, produced a 25.9 percent pre-tax non-GAAP return on
invested capital (“ROIC”), compared with the Company’s ROIC of 30.0 percent for the twelve months
ended December 31, 2016. The primary cause of the year-over-year decline in ROIC was the decrease
in Operating income for the twelve months ended December 31, 2017, compared with the twelve
months ended December 31, 2016. See the Company’s calculation of ROIC in the accompanying
reconciliation tables as well as the Note Regarding Use of Non-GAAP Financial Measures.

43

During 2017, the Company continued to return value to its Shareholders. The Company returned
$1.9 billion to Shareholders through $274 million in dividend payments and $1.6 billion through four
separate accelerated share repurchase programs and other open market repurchases. During November
2017, the Company launched the Fourth Quarter 2017 ASR Program by advancing $250 million to a
financial institution in a privately negotiated transaction. The Company received 4.1 million shares in
total under the Fourth Quarter 2017 ASR Program, which was completed in January 2018. The
purchase was recorded as a treasury share purchase for purposes of calculating earnings per share.

On January 31, 2018,
the Company launched a new accelerated share repurchase program by
advancing $500 million to a financial institution in a privately negotiated transaction (“First Quarter
2018 ASR Program”). The specific number of shares that the Company ultimately will repurchase
under the First Quarter 2018 ASR Program will be determined based generally on a discount to the
volume-weighted average price per share of the Company’s common stock during a calculation period
to be completed no later than May 2018. The purchase will be recorded as a treasury share purchase for
purposes of calculating earnings per share. Subsequent to the launch of the First Quarter 2018 ASR
Program, the Company has $850 million remaining under its May 2017 $2.0 billion share repurchase
authorization. See Part II, Item 5 for further information on the Company’s share repurchase
authorizations.

Company Overview

During 2017, the Company began scheduled service to new international destinations of Grand
Cayman Island and Providenciales, Turks & Caicos, as well as new domestic service to Cincinnati/
Northern Kentucky International airport. With the addition of these new markets, the Company now
serves 100 destinations across 40 states and ten near-international countries, and operates over 4,000
departures a day. Additionally, the Company announced plans to begin selling tickets in 2018 for
service to Hawaii, subject to requisite governmental approvals, including approval from the FAA for
Extended Operations (“ETOPS”), a regulatory requirement to operate between the U.S. mainland and
the Hawaiian Islands.

During 2017, the Company took delivery of 39 new 737-800 aircraft from Boeing, 13 new 737 MAX 8
aircraft from Boeing, and 18 pre-owned Boeing 737-700 aircraft from third parties. The Company also
retired its remaining 87 Boeing 737-300 (“Classic”) aircraft, which included 61 Classic aircraft
grounded in September 2017 as part of an accelerated retirement schedule. The Company recorded a
charge of $63 million related to the leased portion of the Classic fleet, representing the remaining net
lease payments due and certain lease return requirements that could have to be performed on these
leased aircraft prior to their return to the lessors, as of the cease-use date. For 2018, the Company’s
current firm aircraft commitments would result in 750 aircraft by year-end 2018. See Part I, Item 2 for
further information.

The Company became the first airline in North America to offer scheduled service utilizing Boeing’s
new, more fuel-efficient, 737 MAX 8 aircraft, which entered service in fourth quarter 2017. The
Company is scheduled to be the launch customer for the Boeing 737 MAX 7 series aircraft, with
deliveries expected to begin in 2019. Currently, the Company has firm orders in place for 197 737
MAX 8 aircraft and 30 737 MAX 7 aircraft. See Part I, Item 2 for further information.

The Company plans to continue its route network and schedule optimization efforts through the
addition of new markets and itineraries, while also pruning less profitable flights from its schedule.

44

The Company currently plans to grow its 2018 available seat miles in the low five percent range, year-
over-year, with first half 2018 year-over-year growth in the low three percent range and second half
2018 year-over-year growth in the low seven percent range. The Company continues to expect the
retirement of its Classic aircraft to produce significant incremental cost savings and improvements in
pre-tax results of at least $200 million, cumulatively, by the end of 2020.

On May 9, 2017, the Company completed a multi-year initiative to completely transition its reservation
system to the Amadeus Altéa Passenger Service System. The new reservation system, which
represented the largest technology project in the Company’s history, was designed to improve flight
scheduling and inventory management, enable operational enhancements to manage flight disruptions,
such as those caused by extreme weather conditions, enable revenue enhancements, further schedule
optimization, support additional international growth, and enable other foundational and operational
capabilities. The Company continues to expect the new reservation system to produce incremental
benefits in pretax results of approximately $200 million in 2018.

During November 2017, the Company’s Facilities Maintenance Technicians, represented by Aircraft
Mechanics Fraternal Association (“AMFA”), ratified a tentative collective-bargaining agreement with
the Company. The newly ratified contract becomes amendable in November 2022.

2017 Compared with 2016

Operating Revenues

Passenger revenues for 2017 increased by $547 million, or 2.9 percent, compared with 2016. Holding
Load factor and Passenger yield constant, the increase was primarily attributable to a 3.6 percent
increase in capacity, partially offset by approximately $100 million in reduced revenues as a result of
the hurricanes and earthquakes during third quarter 2017. On a unit basis, Passenger revenues
decreased 0.6 percent, year-over-year, largely driven by a 0.5 percent decrease in Passenger revenue
yield due to the industry’s competitive domestic fare environment. Load factor remained solid
at 83.9 percent.

Freight revenues for 2017 increased by $2 million, or 1.2 percent, compared with 2016, primarily due
to increased demand. Based on current trends, the Company currently expects Freight revenues in first
quarter 2018 to increase, compared with first quarter 2017.

revenues for 2017 increased by $197 million, or 11.9 percent, compared with 2016.
Other
Approximately 70 percent of the increase was due to an increase in revenue associated with cardholder
spend on the Company’s co-branded Chase® Visa credit card, and the remainder of the increase was
due to higher ancillary revenues primarily as a result of EarlyBird Check-In revenues of $358 million
in 2017, an increase of $29 million, or 8.7 percent, compared with 2016. The Company currently
expects Other revenues in first quarter 2018 to increase, compared with first quarter 2017. The
Company currently expects EarlyBird Check-in revenues to have a similar year-over-year growth rate
in 2018, as compared with 2017.

Based on revenue and booking trends thus far in first quarter 2018, the Company is currently
expecting first quarter 2018 operating unit revenues to increase in the one to two percent range,
compared with first quarter 2017.

Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, is
effective for fiscal years, and interim periods within those years, beginning after December 15, 2017.

45

Therefore, the Company will adopt the standard as of January 1, 2018, utilizing the full retrospective
method of adoption allowed by the standard, in order to provide for comparative results in all periods
presented. As such, in the Company’s first quarter 2018 Form 10-Q, both first quarter 2018 results and
first quarter 2017 results will be presented under the new standard. On the Consolidated Statement of
Income, the estimated impact of this ASU for full year 2017 and 2016 will be a decrease to Operating
revenues of approximately $25 million and $135 million, respectively, and a decrease to Operating
expenses of approximately $40 million in each year. The ASU will also result in the reclassification of
certain ancillary revenues from Other revenues to Passenger revenues for each period. See Note 2 to
the Consolidated Financial Statements for further information.

Operating Expenses

Operating expenses for 2017 increased by $991 million, or 5.9 percent, compared with 2016, while
capacity increased 3.6 percent over the same period. Historically, except for changes in the price of
fuel, changes in Operating expenses for airlines have been largely driven by changes in capacity, or
ASMs. The following table presents the Company’s Operating expenses per ASM for 2017 and 2016,
followed by explanations of these changes on a per ASM basis and dollar basis:

(in cents, except for percentages)

Salaries, wages, and benefits

Fuel and oil

Maintenance materials and repairs

Aircraft rentals

Landing fees and other rentals

Depreciation and amortization

Other operating expenses

Total

Year ended December 31,

2017

2016

Per ASM
change

Percent
change

4.76¢

4.57¢

2.56

0.65

0.13

0.84

0.79

1.75

2.46

0.70

0.15

0.82

0.82

1.70

11.48¢

11.22¢

0.19¢

0.10

(0.05)

(0.02)

0.02

(0.03)

0.05

0.26¢

4.2%

4.1

(7.1)

(13.3)

2.4

(3.7)

2.9

2.3%

Operating expenses per ASM for 2017 increased 2.3 percent, compared with 2016, primarily due to
wage rate increases, increases in market jet fuel prices, and charges associated with the grounding of
the Company’s remaining Classic aircraft. Prior year results included $356 million of ratification
bonuses accrued during 2016, associated with collective-bargaining agreements reached with multiple
unionized workgroups. Operating expenses per ASM for 2017, excluding Fuel and oil expense and
special items (a non-GAAP financial measure), increased 4.2 percent year-over-year, primarily due to
wage rate increases. See Note Regarding Use of Non-GAAP Financial Measures and the
Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding
non-GAAP financial measures. Based on current trends and excluding Fuel and oil expense, special
items, and profitsharing expense, the Company expects its first quarter 2018 unit costs to increase in
the range of 0.5 to 1.5 percent, compared with first quarter 2017. The year-over-year projections do not
reflect the potential impact of Fuel and oil expense, special items, and profitsharing expense in both
years because the Company cannot reliably predict or estimate those items or expenses or their impact
to its financial statements in future periods, especially considering the significant volatility of the Fuel
and oil expense line item. Accordingly, the Company believes a reconciliation of non-GAAP financial
measures to the equivalent GAAP financial measures for projected results is not meaningful or
available without unreasonable effort.

46

Salaries, wages, and benefits expense for 2017 increased by $521 million, or 7.7 percent, compared
with 2016. Salaries, wages, and benefits expense per ASM for 2017 increased 4.2 percent, compared
with 2016. On both a dollar and per ASM basis, the majority of the increases were the result of higher
salaries and resulting Company contributions to the Company sponsored 401(k) plans, primarily driven
by wage rate increases. In addition, the Company announced a $1,000 per Employee bonus as a result
of the 2017 tax reform, which comprised approximately $70 million of the increase in Salaries, wages,
and benefits expense. Prior year results included $356 million of ratification bonuses accrued during
2016, associated with collective-bargaining agreements reached with multiple unionized workgroups.
Based on current cost trends and anticipated capacity, the Company expects first quarter 2018 Salaries,
to increase, compared
wages, and benefits expense per ASM, excluding profitsharing expense,
with first quarter 2017. The year-over-year projection does not reflect
impact of
profitsharing expense in both years because the Company cannot reliably predict or estimate that
expense or its impact to the Company’s financial statements in future periods. Accordingly, the
Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial
measures for projected results is not meaningful or available without unreasonable effort.

the potential

During 2017, the Company conducted negotiations with various unionized Employee groups. See the
above discussion in Company Overview regarding an agreement reached during the year. The
following table sets forth the Company’s unionized Employee groups that are currently in negotiations
on collective-bargaining agreements:

Employee Group
Southwest Material Specialists
(formerly known as Stock Clerks)

Southwest Mechanics

Approximate
Number of
Employees

300

2,400

Representatives
International Brotherhood of
Teamsters, Local 19 (“IBT 19”)
Aircraft Mechanics Fraternal
Association (“AMFA”)

Amendable Date

August 2013

August 2012

Fuel and oil expense for 2017 increased by $293 million, or 8.0 percent, compared with 2016. On a per
ASM basis, Fuel and oil expense for 2017 increased 4.1 percent, compared with 2016. On both a dollar
and per ASM basis, the increases were attributable to higher market jet fuel prices, partially offset by a
decrease in net hedging losses recognized compared to 2016. See Note Regarding Use of Non-GAAP
Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures
for additional detail regarding non-GAAP financial measures. The Company’s average economic jet
fuel price per gallon increased 4.2 percent, year-over-year, from $1.92 for 2016 to $2.00 for 2017.
These figures do not include premium expense associated with the Company’s fuel hedges, which on a
per gallon basis equated to approximately $0.08 and $0.06 for 2016 and 2017, respectively. The
Company also improved its fuel efficiency during 2017, compared with 2016, when measured on the
basis of ASMs generated per gallon of fuel. Fuel gallons consumed increased 2.5 percent, compared
with 2016, while year-over-year capacity increased 3.6 percent. As a result of the Company’s fuel
hedging program, the Company recognized net losses totaling $416 million in Fuel and oil expense for
2017, compared with net losses totaling $820 million for 2016. These totals include cash settlements
realized from the settlement of fuel derivative contracts associated with the Company’s economic fuel
hedge totaling $572 million paid to counterparties for 2017, compared with $1.0 billion paid to
counterparties for 2016. Additionally, these totals exclude gains and/or losses recognized from hedge
ineffectiveness and from derivatives that did not qualify for hedge accounting. These items are
recorded as a component of Other (gains) losses, net. See Note 10 to the Consolidated Financial
Statements.

47

As of January 19, 2018, on an economic basis, the Company had derivative contracts in place related
to expected future fuel consumption as follows:

Period

2018

2019

2020

Beyond 2020 (b)

Maximum percent of estimated fuel consumption covered by
fuel derivative contracts at varying West Texas Intermediate/ Brent
Crude Oil, Heating Oil, and Gulf Coast Jet Fuel-equivalent price levels (a)

78%

63%

31%

11%

(a) The Company’s hedge position can vary significantly at different price levels, including prices at which the
Company considers “catastrophic” coverage. The percentages provided are not indicative of the Company’s
hedge coverage at every price, but represent the highest level of coverage at a single price. The Company
believes its coverage related to first quarter 2018 is best reflected within the jet fuel forecast price sensitivity
table provided below. See Note 10 to the Consolidated Financial Statements for further information.
(b) The Company’s coverage for 2021 was approximately 11 percent of estimated fuel consumption. The
coverage beyond 2021 was not significant.

As a result of applying hedge accounting in prior periods, including related to hedge positions that
have either been offset or settled early on a cash basis, the Company has amounts “frozen” in
Accumulated other comprehensive income (loss) (“AOCI”), and these amounts will be recognized in
earnings in future periods when the underlying fuel derivative contracts settle. The following table
displays the Company’s estimated fair value of remaining fuel derivative contracts (not considering the
impact of the cash collateral provided to or received from counterparties - see Note 10 to the
Consolidated Financial Statements for further information), as well as the amount of deferred gains/
losses in AOCI at December 31, 2017, and the expected future periods in which these items are
expected to settle and/or be recognized in earnings (in millions):

Year

2018

2019

2020

Beyond 2020

Total

$

$

Fair value of fuel
derivative contracts
at December 31, 2017

Amount of gains (losses)
deferred in AOCI at
December 31, 2017 (net of tax)

112

$

75

42

19

248

$

(9)

8

3

—

2

Based on forward market prices and the amounts in the above table (and excluding any other
subsequent changes to the fuel hedge portfolio), the Company’s jet fuel costs per gallon could exceed
market (i.e., unhedged) prices during some of these future periods. This is based primarily on expected
future cash settlements associated with fuel derivatives, but excludes any impact associated with the
ineffectiveness of fuel hedges or fuel derivatives that are marked to market because they do not qualify
for hedge accounting. See Note 10 to the Consolidated Financial Statements for further information.
Assuming no changes to the Company’s current fuel derivative portfolio, but including all previous
hedge activity for fuel derivatives that have not yet settled and expected fuel hedge premium costs
associated with settling contracts each period, and considering only the expected net cash payments
and/or receipts related to hedges that will settle, the Company is providing the below sensitivity table

48

for first quarter 2018 and full year 2018 jet fuel prices at different crude oil assumptions as of
January 19, 2018, and for expected premium costs associated with settling contracts each period,
respectively.

Fuel hedging
premium expense
per gallon (b)

Estimated economic
fuel price per
gallon, including
taxes and premiums
(c)(e)

Fuel hedging
premium expense
per gallon (b)

Estimated economic
fuel price per
gallon, including
taxes and premiums
(d)(e)

Average Brent Crude Oil
price per barrel

$55

$65
Current Market (a)

$75

1Q 2018

Full Year 2018

$0.07

$0.07

$0.07

$0.07

$1.85 - $1.90

$2.05 - $2.10
$2.10 - $2.15

$2.25 - $2.30

$0.06

$0.06

$0.06

$0.06

$1.75 - $1.80

$2.00 - $2.05
$2.10 - $2.15

$2.30 - $2.35

$80
$85
Estimated premium costs

$0.07
$2.30 - $2.35
$0.07
$2.35 - $2.40
Approximately $34 million

$0.06
$2.35 - $2.40
$0.06
$2.45 - $2.50
Approximately $135 million

(a) Brent crude oil average market prices as of January 19, 2018, were approximately $68 and $67 per barrel for
first quarter 2018 and full year 2018, respectively.
(b) In accordance with the Company’s planned early adoption of Accounting Standards Update No. 2017-12,
Targeting Improvements to Accounting for Hedging Activities, the Company will begin reporting premium
expense within Fuel and oil expense as of January 1, 2018.
(c) Based on the Company’s existing fuel derivative contracts and market prices as of January 19, 2018, first
quarter 2018 economic fuel costs are estimated to be in the $2.10 to $2.15 per gallon range, including fuel
hedging premium expense of approximately $34 million, or $0.07 per gallon. First quarter 2018’s expected
economic fuel cost range of $2.10 to $2.15 per gallon compares with first quarter 2017’s economic fuel cost of
$1.96 per gallon, as reported, but including fuel hedging premium expense of $34 million, or $.07 per gallon, will
be recast as $2.03 per gallon.
(d) Based on the Company’s existing fuel derivative contracts and market prices as of January 19, 2018, annual
2018 economic fuel costs are estimated to be in the $2.10 to $2.15 per gallon range, including fuel hedging
premium expense of approximately $135 million, or $.06 per gallon. 2018’s annual expected economic fuel cost
range of $2.10 to $2.15 per gallon compares with 2017’s annual economic fuel costs of $2.00 per gallon, as
reported herein, but including fuel hedging premium expense of $135 million, or $.06 per gallon, will be recast as
$2.06 per gallon.
(e) The economic fuel price per gallon sensitivities provided assume the relationship between Brent crude oil and
refined products based on market prices as of January 19, 2018. Economic fuel cost projections do not reflect the
potential impact of special items because the Company cannot reliably predict or estimate the hedge accounting
impact associated with the volatility of the energy markets or the impact to its financial statements in future
periods. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent
GAAP financial measures for projected results is not meaningful or available without unreasonable effort.

ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities, is effective for fiscal
years, and interim periods within those years, beginning after December 15, 2018, with early adoption
permitted in any interim or annual period. The Company plans to adopt the standard as of January 1,
2018. See Note 2 to the Consolidated Financial Statements for further information.

Maintenance materials and repairs expense for 2017 decreased by $44 million, or 4.2 percent,
compared with 2016. On a per ASM basis, Maintenance materials and repairs expense for 2017

49

decreased 7.1 percent, compared with 2016. On both a dollar and per ASM basis, the majority of the
decreases were attributable to a decrease in airframe maintenance expenses primarily as a result of the
retirement of the Company’s Classic fleet, partially offset by increases in Boeing 737-700 engine
maintenance due to increased utilization. The Company currently expects Maintenance materials and
repairs expense per ASM for first quarter 2018 to increase, compared with first quarter 2017.

Aircraft rentals expense for 2017 decreased by $31 million, or 13.5 percent, compared with 2016. On a
per ASM basis, Aircraft rentals expense decreased 13.3 percent, compared with 2016. On both a dollar
and per ASM basis, the majority of the decreases were due to 737-300 lease returns and the purchase
of ten 737-300 aircraft, that were previously on operating leases, since 2016. See the accompanying
Note Regarding Use of Non-GAAP Financial Measures for further information. The Company
currently expects Aircraft rentals expense per ASM for first quarter 2018 to decrease, compared with
first quarter 2017.

Landing fees and other rentals expense for 2017 increased by $81 million, or 6.7 percent, compared
with 2016. On a per ASM basis, Landing fees and other rentals expense for 2017 increased 2.4 percent,
compared with 2016. On a dollar basis, approximately 50 percent of the increase was due to an
increase in Landing fees as a result of the 2.8 percent increase in Trips flown and a change in fleet mix
to larger capacity aircraft. Approximately 25 percent of the increase on a dollar basis was an increase
in space rentals related to rate escalations and capital projects at many airports across the Company’s
network. The remaining increase was due to growth in international markets which gives rise to
additional fees. The increase per ASM was primarily due to rate escalations at many airports across the
Company’s network. The Company currently expects Landing fees and other rentals expense per ASM
for first quarter 2018 to increase, compared with first quarter 2017.

Depreciation and amortization expense for 2017 decreased by $3 million, or 0.2 percent, compared
with 2016. On a per ASM basis, Depreciation and amortization expense decreased 3.7 percent,
compared with 2016. On both a dollar and per ASM basis, the majority of the decreases were
associated with a net decrease in depreciation expense related to the Company’s flight equipment, as
the decrease from the retirement of the Company’s Classic fleet exceeded the additional depreciation
from the addition of new 737 MAX 8 aircraft, new 737-800 aircraft, and pre-owned 737-700 aircraft
on capital leases. These decreases were partially offset by the deployment of new technology assets.
The Company currently expects Depreciation and amortization expense per ASM for first quarter 2018
to decrease, compared with first quarter 2017.

Other operating expenses for 2017 increased by $174 million, or 6.9 percent, compared with 2016. On
a per ASM basis, Other operating expenses for 2017 increased 2.9 percent, compared with 2016. These
increases were both impacted by charges associated with the retirement of the Company’s remaining
Classic aircraft. These charges included a $63 million aircraft grounding charge related to the leased
portion of the Classic fleet, representing the remaining net lease payments due and certain lease return
requirements that could have to be performed on these leased aircraft prior to their return to the lessors,
as of the cease-use date. The Classic fleet charges in 2017 also included $33 million in lease
termination expenses associated with Classic aircraft being acquired off their operating leases,
compared with $22 million related to the acquisition of aircraft coming off operating leases in 2016.
These charges related to the grounding or cease-use of the Classic fleet were considered special items
and thus excluded from the Company’s non-GAAP results. See Note Regarding Use of Non-GAAP
Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures
for additional detail regarding non-GAAP financial measures. The remainder of the increase on a

50

dollar basis was primarily due to increased personnel expenses due to higher travel expenses for Flight
Crews and higher hotel rates, as well as new Heart-themed uniforms for the Company’s operations
personnel. The Company currently expects Other operating expenses per ASM for first quarter 2018 to
increase slightly, compared with first quarter 2017.

Other

Other expenses (income) include interest expense, capitalized interest, interest income, and other gains
and losses.

Interest expense for 2017 decreased by $8 million, or 6.6 percent, compared with 2016, primarily due
to the timing of debt activity. The Company had three debt facilities mature during or since 2016 with
higher interest expense than the four debt facilities issued during or since 2016. The three debt
facilities that matured during or since 2016 included the Company’s remaining 5.25% convertible
senior notes in October 2016, $300 million of 5.75% senior unsecured notes in December 2016, and
$300 million of 5.125% senior unsecured notes in March 2017. The four debt facilities issued during or
since 2016 included a $215 million floating rate term loan in October 2016, $300 million of 3.00%
senior unsecured notes in November 2016, $300 million of 2.75% senior unsecured notes in November
2017, and $300 million of 3.45% senior unsecured notes in November 2017.

Capitalized interest for 2017 increased by $2 million, or 4.3 percent, compared with 2016, primarily
due to interest on facility construction projects.

Interest income for 2017 increased by $11 million, or 45.8 percent, compared with 2016, primarily due
to higher interest rates.

Other (gains) losses, net, primarily includes amounts recorded as a result of the Company’s hedging
activities. See Note 10 to the Consolidated Financial Statements for further information on the
Company’s hedging activities. The following table displays the components of Other (gains) losses,
net, for the years ended December 31, 2017, and 2016:

(in millions)

Year ended December 31,

2017

2016

Mark-to-market impact from fuel contracts settling in future periods

$

Ineffectiveness from fuel hedges settling in future periods

Realized ineffectiveness and mark-to-market (gains) or losses

$

69

31

6

135

(7)

$

234

$

9

(11)

5

153

6

162

Premium cost of fuel contracts

Other

Income Taxes

The Company’s effective tax rate was (7.3) percent for 2017, compared with 36.8 percent for 2016.
The decrease in rate was driven by a $1.4 billion reduction in Provision for income taxes related to the
Tax Cuts and Jobs Act legislation enacted in December 2017, which resulted in a re-measurement of
the Company’s deferred tax assets and liabilities at the new federal corporate tax rate of 21 percent.
The Company currently projects a full year 2018 effective tax rate to be in the 23 to 23.5 percent range,
as a result of a lower federal corporate tax rate, and including the estimated impact of state taxes.

51

2016 Compared with 2015

Operating Revenues

Passenger revenues for 2016 increased by $295 million, or 1.6 percent, compared with 2015. Holding
Load factor and Passenger yield constant,
the increase was primarily attributable to a 5.7
percent increase in capacity as strong Customer demand for low-fare air travel enabled the Company to
fill the additional seats, as evidenced by a Company record annual load factor of 84.0 percent. On a
unit basis, Passenger revenues decreased 3.8 percent, year-over-year, largely driven by a 4.3 percent
decrease in passenger revenue yield, year-over-year, which included a reduction to 2016 Passenger
revenues associated with the Company’s July 2015 amended co-branded credit card agreement
(“Agreement”) with Chase Bank USA, N.A. (“Chase”) and a resulting required change in accounting
methodology. See Note 1 to the Consolidated Financial Statements for further information. The
Agreement resulted in an acceleration of the timing of revenue recognition on a prospective basis
beginning July 1, 2015, as well as a change in classification.

Freight revenues for 2016 decreased by $8 million, or 4.5 percent, compared with 2015, primarily due
to sluggish demand.

The Company recorded a Special revenue adjustment during 2015 of $172 million. This adjustment
represented a one-time non-cash reduction to deferred revenue liability as a result of the Agreement
with Chase and the resulting required change in accounting methodology, and is classified as a special
item and thus excluded from the Company’s 2015 non-GAAP financial results. See Note 1 to the
Consolidated Financial Statements and the Note Regarding Use of Non-GAAP Financial Measures for
further information.

Other revenues for 2016 increased by $490 million, or 41.9 percent, compared with 2015, primarily as
a result of the Agreement with Chase and the resulting required change in accounting methodology.
This change resulted in approximately 90 percent of the increase to Other revenue year-over-year.
Excluding this impact of the Agreement with Chase, Other revenues increased primarily due to higher
ancillary revenues associated with EarlyBird Check-in® and A1-15 select open priority boarding
positions sold at the airport.

52

Operating Expenses

Operating expenses for 2016 increased by $961 million, or 6.1 percent, compared with 2015, while
capacity increased 5.7 percent over the same period. Historically, except for changes in the price of
fuel, changes in Operating expenses for airlines have been largely driven by changes in capacity, or
ASMs. The following table presents the Company’s Operating expenses per ASM for 2016 and 2015,
followed by explanations of these changes on a per ASM basis and/or on a dollar basis:

(in cents, except for percentages)

Salaries, wages, and benefits

Fuel and oil

Maintenance materials and repairs

Aircraft rentals

Landing fees and other rentals
Depreciation and amortization

Acquisition and integration

Other operating expenses

Total

Year ended December 31,

2016

2015

Per ASM
change

Percent
change

4.57¢

4.54¢

2.46

0.70

0.15

0.82
0.82

—

1.70

2.58

0.72

0.17

0.83
0.72

0.03

1.59

11.22¢

11.18¢

0.03¢

(0.12)

(0.02)

(0.02)

(0.01)
0.10

(0.03)

0.11

0.04¢

0.7%

(4.7)

(2.8)

(11.8)

(1.2)
—

(100.0)

6.9

0.4%

Operating expenses per ASM for 2016 increased 0.4 percent, compared with 2015, primarily due to the
accelerated depreciation expense associated with the planned early retirement of the Classic fleet,
higher contract programming and consulting expenses associated with large technology projects, and
higher wage rates due to new labor agreements. These increases were partially offset by lower jet fuel
prices and lower profitsharing expense. See Note 1 to the Consolidated Financial Statements for further
information on the early retirement of the Classic fleet. Operating expenses per ASM for 2016,
excluding Fuel and oil expense and special
increased
1.6 percent year-over-year. See Note Regarding Use of Non-GAAP Financial Measures for additional
detail regarding non-GAAP financial measures.

items (a non-GAAP financial measure),

Salaries, wages, and benefits expense for 2016 increased by $415 million, or 6.5 percent, compared
with 2015. Salaries, wages, and benefits expense per ASM for 2016 increased 0.7 percent, compared
with 2015. On both a dollar and per ASM basis, the increases were primarily due to wage rate
increases as a result of agreements reached with multiple workgroups, increased training, additional
headcount, and contractual increases.

Fuel and oil expense for 2016 increased by $31 million, or 0.9 percent, compared with 2015. On a per
ASM basis, Fuel and oil expense for 2016 decreased 4.7 percent, compared with 2015, as the dollar
increases were more than offset by the 5.7 percent increase in capacity. On a dollar basis, the increase
was attributable to the $566 million increase in net losses resulting from the Company’s fuel hedging
program. Excluding the impact of hedging, Fuel and oil expense would have decreased by
$535 million, or 15.9 percent, compared with 2015, due to lower market
jet fuel prices. The
Company’s average economic jet fuel price per gallon decreased 7.2 percent year-over-year, from
$2.07 for 2015 to $1.92 for 2016, not including premium expense of $0.06 and $0.08 per gallon,
respectively. Fuel gallons consumed increased 5.0 percent, compared with 2015, while year-over-year
capacity increased 5.7 percent. As a result of the Company’s fuel hedging program, the Company
recognized net losses totaling $820 million in Fuel and oil expense for 2016, compared with net losses

53

totaling $254 million for 2015. These totals include cash settlements realized from the settlement of
fuel derivative contracts associated with the Company’s economic fuel hedge totaling $1.0 billion paid
to counterparties for 2016, compared with $577 million paid to counterparties for 2015. Additionally,
these totals exclude gains and/or losses recognized from hedge ineffectiveness and from derivatives
that did not qualify for hedge accounting. These items are recorded as a component of Other (gains)
losses, net.

Maintenance materials and repairs expense for 2016 increased by $40 million, or 4.0 percent,
compared with 2015. On a per ASM basis, Maintenance materials and repairs expense for 2016
decreased 2.8 percent, compared with 2015, as the dollar increases were more than offset by the
5.7 percent increase in capacity. On a dollar basis, the majority of the increase was attributable to the
timing of regular maintenance checks and ongoing cabin refresh projects including updates for the
Company’s new Heart cabin interior. These increases were partially offset by lower engine expense as
a result of the early retirement of the Classic fleet, as this decrease in engine repairs was only partially
offset by higher 737-700 engine expense due to increased flight hours.

Aircraft rentals expense for 2016 decreased by $9 million, or 3.8 percent, compared with 2015. On a
per ASM basis, Aircraft rentals expense decreased 11.8 percent, compared with 2015. On both a dollar
and per ASM basis, the decreases were primarily due to the retirement of five 737-300 leased aircraft
and two 737-500 leased aircraft since 2015, as well as the purchase of five leased 737-300s that were
previously on operating lease during 2016. See Note Regarding Use of Non-GAAP Financial Measures
for further information.

Landing fees and other rentals expense for 2016 increased by $45 million, or 3.9 percent, compared
with 2015. On a per ASM basis, Landing fees and other rentals expense for 2016 decreased
1.2 percent, compared with 2015, as the dollar increases were more than offset by the 5.7 percent
increase in capacity. On a dollar basis, approximately 70 percent of the increase was due to higher
space rental rates and usage at various airports. The remainder was due to a 3.5 percent increase in
Trips flown coupled with heavier landing weights for the Company’s higher capacity 737-800 aircraft,
which in 2016 made up a larger portion of the Company’s fleet than in 2015.

Depreciation and amortization expense for 2016 increased by $206 million, or 20.3 percent, compared
with 2015. On a per ASM basis, Depreciation and amortization expense increased 13.9 percent,
compared with 2015. On both a dollar and per ASM basis, approximately 60 percent of the increases
were due to the accelerated depreciation expense resulting from a change in the estimated retirement
dates of many of the Company’s owned Classic fleet from mid-2021 to third quarter 2017. The
remainder of the increases were due to the purchase and capital lease of new and used aircraft since
2015.

The Company incurred no Acquisition and integration costs in 2016, compared with $39 million in
2015. The 2015 costs primarily consisted of Employee training and certain expenses associated with
the grounding and conversion costs resulting from the transition of the Company’s Boeing 717-200
fleet (“B717s”) to Delta Air Lines (“Delta”). See Note 7 to the Consolidated Financial Statements for
further information.

Other operating expenses for 2016 increased by $272 million, or 12.1 percent, compared with 2015.
On a per ASM basis, Other operating expenses for 2016 increased 6.9 percent, compared with 2015.
On both a dollar and per ASM basis, approximately 30 percent of the increases were due to higher

54

contract programming and consulting expenses associated with large technology projects and
approximately 15 percent of the increases were due to increased personnel expenses. Other operating
expenses for 2016 also increased as the result of a $37 million litigation settlement received
during 2015 which reduced 2015 Other operating expenses, a $22 million lease termination expense as
a result of the Company acquiring five of its Boeing 737-300 aircraft off operating leases, and a
$21 million increase due to an impairment charge related to leased slots at Newark Liberty
International Airport. The remainder of the increases were due to revenue related costs driven by
the 5.5 percent increase in Revenue Passengers Carried.

Other

Other expenses (income) include interest expense, capitalized interest, interest income, and other gains
and losses.

Interest expense for 2016 increased by $1 million, or 0.8 percent, compared with 2015, primarily due
to the timing of debt issuances and payoffs in 2015 and 2016.

Capitalized interest for 2016 increased by $16 million, or 51.6 percent, compared with 2015, primarily
due to an increase in average progress payment balances for scheduled future aircraft deliveries.

Interest income for 2016 increased by $15 million, or 166.7 percent, compared with 2015, primarily
due to higher interest rates coupled with a greater amount of interest earned on cash collateral held by
counterparties. See Note 10 to the Consolidated Financial Statements for further information on the
Company’s derivatives.

Other (gains) losses, net, primarily includes amounts recorded as a result of the Company’s hedging
activities. See Note 10 to the Consolidated Financial Statements for further information on the
Company’s hedging activities. The following table displays the components of Other (gains) losses,
net, for the years ended December 31, 2016, and 2015:

(in millions)

Year ended December 31,

2016

2015

Mark-to-market impact from fuel contracts settling in future periods

$

9

$

Ineffectiveness from fuel hedges settling in future periods

Realized ineffectiveness and mark-to-market (gains) or losses

Premium cost of fuel contracts

Other

(11)

5

153

6

$

162

$

373

(9)

72

124

(4)

556

Income Taxes

The Company’s effective tax rate was 36.8 percent for 2016, compared with 37.3 percent for 2015.

55

Reconciliation of Reported Amounts to Non-GAAP Financial Measures (unaudited) (in millions,
except per share and per ASM amounts)

Year ended
December 31,

2017

2016

Percent
Change

Fuel and oil expense, unhedged
Add: Fuel hedge (gains) losses included in Fuel and oil expense, net
Fuel and oil expense, as reported
Add: Net impact from fuel contracts
Fuel and oil expense, excluding special items (economic)

Total operating expenses, as reported
Deduct: Contract ratification bonuses
Add: Reclassification between Fuel and oil and Other (gains) losses, net,

associated with current period settled contracts

Add: Contracts settling in the current period, but for which gains and/or

(losses) have been recognized in a prior period (a)

Deduct: Asset impairment
Deduct: Lease termination expense
Deduct: Aircraft grounding charge
Total operating expenses, excluding special items

Operating income, as reported
Add: Contract ratification bonuses
Deduct: Reclassification between Fuel and oil and Other (gains) losses, net,

associated with current period settled contracts

Deduct: Contracts settling in the current period, but for which gains and/or

(losses) have been recognized in a prior period (a)

Add: Asset impairment
Add: Lease termination expense
Add: Aircraft grounding charge
Operating income, excluding special items

Provision for income taxes, as reported
Add: Income tax impact of fuel and special items, excluding Tax reform

impact (b)

Add: Tax reform impact (c)
Provision for income taxes, excluding special items

Net income, as reported
Add: Contract ratification bonuses
Add: Mark-to-market impact from fuel contracts settling in future periods
Add (Deduct): Ineffectiveness from fuel hedges settling in future periods
Deduct: Other net impact of fuel contracts settling in the current or a prior

period (excluding reclassifications)

Add: Asset impairment
Add: Lease termination expense
Add: Aircraft grounding charge
Deduct: Net income tax impact from fuel and special items (b)
Deduct: Tax reform impact (c)
Net income, excluding special items

$

$

$

$

$

$

$

$

$

$

$

3,524
416
3,940
156
4,096

17,656
—

6

150
—
(33)
(63)
17,716

3,515
—

(6)

(150)
—
33
63
3,455

(237)

17
1,410
1,190

3,488
—
69
31

(150)
—
33
63
(17)
(1,410)
2,107

$

$

$

$

$

$

$

$

$

$

$

2,827
820
3,647
202
3,849

16,665
(356)

5

197
(21)
(22)
—
16,468

3,760
356

(5)

(197)
21
22
—
3,957

1,303

74
—
1,377

2,244
356
9
(11)

(197)
21
22
—
(74)
—
2,370

6.4%

7.6%

(12.7)%

(13.6)%

(11.1)%

56

Year ended
December 31,

2017

2016

$

5.79

$

3.55

Percent
Change

(0.08)
0.16

(0.03)
(2.34)

(0.31)
0.63

(0.12)
—

3.75

11.22¢
(2.46)
(0.27)

(6.7)%

Net income per share, diluted, as reported
Deduct: Net impact to net income above from fuel contracts divided by

dilutive shares

Add: Impact of special items
Deduct: Net income tax impact of fuel and special items, excluding Tax

reform impact (b)

Deduct: Tax reform impact (c)

Net income per share, diluted, excluding special items

$

3.50

$

Operating expenses per ASM (cents)
Deduct: Fuel expense divided by ASMs
Deduct: Impact of special items

11.48¢
(2.56)
(0.07)

Operating expenses per ASM, excluding Fuel and oil and special items

(cents)

8.85¢

8.49¢

4.2%

(a) As a result of prior hedge ineffectiveness and/or contracts marked to market through earnings.
(b) Tax amounts for each individual special item are calculated at the Company’s effective rate for the applicable
period and totaled in this line item.
(c) Adjustment related to the Tax Cuts and Jobs Act legislation enacted in December 2017, which resulted in a
re-measurement of the Company’s deferred tax assets and liabilities at the new federal corporate tax rate of
21 percent.

57

Non-GAAP Return on Invested Capital (ROIC) (in millions) (unaudited)

Year Ended

Year Ended
December 31, 2017 December 31, 2016 December 31, 2015

Year Ended

Operating income, as reported
Special revenue adjustment (a)
Contract ratification bonuses
Net impact from fuel contracts
Acquisition and integration costs
Litigation settlement
Asset impairment
Lease termination expense
Aircraft grounding charge

Operating income, non-GAAP
Net adjustment for aircraft leases (b)
Adjustment for fuel hedge accounting (c)

Adjusted Operating income, non-GAAP (A)

Debt, including capital leases (d)
Equity (d)
Net present value of aircraft operating leases (d)

Average invested capital
Equity adjustment for hedge accounting (c)

Adjusted average invested capital (B)

$

$

$

$

$

3,515
—
—
(156)
—
—
—
33
63

3,455
109
(135)

3,429

3,259
8,881
785

12,925
296

13,221

$

$

$

$

$

3,760
—
356
(202)
—
—
21
22
—

3,957
111
(152)

3,916

3,304
7,833
1,015

12,152
886

13,038

$

$

$

$

$

4,116
(172)
334
(323)
39
(37)
—
—
—

3,957
114
(124)

3,947

2,782
7,032
1,223

11,037
1,027

12,064

Non-GAAP ROIC, pre-tax (A/B)

25.9%

30.0%

32.7%

(a) The adjustment related to the execution of the Agreement with Chase and the resulting required change in
accounting methodology. See Note 1 to the Consolidated Financial Statements for further information.
(b) Net adjustment related to presumption that all aircraft in fleet are owned (i.e., the impact of eliminating
aircraft rent expense and replacing with estimated depreciation expense for those same aircraft). The Company
makes this adjustment to enhance comparability to other entities that have different capital structures by utilizing
alternative financing decisions.
(c) The Adjustment for fuel hedge accounting in the numerator is due to the Company’s accounting policy
decision to classify fuel hedge accounting premiums below the Operating income line, and thus is adjusting
Operating income to reflect such policy decision. The Equity adjustment for hedge accounting in the
denominator adjusts for the cumulative impacts, in Accumulated other comprehensive income and Retained
earnings, of gains and/or losses associated with hedge accounting related to fuel hedge derivatives that will settle
in future periods. The current period impact of these gains and/or losses are reflected in the Net impact from fuel
contracts in the numerator.
(d) Calculated as an average of the five most recent quarter end balances or remaining obligations. The Net
present value of aircraft operating leases represents the assumption that all aircraft in the Company’s fleet are
owned, as it reflects the remaining contractual commitments discounted at the Company’s estimated incremental
borrowing rate as of the time each individual lease was signed.

58

Note Regarding Use of Non-GAAP Financial Measures

The Company’s Consolidated Financial Statements are prepared in accordance with accounting
principles generally accepted in the United States (“GAAP”). These GAAP financial statements
include (i) unrealized noncash adjustments and reclassifications, which can be significant, as a result of
accounting requirements and elections made under accounting pronouncements relating to derivative
instruments and hedging and (ii) other charges and benefits the Company believes are unusual and/or
infrequent in nature and thus may make comparisons to its prior or future performance difficult.

As a result, the Company also provides financial information in this filing that was not prepared in
accordance with GAAP and should not be considered as an alternative to the information prepared in
accordance with GAAP. The Company provides supplemental non-GAAP financial information (also
referred to as “excluding special items”), including results that it refers to as “economic,” which the
Company’s management utilizes to evaluate its ongoing financial performance and the Company
believes provides additional insight to investors as supplemental information to its GAAP results. The
non-GAAP measures provided that relate to the Company’s performance on an economic fuel cost
basis include Fuel and oil expense, non-GAAP; Total operating expenses, non-GAAP; Operating
income, non-GAAP; Net income, non-GAAP; and Net income per share, diluted, non-GAAP. The
Company’s economic Fuel and oil expense results differ from GAAP results in that they only include
the actual cash settlements from fuel hedge contracts—all reflected within Fuel and oil expense in the
period of settlement. Thus, Fuel and oil expense on an economic basis has historically been utilized by
the Company, as well as some of the other airlines that utilize fuel hedging, as it reflects the
Company’s actual net cash outlays for fuel during the applicable period, inclusive of settled fuel
derivative contracts. Any net premium costs paid related to option contracts are reflected as a
component of Other (gains) losses, net, for both GAAP and non-GAAP (including economic) purposes
in the period of contract settlement. The Company believes these economic results provide further
insight on the impact of the Company’s fuel hedges on its operating performance and liquidity since
they exclude the unrealized, noncash adjustments and reclassifications that are recorded in GAAP
results in accordance with accounting guidance relating to derivative instruments, and they reflect all
cash settlements related to fuel derivative contracts within Fuel and oil expense. This enables the
Company’s management, as well as investors and analysts, to consistently assess the Company’s
operating performance on a year-over-year or quarter-over-quarter basis after considering all efforts in
place to manage fuel expense. However, because these measures are not determined in accordance
with GAAP, such measures are susceptible to varying calculations, and not all companies calculate the
measures in the same manner. As a result, the aforementioned measures, as presented, may not be
directly comparable to similarly titled measures presented by other companies.

Further information on (i) the Company’s fuel hedging program, (ii) the requirements of accounting for
derivative instruments, and (iii) the causes of hedge ineffectiveness and/or mark-to-market gains or
losses from derivative instruments is included in Note 10 to the Consolidated Financial Statements.

The Company’s GAAP results in the applicable periods include other charges or benefits that are also
deemed “special items” that the Company believes make its results difficult to compare to prior
periods, anticipated future periods, or industry trends. Financial measures identified as non-GAAP (or
as excluding special items) have been adjusted to exclude special items. Special items include:

1. A one-time $172 million Special revenue adjustment

in July 2015 as a result of the
Agreement with Chase and the resulting required change in accounting methodology. This

59

increase to revenue represented a nonrecurring required acceleration of revenues associated
with the adoption of Accounting Standards Update 2009-13;

2. Contract ratification bonuses recorded for certain workgroups. As the bonuses would only be
paid at ratification of the associated tentative agreement and would not represent an ongoing
expense to the Company, management believes its results for the associated periods are more
usefully compared if the impacts of ratification bonus amounts are excluded from results.
Generally, union contract agreements cover a specified three- to five- year period, although
such contracts officially never expire, and the agreed upon terms remain in place until a
revised agreement is reached, which can be several years following the amendable date;

3.

Expenses associated with the Company’s acquisition and integration of AirTran. Such
expenses were primarily incurred during the acquisition and integration period of the two
companies from 2011 through 2015 as a result of the Company’s acquisition of AirTran,
which closed on May 2, 2011. The exclusion of these expenses provides investors with a
the
more applicable basis with which to compare results in future periods now that
integration process has been completed;

4. A gain resulting from a litigation settlement received in January 2015. This cash settlement
meaningfully lowered Other operating expenses during the applicable period and the
Company does not expect a similar impact on its cost structure in the future;

5. A noncash impairment charge related to leased slots at Newark Liberty International Airport
as a result of the FAA announcement in April 2016 that this airport was being changed to a
Level 2 schedule-facilitated airport from its previous designation as Level 3;

6.

Lease termination costs recorded as a result of
its
Boeing 737-300 aircraft off operating leases as part of the Company’s strategic effort to
remove its Classic aircraft from operations on or before September 29, 2017, in the most
economically advantageous manner possible. The Company had not budgeted for these early
lease termination costs, as they were subject to negotiations being concluded with the third
party lessors. The Company recorded the fair value of the aircraft acquired off operating
leases, as well as any associated remaining obligations to the balance sheet as debt;

the Company acquiring 13 of

7. An Aircraft grounding charge recorded in third quarter 2017, as a result of the Company
grounding its remaining Boeing 737-300 aircraft on September 29, 2017. The loss was a
result of the remaining net lease payments due and certain lease return requirements that
could have to be performed on these leased aircraft prior to their return to the lessors as of
the cease-use date. The Company had not budgeted for the lease return requirements, as they
are subject to negotiation with third party lessors; and

8. An adjustment to Provision for income taxes related to the Tax Cuts and Jobs Act legislation
enacted in December 2017, which resulted in a re-measurement of the Company’s deferred
tax assets and liabilities at the new federal corporate tax rate of 21 percent. This adjustment
is a non-cash item and is being treated as a special item.

the trends associated with the
Because management believes each of these items can distort
Company’s ongoing performance as an airline, the Company believes that evaluation of its financial
performance can be enhanced by a supplemental presentation of results that exclude the impact of

60

these items in order to enhance consistency and comparativeness with results in prior periods that do
not include such items and as a basis for evaluating operating results in future periods. The following
measures are often provided, excluding special items, and utilized by the Company’s management,
analysts, and investors to enhance comparability of year-over-year results, as well as to industry trends:
Total operating expenses, non-GAAP; Operating income, non-GAAP; Provision for income taxes,
non-GAAP; Net income, non-GAAP; Net income per share, diluted, non-GAAP; and Operating
expenses per ASM, non-GAAP, excluding Fuel and oil and special items.

The Company has also provided its calculation of return on invested capital, which is a measure of
financial performance used by management to evaluate its investment returns on capital. Return on
invested capital is not a substitute for financial results as reported in accordance with GAAP, and
should not be utilized in place of such GAAP results. Although return on invested capital is not a
measure defined by GAAP, it is calculated by the Company, in part, using non-GAAP financial
measures. Those non-GAAP financial measures are utilized for the same reasons as those noted above
for Net income, non-GAAP and Operating income, non-GAAP - the comparable GAAP measures
include charges or benefits that are deemed “special items” that the Company believes make its results
difficult to compare to prior periods, anticipated future periods, or industry trends, and the Company’s
profitability targets and estimates, both internally and externally, are based on non-GAAP results since
in the vast majority of cases the “special items” cannot be reliably predicted or estimated. The
Company believes non-GAAP return on invested capital is a meaningful measure because it quantifies
the Company’s effectiveness in generating returns relative to the capital it has invested in its business.
Although return on invested capital is commonly used as a measure of capital efficiency, definitions of
return on invested capital differ; therefore, the Company is providing an explanation of its calculation
for non-GAAP return on invested capital in the accompanying reconciliation, in order to allow
investors to compare and contrast its calculation to those provided by other companies.

Liquidity and Capital Resources

Net cash provided by operating activities for 2017, 2016, and 2015 was $3.9 billion, $4.3 billion, and
respectively. Operating cash inflows are primarily derived from providing air
$3.2 billion,
transportation to Customers. The vast majority of tickets are purchased prior to the day on which travel
is provided and, in some cases, several months before the anticipated travel date. Operating cash
outflows are related to the recurring expenses of airline operations. The operating cash flows for 2017,
2016, and 2015 were impacted primarily by the Company’s results of operations, as adjusted for
non-cash items as well as changes in the Air traffic liability and Accrued liabilities balances. Operating
cash flows also can be significantly impacted by the Company’s fuel and interest rate hedge positions
and the corresponding cash collateral requirements associated with those positions. The Company has
in certain situations. See Note 10 to the
the ability to post aircraft
Consolidated Financial Statements for further information. During 2017 and 2016, the Company had
net cash inflows of $316 million and $535 million, respectively, in cash collateral from derivative
counterparties. During 2015, the Company provided $570 million in cash collateral to derivative
counterparties. Cash flows related to the purchase of derivatives utilized to offset a portion of the
Company’s future fuel hedge positions prior to their settlement, as well as new fuel derivatives, which
are also classified as Other, net, operating cash flows, were net outflows of $142 million in 2017,
$165 million in 2016, and $556 million in 2015. Net cash provided by operating activities is primarily
used to finance capital expenditures, repay debt, fund stock repurchases, pay dividends, and provide
working capital.

in lieu of cash collateral

61

Net cash used in investing activities for 2017, 2016, and 2015 was $2.4 billion, $2.3 billion, and
$1.9 billion, respectively. Investing activities in 2017, 2016, and 2015 included Capital expenditures,
primarily related to aircraft and other equipment, and payments associated with airport construction
projects, denoted as Assets constructed for others, and also included purchases and sales of short-term
investments. See Note 4 to the Consolidated Financial Statements for further
and noncurrent
information. During 2017, Capital expenditures were $2.1 billion,
the majority of which were
payments for new aircraft delivered to the Company, but also included payments associated with
facility construction projects and technology projects. This compared with
airport and other
$2.0 billion in Capital expenditures during both 2016 and 2015. During 2017 and 2016, the Company’s
purchases and sales of short-term and noncurrent
investments resulted in net cash outflows of
$159 million and $125 million, respectively, and a net cash inflow of $237 million in 2015. The
Company currently estimates its 2018 capital expenditures will be approximately $1.9 billion.

Net cash used in financing activities for 2017, 2016, and 2015 was $1.7 billion, $1.9 billion, and
$1.0 billion, respectively. During 2017, the Company repaid $592 million in debt and capital lease
obligations, compared with $591 million (including convertible notes) and $213 million during 2016
and 2015, respectively. During 2017, the Company issued, under its shelf registration statement,
$300 million 2.75% senior unsecured notes due 2022 and $300 million 3.45% senior unsecured notes
due 2027, compared with the 2016 borrowing of $215 million under a secured term loan agreement
and issuance of $300 million 3.00% senior unsecured notes due 2026 under its shelf registration
statement, and the 2015 issuance of $500 million 2.65% senior unsecured notes due 2020 under its
shelf registration statement. See Note 6 to the Consolidated Financial Statements for further
information. The Company repurchased $1.6 billion of its outstanding common stock through
authorized share repurchases during 2017, compared with repurchases of $1.8 billion and $1.2 billion
during 2016 and 2015, respectively. The Company also paid $274 million in dividends to Shareholders
during 2017, compared with $222 million in 2016 and $180 million in 2015. Although the Company
currently intends to continue paying dividends on a quarterly basis for the foreseeable future, the
Company’s Board of Directors may change the timing, amount, and payment of dividends on the basis
of results of operations, financial condition, cash requirements, future prospects, and other factors
deemed relevant by the Board of Directors.

The Company is a “well-known seasoned issuer” and currently has an effective shelf registration
statement registering an indeterminate amount of debt and equity securities for future sales. The
Company currently intends to use the proceeds from any future securities sales off this shelf
registration statement for general corporate purposes.

The Company has access to a $1 billion unsecured revolving credit facility expiring in August 2022.
The revolving credit agreement has an accordion feature that would allow the Company, subject to,
among other things, the procurement of incremental commitments, to increase the size of the facility to
$1.5 billion. Interest on the facility is based on the Company’s credit ratings at the time of borrowing.
At the Company’s current ratings, the interest cost would be LIBOR plus a spread of 100.0 basis
points. The facility contains a financial covenant requiring a minimum coverage ratio of adjusted
pre-tax income to fixed obligations, as defined. As of December 31, 2017, the Company was in
compliance with this covenant and there were no amounts outstanding under the revolving credit
facility.

During November 2017, the Company launched the Fourth Quarter 2017 ASR Program by advancing
$250 million to a financial institution in a privately negotiated transaction. The Company received

62

4.1 million shares in total under the Fourth Quarter 2017 ASR Program, which was completed in
January 2018. The purchase was recorded as a treasury share purchase for purposes of calculating
earnings per share. Following the launch of the Fourth Quarter 2017 ASR Program, during the period
from November 29, 2017 to December 15, 2017, the Company repurchased 1.6 million shares of its
common stock on the open market. See Part II, Item 5 for further information on the Company’s share
repurchase authorizations.

During second quarter 2017, the Company completed its previously authorized $2.0 billion share
repurchase program, bringing in a total of 41.3 million shares over the course of the program. On
May 17, 2017, the Company’s Board of Directors approved a new $2.0 billion share repurchase
program. Following the Board of Directors’ authorization of the Company’s new $2.0 billion share
repurchase program, the Company entered into the following share repurchases:

Share repurchases (in millions)

Shares received

Cash paid

Third Quarter 2017 Accelerated Share Repurchase Program

Fourth Quarter 2017 Accelerated Share Repurchase Program

Open Market Share Repurchases

Total

$

5.3

4.1

1.6

11.0

$

300

250

100

650

On June 1, 2017, Moody’s upgraded the Company’s secured equipment trust certificates and its senior
unsecured debt rating to “A3” from “Baa1.” The upgrade of the Company’s senior unsecured debt
rating was based on the Company’s strong liquidity, manageable funded debt, competitive fares, and
expanding network. Also on August 14, 2017, Standard & Poor’s upgraded the Company’s investment
grade credit ratings to “BBB+” from “BBB.” The upgrade of the Company’s investment grade rating
was based on the Company’s consistent profitability and cost advantage, exceptional liquidity, and
manageable funded debt. The Company maintained its investment grade credit ratings of “BBB+” with
Fitch.

The Company routinely carries a working capital deficit, in which its current liabilities exceed its
current assets. This is common within the airline industry and is primarily due to the nature of the Air
traffic liability account, which is related to advance ticket sales and frequent flyer deferred revenue,
which are performance obligations for future customer flights, do not require future settlement in cash,
and are mostly nonrefundable. The Company believes that its current liquidity position, including
unrestricted cash and short-term investments of $3.3 billion as of December 31, 2017, anticipated
future internally generated funds from operations, and its fully available, unsecured revolving credit
facility of $1.0 billion that expires in August 2022, will enable it to meet its future known obligations
in the ordinary course of business. However, if a liquidity need were to arise, the Company believes it
has access to financing arrangements because of its investment grade credit ratings, large value of
unencumbered assets, and modest leverage, which should enable it to meet its ongoing capital,
operating, and other liquidity requirements. The Company will continue to consider various borrowing
or leasing options to maximize liquidity and supplement cash requirements, as necessary.

The Company has a large net deferred tax liability on its Consolidated Balance Sheet. The deferral of
income taxes has resulted in a significant benefit to the Company and its liquidity position. Since the
Company purchases the majority of the aircraft it acquires, it has been able to utilize accelerated
depreciation methods (including bonus depreciation) available under the Internal Revenue Code of
1986, as amended, in 2017 and in previous years, which has enabled the Company to defer the cash tax

63

payments associated with these depreciable assets to future years. Based on the Company’s scheduled
future aircraft deliveries from Boeing and existing tax laws in effect, the Company will continue to
defer a portion of cash income taxes to future years. The Company has paid in the past, and will
continue to pay in the future, significant cash taxes to the various taxing jurisdictions where it operates.
The Company expects to be able to continue to meet such obligations utilizing cash and investments on
hand, as well as cash generated from its ongoing operations.

Off-Balance Sheet Arrangements, Contractual Obligations, and Contingent Liabilities and
Commitments

The Company has contractual obligations and commitments primarily with regard to future purchases
of aircraft, payment of debt, and lease arrangements. The Company revised its future firm order
delivery schedule with Boeing during fourth quarter 2017, to support future growth opportunities and
fleet modernization. During fourth quarter 2017, the Company exercised 40 737 MAX 8 options for
15 firm orders in 2019 and 25 firm orders in 2020. The Company also deferred 23 737 MAX 7 firm
orders from 2019 through 2021 to 12 firm orders in 2023 and 11 firm orders in 2024. The Company
also accelerated 23 737 MAX 8 firm orders from 2023 through 2024 to an additional 21 firm orders in
2021 and 2 firm orders in 2022. Earlier in 2017, the Company also exercised five 737-800 options for
2018, and substituted four 737-800 options for two 737 MAX 8 options for both 2021 and 2022. For
aircraft commitments with Boeing, the Company is required to make cash deposits toward the purchase
of aircraft in advance. These deposits are classified as Deposits on flight equipment purchase contracts
in the Consolidated Balance Sheet until the aircraft is delivered, at which time deposits previously
made are deducted from the final purchase price of the aircraft and are reclassified as Flight equipment.
See Part 1, Item 2 for a complete table of the Company’s firm deliveries and options for
Boeing 737-700, 737-800, 737 MAX 7, and 737 MAX 8 aircraft, and Note 4 to the Consolidated
Financial Statements for the financial commitments related to these firm deliveries.

The leasing of aircraft (including the sale and leaseback of aircraft) provides flexibility to the Company
as a source of financing. Although the Company is responsible for all maintenance, insurance, and
expense associated with operating leased aircraft, and retains the risk of loss for these aircraft, it has
not made guarantees to the lessors regarding the residual value (or market value) of the aircraft at the
end of the lease terms. As of December 31, 2017, the Company had 215 leased aircraft, including
78 B717s subleased to Delta and 15 Classic aircraft grounded in September 2017. Of these leased
aircraft, 144 are under operating leases, including 76 B717s subleased to Delta and 15 Classic aircraft.
See Note 7 to the Consolidated Financial Statements for further information on this transaction. Assets
and obligations under operating leases are not included in the Company’s Consolidated Balance Sheet.
Disclosure of the contractual obligations associated with the Company’s leased aircraft is included
below.

The Company is required to provide standby letters of credit to support certain obligations that arise in
the ordinary course of business and may choose to provide letters of credit in place of posting cash
collateral related to its fuel hedging positions. Although the letters of credit are off-balance sheet, the
majority of the obligations to which they relate are reflected as liabilities in the Consolidated Balance
Sheet. Outstanding letters of credit totaled $167 million at December 31, 2017.

64

The following table aggregates the Company’s material expected contractual obligations and
commitments as of December 31, 2017:

Contractual obligations

2018

2019 - 2020

2021 - 2022 Thereafter

Total

Obligations by period (in millions)

Long-term debt (a)

$

256

$

1,239

$

481

$

Interest commitments - fixed (b)

Interest commitments - floating (c)

Facility construction commitments (d)

Facility operating lease commitments

Aircraft operating lease commitments (e)

Aircraft capital lease commitments (f)

Aircraft purchase commitments (g)

Other commitments

77

31

65

34

223

107

874

171

116

56

130

64

355

211

1,717

229

83

10

130

45

137

196

2,174

84

818

121

12

232

89

80

416

5,191

322

$

2,794

397

109

557

232

795

930

9,956

806

Total contractual obligations

$

1,838

$

4,117

$

3,340

$

7,281

$

16,576

Includes principal only. See Note 6 to the Consolidated Financial Statements.

(a)
(b) Related to fixed-rate debt (either at issuance or through swaps) only.
(c)

(d)

(e)

Interest obligations associated with floating-rate debt (either at issuance or through swaps) is estimated
utilizing forward interest rate curves as of December 31, 2017, and can be subject to significant fluctuation.
Includes some lease payments that are considered variable which have a related construction obligation. See
Note 4 to the Consolidated Financial Statements.
Includes the impact of the B717 lease/sublease transaction entered into in 2012. Also includes 15 remaining
Classic aircraft on operating leases, which net remaining lease payments were included in the $63 million
grounding charge recorded during 2017. See Note 7 to the Consolidated Financial Statements.
Includes principal and interest on capital leases.

(f)
(g) Firm orders from Boeing.

Airport Projects

The Company has commitments associated with various airport improvement projects that will impact
its future liquidity needs in differing ways. These projects include the construction of new facilities and
the rebuilding or modernization of existing facilities and are discussed in more detail in Note 4 to the
Consolidated Financial Statements.

Dallas Love Field

For the rebuilding of the facilities at Dallas Love Field, the Company guaranteed principal, premium,
and interest on $456 million in bonds issued by the Love Field Airport Modernization Corporation
(“LFAMC”) that were utilized to fund the majority of the project. The amount of bonds outstanding as
of December 31, 2017, was $424 million. Repayment of the bonds is through the “Facilities Payments”
described below. Reimbursement of the Company for its payment of Facilities Payments is made
through recurring ground rents, fees, and other revenues collected at the airport.

Prior to the issuance of the bonds by the LFAMC, the Company entered into two separate funding
agreements: (i) a “Facilities Agreement” pursuant to which the Company is obligated to make debt

65

service payments on the principal and interest amounts associated with the bonds (“Facilities
Payments”), less other sources of funds the City of Dallas may apply to the repayment of the bonds
(including but not limited to passenger facility charges collected from passengers originating from the
airport); and (ii) a “Revenue Credit Agreement” pursuant to which the City of Dallas reimburses the
Company for the Facilities Payments made by the Company.

A majority of the monies transferred from the City of Dallas to the Company under the Revenue Credit
Agreement originate from a reimbursement account created in the “Use and Lease Agreement”
between the City of Dallas and the Company. The Use and Lease Agreement is a 20-year agreement
providing for, among other things, the Company’s lease of space at the Airport from the City of Dallas.
The remainder of such monies transferred from the City of Dallas to the Company under the Revenue
Credit Agreement originates from (i) use and lease agreements with other airlines, (ii) various
concession agreements, and (iii) other airport miscellaneous revenues.

The Company’s liquidity could be impacted by this project to the extent there are timing differences
between the Company’s payment of the Facilities Payments pursuant to the Facilities Agreement and
the transfer of monies back to the Company pursuant to the Revenue Credit Agreement; however, the
Company does not currently expect that to occur. The project has not had a significant impact on the
Company’s capital resources or financial position.

Fort Lauderdale-Hollywood International Airport

and manage

committed to oversee

The Company has
the design and construction of
Fort Lauderdale-Hollywood International Airport’s Terminal 1 Modernization Project, including the
design and construction of a new five-gate Concourse A with an international processing facility, at a
cost not to exceed $333 million. Funding for the project has come directly from Broward County
aviation sources, but flows through the Company in its capacity as manager of the project.
Construction of Concourse A was completed during second quarter 2017, and construction on
Terminal 1 is estimated to be completed by mid-2018. In general, as work is being completed on the
project by various contractors, invoices are submitted to Broward County for initial payment to the
Company, which then makes such payments to the contractors performing the work.

The Company’s liquidity could be impacted by this project to the extent there are instances in which
the Company chooses to make payments to contractors prior to receiving initial payment from Broward
County, although the Company currently does not expect this to occur often based on its past
experience with smaller projects conducted at the airport. The project is not expected to have a
significant impact on the Company’s capital resources or financial position.

Los Angeles International Airport

In March 2013, the Company executed a lease agreement (the “T1 Lease”) with Los Angeles World
Airports (“LAWA”), which owns and operates Los Angeles International Airport (“LAX”). Under the
T1 Lease, which was amended in June 2014 and September 2017, the Company is overseeing and
managing the design, development, financing, construction, and commissioning of the airport’s
Terminal 1 Modernization Project at a cost not
to exceed $526 million (including proprietary
renovations, or $510 million excluding proprietary renovations). In October 2017, the Company
executed a separate lease agreement with LAWA (the “T1.5 Lease”). The Company intends to oversee
and manage the design, development, financing, construction, and commissioning of a passenger
processing facility between Terminal 1 and 2 (the “Terminal 1.5 Project”). The Terminal 1.5 Project is

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expected to include ticketing, baggage claim, passenger screening, and a bus gate at a cost not to
exceed $479 million for site improvements and non-proprietary improvements.

These projects are being funded primarily using the Regional Airports Improvement Corporation
(“RAIC”), which is a quasi-governmental special purpose entity that acts as a conduit borrower under
syndicated credit facilities provided by groups of lenders. Loans made under the separate credit
facilities for the Terminal 1 Modernization Project and the Terminal 1.5 Project are being used to fund
the development of each of these projects, and the outstanding loans will be repaid with the proceeds
of LAWA’s payments to purchase completed construction phases. The Company has guaranteed the
obligations of the RAIC under each of the credit facilities of the respective lease agreements.

The Company’s liquidity could be impacted by these projects under certain circumstances; however,
the Company does not expect this to occur based on its past experience with other projects. These
projects are not expected to have a significant impact on the Company’s capital resources or financial
position. Construction on the Terminal 1 Modernization Project began during 2014 and is estimated to
be completed during 2018. Construction on the Terminal 1.5 Project began during third quarter 2017
and is estimated to be completed during 2020.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company’s Consolidated Financial Statements have been prepared in accordance with GAAP. The
Company’s significant accounting policies are described in Note 1 to the Consolidated Financial
Statements. The preparation of financial statements in accordance with GAAP requires the Company’s
management to make estimates and assumptions that affect the amounts reported in the Consolidated
Financial Statements and accompanying footnotes. The Company’s estimates and assumptions are
based on historical experience and changes in the business environment. However, actual results may
differ from estimates under different conditions, sometimes materially. Critical accounting policies and
estimates are defined as those that both (i) are most important to the portrayal of the Company’s
financial condition and results and (ii) require management’s most subjective judgments. The
Company’s most critical accounting policies and estimates are described below.

Revenue Recognition

Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue is
recognized and Air traffic liability is reduced when the service is provided (i.e., when the flight takes
place). Air traffic liability primarily represents tickets sold for future travel dates and funds that are
past flight date and remain unused, as well as a portion of the Company’s liability associated with its
frequent flyer program. Air traffic liability fluctuates throughout the year based on seasonal travel
patterns, fare sale activity, and activity associated with the Company’s frequent flyer program. See
Note 2 to the Consolidated Financial Statements for information about changes to Accounting
Standards Update (“ASU”) No. 2014-09 for revenue recognition that are effective for 2018.

For air travel on Southwest, the amount of tickets that will expire unused are estimated and recognized
in Passenger revenue once the scheduled flight date has passed. Estimating the amount of tickets that
will expire unused involves some level of subjectivity and judgment. The majority of Southwest’s
tickets sold are nonrefundable, which is the primary source of unused tickets. Southwest has a
No Show policy that applies to fares that are not canceled or changed by a Customer at least
ten minutes prior to a flight’s scheduled departure. See Note 1 to the Consolidated Financial
Statements for further information. According to Southwest’s current “Contract of Carriage,” all

67

refundable tickets that are sold but not flown on the travel date can be reused for another flight up to a
year from the date of sale, or some tickets can be refunded. This policy also applies to unused
Customer funds that may be the result of an exchange downgrade, in which a Customer exchanges
their ticket from a previously purchased flight for a lower priced ticket, with the price difference being
available for use by the Customer towards travel up to twelve months from the date of original
purchase. Fully refundable tickets rarely expire unused. Estimates of tickets that will expire unused are
based on historical experience over many years. Southwest has consistently applied this accounting
method to estimate revenue from unused tickets at the date of scheduled travel.

Events and circumstances outside of historical fare sale activity or historical Customer travel patterns
can result in actual spoiled tickets differing significantly from estimates. The Company evaluates its
estimates within a narrow range of acceptable amounts. If actual spoilage results in an amount outside
of this range, estimates and assumptions are reviewed and adjustments to Air traffic liability and to
Passenger revenue are recorded, as necessary. Additional factors that may affect estimated spoiled
tickets include, but may not be limited to, changes to the Company’s ticketing policies, the Company’s
the mix of refundable and nonrefundable fares,
refund, exchange, and unused funds policies,
promotional fare activity, events leading to significant flight cancellations, and the impact of the
economic environment on Customer behavior. The Company’s estimation techniques have been
consistently applied from year to year; however, as with any estimates, actual spoiled tickets may vary
from estimated amounts.

The Company believes it is unlikely that materially different estimates for future spoiled tickets would
be reported based on other reasonable assumptions or conditions suggested by actual historical
experience and other data available at the time estimates were made.

Accounting for Long-Lived Assets

Flight equipment and related assets make up the majority of the Company’s long-lived assets. Flight
equipment primarily relates to the 653 Boeing 737 aircraft in the Company’s fleet at December 31,
2017, which are either owned or on capital lease. The remaining 53 Boeing 737 aircraft in the
Company’s fleet at December 31, 2017, are operated under operating leases. The Company also has
88 B717 aircraft, which are part of the lease/sublease with Delta. As these aircraft are not in service for
the Company, they are not included in the fleet count as of December 31, 2017 or 2016. In addition,
the Company retired its remaining Classic aircraft during the year as part of an accelerated retirement
schedule, including 54 of which are still owned or on operating lease. As these aircraft are not in
service for the Company, they are not included in the fleet count as of December 31, 2017. See Note 7
to the Consolidated Financial Statements for further information. In accounting for long-lived assets,
the Company must make estimates about the expected useful lives of the assets, the expected residual
values of the assets, and the potential for impairment based on the fair value of the assets and their
future expected cash flows.

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The following table shows a breakdown of the Company’s long-lived asset groups along with
information about estimated useful lives and residual values for new assets generally purchased from
the manufacturer and assets constructed for others:

Airframes and engines

Aircraft parts

Assets constructed for others

Ground property and equipment

Estimated
useful life

25 years

Fleet life

10 to 30 years

5 to 30 years

Estimated
residual value

15 percent

4 percent

17 to 75 percent

0 to 10 percent

In estimating the lives and expected residual values of its aircraft, the Company primarily has relied
upon actual experience with the same or similar aircraft types, current and projected future market
information, and recommendations from Boeing. Aircraft estimated useful lives are based on the
number of “cycles” flown (one take-off and landing) as well as the aircraft age. The Company has
made a conversion of cycles into years based on both historical and anticipated future utilization of the
aircraft. Subsequent revisions to these estimates, which can be significant, could be caused by changes
to aircraft maintenance programs, changes in utilization of the aircraft (actual cycles during a given
period of time), governmental regulations on aging aircraft, and changing market prices of new and
used aircraft of the same or similar types. The Company evaluates its estimates and assumptions each
reporting period and, when warranted, adjusts these estimates and assumptions. Generally, these
adjustments are accounted for on a prospective basis through depreciation and amortization expense.
See Note 1 to the Consolidated Financial Statements for further information.

The Company believes it is unlikely that materially different estimates for expected lives, expected
residual values, and impairment evaluations would be made or reported based on other reasonable
assumptions or conditions suggested by actual historical experience and other data available at the time
estimates were made.

Financial Derivative Instruments

The Company utilizes financial derivative instruments primarily to manage its risk associated with
changing jet fuel prices. See “Quantitative and Qualitative Disclosures about Market Risk” for more
information on these risk management activities, and see Note 10 to the Consolidated Financial
Statements for more information on the Company’s fuel hedging program and financial derivative
instruments. Also, see Note 2 to the Consolidated Financial Statements for information about future
required changes to hedge accounting per ASU No. 2017-12.

All derivatives are required to be reflected at fair value and recorded on the Consolidated Balance
Sheet. At December 31, 2017, the Company was a party to over 400 separate financial derivative
instruments related to its fuel hedging program for future periods. Changes in the fair values of these
instruments can vary dramatically based on changes in the underlying commodity prices. For example,
during 2017, market “spot” prices for Brent crude oil peaked at a high of approximately $67 per barrel
and hit a low price of approximately $45 per barrel. During 2016, market spot prices ranged from a
high of approximately $57 per barrel to a low of approximately $28 per barrel. Market price changes
can be driven by factors such as supply and demand, inventory levels, weather events, refinery
capacity, political agendas, the value of the U.S. dollar, geopolitical events, and general economic
conditions, among other items. The financial derivative instruments utilized by the Company primarily

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are a combination of collars, purchased call options, call spreads, put spreads, and fixed price swap
agreements.

into financial derivative instruments with third party institutions

in
The Company enters
“over-the-counter” markets. Since the majority of the Company’s financial derivative instruments are
not traded on a market exchange, the Company estimates their fair values. Depending on the type of
instrument, the values are determined by the use of present value methods or standard option value
models with assumptions about commodity prices based on those observed in underlying markets.
Also, since there is not a reliable forward market for jet fuel beyond approximately 24 months, the
Company must estimate the future prices of jet fuel in order to measure the effectiveness of the
hedging instruments in offsetting changes to those prices. Forward jet fuel prices are estimated through
the observation of similar commodity futures prices (such as crude oil, heating oil, and unleaded
gasoline) and adjusted based on variations of those like commodities to the Company’s ultimate
expected price to be paid for jet fuel at the specific locations in which the Company hedges.

Fair values for financial derivative instruments and forward jet fuel prices are estimated prior to the
time that the financial derivative instruments settle and the time that jet fuel is purchased and
consumed, respectively. However, once settlement of the financial derivative instruments occurs and
the hedged jet fuel is purchased and consumed, all values and prices are known and are recognized in
the financial statements. Although the Company continues to use a prospective assessment
to
determine that commodities continue to qualify for hedge accounting in specific locations where the
Company hedges, there are no assurances that these commodities will continue to qualify in the future.
This is due to the fact that future price changes in these refined products may not be consistent with
historical price changes. Increased volatility in these commodity markets for an extended period of
time, especially if such volatility were to worsen, could cause the Company to lose hedge accounting
altogether for the commodities used in its fuel hedging program, which would create further volatility
in the Company’s GAAP financial results.

Estimating the fair value of these fuel derivative instruments and forward prices for jet fuel will also
result in changes in their fair values from period to period and thus determine their accounting
treatment. To the extent that the change in the estimated fair value of a fuel derivative instrument
differs from the change in the estimated price of the associated jet fuel to be purchased, both on a
cumulative and a period-to-period basis, ineffectiveness of the fuel hedge can result. This could result
in the immediate recording of non-cash charges or income, representing the change in the fair value of
the derivative, even though the derivative instrument may not expire/settle until a future period.
Likewise, if a derivative contract ceases to qualify for hedge accounting, the change in the fair value of
the derivative instrument is recorded every period to Other (gains) and losses, net in the Consolidated
Statement of Income in the period of the change.

ineffectiveness is inherent

Under current hedge accounting guidance,
in hedging jet fuel with
derivative positions based in other crude oil related commodities, especially given the past volatility in
the prices of refined products. Due to the volatility in markets for crude oil and related products, the
Company is unable to predict the amount of ineffectiveness each period, including the loss of hedge
accounting, which could be determined on a derivative by derivative basis or in the aggregate for a
specific commodity. This may result, and has historically resulted, in increased volatility in the
Company’s financial statements. The amount of hedge ineffectiveness and unrealized gains and losses
due to the change in fair value of derivative contracts settling in future periods, recorded during
the significant
historical periods, has been due to a number of factors. These factors include:

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fluctuation in energy prices, the number of derivative positions the Company holds, significant weather
events that have affected refinery capacity and the production of refined products, and the volatility of
the different
types of products the Company uses for mitigation of fuel price volatility. The
discontinuation of hedge accounting for specific hedges and for specific refined products, such as
unleaded gasoline, can also be a result of these factors. Depending on the level at which the Company
is hedged at any point in time, as the fair value of the Company’s hedge positions fluctuate in amount
from period to period, there could be continued variability recorded in the Consolidated Statement of
Income, and furthermore, the amount of hedge ineffectiveness and unrealized gains or losses recorded
in earnings may be material. This is primarily because small differences in the correlation of crude oil
related products could be leveraged over large volumes.

The Company continually looks for better and more accurate methodologies in forecasting expected
future cash flows relating to its jet fuel hedging program. These estimates are an important component
used in the measurement of effectiveness for the Company’s fuel hedges. The current methodology
used by the Company in forecasting forward jet fuel prices is primarily based on the idea that different
types of commodities are statistically better predictors of forward jet fuel prices, depending on specific
geographic locations in which the Company hedges. The Company then adjusts for certain items, such
as transportation costs, that are stated in fuel purchasing contracts with its vendors, in order to estimate
the actual price paid for jet fuel associated with each hedge. This methodology for estimating expected
future cash flows (i.e., jet fuel prices) has been consistently applied during 2017, 2016, and 2015, and
has not changed for either assessing or measuring hedge ineffectiveness during these periods.

The Company believes it is unlikely that materially different estimates for the fair value of financial
derivative instruments and forward jet fuel prices would be made or reported based on other reasonable
assumptions or conditions suggested by actual historical experience and other data available at the time
estimates were made.

Fair Value Measurements

The Company utilizes unobservable (Level 3) inputs in determining the fair value of certain assets and
liabilities. At December 31, 2017, these consisted of a portion of its fuel derivative option contracts,
which were a net asset of $248 million.

The Company determines the fair value of fuel derivative option contracts utilizing an option pricing
model based on inputs that are either readily available in public markets, can be derived from
information available in publicly quoted markets, or are quoted by its counterparties. In situations
where the Company obtains inputs via quotes from its counterparties, it verifies the reasonableness of
these quotes via similar quotes from another counterparty as of each date for which financial
statements are prepared. The Company has consistently applied these valuation techniques in all
periods presented and believes it has obtained the most accurate information available for the types of
derivative contracts it holds. Due to the fact that certain inputs used in determining estimated fair value
of its option contracts are considered unobservable (primarily implied volatility), the Company has
categorized these option contracts as Level 3. Although implied volatility is not directly observable, it
is derived primarily from changes in market prices, which are observable. Based on the Company’s
portfolio of option contracts as of December 31, 2017, a 10 percent change in implied volatility,
holding all other factors constant, would have resulted in a change in the fair value of this portfolio of
less than $35 million.

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As discussed in Note 10 to the Consolidated Financial Statements, any changes in fair value of cash
flow hedges that are considered to be effective, as defined, are offset within AOCI until the period in
which the expected future cash flow impacts earnings. Any changes in the fair value of fuel derivatives
that are ineffective, as defined, or that do not qualify for hedge accounting, are reflected in earnings
within Other (gains) losses, net, in the period of the change. Because the Company has extensive
historical experience in valuing the derivative instruments it holds, and such experience is continually
evaluated against its counterparties each period when such instruments expire and are settled for cash,
the Company believes it is unlikely that an independent third party would value the Company’s
derivative contracts at a significantly different amount than what is reflected in the Company’s
financial statements. In addition, the Company also has bilateral credit provisions in some of its
counterparty agreements, which provide for parties (or the Company) to provide cash collateral when
the fair value of fuel derivatives with a single party exceeds certain threshold levels. Since this cash
collateral is based on the estimated fair value of the Company’s outstanding fuel derivative contracts,
this provides further validation to the Company’s estimate of fair values.

Frequent Flyer Accounting

The Company utilizes estimates in the recognition of liabilities associated with its frequent flyer
program. These estimates primarily include the liability associated with Rapid Rewards frequent flyer
member (“Member”) account balances that are expected to be redeemed for travel or other products at
a future date. Frequent flyer account balances include points earned through flights taken, points sold
to Customers, or points earned through business partners participating in the frequent flyer program.

Under the Southwest Rapid Rewards frequent flyer program, Members earn points for every dollar
spent. The amount of points earned under the program is based on the fare and fare class purchased,
with higher fare products (e.g., Business Select) earning more points than lower fare products (e.g.,
Wanna Get Away). Each fare class is associated with a points earning multiplier, and points for flights
are calculated by multiplying the fare for the flight by the fare class multiplier. Likewise, the amount of
points required to be redeemed for a flight is based on the fare and fare class purchased. Under the
program, (i) Members are able to redeem their points for every available seat, every day, on every
flight, with no blackout dates; and (ii) points do not expire so long as the Rapid Rewards Member has
points-earning activity during a 24-month time period. In addition, Southwest co-branded Chase Visa
credit card holders are able to redeem their points for items other than travel on Southwest Airlines,
such as international flights on other airlines, cruises, hotel stays, rental cars, gift cards, event tickets,
and more. In addition to earning points for revenue flights and qualifying purchases with Rapid
Rewards Partners, Rapid Rewards Members also have the ability to purchase, gift, and transfer points,
as well as the ability to donate points to selected charities.

The Company utilizes the incremental cost method of accounting for points earned through flights
taken in its frequent flyer program. Liabilities are recorded for the estimated incremental cost of
providing free travel as points are being earned and companion passes earned. The liabilities recorded
represent the total number of points expected to be redeemed by Members, regardless of whether the
Members may have enough to qualify for a full travel award. The incremental cost liabilities are
primarily composed of direct Passenger costs such as fuel, food, and other operational costs, but do not
include any contribution to fixed overhead costs or profit. At December 31, 2017, the incremental cost
the Company will adopt
liabilities were approximately $76 million. As previously discussed,
ASU No. 2014-09, Revenue from Contracts with Customers, as of January 1, 2018. See Note 2 to the
Consolidated Financial Statements for further information.

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The Company also sells frequent flyer points and related services to business partners participating in
the frequent flyer program. The majority of the points sold to business partners are through the
Southwest co-branded Chase Visa credit card. Prior to third quarter 2015, funds received from the sale
of points associated with these agreements were accounted for under the residual method. Under the
residual method, the Company estimated the percent of the amount received from frequent flyer points
sold associated with Southwest’s co-branded Chase Visa credit card that related to free travel. The
estimated amounts associated with free travel were deferred and recognized as Passenger revenue
when the ultimate free travel awards were flown. During third quarter 2015, the Company executed an
amended co-branded credit card agreement (“Agreement”) with Chase Bank USA, N.A. (“Chase”),
which materially modified the previously existing agreement between Chase and the Company.
Consideration received as part of this Agreement is subject to ASU No. 2009-13, Multiple-Deliverable
Revenue Arrangements - a consensus of the FASB Emerging Issues Task Force. The modified
Agreement has the following multiple elements: travel points to be awarded; use of the Southwest
Airlines’ brand and access to Rapid Reward Member lists; advertising elements; and the Company’s
resource team. Under ASU No. 2009-13, these deliverables are accounted for separately and allocation
of consideration from the Agreement is determined based on the relative selling price of each
deliverable. The application of ASU No. 2009-13 to the Agreement decreases the relative value of the
air transportation deliverables that the Company records as deferred revenue (and ultimately Passenger
revenues when redeemed awards are flown) and increases the relative value of the marketing-related
deliverables recorded in Other revenues at the time these marketing-related deliverables are provided.
This is principally due to the previous application of the residual method, which effectively applied the
entire discount associated with the agreement to the marketing deliverables.

Significant management judgment was used to estimate the selling price of each of the deliverables.
The objective was to determine the price at which the Company would transact a sale if the product or
service was sold on a stand-alone basis. The Company determined the best estimate of selling price by
considering multiple inputs and methods including, but not limited to, the estimated selling price of
comparable travel, discounted cash flows, brand value, published selling prices, number of points
awarded, and the number of points redeemed. The Company estimated the selling prices and volumes
over the term of the Agreement in order to determine the allocation of proceeds to each of the multiple
deliverables. The Company records passenger revenue related to air transportation and certificates for
discounted companion travel when the transportation is delivered. A one percent increase or decrease
in the Company’s estimate of the standalone selling prices, implemented as of January 1, 2017,
resulting in an allocation of proceeds to air transportation would have changed the Company’s
Operating revenues by less than $17 million for 2017.

The Company followed the transition approach of ASU No. 2009-13, which required that
the
Company’s existing deferred revenue balance, classified within Air traffic liability, be adjusted to
reflect the value, on a relative selling price basis, of any undelivered element remaining at the date of
contract modification. The relative selling price of the undelivered element (air transportation) was
lower than the rate at which it had been deferred under the previous contract and the Company
recorded a one-time, non-cash adjustment to decrease frequent flyer deferred revenue and increase
revenue through the recording of a Special revenue adjustment of $172 million during 2015. In
addition, 2015, 2016, and 2017 Operating revenues increased year-over-year by an estimated
net $255 million, $544 million, and $544 million respectively, as a result of the amended Agreement
with Chase and the resulting July 1, 2015, required change in accounting methodology. See Note 1 to
the Consolidated Financial Statements for further information.

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Under its current program, Southwest estimates the portion of frequent flyer points that will not be
redeemed. In estimating spoilage, the Company takes into account the Member’s past behavior, as well
as several factors related to the Member’s account that are expected to be indicative of the likelihood
of future point redemption. These factors include, but are not limited to, tenure with program, points
accrued in the program, and whether or not the customer has a co-branded credit card. During fourth
quarter 2014, the Company obtained sufficient historical behavioral data to develop a predictive
statistical model to analyze the amount of spoilage expected for points sold to business partners. The
Company updates this model at least annually, and applies the new spoilage rates effective October 1st
each year, or more frequently if required by changes in the business. The new spoilage rates applied in
2015, 2016, and 2017 did not have a material impact to Passenger revenues during 2015, 2016, or
2017. For the year ended December 31, 2017, based on actual redemptions of points sold to business
partners, a hypothetical one percentage point change in the estimated spoilage rate would have resulted
in a change to Passenger revenue of approximately $48 million (an increase in spoilage would have
resulted in an increase in revenue and a decrease in spoilage would have resulted in a decrease in
revenue). Given that Member behavior will continue to develop as the program matures, the Company
expects the current estimates may change in future periods. However, the Company believes its current
estimates are reasonable given current facts and circumstances.

Goodwill and Other Intangible Assets

As a result of the Company’s acquisition of AirTran on May 2, 2011, the Company has reflected
Goodwill on its Consolidated Balance Sheet in the amount of $970 million at December 31, 2017, the
excess of the consideration transferred over the fair value of AirTran’s assets and liabilities on the
acquisition date. In addition, the Company’s other intangible assets have a net carrying amount of
approximately $413 million at December 31, 2017, of which $295 million related to indefinite-lived
intangible assets. Indefinite-lived assets are not amortized and primarily consist of take-off and landing
slots at certain domestic slot-controlled airports. Goodwill and indefinite-lived intangible assets are not
amortized, but tested for impairment annually, as of October 1st, or more frequently if events or
circumstances indicate that impairment may exist.

The Company applies a fair value based impairment test to the carrying value of goodwill and
indefinite-lived intangible assets annually on October 1st, or more frequently if certain events or
circumstances indicate that an impairment loss may have been incurred. The Company assesses the
value of goodwill and indefinite-lived assets under either a qualitative or quantitative approach. Under
a qualitative approach, the Company considers various market factors, including applicable key
assumptions listed below. These factors are analyzed to determine if events and circumstances have
affected the fair value of goodwill and indefinite-lived intangible assets. If the Company determines
that it is more likely than not that an indefinite-lived intangible asset is impaired, the quantitative
approach is used to assess the asset’s fair value and the amount of the impairment. Under a quantitative
approach, the fair value is calculated based on key assumptions listed below. If the asset’s carrying
value exceeds its fair value calculated using the quantitative approach, an impairment charge is
recorded for the difference in fair value and carrying value.

When performing a quantitative impairment assessment of goodwill and indefinite-lived intangible
assets, fair value is estimated based on (i) recent market transactions, where available; (ii) projected
discounted cash flows (an income approach); or (iii) a combination of limited market transactions and
the lease savings method (which reflects potential annual after-tax lease savings arising from owning
the slots rather than leasing them from another airline at market rates).

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Key assumptions and/or estimates made in the Company’s impairment tests include: (i) a projection of
revenues, expenses, and cash flows; (ii) terminal period revenue growth and cash flows; (iii) an
estimated weighted average cost of capital; (iv) an assumed discount rate depending on the asset; (v) a
tax rate; and (vi) market prices for comparable assets. The Company believes these assumptions are
consistent with those a hypothetical market participant would use given circumstances that were
present at the time the estimates were made. However, actual results and amounts may be significantly
different from the Company’s estimates.

As part of this evaluation, the Company assesses whether changes in (i) macroeconomic conditions;
(ii) industry and market conditions; (iii) cost factors; (iv) overall financial performance; and
(v) Company-specific events, have occurred which would impact the use and/or fair value of these
assets since the Company’s quantitative analysis in 2013. In 2017 and 2016, the Company performed a
qualitative assessment of goodwill and determined that there was no indication that goodwill was
impaired. The qualitative assessments included analyses and weighting of all relevant factors noted
above. The Company performed a quantitative assessment of all indefinite-lived intangible assets in
2015 and a qualitative assessment in 2016 and 2017 and determined that there was no impairment in
any of these years as a result of the assessments. The Company did record a $21 million noncash
impairment charge related to leased slots at Newark Liberty International Airport (not indefinite-lived
assets) as a result of the FAA announcement in April 2016 that this airport was being changed to a
Level 2 schedule-facilitated airport from its previous designation as Level 3. Southwest does not
believe this FAA decision is indicative of a similar decision being made at its other slot-controlled
airports.

Future impairment of Goodwill and indefinite-lived intangible assets may result from changes in
assumptions, estimates, or circumstances, some of which are beyond the Company’s control. Factors
which could result in an impairment of Goodwill, holding other assumptions constant, could include,
but are not limited to: (i) a significant reduction in passenger demand as a result of domestic or global
economic conditions; (ii) significantly higher prices for jet fuel; (iii) lower fares or passenger yields as
a result of increased competition or lower demand; (iv) a significant increase in future capital
expenditure commitments; and (v) significant disruptions to the Company’s operations as a result of
both internal and external events such as terrorist activities, actual or threatened war, labor actions by
Employees, or further industry regulation. Factors which could result in an impairment of owned
domestic slots, holding other assumptions constant, could include, but are not limited to: (i) a change in
competition in the slotted airport; (ii) a change in governmental regulations in the slotted airport;
(iii) significantly higher prices for jet fuel; and (iv) increased competition at a nearby airport.

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

The Company has interest rate risk in its floating-rate debt obligations and interest rate swaps,
commodity price risk in jet fuel required to operate its aircraft fleet, and market risk in the derivatives
used to manage its fuel hedging program and in the form of fixed-rate debt instruments. As of
December 31, 2017, the Company operated a total of 122 aircraft under operating and capital lease.
However, except for a small number of aircraft that have lease payments that fluctuate based in part on
changes in market interest rates, the remainder of the leases are not considered market sensitive
financial instruments and, therefore, are not included in the interest rate sensitivity analysis below. The
Company also has 78 aircraft under operating and capital lease that have been subleased to another
carrier. In addition, the Company has 15 remaining Classic aircraft under operating leases which were
grounded in September 2017. Further information about these leases is disclosed in Note 7 to the

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Consolidated Financial Statements. The Company does not purchase or hold any derivative financial
instruments for trading purposes. See Note 10 to the Consolidated Financial Statements for information
on the Company’s accounting for its hedging program and for further details on the Company’s
financial derivative instruments.

Hedging

The Company purchases jet fuel at prevailing market prices, but seeks to manage market risk through
execution of a documented hedging strategy. The Company utilizes financial derivative instruments, on
both a short-term and a long-term basis, as a form of insurance against the potential for significant
increases in fuel prices. The Company believes there can be significant risk in not hedging against the
possibility of such fuel price increases, especially in energy markets in which prices are high and/or
rising. The Company expects to consume approximately 2.1 billion gallons of jet fuel in 2018. Based
on this anticipated usage, a change in jet fuel prices of just one cent per gallon would impact the
Company’s Fuel and oil expense by approximately $21 million for 2018, excluding any impact
associated with fuel derivative instruments held.

As of December 31, 2017, the Company held a net position of fuel derivative instruments that
represented a hedge for a portion of its anticipated jet fuel purchases for future periods. See Note 10 to
the Consolidated Financial Statements for further information. The Company may increase or decrease
the size of its fuel hedge based on its expectation of future market prices, as well as its perceived
exposure to cash collateral requirements contained in the agreements it has signed with various
counterparties, while considering the significant cost that can be associated with different types of
hedging strategies. The gross fair value of outstanding financial derivative instruments related to the
Company’s jet fuel market price risk at December 31, 2017, was a net asset of $248 million. In
addition, $15 million in cash collateral deposits were held by the Company in connection with these
instruments based on their fair value as of December 31, 2017. The fair values of the derivative
instruments, depending on the type of instrument, were determined by use of present value methods or
standard option value models with assumptions about commodity prices based on those observed in
underlying markets. An immediate 10 percent
increase or decrease in underlying fuel-related
commodity prices from the December 31, 2017, prices would correspondingly change the fair value of
the commodity derivative instruments in place by approximately $214 million. Fluctuations in the
related commodity derivative instrument cash flows may change by more or less than this amount
based upon further fluctuations in futures prices, as well as related income tax effects. In addition, this
does not consider changes in cash, aircraft, or letters of credit utilized as collateral provided to or by
counterparties, which would fluctuate in an amount equal to or less than this amount, depending on the
type of collateral arrangement in place with each counterparty. This sensitivity analysis uses industry
standard valuation models and holds all
levels, except
underlying futures prices.

inputs constant at December 31, 2017,

The Company’s credit exposure related to fuel derivative instruments is represented by the fair value of
contracts that are an asset position to the Company. At such times, these outstanding instruments
expose the Company to credit loss in the event of nonperformance by the counterparties to the
agreements. As of December 31, 2017, the Company had eight counterparties in which the derivatives
held were a net asset. To manage credit risk,
the Company selects and periodically reviews
counterparties based on credit ratings, limits its exposure with respect to each counterparty, and
monitors the market position of the fuel hedging program and its relative market position with each
counterparty. However, if one or more of these counterparties were in a liability position to the

76

Company and were unable to meet
their obligations, any open derivative contracts with the
counterparty could be subject to early termination, which could result in substantial losses for the
Company. At December 31, 2017, the Company had agreements with all of its active counterparties
containing early termination rights and/or bilateral collateral provisions whereby security is required if
market risk exposure exceeds a specified threshold amount based on the counterparty’s credit rating.
The Company also had agreements with counterparties in which cash deposits, letters of credit, and/or
pledged aircraft are required to be posted as collateral whenever the net fair value of derivatives
associated with those counterparties exceeds specific thresholds. Refer to the counterparty credit risk
and collateral table provided in Note 10 to the Consolidated Financial Statements for the fair values of
fuel derivatives, amounts held as collateral, and applicable collateral posting threshold amounts as of
December 31, 2017, at which such postings are triggered.

Due to the Company’s investment grade credit rating, terms of the Company’s current fuel hedging
agreements with counterparties, and the types of derivatives held as of December 31, 2017, in the
Company’s judgment, it does not have cash collateral exposure. See Note 10 to the Consolidated
Financial Statements. The Company is also subject to the risk that the fuel derivatives it uses to hedge
against fuel price volatility do not provide adequate protection. The Company has found that financial
derivative instruments in commodities, such as West Texas Intermediate crude oil, Brent crude oil, and
refined products, such as heating oil and unleaded gasoline, can be useful in decreasing its exposure to
jet fuel price volatility. In addition, to add further protection, the Company may periodically enter into
jet fuel derivatives for short-term timeframes. Jet fuel is not widely traded on an organized futures
exchange and, therefore, there are limited opportunities to hedge directly in jet fuel for time horizons
longer than approximately 24 months into the future.

The Company also has agreements with each of its counterparties associated with its outstanding
interest rate swap agreements in which cash collateral may be required based on the fair value of
outstanding derivative instruments, as well as the Company’s and its counterparty’s credit ratings. As
of December 31, 2017, no cash collateral deposits were provided by or held by the Company based on
its outstanding interest rate swap agreements.

Due to the significance of the Company’s fuel hedging program and the emphasis that the Company
places on utilizing fuel derivatives to reduce its fuel price risk, the Company has created a system of
governance and management oversight and has put in place a number of internal controls designed so
that procedures are properly followed and accountability is present at the appropriate levels. For
example, the Company has put in place controls designed to: (i) create and maintain a comprehensive
risk management policy; (ii) provide for proper authorization by the appropriate levels of management;
(iii) provide for proper segregation of duties; (iv) maintain an appropriate level of knowledge regarding
the execution of and the accounting for derivative instruments; and (v) have key performance
indicators in place in order to adequately measure the performance of its hedging activities. The
Company believes the governance structure that it has in place is adequate given the size and
sophistication of its hedging program.

Financial Market Risk

The vast majority of the Company’s tangible assets are aircraft, which are long-lived. The Company’s
strategy is to maintain a conservative balance sheet and grow capacity steadily and profitably under the
right conditions. While the Company uses financial leverage, it strives to maintain a strong balance
sheet and has a “BBB+” rating with Fitch, a “BBB+” rating with Standard & Poor’s, and an “A3”

77

credit rating with Moody’s as of December 31, 2017, all of which are considered “investment grade.”
The Company’s French Credit Agreements due 2018 do not give rise to significant fair value risk but
do give rise to interest rate risk because this borrowing was originally issued as floating-rate debt. In
addition, as disclosed in Note 10 to the Consolidated Financial Statements, the Company has converted
certain of its long-term debt to floating rate debt by entering into an interest rate swap agreement.
Although there is interest rate risk associated with these floating rate borrowings, the risk of the French
Credit Agreements due 2018 is somewhat mitigated by the fact that the Company may prepay this debt
under certain conditions. See Note 6 to the Consolidated Financial Statements for more information on
the material terms of the Company’s short-term and long-term debt.

As of December 31, 2017, excluding the notes or debentures that have been converted to a floating
rate, the Company’s fixed-rate senior unsecured notes outstanding included its $300 million 2.75%
senior unsecured notes due 2022, its $300 million 3.00% senior unsecured notes due 2026, its
$100 million 7.375% senior unsecured notes due 2027, and its $300 million 3.45% senior unsecured
notes due 2027. The $100 million 7.375% senior unsecured notes due 2027 had at one point been
converted to a floating rate, but the Company subsequently terminated the fixed-to-floating interest rate
swap agreements related to it. The effect of this termination was that the interest associated with this
debt prospectively reverted back to its original fixed rate. As a result of the gain realized on this
transaction, which is being amortized over the remaining term of the corresponding notes, and based
on projected interest rates at the date of termination, the Company does not believe its future interest
expense, based on projected future interest rates at the date of termination, associated with these notes
will significantly differ from the expense it would have recorded had the notes remained at floating
rates. The following table displays the characteristics of the Company’s secured fixed rate debt as of
December 31, 2017:

Principal
amount
(in millions)

Effective
fixed rate

Final
maturity

Underlying collateral

Term Loan Agreement

$

Term Loan Agreement

Term Loan Agreement

66

19

237

6.315%

4.84%

5.223%

5/6/2019 14 specified Boeing 737-700 aircraft

7/1/2019

4 specified Boeing 737-700 aircraft

5/9/2020 21 specified Boeing 737-700 aircraft

The carrying value of the Company’s floating rate debt totaled $1.0 billion, and this debt had a
weighted-average maturity of 3.04 years at floating rates averaging 2.42 percent for the year ended
December 31, 2017. In total, the Company’s fixed-rate debt and floating rate debt represented
13 percent and 5 percent, respectively, of consolidated noncurrent assets at December 31, 2017.

The Company also has some risk associated with changing interest rates due to the short-term nature of
its invested cash, which totaled $1.5 billion, and short-term investments, which totaled $1.8 billion at
December 31, 2017. See Notes 1 and 11 to the Consolidated Financial Statements for further
information. The Company currently invests available cash in certificates of deposit, highly rated
money market instruments, investment grade commercial paper, treasury securities, U.S. government
agency securities, and other highly rated financial instruments, depending on market conditions and
operating cash requirements. Because of the short-term nature of these investments, the returns earned
parallel closely with short-term floating interest rates. The Company has not undertaken any additional
actions to cover interest rate market risk and is not a party to any other material market interest rate
risk management activities.

78

A hypothetical 10 percent change in market interest rates as of December 31, 2017, would not have a
material effect on the fair value of the Company’s fixed-rate debt instruments. See Note 11 to the
Consolidated Financial Statements for further information on the fair value of financial instruments. A
change in market interest rates could, however, have a corresponding effect on earnings and cash flows
associated with the Company’s floating-rate debt, invested cash (excluding cash collateral deposits
held, if applicable), floating-rate aircraft leases, and short-term investments because of the floating-rate
nature of these items. Assuming floating market rates in effect as of December 31, 2017 were held
constant throughout a 12-month period, a hypothetical 10 percent change in those rates would have an
immaterial impact on the Company’s net earnings and cash flows. Utilizing these assumptions and
considering the Company’s cash balance (excluding the impact of cash collateral deposits held or
provided to counterparties, if applicable), short-term investments, and floating-rate debt outstanding at
December 31, 2017, an increase in rates would have a net positive effect on the Company’s earnings
and cash flows, while a decrease in rates would have a net negative effect on the Company’s earnings
and cash flows. However, a 10 percent change in market rates would not impact the Company’s
earnings or cash flow associated with the Company’s publicly traded fixed-rate debt.

The Company is also subject to a financial covenant included in its revolving credit facility, and is
subject to credit rating triggers related to its credit card transaction processing agreements, the pricing
related to any funds drawn under its revolving credit facility, and some of its hedging counterparty
agreements. Certain covenants include the maintenance of minimum credit ratings and/or triggers that
are based on changes in these ratings. The Company’s revolving credit facility contains a financial
covenant requiring a minimum coverage ratio of adjusted pre-tax income to fixed obligations, as
defined. As of December 31, 2017, the Company was in compliance with this covenant and there were
no amounts outstanding under the revolving credit facility. However, if conditions change and the
Company fails to meet the minimum standards set forth in the revolving credit facility, there could be a
reduction in the availability of cash under the facility, or an increase in the costs to keep the facility
intact as written. The Company’s hedging counterparty agreements contain ratings triggers in which
cash collateral could be required to be posted with the counterparty if the Company’s credit rating were
to fall below investment grade by two of the three major rating agencies, and if the Company was in a
net liability position with the counterparty. See Note 10 to the Consolidated Financial Statements for
further information.

The Company currently has agreements with organizations that process credit card transactions arising
from purchases of air travel tickets by its Customers utilizing American Express, Discover, and
MasterCard/VISA. Credit card processors have financial risk associated with tickets purchased for
travel because the processor generally forwards the cash related to the purchase to the Company soon
after the purchase is completed, but the air travel generally occurs after that time; therefore, the
processor will have liability if the Company does not ultimately provide the air travel. Under these
processing agreements, and based on specified conditions, increasing amounts of cash reserves could
be required to be posted with the counterparty.

A majority of the Company’s sales transactions are processed by Chase Paymentech. Should
chargebacks processed by Chase Paymentech reach a certain level, proceeds from advance ticket sales
could be held back and used to establish a reserve account to cover such chargebacks and any other
disputed charges that might occur. Additionally, cash reserves are required to be established if the
Company’s credit rating falls to specified levels below investment grade. Cash reserve requirements
are based on the Company’s public debt rating and a corresponding percentage of the Company’s Air
traffic liability.

79

As of December 31, 2017, the Company was in compliance with all credit card processing agreements.
The inability to enter into credit card processing agreements would have a material adverse effect on
the business of the Company. The Company believes that it will be able to continue to renew its
existing credit card processing agreements or will be able to enter into new credit card processing
agreements with other processors in the future.

80

Item 8.

Financial Statements and Supplementary Data

Southwest Airlines Co.
Consolidated Balance Sheet
(in millions, except share data)

December 31, 2017

December 31, 2016

ASSETS
Current assets:

Cash and cash equivalents
Short-term investments
Accounts and other receivables
Inventories of parts and supplies, at cost
Prepaid expenses and other current assets

Total current assets

Property and equipment, at cost:

Flight equipment
Ground property and equipment
Deposits on flight equipment purchase contracts
Assets constructed for others

Less allowance for depreciation and amortization

Goodwill
Other assets

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:

Accounts payable
Accrued liabilities
Air traffic liability
Current maturities of long-term debt

Total current liabilities

Long-term debt less current maturities
Deferred income taxes
Construction obligation
Other noncurrent liabilities
Stockholders’ equity:

Common stock, $1.00 par value: 2,000,000,000 shares authorized;

807,611,634 shares issued in 2017 and 2016

Capital in excess of par value
Retained earnings
Accumulated other comprehensive income (loss)
Treasury stock, at cost: 219,060,856 and 192,450,855 shares

in 2017 and 2016 respectively
Total stockholders’ equity

See accompanying notes.

81

$

$

$

$

$

$

$

1,495
1,778
662
420
460
4,815

21,368
4,399
919
1,543
28,229
9,690
18,539
970
786
25,110

1,320
1,777
3,460
348
6,905

3,320
2,358
1,390
707

808
1,451
14,621
12

(6,462)
10,430
25,110

$

1,680
1,625
546
337
310
4,498

20,275
3,779
1,190
1,220
26,464
9,420
17,044
970
774
23,286

1,178
1,985
3,115
566
6,844

2,821
3,374
1,078
728

808
1,410
11,418
(323)

(4,872)
8,441
23,286

Southwest Airlines Co.
Consolidated Statement of Income
(in millions, except per share amounts)

OPERATING REVENUES:

Passenger

Freight

Special revenue adjustment

Other

Total operating revenues

OPERATING EXPENSES:

Salaries, wages, and benefits

Fuel and oil

Maintenance materials and repairs

Aircraft rentals

Landing fees and other rentals

Depreciation and amortization

Acquisition and integration

Other operating expenses

Total operating expenses

Year ended December 31,

2017

2016

2015

$

19,141

$

18,594

$

18,299

173

—

1,857

21,171

7,319

3,940

1,001

198

1,292

1,218

—

2,688

17,656

171

—

1,660

20,425

6,798

3,647

1,045

229

1,211

1,221

—

2,514

16,665

179

172

1,170

19,820

6,383

3,616

1,005

238

1,166

1,015

39

2,242

15,704

OPERATING INCOME

3,515

3,760

4,116

OTHER EXPENSES (INCOME):

Interest expense

Capitalized interest

Interest income

Other (gains) losses, net

Total other expenses (income)

INCOME BEFORE INCOME TAXES

PROVISION FOR INCOME TAXES

NET INCOME

NET INCOME PER SHARE, BASIC

NET INCOME PER SHARE, DILUTED

Cash dividends declared per common share

See accompanying notes.

114

(49)

(35)

234

264

3,251

(237)

3,488

5.80

5.79

.4750

$

$

$

$

122

(47)

(24)

162

213

3,547

1,303

2,244

3.58

3.55

.3750

$

$

$

$

121

(31)

(9)

556

637

3,479

1,298

2,181

3.30

3.27

.2850

$

$

$

$

82

Southwest Airlines Co.
Consolidated Statement of Comprehensive Income
(in millions)

Year ended December 31,

2017

2016

2015

NET INCOME

$

3,488 $

2,244 $

Unrealized gain (loss) on fuel derivative instruments,
net of deferred taxes of $185, $432, and ($181)

Unrealized gain on interest rate derivative instruments,

net of deferred taxes of $4, $5, and $6

Unrealized gain (loss) on defined benefit plan items, net

of deferred taxes of $2, ($13), and ($7)

Other, net of deferred taxes of $5, $5, and $-

317

7

3

8

735

7

(23)

9

OTHER COMPREHENSIVE INCOME (LOSS)

COMPREHENSIVE INCOME

$

$

335 $

3,823 $

728 $

2,972 $

2,181

(308)

9

(12)

(2)

(313)

1,868

See accompanying notes.

83

Southwest Airlines Co.
Consolidated Statement of Stockholders’ Equity
(in millions, except per share amounts)

Year ended December 31, 2017, 2016, and 2015

Balance at December 31, 2014

$

808 $

1,315 $

7,416 $

Common
Stock

Capital in
excess of
par value

Retained
earnings

Accumulated
other
comprehensive
income (loss)
(738)

Repurchase of common stock

Issuance of common and treasury stock
pursuant to Employee stock plans

Net tax benefit (expense) of options
exercised

Share-based compensation

Cash dividends, $.2850 per share

Comprehensive income

—

—

—

—

—

—

—

6

24

29

—

—

—

—

—

—

(188)

2,181

—

—

—

—

—

(313)

Treasury
stock
(2,026) $

Total

6,775

(1,180)

(1,180)

24

—

—

—

—

30

24

29

(188)

1,868

Balance at December 31, 2015

$

808 $

1,374 $

9,409 $

(1,051) $

(3,182) $

7,358

Repurchase of common stock

Issuance of common and treasury stock
pursuant to Employee stock plans

Conversion of 5.25% senior notes to
common stock

Share-based compensation

Cash dividends, $.3750 per share

Comprehensive income

—

—

—

—

—

—

—

8

(5)

33

—

—

—

—

—

—

(235)

2,244

—

—

—

—

—

728

(1,750)

(1,750)

12

48

—

—

—

20

43

33

(235)

2,972

Balance at December 31, 2016

$

808 $

1,410 $ 11,418 $

(323) $

(4,872) $

8,441

Repurchase of common stock

Issuance of common and treasury stock
pursuant to Employee stock plans

Share-based compensation

Cash dividends, $.4750 per share

—

—

—

—

Comprehensive income

Balance at December 31, 2017

—
808 $

$

—

4

37

—

—

—

—

—

(285)

3,488

1,451 $ 14,621 $

—

—

—

—

(1,600)

(1,600)

10

—

—

14

37

(285)

335

12 $

—

3,823
(6,462) $ 10,430

See accompanying notes.

84

Southwest Airlines Co.
Consolidated Statement of Cash Flows
(in millions)

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income
Adjustments to reconcile net income to cash provided by (used in) operating activities:

Depreciation and amortization
Loss on asset impairment
Aircraft grounding charge
Unrealized/realized (gain) loss on fuel derivative instruments
Deferred income taxes

Changes in certain assets and liabilities:

Accounts and other receivables
Other assets
Accounts payable and accrued liabilities
Air traffic liability

Cash collateral received from (provided to) derivative counterparties
Other, net

Net cash provided by operating activities

CASH FLOWS FROM INVESTING ACTIVITIES:

Capital expenditures
Assets constructed for others
Purchases of short-term investments
Proceeds from sales of short-term and other investments
Other, net

Net cash used in investing activities

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt
Proceeds from Employee stock plans
Reimbursement for assets constructed for others
Proceeds from termination of interest rate derivative instrument
Payments of long-term debt and capital lease obligations
Payments of convertible debt
Payments of cash dividends
Repayment of construction obligation
Repurchase of common stock
Other, net

Net cash used in financing activities

Year ended December 31,

2017

2016

2015

$

3,488

$

2,244

$

2,181

1,218
—
63
(50)
(1,212)

(102)
(262)
246
345
316
(121)
3,929

(2,123)
(126)
(2,380)
2,221
—
(2,408)

600
29
126
—
(592)
—
(274)
(10)
(1,600)
15
(1,706)

1,221
21
—
(200)
455

(50)
(119)
226
125
535
(165)
4,293

(2,038)
(109)
(2,388)
2,263
—
(2,272)

515
29
107
—
(523)
(68)
(222)
(9)
(1,750)
(3)
(1,924)

1,015
—
—
113
(109)

(88)
103
961
94
(570)
(462)
3,238

(2,041)
(102)
(1,986)
2,223
(7)
(1,913)

500
46
24
12
(213)
—
(180)
(10)
(1,180)
(23)
(1,024)

NET CHANGE IN CASH AND CASH EQUIVALENTS

(185)

97

301

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

1,680

1,583

1,282

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

1,495

$

1,680

$

1,583

CASH PAYMENTS FOR:

Interest, net of amount capitalized
Income taxes

SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:

Flight equipment acquired through the assumption of debt
Flight equipment under capital leases
Assets constructed for others

See accompanying notes.

85

$
$

$
$
$

81
992

$
$

— $
$
$

233
197

100
902

20
307
196

$
$

$
$
$

105
1,440

—
193
192

Southwest Airlines Co.
Notes to Consolidated Financial Statements

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

the former parent company of AirTran Airways,

Southwest Airlines Co. (the “Company”) operates Southwest Airlines, a major domestic airline. The
Consolidated Financial Statements include the accounts of the Company and its wholly owned
subsidiaries, which include AirTran Holdings, LLC, the successor to AirTran Holdings, Inc. (“AirTran
Holdings”),
(“AirTran Airways”). The
accompanying Consolidated Financial Statements include the results of operations and cash flows for
all periods presented and all significant inter-entity balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted accounting principles in
the United States (GAAP) requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Actual results could differ from
these estimates.

Inc.

Cash and Cash Equivalents

Cash in excess of that necessary for operating requirements is invested in short-term, highly liquid,
income-producing investments. Investments with original maturities of three months or less when
purchased are classified as cash and cash equivalents, which primarily consist of certificates of deposit,
money market funds, and investment grade commercial paper issued by major corporations and
financial institutions. Cash and cash equivalents are stated at cost, which approximates fair value.

As of December 31, 2017, $15 million in cash collateral deposits were held by the Company from its
fuel hedge counterparties and no cash collateral deposits were held by or provided by the Company to
its interest rate hedge counterparties. As of December 31, 2016, $301 million in cash collateral
deposits were provided by the Company to its fuel hedge counterparties and no cash collateral deposits
were held by or provided by the Company to its interest rate hedge counterparties. Cash collateral
amounts provided or held associated with fuel and interest rate derivative instruments are not restricted
in any way and earn interest income at an agreed upon rate that approximates the rates earned on short-
term securities issued by the U.S. Government. Depending on the fair value of the Company’s fuel and
interest rate derivative instruments, the amounts of collateral deposits held or provided at any point in
time can fluctuate significantly. See Note 10 for further information on these collateral deposits and
fuel derivative instruments.

Short-term and Noncurrent Investments

Short-term investments consist of investments with original maturities of greater than three months but
less than twelve months when purchased. These are primarily short-term securities issued by the U.S.
Government and certificates of deposit issued by domestic banks. All of these investments are
classified as available-for-sale securities and are stated at fair value, which approximates cost. For all
short-term investments, at each reset period or upon reinvestment, the Company accounts for the
transaction as Proceeds from sales of short-term investments for the security relinquished, and
in the accompanying Consolidated
Purchases of short-investments for the security purchased,
Statement of Cash Flows. Unrealized gains and losses, net of tax,
if any, are recognized in
Accumulated other comprehensive income (loss) (“AOCI”) in the accompanying Consolidated

86

Balance Sheet. Realized net gains and losses on specific investments, if any, are reflected in Interest
income in the accompanying Consolidated Statement of Income. Both unrealized and realized gains
and/or losses associated with investments were immaterial for all years presented.

Noncurrent
investments consist of investments with maturities of greater than twelve months.
Noncurrent investments are included as a component of Other assets in the Consolidated Balance
Sheet.

Accounts and Other Receivables

Accounts and other receivables are carried at cost. They primarily consist of amounts due from credit
card companies associated with sales of tickets for future travel, and amounts due from business
partners in the Company’s frequent flyer program. The allowance for doubtful accounts was
immaterial at December 31, 2017 and 2016. In addition, the provision for doubtful accounts and write-
offs for 2017, 2016, and 2015 were each immaterial.

Inventories

Inventories primarily consist of aircraft fuel, flight equipment expendable parts, materials, and
supplies. All of these items are carried at average cost, less an allowance for obsolescence. These items
are generally charged to expense when issued for use. The reserve for obsolescence was $45 million
and $57 million at December 31, 2017, and 2016, respectively. In addition, the Company’s provision
for obsolescence and write-offs for 2017, 2016, and 2015 were each immaterial.

Property and Equipment

Property and equipment is stated at cost. Capital expenditures includes payments made for aircraft,
other flight equipment, purchase deposits related to future aircraft deliveries, airport and other facility
construction projects, and ground and other property and equipment. Depreciation is provided by the
straight-line method to estimated residual values over periods of approximately 25 years for flight
equipment, 5 to 30 years for ground property and equipment, and 10 to 30 years, or the expected term
of the Company’s lease if shorter, for Assets constructed for others, once the asset is placed in service.
Residual values estimated for aircraft are approximately 15 percent, for ground property and equipment
generally range from 0 to 10 percent, and for Assets constructed for others range from 17 to 75 percent.
Property under capital leases and related obligations are initially recorded at an amount equal to the
present value of future minimum lease payments computed on the basis of the Company’s incremental
borrowing rate or, when known, the interest rate implicit in the lease. Amortization of property under
capital leases is on a straight-line basis over the lease term and is included in Depreciation and
amortization expense. Leasehold improvements generally are amortized on a straight-line basis over
the shorter of the estimated useful life of the improvement or the remaining term of the lease. Assets
constructed for others primarily consists of airport improvement projects in which the Company is
considered the accounting owner of the facilities. See Note 4 for further information.

During first quarter 2016, the Company made the decision to further simplify its operations and
accelerate the retirement of its less-efficient Boeing 737-300 (“Classic”) fleet. In September 2017, the
Company retired the remaining 61 Classic aircraft as part of this accelerated retirement schedule. This
change in retirement dates was considered a change in estimate and was accounted for on a prospective
basis as of the dates the decisions were finalized. Therefore, the Company recorded accelerated
depreciation expense over the remainder of the useful lives for each Classic aircraft and related parts.
See Note 7 for further information regarding the Company’s aircraft fleet.

87

The impacts on expense and earnings from the accelerated depreciation were as follows:

(in millions, except per share amounts)

Depreciation and amortization expense

Net income *

Net income per basic share

Net income per diluted share

* net of profitsharing benefit

Year ended
December 31, 2017

Year ended
December 31, 2016

$

$

$

$

21

(19)

(0.03)

(0.03)

$

$

$

$

123

(66)

(0.11)

(0.10)

The Company evaluates its long-lived assets used in operations for impairment when events and
circumstances indicate that the undiscounted cash flows to be generated by that asset are less than the
carrying amounts of the asset and may not be recoverable. Factors that would indicate potential
impairment include, but are not limited to, significant decreases in the market value of the long-lived
asset(s), a significant change in the long-lived asset’s physical condition, and operating or cash flow
losses associated with the use of the long-lived asset. If an asset is deemed to be impaired, an
impairment loss is recorded for the excess of the asset book value in relation to its estimated fair value.

Aircraft and Engine Maintenance

The cost of scheduled inspections and repairs and routine maintenance costs for all aircraft and engines
are charged to Maintenance materials and repairs expense as incurred. The Company has maintenance
agreements related to certain of its aircraft engines with external service providers, including a
“power-by-the-hour” agreement associated with its Boeing 737-700 fleet. Under these agreements,
which the Company has determined effectively transfer the risk and create an obligation associated
with the maintenance on such engines to the counterparty, expense is recorded commensurate with
each hour flown on an engine. In situations where the payments to the counterparty do not sufficiently
match the level of services received during the period, expense is recorded on a straight-line basis over
the term of the agreement based on the Company’s best estimate of expected future aircraft utilization.
For its engine maintenance contracts that do not transfer risk to the service provider, the Company
records expense on a time and materials basis when an engine repair event takes place. Modifications
that significantly enhance the operating performance or extend the useful lives of aircraft or engines
are capitalized and amortized over the remaining life of the asset.

Goodwill and Intangible Assets

The Company applies a fair value based impairment test to the carrying value of goodwill and
indefinite-lived intangible assets annually on October 1st, or more frequently if certain events or
circumstances indicate that an impairment loss may have been incurred. The Company assesses the
value of goodwill and indefinite-lived assets under either a qualitative or quantitative approach. Under
a qualitative approach, the Company considers various market factors, including applicable key
assumptions listed below. These factors are analyzed to determine if events and circumstances could
reasonably have affected the fair value of goodwill and indefinite-lived intangible assets. If the
Company determines that it is more likely than not that an indefinite-lived intangible asset is impaired,
the quantitative approach is used to assess the asset’s implied fair value and the amount of the
impairment. Under a quantitative approach, the implied fair value of the Company’s identifiable assets
and liabilities is calculated based on key assumptions. If the Company assets’ carrying value exceeds

88

the fair value calculated using the quantitative approach, an impairment charge is recorded for the
difference in fair value and carrying value. During 2016, the Company recorded a $21 million
impairment charge associated with leased slots at Newark Liberty International Airport as a result of
the FAA announcement, in April 2016, that this airport was being changed to a Level 2 schedule-
facilitated airport from its previous designation as Level 3. This impairment loss was reflected in Other
Operating Expenses within the accompanying Consolidated Statement of Income. The Company does
not believe this FAA decision is indicative of a similar decision being made at the Company’s other
slot-controlled airports, Washington Reagan and New York LaGuardia.

The following table is a summary of the Company’s intangible assets, which are included as a
component of Other assets in the Company’s Consolidated Balance Sheet, as of December 31, 2017
and 2016:

Year ended December 31, 2017 Year ended December 31, 2016

Weighted-
average useful
life (in years)

Gross carrying
amount

Accumulated
amortization

Gross carrying
amount

Accumulated
Amortization

(in millions)

Customer relationships/
marketing agreements

10

$

Owned domestic slots (a)

Indefinite

Gate leasehold rights (a)

Total

15

14

$

27

295

180

502

$

$

23

n/a

66

89

$

$

38

295

180

513

$

$

32

n/a

55

87

(a) Intangible assets primarily consist of acquired leasehold rights to certain airport owned gates, takeoff and
landing slots (a “slot” is the right of an air carrier, pursuant to regulations of the FAA, to operate a takeoff or
landing at a specific time at certain airports) at certain domestic slot-controlled airports, and certain intangible
assets acquired.

The Company’s definite lived assets are amortized on a straight-line basis over the useful life of the
asset. The aggregate amortization expense for 2017, 2016, and 2015 was $13 million, $17 million, and
$19 million, respectively. Estimated aggregate amortization expense for the five succeeding years and
thereafter is as follows: 2018 – $13 million, 2019 – $13 million, 2020 – $12 million, 2021 –
$12 million, 2022 – $12 million, and thereafter – $56 million.

Revenue Recognition

Tickets sold are initially deferred as Air traffic liability. Passenger revenue is recognized when
transportation is provided. Air traffic liability primarily represents tickets sold for future travel dates
and funds that are past flight date and remain unused. The majority of the Company’s tickets sold are
nonrefundable. Refundable tickets that are sold but not flown on the travel date can be reused for
another flight, up to a year from the date of sale, or refunded, subject to certain conditions. A small
percentage of tickets (or partial tickets) expire unused. The Company has a No Show policy that
applies to fares that are not canceled or changed by a Customer at least ten minutes prior to a flight’s
scheduled departure. Based on the Company’s revenue recognition policy, revenue is recorded at the
flight date for a Customer who does not change his/her itinerary and loses his/her funds. Amounts
collected from passengers for ancillary service fees are generally recognized as Other revenue when
the service is provided, which is typically the flight date.

The Company’s policy is to record Passenger revenue for the estimated spoilage of tickets (including
partial tickets) once the flight date has passed under the redemption method. Initial spoilage estimates

89

are routinely adjusted and ultimately finalized once the tickets expire, which is typically twelve months
after the original purchase date. Spoilage estimates are based on the Customers’ historical travel
behavior as well as assumptions about the Customers’ future travel behavior. Assumptions used to
generate spoilage estimates can be impacted by several factors including, but not limited to: fare
increases, fare sales, events leading to significant flight cancellations, changes to the Company’s
ticketing policies, changes to the Company’s refund, exchange and unused funds policies, and
economic factors.

The Company is also required to collect certain taxes and fees from Customers on behalf of
government agencies and remit these back to the applicable governmental entity on a periodic basis.
These taxes and fees include foreign and U.S. federal transportation taxes, federal security charges, and
airport passenger facility charges. These items are collected from Customers at the time they purchase
their tickets, but are not included in Passenger revenue. The Company records a liability upon
collection from the Customer and relieves the liability when payments are remitted to the applicable
governmental agency.

Frequent Flyer Program

The Company records a liability for the estimated incremental cost of providing free travel under its
frequent flyer program for all amounts earned from flight activity that are expected to be redeemed for
future travel. The estimated incremental cost includes direct passenger costs such as fuel, food, and
other operational costs, but does not include any contribution to fixed overhead costs or profit.

The Company also sells frequent flyer points and related services to companies participating in its
frequent flyer program. Historically, until July 1, 2015, funds received from the sale of points
associated with these agreements were accounted for under the residual method. Under this method,
the Company estimated the portion of the amounts received from the sale of frequent flyer points that
related to free travel and these amounts were deferred and recognized as Passenger revenue when the
ultimate free travel awards were flown. Effective July 1, 2015, the Company entered into an amended
co-branded credit card agreement (“Agreement”) with Chase Bank USA, N.A. (“Chase”), through
which the Company sells loyalty points and other items to Chase. This material modification triggered
a required accounting change under Accounting Standards Update (“ASU”) No. 2009-13, which was
recorded on a prospective basis. The impact of the accounting change is that the Company estimated
the selling prices and volumes over the term of the Agreement in order to determine the allocation of
proceeds to each of the deliverables (travel points to be awarded; use of the Southwest Airlines’ brand
and access to Rapid Reward Member lists; advertising elements; and the Company’s resource team).
The Company records passenger revenue related to air transportation and certificates for discounted
companion travel when the transportation is delivered. The other elements are recognized as Other—
net revenue when earned.

The Company followed the transition approach of ASU No. 2009-13, which required that the Company
adjust the existing deferred revenue balance, classified within Air traffic liability, to reflect the value,
on a relative selling price basis, of any undelivered element remaining at the date of contract
modification. The relative selling price of the undelivered element (air transportation) was lower than
the rate at which it had been deferred under the residual method, and the Company recorded a
one-time, non-cash adjustment to decrease frequent flyer deferred revenue and increase revenue
through the recording of a Special revenue adjustment of $172 million in 2015. The estimated impacts

90

on revenue and earnings associated with the Agreement and the resulting required change in
accounting methodology recognized subsequent to the effective date of July 1, 2015, are as follows:

(in millions, except per share amounts)

Year ended
December 31, 2017

Year ended
December 31, 2016

Year ended
December 31, 2015

Passenger revenue

Special revenue adjustment

Other revenue

Operating revenues

Net income

Net income per basic share

Net income per diluted share

$

$

$

$

$

(364)

$

(250)

$

—

908

544

496

0.82

0.82

$

$

$

$

—

794

544

293

0.47

0.46

$

$

$

$

(89)

172

344

427

227

0.34

0.34

For all points sold to business partners that are expected to expire unused, the Company recognizes
spoilage in accordance with the redemption method. The Company’s consolidated liability associated
with the sale of frequent flyer points, was approximately $1.6 billion and $1.4 billion as of
December 31, 2017, and 2016, respectively, which is classified within Air traffic liability. The
Company continues to evaluate spoilage annually in October, but these analyses have not resulted in
material adjustments in 2015, 2016, or 2017.

Advertising

Advertising costs are charged to expense as incurred. Advertising and promotions expense for the
years ended December 31, 2017, 2016, and 2015 was $224 million, $232 million, and $218 million,
respectively, and is included as a component of Other operating expense in the accompanying
Consolidated Statement of Income.

Share-based Employee Compensation

The Company has share-based compensation plans covering certain Employees, including a plan that
also covers the Company’s Board of Directors. The Company accounts for share-based compensation
based on its grant date fair value. See Note 9 for further information.

Financial Derivative Instruments

The Company accounts for financial derivative instruments at fair value and applies hedge accounting
rules where appropriate. The Company utilizes various derivative instruments, including jet fuel, crude
oil, unleaded gasoline, and heating oil-based derivatives, to attempt to reduce the risk of its exposure to
jet fuel price increases. These instruments consist primarily of purchased call options, collar structures,
call spreads, put spreads, and fixed price swap agreements, and upon proper qualification are
accounted for as cash-flow hedges. The Company also has interest rate swap agreements to convert a
portion of its fixed-rate debt to floating rates and has swap agreements that convert certain floating-rate
debt to a fixed-rate. These interest rate hedges are appropriately designated as either fair value hedges
or as cash flow hedges.

Since the majority of the Company’s financial derivative instruments are not traded on a market
exchange, the Company estimates their fair values. Depending on the type of instrument, the values are

91

determined by the use of present value methods or option value models with assumptions about
commodity prices based on those observed in underlying markets. Also, since there is not a reliable
forward market for jet fuel, the Company must estimate the future prices of jet fuel in order to measure
the effectiveness of the hedging instruments in offsetting changes to those prices. Forward jet fuel
prices are estimated through utilization of a statistical-based regression equation with data from market
forward prices of like commodities. This equation is then adjusted for certain items, such as
transportation costs, that are stated in the Company’s fuel purchasing contracts with its vendors.

For the effective portion of settled fuel hedges, the Company records the associated gains or losses as a
component of Fuel and oil expense in the Consolidated Statement of Income. For amounts representing
ineffectiveness, as defined, or changes in fair value of derivative instruments for which hedge
accounting is not applied, the Company records any gains or losses as a component of Other (gains)
losses, net, in the Consolidated Statement of Income. Amounts that are paid or received in connection
with the purchase or sale of financial derivative instruments (i.e., premium costs of option contracts)
are classified as a component of Other (gains) losses, net, in the Consolidated Statement of Income in
the period in which the instrument settles or expires. All cash flows associated with purchasing and
selling derivatives are classified as operating cash flows in the Consolidated Statement of Cash Flows,
within Changes in certain assets and liabilities. See Note 10 for further information on hedge
accounting and financial derivative instruments.

The Company classifies its cash collateral provided to or held from counterparties in a “net”
presentation on the Consolidated Balance Sheet against the fair value of the derivative positions with
those counterparties. See Note 10 for further information.

Software Capitalization

included as a component of Ground property and equipment

The Company capitalizes certain internal and external costs related to the acquisition and development
of internal use software during the application development stages of projects. The Company amortizes
these costs using the straight-line method over the estimated useful life of the software, which is
typically five to fifteen years. Costs incurred during the preliminary project or
the post-
implementation/operation stages of the project are expensed as incurred. Capitalized computer
software,
in the accompanying
Consolidated Balance Sheet, net of accumulated depreciation, was $654 million and $544 million at
December 31, 2017, and 2016,
software depreciation expense was
$168 million, $111 million, and $106 million for the years ended December 31, 2017, 2016, and 2015,
respectively, and is included as a component of Depreciation and amortization expense in the
accompanying Consolidated Statement of Income. The Company evaluates internal use software for
impairment on a quarterly basis; if it is determined the value of an asset was not recoverable or it
qualifies for impairment, a charge would be recorded to write down the software to the lower of its
carrying value or fair value. The Company had no significant impairments during 2017, 2016, or 2015.

respectively. Computer

Income Taxes

The Company accounts for deferred income taxes utilizing an asset and liability method, whereby
deferred tax assets and liabilities are recognized based on the tax effect of temporary differences
between the financial statements and the tax basis of assets and liabilities, as measured by current
enacted tax rates. The Company also evaluates the need for a valuation allowance to reduce deferred
tax assets to estimated recoverable amounts.

92

The Company’s policy for recording interest and penalties associated with uncertain tax positions is to
record such items as a component of income before income taxes. Penalties are recorded in Other
(gains) losses, net, and interest paid or received is recorded in Interest expense or Interest income,
respectively, in the Consolidated Statement of Income. Amounts recorded for penalties and interest
related to uncertain tax positions were immaterial for all years presented. See Note 14 for further
information.

Concentration Risk

Approximately 83 percent of the Company’s full-time equivalent Employees are unionized and are
covered by collective-bargaining agreements. A small percentage of the Company’s unionized
Employees, including its Mechanics and Material Specialists, are in discussions on labor agreements.
Those unionized Employee groups in discussions represent approximately 4.9 percent of the
Company’s full-time equivalent Employees as of December 31, 2017.

The Company attempts to minimize its concentration risk with regards to its cash, cash equivalents,
and its investment portfolio. This is accomplished by diversifying and limiting amounts among
different counterparties, the type of investment, and the amount invested in any individual security or
money market fund.

To manage risk associated with financial derivative instruments held, the Company selects and will
periodically review counterparties based on credit ratings, limits its exposure to a single counterparty,
and monitors the market position of the program and its relative market position with each
counterparty. The Company also has agreements with counterparties containing early termination
rights and/or bilateral collateral provisions whereby security is required if market risk exposure
exceeds a specified threshold amount or credit ratings fall below certain levels. Collateral deposits
provided to or held from counterparties serve to decrease, but not totally eliminate, the credit risk
associated with the Company’s hedging program. See Note 10 for further information.

As of December 31, 2017, the Company operated an all-Boeing fleet, all of which are variations of the
Boeing 737. If the Company was unable to acquire additional aircraft or associated aircraft parts from
Boeing, or Boeing was unable or unwilling to make timely deliveries of aircraft or to provide adequate
support for its products, the Company’s operations would be materially adversely impacted. In
addition, the Company would be materially adversely impacted in the event of a mechanical or
regulatory issue associated with the Boeing 737 aircraft type, whether as a result of downtime for part
or all of the Company’s fleet, increased maintenance costs, or because of a negative perception by the
flying public. The Company is also dependent on sole suppliers for aircraft engines and certain other
aircraft parts and would,
therefore, also be materially adversely impacted in the event of the
unavailability of, or a mechanical or regulatory issue associated with, engines and other parts.

The Company has historically entered into agreements with some of its co-brand, payment, and loyalty
partners that contain exclusivity aspects which place certain confidential restrictions on the Company
from entering into certain arrangements with other payment and loyalty partners. These arrangements
generally extend for the terms of the agreements, none of which currently extend beyond May 2022.
The Company believes the financial benefits generated by the exclusivity aspects of
these
arrangements outweigh the risks involved with such agreements.

93

2. NEW ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING CHANGES

the Financial Accounting Standards Board (the “FASB”)

On August 28, 2017,
issued ASU
No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. The standard amends the
hedge accounting model to enable entities to better portray the economics of their risk management
activities in the financial statements and enhance the transparency and understandability of hedge
results. The amendments also simplify the application of hedge accounting in certain situations. This
ASU is effective for fiscal years, and interim periods within those years, beginning after December 15,
2018, with early adoption permitted in any interim or annual period. The Company plans to adopt this
ASU as of January 1, 2018. See Note 10 for further information on current accounting for financial
derivative instruments. The most significant
impacts of this ASU on the Company’s financial
statements is the elimination of the requirement to separately measure and report ineffectiveness for all
cash flow hedges in a hedging relationship, as well as a change in classification of premium expense
associated with option contracts. The estimate of the cumulative effect of the adjustment to move the
reporting of ineffectiveness as of January 1, 2018, to Accumulated other comprehensive income (loss)
from Retained earnings, is an approximate $20 million loss, net of taxes. Historically amounts that are
paid or received in connection with the purchase or sale of financial derivative instruments (i.e.,
premium costs of option contracts) have been classified as a component of Other (gains) losses, net, in
the Consolidated Statement of Income in the period in which the instrument settles or expires. Under
the new ASU, such amounts are reflected as a component of the line item to which the hedge relates,
which in the case of the Company’s jet fuel hedges is Fuel and oil expense. This ASU requires
prospective adoption. However, as previous hedge accounting rules did not specify the classification of
such premium expense, and such provision only consists of a reclassification of expense between
income statement line items, the Company will retrospectively apply this reclassification to prior
period financial statements in 2018 in order to enhance comparability. For the Company’s full year
2017 and 2016 results, the amounts to be reclassified in 2018 are $135 million and $153 million,
respectively.

On March 10, 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic
Pension Cost and Net Periodic Postretirement Benefit Cost. The standard requires employers to present
the service cost component of the net periodic benefit cost in the same income statement line item as
other employee compensation costs arising from services rendered during the period. The other
components of net benefit cost, including amortization of prior service cost/credit, and settlement and
curtailment effects, are to be included in nonoperating expenses. This ASU requires retrospective
application and is effective for fiscal years, and interim periods within those years, beginning after
December 15, 2017. The Company thus will reclassify $14 million and $12 million of Salaries, wages,
and benefits expense to Other (gains) and losses within the Consolidated Statement of Income for years
ended 2017 and 2016, respectively. The Company will adopt this guidance as of January 1, 2018.

On January 26, 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill
Impairment. The standard simplifies the accounting for goodwill impairment by removing Step 2 of the
goodwill impairment test (as defined by the FASB), which requires a hypothetical purchase price
allocation (implied fair value of goodwill) to measure impairment loss. This ASU is effective for fiscal
years, and interim periods within those years, beginning after December 15, 2019, with early adoption
permitted. The Company does not expect this ASU to have a significant impact on its financial
statement presentation or results.

On February 25, 2016, the FASB issued ASU No. 2016-02, Leases. The standard is effective for fiscal
years, and interim periods within those years, beginning after December 15, 2018, with early adoption

94

permitted. The guidance requires lessees to recognize a right-of-use asset and a lease liability on the
balance sheet for all leases (with the exception of short-term leases) at the lease commencement date
and recognize expenses on the income statement in a similar manner to the current guidance in
Accounting Standards Codification 840, Leases. The lease liability will be measured at the present
value of the unpaid lease payments and the right-of-use asset will be derived from the calculation of
the lease liability. Lease payments will include fixed and in-substance fixed payments, variable
payments based on an index or rate, reasonably certain purchase options, termination penalties, fees
paid by the lessee to the owners of a special-purpose entity for restructuring the transaction, and
probable amounts the lessee will owe under a residual value guarantee. Lease payments will not
include variable lease payments other than those that depend on an index or rate, any guarantee by the
lessee of the lessor’s debt, or any amount allocated to non-lease components.

The Company has formed a project team to evaluate and implement the standard, and currently
believes the most significant impact of this ASU on its accounting will be the balance sheet impact of
its aircraft operating leases, which will significantly increase assets and liabilities. See Note 7 for
further information on leases. The future lease commitments disclosed in Note 7 include contractual
payments due to lessors, but does not consider certain items that the standard requires to be assessed in
determining the final asset and liability to be reflected on the Company’s balance sheet, such as lease
renewal options and potential impairments, nor does it consider the sublease income that is due from
third parties (which will be disclosed separately). The Company also has operating leases related to
terminal operations space and other real estate leases. Although the real estate leases may also have a
substantial impact to the balance sheet, the Company does not expect the leases related to terminal
operations space to have a significant impact since variable lease payments, other than those based on
an index or rate, are excluded from the measurement of the lease liability. The Company also does not
expect the adoption of this ASU to impact any of its existing debt covenants.

In addition, the standard eliminates the current build-to-suit lease accounting guidance and could result
in derecognition of build-to-suit assets and liabilities that remained on the balance sheet after the end of
the construction period. The underlying leases for these facilities will be subject to evaluation under the
new standard.

The Company anticipates utilizing the modified retrospective transition approach to adopt the standard,
which requires application of the new guidance for all periods presented with an option to use certain
practical expedients. The Company continues to assess early adoption of this ASU as of an interim
period in 2018, and will continue to provide updates to its plans in future periods.

On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers.
Following the FASB’s finalization of a one year deferral of this standard, the ASU is now effective for
fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company
will adopt the ASU in first quarter 2018. The most significant impact of this ASU on the Company’s
accounting will be the elimination of the incremental cost method for frequent flyer accounting, which
will require the Company to re-value its liabilities associated with Customer flight points with a
relative fair value approach, resulting in a significant increase in the liabilities. The Company’s
liabilities associated with these flight points were $59 million at December 31, 2017, and the Company
currently estimates that applying a relative fair value would increase the liabilities by approximately
$1.0 billion to $1.2 billion. The adoption of the new standard is also expected to result in different
income statement classification for certain types of revenues which are currently classified as Other
revenues, but under the new ASU would be included in Passenger revenues, and certain expenses,

95

which are currently classified as Other operating expenses, but under the new ASU would be offset
against Passenger revenues. Based on the Company’s full year 2017 and 2016 results, the amounts to
be reclassified from Other revenues to Passenger revenues would have been $638 million and
$610 million, respectively. For full year 2017 and 2016, the amounts to be reclassified from Other
operating expenses to be offset against Passenger
revenues would have been approximately
$40 million in each year. The estimated impact of this ASU is expected to be a less than one percent
reduction to Operating revenues for both full year 2017 and 2016, and it will not impact any of the
Company’s existing debt covenants. The Company will adopt the standard as of January 1, 2018,
utilizing the full retrospective method of adoption allowed by the standard, in order to provide for
comparative results in all periods presented. The Company is in the process of completing its analysis
of information necessary to recast prior period results, however it does not believe there are any
remaining significant implementation topics associated with the adoption of this ASU that have not yet
been addressed.

3. NET INCOME PER SHARE

The following table sets forth the computation of basic and diluted net income per share (in millions
except per share amounts):

Year ended December 31,
2016

2015

2017

NUMERATOR:

Net income

Incremental income effect of interest on 5.25% convertible notes

Net income after assumed conversion

$

$

3,488

—

3,488

$

$

2,244

2

2,246

$

$

2,181

4

2,185

DENOMINATOR:

Weighted-average shares outstanding, basic

Dilutive effect of Employee stock options and restricted stock units

Dilutive effect of 5.25% convertible notes

Adjusted weighted-average shares outstanding, diluted

601

2

—

603

627

1

5

633

661

2

6

669

NET INCOME PER SHARE:

Basic

Diluted

4. COMMITMENTS AND CONTINGENCIES

Commitments

$

$

5.80

5.79

$

$

3.58

3.55

$

$

3.30

3.27

The Company has contractual obligations and commitments primarily with regard to future purchases
of aircraft, repayment of debt (see Note 6), and lease arrangements (see Note 7). During the year ended
December 31, 2017, the Company purchased 13 new 737 MAX 8 aircraft and 39 new 737-800 aircraft
from Boeing and acquired 18 used 737-700 aircraft from third parties under capital leases. The
Company has firm orders in place for 197 737 MAX 8 aircraft, 30 737 MAX 7 aircraft, and 26

96

737-800 aircraft, as well as options for 155 737 MAX 8 aircraft as of December 31, 2017, which are
outlined in Part I, Item 2. The Company’s capital commitments associated with these firm orders and
additional aircraft are as follows: $874 million in 2018, $666 million in 2019, $1.1 billion in 2020,
$1.3 billion in 2021, $877 million in 2022, and $5.2 billion thereafter.

Fort Lauderdale-Hollywood International Airport

In December 2013, the Company entered into an agreement with Broward County, Florida, which
owns and operates Fort Lauderdale-Hollywood International Airport, to oversee and manage the design
and construction of the airport’s Terminal 1 Modernization Project. Pursuant to an addendum entered
into during 2016, the cost of the project is not to exceed $333 million. In addition to significant
improvements to the existing Terminal 1, the project includes the design and construction of a
new five-gate Concourse A with an international processing facility. Funding for the project has come
directly from Broward County aviation sources, but flows through the Company in its capacity as
manager of the project. Major construction on the project began during third quarter 2015.
Construction of Concourse A was completed during second quarter 2017, and construction on
Terminal 1 is expected to be completed by mid-2018. The Company has determined that due to its
agreed upon role in overseeing and managing the project, it is considered the owner of the project for
accounting purposes. As such, during construction the Company records expenditures as Assets
constructed for others (“ACFO”) in the Consolidated Balance Sheet, along with a corresponding
outflow within Assets constructed for others in the Consolidated Statement of Cash Flows, and an
increase to Construction obligation (with a corresponding cash inflow from Financing activities in the
Consolidated Statement of Cash Flows) as reimbursements are received from Broward County.

Los Angeles International Airport

In March 2013, the Company executed a lease agreement (the “T1 Lease”) with Los Angeles World
Airports (“LAWA”), which owns and operates Los Angeles International Airport (“LAX”). Under the
T1 Lease, which was amended in June 2014 and September 2017, the Company is overseeing and
managing the design, development, financing, construction, and commissioning of the airport’s
to exceed $526 million (including proprietary
Terminal 1 Modernization Project at a cost not
renovations, or $510 million excluding proprietary renovations). In October 2017, the Company
executed a separate lease agreement with LAWA (the “T1.5 Lease”). The Company will oversee and
manage the design, development,
financing, construction, and commissioning of a passenger
processing facility between Terminal 1 and 2 (the “Terminal 1.5 Project”). The Terminal 1.5 Project is
expected to include ticketing, baggage claim, passenger screening, and a bus gate at a cost not to
exceed $479 million for site improvements and non-proprietary improvements.

These projects are being funded primarily using the Regional Airports Improvement Corporation (the
“RAIC”), which is a quasi-governmental special purpose entity that acts as a conduit borrower under
syndicated credit facilities provided by groups of lenders. Loans made under the separate credit
facilities for the Terminal 1 Modernization Project and the Terminal 1.5 Project are being used to fund
the development of each of these projects, and the outstanding loans will be repaid with the proceeds
of LAWA’s payments to purchase completed construction phases. The Company has guaranteed the
obligations of the RAIC under each of the credit facilities of the respective lease agreements. At
December 31, 2017, the Company’s outstanding remaining guaranteed obligations under the credit
facilities for the Terminal 1 Modernization Project and the Terminal 1.5 Project were $230 million and
$36 million, respectively.

97

Construction on the Terminal 1 Modernization Project began during 2014 and is estimated to be
completed during 2018. Construction on the Terminal 1.5 Project began during third quarter 2017 and
is estimated to be completed during 2020. The Company has determined that due to its agreed upon
role in overseeing and managing these projects, it is considered the owner of these projects for
accounting purposes. LAWA is reimbursing the Company (through the RAIC credit facilities) for the
site improvements and non-proprietary improvements, while proprietary improvements will not be
reimbursed. As a result, the costs incurred to fund these projects are included within ACFO and all
amounts that have been or will be reimbursed will be included within Construction obligation on the
accompanying Consolidated Balance Sheet.

Dallas Love Field

During 2008, the City of Dallas approved the Love Field Modernization Program (“LFMP”), a project
to reconstruct Dallas Love Field with modern, convenient air travel facilities. Pursuant to a Program
Development Agreement with the City of Dallas and the Love Field Airport Modernization
Corporation (or “LFAMC,” a Texas non-profit “local government corporation” established by the City
of Dallas to act on the City of Dallas’ behalf to facilitate the development of the LFMP), the Company
managed this project.

Although the City of Dallas received commitments from various sources that helped to fund portions
of the LFMP project, including the FAA, the Transportation Security Administration, and the City of
Dallas’ Aviation Fund, the majority of the funds used were from the issuance of bonds. The Company
guaranteed principal and interest payments on $456 million of such bonds issued by the LFAMC. As
of December 31, 2017, $424 million of principal remained outstanding. The Company utilized the
accounting guidance provided for lessees involved in asset construction. Upon completion of different
phases of the LFMP project, the Company has placed the associated assets in service and has begun
depreciating the assets over their estimated useful lives. The corresponding LFMP liabilities are being
reduced primarily through the Company’s airport rental payments to the City of Dallas as the
construction costs of this project are passed through to the Company via recurring airport rates and
charges. Major construction was effectively completed by December 31, 2014. During second quarter
2017, the City of Dallas approved using the remaining bond funds for additional terminal construction
projects which began during second quarter and are expected to be completed in 2018.

During 2015, the City of Dallas issued additional bonds for the construction of a new parking garage at
Dallas Love Field. The Company has not guaranteed the principal or interest payments on these bonds,
but remains the accounting owner of this project.

98

Construction costs recorded in ACFO for the Company’s various projects as of December 31, 2017,
and December 31, 2016, were as follows:

(in millions)

FLL Terminal

LAX Terminal 1

LAX Terminal 1.5

LFMP - Terminal

LFMP - Parking Garage

HOU International Terminal

December 31, 2017

December 31, 2016

ACFO,
Net (a)

Construction
Obligation
(b)

ACFO

ACFO,
Net (a)

Construction
Obligation
(b)

ACFO

(c) $

258 $

256 $

258 $

132 $

132 $

(c)

(c)

(c)

(c)

(d)

433

31

543

152

126

417

31

474

152

118

433

31

516

152

—

344

—

538

80

126

336

—

486

80

122

132

344

—

522

80

—

$

1,543 $

1,448 $

1,390 $

1,220 $

1,156 $

1,078

(a) Net of accumulated depreciation.
(b) Construction obligation will be reduced through future facility rent payments. These future payments are not
fixed per the lease agreement, but are variable and fluctuate based on various market and other factors outside the
control of the Company.
(c) Projects still in progress.
(d) Project completed in 2015 at Houston William P. Hobby Airport (“HOU”).

Contingencies

The Company is from time to time subject to various legal proceedings and claims arising in the
ordinary course of business, including, but not limited to, examinations by the Internal Revenue
Service (“IRS”). The Company’s management does not expect that the outcome of any of its currently
ongoing legal proceedings or the outcome of any adjustments presented by the IRS, individually or
collectively, will have a material adverse effect on the Company’s financial condition, results of
operations, or cash flow.

99

5. SUPPLEMENTAL FINANCIAL INFORMATION

(in millions)

Derivative contracts

Intangible assets, net

Capital lease receivable

Other

Other assets

(in millions)

Accounts payable trade

Salaries payable

Taxes payable

Aircraft maintenance payable
Fuel payable

Other payable

Accounts payable

(in millions)

Profitsharing and savings plans

Aircraft and other lease related obligations

Permanently grounded aircraft liability

Vacation pay

Contract ratification bonuses

Health

Derivative contracts

Workers compensation

Property and income taxes

Other

Accrued liabilities

(in millions)

Postretirement obligation

Non-current lease-related obligations

Permanently grounded aircraft liability

Other deferred compensation

Derivative contracts

Other

Other noncurrent liabilities

December 31, 2017 December 31, 2016

$

$

136

413

76

161

786

$

$

120

426

90

138

774

December 31, 2017 December 31, 2016

$

$

$

186

201

203

38
123

569

138

200

184

26
95

535

1,320

$

1,178

December 31, 2017 December 31, 2016

$

$

579

40

34 (a)

365

83

100

1

172

57

346

645

55

—

355

188

96

158

183

68

237

$

1,777

$

1,985

December 31, 2017 December 31, 2016

$

$

$

275

85

13 (a)

237

21

76

707

$

256

125

—

204

35

108

728

(a) These amounts represent the current and noncurrent portion of the Company’s cease-use liability recorded
during third quarter 2017, as a result of the Company grounding its remaining leased Boeing 737-300 aircraft on

100

September 29, 2017. The liability reflects the remaining net lease payments due and certain lease return
requirements that could have to be performed on these leased aircraft prior to their return to the lessors as of the
cease-use date, but does not include the write–off of approximately $15 million in net prepaid rents associated
with the aircraft at the grounding date, which were included in the $63 million charge recorded. See Note 7 for
further information. This loss related to the grounding of the Classic fleet was recorded to Other operating
expenses in the Consolidated Statement of Income during third quarter 2017. Approximately $3 million of this
liability was paid during fourth quarter 2017.

For further information on fuel derivative and interest rate derivative contracts, see Note 10.

Other Operating Expenses

Other operating expenses consist of distribution costs, advertising expenses, personnel expenses,
professional fees, and other operating costs, none of which individually exceed 10 percent of Operating
expenses.

6. LONG-TERM DEBT

(in millions)

5.125% Notes due March 2017

French Credit Agreements due 2018 - 2.54%

Fixed-rate 737 Aircraft Notes payable through 2018 - 7.03%

2.75% Notes due 2019

Term Loan Agreement payable through 2019 - 6.315%

Term Loan Agreement payable through 2019 - 4.84%

2.65% Notes due 2020

Term Loan Agreement payable through 2020 - 5.223%

737 Aircraft Notes payable through 2020

Term Loan Agreements payable through 2021 - 7.94%

2.75% Notes due 2022

Pass Through Certificates due 2022 - 6.24%

Term Loan Agreement payable through 2026 - 2.67%

3.00% Notes due 2026

3.45% Notes due 2027

7.375% Debentures due 2027

Capital leases

Less current maturities

Less debt discount and issuance costs

December 31, 2017 December 31, 2016

$

— $

1

3

300

66

19

491

237

155

—

300

294

215

300

300

127

885

$

$

3,693

$

348

25

3,320

$

301

14

8

301

106

28

492

284

206

20

—

324

215

300

—

130

681

3,410

566

23

2,821

AirTran Holdings is party to aircraft purchase financing facilities, and as of December 31, 2017, 17
Boeing 737 aircraft remained that were financed under floating-rate facilities. Each note is secured by a
first mortgage on the aircraft to which it relates. The notes bear interest at a floating rate per annum
equal to a margin plus the three or six-month LIBOR in effect at the commencement of each semi-

101

annual or three-month period, as applicable. As of December 31, 2017, the weighted average interest
rate was 4.81 percent. Principal and interest under the notes are payable semi-annually or every three
months as applicable. As of December 31, 2017, the remaining debt outstanding may be prepaid
without penalty under all aircraft loans provided under such facilities. The remaining notes mature in
years 2018 to 2020. As discussed further in Note 10, a portion of the above floating-rate debt has been
effectively converted to a fixed rate via interest rate swap agreements which expire as the underlying
notes mature.

At December 31, 2017, AirTran Holdings was party to an additional aircraft purchase financing
facility, and one Boeing 737 aircraft was financed under the fixed-rate facility. The note is secured by a
first mortgage on the aircraft to which it relates. As of December 31, 2017, the interest rate was
7.03 percent. The remaining note matured on January 11, 2018.

In October 2009, AirTran Holdings completed a public offering of $115 million of convertible senior
notes due November 1, 2016. Such notes bore interest at 5.25 percent payable semi-annually, in
arrears, on May 1 and November 1. As a result of the Company’s acquisition of AirTran in 2011 and
subsequent dividends declared by the Company, the convertible senior notes were convertible into
AirTran conversion units of 169.8265 per $1,000 in principal amount of such notes. Based on the terms
of the merger agreement, the holders of these notes could receive shares of the Company’s common
stock at a conversion rate of 54.5143 shares and $615.16 in cash per $1,000 in principal amount of
such notes. During 2016, all the bonds matured, the majority of which had been converted prior to the
maturity date, with approximately 6 million shares issued and cash paid of approximately $68 million.

During November 2017, the Company issued $300 million senior unsecured notes due 2022. The notes
bear interest at 2.75 percent. Interest is payable semi-annually in arrears on May 16 and November 16,
beginning in 2018.

Also during November 2017, the Company issued $300 million senior unsecured notes due 2027. The
notes bear interest at 3.45 percent. Interest is payable semi-annually in arrears on May 16 and
November 16, beginning in 2018.

During November 2016, the Company issued $300 million senior unsecured notes due 2026. The notes
bear interest at 3.00 percent. Interest is payable semi-annually in arrears on May 15 and November 15.

During October 2016, the Company entered into a term loan agreement providing for loans to the
Company aggregating up to $215 million, to be secured by mortgages on seven of the Company’s
737-800 aircraft. The Company borrowed the full $215 million and secured this loan with the
requisite seven aircraft mortgages. The loan matures on October 31, 2026, and is repayable via semi-
annual installments of principal that begin April 30, 2018. The loan bears interest at the LIBO Rate (as
defined in the term loan agreement) plus 1.10 percent, which equates to a current rate of 2.67 percent,
and interest is payable semi-annually in installments.

During third quarter 2016, the Company entered into term loan agreements to purchase the equity
interest in four aircraft that were previously classified as operating leases, for a total of $20 million.
The loans were set to mature in years 2018 to 2021, but were paid in full on August 1, 2017, utilizing
available cash on hand.

During November 2015, the Company issued $500 million senior unsecured notes due 2020. The notes
bear interest at 2.65 percent, payable semi-annually in arrears on May 5 and November 5.

102

Concurrently, the Company entered into a fixed-to-floating interest rate swap to convert the interest on
these unsecured notes to a floating rate until their maturity. See Note 10 for further information on the
interest-rate swap agreement.

During November 2014, the Company issued $300 million senior unsecured notes due 2019. The notes
bear interest at 2.75 percent, payable semi-annually in arrears on May 6 and November 6.
Concurrently, the Company entered into a fixed-to-floating interest rate swap to convert the interest on
these unsecured notes to a floating rate until their maturity. See Note 10 for further information on the
interest-rate swap agreement.

On July 1, 2009, the Company entered into a term loan agreement providing for loans to the Company
aggregating up to $124 million, to be secured by mortgages on five of the Company’s 737-700 aircraft.
The Company borrowed the full $124 million and secured this loan with the requisite five aircraft
mortgages. The loan matures on July 1, 2019, and is repayable semi-annually in installments of
principal and interest that began January 1, 2010. The loan bears interest at a fixed rate of 4.84 percent.
In September 2015, the Company prepaid $24 million on the loan agreement, which in turn released
one of the encumbered aircraft. As such, the remaining four aircraft related to this transaction are still
encumbered as of December 31, 2017.

On April 29, 2009, the Company entered into a term loan agreement providing for loans to the
Company aggregating up to $332 million, to be secured by mortgages on 14 of the Company’s
737-700 aircraft. The Company borrowed the full $332 million and secured the loan with the requisite
14 aircraft mortgages. The loan matures on May 6, 2019, and is being repaid via quarterly installments
of principal and interest that began August 6, 2009. The loan bears interest at the LIBO Rate (as
defined in the term loan agreement) plus 3.30 percent. Pursuant to the terms of the term loan
agreement, the Company entered into an interest rate swap agreement to convert the variable rate on
the term loan to a fixed 6.315 percent until maturity.

On May 6, 2008, the Company entered into a term loan agreement providing for loans to the Company
aggregating up to $600 million, to be secured by first-lien mortgages on 21 of the Company’s 737-700
aircraft. On May 9, 2008, the Company borrowed the full $600 million and secured these loans with
the requisite 21 aircraft mortgages. The loans mature on May 9, 2020, and are repayable quarterly in
installments of principal and interest, with the first payment made on August 9, 2008. The loans bear
interest at the LIBO Rate (as defined in the term loan agreement) plus 0.95 percent. Pursuant to the
terms of the term loan agreement, the Company entered into an interest rate swap agreement to convert
the variable rate on the term loan to a fixed 5.223 percent until maturity.

On October 3, 2007, grantor trusts established by the Company issued $500 million Pass Through
Certificates consisting of $412 million 6.15 percent Series A certificates and $88 million 6.65 percent
Series B certificates. A separate trust was established for each class of certificates. The trusts used the
proceeds from the sale of certificates to acquire equipment notes in the same amounts, which were
issued by the Company on a full recourse basis. Payments on the equipment notes held in each trust
will be passed through to the holders of certificates of such trust. The equipment notes were issued for
each of 16 Boeing 737-700 aircraft owned by the Company and are secured by a mortgage on each
aircraft. Beginning February 1, 2008, principal and interest payments on the equipment notes held for
both series of certificates are due semi-annually until the balance of the certificates mature on
August 1, 2022. Prior to their issuance, the Company also entered into swap agreements to hedge the
variability in interest rates on the Pass Through Certificates. The swap agreements were accounted for

103

as cash flow hedges, and resulted in a payment by the Company of $20 million upon issuance of the
Pass Through Certificates. The effective portion of the hedge is being amortized to interest expense
concurrent with the amortization of the debt and is reflected in the above table as a reduction in the
debt balance. The ineffectiveness of the hedge transaction was immaterial.

During February 2005, the Company issued $300 million senior unsecured notes due 2017. The notes
bore interest at 5.125 percent, payable semi-annually in arrears. The notes matured and were redeemed
in full on March 1, 2017, utilizing available cash on hand.

In fourth quarter 2004, the Company entered into four identical 13-year floating-rate financing
arrangements, whereby it borrowed a total of $112 million from French banking partnerships.
inception that,
Although the interest rates on the borrowings float,
considering the full effect of the “net present value benefits” included in the transactions, the effective
economic yield over the 13-year term of the loans will be approximately LIBOR minus 45 basis points.
Principal and interest are payable semi-annually on June 30 and December 31 for each of the loans,
and the Company may terminate the arrangements in any year on either of those dates, under certain
conditions. The Company pledged four aircraft as collateral for the transactions.

the Company estimated at

On February 28, 1997, the Company issued $100 million of senior unsecured 7.375 percent debentures
due March 1, 2027. Interest is payable semi-annually on March 1 and September 1. The debentures
may be redeemed, at the option of the Company, in whole at any time or in part from time to time, at a
redemption price equal to the greater of the principal amount of the debentures plus accrued interest at
the date of redemption or the sum of the present values of the remaining scheduled payments of
principal and interest thereon, discounted to the date of redemption at the comparable treasury rate plus
20 basis points, plus accrued interest at the date of redemption.

The Company is required to provide standby letters of credit to support certain obligations that arise in
the ordinary course of business. Although the letters of credit are an off-balance sheet item, the
majority of the obligations to which they relate are reflected as liabilities in the Consolidated Balance
Sheet. Outstanding letters of credit totaled $167 million at December 31, 2017.

The Company has pledged a total of up to 77 of its Boeing 737-700 and 7 of its Boeing 737-800
aircraft at a net book value of $1.8 billion, as collateral for the Company’s secured borrowings at
December 31, 2017. In addition, the Company has pledged a total of up to 82 of its Boeing 737-700
and 37 of its Boeing 737-800 aircraft at a net book value of $2.8 billion, in the case that it has
obligations related to its fuel derivative instruments with counterparties that exceed certain thresholds.
See Note 10 for further information on these collateral arrangements.

As of December 31, 2017, aggregate annual principal maturities of debt and capital leases (not
including amounts associated with interest
leases,
amortization of capital lease incentives, and amortization of purchase accounting adjustments) for the
five-year period ending December 31, 2022, and thereafter, were $335 million in 2018, $586 million in
2019, $817 million in 2020, $169 million in 2021, $473 million in 2022, and $1.2 billion thereafter.

rate swap agreements,

interest on capital

7. LEASES

The Company’s fleet included 53 aircraft on operating lease and 69 aircraft on capital lease as of
December 31, 2017, compared with 83 aircraft on operating lease and 51 aircraft on capital lease, as of

104

December 31, 2016. Amounts applicable to these aircraft on capital lease that are included in property
and equipment were:

(in millions)

Flight equipment

Less: accumulated amortization

2017

2016

$

$

1,207

$

172

1,035

$

923

82

841

Total rental expense for operating leases, both aircraft and other, charged to operations in 2017, 2016,
and 2015 was $939 million, $932 million, and $909 million, respectively. The majority of the
Company’s terminal operations space, as well as 144 aircraft, including 76 B717s subleased to Delta
and 15 Classic aircraft grounded in September 2017, were under operating leases at December 31,
2017. For aircraft operating leases and for terminal operations leases and other real estate leases,
expense is recorded on a straight–line basis and included in Aircraft rentals and in Landing fees and
other rentals, respectively, in the Consolidated Statement of Income. The majority of the Company’s
terminal operations space was under operating leases at December 31, 2017; however, due to the
nature of airport terminal lease arrangements, most of those future lease payments are considered
variable, and thus excluded from the Company’s disclosures of future minimum lease payments.
Future minimum lease payments under capital leases and noncancelable operating leases and rentals to
be received under subleases with initial or remaining terms in excess of one year at December 31,
2017, were:

(in millions)

2018

2019

2020

2021

2022

Thereafter

Total minimum lease payments

Less amount representing interest

Present value of minimum lease payments (a)

Less current portion

Long-term portion

Capital
leases

Operating
leases (b)

Subleases

$

(102)

$

(98)

(78)

(41)

(17)

(8)

Operating
leases, net

257

233

186

114

68

169

$

359

331

264

155

85

177

$

1,371

$

(344)

$

1,027

$

$

$

107

106

105

100

96

416

930

150

780

79

701

* See Note 4 for further details
(a) Excludes lease incentive obligation of $105 million.
(b) Includes 15 remaining Classic aircraft on operating leases, which net remaining lease payments were included
in the $63 million grounding charge recorded during 2017.

The aircraft leases generally can be renewed for one to five years at rates based on fair market value at
the end of the lease term. Most aircraft leases have purchase options at or near the end of the lease term
at fair market value, generally limited to a stated percentage of the lessor’s defined cost of the aircraft.

105

On July 9, 2012, the Company signed an agreement with Delta Air Lines, Inc. and Boeing Capital
Corp. to lease or sublease all 88 of AirTran Airways’ B717s to Delta at agreed-upon lease rates. As of
December 31, 2016, the Company had delivered all B717s to Delta. A total of 76 of the B717s are on
operating lease, ten are owned, and two are on capital lease.

The sublease terms for the 76 B717s on operating lease and the two B717s on capital lease coincide
with the Company’s remaining lease terms for these aircraft from the original lessor, which range from
approximately two to seven years. The leasing of the ten B717s that are owned by the Company is
subject to certain conditions, and the lease terms are for up to six years, after which Delta will have the
option to purchase the aircraft at the then-prevailing market value. The ten owned B717s are accounted
for as sales type leases, the two B717s classified by the Company as capital leases are accounted for as
direct financing leases, and the remaining 76 subleases are accounted for as operating leases with
Delta. There are no contingent payments and no significant residual value conditions associated with
the transaction.

During 2017, the Company retired its remaining 87 Classic aircraft, which included 61 Classic aircraft
grounded in September 2017 as part of an accelerated retirement schedule. The Company recorded a
charge of $63 million related to the leased portion of the Classic fleet, representing the remaining net
lease payments due and certain lease return requirements that could have to be performed on these
leased aircraft prior to their return to the lessors, as of the cease-use date.

8. COMMON STOCK

The Company has one class of capital stock, its common stock. Holders of shares of common stock are
entitled to receive dividends when and if declared by the Board of Directors and are entitled to one
vote per share on all matters submitted to a vote of the Shareholders. At December 31, 2017, the
Company had 60 million shares of common stock reserved for issuance pursuant to Employee equity
plans (of which 30 million shares had not been granted) through various share-based compensation
arrangements. See Note 9 to the Consolidated Financial Statements for information regarding the
Company’s equity plans.

9. STOCK PLANS

Share-based Compensation

The Company accounts for share-based compensation utilizing fair value, which is determined on the
date of grant for all
instruments. The Consolidated Statement of Income for the years ended
December 31, 2017, 2016, and 2015, reflects share-based compensation expense of $37 million,
$33 million, and $29 million, respectively. The total tax benefit recognized in earnings from share-
based compensation arrangements for the years ended December 31, 2017, 2016, and 2015, was not
material. As of December 31, 2017, there was $35 million of total unrecognized compensation cost
related to share-based compensation arrangements, which is expected to be recognized over a
weighted-average period of 1.8 years. The Company expects substantially all unvested awards to vest.

Restricted Stock Units and Stock Grants

Under the Company’s Amended and Restated 2007 Equity Incentive Plan (“2007 Equity Plan”), it
granted restricted stock units (“RSUs”) and performance-based restricted stock units (“PBRSUs”) to
certain Employees during 2015, 2016, and 2017. Outstanding RSUs vest over three years, subject

106

generally to the individual’s continued employment or service. The PBRSUs granted in January 2015,
January 2016, and February 2017 are subject to the Company’s performance with respect to a three-
year simple average of Return on Invested Capital, before taxes and excluding special items (“ROIC”),
for the defined performance period and the individual’s continued employment or service. The number
of PBRSUs vesting on the vesting date will be interpolated based on the Company’s ROIC
performance and ranges from zero PBRSUs to 200 percent of granted PBRSUs. Forfeiture rates are
estimated at the time of grant based on historical actuals for similar grants, and are trued-up to actuals
over the vesting period. The Company recognizes all expense on a straight-line basis over the vesting
period, with any changes in expense due to the number of PBRSUs expected to vest being modified on
a prospective basis.

Aggregated information regarding the Company’s RSUs and PBRSUs is summarized below:

Outstanding December 31, 2014

Granted

Vested

Surrendered

Outstanding December 31, 2015

Granted

Vested

Surrendered

Outstanding December 31, 2016, Unvested

Granted

Vested

Surrendered

Outstanding December 31, 2017, Unvested

(a) Includes 183 thousand PBRSUs
(b) Includes 247 thousand PBRSUs
(c) Includes 235 thousand PBRSUs

All Restricted Stock Units

Units (000)

Wtd. Average
Fair Value
(per share)

2,077

$

561 (a)

(1,095)

(58)

1,485

675 (b)

(665)

(56)

1,439

717 (c)

(806)

(56)

1,294

$

16.92

45.80

13.33

25.49

30.17

37.29

23.29

36.29

36.52

52.73

30.23

43.86

45.32

In addition, the Company granted approximately 26 thousand shares of unrestricted stock at a weighted
average grant price of $57.04 in 2017, approximately 27 thousand shares at a weighted average grant
price of $42.90 in 2016, and approximately 28 thousand shares at a weighted average grant price of
$41.27 in 2015, to members of its Board of Directors.

A remaining balance of up to 22 million shares of the Company’s common stock may be issued
pursuant to grants under the 2007 Equity Plan.

Employee Stock Purchase Plan

Under the amended 1991 Employee Stock Purchase Plan (“ESPP”), which has been approved by
Shareholders, the Company is authorized to issue up to a remaining balance of 9 million shares of the

107

Company’s common stock to Employees of the Company. These shares may be issued at a price equal
to 90 percent of the market value at the end of each monthly purchase period. Common stock
purchases are paid for through periodic payroll deductions. For the years ended December 31, 2017,
2016, and 2015, participants under the plan purchased 544 thousand shares, 622 thousand shares, and
597 thousand shares at average prices of $50.13, $36.57, and $36.40, respectively. The weighted-
average fair value of each purchase right under the ESPP granted for the years ended December 31,
2017, 2016, and 2015, which is equal to the ten percent discount from the market value of the Common
Stock at the end of each monthly purchase period, was $5.57, $4.06, and $4.04, respectively.

Taxes

Grants of RSUs result in the creation of a deferred tax asset, which is a temporary difference, until the
time the RSU vests. All excess tax benefits and tax deficiencies are recorded through the income
statement. Due to the treatment of RSUs for tax purposes, the Company’s effective tax rate from year
to year is subject to variability.

10. FINANCIAL DERIVATIVE INSTRUMENTS

Fuel Contracts

Airline operators are inherently dependent upon energy to operate and, therefore, are impacted by
changes in jet fuel prices. Furthermore, jet fuel and oil typically represent one of the largest operating
expenses for airlines. The Company endeavors to acquire jet fuel at the lowest possible cost and to
reduce volatility in operating expenses through its fuel hedging program. Although the Company may
periodically enter into jet fuel derivatives for short-term timeframes, because jet fuel is not widely
traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel for
time horizons longer than approximately 24 months into the future. However, the Company has found
that financial derivative instruments in other commodities, such as West Texas Intermediate (“WTI”)
crude oil, Brent crude oil, and refined products, such as heating oil and unleaded gasoline, can be
useful in decreasing its exposure to jet fuel price volatility. The Company does not purchase or hold
any financial derivative instruments for trading or speculative purposes.

The Company has used financial derivative instruments for both short-term and long-term time frames,
and primarily uses a mixture of purchased call options, collar structures (which include both a
purchased call option and a sold put option), call spreads (which include a purchased call option and a
sold call option), put spreads (which include a purchased put option and a sold put option), and fixed
price swap agreements in its portfolio. Although the use of collar structures and swap agreements can
reduce the overall cost of hedging, these instruments carry more risk than purchased call options in that
the Company could end up in a liability position when the collar structure or swap agreement settles.
With the use of purchased call options and call spreads, the Company cannot be in a liability position
at settlement, but does not have coverage once market prices fall below the strike price of the
purchased call option.

For the purpose of evaluating its net cash spend for jet fuel and for forecasting its future estimated jet
fuel expense, the Company evaluates its hedge volumes strictly from an “economic” standpoint and
thus does not consider whether the hedges have qualified or will qualify for hedge accounting. The
Company defines its “economic” hedge as the net volume of fuel derivative contracts held, including
the impact of positions that have been offset through sold positions, regardless of whether those
contracts qualify for hedge accounting. The level at which the Company is economically hedged for a

108

particular period is also dependent on current market prices for that period, as well as the types of
derivative instruments held and the strike prices of those instruments. For example, the Company may
enter into “out-of-the-money” option contracts (including catastrophic protection), which may not
generate intrinsic gains at settlement if market prices do not rise above the option strike price.
Therefore, even though the Company may have an economic hedge in place for a particular period, that
hedge may not produce any hedging gains at settlement and may even produce hedging losses
depending on market prices, the types of instruments held, and the strike prices of those instruments.

For 2017, the Company had fuel derivative instruments in place for up to 63 percent of its fuel
consumption. As of December 31, 2017, the Company also had fuel derivative instruments in place to
provide coverage at varying price levels, but up to a maximum of approximately 78 percent of its 2018
estimated fuel consumption, depending on where market prices settle. The following table provides
information about the Company’s volume of fuel hedging on an economic basis considering current
market prices:

Period (by year)

2018

2019

2020

Beyond 2020

Maximum fuel hedged as of
December 31, 2017
(gallons in millions) (a)

Derivative underlying commodity type as of
December 31, 2017

1,647

1,377

685

315

WTI crude and Brent crude oil

WTI crude and Brent crude oil

WTI crude oil

WTI crude oil

(a) Due to the types of derivatives utilized by the Company and different price levels of those contracts, these
volumes represent the maximum economic hedge in place and may vary significantly as market prices fluctuate.

Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow
hedges. Generally, utilizing hedge accounting, all periodic changes in fair value of the derivatives
designated as hedges that are considered to be effective are recorded in Accumulated other
comprehensive income (loss) (“AOCI”) until the underlying jet fuel is consumed. See Note 12. The
Company’s results are subject to the possibility that periodic changes will not be effective, as defined,
or that the derivatives will no longer qualify for hedge accounting. Ineffectiveness results when the
change in the fair value of the derivative instrument exceeds the change in the value of the Company’s
expected future cash outlay to purchase and consume jet fuel. To the extent that the periodic changes in
the fair value of the derivatives are ineffective, the ineffective portion is recorded to Other (gains)
losses, net, in the Consolidated Statement of Income in the period of the change. Likewise, if a hedge
ceases to qualify for hedge accounting, any change in the fair value of derivative instruments since the
last reporting period is recorded to Other (gains) losses, net, in the Consolidated Statement of Income
in the period of the change; however, any amounts previously recorded to AOCI would remain there
until such time as the original forecasted transaction occurs, at which time these amounts would be
reclassified to Fuel and oil expense. When the Company has sold derivative positions in order to
effectively “close” or offset a derivative already held as part of its fuel derivative instrument portfolio,
any subsequent changes in fair value of those positions are marked to market through earnings.
Likewise, any changes in fair value of those positions that were offset by entering into the sold
positions and were de-designated as hedges are concurrently marked to market through earnings.
However, any changes in value related to hedges that were deferred as part of AOCI while designated
as a hedge would remain until the originally forecasted transaction occurs. In a situation where it
becomes probable that a fuel hedged forecasted transaction will not occur, any gains and/or losses that

109

have been recorded to AOCI would be required to be immediately reclassified into earnings. The
Company did not have any such situations occur during 2015, 2016, or 2017.

Ineffectiveness is inherent in hedging jet fuel with derivative positions based in other crude oil related
commodities. Due to the volatility in markets for crude oil and related products, the Company is unable
to predict the amount of ineffectiveness each period, including the loss of hedge accounting, which
could be determined on a derivative by derivative basis or in the aggregate for a specific commodity.
This may result, and has resulted, in increased volatility in the Company’s financial results. Factors
that have and may continue to lead to ineffectiveness and unrealized gains and losses on derivative
contracts include: significant fluctuation in energy prices, the number of derivative positions the
Company holds, significant weather events affecting refinery capacity and the production of refined
products, and the volatility of the different types of products the Company uses in hedging. However,
even though derivatives may not qualify for hedge accounting, the Company continues to hold the
instruments as management believes derivative instruments continue to afford the Company the
opportunity to stabilize jet fuel costs.

Accounting pronouncements pertaining to derivative instruments and hedging are complex with
stringent requirements,
including the documentation of a Company hedging strategy, statistical
analysis to qualify a commodity for hedge accounting both on a historical and a prospective basis, and
strict contemporaneous documentation that is required at the time each hedge is designated by the
Company. The Company also examines the effectiveness of each individual hedge and its entire
hedging program on a quarterly basis utilizing statistical analysis. This analysis involves utilizing
regression and other statistical analyses that compare changes in the price of jet fuel to changes in the
prices of the commodities used for hedging purposes.

110

All cash flows associated with purchasing and selling fuel derivatives are classified as Other operating
cash flows in the Consolidated Statement of Cash Flows. The following table presents the location of
all assets and liabilities associated with the Company’s derivative instruments within the Consolidated
Balance Sheet:

(in millions)

Derivatives designated as hedges*
Fuel derivative contracts (gross)

Fuel derivative contracts (gross)
Fuel derivative contracts (gross)
Interest rate derivative contracts

Balance Sheet
location

Prepaid expenses and
other current assets
Other assets
Accrued liabilities
Other noncurrent

liabilities

Total derivatives designated as hedges

Derivatives not designated as hedges*
Fuel derivative contracts (gross)

Prepaid expenses and
other current assets
Other assets
Accrued liabilities
Accrued liabilities
Other noncurrent
liabilities

Fuel derivative contracts (gross)
Fuel derivative contracts (gross)
Interest rate derivative contracts
Interest rate derivative contracts

Total derivatives not designated as hedges

Total derivatives

Asset derivatives

Liability derivatives

Fair value
at
12/31/2017

Fair value
at
12/31/2016

Fair value
at
12/31/2017

Fair value
at
12/31/2016

$

$

$

$

$

112 $
136
—

—

7 $

126
4

—

248 $

137 $

35 $
—
—
—

—

35 $

283 $

54 $
52
201
—

—

307 $

444 $

— $
—
—

20

20 $

35 $
—
—
1

1

37 $

57 $

44
—
412

35

491

—
52
262
—

—

314

805

* Represents the position of each trade before consideration of offsetting positions with each counterparty and
does not include the impact of cash collateral deposits provided to or received from counterparties. See
discussion of credit risk and collateral following in this Note.

In addition, the Company also had the following amounts associated with fuel derivative instruments
and hedging activities in its Consolidated Balance Sheet:

Balance Sheet
location

December 31,
2017

December 31,
2016

(in millions)

Cash collateral deposits held from counterparties

for fuel contracts - current

Offset against Prepaid
expenses and other
current assets

$

Cash collateral deposits held from counterparties

for fuel contracts - noncurrent

Cash collateral deposits provided to

counterparties for fuel contracts - current

Due to third parties for fuel contracts

Offset against Other
assets

Offset against
Accrued liabilities
Accounts payable

111

15

$

—

—

29

4

6

311

75

All of the Company’s fuel derivative instruments and interest rate swaps are subject to agreements that
follow the netting guidance in the applicable accounting standards for derivatives and hedging. The
types of derivative instruments the Company has determined are subject to netting requirements in the
accompanying Consolidated Balance Sheet are those in which the Company pays or receives cash for
transactions with the same counterparty and in the same currency via one net payment or receipt. For
cash collateral held by the Company or provided to counterparties, the Company nets such amounts
against the fair value of the Company’s derivative portfolio by each counterparty. The Company has
elected to utilize netting for both its fuel derivative instruments and interest rate swap agreements and
also classifies such amounts as either current or noncurrent, based on the net fair value position with
each of the Company’s counterparties in the Consolidated Balance Sheet.

The Company’s application of its netting policy associated with cash collateral differs depending on
whether its derivative instruments are in a net asset position or a net liability position. If its fuel
derivative instruments are in a net asset position with a counterparty, cash collateral amounts held are
first netted against current outstanding derivative amounts associated with that counterparty until that
balance is zero, and then any remainder is applied against the fair value of noncurrent outstanding
derivative instruments. If the Company’s fuel derivative instruments are in a net liability position with
the counterparty, cash collateral amounts provided are first netted against noncurrent outstanding
derivative amounts associated with that counterparty until that balance is zero, and then any remainder
is applied against the fair value of current outstanding derivative instruments.

The Company has the following recognized financial assets and financial liabilities resulting from
those transactions that meet the scope of the disclosure requirements as necessitated by applicable
accounting guidance for balance sheet offsetting:

Offsetting of derivative assets

(in millions)

(i)

(ii)
December 31, 2017

(iii) = (i) + (ii)

(i)

(ii)
December 31, 2016

(iii) = (i) + (ii)

Balance
Sheet
location

Gross amounts
of recognized
assets

Gross amounts
offset in the
Balance Sheet

Description

Net amounts of
assets presented
in the Balance
Sheet

Gross amounts
of recognized
assets

Gross amounts
offset in the
Balance Sheet

Net amounts of
assets presented
in the Balance
Sheet

Fuel
derivative
contracts

Fuel
derivative
contracts

Fuel
derivative
contracts

Prepaid
expenses and
other current
assets

$

147

$

(50) $

97

$

61 $

(48) $

13

Other assets $

136

$

— $

136 (a) $

178 $

(58) $

120 (a)

Accrued
liabilities

$

— $

— $

— (a) $

516 $

(516) $

— (a)

(a) The net amounts of derivative assets and liabilities are reconciled to the individual line item amounts
presented in the Consolidated Balance Sheet in Note 5.

112

Offsetting of derivative liabilities

(in millions)

(i)

(ii)
December 31, 2017

(iii) = (i) + (ii)

(i)

(ii)
December 31, 2016

(iii) = (i) + (ii)

Gross amounts
of recognized
liabilities

Gross amounts
offset in the
Balance Sheet

Net amounts of
liabilities
presented in the
Balance Sheet

Gross amounts
of recognized
liabilities

Gross amounts
offset in the
Balance Sheet

Net amounts of
liabilities
presented in the
Balance Sheet

$

$

$

$

$

50

$

(50) $

— $

48

$

(48) $

—

— $

— $

— (a) $

58

$

(58) $

— (a)

— $

— $

— (a) $

674

$

(516) $

158 (a)

1

$

— $

1 (a) $

— $

— $

— (a)

21

$

— $

21 (a) $

35

$

— $

35 (a)

Description

Fuel
derivative
contracts

Fuel
derivative
contracts

Fuel
derivative
contracts

Interest rate
derivative
contracts

Interest rate
derivative
contracts

Balance Sheet
location

Prepaid
expenses and
other current
assets

Other assets

Accrued
liabilities

Accrued
liabilities

Other
noncurrent
liabilities

(a) The net amounts of derivative assets and liabilities are reconciled to the individual line item amounts
presented in the Consolidated Balance Sheet in Note 5.

The following tables present the impact of derivative instruments and their location within the
Consolidated Statement of Income for the year ended December 31, 2017 and 2016:

Derivatives in cash flow hedging relationships

(Gain) loss recognized in
AOCI on derivatives
(effective portion)
Year ended
December 31,

(Gain) loss reclassified
from AOCI into income
(effective portion)(a)
Year ended
December 31,

(Gain) loss recognized in
income on derivatives
(ineffective portion)(b)
Year ended
December 31,

(in millions)

2017

2016

2017

2016

2017

2016

Fuel derivative contracts $

Interest rate derivatives

Total

$

32 * $

— *

32

$

(122) *$

349 * $

613 * $

2 *

7 *

9

(120) $

356

$

622

$

31

1

32

$

$

(11)

(3)

(14)

*Net of tax

(a) Amounts related to fuel derivative contracts and interest rate derivatives are included in Fuel and oil and
Interest expense, respectively.

(b) Amounts are included in Other (gains) losses, net.

113

Derivatives not in cash flow hedging relationships

(in millions)

Fuel derivative contracts

Interest rate derivatives

Total

(Gain) loss
recognized in income on
derivatives
Year ended
December 31,

2017

2016

$

$

75

$

(4)

71

$

14

(2)

12

Location of (gain) loss
recognized in income
on derivatives

Other (gains) losses, net

Interest Expense

The Company also recorded expense associated with premiums paid for fuel derivative contracts that
settled/expired during 2017, 2016, and 2015 of $135 million, $153 million, and $124 million,
respectively. These amounts are excluded from the Company’s measurement of effectiveness for
related hedges and are included as a component of Other (gains) losses, net, in the Consolidated
Statement of Income.

The fair values of the derivative instruments, depending on the type of instrument, were determined by
the use of present value methods or option value models with assumptions about commodity prices
based on those observed in underlying markets or provided by third parties. Included in the Company’s
cumulative net unrealized gains from fuel hedges as of December 31, 2017, recorded in AOCI, were
approximately $11 million in unrealized losses, net of taxes, which are expected to be realized in
earnings during the twelve months subsequent to December 31, 2017.

Interest Rate Swaps

The Company is party to certain interest rate swap agreements that are accounted for as either fair
value hedges or cash flow hedges, as defined in the applicable accounting guidance for derivative
instruments and hedging. Several of the Company’s interest rate swap agreements qualify for the
“shortcut” method of accounting for hedges, which dictates that the hedges are assumed to be perfectly
effective, and, thus, there is no ineffectiveness to be recorded in earnings. For the Company’s interest
rate swap agreements that do not qualify for the “shortcut” method of accounting, ineffectiveness is
required to be measured at each reporting period. The ineffectiveness associated with all of the
Company’s, including AirTran Holdings’, interest rate swap agreements for all periods presented was
not material.

The fair values of the interest rate swap agreements, which are adjusted regularly, have been
aggregated by counterparty for classification in the Consolidated Balance Sheet. Agreements totaling a
net liability of $22 million are fair value hedges, cash flow hedges, and interest rate derivatives not
utilizing hedge accounting, and are classified as components of Accrued liabilities and Other
noncurrent liabilities. The corresponding adjustment related to the net liability associated with the
Company’s cash flow hedges is to AOCI, fair value hedges is to the carrying value of the long-term
debt, and interest rate derivatives not utilizing hedge accounting is to Interest expense. See Note 12.

The Company has fixed-to-floating interest rate swap agreements in place associated with its
$500 million 2.65 percent Notes due 2020 and its $300 million 2.75 percent Notes due 2019 that are
accounted for as fair value hedges. As a result of the fixed-to-floating interest rate swap agreements in

114

place, the average floating rate recognized during 2017 was approximately 2.47 percent on the
$500 million Note, and approximately 2.29 percent on the $300 million Note, based on actual and
forward rates as of December 31, 2017.

The Company has floating-to-fixed interest rate swap agreements associated with its $600 million
floating-rate term loan agreement due 2020 and its $332 million term loan agreement due 2019 that are
accounted for as cash flow hedges. These interest rate hedges have fixed the interest rate on the
$600 million floating-rate term loan agreement at 5.223 percent until maturity, and for the $332 million
term loan agreement at 6.315 percent until maturity.

There are also a number of interest rate swap agreements, which convert a portion of AirTran
Holdings’ floating-rate debt to a fixed-rate basis for the remaining life of the debt, thus reducing the
impact of interest rate changes on future interest expense and cash flows. Under these agreements,
which expire between 2018 and 2020, it pays fixed rates between 4.35 percent and 6.435 percent and
receives either three-month or six-month LIBOR on the notional values. The notional amount of
outstanding debt related to interest rate swaps as of December 31, 2017, was $124 million. The
mark-to-market impact associated with these hedges for all periods presented was not material.

115

Credit Risk and Collateral

Credit exposure related to fuel derivative instruments is represented by the fair value of contracts that
are an asset to the Company at the reporting date. At such times, these outstanding instruments expose
the Company to credit loss in the event of nonperformance by the counterparties to the agreements.
However, the Company has not experienced any significant credit loss as a result of counterparty
nonperformance in the past. To manage credit risk, the Company selects and periodically reviews
counterparties based on credit ratings, limits its exposure with respect to each counterparty, and
monitors the market position of the fuel hedging program and its relative market position with each
counterparty. At December 31, 2017, the Company had agreements with all of its active counterparties
containing early termination rights and/or bilateral collateral provisions whereby security is required if
market risk exposure exceeds a specified threshold amount based on the counterparty credit rating. The
Company also had agreements with counterparties in which cash deposits, letters of credit, and/or
pledged aircraft are required to be posted as collateral whenever the net fair value of derivatives
associated with those counterparties exceeds specific thresholds. The following table provides the fair
values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold
amounts as of December 31, 2017, at which such postings are triggered:

(in millions)

A

B

C

D

E

F

Other(a)

Total

Counterparty (CP)

Fair value of fuel
derivatives
Cash collateral held
from CP
Aircraft collateral
pledged to CP
Letters of credit (LC)
Option to substitute
LC for aircraft
Option to substitute
LC for cash
If credit rating is
investment grade,
fair value of fuel
derivative level at
which:
Cash is provided to
CP
Cash is received
from CP

Aircraft or cash can
be pledged to CP as
collateral
If credit rating
is non-investment
grade, fair value
of fuel derivative
level at which:
Cash is provided to

CP
Cash is received
from CP
Aircraft or cash
can be pledged to
CP as collateral

$

89 $

44 $

54 $

35 $

15 $

6 $

5 $

248

15

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

15

—

—

(200) to
(600)(b)
N/A

(100) to
(500)(c)
>(500)(c)

(150) to
(550)(c)
(75) to (150)
or >(550)(c)

(150) to
(550)(c)
(125) to (150)
or >(550)(d)

N/A

N/A

(d)

N/A

(50) to (200)
or >(600)
>50(e)

(50) to (100)
or >(500)
>150(e)

(75) to (150)
or >(550)(e)
>250(e)

(125) to (150)
or >(550)(e)
>75(e)

>(125) >(65)(e)

>100(e) >30(e)

(200) to
(600)(f)

(100) to
(500)(c)

(150) to
(550)(c)

(150) to
(550)(c)

N/A

N/A

(0) to (200)
or >(600)
(g)

(0) to (100)
or >(500)
(g)

(0) to (150)
or >(550)
(g)

(0) to (150)
or >(550)
(g)

(g)

(g)

(g)

(g)

(200) to
(600)

(100) to
(500)

(150) to
(550)

(150) to
(550)

N/A

N/A

116

(a) Individual counterparties with fair value of fuel derivatives <$5 million.

(b) The Company has the option of providing letters of credit in addition to aircraft collateral if the appraised value of the
aircraft does not meet the collateral requirement.

(c) The Company has the option of providing cash, letters of credit, or pledging aircraft as collateral.

(d) The Company has the option to substitute letters of credit for 100 percent of cash collateral requirement.

(e) Thresholds may vary based on changes in credit ratings within investment grade.

(f) The Company has the option of providing cash or pledging aircraft as collateral.

(g) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.

11. FAIR VALUE MEASUREMENTS

Accounting standards pertaining to fair value measurements establish a three-tier fair value hierarchy,
which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as
observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted
prices in active markets that are either directly or indirectly observable; and Level 3, defined as
unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its
own assumptions.

As of December 31, 2017, the Company held certain items that are required to be measured at fair
value on a recurring basis. These included cash equivalents, short-term investments (primarily treasury
bills and certificates of deposit), interest rate derivative contracts, fuel derivative contracts, and
available-for-sale securities. The majority of the Company’s short-term investments consist of
instruments classified as Level 1. However, the Company has certificates of deposit and commercial
paper that are classified as Level 2, due to the fact that the fair value for these instruments is
determined utilizing observable inputs in non-active markets. Other available-for-sale securities
primarily consist of investments associated with the Company’s excess benefit plan.

The Company’s fuel and interest rate derivative instruments consist of over-the-counter contracts,
which are not traded on a public exchange. Fuel derivative instruments include swaps, as well as
different types of option contracts, whereas interest rate derivatives consist solely of swap agreements.
See Note 10 for further information on the Company’s derivative instruments and hedging activities.
The fair values of swap contracts are determined based on inputs that are readily available in public
markets or can be derived from information available in publicly quoted markets. Therefore, the
Company has categorized these swap contracts as Level 2. The Company’s Treasury Department,
which reports to the Chief Financial Officer, determines the value of option contracts utilizing an
option pricing model based on inputs that are either readily available in public markets, can be derived
from information available in publicly quoted markets, or are provided by financial institutions that
trade these contracts. The option pricing model used by the Company is an industry standard model for
valuing options and is the same model used by the broker/dealer community (i.e., the Company’s
counterparties). The inputs to this option pricing model are the option strike price, underlying price,
risk free rate of interest, time to expiration, and volatility. Because certain inputs used to determine the
fair value of option contracts are unobservable (principally implied volatility), the Company has
categorized these option contracts as Level 3. Volatility information is obtained from external sources,
but is analyzed by the Company for reasonableness and compared to similar information received from
other external sources. The fair value of option contracts considers both the intrinsic value and any
remaining time value associated with those derivatives that have not yet settled. The Company also

117

considers counterparty credit risk and its own credit risk in its determination of all estimated fair
values. To validate the reasonableness of the Company’s option pricing model, on a monthly basis, the
Company compares its option valuations to third party valuations. If any significant differences were to
be noted, they would be researched in order to determine the reason. However, historically, no
significant differences have been noted. The Company has consistently applied these valuation
techniques in all periods presented and believes it has obtained the most accurate information available
for the types of derivative contracts it holds.

Included in Other available-for-sale securities are the Company’s investments associated with its
deferred compensation plans, which consist of mutual funds that are publicly traded and for which
market prices are readily available. These plans are non-qualified deferred compensation plans
designed to hold contributions in excess of limits established by the Internal Revenue Code of 1986, as
amended. The distribution timing and payment amounts under these plans are made based on the
participant’s distribution election and plan balance. Assets related to the funded portions of the
deferred compensation plans are held in a rabbi trust, and the Company remains liable to these
participants for the unfunded portion of the plans. The Company records changes in the fair value of
the assets in the Company’s earnings.

The following tables present the Company’s assets and liabilities that are measured at fair value on a
recurring basis at December 31, 2017, and December 31, 2016:

Description

Assets

Cash equivalents

December 31, 2017

Fair value measurements at reporting date using:
Significant
Quoted prices in
unobservable
active markets
inputs
for identical assets
(Level 3)
(Level 1)

Significant
other observable
inputs
(Level 2)

(in millions)

Cash equivalents (a)

$

1,133 $

1,133 $

— $

Commercial paper

Certificates of deposit

Short-term investments:

Treasury bills

Certificates of deposit

Fuel derivatives:

Option contracts (b)

Other available-for-sale

securities

Total assets

Liabilities

Fuel derivatives:

Option contracts (b)

Interest rate derivatives (see

Note 10)

Total liabilities

$

$

—

—

1,491

—

—

107

2,731 $

—

—

— $

350

12

—

287

—

—

649 $

—

(22)

(22) $

350

12

1,491

287

283

107

3,663 $

(35)

(22)

(57) $

118

—

—

—

—

—

283

—

283

(35)

—

(35)

(a) Cash equivalents are primarily composed of money market investments.

(b) In the Consolidated Balance Sheet amounts are presented as a net asset. See Note 10.

Description

Assets

Cash equivalents

December 31, 2016

Fair value measurements at reporting date using:
Significant
Quoted prices in
unobservable
active markets
inputs
for identical assets
(Level 3)
(Level 1)

Significant
other observable
inputs
(Level 2)

(in millions)

Cash equivalents (a)

$

1,344 $

1,344 $

— $

Commercial paper

Certificates of deposit

Short-term investments:

Treasury bills
Certificates of deposit

Fuel derivatives:

Swap contracts (c)

Option contracts (b)

Option contracts (c)

Other available-for-sale

securities

Total assets

Liabilities

Fuel derivatives:

Swap contracts (c)

Option contracts (b)

Option contracts (c)

Interest rate derivatives (see

Note 10)

Total liabilities

$

$

$

325

11

1,345
280

42

239

163

83

—

—

1,345
—

—

—

—

83

325

11

—
280

42

—

—

—

3,832 $

2,772 $

658 $

(110) $

(96)

(564)

(35)

(805) $

— $

(110) $

—

—

—

— $

—

—

(35)

(145) $

(a) Cash equivalents are primarily composed of money market investments.

(b) In the Consolidated Balance Sheet amounts are presented as a net asset. See Note 10.

(c) In the Consolidated Balance Sheet amounts are presented as a net liability. See Note 10.

—

—

—

—
—

—

239

163

—

402

—

(96)

(564)

—

(660)

119

The Company had no transfers of assets or liabilities between any of the above levels during the years
ended December 31, 2017 or 2016. The Company did not have any assets or liabilities measured at fair
value on a nonrecurring basis as of December 31, 2017 or 2016. The following tables present the
Company’s activity for items measured at fair value on a recurring basis using significant unobservable
inputs (Level 3) for 2017 and 2016:

Fair value measurements using significant unobservable inputs (Level 3)

(in millions)

Balance at December 31, 2016

Total losses (realized or unrealized)

Included in earnings

Included in other comprehensive income

Purchases

Sales
Settlements

Balance at December 31, 2017

The amount of total losses for the period included in earnings
attributable to the change in unrealized gains or losses
relating to assets still held at December 31, 2017

$

$

$

Fuel
derivatives

(258)

(125)

(50)

142 (a)

— (a)

539

248

(42)

(a) The purchase and sale of fuel derivatives are recorded gross based on the structure of the derivative
instrument and whether a contract with multiple derivatives is purchased as a single instrument or separate
instruments.

(in millions)

Fair value measurements using significant unobservable inputs (Level 3)
Other
securities

Fuel
derivatives

Total

Balance at December 31, 2015

Total gains (losses) (realized or unrealized)

Included in earnings

Included in other comprehensive income

Purchases
Sales

Settlements

Balance at December 31, 2016

The amount of total gains for the period included in earnings

attributable to the change in unrealized gains or losses relating
to assets still held at December 31, 2016

$ (1,676)

$

27

$

(1,649)

175

201

221 (a)
(61)(a)

882

(258)

93

$

$

$

$

(2)

8

—
(33)

—

173

209

221
(94)

882

— $

(258)

— $

93

(a) The purchase and sale of fuel derivatives are recorded gross based on the structure of the derivative
instrument and whether a contract with multiple derivatives is purchased as a single instrument or separate
instruments.

120

The significant unobservable input used in the fair value measurement of the Company’s derivative
option contracts is implied volatility. Holding other inputs constant, an increase (decrease) in implied
volatility would result in a higher (lower) fair value measurement, respectively, for the Company’s
derivative option contracts.

The following table presents a range of the unobservable inputs utilized in the fair value measurements
of the Company’s fuel derivatives classified as Level 3 at December 31, 2017:

Quantitative information about Level 3 fair value measurements

Valuation technique

Unobservable input

Period (by year)

Fuel derivatives

Option model

Implied volatility

2018

2019

2020

Beyond 2020

Range

11-26%

17-22%

17-21%

18-20%

The carrying amounts and estimated fair values of the Company’s long-term debt (including current
maturities), as well as the applicable fair value hierarchy tier, at December 31, 2017, are presented in
the table below. The fair values of the Company’s publicly held long-term debt are determined based
on inputs that are readily available in public markets or can be derived from information available in
publicly quoted markets; therefore, the Company has categorized these agreements as Level 2. Debt
under seven of the Company’s debt agreements is not publicly held. The Company has determined the
estimated fair value of this debt to be Level 3, as certain inputs used to determine the fair value of these
agreements are unobservable. The Company utilizes indicative pricing from counterparties and a
discounted cash flow method to estimate the fair value of the Level 3 items.

(in millions)

Carrying value

Estimated fair
value

Fair value level
hierarchy

French Credit Agreements due 2018 - 2.54%

$

Fixed-rate 737 Aircraft Notes payable through 2018 - 7.03%

$

1

3

2.75% Notes due 2019

Term Loan Agreement payable through 2019 - 6.315%

Term Loan Agreement payable through 2019 - 4.84%

2.65% Notes due 2020

Term Loan Agreement payable through 2020 - 5.223%

737 Aircraft Notes payable through 2020

2.75% Notes due 2022

Pass Through Certificates due 2022 - 6.24%

Term Loan Agreement payable through 2026 - 2.67%

3.00% Notes due 2026

3.45% Notes due 2027

7.375% Debentures due 2027

300

66

19

491

237

155

300

294

215

300

300

127

1

3

302

66

20

494

240

154

300

318

215

293

299

154

Level 3

Level 3

Level 2

Level 3

Level 3

Level 2

Level 3

Level 3

Level 2

Level 2

Level 3

Level 2

Level 2

Level 2

12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

Comprehensive income includes changes in the fair value of certain financial derivative instruments
that qualify for hedge accounting, unrealized gains and losses on certain investments, and actuarial

121

gains/losses arising from the Company’s postretirement benefit obligation. A rollforward of the
amounts included in AOCI, net of taxes, is shown below for 2017 and 2016:

(in millions)

Fuel
derivatives

Interest
rate
derivatives

Defined
benefit plan
items

Other

Deferred
tax
impact

Accumulated other
comprehensive
income (loss)

Balance at December 31, 2015

$

(1,666) $

(30) $

22 $

6 $

617 $

(1,051)

Changes in fair value

Reclassification to earnings

194

973

(3)

15

(36)

—

14

—

(63)

(366)

Balance at December 31, 2016

$

(499) $

(18) $

(14) $

20 $

188 $

Changes in fair value

Reclassification to earnings

(50)

552

—

11

5

—

13

—

11

(207)

Balance at December 31, 2017

$

3 $

(7) $

(9) $

33 $

(8) $

106

622

(323)

(21)

356

12

The following table illustrates the significant amounts reclassified out of each component of AOCI for
the year ended December 31, 2017:

Year ended December 31, 2017

(in millions)

AOCI components

Unrealized loss on fuel derivative instruments

Unrealized loss on interest rate derivative instruments

Total reclassifications for the period

13. EMPLOYEE RETIREMENT PLANS

Defined Contribution Plans

Amounts reclassified
from AOCI

Affected line item in the
Consolidated Statement of
Comprehensive Income

$

$

$

$

$

552 Fuel and oil expense

203 Less: Tax expense

349 Net of tax

11

Interest expense

4 Less: Tax expense

7 Net of tax

356 Net of tax

Southwest has defined contribution plans covering substantially all of its Employees. Contributions
under all defined contribution plans are primarily based on Employee compensation and performance
of the Company. The Company sponsors Employee savings plans under section 401(k) of the Internal
Revenue Code of 1986, as amended. The Southwest Airlines Co. 401(k) Plan includes Company
matching contributions and the Southwest Airlines Pilots Retirement Saving Plan has non-elective
Company contributions. In addition, the Southwest Airlines Co. ProfitSharing Plan (ProfitSharing
Plan) is a defined contribution plan to which the Company may contribute a percentage of its eligible
pre-tax profits, as defined, on an annual basis. No Employee contributions to the ProfitSharing Plan are
allowed.

122

Amounts associated with the Company’s defined contribution plans expensed in 2017, 2016, and 2015,
reflected as a component of Salaries, wages, and benefits, were $1.0 billion, $937 million, and
$945 million, respectively.

Postretirement Benefit Plans

The Company provides postretirement benefits to qualified retirees in the form of medical and dental
coverage. Employees must meet minimum levels of service and age requirements as set forth by the
Company, or as specified in collective-bargaining agreements with specific workgroups. Employees
meeting these requirements, as defined, may use accrued unused sick time to pay for medical and
dental premiums from the age of retirement until age 65.

The following table shows the change in the accumulated postretirement benefit obligation (APBO) for
the years ended December 31, 2017 and 2016:

(in millions)

APBO at beginning of period

Service cost

Interest cost

Benefits paid

Actuarial (gain)/loss

Plan amendments

APBO at end of period

2017

2016

$

256

$

201

18

11

(8)

(2)

—

13

9

(6)

38

1

$

275

$

256

All plans are unfunded, and benefits are paid as they become due. Estimated future benefit payments
expected to be paid are $8 million in 2018, $10 million in 2019, $11 million in 2020, $12 million in
2021, $14 million in 2022, and $101 million for the next five years thereafter.

The funded status (the difference between the fair value of plan assets and the projected benefit
obligations) of the Company’s consolidated benefit plans are recognized in the Consolidated Balance
Sheet, with a corresponding adjustment to AOCI. The following table reconciles the funded status of
the plans to the accrued postretirement benefit cost recognized in Other non-current liabilities on the
Company’s Consolidated Balance Sheet at December 31, 2017 and 2016.

(in millions)

Funded status

Unrecognized net actuarial loss

Unrecognized prior service cost

Accumulated other comprehensive loss

Cost recognized on Consolidated Balance Sheet

2017

2016

(275)

$

(256)

5

4

(9)

(275)

$

7

7

(14)

(256)

$

$

123

The consolidated periodic postretirement benefit cost for the years ended December 31, 2017, 2016,
and 2015, included the following:

(in millions)

Service cost

Interest cost

Amortization of prior service cost

Recognized actuarial gain

Net periodic postretirement benefit cost

2017

2016

2015

$

$

18

11

3

—

32

$

$

13

$

9

3

—

25

$

11

7

3

(3)

18

Unrecognized prior service cost is expensed using a straight-line amortization of the cost over the
average future service of Employees expected to receive benefits under the plans. Actuarial gains are
amortized utilizing the minimum amortization method. The following actuarial assumptions were used
to account for the Company’s postretirement benefit plans at December 31, 2017, 2016, and 2015:

Weighted-average discount rate

Assumed healthcare cost trend rate (1)

2017

2016

2015

3.65%

7.08%

4.25%

7.08%

4.50%

7.08%

(1) The assumed healthcare cost trend rate is assumed to remain at 7.08% for 2018, then decline gradually to
5.19% by 2028 and remain level thereafter.

The assumed healthcare cost trend rates have a significant effect on the amounts reported for the
consolidated postretirement plans. A one percent change in all healthcare cost trend rates used in
measuring the APBO at December 31, 2017, would have the following effects:

(in millions)

Increase (decrease) in total service and interest costs

Increase (decrease) in the APBO

1% increase

1% decrease

$

$

5

37

$

$

(4)

(32)

The selection of a discount rate is made annually and is selected by the Company based upon
comparison of the expected future cash flows associated with the Company’s future payments under its
consolidated postretirement obligations to a yield curve created using high quality bonds that closely
match those expected future cash flows. This rate decreased during 2017 due to market conditions. The
assumed healthcare trend rate is also reviewed at least annually and is determined based upon both
historical experience with the Company’s healthcare benefits paid and expectations of how those
trends may or may not change in future years.

14. INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax
purposes. The Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act reduces
the U.S. federal corporate tax rate from the previous rate of 35 percent to 21 percent, requires
companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were
previously tax deferred, and creates new taxes on certain foreign sourced earnings. At December 31,
2017, the Company has calculated the accounting for the tax effects of enactment of the Act as

124

written, and made a reasonable estimate of the effects on the existing deferred tax balances. The
Company will continue to refine the calculations as additional analysis is completed. In addition, these
estimates may also be affected as the Company gains a more thorough understanding of the tax law,
including those related to the deductibility of purchased assets, state tax treatment, and amounts related
to Employee compensation. This re-measurement in 2017 resulted in a reduction in the Company’s net
deferred tax liability, as noted by the change in federal statutory tax rate as noted in the provision for
income taxes below. The components of deferred tax assets and liabilities at December 31, 2017 and
2016, are as follows:

(in millions)

DEFERRED TAX LIABILITIES:

Accelerated depreciation

Other

Total deferred tax liabilities

DEFERRED TAX ASSETS:

Fuel derivative instruments

Construction obligation

Accrued employee benefits

Other

Total deferred tax assets

Net deferred tax liability

2017

2016

$

3,193 $

86

3,279

12

326

309

274

921

$

2,358 $

4,726

134

4,860

233

402

451

400

1,486

3,374

The provision for income taxes is composed of the following:

(in millions)

CURRENT:

Federal

State

Total current

DEFERRED:

Federal

State

Change in federal statutory tax rate

Total deferred

2017

2016

2015

$

904 $

778 $

72

976

192

5

(1,410)

(1,213)

69

847

426

30

—

456

$

(237) $

1,303 $

1,292

114

1,406

(97)

(11)

—

(108)

1,298

125

The effective tax rate on income before income taxes differed from the federal income tax statutory
rate for the following reasons:

(in millions)

Tax at statutory U.S. tax rates

State income taxes, net of federal benefit

Change in federal statutory tax rate

Other, net

Total income tax provision

2017

2016

2015

1,138 $

1,241 $

1,218

50

(1,410)

(15)

64

—

(2)

66

—

14

(237) $

1,303 $

1,298

$

$

The only periods subject to examination for the Company’s federal tax return are the 2016 and 2017
tax years.

126

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of Southwest Airlines Co.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Southwest Airlines Co. (the
Company) as of December 31, 2017 and 2016,
the related consolidated statements of income,
comprehensive income, stockholders’ equity and cash flows for each of the three years in the period
ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”).
In our opinion, the financial statements present fairly, in all material respects, the consolidated
financial position of the Company at December 31, 2017 and 2016, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended December 31, 2017, in
conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States) (PCAOB), the Company’s internal control over financial reporting as of
December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our
report dated February 7, 2018 expressed an unqualified opinion thereon.

Adoption of ASU No. 2009-13

As discussed in Note 1 to the consolidated financial statements, the Company changed its method of
accounting for its co-brand credit card agreement in 2015 due to the adoption of ASU No. 2009-13,
Multiple Deliverable Revenue Arrangements.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is
to express an opinion on the Company’s financial statements based on our audits. We are a public
accounting firm registered with the PCAOB and are required to be independent with respect to the
Company in accordance with the U.S. federal securities laws and the applicable rules and regulations
of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement, whether due to error or fraud. Our audits included performing
procedures to assess the risks of material misstatement of the financial statements, whether due to
fraud or error, and performing procedures that respond to those risks. Such procedures included
examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.
Our audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial statements. We believe that
our audits provide a reasonable basis for our opinion.

/s/ Ernst & Young LLP

We have served as the Company’s auditor since 1971.

Dallas, Texas
February 7, 2018

127

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of Southwest Airlines Co.

Opinion on Internal Control over Financial Reporting

We have audited Southwest Airlines Co.’s internal control over financial reporting as of December 31,
2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (2013 Framework), (the COSO criteria). In
our opinion, Southwest Airlines Co. (the Company) maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2017, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States) (PCAOB), the consolidated balance sheets of Southwest Airlines Co. as of
December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income,
stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017,
and the related notes (collectively referred to as the “financial statements”) of the Company and our
report dated February 7, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting
included in the accompanying “Management’s Annual Report on Internal Control Over Financial
Reporting”. Our responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and
are required to be independent with respect to the Company in accordance with U.S. federal securities
laws and the applicable rules and regulations of the Securities and Exchange Commission and the
PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects.

Our audit included obtaining an understanding of internal control over financial reporting, assessing
the risk that a material weakness exists, testing and evaluating the design and operating effectiveness
of internal control based on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only

128

in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.

/s/ Ernst & Young LLP

Dallas, Texas
February 7, 2018

129

QUARTERLY FINANCIAL DATA
(unaudited)

(in millions except per share amounts)

March 31

June 30

Sept. 30

Dec. 31

Three months ended

Operating revenues

Operating income

Income before income taxes

Net income

Net income per share, basic

Net income per share, diluted

2017

2016

$

4,883

$

658

553

351

0.57

0.57

5,744

1,250

1,170

746

1.24

1.23

$

5,271

$

5,274

834

791

503

0.84

0.84

773

737

1,888(a)

3.19(a)

3.18(a)

March 31

June 30

Sept. 30

Dec. 31

Operating revenues

Operating income

Income before income taxes

Net income

Net income per share, basic

Net income per share, diluted

$

4,826

$

944

816

513

0.80

0.79

5,384

1,276

1,304

820

1.30

1.28

$

5,139

$

5,076

695

618

388

0.63

0.62

846

809

522

0.85

0.84

(a) Includes a $1.4 billion reduction in Provision for income taxes related to the Tax Cuts and Jobs Act
legislation enacted in December 2017, which resulted in a re-measurement of the Company’s deferred tax assets
and liabilities at the new federal corporate tax rate of 21 percent. See Note 14 to the Consolidated Financial
Statements for further information.

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure

None.

Item 9A.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures. The Company maintains disclosure controls and
procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act (the “Exchange Act”))
designed to provide reasonable assurance that the information required to be disclosed by the Company
in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in the SEC’s rules and forms. These include controls and
procedures designed to ensure that
this information is accumulated and communicated to the
including its Chief Executive Officer and Chief Financial Officer, as
Company’s management,
appropriate to allow timely decisions regarding required disclosure. Management, with the
participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the
effectiveness of the Company’s disclosure controls and procedures as of December 31, 2017. Based on
this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded
that the Company’s disclosure controls and procedures were effective as of December 31, 2017, at the
reasonable assurance level.

130

Management’s Annual Report on Internal Control over Financial Reporting. Management of the
Company is responsible for establishing and maintaining adequate internal control over financial
reporting (as defined in Rule 13a-15(f) of the Exchange Act). The Company’s internal control over
financial reporting is a process, under the supervision of the Company’s Chief Executive Officer and
Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Therefore, even those systems determined to be effective can provide only reasonable
assurance of achieving their control objectives.

Management, with the participation of the Company’s Chief Executive Officer and Chief Financial
Officer, evaluated the effectiveness of the Company’s internal control over financial reporting as of
December 31, 2017. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -
Integrated Framework (2013 Framework). Based on this evaluation, management, with the
participation of the Company’s Chief Executive Officer and Chief Financial Officer, concluded that, as
of December 31, 2017, the Company’s internal control over financial reporting was effective.

Ernst & Young, LLP, the independent registered public accounting firm who audited the Company’s
Consolidated Financial Statements included in this Form 10-K, has issued a report on the Company’s
internal control over financial reporting, which is included herein.

Changes in Internal Control over Financial Reporting. There were no changes in the Company’s
internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the
quarter ended December 31, 2017, that have materially affected, or are reasonably likely to materially
affect, the Company’s internal control over financial reporting.

Item 9B.

Other Information

None.

131

PART III

Item 10.

Directors, Executive Officers, and Corporate Governance

Directors and Executive Officers

The information required by this Item 10 regarding the Company’s directors will be set forth under the
heading “Proposal 1 — Election of Directors” in the Proxy Statement for the Company’s 2018 Annual
Meeting of Shareholders and is incorporated herein by reference. The information required by this
Item 10 regarding the Company’s executive officers is set forth under the heading “Executive Officers
of the Registrant” in Part I of this Form 10-K and is incorporated herein by reference.

Section 16(a) Compliance

The information required by this Item 10 regarding compliance with Section 16(a) of the Exchange Act
will be set forth under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” in the
Proxy Statement for the Company’s 2018 Annual Meeting of Shareholders and is incorporated herein
by reference.

Corporate Governance

Except as set forth in the following paragraph, the remaining information required by this Item 10 will
be set forth under the heading “Corporate Governance” in the Proxy Statement for the Company’s
2018 Annual Meeting of Shareholders and is incorporated herein by reference.

The Company has adopted a Code of Ethics that applies to its principal executive officer, principal
financial officer, and principal accounting officer or controller. The Company’s Code of Ethics, as well
as its Corporate Governance Guidelines and the charters of its Audit, Compensation, and Nominating
and Corporate Governance Committees,
the Company’s website,
are
www.southwest.com. Copies of these documents are also available upon request to Investor Relations,
Southwest Airlines Co., P.O. Box 36611, Dallas, TX 75235. The Company intends to disclose any
amendments to, or waivers from, its Code of Ethics that apply to the Company’s principal executive
officer, principal financial officer, and principal accounting officer or controller on the Company’s
website, www.southwest.com, under the “About Southwest” caption, promptly following the date of
any such amendment or waiver.

available

on

Item 11.

Executive Compensation

The information required by this Item 11 will be set forth under the headings “Compensation of
Executive Officers” and “Compensation of Directors” in the Proxy Statement for the Company’s 2018
Annual Meeting of Shareholders and is incorporated herein by reference.

Item 12.
Stockholder Matters

Security Ownership of Certain Beneficial Owners and Management and Related

Except as set forth below regarding securities authorized for issuance under equity compensation
plans, the information required by this Item 12 will be set forth under the heading “Voting Securities
and Principal Shareholders” in the Proxy Statement for the Company’s 2018 Annual Meeting of
Shareholders and is incorporated herein by reference.

132

Securities Authorized for Issuance under Equity Compensation Plans

The following table provides information as of December 31, 2017, regarding compensation plans
(including individual compensation arrangements) under which equity securities of the Company are
authorized for issuance.

Equity Compensation Plan Information

Number of Securities
to be Issued Upon
Exercise of
Outstanding
Options,
Warrants, and
Rights
(a)

Weighted-Average
Exercise Price of
Outstanding Options,
Warrants, and
Rights
(b)

Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding
Securities Reflected
in Column (a))
(c)

1,406,539 (1) $

9.43 (2)

30,454,580

(3)

2,100

1,408,639

$

$

9.43

9.43 (2)

—

30,454,580

Plan Category

Equity Compensation Plans
Approved by Security Holders
Equity Compensation Plans not
Approved by Security Holders

Total

(1)

Includes 112,285 shares of common stock issuable upon exercise of outstanding stock options and
1,294,254 restricted share units settleable in shares of the Company’s common stock.

(2) The weighted-average exercise price does not take into account the restricted share units discussed in

footnote (1) above because the restricted share units do not have an exercise price upon vesting.

(3) Of

these shares,

issuance under

(i) 8,830,202 shares remained available for

the Company’s
tax-qualified employee stock purchase plan; and (ii) 21,624,378 shares remained available for issuance
under the Company’s 2007 Equity Incentive Plan in connection with the exercise of stock options and
stock appreciation rights, the settlement of awards of restricted stock, restricted stock units, and
phantom shares, and the grant of unrestricted shares of common stock; however, no more than
1,211,599 shares remain available for grant in connection with awards of unrestricted shares of
common stock, stock-settled phantom shares, and awards to non-Employee members of the Board.
These shares are in addition to the shares reserved for issuance pursuant to outstanding awards included
in column (a).

See Note 9 to the Consolidated Financial Statements for information regarding the material features of
the above plans. Each of the above plans provides that the number of shares with respect to which
options may be granted, the number of shares of common stock subject to an outstanding option, and
the number of restricted share units granted shall be proportionately adjusted in the event of a
subdivision or consolidation of shares or the payment of a stock dividend on common stock, and the
purchase price per share of outstanding options shall be proportionately revised.

Item 13.

Certain Relationships and Related Transactions, and Director Independence

The information required by this Item 13 will be set forth under the heading “Certain Relationships and
Related Transactions, and Director Independence” in the Proxy Statement for the Company’s 2018
Annual Meeting of Shareholders and is incorporated herein by reference.

Item 14.

Principal Accounting Fees and Services

The information required by this Item 14 will be set forth under the heading “Relationship with
Independent Auditors” in the Proxy Statement
the Company’s 2018 Annual Meeting of
Shareholders and is incorporated herein by reference.

for

133

PART IV

Item 15.

Exhibits and Financial Statement Schedules

(a) 1. Financial Statements:

The financial statements included in Item 8. Financial Statements and Supplementary Data above are
filed as part of this annual report.

2. Financial Statement Schedules:

There are no financial statement schedules filed as part of this annual report, since the required
information is included in the Consolidated Financial Statements, including the notes thereto, or the
circumstances requiring inclusion of such schedules are not present.

3. Exhibits:

3.1

3.2

4.1

4.2

4.3

4.4

10.1

Restated Certificate of Formation of the Company, effective May 18, 2012
(incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2012 (File No. 1-7259)).

Second Amended and Restated Bylaws of the Company, effective November 17,
2016 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report
on Form 8-K filed November 21, 2016 (File No. 1-7259)).

Specimen certificate representing common stock of the Company (incorporated by
reference to Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the
year ended December 31, 1994 (File No. 1-7259)).

Indenture dated as of February 14, 2005, between the Company and The Bank of
New York Trust Company, N.A., Trustee (incorporated by reference to Exhibit 4.2
to the Company’s Current Report on Form 8-K filed February 14, 2005 (File
No. 1-7259)).

Indenture dated as of September 17, 2004, between the Company and Wells Fargo
Bank, N.A., Trustee (incorporated by reference to Exhibit 4.1 to the Company’s
Registration Statement on Form S-3 filed October 30, 2002 (File
No. 333-100861)).

Indenture dated as of February 25, 1997, between the Company and U.S.
Trust Company of Texas, N.A. (incorporated by reference to Exhibit 4.12 to the
Company’s Annual Report on Form 10-K for the year ended December 31, 1996
(File No. 1-7259)).

The Company is not filing any other instruments evidencing any indebtedness
because the total amount of securities authorized under any single such instrument
does not exceed 10 percent of its total consolidated assets. Copies of such
instruments will be furnished to the Securities and Exchange Commission upon
request.

Purchase Agreement No. 1810, dated January 19, 1994, between The Boeing
Company and the Company (incorporated by reference to Exhibit 10.4 to the
Company’s Annual Report on Form 10-K for the year ended December 31, 1993
(File No. 1-7259)); Supplemental Agreement No. 1 (incorporated by reference to

134

Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the year ended
December 31, 1996 (File No. 1-7259)); Supplemental Agreements Nos. 2, 3, and 4
(incorporated by reference to Exhibit 10.2 to the Company’s Annual Report on
Form 10-K for the year ended December 31, 1997 (File No. 1-7259));
Supplemental Agreements Nos. 5, 6, and 7 (incorporated by reference to
Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the year ended
December 31, 1998 (File No. 1-7259)); Supplemental Agreements Nos. 8, 9, and
10 (incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on
Form 10-K for the year ended December 31, 1999 (File No. 1-7259));
Supplemental Agreement No. 11 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,
2000, including Letter Agreement 6-1162-RLL-932R1 and Table of Contents (File
No. 1-7259)); Supplemental Agreement No. 12 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2000, including Purchase Agreement Amendments (File
No. 1-7259)); Supplemental Agreement No. 13 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2000, including Purchase Agreement Amendments, Letter
Agreement No. 6-1162-RLL-932R2, Letter Agreement No. 6-1162-RLL-933R9,
Letter Agreement No. 6-1162-RLL-934R1, Letter Agreement No.
6-1162-RLL-941R1, Letter Agreement No. 6-1162-KJJ-054, Letter Agreement
No. 6-1162-KJJ-055, Letter Agreement No. 6-1162-KJJ-056, Letter Agreement
No. 6-1162-KJJ-057, Letter Agreement No. 6-1162-KJJ-058, and Price
Adjustment (File No. 1-7259)); Supplemental Agreement No. 14 (incorporated by
reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000, including Purchase Agreement Amendments,
Letter Agreement No. 6-1162-RLL-934R2, and Letter Agreement No.
6-1162-KJJ-150 (File No. 1-7259)); Supplemental Agreements Nos. 15, 16, 17,
18, and 19 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001
(File No. 1-7259)); Supplemental Agreements Nos. 20, 21, 22, 23, and 24
(incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2002 (File No. 1-7259));
Supplemental Agreements Nos. 25, 26, 27, 28, and 29 (incorporated by reference
to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2003 (File No. 1-7259)); Supplemental Agreements Nos. 30, 31,
32, and 33 (incorporated by reference to Exhibit 10.1 to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2003 (File No. 1-7259));
Supplemental Agreements Nos. 34, 35, 36, 37, and 38 (incorporated by reference
to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2004 (File No. 1-7259)); Supplemental Agreements Nos. 39 and 40
(incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2004 (File No. 1-7259));
Supplemental Agreement No. 41 (incorporated by reference to Exhibit 10.1 to the
Company’s Annual Report on Form 10-K for the year ended December 31, 2004
(File No. 1-7259)); Supplemental Agreements Nos. 42, 43, and 44 (incorporated
by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for
the quarter ended March 31, 2005 (File No. 1-7259)); Supplemental Agreement
No. 45 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended June 30, 2005 (File No. 1-7259));
Supplemental Agreements Nos. 46 and 47 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter

135

ended March 31, 2006 (File No. 1-7259)); Supplemental Agreement No. 48
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2006 (File No. 1-7259)); Supplemental
Agreements Nos. 49 and 50 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,
2006 (File No. 1-7259)); Supplemental Agreement No. 51 (incorporated by
reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the
year ended December 31, 2006 (File No. 1-7259)); Supplemental Agreement
No. 52 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended March 31, 2007 (File No. 1-7259));
Supplemental Agreement No. 53 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007
(File No. 1-7259)); Supplemental Agreement No. 54 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2007 (File No. 1-7259)); Supplemental Agreement No. 55
(incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2007 (File No. 1-7259));
Supplemental Agreement No. 56 (incorporated by reference to Exhibit 10.1 to
Southwest’s Annual Report on Form 10-K for the year ended December 31, 2007
(File No. 1-7259)); Supplemental Agreement No. 57 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2008 (File No. 1-7259)); Supplemental Agreement No. 58
(incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended March 31, 2008 (File No. 1-7259));
Supplemental Agreement No. 59 (incorporated by reference to Exhibit 10.3 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008
(File No. 1-7259)); Supplemental Agreement No. 60 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2008 (File No. 1-7259)); Supplemental Agreement No. 61
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2008 (File No. 1-7259));
Supplemental Agreement No. 62 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2009
(File No. 1-7259)); Supplemental Agreement No. 63 (incorporated by reference to
Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2009 (File No. 1-7259)); Supplemental Agreement No. 64
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended March 31, 2010 (File No. 1-7259));
Supplemental Agreement No. 65 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010
(File No. 1-7259)); Supplemental Agreement No. 66 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2010 (File No. 1-7259)); Supplemental Agreement No. 67
(incorporated by reference to Exhibit 10.1(a) to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2010 (File No. 1-7259));
Supplemental Agreement No. 68 (incorporated by reference to Exhibit 10.1(b) to
the Company’s Annual Report on Form 10-K for the year ended December 31,
2010 (File No. 1-7259)); Supplemental Agreement No. 69 (incorporated by
reference to Exhibit 10.1(c) to the Company’s Annual Report on Form 10-K for
the year ended December 31, 2010 (File No. 1-7259)); Supplemental Agreement
No. 70 (incorporated by reference to Exhibit 10.1(d) to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2010 (File No. 1-7259));

136

Supplemental Agreement No. 71 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011
(File No. 1-7259)); Supplemental Agreement No. 72 (incorporated by reference to
Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2011 (File No. 1-7259)); Supplemental Agreement No. 73
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2011 (File No. 1-7259)); Supplemental
Agreement No. 74 (incorporated by reference to Exhibit 10.1 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended September 30, 2011
(File No. 1-7259)); Supplemental Agreement No. 75 (incorporated by reference to
Exhibit 10.1(a) to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2011 (File No. 1-7259)); Supplemental Agreement No. 76
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2012 (File No. 1-7259)); Supplemental
Agreement No. 77 (incorporated by reference to Exhibit 10.2 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2012
(File No. 1-7259)); Supplemental Agreement No. 78 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2012 (File No. 1-7259)); Supplemental Agreement No. 79
(incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2012 (File No. 1-7259));
Supplemental Agreement No. 80 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013
(File No. 1-7259)); Supplemental Agreement No. 81 (incorporated by reference to
Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2013 (File No. 1-7259)); Supplemental Agreement No. 82
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2013 (File No. 1-7259)); Supplemental
Agreement No. 83 (incorporated by reference to Exhibit 10.2 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2013
(File No. 1-7259)); Supplemental Agreement No. 84 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2013 (File No. 1-7259)); Supplemental Agreement No. 85
(incorporated by reference to Exhibit 10.1(a) to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2013 (File No. 1-7259));
Supplemental Agreement No. 86 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014
(File No. 1-7259)); Supplemental Agreement No. 87 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2014 (File No. 1-7259)); Supplemental Agreement No. 88
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2014 (File No. 1-7259));
Supplemental Agreement No. 89 (incorporated by reference to Exhibit 10.1(a) to
the Company’s Annual Report on Form 10-K for the year ended December 31,
2014 (File No. 1-7259)); Supplemental Agreement No. 90 (incorporated by
reference to Exhibit 10.1(b) to the Company’s Annual Report on Form 10-K for
the year ended December 31, 2014 (File No. 1-7259)); Supplemental Agreement
No. 91 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended June 30, 2015 (File No. 1-7259));
Supplemental Letter Agreement No. 1810-LA-1501773 (incorporated by reference
to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2015 (File No. 1-7259)); Supplemental Agreement No. 92

137

(incorporated by reference to Exhibit 10.1(a) to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2015 (File No. 1-7259));
Supplemental Agreement No. 93 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016
(File No. 1-7259)); Supplemental Agreement No. 94 (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2016 (File No. 1-7259)); Supplemental Agreement No. 95
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2016 (File No. 1-7259));
Supplemental Agreement No. 96 (incorporated by reference to Exhibit 10.2 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,
2016 (File No. 1-7259)); Supplemental Agreement No. 97 (incorporated by
reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended September 30, 2016 (File No. 1-7259)); Supplemental Agreement
No. 98 (incorporated by reference to Exhibit 10.1(a) to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2016 (File No. 1-7259));
Supplemental Agreement No. 99 (incorporated by reference to Exhibit 10.1(b) to
the Company’s Annual Report on Form 10-K for the year ended December 31,
2016 (File No. 1-7259)); Supplemental Agreement No. 100 (incorporated by
reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended March 31, 2017 (File No. 1-7259)); Supplemental Agreement
No. 101 (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended March 31, 2017 (File No. 1-7259));
Supplemental Agreement No. 102 (incorporated by reference to Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017
(File No. 1-7259)); Supplemental Agreement No. 103 (incorporated by reference
to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2017 (File No. 1-7259)); Supplemental Letter Agreement
No. 6-1162-KLK-0059R3 (incorporated by reference to Exhibit 10.4 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,
2017 (File No. 1-7259)). (1)

Form of Amended and Restated Executive Service Recognition Plan Executive
Employment Agreement between the Company and certain Officers of the
Company (incorporated by reference to Exhibit 10.2 to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008 (File
No. 1-7259)). (2)

Letter Agreement between Southwest Airlines Co. and Gary C. Kelly, effective as
of February 1, 2011 (incorporated by reference to Exhibit 99.1 to the Company’s
Current Report on Form 8-K filed February 1, 2011 (File No. 1-7259)). (2)

Southwest Airlines Co. Amended and Restated Severance Plan for Directors (as
amended and restated effective May 19, 2009) (incorporated by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2009 (File No. 1-7259)).

Southwest Airlines Co. Outside Director Incentive Plan (as amended and restated
effective May 16, 2007) (incorporated by reference to Exhibit 10.2 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007
(File No. 1-7259)).

138

10.2

10.3

10.4

10.5

10.6

10.7

10.8

10.9

10.10

10.11

10.12

10.13

10.14

10.15

10.16

Southwest Airlines Co. 2002 SWAPIA Non-Qualified Stock Option Plan
(incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement
on Form S-8 filed October 30, 2002 (File No. 333-100862)).

Southwest Airlines Co. Amended and Restated 2007 Equity Incentive Plan
(incorporated by reference to Exhibit 99.1 to the Company’s Current Report on
Form 8-K filed May 18, 2015(File No. 1-7259)). (2)

Southwest Airlines Co. 2007 Equity Incentive Plan Form of Notice of Grant and
Terms and Conditions for Stock Option Grant (incorporated by reference to
Exhibit 10.31 to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2007 (File No. 1-7259)). (2)

Southwest Airlines Co. Excess Benefit Plan (incorporated by reference to Exhibit
10.32 to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008 (File No. 1-7259)). (2)

Amendment No. 1 to the Southwest Airlines Co. Excess Benefit Plan
(incorporated by reference to Exhibit 10.33 to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008 (File No. 1-7259)). (2)

Amendment No. 2 to the Southwest Airlines Co. Excess Benefit Plan
(incorporated by reference to Exhibit 10.34 to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008 (File No. 1-7259)). (2)

Amended and Restated Southwest Airlines Co. 2005 Excess Benefit Plan (as
amended and restated, effective as of January 1, 2018) (incorporated by reference
to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2017 (File No. 1-7259)). (2)

Form of Indemnification Agreement between the Company and its Directors
(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on
Form 8-K filed January 22, 2009 (File No. 1-7259)).

Southwest Airlines Co. Amended and Restated 2007 Equity Incentive Plan Form
of Notice of Grant and Terms and Conditions for Restricted Stock Unit grants
(incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2014 (File No. 1-7259)). (2)

$1,000,000,000 Revolving Credit Facility Agreement among the Company, the
Banks party thereto, Barclays Bank PLC, as Syndication Agent, Bank of America,
N.A., BNP Paribas, Goldman Sachs Bank USA, Morgan Stanley Senior Funding,
Inc., U.S. Bank National Association, and Wells Fargo Bank, N.A., as
Documentation Agents, JPMorgan Chase Bank, N.A. and Citibank, N.A., as
Co-Administrative Agents, and JPMorgan Chase Bank, N.A., as Paying Agent,
dated as of August 3, 2016 (incorporated by reference to Exhibit 10.1 to the
Company’s Current Report on Form 8-K filed August 9, 2016 (File No. 1-7259)).

Purchase Agreement No. 3729 and Aircraft General Terms Agreement, dated
December 13, 2011, between The Boeing Company and the Company
(incorporated by reference to Exhibit 10.28 to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2011 (File No. 1-7259));
Supplemental Agreement No. 1 (incorporated by reference to Exhibits 10.3 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013
(File No. 1-7259)); Supplemental Agreement No. 2 (incorporated by reference to
Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2013 (File No. 1-7259)); Supplemental Agreement No. 3

139

(incorporated by reference to Exhibit 10.27(a) to the Company’s Annual Report on
Form 10-K for the year ended December 31, 2013 (File No. 1-7259));
Supplemental Agreement No. 4 (incorporated by reference to Exhibit 10.18(a) to
the Company’s Annual Report on Form 10-K for the year ended December 31,
2015 (File No. 1-7259)); Supplemental Agreement No. 5 (incorporated by
reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2016 (File No. 1-7259)); Supplemental Agreement No. 6
(incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2017 (File No. 1-7259));
Supplemental Agreement No. 7 (incorporated by reference to Exhibit 10.3 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,
2017 (File No. 1-7259)); Supplemental Letter Agreement No.
6-1162-KLK-0059R3 (incorporated by reference to Exhibit 10.4 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 (File
No. 1-7259)). (1)

Supplemental Agreement No. 8 to Purchase Agreement No. 3729, dated
December 13, 2011, between The Boeing Company and the Company. (1)

Southwest Airlines Co. Senior Executive Short Term Incentive Plan (incorporated
by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed
January 30, 2013 (File No. 1-7259)). (2)

Southwest Airlines Co. Deferred Compensation Plan for Senior Leadership and
Non-Employee Members of the Southwest Airlines Co. Board of Directors (as
amended and restated, effective as of January 1, 2018) (incorporated by reference
to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the quarter
ended September 30, 2017 (File No. 1-7259)). (2)

Southwest Airlines Co. Amended and Restated 2007 Equity Incentive Plan Form
of Notice of Grant and Terms and Conditions for Performance-Based Restricted
Stock Unit grants (incorporated by reference to Exhibit 10.4 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2014
(File No. 1-7259)). (2)

Consulting Agreement, dated as of June 30, 2017, by and between Arthur
Jefferson Lamb III and Southwest Airlines Co. (incorporated by reference to
Exhibit 10.1 to the Company’s Current Report on Form 8–K filed July 3, 2017
(File No. 1–7259)). (2)

Subsidiaries of the Company.

Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.

Rule 13a-14(a) Certification of Chief Executive Officer.

Rule 13a-14(a) Certification of Chief Financial Officer.

Section 1350 Certification of Chief Executive Officer and Chief Financial
Officer. (3)

140

10.16(a)

10.17

10.18

10.19

10.20

21

23

31.1

31.2

32

101.INS

101.SCH

101.CAL

101.DEF

101.LAB

101.PRE

XBRL Instance Document

XBRL Taxonomy Extension Schema Document

XBRL Taxonomy Extension Calculation Linkbase Document

XBRL Taxonomy Extension Definition Linkbase Document

XBRL Extension Labels Linkbase Document

XBRL Taxonomy Extension Presentation Linkbase Document

(1) Pursuant to 17 CFR 240.24b-2, confidential information has been omitted and has been filed separately
with the Securities and Exchange Commission pursuant to a Confidential Treatment Application filed
with the Commission.

(2) Management contract or compensatory plan or arrangement.
(3) This exhibit is being furnished rather than filed and shall not be deemed incorporated by reference into

any filing, in accordance with Item 601 of Regulation S-K.

A copy of each exhibit may be obtained at a price of 15 cents per page, $10.00 minimum order, by
writing to: Investor Relations, Southwest Airlines Co., P.O. Box 36611, Dallas, Texas 75235-1611.

Item 16.

10-K Summary

None.

141

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.

February 7, 2018

SOUTHWEST AIRLINES CO.

By

/s/ Tammy Romo

Tammy Romo
Executive Vice President & Chief Financial
Officer (On behalf of the Registrant and in her
capacity as Principal Financial and Accounting
Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below
by the following persons on February 7, 2018, on behalf of the registrant and in the capacities indicated.

Signature

/s/ GARY C. KELLY
Gary C. Kelly

/s/ TAMMY ROMO
Tammy Romo

/s/ RON RICKS
Ron Ricks

/s/ DAVID W. BIEGLER
David W. Biegler

/s/

J. VERONICA BIGGINS
J. Veronica Biggins

/s/ DOUGLAS H. BROOKS
Douglas H. Brooks

/s/ WILLIAM H. CUNNINGHAM
William H. Cunningham

/s/

JOHN G. DENISON
John G. Denison

/s/ THOMAS W. GILLIGAN
Thomas W. Gilligan

/s/ GRACE D. LIEBLEIN
Grace D. Lieblein

/s/ NANCY B. LOEFFLER
Nancy B. Loeffler

/s/

JOHN T. MONTFORD
John T. Montford

Title

Chairman of the Board & Chief Executive Officer
(Principal Executive Officer)

Executive Vice President & Chief Financial Officer
(Principal Financial & Accounting Officer)

Vice Chairman of the Board

Director

Director

Director

Director

Director

Director

Director

Director

Director

142

BOARD OF DIRECTORS

DAVID W. BIEGLER

GARY C. KELLY

Acting Chairman of the Board, President, and
Chief Executive Officer
Southcross Energy Partners GP, LLC
(midstream natural gas company)
Retired Vice Chairman of TXU Corp.
Audit Committee, Compensation Committee (Chair),
and Safety and Compliance Oversight Committee

J. VERONICA BIGGINS

Managing Partner
Diversified Search LLC (executive and
board search firm)
Compensation Committee and Nominating and
Corporate Governance Committee

DOUGLAS H. BROOKS

Former Chairman of the Board, President, and
Chief Executive Officer
Brinker International, Inc. (casual dining
restaurant company)
Nominating and Corporate Governance Committee
and Safety and Compliance Oversight Committee

WILLIAM H. CUNNINGHAM, PHD
(Presiding Director)

James L. Bayless Chair for Free Enterprise
The University of Texas at Austin Red McCombs
School of Business
Former Chancellor of The University of Texas System
Audit Committee, Nominating and Corporate
Governance Committee (Chair), and Executive
Committee

JOHN G. DENISON

Former Chairman of the Board
Global Aero Logistics Inc. (diversified
passenger airline)
Audit Committee, Safety and Compliance Oversight
Committee (Chair), and Executive Committee

THOMAS W. GILLIGAN, PHD

Tad and Diane Taube Director of the Hoover
Institution at Stanford University
Audit Committee and Safety and Compliance
Oversight Committee

Chairman of the Board and Chief Executive Officer
Southwest Airlines Co.
Executive Committee (Chair)

GRACE D. LIEBLEIN

Former Vice President, Global Quality
General Motors Corporation (automobile company)
Compensation Committee and Safety
and Compliance Oversight Committee

NANCY B. LOEFFLER

Consultant for Frost Bank and member of the
Frost Bank Advisory Board
Long-time advocate of volunteerism
Compensation Committee and Nominating and
Corporate Governance Committee

JOHN T. MONTFORD, JD

President and Chief Executive Officer
JTM Consulting, LLC
Audit Committee (Chair), Compensation Committee,
and Nominating and Corporate Governance
Committee

RON RICKS

Vice Chairman of the Board
Southwest Airlines Co.
Executive Committee and Safety
and Compliance Oversight Committee

HONORARY DESIGNATIONS

HERBERT D. KELLEHER
Chairman Emeritus
Southwest Airlines Co.
COLLEEN C. BARRETT
President Emeritus
Southwest Airlines Co.

CORPORATE INFORMATION

SOUTHWEST AIRLINES CO. GENERAL OFFICES
P.O. Box 36611
2702 Love Field Drive
Dallas, TX 75235
Telephone: 214-792-4000

FINANCIAL INFORMATION
A copy of the Company’s Annual Report on Form 10-K, as
filed with the U.S. Securities and Exchange Commission, is
included herein. Other financial information can be found
on Southwest’s web site (southwest.com) or may be
obtained without charge by writing or calling:

Southwest Airlines Co.
Investor Relations, HDQ-6IR
P.O. Box 36611
2702 Love Field Drive
Dallas, Texas 75235
Telephone: 214-792-4908

ANNUAL MEETING
The Annual Meeting of Shareholders of Southwest Airlines
Co. will be held at 10:00 a.m. on May 16, 2018, at the
Historic Inns of Annapolis located at 58 State Circle,
Annapolis, Maryland 21401.

STOCK EXCHANGE LISTING
New York Stock Exchange Ticker Symbol: LUV

TRANSFER AGENT AND REGISTRAR
Registered shareholder inquiries regarding stock transfers,
address changes, lost stock certificates, dividend payments
and reinvestments, direct stock purchases, or account
consolidation should be directed to:

EQ Shareowner Services
1110 Centre Pointe Curve, Suite 101
Mendota Heights, MN 55120-4100
866-877-6206
651-450-4064
www.shareowneronline.com

INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
Ernst & Young LLP
Dallas, Texas

2017 SOUTHWEST AIRLINES ONE REPORT

To illustrate our steadfast focus on a triple bottom line – our Performance, our People, and our Planet – we will highlight these
three elements of sustainability in an interactive, electronic publication for our ninth annual Southwest Airlines One Report.
Our award-winning integrated One Report combines financial, corporate responsibility, and environmental reporting into one
comprehensive report, using the Global Reporting Initiative as a guide, an internationally recognized standard for sustainability
reporting. Upon publication, the 2017 Southwest Airlines One Report will be available at http://www.southwest.com/citizenship
or http://www.southwestairlinesinvestorrelations.com/financials.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Our Letter to Shareholders contains forward-looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Specific forward-looking statements
include, without limitation, statements related to (i) the Company’s financial position, outlook, goals, strategies, and projected
results of operations, including specific factors expected to impact the Company’s results of operations; (ii) the Company’s
plans and expectations with respect to its new reservation system; (iii) the Company’s network and growth plans, strategies,
opportunities, and expectations; (iv) the Company’s capacity plans and expectations; (v) the Company’s fleet plans, strategies,
and expectations, including its fleet modernization initiatives, and the Company’s related financial and operational
expectations; and (vi) the Company’s operational initiatives and related plans and expectations, including with respect to its
technology initiatives. These statements involve risks, uncertainties, assumptions, and other factors that are difficult to predict
and that could cause actual results to vary materially from those expressed in or indicated by them. Factors include, among
others, (i) changes in demand for the Company’s services and other changes in consumer behavior; (ii) the impact of a
continually changing business environment, economic conditions, fuel prices, actions of competitors (including without
limitation pricing, product, scheduling, capacity, and network decisions, and consolidation and alliance activities), and other
factors beyond the Company’s control, on the Company’s business decisions, plans, strategies, and results; (iii) the Company’s
dependence on third parties, in particular with respect to its fleet and technology plans; (iv) the Company’s ability to timely and
effectively implement, transition, and maintain the necessary information technology systems and infrastructure to support its
operations and initiatives; (v) the impact of governmental regulations and other governmental actions related to the Company’s
operations; (vi) the Company’s ability to timely and effectively prioritize its initiatives and related expenditures; (vii) the
impact of labor matters on the Company’s business decisions, plans, strategies, and costs; and (viii) other factors, as described
in the Company’s filings with the Securities and Exchange Commission, including the detailed factors discussed under the
heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.