Southwest Airlines

SOUTHWEST AIRLINES CO.
2019 ANNUAL REPORT TO SHAREHOLDERS

To our Shareholders:

I write this at a critical time for our Country and our world, as we are gripped by the
novel coronavirus COVID-19 pandemic. Much of our Country is suffering, not only from the
health crisis presented by the pandemic, but also the economic crisis that unfolded in March
2020, as well. Many U.S. cities are under orders to shelter at home, travel is prohibited to
international destinations, and the U.S. economy has essentially ground to a halt. Layoffs and
unemployment claims are escalating quickly, and many business establishments are
temporarily shuttered, either to comply with local health ordinances or out of business
necessity due to the lack of demand. Air traffic has plunged during the month of March, along
with future bookings. Our schedule is out for sale into October; but, we are in the process of
significantly reducing our published schedule for travel through June 5 due to a lack of
demand. Our best current estimate is that we will reduce the schedule after that travel date,
as well.

Prior to March, our business this year was very strong, and we were on track for a
solid first quarter 2020 earnings performance. For March, we are significantly off of our
financial plan. At this date, second quarter 2020 passenger demand continues to deteriorate
compared with March levels. It is too early to predict what the status of the pandemic will be in
second half 2020 and, therefore, what passenger demand and revenues will be. Indeed, it is a
stressful time.

Our performance for 2019 was strong, especially considering the estimated
$828 million reduction in operating income attributable to the grounding of the Boeing 737
MAX aircraft. On March 13, 2019, the Federal Aviation Administration (FAA) ordered the
grounding of the MAX aircraft following two fatal accidents at Lion Air and Ethiopian Airlines in
October 2018 and March 2019, respectively. The Boeing Company (Boeing) is in the process
of making various changes to its flight control system software and, upon successful
certification of these and other changes by the FAA, expects the MAX to return to service
mid-year 2020. Upon a rescission of the FAA order to ground the MAX fleet, our priority will
be to return our MAX aircraft to service in a safe and controlled manner. At the time of the
grounding, we had 34 MAX 8 aircraft in our fleet. They remain in our possession and
grounded pending FAA approval of a return to service.

Even with the negative impacts from the MAX, we had net income last year of
$2.3 billion, or $4.27 per diluted share. Excluding special
income of
$2.3 billion was just shy of 2018’s record net income, and earnings per diluted share was a
record $4.27.

items1, 2019 net

This represented our 47th consecutive year of profitability, a record unmatched in
commercial airline history. These earnings translated to strong operating cash flow of
$4.0 billion; record free cash flow2 of $3.4 billion; and record shareholder returns of

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, 2019, for additional information on special items and Return on Invested Capital
(ROIC).

2 Free cash flow is calculated as operating cash flows of $4.0 billion less capital expenditures of $1.0 billion plus supplier

proceeds of $400 million.

$2.4 billion. For the sixth consecutive year, we produced exceptional returns on capital,
excluding special items1, of 22.9 percent, pre-tax, and 17.8 percent, after-tax, in 2019, well in
excess of our weighted average cost of capital.

We ended 2019 with exceptionally strong liquidity of $5.1 billion, including $4.1 billion
in cash, cash equivalents, and short-term investments, and a fully available, unsecured
revolving credit line of $1.0 billion. Our investment-grade balance sheet was rated A3 by
Moody’s; BBB+ by S&P; and A- by Fitch. All three rated our debt as stable. We ended the
year with the strongest balance sheet in Southwest’s history, with adjusted debt3 to total
invested capital of only 24 percent.

Total operating revenues were a record $22.4 billion, up 2.1 percent, year-over-year,
even though there were 1.6 percent fewer available seat miles (ASMs) due to the MAX
groundings. Revenue per ASM (RASM) was a record 14.26 cents, up 3.7 percent, year-over-
year, due to strong yields and demand.

We ended the year with service to 101 destinations and 747 aircraft in our fleet. We
made exciting additions to our route network last year, launching service from California to the
Hawaiian Islands. Today, we serve five destinations in Hawaii: Honolulu, Maui, Kauai, Kona,
and Hilo. Currently, our mainland gateway service is all from three California cities: Oakland,
San Jose, and Sacramento. Our initial service has been very well received and was
performing better than our expectations until the COVID-19 crisis hit.

The MAX groundings created an airplane deficit relative to our planned service and
had a significant impact on our route network and expansion plans in 2019. By year end, we
were missing roughly 8 percent of our planned capacity. To help fund the aircraft needed for
our Hawaii expansion, we made the difficult decision to close Newark Liberty International
Airport and consolidate our New York City operations into New York LaGuardia Airport. We
had a successful 37 flights-per-day presence there at year end, and at newly-renovated
departure facilities.

In addition to ceasing operations at Newark, we were forced to trim capacity
throughout our system in 2019. And, because previously-published schedules were modified
due to the unexpected grounding of the MAX, the flight schedules were not as efficient or
productive from commercial and operations perspectives. Even so, we performed
exceptionally well, and I want to commend our People for doing an extraordinary job in
managing through this challenge. The will power, the brain power, and the computing power
were, all combined, an impressive and crucial array. Our record performance was, as usual,
accomplished because of our People.

To compensate us for estimated 2019 financial damages due to the MAX groundings,
we reached a confidential agreement with Boeing in 2019. Even though the agreement
covered a substantial portion of 2019 estimated losses, the accounting for the compensation
is a reduction of the MAX purchase price, with a depreciation expense benefit realized over
future decades. In order to properly reward our Employees for their 2019 performance, a
discretionary, special $124 million profitsharing contribution was authorized by our Board of
Directors, which drove profitsharing expense higher in 2019 by 22.8 percent.

3 Adjusted debt is calculated as short-term and long-term debt including the net present value of aircraft rentals related to

operating leases.

Operating expenses in 2019 increased 3.8 percent, year-over-year, to $19.5 billion.
That represents a 5.5 percent increase on a unit basis4, primarily due to reduced capacity, as
a result of the MAX groundings, spread over a predominantly fixed cost base, along with the
special profitsharing contribution. These increases were offset by lower jet fuel prices. Our jet
fuel costs were $4.3 billion for the year, or 22.3 percent of total operating expenses. Jet fuel
prices per gallon declined 5.0 percent, year-over-year, leading to a decline in jet fuel costs of
$269 million, or 5.8 percent. Unit costs, excluding fuel and oil expense and profitsharing
expense, were up 8.0 percent, year-over-year, or 7.7 percent, excluding special items1.

Our operational performance was superb in 2019. Our ontime performance improved
to 80.2—our best in three years—placing us in the top tier in the industry5, despite the
challenge of managing through the MAX groundings. Our baggage handling performance was
the best in our history. Once again, we ranked first in Customer Service as we logged the
lowest Customer complaints ratio in the U.S. Department of Transportation’s ratings6. Finally,
once again, Southwest received numerous awards and recognitions, including being named
to FORTUNE’s list of World’s Most Admired Companies, ranked #11. I am very proud of our
People and their resiliency, no matter the challenge.

Our Board of Directors rewarded our Shareholders last year with a $2.0 billion share
repurchase authorization in May 2019, along with a 12.5 percent increase in the quarterly
dividend, to $.18 per share, or $.72 annually. This represents the 8th year in a row that
Southwest has increased the dividend and the 43rd consecutive year that Southwest has paid
a dividend.

Now, back to the present crisis. The pandemic and the economic shock hit with
alarming velocity this month. Our bookings began to plunge in late February, and the traffic
began to significantly weaken within two weeks. We reacted swiftly:

(cid:129) We assembled a group of Operations Leaders to enhance our cleaning
procedures for the safety of our Employees and Customers, and to coordinate the
daily complexities of flight schedule changes, emerging executive orders, and
travel restrictions;

(cid:129) Our named executive officers and Board of Directors have reduced their salaries/

cash fees by 20 percent;

(cid:129) We have suspended all hiring and non-contract salary increases;

(cid:129) We have engaged with our Union Employees’ representatives in discussions

regarding cost-savings initiatives;

(cid:129) We have suspended share repurchases;

(cid:129) We have canceled or deferred a variety of capital spending projects;

(cid:129) We have begun to reduce our flight schedules to better match passenger demand

with the supply of seats;

4 Operating expenses per available seat mile.
5 Source: Air Travel Consumer Reports. Ontime performance is measured by the percentage of flights that arrive within 15

minutes of scheduled arrival time as reported to the Department of Transportation (DOT).

6 Source: Air Travel Consumer Reports. Rankings based on complaints filed with the U.S. Department of Transportation per

100,000 passengers enplaned.

3

(cid:129) We have eliminated or deferred all non-essential operating costs;

(cid:129) We are benefitting from dramatically lower crude oil prices in the form of lower jet
fuel prices, with our fuel hedging program allowing for the full benefit of falling
prices;

(cid:129) We have obtained $4.8 billion of additional cash in 2020, thus far, with billions in
available, unencumbered collateral; an investment-grade balance sheet;
low
operating costs; and the industry’s most successful business model over five
decades.

Last Friday, Congress passed the “Coronavirus Aid, Response, and Economic
Stabilization Act of 2020” (CARES), and President Trump signed it. It is a $2 trillion package
that, among many other things, provides the opportunity for financial assistance to the
passenger and cargo airlines. I believe it is critical for our Nation to have this kind of bold,
broad stimulus for our economy to weather this terrible storm. Arguably, no sectors of the
economy are as negatively impacted as the travel and tourism industries. In the coming days,
we will carefully evaluate the CARES Act,
the cost, and the
conditions and restrictions that are mandated by the Act. Our goals will be, as always, to keep
Southwest financially healthy, job-secure, and reliable and hospitable for our Customers. I am
very grateful and appreciative of the work of our federal leaders who have recognized the
unprecedented economic challenge that our Nation is facing and who have moved swiftly and
aggressively to combat it.

the need for assistance,

I want to close by thanking two groups. This is an unprecedented health crisis, first
and foremost. Our magnificent, dedicated, and fearless health care professionals deserve our
deepest appreciation. Godspeed in their efforts to bring this virus under control with testing,
medications, and vaccines. And second, our appreciation and admiration goes to all the
essential personnel from first responders to truck drivers, from grocery store workers to
frontline communication workers. Too many to list, but heroes all.

Finally, I must thank the 60,000 Southwest Family Members, who are warriors. Our
beloved Founder, Herb Kelleher, who we lost on Jan. 3, 2019, would be as proud of our
Employees as I am for all they are doing on the frontlines and behind the scenes to battle
through this crisis and provide America the freedom to travel for what is important in their
lives—safely, reliably, and with friendly service at a low price. They have performed fearlessly
and flawlessly during this crisis. They have my deepest appreciation and love, and I know
Herb is looking down on them with gratitude.

We will get through this. And, when we do, you can count on our Southwest Warriors

to be there for you. All of us.

Sincerely,

Gary C. Kelly
Chairman of the Board and
Chief Executive Officer
April 2, 2020

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, 2019
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)

Trading Symbol

LUV

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 every Interactive Data File required to be submitted 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 such
files). Yes Í No ‘

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 $27,212,024,231 computed by
reference to the closing sale price of the common stock on the New York Stock Exchange on June 28, 2019, the last trading day of the registrant’s
most recently completed second fiscal quarter.

Number of shares of common stock outstanding as of the close of business on January 30, 2020: 517,295,540 shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement for the Company’s Annual Meeting of Shareholders to be held May 21, 2020, are incorporated

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

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
24
35
36
38
39

42
45
47
60

62
65
71
76
76
77
78
79
80
81
131
131
132

133
133

133
134
134

135
143
144

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. Southwest commenced service on June 18, 1971, with three Boeing 737 aircraft serving three
Texas cities: Dallas, Houston, and San Antonio. At December 31, 2019, Southwest had a total of
747 Boeing 737 aircraft in its fleet and served 101 destinations in 40 states, the District of Columbia,
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.

In 2019, the Company began service to four destinations in Hawaii after receiving approval from the
for Extended Operations (“ETOPS”), a regulatory
Federal Aviation Administration (“FAA”)
requirement to operate between the U.S. mainland and the Hawaiian Islands. These destinations
included Honolulu on the Island of Oahu, Kahului on Maui, Kona on Hawaii, and Lihue on Kauai. The
Company added a fifth Hawaiian destination, Hilo on Hawaii, on January 19, 2020. The Company has
also announced its decision to begin serving Cozumel International Airport, subject to requisite
government approvals, with service scheduled to begin March 7, 2020.

During first quarter 2019, the Company ceased service at Benito Juárez Mexico City International
Airport. Further, in fourth quarter 2019, the Company ceased service at Newark Liberty International
Airport, in order to consolidate its New York City presence at New York LaGuardia Airport.

On March 13, 2019, the FAA issued an emergency order for all U.S. airlines to ground the Boeing 737
MAX aircraft, including the 34 MAX 8 aircraft in the Company’s fleet at that time (the “MAX
groundings”). As discussed below under “Company Operations” and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” the MAX groundings adversely affected
the Company’s operations and financial results for the year ended December 31, 2019. The MAX
aircraft remains grounded and, based on continued uncertainty around the timing of the MAX return to
service, the Company has removed the MAX from its flight schedule through June 6, 2020.

Based on the most recent data available from the U.S. Department of Transportation (the “DOT”), as
of September 30, 2019, Southwest was the largest domestic air carrier in the United States, as
measured by the number of domestic originating passengers boarded.

Industry

to numerous
The airline industry has historically been an extremely volatile industry subject
challenges. Among other things,
labor intensive, capital
intensive, technology intensive, highly regulated, heavily taxed, and extremely competitive. The airline
industry has also been particularly susceptible to detrimental events such as economic recessions, jet
fuel price volatility, unscheduled maintenance disruptions, U.S. government shutdowns, acts of
terrorism, poor weather, and natural disasters.

it has been cyclical, energy intensive,

The MAX groundings and the uncertainty of the timing of the MAX aircraft’s return to service caused
air carriers with the MAX aircraft in their fleets, including Southwest, to remove the aircraft from their

1

flight schedules through 2019, reducing 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). This,
led to slower aggregate industry growth.
in turn,
MAX-impacted carriers also experienced lost revenues and unforecasted expenses as a result of the
MAX groundings. As discussed further below under “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” the Company’s capacity declined 1.6 percent year-
over-year for 2019. It remains uncertain how long MAX-impacted carriers will be unable to fly the
MAX.

The U.S. airline industry continued to benefit from modest (although declining) economic growth
during 2019, despite a very competitive domestic fare environment. The airline industry also
experienced a relatively stable and moderate fuel environment in 2019, as compared with recent years,
with year-over-year fuel prices lower throughout most of 2019.

During recent years, the airline industry has continued to be impacted by the significant growth of
“Ultra-Low Cost Carriers” (“ULCCs”). ULCCs provide “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,
most major U.S. airlines offer expanded cabin segmentation 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 may include 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 competitive ULCC
pricing, some carriers no longer have fare floors for certain routes, leading to a lower fare offering
across the industry. Further, to better derive revenue from customers, some carriers offer a “premium
economy” fare that targets consumers willing to pay a premium for certain amenities that were
previously included in the carriers’ base fare (e.g., more favorable seating locations in the main cabin).

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. The Company continues to focus on adding depth to
schedule offerings in certain key cities, which is expected to benefit operational efficiency and give
Customers additional options to reach their final destination. Approximately 77 percent of the
Company’s Customers flew nonstop during 2019, and, as of December 31, 2019, Southwest served
720 nonstop city pairs. For 2019, the Company’s average aircraft trip stage length was 748 miles, with
an average duration of approximately 2.0 hours, as compared with an average aircraft trip stage length
of 757 miles and an average duration of approximately 2.0 hours in 2018.

to provide its markets with frequent,
Southwest’s point-to-point service has also enabled it
conveniently timed flights and low fares. For example, Southwest currently offers 21 weekday
roundtrips between Dallas Love Field and Houston Hobby, 13 weekday roundtrips between Burbank

2

and Oakland, 16 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 including flights between California and Hawaii and between markets such as Los Angeles and
Nashville, Las Vegas and Orlando, San Diego and Baltimore, Houston and New York LaGuardia, and
Oakland and Baltimore.

The Company continually works to optimize its route network and schedule through the addition of
frequencies in its core markets and the addition of new markets and itineraries, while also pruning less
profitable flights from its schedule. The Company’s network and schedule optimization efforts have
been particularly beneficial in addressing the impact of the MAX groundings.

The Company continued its focus on California in 2019, and continues to invest significant resources
to solidify its leadership position in California, including the planned addition of new destination
options and flights for California Customers. For example, as Hawaii is an attractive leisure destination
for the Company’s California Customers, the Company began service to Hawaii in first quarter 2019
with inaugural service from Oakland to Honolulu on the Island of Oahu. In second quarter 2019, the
Company began service from Oakland to Kahului on the Island of Maui, and service from San Jose to
Honolulu and Kahului. Interisland service also began during second quarter 2019, with service
between Honolulu and Kahului, and between Honolulu and Kona on the Island of Hawaii. During
fourth quarter 2019, the Company began service at Lihue Airport on the Island of Kauai; and added
Sacramento as an additional California gateway city. Additionally, in January 2020, the Company
began service at Hilo International Airport on the Island of Hawaii. The Company is also scheduled to
begin service from San Diego to Kahului on April 14, 2020, and from San Diego to Honolulu on
April 20, 2020. By April 20, 2020, the Company is scheduled to offer 28 daily departures between
California and Hawaii, and 38 daily departures among the Hawaiian Islands. The Company is currently
scheduled to offer over 800 departures from California on peak flying days in the summer of 2020 and,
based on the most recent data available from the DOT, for the year ended September 30, 2019,
Southwest already carried more California travelers to, from, and within California than any other
airline. In addition to California and Hawaii, the Company remains focused on strengthening its
schedule in core markets to provide additional regional and international connectivity, improving its
recoverability during irregular operations, and growing its presence in strategic markets that serve as
cornerstones for its network such as Baltimore, Denver, and Houston.

The Company ended 2019 with international service to 13 destinations through 25 international
gateway cities within the 48 contiguous United States.

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 the largest domestic carriers; however, as discussed below under
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the
Company experienced significant unit cost pressure in 2019 following the MAX groundings.

The Company’s low-cost strategy includes, among other elements, (i) the use of a single aircraft type,
the Boeing 737, (ii) the Company’s operationally efficient point-to-point route structure, and (iii) its
type allows for simplified
highly productive Employees. Southwest’s use of a single aircraft

3

scheduling, maintenance, flight operations, and training activities. Southwest’s 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.
Although Fuel and oil expense for 2019 decreased compared with 2018, primarily due to lower market
jet fuel prices, it nonetheless remained the Company’s second largest operating cost for 2019. 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 2009
and during each quarter of 2019.

Year

2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
First Quarter 2019
Second Quarter 2019
Third Quarter 2019
Fourth Quarter 2019

Cost
(Millions)

Average
Cost Per
Gallon

Percentage of
Operating
Expenses

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

3,193 $
3,755 $
5,751 $
6,156 $
5,823 $
5,355 $
3,740 $
3,801 $
4,076 $
4,616 $
4,347 $
1,015 $
1,136 $
1,090 $
1,105 $

2.22
2.61
3.25
3.32
3.19
2.97
1.96
1.90
1.99
2.20
2.09
2.05
2.13
2.07
2.09

31.2%
33.4%
38.2%
37.3%
35.3%
32.6%
23.6%
22.7%
23.0%
24.6%
22.3%
21.9%
23.0%
22.6%
21.8%

The Company focuses on reducing fuel consumption and improving fuel efficiency through fleet
modernization and other fuel initiatives. For example, the Company previously retired all Boeing
737-300 aircraft from its fleet and introduced service with the MAX 8 aircraft, which is more fuel-
efficient and releases fewer CO2 emissions than the Company’s other aircraft; however, the MAX
groundings resulted in the removal of these more fuel-efficient aircraft from the Company’s schedule,
which, in turn, drove a decline in the Company’s overall fuel efficiency in 2019. The Company
continues to undertake a number of other fuel conservation initiatives, which are discussed in detail
under “Regulation - Environmental Regulation.”

4

The table below sets forth the Company’s available seat miles produced per fuel gallon consumed over
the last five years:

2019

Year ended December 31,
2017

2016

2018

2015

Available seat miles per fuel

gallon consumed

75.7

76.3

75.2

74.4

73.9

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 42.6 percent of the Company’s
operating expenses during 2019 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) and complimentary soft drinks
and snacks, as well as free messaging, music, movies-on-demand, and live and on-demand television
on WiFi-enabled aircraft. 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 towards future travel on Southwest. Wanna Get Away fares earn six
Rapid Rewards® points, under Southwest’s Rapid Rewards loyalty program, for each dollar
spent on the base fare. The Company’s loyalty program is discussed below under “Rapid
Rewards Loyalty Program.”

“Anytime” fares are, subject to Southwest’s No Show Policy, refundable if canceled, or
funds may be applied towards future travel on Southwest. If this fare is purchased with
nonrefundable funds, then the funds will be nonrefundable if travel is canceled. Anytime
fares earn 10 Rapid Rewards points for each dollar spent on the base fare.

“Business Select” fares are, subject to Southwest’s No Show Policy, refundable if canceled,
or funds may be applied towards future travel on Southwest. If this fare is purchased with

5

nonrefundable funds, then the funds will be nonrefundable if travel is canceled. 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,” 12 Rapid Rewards points per
dollar spent on the base fare - the highest loyalty point multiplier of all Southwest fare
products, “Fly By®” priority security and/or ticket counter access in participating airports,
and one complimentary premium beverage coupon for the day of travel (Customers must be
of legal drinking age to drink alcoholic beverages).

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®, Upgraded Boarding,
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 Loyalty Program). The Company has implemented a variable pricing
model for EarlyBird Check-In based on the length of the flight and the historical popularity of
EarlyBird Check-In on the route.

When available, Southwest sells Upgraded Boarding at the airport, which allows a Customer to pay for
an open priority boarding position in the first 15 positions in its “A” boarding group.

Southwest’s Pet Policy provides Customers an opportunity to travel with a small cat or dog in the
aircraft cabin on domestic flights. Southwest also has an unaccompanied minor travel policy to address
the administrative costs and the extra care necessary to safely transport these Customers.

Inflight Entertainment Portal and WiFi Service

Southwest offers inflight entertainment and connectivity service on WiFi-enabled aircraft on the
majority of its fleet. Southwest’s suite of complimentary offerings onboard its inflight entertainment
portal offers free movies, free messaging, free music, free games, and free live and on-demand
television while onboard WiFi-enabled aircraft. The inflight entertainment service allows Customers to
enjoy gate-to-gate entertainment directly on their personal wireless devices.

The free inflight entertainment offerings include approximately 45 free movies-on-demand per month
and free app messaging via iMessage or WhatsApp. The television product consists of over 15 live
channels and up to 75 on-demand recorded episodes from popular television series. In addition, the
onboard entertainment portal offers free digital music and live streaming radio service to Customers
within the onboard entertainment portal.

6

Customers can also purchase satellite internet service while on WiFi-enabled aircraft. Customers do
not have to purchase WiFi to access the free inflight entertainment options including free movies, free
messaging, free television, free music, free games, weather, destination guides, a flight tracker, and
connecting flight information.

Rapid Rewards Loyalty Program

Southwest’s Rapid Rewards loyalty program enables program members (“Members”) to earn points for
every dollar spent on Southwest base fares. 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
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.

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 ticket (including many fare sales) and redeem fewer points or by being able to redeem more points
and book at the last minute if seats are still available for sale. In addition to redeeming points for
Southwest flights, Members are also able to redeem their points for items such as international flights
on other airlines, cruises, hotel stays, rental cars, gift cards, event tickets, and more. Members can also
earn points through qualifying purchases with Rapid Rewards Partners (which include, for example,
car rental agencies, hotels, and restaurants), as well as by using Southwest’s co-branded Chase® Visa
credit card. 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 loyalty 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 satellite internet service on WiFi-enabled aircraft. 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. Beginning January 1, 2021, A-List and
A-List Preferred Members will have the same standby privileges free of airline charges, but will be
required to pay any additional government taxes and fees associated with changes in their itinerary.
Members who fly 100 qualifying one-way flights or earn 125,000 qualifying points in a calendar year
automatically receive a Companion Pass, which provides for unlimited travel for the designated
Companion 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

7

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 loyalty 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; (ii) increasing business from existing Customers; and (iii) strengthening the
Company’s Rapid Rewards hotel, rental car, credit card, and other partnerships.

For 2019, Customers of Southwest redeemed approximately 10.7 million flight awards, accounting for
approximately 14.1 percent of revenue passenger miles flown. For 2018, Customers of Southwest
redeemed approximately 10.4 million flight awards, accounting for approximately 13.8 percent of
revenue passenger miles flown. For 2017, Customers of Southwest
redeemed approximately
9.6 million flight awards, accounting for approximately 13.8 percent of revenue passenger miles flown.
The Company’s accounting policies with respect to its loyalty programs are discussed in more detail in
Note 1 to the Consolidated Financial Statements.

Southwest Business® Initiatives

During 2019, the Company increased its focus on growing the Company’s corporate travel business
with the goal of making it easier for corporate travel Customers and travel management companies to
do business with Southwest.

the Company entered into an agreement with Amadeus IT Group, S.A.
In third quarter 2019,
(“Amadeus”), and expanded its agreement with Travelport, LP and Travelport International Operations
Limited (collectively, “Travelport”), to enable corporate travel Customers and travel management
companies to book Southwest products on the Amadeus and Travelport global distribution system
(“GDS”) platforms. The Company’s expansion into the Travelport and Amadeus GDS channels is
intended to facilitate corporate travel managers’ ability to book, change, cancel, and modify Southwest
reservations. The Company expects the new capabilities to be ready for bookings in 2020. The
Company also has an agreement with Airlines Reporting Corporation to implement industry-standard
processes to handle the settlement of tickets booked through Travelport and Amadeus channels.

In 2019, Southwest Business also continued to invest
in and enhance its online booking tool
SWABIZ®. SWABIZ is designed for business Customers who prefer a self-service and low-cost
solution for booking their air travel on Southwest. The site also offers car and hotel booking functions.

Digital Customer Platforms including Southwest.com

The Company offers a broad suite of digital platforms to support Customers’ needs prior to and during
including Southwest.com®, mobile.southwest.com, an iOSTM app, an
the course of their travel,
iPadOSTM app, and an Android app. These digital platforms help Customers to learn, shop, book, and
manage their Southwest air travel and also facilitate the purchase of the Company’s ancillary products,
including EarlyBird, Business Select, vacation packages, rental car reservations, hotel reservations, and
travel activities. In addition, the digital platforms provide self-service tools for reservation management
and Customer support.

During 2019, to improve customer support, Southwest also added live chat functionality to the
Southwest apps to enable Customers to connect directly with Customer Support and Services

8

representatives. Southwest.com was also updated with a digital feedback tool to enhance Customer
self-service options, including the ability to provide feedback on their experience.

During 2019, to improve the booking process, Southwest added PayPal® to its mobile website and
apps. Payment choices were also improved by adding Apple Pay® to the Southwest iOS and iPadOS
apps as well as to the Inflight WiFi purchase page. Southwest also enhanced Southwest.com and
Southwest’s mobile website and apps to make it easier for Customers to manage unused travel funds
after a cancellation or change.

For the year ended December 31, 2019, approximately 80 percent of the Company’s Passenger
revenues originated from its website (including revenues from SWABIZ).

Marketing

During 2019, Southwest continued to market and benefit from its competitive points of differentiation.
The Company’s TransfarencySM campaign, for example, emphasized Southwest’s approach to treating
Customers fairly, honestly, and respectfully, by offering low fares and no unexpected bag fees, change
fees, or hidden fees.

Southwest, unlike its competitors, does not charge a fee on any fare for a change in flight reservation.
While a difference in airfare may apply, the Customer will not be charged a change fee on top of that
fare difference. Southwest also does not impose additional fees for items such as seat selection, snacks,
curb-side check-in, and telephone reservations, commonly found on other carriers.

Southwest also continues to be the only major U.S. airline that offers to all ticketed Customers up to
two checked bags that fly free (subject to weight and size limits). In addition, each ticketed Customer
may check one stroller and one car seat free of charge. Southwest has continued to promote this unique
benefit with its “Bags Fly Free®” message.

The Company also continues to promote all of the many other reasons to fly Southwest in its
marketing, such as its hospitality, low fares, network, Customer Service, free inflight entertainment,
and its Rapid Rewards loyalty program.

Technology Initiatives

The Company has committed significant resources to technology improvements in support of its
ongoing operations and initiatives. The Company continues to focus on the prioritization and execution
of its technology investments and is in the process of continually executing an evolving multi-year plan
for technology, with the goal of developing a stronger, adaptable, and more efficient and reliable
technology foundation to support the Company’s strategic priorities. 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) technology infrastructure.

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, an agency within the DOT, regulates aviation safety. The DOT and the FAA
may impose civil penalties on air carriers for violating their 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 failure to comply with federal aviation statutes,
regulations, orders, or the terms of the certificate or exemption itself.

The DOT’s consumer protection and enforcement authority is derived primarily from a federal
statutory prohibition on “unfair or deceptive practices or unfair methods of competition” by air
carriers. DOT activity under this statute concerns matters such as false or 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 (i) disability; and (ii) race,
religion, national origin, sex, or ancestry.

Under the above-described authority, the DOT has also 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. For example,
under the Tarmac Delay Rule, air carriers must not allow an aircraft to remain on the tarmac for more
than 3 hours (for domestic delays) or more than 4 hours (for international delays), without allowing
passengers to deplane. There are certain exceptions for safety and security-related reasons, or if air
traffic control advises the pilot-in-command that returning to the gate or permitting passengers to
disembark elsewhere would significantly disrupt airport operations.

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 (defined as 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 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 four times the passenger’s one-way
fare to their final destination that day in compensation to each passenger denied boarding involuntarily

10

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 FAA Reauthorization Act of 2018, passed by Congress on October 3,
2018, and signed into law on October 5, 2018 (the “Reauthorization Act”), directs the DOT to revise
regulations to clarify there is not a maximum level of compensation an air carrier may pay to a
passenger who is involuntary denied boarding as a result of an oversold flight.

The Passenger Protection Rules also require that (i) advertised fares 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.

The DOT has expressed its intent to aggressively investigate alleged violations of its consumer
protection rules. Airlines that violate certain aviation economic regulations and statutes are subject to
potential fines of up to $34,174 per occurrence.

The DOT is currently seeking comments on a proposed rule that would include modifications to the
aircraft lavatory and on-board wheelchair requirements to accommodate passengers with disabilities.
The DOT is also expected to seek comments on a separate advanced proposed rule involving
accessible lavatories. The advanced proposed rule would “gather updated information on the costs and
benefits of requiring airlines to make lavatories on new single-aisle aircraft large enough, equivalent to
that currently found on twin-aisle aircraft, to permit a passenger with a disability (with the help of an
assistant, if necessary) to approach, enter, and maneuver within the aircraft lavatory as necessary to use
all lavatory facilities and leave by means of the aircraft’s on-board wheelchair.” Requirements to
expand the size of lavatories could impose substantial costs on the Company, either in the short-term or
the long-term. Whether the DOT will actually adopt a new rule requiring larger lavatories, and the
timing and application of any new rule, are unknown at this time.

In January 2020, the DOT proposed new regulations that would allow airlines to recognize emotional
support animals as pets rather than service animals. Under the proposed rule, airlines would still be
required to accept trained service dogs. If adopted by the DOT, the rule would likely simplify the
Company’s procedures for accepting animals in the cabin.

The Reauthorization Act includes numerous provisions related to the DOT’s rules and authority. For
example:

•

•

the DOT has been given the authority to impose triple the maximum fines for damages to
passengers’ wheelchairs or other mobility aids, as well as for injury to passengers with
disabilities;

the DOT has been directed to implement a rulemaking to require air carriers to promptly
provide a refund for any ancillary fee paid for services a passenger does not receive; and

11

•

the Reauthorization Act makes it an unfair and deceptive practice to involuntarily deplane a
revenue passenger onboard an aircraft
if that passenger is traveling on a confirmed
reservation and is checked-in for the relevant flight prior to the applicable check-in deadline.

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. The Reauthorization Act extends most commercial aviation taxes
through
September 30, 2023.

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 originating in the
U.S. In addition, international passengers arriving in the U.S. are subject to U.S. 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 an agriculture inspection fee on international passengers
arriving in the U.S.

In 2020, Congress is expected to consider
legislation related to federal spending on public
infrastructure, including at airports. This legislation could result in an increase in the maximum
Passenger Facility Charge, which is assessed by airports and collected by airlines, currently capped at
$4.50 per enplanement (with a maximum of two Passenger Facility Charges on a one-way trip).
Conversely,
in public
infrastructure that may benefit all modes of transportation.

this legislation could also result

in an infusion of

investment

federal

Finally, the annual congressional budget process is another legislative vehicle by which new aviation
taxes or regulations may be imposed. The annual appropriations bill funds the federal government -
including the DOT, the FAA, the Transportation Security Administration (the “TSA”), and CBP.
Passage of the fiscal year 2021 appropriations bill will be considered throughout 2020 and could result
in an increase in one or more of the taxes and fees discussed above, as well as new mandates on the
DOT to begin or complete rulemakings related to airline consumer protection.

Operational, Safety, and Health Regulation

to aircraft maintenance and operations,

The FAA has the authority to regulate safety aspects of civil aviation operations. Specifically, the
Company and certain of its third-party service providers are subject to the jurisdiction of the FAA with
including equipment, ground facilities, dispatch,
respect
communications, training, and other matters affecting air safety. The FAA, from time to time, issues
orders or directives relating to the maintenance and operation of aircraft that require significant
expenditures or operational restrictions. The FAA, acting through its own powers or through the
appropriate U.S. Attorney, has the power to bring proceedings for the imposition and collection of civil
penalties 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.

12

The FAA has rules in effect with respect to flight, duty, and rest regulations. Among other things, the
rules (i) require a ten hour minimum rest period prior to a pilot’s flight duty period; (ii) mandate that a
pilot must have an opportunity for eight hours of uninterrupted sleep within the rest period; and
(iii) impose pilot “flight time” and “duty time” limitations based upon report times, the number of
scheduled flight segments, and other operational factors. The FAA has established flight attendant duty
period limitations and rest requirements based on the length of a flight attendant’s scheduled duty
period, number of
factors. The
Reauthorization Act contains a provision requiring a modification to the FAA’s rules to increase the
required flight attendant rest period between duty periods. The FAA is soliciting input from the airline
industry and other interested parties to obtain more information about current operations with flight
attendants and the potential benefits and costs to inform the rulemaking. Flight, duty, and rest
regulations affect the Company’s staffing flexibility, which could impact the Company’s operational
performance, costs, and Customer Experience.

flight attendants assigned to a flight, and other operational

The Reauthorization Act also contains provisions directing the FAA to issue new regulations to
establish minimum dimensions for seat size that are necessary for the safety of passengers. Further, the
Reauthorization Act expands human trafficking training requirements beyond flight attendants to
include several public-facing Employee work groups, as well as requires air carriers to implement a
plan and develop training with protocols for preventing and responding to verbal or physical assault
committed against customer service agents.

In addition to its role as safety regulator, the FAA operates the nation’s air traffic control system and
to implement a multi-faceted, air traffic control
has continued its lengthy and ongoing effort
modernization program called “NextGen.” As part of the NextGen initiative, in 2010 the FAA
published rules requiring most commercial aircraft operating in the national airspace system to be
equipped with Automatic Dependent Surveillance - Broadcast (“ADS-B”) technology by January 1,
2020. ADS-B technology is intended to enhance safety and efficiency by moving from ground-based
radar and navigational aids to precise tracking using satellite signals. In addition to environmental and
efficiency benefits, ADS-B technology is expected to give pilots and air traffic controllers new tools to
reduce the risk of runway incursions and aircraft collisions. The Company intends to comply with all
applicable ADS-B requirements.

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 Reauthorization Act directs the FAA to (i) undertake
a comprehensive review and prepare a full report on NextGen implementation and (ii) annually report
on NextGen progress and return on investment.

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 TSA, a federal agency of the
U.S. Department of Homeland Security, is responsible for certain civil aviation security matters. ATSA

13

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 and aircraft
access security; (iv) airline crew security training; (v) security screening 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 more extensive 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’s multi-layered approach to airport security also
includes physical pat down procedures at security checkpoints. These procedures have raised privacy
concerns by some air travelers, and have caused delays at screening checkpoints.

Pursuant to the Reauthorization Act, the FAA is required to issue an order requiring installation of a
physical secondary cockpit barrier on “each new aircraft that is manufactured” for delivery to a
passenger air carrier. The FAA has formed a working group comprised of industry technical experts to
provide advice and recommendations on the most effective ways to implement the physical secondary
cockpit barrier requirement. Depending on the advice and recommendations of the working group, as
well as the FAA’s interpretation and application of the statutory requirement, compliance with the
future FAA order could impose a substantial cost on the Company.

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 TSA has expressed its plans to leverage advanced transportation
security screening technologies, including biometric solutions, to improve security effectiveness and
operational efficiency, while also enhancing the passenger experience. The advanced technologies
have prompted privacy, cost, and legal concerns from air carriers, travelers, and advocacy groups,
which could affect the timing and viability of the TSA’s plans.

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 TSA, foreign national governments, and airports to provide
risk-based security measures at international locations served by the Company.

14

The Department of Homeland Security has granted the Company designation coverage under the
Support Anti-Terrorism by Fostering Effective Technologies Act of 2002 (the “SAFETY Act”)
through September 29, 2022. 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 designation is
based on the security program used by the Company to protect its Employees, Customers, and assets
from terrorists and other criminal activities.

The Company has made significant investments in facilities, equipment, and technology to process
Customers, checked baggage, and cargo efficiently in compliance with applicable security regulations;
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.

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 adversely affect its operations, operating
costs, or competitive position in a material way.

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”) have
implemented 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 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 carbon offsetting system on aircraft operators designed to cap

15

the growth of emissions related to international aviation emissions. ICAO’s Carbon Offsetting and
Reduction Scheme for International Aviation (“CORSIA”) program is a global market-based measure
intended to cap carbon emissions from international civil aviation at their 2020 levels, enabling carbon-
neutral growth for the international aviation sector from 2020. The U.S. federal government has opted
to participate in the voluntary phases of the CORSIA program from 2021-2026. As part of the
CORSIA program, the Company is currently monitoring its international emissions for reporting
purposes. Data collected from the monitoring phase will form the baseline and be used in the
calculations to determine subsequent carbon offsetting requirements under the CORSIA program.
Regardless of the method of regulation or application of CORSIA, further 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 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.

to implement

level,

the federal

the FAA has committed to inform and involve the public, engage with
At
communities, and give meaningful consideration to community concerns and views when developing
new flight procedures, and there is a possibility that Congress may enact legislation in 2020 to address
local noise concerns at one or more commercial airports in the United States. In addition, the
Reauthorization Act requires the FAA to consider community noise concerns when proposing a new
navigation departure procedure or amending an existing navigation procedure that would direct aircraft
over noise sensitive areas. This requirement could delay or otherwise impede the implementation or
use of more efficient flight paths.

The Company remains steadfast in its desire to pursue, implement, and enhance initiatives that will
reduce fuel consumption, which reduces carbon emissions, and improve fuel efficiency. During 2019,
the Company continued its efforts at more efficient flight planning and flight operation. In addition,
over the years, the Company has undertaken a number of other fuel conservation and carbon emission
reduction initiatives such as the following:

•

•

•

•

•

introduced the MAX aircraft into the Company’s fleet, which is more fuel-efficient and
releases fewer CO2 emissions than the Company’s other aircraft;

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 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;

16

•

•

•

•

•

•

•

•

•

•

•

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 enable the Company to fly at the most efficient altitudes;

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, a key component of the NextGen program, which
is intended to modernize the U.S. air traffic control system by addressing limitations on air
transportation capacity and making more 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 237,000 RNP approaches, including over 93,000 in 2019. 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 55 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 often 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.

17

Data Privacy and Security Regulation

Like all industries, the airline industry has experienced heightened legislative and regulatory focus on
data privacy and security in the United States and elsewhere. As a result, the Company must monitor a
growing and fast-evolving set of legal requirements in this area. New laws give consumers much
broader access and control over their personal information. This regulatory environment is increasingly
challenging and may present material obligations and risks to the Company’s business, including
significantly expanded compliance burdens, costs, and enforcement risks.

The Company expects the federal government to continue to closely examine cyber-security and data
privacy in 2020. This could include the DOT looking at new requirements, guidance, or best practices
for the industry, as well as the introduction of new legislation in Congress.

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 markets 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
changes in diplomatic relations between the two governments, as well as travel and trade restrictions
implemented by the U.S. government. 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 into those destinations and/or its related 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 numbers at

18

international passengers, baggage, 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. With respect to any insurance claims, policy coverages and claims are subject
to acceptance by the many insurers involved and may require arbitration and/or mediation to
effectively settle the claims over prolonged periods of time.

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.

Key competitive factors within the airline industry include (i) pricing and cost structure; (ii) routes,
loyalty 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 13 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

19

discounts. During 2019, the Company continued to experience a competitive fare environment, which
included further industry changes from both a fare level and product offering perspective. As discussed
above under “Business - Industry,” other carrier offerings ranged from a “Basic Economy” fare
product, designed to compete with ULCC fares, to a “Premium Economy” product, that targets
consumers willing to pay a premium for certain amenities that were previously included in the carriers’
base fares (e.g., more favorable seating locations in the main cabin). Also in response to ULCC
pricing, some carriers no longer have fare floors for certain routes, leading to a lower fare offering
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 grow market
share. Some airlines have been able to reduce fares because they have been able to lower their
operating costs. Further, some of the Company’s competitors have launched multi-year cost savings
efforts to meet specific financial and growth targets. Common efforts include fleet transformation to
gain fuel efficiencies, fleet simplification, and increasing the number of seats per trip through seat
retrofits and the use of larger aircraft.

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 aircraft,
increased seat density, and lower wages. Further, as discussed below under
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the
Company continues to experience significant unit cost pressure as a result of the MAX groundings.
While it has become increasingly difficult for the Company to improve upon its industry cost position,
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.

Routes, Loyalty Programs, and Schedules

The Company also competes with other airlines based on markets served, loyalty 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 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. More extensive route structures, as well as 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 loyalty 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

20

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
having the lowest Customer complaint
ratio. However, carriers are increasingly focusing on
operational reliability as an opportunity to win and retain Customers. In addition, some airlines have
more seating options and associated passenger amenities than 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
attractive to certain consumers than those associated with the Company’s existing fleet.

Other Forms of Competition

The airline industry is subject to varying degrees of competition from other forms of transportation,
including 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 technology advancements that may limit the demand for air travel,
including competition from alternatives to air travel such as videoconferencing and the Internet, which
can increase in the event of travel inconveniences and economic downturns. The Company is subject to
in
inconveniences and economic downturns may,
the risk that air travel
permanent changes to consumer behavior
in favor of surface transportation and electronic
communications.

in some cases, result

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, changes in consumer
behavior, governmental action, 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.

Employees

At December 31, 2019, the Company had approximately 60,800 active fulltime equivalent Employees,
consisting of approximately 25,900 flight, 3,200 maintenance, 21,000 ground, Customer, and fleet
service, and 10,700 management, technology, finance, marketing, and clerical personnel (associated

21

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, 2019:

Employee Group

Approximate Number
of Employees

Representatives

Southwest Pilots

9,300

Southwest Flight Attendants

16,000

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

13,800

7,200

300

2,600

200

40

400

50

130
10

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

In negotiations

Amendable February 2021

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

In negotiations

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

Amendable April 2024

Amendable August 2024

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

22

Amendable November 2022

In negotiations

Amendable May 2024

In negotiations
In negotiations

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.

23

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,” “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 Company is currently dependent on Boeing as the sole manufacturer of the Company’s
aircraft. Further prolonged grounding by the FAA of the Boeing 737 MAX aircraft could
materially and adversely affect
the Company’s business plans, strategies, and results of
operations.

The Boeing 737 MAX aircraft are crucial to the Company’s growth plans and fleet modernization
initiatives. On March 13, 2019, the FAA issued an emergency order for all U.S. airlines to ground the
MAX aircraft, including the 34 MAX aircraft in the Company’s fleet. The MAX aircraft remains
grounded and, based on continued uncertainty around the timing of the MAX return to service, the
Company has removed the MAX from its flight schedule through June 6, 2020, and will likely further
extend MAX-related flight schedule adjustments. Further, MAX deliveries have remained suspended
following the MAX groundings, and Boeing is not currently manufacturing new MAX aircraft. The
Company does not know whether, on what conditions, or when the MAX groundings will
end. Regulatory approval of MAX return to service is subject to Boeing’s ongoing work with the FAA,
who will determine the timing of MAX return to service.

The MAX groundings adversely affected operating results for the year ended December 31, 2019, and
could have a material, adverse effect on the Company’s operating results in future periods. A continued
prolonged extension or permanent grounding of the MAX aircraft would require additional flight
schedule adjustments and result in further delays in aircraft deliveries, as well as lower operating
revenues, operating income, and net income due to a variety of factors, including, among others,
(i) lost revenue due to flight cancellations and disruptions as a result of a smaller operating aircraft

24

fleet, (ii) the lack of ability to make corresponding reductions in expenses because of the fixed nature
of many expenses, and (iii) possible negative effects on Customer confidence and airline choice.

Boeing no longer manufactures versions of the 737 other than the 737 MAX family of aircraft. If the
737 MAX aircraft were to remain unavailable for the Company’s flight operations, the Company’s
growth would be restricted unless and until it could procure and operate other types of aircraft from
Boeing or another manufacturer, seller, or lessor, and the Company’s operations would be materially
adversely affected. In particular, if the Company’s growth were to be dependent upon the introduction
of a new aircraft make and model to the Company’s fleet, the Company would need to, among other
things, (i) develop and implement new maintenance, operating, and training programs, (ii) secure
extensive regulatory approvals, and (iii) implement new technologies. The requirements associated
with operating a new aircraft make and model could take an extended period of time to fulfill and
would likely impose substantial costs on the Company. A shift away from a single fleet type could also
add complexity to the Company’s operations, present operational and compliance risks, and materially
increase the Company’s costs. Any of these events would have a material, adverse effect on the
Company’s business, operating results, and financial condition. The Company could also be materially
adversely affected if the pricing or operational attributes of its aircraft were to become less
competitive.

Further, even upon a rescission of the FAA order to ground the MAX aircraft, the Company will
continue to be reliant on Boeing to provide necessary resources and support to return the MAX to
service. Boeing has recommended that pilots receive special flight simulator training before operating
the MAX aircraft, although the FAA is ultimately responsible for establishing the training requirements
for operating the MAX. Special simulator training would further delay the MAX return to service. In
addition, following the MAX return to service, the Company could face significant operational
challenges in efficiently taking delivery of a large number of MAX aircraft from Boeing and
reintroducing the MAX aircraft into the Company’s network in a controlled and steady manner.

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 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. Further, 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 could adversely affect the Company’s results of
operations.

25

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 2019. 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, environmental, 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) disruptions in 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 in some cases 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 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, could 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. See Note 2 to the Consolidated Financial Statements
for information on 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.

The Company is also reliant upon the readily available supply and timely delivery of jet fuel to the
it serves. A disruption in that supply could present significant challenges to the
airports that

26

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 fare offerings of other carriers, as 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 airport costs and 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
2019, and the Company’s ability to control the cost of fuel is subject to the external factors discussed
in the third Risk Factor above.

Salaries, wages, and benefits constituted approximately 43 percent of the Company’s operating
expenses during 2019. 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, which has put pressure on the Company’s labor costs. Additionally, as indicated above under
“Business - Employees,” the majority of Southwest’s unionized Employee work groups, including its
Pilots; Flight Attendants; Customer Service Agents, Customer Representatives, and Source of Support
Representatives; Aircraft Appearance Technicians; Dispatchers; Flight Crew Training Instructors; and
Meteorologists, are in unions currently in negotiations for labor agreements or have labor agreements
that become amendable in 2020, 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,
because of airport infrastructure updates and other factors, the Company has experienced increased
space rental rates at various airports in its network. Further, the Company cannot control decisions by
other airlines to reduce their capacity. When this occurs, certain fixed 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 reliant upon third party vendors and service providers, and the Company’s low-cost
advantage is dependent in part on its ability to obtain and maintain commercially reasonable terms with
those parties. Disruptions to capital markets, shortages of skilled personnel, geopolitical developments,
and/or adverse economic conditions could subject certain of the Company’s third party vendors and
service providers to significant financial pressures which could lead to performance problems, ceased

27

operations, or bankruptcies among these third party vendors and service providers. If a third party
vendor or service provider is unable to fulfill its commitments to the Company, the Company may be
unable to replace that third party vendor or service provider in a short period of time, or at competitive
terms, which could have a material adverse effect on the Company’s results of operations.

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
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. With respect to any insurance claims, policy coverages and claims
are subject to acceptance by the many insurers involved and may require arbitration and/or mediation
to effectively settle the claims over prolonged periods of time. 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, which could harm its reputation
and business.

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. Further, some of the Company’s competitors have
launched multi-year cost savings efforts to meet specific financial and growth targets. Common efforts
include fleet transformation to gain fuel efficiencies, fleet simplification, and increasing the number of
seats per trip through seat retrofits and the use of larger aircraft.

As discussed below under “Management’s Discussion and Analysis of Financial Condition and Results
of Operations,” the Company experienced significant unit cost pressure in 2019 following the MAX
groundings. Historically, except for changes in the price of fuel, changes in operating expenses for
airlines have been largely driven by changes in capacity. However, the Company’s operating expenses
are largely fixed once flight schedules are published; and the Company experienced lower than
expected capacity during 2019 due to the MAX groundings. Throughout the duration of the MAX
groundings, the Company has made schedule adjustments and canceled flights based on guidance from
Boeing estimating the timing of MAX return to service. Further changes to guidance relating to the
expected duration of the MAX groundings could require the Company to make additional schedule
adjustments and drive additional unit cost pressure and negatively affect fuel efficiency. The Company
offers no assurances that current estimations and timelines related to the MAX groundings are correct.

28

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.

simulators,

The Company is increasingly dependent on the use of complex technology and systems to run its
ongoing operations and support its strategic objectives. These technologies and systems include,
among others, the Company’s website and reservation system, flight dispatch and tracking systems,
flight
systems,
telecommunications systems, flight planning and scheduling systems, crew scheduling systems, and
financial planning, management, and accounting systems. The performance, reliability, and security of
to the Company’s
the Company’s technology infrastructure and supporting systems are critical
operations and initiatives.

keeping management

kiosks, maintenance

check-in

record

Implementation and integration of complex systems and technology present 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
implementation and support of many of its technology initiatives and for maintaining adequate
information security measures. If any of the Company’s significant technologies or automated systems
were to cease functioning, or if its third party vendor service providers were to fail to adequately and
timely provide technical support, system maintenance, or software upgrades for any of the Company’s
existing systems, the Company could experience service interruptions, delays, and loss of critical data,
which could harm its operations, and result in financial losses and reputational damage.

In the ordinary course of business, the Company’s systems will continue to require modification and
refinements to address growth and changing business requirements. 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 the Company 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 have made its websites and
operational systems unavailable or slow to respond, which has prevented the Company from efficiently
processing Customer transactions or providing services. Any future system interruptions or delays
could reduce the Company’s operating revenues and the attractiveness of its services, as well as
increase the Company’s costs.

The Company’s technologies and systems and functions could be damaged or interrupted by
catastrophic events beyond its control 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

29

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 could 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
43 percent of the Company’s operating expenses for the year ended December 31, 2019. In addition, as
of December 31, 2019, 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 matters (some of which relate to negotiated items)
that have impacted, and continue to impact, the Company’s results of operations include hiring/
retention rates, pay rates, outsourcing, work rules, health care costs, and retirement benefits.

The Company is currently dependent on a single engine supplier, as well as single suppliers of
the Company could be materially
certain other aircraft parts and equipment; therefore,
adversely affected (i) if it were unable to obtain timely or sufficient delivery of aircraft parts or
equipment from Boeing or other suppliers or adequate maintenance or other support from any
of these suppliers, or (ii) in the event of a mechanical or regulatory issue associated with the
Company’s aircraft parts or equipment.

The Company is dependent on Boeing as its sole supplier for many of its aircraft parts. The Company
is also dependent on sole or limited suppliers for aircraft engines and certain other aircraft parts,
equipment, and services. If Boeing, or other suppliers, were unable or unwilling to timely provide
adequate products or support for their products, or in the event of a mechanical or regulatory issue
associated with engines or other parts, the Company’s operations could be materially adversely
affected. The Company could also be materially adversely affected if the pricing or operational
attributes of its aircraft equipment were to become less competitive.

Developing and expanding data security and privacy requirements could increase the
Company’s operating costs, and any failure of the Company to maintain the security of certain
in damage to the
Customer, Employee, and business-related information could result
Company’s reputation and could be costly to remediate.

The Company must receive information related to its Customers and Employees 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 continually evolving risk of intrusion, tampering, and theft. Although the
Company maintains systems to prevent or defend against these risks, these systems require ongoing
monitoring and updating as technologies change, and security could be compromised, personal or
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

30

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.

In addition, in response to these types of threats, there has been heightened legislative and regulatory
focus on data privacy and security in the United States and elsewhere. As a result, the Company must
monitor a growing and fast-evolving set of legal requirements in this area. This regulatory environment
is increasingly challenging and may present material obligations and risks to the Company’s business,
including significantly expanded compliance burdens, costs, and enforcement risks.

The Company has a dedicated cyber-security team and program that focuses on current and emerging
data security matters. The Company continues to assess and invest in the growing needs of the cyber-
security team through the allocation of skilled personnel, ongoing training, and support of the adoption
and implementation of technologies coupled with cyber-security risk management frameworks.

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. However, 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.

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

The Company is reliant on the success of its revenue strategies and other strategic plans and initiatives
to grow and to help offset 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) as discussed
further above, the Company’s dependence on third parties with respect to the execution of 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, even if not made directly on the airline
industry, 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 and security 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, government travel warnings to certain destinations, travel restrictions, 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.

31

The Company is subject to extensive FAA regulation, which may materially and adversely affect
the Company’s business plans, strategies, and results of operations.

The FAA promulgates and enforces regulations affecting the airline industry, and exercises extensive
regulatory oversight of the Company’s operations. The FAA from time to time also issues orders or
directives relating to the maintenance and operation of aircraft that require significant expenditures or
operational restrictions. FAA orders and directives can be issued with little or no notice, and in certain
instances, require the temporary grounding of aircraft. Recently, the Company reviewed a draft report
from the Office of Inspector General (OIG) for the DOT regarding its audit of the FAA’s oversight of
the Company. The Company strongly disagrees with many of the draft statements and conclusions in
the report and is not aware of any action the FAA might take against the Company arising from the
OIG’s audit of the FAA; however, the issuance of new FAA regulations, regulatory amendments, or
orders or directives could result in flight schedule adjustments and groundings or delays in aircraft
deliveries, as well as lower operating revenues, operating income, and net income due to a variety of
factors, including, among others, (i) lost revenue due to flight cancellations and disruptions as a result
of a smaller operating aircraft fleet, (ii) the lack of ability to make corresponding reductions in
expenses because of the fixed nature of many expenses, and (iii) possible negative effects on Customer
confidence and airline choice. Government regulation affecting the Company is discussed in more
detail in the below risk factor and above under “Business - Regulation.”

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. In order to operate efficiently, as well as to add service in
current and new markets, the Company must be able to maintain and/or obtain space and facilities at
desirable airports with adequate infrastructure. As airports become more congested, space, facility, and
the Company from maintaining existing service and/or
infrastructure constraints may prevent
implementing new service in a commercially viable manner.

Similarly, the federal government singularly controls all U.S. airspace, and airlines are dependent on
the FAA controlling that airspace in a safe and efficient manner. The current air traffic control system
is mainly radar-based, supported in large part by antiquated equipment and technologies, and heavily
dependent on skilled personnel. 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
GPS-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. The current air traffic control system faces challenges in supporting the growing demand for
U.S. air travel and may not be able to effectively keep pace with future air traffic growth. The
continuation of these air traffic control constraints or the FAA’s inability to meet staffing needs on a
long-term basis may have a material adverse effect on the Company’s operations.

As discussed above under “Business - Regulation,” airlines are also subject to other extensive
regulatory requirements. These requirements often impose substantial costs on airlines. The

32

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 annual
reallocation of capacity at John Wayne Airport in Orange County, California, which has
caused the Company to reduce service at that airport in each of the last several years;

limitations on route authorities;

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

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;

airspace closures or restrictions;

grounding of commercial air traffic by the FAA; and

the adoption of more restrictive locally-imposed noise regulations.

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 weather-related disruptions in fourth
quarter 2019, which resulted in approximately 2,100 canceled flights;

33

•

•

•

•

•

•

•

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

actual or potential disruptions in the air traffic control system (including, for example, as a
result of inadequate FAA staffing levels due to government shutdowns or sequestration);

actual or perceived delays at various airports resulting from government shutdowns
(including, for example, longer wait-times at TSA checkpoints due to inadequate TSA
staffing levels);

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

delays in deliveries of new aircraft (including, without limitation, due to FAA groundings of
certain aircraft types or due to the closure of the FAA’s aircraft registry during government
shutdowns);

outbreaks of disease; and

actual or threatened war, terrorist attacks, government travel warnings to certain destinations,
travel restrictions, 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, loyalty 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”).

The Company’s international flight offerings are subject to CBP-mandated procedures, which 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.
Certain international routes served by the Company are also subject to specific aircraft equipage
requirements and unique consumer behavior. Route-specific equipage requirements and unique
the Company’s flexibility when
consumer behavior,
scheduling and routing aircraft and crews, (ii) require the Company to modify its policies or
procedures, and (iii) impact the Company’s operational performance, costs, and Customer Experience.

together or individually, may (i) restrict

locations with respect

to, among other

34

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 international 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.

The Company’s operations in non-U.S. jurisdictions may subject the Company to the laws of those
jurisdictions rather than, or in addition to, 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.

In first quarter 2019, the Company began service to Hawaii after receiving approval from the FAA for
ETOPS, a regulatory requirement to operate between the U.S. mainland and the Hawaiian Islands. The
Company is subject to additional, ongoing, ETOPS-specific regulatory and procedural requirements,
which present 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 is subject to pending litigation.

Regardless of merit, these litigation matters and any potential future claims against the Company may
be both time consuming and disruptive to the Company’s operations and cause significant expense and
diversion of management attention. Should the Company 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.

The Company’s reputation and brand could be harmed if it were to experience significant
negative publicity, including through social media.

The Company operates in a public-facing industry with significant exposure to social media. Negative
publicity, whether or not justified, can spread rapidly through social media. To the extent that the
the Company’s
Company is unable to respond timely and appropriately to negative publicity,
reputation and brand can be harmed. Damage to the Company’s overall reputation and brand could
have a negative impact on its financial results.

Item 1B.

Unresolved Staff Comments

None.

35

Item 2.

Properties

Aircraft

Southwest operated a total of 747 Boeing 737 aircraft as of December 31, 2019, of which 52 and 70
were under operating and finance leases, respectively. The following table details information on the
747 aircraft as of December 31, 2019:

Type

737-700

737-800

737 MAX 8

Totals

Seats

143

175

175

Average
Age
(Yrs)

15

4

2

12

Number of
Aircraft

Number
Owned (a)

Number
Leased

506

207

34

747

394

200

31

625

112

7

3

122

(a) As discussed further in Note 6 to the Consolidated Financial Statements, 96 of the Company’s aircraft were
pledged as collateral as of December 31, 2019, 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.

Note: All MAX deliveries were suspended as of March 13, 2019, upon the FAA emergency order for
all U.S. airlines to ground all MAX aircraft. The FAA’s timetables and directives will determine the
timing of MAX return to service.

The delivery schedule below reflects contractual commitments; although,
the timing of future
deliveries is uncertain. One of the Company’s 2019 undelivered aircraft contractually shifted to 2021.
For purposes of the delivery schedule below, the Company has included the remaining 40 of its 2019
undelivered aircraft within its 2020 contractual commitments, and has not made any further
adjustments to this schedule based on current estimations. However, Boeing currently has 27 MAX 8
aircraft produced and in storage that the Company is including in its current 2020 fleet planning
assumptions. The Company also currently expects to retire 16 737-700 aircraft in 2020. The Company
offers no assurances that current estimations and timelines are correct.

36

As of December 31, 2019, the Company had firm deliveries and options for Boeing 737 MAX 7 and
737 MAX 8 aircraft as follows:

The Boeing Company
MAX 8
Firm
Orders

MAX 7
Firm
Orders

MAX 8
Options

7

—

—

12

11

—

—

30

2020

2021

2022

2023

2024

2025

2026

(a) 2020 Contractual Detail

2019 Contractual Deliveries

2020 Contractual Deliveries

2020 Contractual Total

Additional
MAX 8s

16

—

—

—

—

—

—

Total

78 (a)

45 (b)

41

57

64

76

19

55

45

27

22

30

40

—

—

—

14

23

23

36

19

219 (c)

115

16 (d)

380

The Boeing Company
MAX 8
MAX 7
Firm
Firm
Orders
Orders

7

—

7

20

35

55

Additional
MAX 8s

13

3

16

Total

40

38

78

2020 total contractual deliveries include 40 contractual aircraft that the Company expected to be
delivered in 2019, but were not received due to the MAX groundings.

Includes one contractual aircraft delivery that shifted from 2019 to 2021.

(b)
(c) The Company has flexibility to substitute 737 MAX 7 in lieu of 737 MAX 8 firm orders, upon written

advance notification as stated in the contract.
(d) To be acquired in leases from various third parties.

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. In 2018, the Company announced its intent to build a new aircraft maintenance facility,
expected to be completed in 2022, at Baltimore-Washington International Airport. In 2019, the
Company announced its intent to build a new aircraft maintenance facility, scheduled to be completed
by the end of 2020, at Denver International Airport.

The Company has commitments associated with various airport improvement projects, including
ongoing construction at Los Angeles International Airport. These projects include the construction of

37

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 two additional headquarters buildings,
located across the street from the
Company’s main headquarters building, on land owned by the Company including (a) an energy-
efficient, modern building, called TOPS, which houses certain operational and training functions,
including the Company’s 24-hour operations and (b) the Wings Complex, completed in 2018,
consisting of a Leadership Education and Aircrew Development (LEAD) Center (housing 18 of the
Company’s 20 Boeing 737 flight simulators and classroom space for Pilot training), an additional
office building, and a parking garage. Construction has begun on an expansion of the LEAD Center,
and is expected to be operational in late 2020.

As of December 31, 2019, 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 providers 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

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. The Company is cooperating fully with the DOJ CID
and the state inquiry.

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
damages, injunctive relief, and attorneys’ fees and expenses. On May 11, 2016, the defendants moved

38

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 the plaintiffs provided notice to the proposed
settlement class. The Court held a fairness hearing on March 22, 2019, and it issued an order granting
final approval of the settlement on May 9, 2019. On June 10, 2019, three objectors filed notices of
appeal to the United States Court of Appeals for the District of Columbia Circuit. Two of the objectors
dismissed their appeals, and the Company and the other settling parties moved to dismiss the
remaining appeal because the district court did not certify the approval order as appealable. The district
court denied the remaining objectors’ request to certify the approval order as a final appealable order,
and on November 6, 2019, the objectors asked the court of appeals to dismiss their appeal. The case is
continuing as to the remaining defendants. The Company denies all allegations of wrongdoing.

On July 11, 2019, a complaint alleging violations of federal and state laws and seeking certification as
a class action was filed against Boeing and the Company in the United States District Court for the
Eastern District of Texas in Sherman. The complaint alleges that Boeing and the Company colluded to
in violation of the Racketeer Influenced and Corrupt
conceal defects with the MAX aircraft
Organization Act and also asserts related state law claims based upon the same alleged facts. The
initial complaint seeks damages on behalf of putative classes of customers who purchased tickets for
air travel from either the Company or American Airlines between August 29, 2017, and March 13,
2019. The complaint generally seeks money damages, equitable monetary relief, injunctive relief,
declaratory relief, and attorneys’ fees and other costs. On September 13, 2019, the Company filed a
motion to dismiss the complaint and to strike certain class allegations. The plaintiffs filed a response to
the Company’s motion, and thereafter the parties filed respective reply briefs. On December 9, 2019,
the Court held a hearing on the Company and Boeing’s motions to dismiss, and the parties are
currently awaiting the Court’s ruling. The Company denies all allegations of wrongdoing, including
those in the complaint. The Company believes the plaintiffs’ positions are without merit and intends to
vigorously defend itself.

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.

39

INFORMATION ABOUT OUR EXECUTIVE OFFICERS

The following information regarding the Company’s executive officers is as of February 1, 2020.

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

Mark R. Shaw

Executive Vice President & Chief Financial Officer

Executive Vice President & Chief Legal & Regulatory Officer

Andrew M. Watterson

Executive Vice President & Chief Commercial Officer

Gregory D. Wells

Executive Vice President Daily Operations

Age

64

58

58

59

57

57

53

61

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. Mr. Jordan also served as Executive Vice President & Chief Commercial Officer from

40

September 2011 to July 2017, Executive Vice President Strategy & Planning from May 2008 to
September 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.

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.

Mark R. Shaw has served as the Company’s Executive Vice President & Chief Legal & Regulatory
Officer since November 2018. Mr. Shaw also served as Executive Vice President, Chief Legal &
Regulatory Officer, & Corporate Secretary from August 2018 to November 2018, Senior Vice
President, General Counsel, & Corporate Secretary from July 2015 to August 2018, 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.

Andrew M. Watterson has served as the Company’s Executive Vice President & Chief Commercial
Officer since January 2020. Mr. Watterson also served as Executive Vice President & Chief Revenue
Officer from July 2017 to January 2020, 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.

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 37 years of experience with the Company.

41

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 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
January 30, 2020, there were approximately 11,920 holders of record of the Company’s common stock.

42

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, 2019, 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, 2014, 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

200

180

160

140

120

100

80

60

12/31/14

12/31/15

12/31/16

12/31/17

12/31/18

12/31/19

Period Ending

Southwest Airlines Co.

S&P 500

NYSE ARCA Airline

Southwest Airlines Co.

S&P 500

NYSE ARCA Airline

12/31/2014 12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019

$

$

$

100 $

100 $

100 $

102 $

101 $

85 $

120 $

113 $

109 $

158 $

138 $

116 $

114 $

132 $

91 $

134

174

112

43

 
 
 
 
Issuer Repurchases

Period

October 1, 2019 through
October 31, 2019

November 1, 2019 through
November 30, 2019

December 1, 2019 through
December 31, 2019

(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

2,019,792 $

— (2)

2,019,792 $

1,900,051,674

— $

— (3)

— $

1,350,051,674

7,276,275 $

— (3)

7,276,275 $

1,350,051,674

Total

9,296,067

9,296,067

(1) On May 16, 2018, the Company’s Board of Directors authorized the repurchase of up to $2.0 billion of the
Company’s common stock. On May 15, 2019,
the Company’s Board of Directors authorized the
repurchase of up to $2.0 billion of the Company’s common stock in a new share repurchase authorization,
upon the completion of the May 2018 share repurchase authorization. Repurchases are made in accordance
with applicable securities laws in open market or private, including 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 2019 (the “Third Quarter 2019 ASR Program”), the Company paid $500 million
and received an initial delivery of 7,471,534 shares during August 2019, representing an estimated
75 percent of the shares to be purchased by the Company under the Third Quarter 2019 ASR Program
based on a volume-weighted average price of $50.1905 per share of the Company’s common stock on the
NYSE during a calculation period between July 30, 2019 and August 20, 2019. Final settlement of the
Third Quarter 2019 ASR Program occurred in October 2019 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 2019. Upon settlement, the third party financial institution
delivered 2,019,792 additional shares of the Company’s common stock to the Company. In total, the
average purchase price per share for the 9,491,326 shares repurchased under the Third Quarter 2019 ASR
Program, upon completion of the Third Quarter 2019 ASR Program in October 2019, was $52.6797.
(3) Under an accelerated share repurchase program entered into by the Company with a third party financial
the Company paid
institution in fourth quarter 2019 (the “Fourth Quarter 2019 ASR Program”),
$550 million and received an initial delivery of 7,276,275 shares during December 2019, representing an
estimated 75 percent of the shares to be purchased by the Company under the Fourth Quarter 2019 ASR
Program based on a volume-weighted average price of $56.6911 per share of the Company’s common
stock on the NYSE during a calculation period between November 13, 2019 and December 11, 2019. The
third party financial institution delivered an additional 1,835,017 shares to the Company in further partial
settlements of the Fourth Quarter 2019 ASR Program in January 2020, which was determined based
generally on a discount to the volume-weighted average price per share of the Company’s common stock
during calculation periods completed in January 2020. The specific number of shares that the Company
ultimately will repurchase under the Fourth Quarter 2019 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 February 13, 2020. At settlement, under certain
circumstances, the third party financial institution may be required to deliver additional shares of common
stock to the Company, or under certain circumstances, the Company may be required to deliver shares of
its common stock or may elect to make a cash payment to the third party financial institution.

44

Item 6.

Selected Financial Data

The following financial information, for the five years ended December 31, 2019, 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 (benefit) 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 (000s)
Enplaned passengers (000s)
Revenue passenger miles (RPMs) (in millions) (a)
Available seat miles (ASMs) (in millions) (b)
Load factor (c)
Average length of passenger haul (miles)
Average aircraft stage length (miles)
Trips flown
Seats flown (000s) (d)
Seats per trip (e)
Average passenger fare
Passenger revenue yield per RPM (cents) (f)
Operating revenues per ASM (cents) (g)(j)
Passenger revenue per ASM (cents) (h)
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

Year ended December 31,

2019

2018

2017

2016

2015

$

22,428
19,471

$

21,965
18,759

$

$

21,146
17,739

20,289
16,767

$

19,820
15,821

2,957
—

2,957
657

2,300

4.28
4.27
0.700
25,895
1,846
9,832

$

$
$
$
$
$
$

3,206
42

3,164
699

2,465

4.30
4.29
0.605
26,243
2,771
9,853

$

$
$
$
$
$
$

134,056
162,681
131,345
157,254
83.5%
980
748
1,367,727
206,390
150.9
154.98
15.82
14.26
13.21
12.38
9.62

$

134,890
163,606
133,322
159,795
83.4%
988
757
1,375,030
207,223
150.7
151.64
15.34
13.75
12.80
11.74
8.85

$

$

$
$
$
$
$
$

$

3,407
142

3,265
(92)

3,357

5.58
5.57
0.475
25,110
3,320
9,641

130,256
157,677
129,041
153,811
83.9%
991
754
1,347,893
200,879
149.0
151.73
15.32
13.75
12.85
11.53
8.88

$
$

9.19
2.09
2.09
2,077
60,767
747

$
$

8.51
2.20
2.20
2,094
58,803
750

$
$

8.53
1.99
2.06
2,045
56,110
706

3,522
72

3,450
1,267

2,183

3.48
3.45
0.375
23,286
2,821
7,784

124,720
151,740
124,798
148,522
84.0%
1,001
760
1,311,149
193,168
147.3
152.89
15.28
13.66
12.84
11.29
8.73

8.34
1.90
2.00
1,996
53,536
723

$

$
$
$
$
$
$

$

$
$

3,999
520

3,479
1,298

2,181

3.30
3.27
0.285
21,312
2,541
7,358

118,171
144,575
117,500
140,501
83.6%
994
750
1,267,358
184,955
145.9
154.85
15.57
13.98
13.02
11.26
8.60

8.16
1.96
2.13
1,901
49,583
704

$

$
$
$
$
$
$

$

$
$

(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.

45

(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 by dividing seats flown by trips flown.
(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.

(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) Year ended 2015 RASM excludes a $172 million one-time special revenue adjustment in July 2015 as a result of the Company’s
amendment of its co-branded credit card agreement with Chase Bank USA, N.A. and the resulting required change in accounting
methodology. Including the special revenue adjustment, RASM would have been 14.11 cents for the year ended 2015.

46

Item 7.
Operations

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

YEAR IN REVIEW

For the 47th consecutive year, the Company was profitable, recording GAAP and non-GAAP results
for 2019 and 2018 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,

2019

2018

Percent
Change

$

$

$

$

$

$

2,957

2,300

4.27

2,957

2,300

4.27

$

$

$

$

$

$

3,206

2,465

4.29

3,167

2,435

4.24

(7.8)

(6.7)

(0.5)

(6.6)

(5.5)

0.7

Net income for the year ended December 31, 2019, was $2.3 billion, a 6.7 percent decrease year-over-
year, as compared to 2018 Net income of $2.5 billion. Diluted earnings per share for 2019 was
$4.27, as compared with $4.29 for 2018. For the year ended December 31, 2019, Non-GAAP Net
income was also $2.3 billion, a 5.5 percent decrease year-over-year. Non-GAAP diluted earnings per
share for 2019 was also $4.27, as compared with $4.24 for 2018. The decrease in GAAP Net income
was primarily due to the impact of the Federal Aviation Administration (“FAA”) grounding of the
Boeing 737 MAX aircraft (“MAX”), unscheduled maintenance disruptions in first quarter 2019, and
the U.S. government shutdown in first quarter 2019. The decrease in GAAP Net income also resulted
from an 8.4 percent increase in Salaries, wages, and benefits expense, which included a discretionary,
special $124 million pre-tax profitsharing award which was accrued in fourth quarter 2019, coupled
with a 6.1 percent increase in Other operating expenses. These increases were partially offset by a
2.1 percent increase in Operating revenues, and a 5.8 percent decrease in Fuel and oil expense. See
below for further information. Operating income for the year ended December 31, 2019, was
$3.0 billion, a decrease of 7.8 percent year-over-year, and non-GAAP Operating income was also
$3.0 billion, a 6.6 percent decrease year-over-year.

Boeing 737 MAX Grounding

The estimated 2019 Operating income reduction attributable to the MAX groundings from March 13,
2019, through the end of the year, was $828 million. The Company reached a confidential agreement
(the “Boeing settlement”) with The Boeing Company on compensation related to estimated 2019
financial damages due to the grounding of the MAX. The terms of the Boeing settlement are
confidential, but are intended to provide for a substantial portion of the Company’s financial damages
in 2019 associated with the MAX grounding. The Boeing settlement did not impact 2019 earnings, as
substantially all of the compensation will be accounted for as a reduction of the cost basis for both
owned MAX aircraft and future purchased MAX aircraft, which is expected to reduce depreciation

47

expense in future years. The Company’s Board of Directors authorized a discretionary, special
$124 million pre-tax profitsharing award for Boeing compensation which was accrued in fourth quarter
2019. The Company continues to engage in discussions with Boeing regarding compensation for 2020
damages related to the MAX groundings; however, no settlement assumptions have been factored into
the Company’s 2020 outlook. Based on continued uncertainty around the timing of MAX return to
service, the Company has proactively removed the MAX from its flight schedule through June 6, 2020.
Based on recent guidance from Boeing estimating that the ungrounding of the MAX will be mid-2020,
to provide
the Company will
operational reliability and a dependable flight schedule for our Customers booking their summer travel.
See Note 16 to the Consolidated Financial Statements for further information.

likely extend MAX-related flight schedule adjustments further

For the twelve months ended December 31, 2019, the Company’s earnings performance, combined
with its actions to manage invested capital, produced a 22.9 percent pre-tax non-GAAP return on
invested capital (“ROIC”), or 17.8 percent on an after-tax basis, compared with the Company’s pre-tax
ROIC of 23.6 percent, or 18.4 percent on an after-tax basis, for the twelve months ended December 31,
2018. As a result of not paying for its scheduled MAX aircraft deliveries following the grounding in
March 2019, the Company’s cash balance at December 31, 2019, was higher than projected. However,
the Company has not factored any amounts for excess cash into its invested capital and ROIC
calculations for any of the periods presented. The primary cause of the year-over-year decline in
pre-tax ROIC was the decrease in Operating income for the twelve months ended December 31, 2019,
compared with the twelve months ended December 31, 2018. See the Company’s calculation of ROIC
in the accompanying reconciliation tables as well as the Note Regarding Use of Non-GAAP Financial
Measures.

During 2019, the Company continued to return value to its Shareholders. The Company returned
$2.4 billion to Shareholders through $372 million in dividend payments and $2.0 billion through four
separate accelerated share repurchase programs and other open market share repurchases. During
November 2019,
the Company launched the Fourth Quarter 2019 ASR Program by
advancing $550 million to a financial institution in a privately negotiated transaction. The Company
subsequently received 7.3 million shares of common stock in December 2019, representing an
estimated 75 percent of the shares to be purchased by the Company under the Fourth Quarter 2019
ASR Program, and subsequently received an additional 1.8 million shares in January 2020 in further
partial settlement of the Fourth Quarter 2019 ASR Program. The specific number of shares that the
Company ultimately will repurchase under the Fourth Quarter 2019 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 February 13, 2020. The
Company also entered into an additional open market share repurchase plan for the purchase of up to
an additional $50 million of its shares of common stock depending on market prices. These purchases
will be recorded as treasury share repurchases for purposes of calculating earnings per share. See
“Liquidity and Capital Resources” below for further information on the Company’s 2019 share
repurchases. The Company has $1.35 billion remaining under its May 2019 $2.0 billion share
repurchase authorization. See Part II, Item 5 for further information on the Company’s share
repurchase authorizations.

Company Overview

As of December 31, 2019, the Company served 101 destinations across 40 states and ten near-
international countries and currently operates over 4,000 departures a day. The Company began service

48

to Hawaii in March 2019 from Oakland to Honolulu, and from San Jose, California in May 2019. On
November 10, 2019, the Company began service between Sacramento and Honolulu, as well as
interisland service between Honolulu and Lihue. The Company currently operates 18 flights daily
between Hawaii and the mainland, and 34 interisland flights daily amongst the Hawaiian Islands. By
April 20, 2020, the Company is scheduled to offer 28 daily departures between California and Hawaii,
and 38 daily departures among the Hawaiian Islands. The Company began service from Oakland and
San Jose to both Lihue and Kona, and new interisland service between Honolulu and Hilo, and Kona
and Kahului, in January 2020. The Company also is scheduled to begin service from San Diego to
Kahului on Maui on April 14, 2020, and from San Diego to Honolulu on April 20, 2020. In 2019, the
Company also announced plans to begin service from Houston Hobby to Cozumel, Mexico in March
2020, subject to government approvals. The Company ceased services at Benito Juárez Mexico City
International Airport on March 30, 2019. Also in 2019, the Company decided to close its operations at
Newark Liberty International Airport and consolidate its New York City presence at New York
LaGuardia Airport.

During 2019, the Company took delivery of three new MAX aircraft from third parties. These
deliveries occurred prior to the March 13, 2019, FAA emergency order issued for all U.S. airlines to
ground all MAX aircraft. All 34 of the Company’s MAX aircraft have remained grounded since
March 13, 2019. Upon a rescission of the FAA order to ground the MAX, the Company currently
estimates it will take at least a couple of months to comply with applicable FAA directives, including
all necessary Pilot training. Based on continued uncertainty around the timing of MAX return to
service, the Company has proactively removed the MAX from its flight schedule through June 6, 2020
and will likely extend MAX-related flight schedule adjustments. The FAA will determine the timing of
MAX return to service, and the Company offers no assurances that current estimations and timelines
are correct. The Company continues to be focused on proactively managing cancellations, minimizing
operational disruptions, reaccommodating Customers, and minimizing the impact on its ontime
performance.

As of December 31, 2019, the Company had firm orders in place with Boeing for 219 737 MAX 8
aircraft and 30 737 MAX 7 aircraft. As previously disclosed, Boeing is not currently delivering new
MAX aircraft and, therefore, not meeting its contractual delivery schedule. The Company had 41 MAX
aircraft on order from Boeing or third parties from 2019 that have yet to be delivered, one of which
contractually shifted to 2021. As a result of the MAX groundings, the Company deferred the planned
retirement of seven of
to future years. The Company
retired one 737-700 aircraft during third quarter 2019 and an additional three 737-700 aircraft
during fourth quarter 2019. The Company also returned two leased 737-700 aircraft during fourth
quarter 2019. See Part I, Item 2 and Note 16 to the Consolidated Financial Statements for further
information.

its owned Boeing 737-700 aircraft

Based on the Company’s MAX-related flight schedule adjustments through June 6, 2020, the Company
currently expects its first quarter 2020 ASMs to decrease in the range of 1.5 to 2.5 percent, compared
with first quarter 2019. Based on continued uncertainty regarding the MAX return to service that could
materially impact current and future flight schedules, the Company is unable to provide annual 2020
available seat mile guidance at this time.

49

During 2019, the following events took place regarding the Company’s unionized Employee groups in
contract negotiations:

•

•

•

The Company’s Mechanics and Related Employees, represented by Aircraft Mechanics
Fraternal Association, ratified a new collective-bargaining agreement with the Company. The
newly ratified contract becomes amendable in August 2024.

The Company’s Flight Simulator Technicians, represented by International Brotherhood of
Teamsters, ratified a new collective-bargaining agreement with the Company. The newly
ratified contract becomes amendable in May 2024.

The Company’s Material Specialists, represented by International Brotherhood of Teamsters
Local 19, ratified a new collective-bargaining agreement with the Company. The newly
ratified contract becomes amendable in April 2024.

2019 Compared with 2018

Operating Revenues

Passenger revenues for 2019 increased by $321 million, or 1.6 percent, compared with 2018. On a unit
basis, Passenger revenues increased 3.2 percent, year-over-year, largely driven by a 3.1 percent
increase in Passenger revenue yield and a slight
to
83.5 percent. The Company’s capacity decreased 1.6 percent in 2019, as compared with 2018. The
increase in Passenger revenue yield was the result of an increase in average fare. In addition, prior year
results included negative revenue effects from its Flight 1380 accident in April 2018. On April 17,
2018, Southwest Airlines Flight 1380 from New York-LaGuardia to Dallas Love Field suffered an
uncontained failure of its port CFM56-7B engine, resulting in a Customer fatality. The nominal dollar
increase was partially offset by several unexpected events during 2019 that contributed to a negative
revenue impact, including the MAX groundings, unscheduled maintenance disruptions in first quarter,
and the U.S. government shutdown in first quarter.

increase in Load factor, year-over-year,

Freight revenues for 2019 decreased by $3 million, or 1.7 percent, compared with 2018, primarily due
to decreased demand. Based on current trends, the Company currently expects Freight revenues in first
quarter 2020 to increase, compared with first quarter 2019.

Other revenues for 2019 increased by $145 million, or 10.9 percent, compared with 2018. The increase
was primarily due to an increase in revenues associated with cardholder spend on the Company’s
co-branded Chase® Visa credit card, driven by the Company’s bonus point offers in the second, third,
and fourth quarters of 2019, and the success of its Companion Pass promotion in first quarter 2019 for
new Cardholders. The Company currently expects Other revenues in first quarter 2020 to increase,
compared with first quarter 2019.

Operating unit revenues for 2019 increased by 3.7 percent, compared with 2018. Currently, passenger
booking and revenue trends remain healthy, and the Company expects first quarter 2020 RASM to
increase in the range of 3.5 to 5.5 percent, compared with first quarter 2019. The Company’s outlook
for first quarter 2020 year-over-year RASM includes an estimated 1.5 point benefit - approximately
one point due to the negative impact to passenger bookings from the U.S. government shutdown during
first quarter 2019 and approximately one-half point related to unscheduled maintenance disruptions
and related flight cancellations during first quarter 2019. Additionally, first quarter 2020 year-over-

50

year RASM is expected to benefit by approximately two points due to the removal of MAX flights
from the Company’s schedule, which will result in lower first quarter 2020 capacity.

Operating Expenses

Operating expenses for 2019 increased by $712 million, or 3.8 percent, compared with 2018, while
capacity decreased 1.6 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. However, the Company’s Operating expenses are largely fixed once flight schedules are
published and the Company experienced lower than expected ASMs during 2019 due to the MAX
groundings. Flight cancellations are expected to drive unit cost pressure for the duration of the MAX
groundings. The following table presents the Company’s Operating expenses per ASM for 2019 and
2018, 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

Landing fees and airport rentals

Depreciation and amortization

Other operating expenses

Total

Year ended December 31,

2019

2018

Per ASM
change

Percent
change

5.27¢

4.79¢

2.76

0.78

0.87

0.78

1.92

2.89

0.69

0.83

0.75

1.79

12.38¢

11.74¢

0.48¢

(0.13)

0.09

0.04

0.03

0.13

0.64¢

10.0%

(4.5)

13.0

4.8

4.0

7.3

5.5%

Operating expenses per ASM for 2019 increased by 5.5 percent, compared with 2018, primarily as a
result of higher Salaries, wages, and benefits expense. See below for further information. Operating
expenses per ASM for 2019, excluding Fuel and oil expense and special items (a non-GAAP financial
measure), increased 8.5 percent year-over-year, also primarily as a result of higher Salaries, wages, and
benefits expense. 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, the Company expects its first quarter 2020 unit costs,
excluding Fuel and oil expense and profitsharing expense, to increase in the range of 6.0 to 8.0 percent,
year-over-year. This outlook includes an estimated seven point year-over-year unit cost headwind in
first quarter 2020 driven by lower first quarter 2020 capacity as a result of the ongoing MAX
groundings, which includes the impact of unabsorbed overhead that will be utilized upon the MAX
return to service. It also includes one to two points of inflation primarily due to higher salaries, wages,
and benefits; maintenance expense; and operating expenses related to investments in technology and
facilities. This inflation will be substantially offset in first quarter 2020 due to the non-recurring first
quarter 2019 costs associated with the Company’s ratified labor agreement with its Mechanics and
costs associated with unscheduled maintenance disruptions and related flight cancellations.

Salaries, wages, and benefits expense for 2019 increased by $644 million, or 8.4 percent, compared
with 2018. On a per ASM basis, Salaries, wages, and benefits expense for 2019 increased 10.0 percent,
compared with 2018. On both a dollar and per ASM basis, the majority of the increases were the result
of higher salaries expense, driven by annual wage rate increases as well as increased headcount. In
addition, the Company’s Board of Directors authorized a discretionary, special $124 million pre-tax

51

profitsharing award for Boeing compensation which was accrued in fourth quarter 2019. Based on
current cost trends and anticipated capacity, the Company expects first quarter 2020 Salaries, wages,
and benefits expense per ASM, excluding profitsharing expense, to increase, compared with first
quarter 2019.

During 2019, the Company conducted negotiations with various unionized Employee groups. The
following table sets forth the Company’s unionized Employee groups with amendable contracts that
are currently in negotiations on collective-bargaining agreements:

Employee Group

Approximate
Number of
Employees

Southwest Flight Attendants
Southwest Customer Service
Agents, Customer
Representatives, and Source of
Support Representatives

Southwest Dispatchers

Southwest Flight Crew Training
Instructors
Southwest Meteorologists

16,000

7,200

400

130
10

Representatives
Transportation Workers of
America, AFL-CIO, Local
556 (“TWU 556”)
International Association of
Machinists and Aerospace
Workers, AFL-CIO
(“IAM 142”)
Transportation Workers of
America, AFL-CIO, Local
550 (“TWU 550”)
Transportation Workers of
America, AFL-CIO, Local
557 (“TWU 557”)
TWU 550

Amendable Date

November 2018

December 2018

June 2019

January 2020
June 2019

In addition to the above, the Southwest Airlines Pilots’ Association (“SWAPA”), which represents the
Company’s approximately 9,300 Pilots, has notified the Company of its request to begin discussions
on a new agreement, prior to the current contract amendable date of September 1, 2020. The Company
and SWAPA are scheduled for initial discussions in first quarter 2020.

Fuel and oil expense for 2019 decreased by $269 million, or 5.8 percent, compared with 2018. On a per
ASM basis, Fuel and oil expense decreased 4.5 percent, compared with 2018. On both a dollar and per
ASM basis, the decreases were primarily attributable to lower market jet fuel prices. The Company’s
2019 average economic jet fuel cost per gallon decreased 5.0 percent, year-over-year, to $2.09 from
$2.20. 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. These figures include $.05 per gallon in premium expense and $.02 per gallon in favorable
cash settlements from fuel derivative contracts in 2019, compared with $.06 per gallon in premium
expense and $.07 per gallon in favorable cash settlements from fuel derivative contracts in 2018. The
decreases were partially offset by a decline in the Company’s fuel efficiency during 2019, compared
with 2018, when measured on the basis of ASMs generated per gallon of fuel. The decline in fuel
efficiency was primarily due to the removal of the Company’s most fuel efficient aircraft from its
schedule as a result of the MAX groundings.

52

As of January 17, 2020, on an economic basis, the Company had derivative contracts in place related
to expected future fuel consumption as follows:

Period

2020

2021

2022

Beyond 2022

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)

59%

54%

31%

less than 5%

(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. See Note 10 to the Consolidated Financial Statements for further information.

As a result of applying hedge accounting in prior periods, the Company has amounts in Accumulated
other comprehensive income (loss) (“AOCI”) that 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, 2019, and the expected future periods in which these items are expected to settle and/or
be recognized in earnings (in millions):

Year

2020

2021

2022

Beyond 2022

Total

$

$

Fair value of fuel
derivative contracts
at December 31, 2019

Amount of losses
deferred in AOCI at
December 31, 2019 (net of tax)

$

48

33

27

2

110

$

(36)

(43)

(17)

—

(96)

53

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 considering only the expected net cash
receipts related to hedges that will settle, the Company is providing the below sensitivity table for first
quarter 2020 and full year 2020 jet fuel prices at different crude oil assumptions as of January 17,
2020, and for expected premium costs associated with settling contracts each period, respectively.

Average Brent Crude Oil
price per barrel

$55

$60
Current Market (a)

$70

$80

$90

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

First Quarter 2020 (c)

Full Year 2020 (d)

$1.85 - $1.95

$1.95 - $2.05
$2.05 - $2.15

$2.15 - $2.25

$2.25 - $2.35

$2.35 - $2.45

$1.80 - $1.90

$1.95 - $2.05
$2.00 - $2.10

$2.20 - $2.30

$2.35 - $2.45

$2.50 - $2.60

Estimated fuel hedging premium expense
per gallon (b)

$0.05

$0.04

(a) Brent crude oil average market prices as of January 17, 2020, were approximately $64 and $62 per barrel for
first quarter 2020 and full year 2020, respectively.
(b) Fuel hedging premium expense per gallon is included in the Company’s estimated economic fuel price per
gallon estimates above.
(c) Based on the Company’s existing fuel derivative contracts and market prices as of January 17, 2020, first
quarter 2020 GAAP and economic fuel costs are estimated to be in the $2.05 to $2.15 per gallon range, including
fuel hedging premium expense of approximately $24 million, or $.05 per gallon, and an estimated $.01 per gallon
in favorable cash settlements from fuel derivative contracts. See Note Regarding Use of Non-GAAP Financial
Measures for additional information.
(d) Based on the Company’s existing fuel derivative contracts and market prices as of January 17, 2020, annual
2020 GAAP and economic fuel costs are estimated to be in the $2.00 to $2.10 per gallon range, including fuel
hedging premium expense of approximately $97 million, or $.04 per gallon, and no cash settlements from fuel
derivative contracts, on a per gallon basis. See Note Regarding Use of Non-GAAP Financial Measures for
additional information.
(e) The Company’s current hedge positions contain a combination of instruments based in West Texas
Intermediate and Brent crude oil; however, 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 17, 2020.

Maintenance materials and repairs expense for 2019 increased by $116 million, or 10.5 percent,
compared with 2018. On a per ASM basis, Maintenance materials and repairs expense increased
13.0 percent, compared with 2018. On both a dollar and per ASM basis, the majority of the increases
were due to the timing and scope of regular airframe maintenance checks. The Company currently
expects Maintenance materials and repairs expense per ASM for first quarter 2020 to increase,
compared with first quarter 2019.

Landing fees and airport rentals expense for 2019 increased by $29 million, or 2.2 percent, compared
with 2018. On a per ASM basis, Landing fees and airport rentals expense increased 4.8 percent,
compared with 2018. On both a dollar and per ASM basis, the majority of the increases were due to an
increase in space rental rates and usage at various stations throughout the network, partially offset by
higher settlements and credits from various airports received in 2019. The Company currently expects

54

Landing fees and airport rentals expense per ASM for first quarter 2020 to increase, compared with
first quarter 2019.

Depreciation and amortization expense for 2019 increased by $18 million, or 1.5 percent, compared
with 2018. On a per ASM basis, Depreciation and amortization expense increased 4.0 percent,
compared with 2018. On both a dollar and per ASM basis, the majority of the increases were
associated with the deployment of new technology assets. Based on the application of 2019 Boeing
settlement proceeds against the cost basis of owned 737 MAX aircraft in the Company’s fleet, the
Company estimates an approximate $5 million benefit to depreciation expense for 2020. See Note 16
to the Consolidated Financial Statements for further information. The Company currently expects
Depreciation and amortization expense per ASM for first quarter 2020 to increase, compared with first
quarter 2019.

Other operating expenses for 2019 increased by $174 million, or 6.1 percent, compared with 2018. On
a per ASM basis, Other operating expenses increased 7.3 percent, compared with 2018. On both a
dollar and per ASM basis, the increases in Other operating expenses were partially due to a $25 million
gain recognized during first quarter 2018 from the sale of 39 Boeing 737-300 aircraft and a number of
spare engines to a third party, which reduced Other operating expenses for first quarter 2018. This gain
on sale of retired Boeing 737-300 aircraft was considered a special item 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. Excluding this item, approximately 40 percent of the increases were
due to technology project-related expenses, approximately 20 percent of the increases were due to
insurance recoveries from the impacts of irregular operations, which were received in first quarter 2018
and reduced Other operating expenses for first quarter 2018, and the biggest portion of the remainder
was due to expenses related to the grounding of the MAX aircraft, such as additional compensation
issued to inconvenienced Passengers associated with flight cancellations. The Company currently
expects Other operating expenses per ASM for first quarter 2020 to increase, compared with first
quarter 2019.

Other

Other expenses (income) include interest expense, capitalized interest, interest income, and other gains
and losses. Total other expenses (income) for 2019 decreased by $42 million primarily due to higher
interest income as a result of higher interest rates, and lower interest expense as a result of lower debt
balances.

Income Taxes

The Company’s effective tax rate was 22.2 percent for 2019, compared with 22.1 percent for 2018. The
Company currently projects the first quarter and full year 2020 effective tax rate to be in the 23 to
24 percent range based on currently forecasted financial results.

2018 Compared with 2017

The Company’s comparison of 2018 results to 2017 results is included in the Company’s Annual
Report on Form 10-K for the fiscal year ended December 31, 2018, under Part II Item 7,
Management’s Discussion and Analysis of Financial Condition and Results of Operations.

55

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

Fuel and oil expense, unhedged
Add: Premium cost of fuel contracts
Deduct: Fuel hedge gains included in Fuel and oil expense, net

Fuel and oil expense, as reported
Add: Contracts settling in the current period, but for which the impact has

been recognized in a prior period (a)

Fuel and oil expense, excluding special items (economic)

Total operating expenses, as reported
Add: Contracts settling in the current period, but for which the impact has

been recognized in a prior period (a)

Add: Gain on sale of retired Boeing 737-300 aircraft

Total operating expenses, excluding special items

Operating income, as reported
Deduct: Contracts settling in the current period, but for which the impact has

been recognized in a prior period (a)

Deduct: Gain on sale of retired Boeing 737-300 aircraft

Operating income, excluding special items

Net income, as reported
Deduct: Contracts settling in the current period, but for which the impact has

been recognized in a prior period (a)

Deduct: Gain on sale of retired Boeing 737-300 aircraft
Add: Net income tax impact of special items (b)

Net income, excluding special items

Net income per share, diluted, as reported
Deduct: Impact from fuel contracts
Deduct: Impact of special items
Add: Net income tax impact of special items (b)

Net income per share, diluted, excluding special items

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

Year ended
December 31,

2019

2018

Percent
Change

$

$

$

$

$

$

$

$

$

$

$

$

4,299
95
(47)

4,347

$

$

$

$

$

$

$

$

$

$

—

4,347

19,471

—
—

19,471

2,957

—
—

2,957

2,300

—
—
—

2,300

4.27
—
—
—

4.27

12.38 ¢
(2.76)
—
(0.43)

4,649
135
(168)

4,616

14

4,630

18,759

14
25

(6.1)%

18,798

3.6%

(6.6)%

3,206

(14)
(25)

3,167

2,465

(14)
(25)
9

2,435

(5.5)%

4.29
(0.02)
(0.04)
0.01

4.24

11.74 ¢
(2.89)
0.02
(0.34)

0.7%

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

items, and profitsharing (cents)

9.19 ¢

8.53 ¢

7.7%

(a) As a result of prior hedge ineffectiveness.
(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.

56

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

Year Ended

Year Ended
December 31, 2019 December 31, 2018 December 31, 2017

Year Ended

Operating income, as reported
Net impact from fuel contracts
Lease termination expense
Boeing 737-300 aircraft grounding charge
Gain on sale of retired Boeing 737-300 aircraft

$

Operating income, non-GAAP
Net adjustment for aircraft leases (a)

Adjusted operating income, non-GAAP (A)

$

2,957
—
—
—
—

2,957
120

3,077

Non-GAAP tax rate (B)

22.2%(d)

Net operating profit after-tax, NOPAT

(A* (1-B) = C)

Debt, including finance leases (b)
Equity (b)
Net present value of aircraft operating leases (b)

Average invested capital
Equity adjustment for hedge accounting (c)

Adjusted average invested capital (D)

$

$

$

$

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

Non-GAAP ROIC, after-tax (C/D)

2,394

3,070
9,869
512

13,451
2

13,453

22.9%

17.8%

$

$

$

$

$

$

3,206
(14)
—
—
(25)

3,167
99

3,266

22.1%(e)

2,545

3,521
9,853
584

13,958
(144)

13,814

$

$

$

$

$

$

3,407
(156)
33
63
—

3,347
110

3,457

36.1%(f)

2,210

3,259
8,194
785

12,238
296

12,534

23.6%

27.6%

18.4%

17.6%

(a) 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.
(b) 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.
(c) The Equity adjustment for hedge accounting in the denominator adjusts for the cumulative impacts, in AOCI
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 is reflected in the Net
impact from fuel contracts in the numerator.
(d) The GAAP annual tax rate as of December 31, 2019, was 22.2 percent, and the annual Non-GAAP tax rate
was also 22.2 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information.
(e) The GAAP annual tax rate as of December 31, 2018, was 22.1 percent, and the annual Non-GAAP tax rate
was also 22.1 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information.
(f) The GAAP annual tax rate as of December 31, 2017, was a 2.8 percent tax benefit due to the significant
impact the Tax Cuts and Jobs Act legislation enacted in December 2017 had on corporate tax rates, and the
annual Non-GAAP tax rate was 36.1 percent. See Note Regarding Use of Non-GAAP Financial Measures for
additional information.

57

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 may
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; Net income per share, diluted, non-GAAP; Operating
expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing; Adjusted operating
income, non-GAAP; and Income tax rate, 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 that are designated as hedges are reflected as a component of Fuel and oil
expense, 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 2 and Note 10 to the Consolidated Financial
Statements.

The Company’s GAAP results in the applicable periods may 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

58

as excluding special items) have been adjusted to exclude special items. For the periods presented, in
addition to the items discussed above, special items include:

1. A gain recognized in first quarter 2018, associated with the sale of 39 Boeing 737-300
(“Classic”) aircraft and a number of spare engines to a third party. These aircraft were
previously retired as part of the Company’s exit of its Classic fleet. The gain was not
anticipated, and the Company associates it with the grounding charge recorded in third
quarter 2017;

2.

Lease termination costs recorded as a result of the Company acquiring 13 of its Classic
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; and

3. An Aircraft grounding charge recorded in third quarter 2017, as a result of the Company
grounding its remaining Classic 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 were subject to
negotiation with third party lessors.

Because management believes special items can distort the trends associated with the 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 special 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; Net income, non-GAAP; Net income per share,
diluted, non-GAAP; Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and
profitsharing; Adjusted operating income, non-GAAP; and Income tax rate, non-GAAP.

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

59

for non-GAAP return on invested capital in the accompanying reconciliation, in order to allow
investors to compare and contrast its calculation to the calculations provided by other companies.

Liquidity and Capital Resources

Net cash provided by operating activities for 2019 and 2018 was $4.0 billion and $4.9 billion,
respectively. Operating cash inflows are primarily derived from providing air 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 2019 and 2018 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 the ability to post
aircraft in lieu of cash collateral in certain situations. See Note 10 to the Consolidated Financial
Statements for further information. During 2019, the Company had net cash inflows of $25 million in
cash collateral from derivative counterparties. During 2018, the Company had net cash outflows of
$15 million in cash collateral to derivative counterparties. Cash flows associated with entering into
new fuel derivatives, which are also classified as Other, net, operating cash flows, were net outflows of
$131 million in 2019 and $63 million in 2018. Net cash provided by operating activities is primarily
used to finance capital expenditures, repay debt, fund stock repurchases, pay dividends, and provide
working capital.

the Company’s short-term and noncurrent

Net cash used in investing activities for 2019 and 2018 was $303 million and $2.0 billion, respectively.
Investing activities in 2019 and 2018 included Capital expenditures, Supplier proceeds, and changes in
the balance of
investments. During 2019, Capital
expenditures were $1.0 billion, the majority of which included ongoing technology projects, airport
and other facility construction projects, and progress payments related to new aircraft to be delivered to
the Company. This was below initial expectations for 2019 due to the MAX grounding and resulting
delay in Boeing deliveries. The Company received $400 million of Supplier proceeds, which the
Company considers an offset to its annual 2019 aircraft capital expenditures. See Note 16 to the
Consolidated Financial Statements for
information. During 2018, Capital expenditures
were $1.9 billion, the majority of which were payments for new aircraft delivered to the Company.
During 2019, the Company’s purchases and sales of short-term and noncurrent investments resulted in
net cash inflows of $324 million, as compared with net cash outflows of $67 million for 2018. Boeing
currently has 27 MAX 8 aircraft produced and in storage for the Company. Assuming these aircraft
and no others are delivered in 2020,
the Company currently estimates its annual 2020 capital
expenditures to be in the range of $1.4 billion to $1.5 billion, including progress payments for future
deliveries, and considering supplier proceeds to be received in 2020. These expected proceeds are
included in Accounts and other receivables on the Company’s Consolidated Balance Sheet as of
December 31, 2019, and the Company considers them to be a reduction to its annual 2020 aircraft
capital expenditures.

further

Net cash used in financing activities for 2019 and 2018 was $3.0 billion and $2.5 billion, respectively.
During 2019, the Company repaid $615 million in debt and finance lease obligations, compared with
$342 million during 2018. During 2018, the Company received a reimbursement from the City of
Houston for $116 million for the investment and updates made at Houston William P. Hobby Airport.
The Company repurchased $2.0 billion of its outstanding common stock through authorized share

60

repurchases during both 2019 and 2018. The Company also paid $372 million in dividends to
Shareholders during 2019, compared with $332 million in 2018. 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’s 2017 results are included in the Company’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2018, under Part II Item 7, Liquidity and Capital Resources.

The Company is a “well-known seasoned issuer” and 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 $1.0 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, 2019, the Company was in
compliance with this covenant and there were no amounts outstanding under the revolving credit
facility.

The Company entered into the following share repurchases during 2019, which were each recorded as
a treasury share purchase for purposes of calculating earnings per share. See Part II, Item 5 for further
information on the Company’s share repurchase authorizations.

Share repurchases (in millions)

Shares received

Cash paid

First Quarter 2019 Accelerated Share Repurchase Program

Second Quarter 2019 Accelerated Share Repurchase Program

Third Quarter 2019 Accelerated Share Repurchase Program

Fourth Quarter 2019 Accelerated Share Repurchase Program

Open Market Share Repurchases

Total

$

9.38

7.82

9.49

9.11(a)

0.95

500

400

500

550

50

36.75

$

2,000

(a) Final settlement of the Fourth Quarter 2019 ASR Program is scheduled to occur in February 2020. The
specific number of shares that the Company ultimately will repurchase under the Fourth Quarter 2019 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 February 13, 2020.

On February 14, 2019, Fitch upgraded the Company’s investment grade credit ratings to “A-” from
“BBB+.” The upgrade of the Company’s investment grade rating was based on the Company’s low
fundamental level of credit risk as demonstrated by its track record of generating positive free cash
flow, its solid financial flexibility, strong balance sheet, and commitment to conservative financial
policies. The Company maintained its investment grade credit ratings of “A3” with Moody’s and
“BBB+” with Standard & Poor’s.

61

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, unused funds available to Customers,
and loyalty deferred revenue, which are performance obligations for future Customer flights, do not
require future settlement in cash, and are mostly nonrefundable. See Note 5 to the Consolidated
Financial Statements for further information. The Company believes that its current liquidity position,
including unrestricted cash and short-term investments of $4.1 billion as of December 31, 2019,
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 2019 and in previous years, which has enabled the Company to defer the cash tax
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. 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 I, Item 2 for a complete
table of the Company’s contractual firm deliveries and options for Boeing 737 MAX 7 and 737 MAX
8 aircraft, Note 4 to the Consolidated Financial Statements for the financial commitments related to
these firm deliveries, and Note 16 to the Consolidated Financial Statements for further information
about the MAX groundings. Because of the MAX groundings, Boeing is not currently delivering new
MAX aircraft and, therefore, not meeting its contractual delivery schedule. As a result, 27 firm orders
for purchased MAX aircraft originally scheduled for delivery in 2019 have shifted into 2020
commitments and one firm order originally scheduled for delivery in 2019 has shifted to 2021. In
addition, commitments for 13 MAX leases from third parties have shifted into 2020. The FAA will
ultimately determine the timing of the MAX return to service, and the Company therefore offers no
assurances that current estimations and timelines are correct.

62

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
generally not made guarantees to the lessors regarding the residual value (or market value) of the
aircraft at the end of the lease terms. Assets and obligations under operating leases are included in the
Company’s Consolidated Balance Sheet. See Note 2 and Note 7 to the Consolidated Financial
Statements for further information. Disclosure of the expected contractual obligations associated with
the Company’s leased aircraft is included below.

As of December 31, 2019, the Company had 189 leased aircraft, including 67 Boeing 717-200 aircraft
(“B717s”) subleased to Delta. Of these leased aircraft, 117 are under operating leases, including 65
B717s subleased to Delta. See Note 7 to the Consolidated Financial Statements for further information
on this transaction.

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 $148 million at December 31, 2019.

The following table aggregates the Company’s material expected contractual obligations and
commitments as of December 31, 2019:

Obligations by period (in millions)

Contractual obligations

2020

2021 - 2022

2023 - 2024 Thereafter

Total

Long-term debt (a)

$

734

$

480

$

Interest commitments - fixed (b)

Interest commitments - floating (c)

Facility and other operating lease

commitments

Aircraft operating lease commitments (d)

Aircraft finance lease commitments (e)

Aircraft purchase commitments (f)

Other commitments

52

18

107

285

107

2,106

217

83

8

131

267

200

2,862

227

43

53

6

88

117

184

3,495

108

$

776

$

2,033

67

4

580

81

230

1,509

320

255

36

906

750

721

9,972

872

Total contractual obligations

$

3,626

$

4,258

$

4,094

$

3,567

$

15,545

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

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

Interest obligations associated with floating-rate debt (either at issuance or through swaps) is estimated
utilizing forward interest rate curves as of December 31, 2019, and can be subject to significant fluctuation.
Includes the impact of the B717 lease/sublease transaction entered into in 2012. See Note 7 to the
Consolidated Financial Statements for additional information.
Includes principal and interest on finance leases. See Note 7 to the Consolidated Financial Statements for
additional information.

(d)

(e)

(f) This reflects firm orders for purchased MAX aircraft from Boeing; shifting the 28 MAX aircraft originally
scheduled for delivery in 2019 into 2020 and 2021 as MAX deliveries were suspended as of March 13,
2019, and the timeline of future deliveries is uncertain. The FAA will ultimately determine the timing of the
MAX return to service, and the Company therefore offers no assurances that current estimation and

63

timelines of aircraft purchase commitments are correct. See Part I, Item 2 for a complete table of the
Company’s contractual firm deliveries.

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, 2019, was $407 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
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.

Los Angeles International Airport

the Company is overseeing and managing the design, development,

In October 2017, the Company executed a lease agreement (the “T1.5 Lease”) with Los Angeles World
Airports (“LAWA”), which owns and operates Los Angeles International Airport (“LAX”). Under the
T1.5 Lease,
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.

64

Funding for the Terminal 1.5 Project
is primarily through the Regional Airports Improvement
Corporation (the “RAIC”), which is a quasi-governmental special purpose entity that acts as a conduit
borrower under a syndicated credit facility provided by a group of lenders. A loan made under the
credit facility for the Terminal 1.5 Project is being used to fund the development of this project, and the
outstanding loan will be repaid with the proceeds of LAWA’s payments to purchase completed
construction phases. The Company guaranteed the obligation of the RAIC under the credit facility
associated with the T1.5 Lease. As of December 31, 2019, the Company’s outstanding guaranteed
obligation under the credit facility for the Terminal 1.5 Project was $176 million.

The Company’s liquidity could be impacted by this project under certain circumstances; however, the
Company does not expect this to occur based on its past experience with other projects. This project is
not expected to have a significant impact on the Company’s capital resources or financial position.
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 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, funds that are past
flight date and remain unused, but are expected to be used in the future, and the Company’s liability for
loyalty benefits that are expected to be redeemed in the future. Air traffic liability fluctuates throughout
the year based on seasonal
travel patterns, fare sale activity, and activity associated with the
Company’s loyalty program. See Note 1 to the Consolidated Financial Statements for information
about the Company’s revenue recognition policies.

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 the Company’s
tickets sold are nonrefundable, which is the primary source of unused tickets. 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. See Note 1 to the Consolidated Financial Statements for further
information. According to the Company’s current “Contract of Carriage,” all 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

65

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 effectively refunded through
it being made 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. The Company has consistently applied this
accounting method to estimate revenue from unused tickets at the date of scheduled travel. Holding
other factors constant, a 10 percent change in the Company’s estimate of the amount of tickets that will
expire unused would have resulted in a $61 million, or less than one percent, change in Passenger
revenues recognized for the year ended December 31, 2019.

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. Assumptions used to generate spoilage estimates can be
impacted by several factors including, but not limited to: fare increases, fare sales, changes to the
Company’s ticketing policies, changes to the Company’s refund, exchange and unused funds policies,
seat availability, and economic factors. 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 695 Boeing 737 aircraft in the Company’s fleet at December 31,
2019, which are either owned or on finance lease. The remaining 52 Boeing 737 aircraft in the
Company’s fleet at December 31, 2019, are operated under operating leases. The Company also has
67 B717 aircraft, which are leased/subleased to Delta. As these aircraft were not in service for the
Company, they were not included in the fleet count as of December 31, 2019 or 2018. The Company
also includes Assets constructed for others in its long-lived assets. These are airport improvement
projects in which the Company is considered to have control of the asset during the construction
period. Once construction is effectively completed, the sale-leaseback model would apply when
control passes from the lessee to the lessor. 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.

66

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:

Airframes and engines

Spare aircraft engines

Aircraft parts

Estimated
useful life

25 years

25 years

Fleet life

Estimated
residual value

15 percent

20 percent

4 percent

Ground property and equipment

5 to 30 years

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 provided by independent
third parties, and recommendations from Boeing. Flight
equipment 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 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.

Fair Value Measurements and Financial Derivative Instruments

The Company utilizes unobservable (Level 3) inputs in determining the fair value of certain assets and
liabilities. At December 31, 2019, these consisted of its fuel derivative option contracts, which were an
asset of $110 million. 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, Note 10 to the Consolidated
Financial Statements for more information on the Company’s fuel hedging program and financial
derivative instruments, and Note 11 to the Consolidated Financial Statements for more information
about fair value measurements.

All derivatives are required to be reflected at fair value and recorded on the Consolidated Balance
Sheet. At December 31, 2019, the Company was a party to over 250 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 2019, market “spot” prices for Brent crude oil peaked at a high of approximately $75 per barrel
and hit a low price of approximately $55 per barrel. During 2018, market spot prices ranged from a
high of approximately $86 per barrel to a low of approximately $50 per barrel. Market price changes
can be driven by factors such as supply and demand, inventory levels, weather events, refinery

67

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
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

The Company enters
in
“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.

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 the 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, 2019, 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 $12 million.

Fair values for financial derivative instruments are estimated prior to the time that the financial
derivative instruments settle. 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.

As discussed in Note 10 to the Consolidated Financial Statements, any changes in fair value of cash
flow derivatives designated as hedges 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 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

68

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.

Loyalty Accounting

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

Under the Southwest Rapid Rewards loyalty program, Members earn points for every dollar spent on
Southwest base fares. 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 can differ based on the fare
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. In addition, Members
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, 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 deferred revenue method of accounting for points earned through flights
taken in its loyalty program. The Company also sells points and related services to business partners
participating in the loyalty program. Liabilities are recorded for the relative standalone selling price of
the Rapid Rewards points which are awarded each period. 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
the loyalty liabilities were
approximately $3.4 billion, including $2.3 billion classified within Air traffic liability and $1.1
million classified as Air traffic liability – noncurrent.

travel award. At December 31, 2019,

In order to determine the value of each loyalty point, certain assumptions must be made at the time of
measurement, which include the following:

•

•

Allocation of Passenger Revenue - Revenues from Passengers, related to travel, who also
earn Rapid Rewards Points have been allocated between flight (recognized as revenue when
transportation is provided) and Rapid Rewards Points (deferred until points are redeemed)
based on each obligation’s relative standalone selling price. The Company utilizes historical
earning patterns to assist in this allocation.

Fair Value of Rapid Rewards Points - Determined from the base fare value of tickets which
were purchased using prior point redemptions for travel and other products and services,
which the Company believes to be indicative of the fair value of points as perceived by
Customers and representative of the value of each point at the time of redemption. The

69

Company’s booking site allows a Customer to toggle between fares utilizing either cash or
point redemptions, which provides the Customer with an approximation of the equivalent
value of their points. The value can differ, however, based on demand, the amount of time
prior to the flight, and other factors. The fare mix during the period measured represents a
constraint, which could result in the assumptions above changing at the measurement date, as
fare classes can have different coefficients used to determine the total loyalty points needed
to purchase an award ticket. The mixture of these fare classes and changes in the coefficients
used by the Company could cause the fair value per point to increase or decrease.

The majority of the points sold to business partners are through the Southwest co-branded credit card
agreement (“Agreement”) with Chase Bank USA, N.A. Consideration received as part of this
Agreement is subject to Accounting Standards Codification 606, Revenue From Contracts With
Customers. The Agreement has the following multiple elements: travel points to be awarded, use of the
Southwest Airlines’ brand and access to Rapid Rewards Member lists, advertising elements, and the
Company’s resource team. These elements are combined into two performance obligations,
transportation and marketing, and consideration from the Agreement is allocated based on the relative
selling price of each performance obligation.

Significant management judgment was used to estimate the selling price of each of the performance
obligations in the Agreement at inception. The objective is 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
determines 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
estimates the selling prices and volumes over the term of the Agreement in order to determine the
allocation of proceeds to each of the multiple performance obligations. The Company records revenue
related to air transportation when the transportation is delivered and revenue related to marketing
elements when the performance obligation is satisfied. A one percent increase or decrease in the
Company’s estimate of the standalone selling prices, implemented as of January 1, 2019, resulting in
an allocation of proceeds to air transportation would have changed the Company’s Operating revenues
by approximately $7 million for the year ended December 31, 2019.

Under its current program, Southwest estimates the portion of loyalty points that will not be redeemed.
In estimating the 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 are typically representative of a Member’s level of engagement
in the loyalty program. They include, but are not limited to, tenure with the program, points accrued in
the program, and points redeemed in the program. The Company believes it has obtained sufficient
historical behavioral data to develop a predictive statistical model to analyze the amount of spoilage
expected for all loyalty points. 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. Changes in the spoilage rates applied annually in recent years have not had a material impact
on Passenger revenues. For the year ended December 31, 2019, based on actual redemptions of points
sold to business partners and earned through flights, a hypothetical one percentage point change in the
estimated
of
approximately $124 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

to Passenger

rate would

spoilage

resulted

revenue

change

have

in

a

70

future periods. However, the Company believes its current estimates are reasonable given current facts
and circumstances.

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, 2019, the Company operated a total of 122 aircraft under operating and finance leases.
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 67 aircraft under operating and finance lease that have been subleased to another
carrier. Further information about these leases is disclosed in Note 7 to the Consolidated Financial
Statements. The Company does not purchase or hold any derivative financial instruments for trading
purposes. See Note 10 to the Consolidated Financial Statements for information on the 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 2.2 billion gallons of jet fuel in 2020. 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 $22 million for 2020, excluding any impact
associated with fuel derivative instruments held.

As of December 31, 2019, 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, 2019, was an asset of $110 million. In addition,
$25 million in cash collateral deposits were held by the Company in connection with these instruments
based on their fair value as of December 31, 2019. 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, 2019, prices would correspondingly change the fair value of the commodity
derivative instruments in place by approximately $143 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

71

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 inputs constant at December 31, 2019, levels, except underlying futures
prices.

The Company’s credit exposure related to fuel derivative instruments is represented by the fair value of
contracts that are in 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, 2019, the Company had nine counterparties in which the derivatives
held were an 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 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, 2019, 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, 2019, at which such postings
are triggered.

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, 2019, 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

72

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 an “A-” rating with Fitch, a “BBB+” rating with Standard & Poor’s, and an “A3” credit
rating with Moody’s as of December 31, 2019, all of which are considered “investment grade.” 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. 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.

The following table presents the Company’s fixed-rate senior unsecured notes outstanding, excluding
the notes or debentures that have been converted to a floating rate, as of December 31, 2019:

(in millions)

2.75% Notes due 2022

3.00% Notes due 2026

7.375% Debentures due 2027

3.45% Notes due 2027

December 31, 2019

$

300

300

100

300

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, 2019:

Principal
amount
(in millions)

Effective
fixed rate

Final
maturity

Underlying collateral

Term Loan Agreement

$

134

5.223%

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

The carrying value of the Company’s floating rate debt totaled $683 million, and this debt had a
weighted-average maturity of 1.73 years at floating rates averaging 3.12 percent for the year ended
December 31, 2019. The Company’s floating rate debt represented 25.6 percent of the Company’s total
outstanding debt as of December 31, 2019. In addition, the Company’s total debt (both floating and
fixed rate debt) divided by total assets was 10.3 percent as of December 31, 2019.

73

The Company also has some risk associated with changing interest rates due to the short-term nature of
its invested cash, which totaled $2.5 billion, and short-term investments, which totaled $1.5 billion at
December 31, 2019. 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.

A hypothetical 10 percent change in market interest rates as of December 31, 2019, 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, 2019 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 from or
provided to counterparties, if applicable), short-term investments, and floating-rate debt outstanding at
December 31, 2019, 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, 2019, 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 were 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

74

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. There was no cash reserved for this purpose as of
December 31, 2019.

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.

As of December 31, 2019, 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.

75

Item 8.

Financial Statements and Supplementary Data

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

December 31, 2019

December 31, 2018

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
Operating lease right-of-use assets
Other assets

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:

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

Total current liabilities

Long-term debt less current maturities
Air traffic liability - noncurrent
Deferred income taxes
Construction obligation
Noncurrent operating lease liabilities
Other noncurrent liabilities
Stockholders’ equity:

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

807,611,634 shares issued in 2019 and 2018

Capital in excess of par value
Retained earnings
Accumulated other comprehensive income (loss)
Treasury stock, at cost: 288,547,318 and 255,008,275 shares in 2019

and 2018 respectively
Total stockholders’ equity

See accompanying notes.

76

$

$

$

$

2,548
1,524
1,086
529
287
5,974

21,629
5,672
248
164
27,713
10,688
17,025
970
1,349
577
25,895

1,574
1,749
353
4,457
819
8,952

1,846
1,053
2,364
164
978
706

808
1,581
17,945
(61)

(10,441)
9,832
25,895

$

$

$

$

1,854
1,835
568
461
310
5,028

21,753
4,960
775
1,768
29,256
9,731
19,525
970
—
720
26,243

1,416
1,749
—
4,134
606
7,905

2,771
936
2,427
1,701
—
650

808
1,510
15,967
20

(8,452)
9,853
26,243

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

Year ended December 31,
2018

2019

2017

$

20,776

$

20,455

$

172

1,480

22,428

8,293

4,347

1,223

1,363

1,219

3,026

175

1,335

21,965

7,649

4,616

1,107

1,334

1,201

2,852

19,763

173

1,210

21,146

7,305

4,076

1,001

1,292

1,218

2,847

19,471

18,759

17,739

OPERATING REVENUES:

Passenger

Freight

Other

Total operating revenues

OPERATING EXPENSES:

Salaries, wages, and benefits

Fuel and oil

Maintenance materials and repairs

Landing fees and airport rentals

Depreciation and amortization

Other operating expenses

Total operating expenses

OPERATING INCOME

2,957

3,206

3,407

OTHER EXPENSES (INCOME):

Interest expense

Capitalized interest

Interest income

Other (gains) losses, net

Total other expenses (income)

INCOME BEFORE INCOME TAXES

PROVISION (BENEFIT) FOR INCOME TAXES

NET INCOME

NET INCOME PER SHARE, BASIC

NET INCOME PER SHARE, DILUTED

$

$

$

See accompanying notes.

118

(36)

(90)

8

—

2,957

657

2,300

4.28

4.27

$

$

$

131

(38)

(69)

18

42

3,164

699

2,465

4.30

4.29

$

$

$

114

(49)

(35)

112

142

3,265

(92)

3,357

5.58

5.57

77

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

2019

Year ended December 31,
2018

2017

NET INCOME

$

2,300 $

2,465 $

Unrealized gain (loss) on fuel derivative instruments,

net of deferred taxes of ($16), ($7), and $185

Unrealized gain (loss) on interest rate derivative

instruments, net of deferred taxes of ($8), $1, and $4

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

of deferred taxes of ($9), $15, and $2

Other, net of deferred taxes of $8, ($2), and $5

(53)

(25)

(29)

26

(26)

6

52

(6)

OTHER COMPREHENSIVE INCOME (LOSS)

COMPREHENSIVE INCOME

$

$

(81) $

2,219 $

26 $

2,491 $

3,357

317

7

3

8

335

3,692

See accompanying notes.

78

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

Year ended December 31, 2019, 2018, and 2017

Common
Stock

Capital in
excess of
par value

Retained
earnings

Accumulated
other
comprehensive
income (loss)

Treasury
stock

Total

Balance at December 31, 2016

$

808 $

1,410 $ 10,761 $

(323) $

(4,872) $

7,784

Repurchase of common stock

Issuance of common and treasury stock
pursuant to Employee stock plans

Share-based compensation

Cash dividends, $.475 per share

Comprehensive income

—

—

—

—

—

—

4

37

—

—

—

—

—

(286)

3,357

—

—

—

—

335

(1,600)

(1,600)

10

—

—

—

14

37

(286)

3,692

Balance at December 31, 2017 (as reported)

$

808 $

1,451 $ 13,832 $

12 $

(6,462) $

9,641

Cumulative effect of adopting Accounting
Standards Update No. 2017-12, Targeted
Improvements to Accounting for Hedging
Activities (See Note 2 to the Consolidated
Financial Statements for additional
information)

Balance after adjustment for the new accounting

—

—

18

(18)

—

—

standard

$

808 $

1,451 $ 13,850 $

(6) $

(6,462) $

9,641

Repurchase of common stock

Issuance of common and treasury stock
pursuant to Employee stock plans

Share-based compensation

Cash dividends, $.605 per share

Comprehensive income

—

—

—

—

—

—

13

46

—

—

—

—

—

(348)

2,465

—

—

—

—

26

(2,000)

(2,000)

10

—

—

—

23

46

(348)

2,491

Balance at December 31, 2018 (as reported)

$

808 $

1,510 $ 15,967 $

20 $

(8,452) $

9,853

Cumulative effect of adopting Accounting
Standards Update No. 2016-02, Leases,
codified in Accounting Standards
Codification 842 (See Note 2 to the
Consolidated Financial Statements for
additional information)

Balance after adjustment for the new accounting

—

—

55

—

—

55

standard

$

808 $

1,510 $ 16,022 $

20 $

(8,452) $

9,908

Repurchase of common stock

Issuance of common and treasury stock
pursuant to Employee stock plans

Share-based compensation

Cash dividends, $.700 per share

Comprehensive income

—

—

—

—

—

—

16

55

—

—

—

—

—

(377)

2,300

—

—

—

—

(81)

(2,000)

(2,000)

11

—

—

—

27

55

(377)

2,219

Balance at December 31, 2019

$

808 $

1,581 $ 17,945 $

(61) $ (10,441) $

9,832

See accompanying notes.

79

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
Boeing 737-300 aircraft grounding charge
Unrealized/realized gains 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
Other liabilities

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

Net cash provided by operating activities

CASH FLOWS FROM INVESTING ACTIVITIES:

Capital expenditures
Supplier proceeds
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
Payments of long-term debt and finance lease obligations
Payments of cash dividends
Repayment of construction obligation
Repurchase of common stock
Other, net

Net cash used in financing activities

Year ended December 31,

2019

2018

2017

$

2,300

$

2,465

$

3,357

1,219
—
—
(55)

(94)
239
298
440
(277)
25
(108)
3,987

(1,027)
400
—
(2,122)
2,446
—
(303)

—
40
—
(615)
(372)
—
(2,000)
(43)
(2,990)

1,201
—
(14)
301

117
(227)
545
506
—
(15)
14
4,893

(1,922)
—
(54)
(2,409)
2,342
5
(2,038)

—
35
170
(342)
(332)
(30)
(2,000)
3
(2,496)

1,218
63
(50)
(1,066)

(102)
(262)
233
343
—
316
(121)
3,929

(2,123)
—
(126)
(2,380)
2,221
—
(2,408)

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

NET CHANGE IN CASH AND CASH EQUIVALENTS

694

359

(185)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

1,854

1,495

1,680

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

2,548

$

1,854

$

1,495

CASH PAYMENTS FOR:

Interest, net of amount capitalized
Income taxes

SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:

Flight equipment under finance leases
Assets constructed for others
Supplier receivables

See accompanying notes.

80

$
$

$
$
$

88
779

1
65
428

$
$

$
$
$

107
327

$
$

$
32
171
$
— $

81
992

233
197
—

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.

Effective as of January 1, 2019, the Company adopted Accounting Standards Update (“ASU”)
No. 2016-02, Leases, codified in Accounting Standards Codification (“ASC”) 842 (the “New Lease
Standard”). All amounts and disclosures set forth in this Form 10-K for the year ended December 31,
2019, reflect the adoption of this ASU, while all periods prior to 2019 remain in accordance with prior
accounting requirements. See Note 2 for further information.

Effective as of January 1, 2018, the Company adopted ASU No. 2017-12, Targeted Improvements to
Accounting for Hedging Activities (the “New Hedging Standard”). All amounts and disclosures set
forth in this Form 10-K reflect the adoption of this ASU. See Note 2 for further information.

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, 2019, $25 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, 2018, no cash collateral deposits were held
by or provided 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. 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.

81

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
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.

investments consist of investments with maturities of greater than twelve months.
Noncurrent
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 the
Company’s business partners and other suppliers, credit card companies associated with sales of tickets
for future travel, and amounts due from business partners in the Company’s loyalty program. See Note
15 for further information. The allowance for doubtful accounts was immaterial at December 31, 2019
and 2018. In addition, the provision for doubtful accounts and write-offs for 2019, 2018, and 2017
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 immaterial at
December 31, 2019, and 2018. In addition, the Company’s provision for obsolescence and write-offs
for 2019, 2018, and 2017 were each immaterial.

Property and Equipment

Property and equipment is stated at cost. Capital expenditures include 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, and 5 to 30 years for ground property and equipment. Residual values estimated for aircraft
are approximately 15 percent, and generally range from 0 to 10 percent for ground property and
equipment. Assets constructed for others consists of airport improvement projects in which the
Company is considered to have control of the asset during the construction period. Once construction
is effectively completed, the sale-leaseback model would apply when control passes from the lessee to
the lessor. See Note 4 for further information.

82

In September 2017, the Company retired its remaining 61 Boeing 737-300 (“Classic”) aircraft as part
of an accelerated retirement schedule. This resulted in a change in anticipated retirement dates, which
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 leased aircraft fleet. The impact 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 and income taxes

Year ended
December 31, 2017

$

$

$

$

21

(19)

(0.03)

(0.03)

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.

Leases

The Company determines if an arrangement is a lease at inception. Operating leases are included in
Operating lease right-of-use assets, Current operating lease liabilities, and Noncurrent operating lease
liabilities in the Consolidated Balance Sheet. Finance leases are included in Property and equipment,
Current maturities of long-term debt, and Long-term debt less current maturities in the Consolidated
Balance Sheet.

Right-of-use assets represent the Company’s right to use an underlying asset for the lease term, and
lease liabilities represent the Company’s obligation to make lease payments arising from the lease. The
lease liability is measured as the present value of the unpaid lease payments, and the right-of-use asset
value is derived from the calculation of the lease liability. Lease payments 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 do not include (i) variable lease payments other than those that depend on
an index or rate, (ii) any guarantee by the lessee of the lessor’s debt, or (iii) any amount allocated to
non-lease components, if such election is made upon adoption, per the provisions of the New Lease
Standard. The Company uses its estimated incremental borrowing rate, which is derived from
information available at the lease commencement date, in determining the present value of lease
payments, since the Company does not know the actual implicit rates in its leases. The Company gives
consideration to its recent debt issuances as well as publicly available data for instruments with similar
characteristics when calculating its incremental borrowing rate. Lease expense for operating lease
payments is recognized on a straight-line basis over the lease term. The Company combines lease and

83

nonlease components for all asset groups. The Company’s lease term includes any option to extend the
lease when it is reasonably certain to be exercised based on considering all relevant economic factors.

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 within the accompanying Consolidated
Statement of Income as incurred.

The Company has maintenance agreements related to certain of its aircraft engines with external
service providers, including agreements that effectively transfer the risk of performance of such work
to the service provider. Under the agreements where the risk of performance is deemed transferred to
the counterparty, the appropriate expense is recorded commensurate with the period in which the
corresponding level of service is provided. Generally, 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 the fair value calculated using the quantitative approach, an impairment
charge is recorded for the difference in fair value and carrying value.

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, 2019
and 2018:

Year ended December 31, 2019 Year ended December 31, 2018

Weighted-
average useful
life (in years)

Gross carrying
amount

Accumulated
amortization

Gross carrying
amount

Accumulated
Amortization

(in millions)

Customer relationships/
marketing agreements

12

$

Owned domestic slots (a)
Gate leasehold rights (b)

Indefinite
—

Total

12

$

13

n/a
—

13

$

$

27

295
180

502

$

$

25

n/a
78

103

$

$

14

295
—

309

84

(a) Intangible assets primarily consist of acquired rights to certain airport owned takeoff and landing slots (a
“slot” is the right of an air carrier, pursuant to regulations of the Federal Aviation Administration (“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.
(b) Airport gate leasehold rights are classified as right-of-use assets upon adoption of the New Lease Standard.
See Note 7.

The Company’s definite lived intangible assets are amortized on a straight-line basis over the useful
life of the asset. The aggregate amortization expense for 2019, 2018, and 2017 was $15 million,
$16 million, and $13 million, respectively. Estimated aggregate amortization expense for the five
succeeding years and thereafter is immaterial.

Revenue Recognition

Tickets sold are initially deferred as Air traffic liability. Passenger revenue is recognized and Air traffic
liability is reduced when transportation is provided. Air traffic liability primarily represents tickets sold
for future travel dates, funds that are past flight date and remain unused, but are expected to be used in
the future, and the Company’s liability for loyalty benefits that are expected to be redeemed in the
future. The majority of the Company’s tickets sold are nonrefundable. 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. Nonrefundable tickets that are sold but not flown on the travel date, and
are canceled in accordance with the No Show policy, can be applied to future travel. Refundable
tickets that are sold but not flown on the travel date can also be applied to future travel. A small
percentage of tickets (or partial tickets) expire unused. The Company estimates the amount of tickets
that expire unused and recognizes such amounts in Passenger revenue once the scheduled flight date
has lapsed in proportion to the pattern of flights taken by the Customer. 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 as the Company has then fulfilled its performance obligation.
Amounts collected from passengers for ancillary services are also recognized when the service is
provided, which is typically the flight date.

Initial spoilage estimates for both tickets and funds available for future use 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 Company’s 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, changes to the Company’s ticketing policies, changes to the Company’s refund, exchange and
unused funds policies, seat availability, and economic factors. See Note 5 for further information.

Approximately $615 million, approximately $566 million, and approximately $489 million of the
Company’s Operating revenues in 2019, 2018, and 2017, respectively, were attributable to foreign
operations. The remainder of the Company’s Operating revenues, approximately $21.8 billion,
approximately $21.4 billion, and approximately $20.7 billion in 2019, 2018, and 2017, respectively,
were attributable to domestic operations.

Loyalty Program

The Company records a liability for the relative fair value of providing free travel under its loyalty
program for all points earned from flight activity or sold to companies participating in the Company’s
Rapid Rewards loyalty program as business partners that are expected to be redeemed for future travel.

85

The loyalty liability represents performance obligations that will be satisfied when a Rapid Rewards
loyalty member redeems points for travel or other goods and services. Points earned from flight
activity are valued at their relative standalone selling price by applying fair value based on historical
redemption patterns. Points earned from business partner activity, which primarily consist of points
sold, along with related marketing services, to companies participating in the Rapid Rewards loyalty
program, are valued using a relative fair value methodology based on the contractual rate which
partners pay to Southwest to award Rapid Rewards points to the business partner’s customers. For
points that are expected to remain unused, the Company recognizes spoilage in proportion to the
pattern of points used by the Customer, which approximates the average period over which the
population of Rapid Reward Members redeem their points. The Company records passenger revenue
related to air transportation when the transportation is delivered. The marketing elements are
recognized as Other—net revenue when earned. The Company’s liability for loyalty benefits includes a
portion that is expected to be redeemed during the following twelve months (classified as a component
of Air traffic liability), and a portion that is not expected to be redeemed during the following twelve
months (classified as Air traffic liability—noncurrent). The Company continually updates this analysis
and adjusts the split between current and non-current liabilities as appropriate. See Note 5 for further
information.

Advertising

Advertising costs are charged to expense as incurred. Advertising and promotions expense for the
years ended December 31, 2019, 2018, and 2017 was $212 million, $215 million, and $224 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 are accounted for as cash flow hedges upon proper
qualification. 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.
The Company has forward-starting interest rate swap agreements, the primary objective of which is to
hedge forecasted debt issuances and aircraft leases. The majority of 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
determined by the use of present value methods or option value models with assumptions about
commodity prices based on those observed in underlying markets.

The Company adopted the New Hedging Standard as of January 1, 2018. See Note 2 for further
information on this adoption.

86

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. 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
the post-
typically five to fifteen years. Costs incurred during the preliminary project or
implementation/operation stages of the project are expensed as incurred. Capitalized computer
software,
in the accompanying
Consolidated Balance Sheet, net of accumulated depreciation, was $630 million and $674 million at
software depreciation expense was
December 31, 2019, and 2018,
$177 million, $155 million, and $168 million for the years ended December 31, 2019, 2018, and 2017,
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 will be recorded to write down the software to the lower of its
carrying value or fair value. The Company had no significant impairments during 2019, 2018, or 2017.

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.

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 accompanying Consolidated Statement of Income. There were no material amounts
recorded for penalties and interest related to uncertain tax positions 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 percentage of the Company’s unionized Employees,
including its Flight Attendants, Customer Service Agents, Dispatchers, Flight Crew Training
Instructors, and Meteorologists, which had contracts that became amendable on or before
December 31, 2019, are in discussions on labor agreements. Those unionized Employee groups in
discussions represent approximately 40 percent of the Company’s full-time equivalent Employees as of
December 31, 2019.

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

87

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, 2019, the Company operated an all-Boeing fleet, all of which are variations of the
Boeing 737. The Boeing 737 MAX aircraft (“MAX”) are crucial to the Company’s growth plans and
fleet modernization initiatives. On March 13, 2019, the FAA issued an emergency order for all
U.S. airlines to ground the MAX aircraft, including the 34 MAX aircraft in the Company’s fleet. The
MAX aircraft remains grounded and, based on continued uncertainty around the timing of the MAX
return to service, the Company has removed the MAX from its flight schedule through June 6, 2020.
Based on recent guidance from Boeing estimating that the ungrounding of the MAX will be mid-2020,
the Company will
to provide
operational reliability and dependable flight schedules for our Customers booking their summer travel.
Further, MAX deliveries have remained suspended following the MAX groundings and Boeing is not
currently manufacturing new MAX aircraft. The Company does not know whether, on what conditions,
or when the MAX groundings will end. Regulatory approval of MAX return to service is subject to
Boeing’s ongoing work with the FAA, who will determine the timing of MAX return to service.

likely extend MAX-related flight schedule adjustments further

The MAX groundings adversely affected operating results for the year ended December 31, 2019, and
could have a material, adverse effect on the Company’s operating results in future periods. A continued
prolonged extension or permanent grounding of the MAX aircraft would require additional flight
schedule adjustments and result in further delays in aircraft deliveries, as well as lower operating
revenues, operating income, and net income due to a variety of factors, including, among others,
(i) lost revenue due to flight cancellations and disruptions as a result of a smaller operating aircraft
fleet, (ii) the lack of ability to make corresponding reductions in expenses because of the fixed nature
of many expenses, and (iii) possible negative effects on Customer confidence and airline choice.

Boeing no longer manufactures versions of the 737 other than the 737 MAX family of aircraft. If the
737 MAX aircraft were to remain unavailable for the Company’s flight operations, the Company’s
growth would be restricted unless and until it could procure and operate other types of aircraft from
Boeing or another manufacturer, seller, or lessor, and the Company’s operations would be materially
adversely affected. In particular, if the Company’s growth were to be dependent upon the introduction
of a new aircraft make and model to the Company’s fleet, the Company would need to, among other
things, (i) develop and implement new maintenance, operating, and training programs, (ii) secure
extensive regulatory approvals, and (iii) implement new technologies. The requirements associated
with operating a new aircraft make and model could take an extended period of time to fulfill and
would likely impose substantial costs on the Company. A shift away from a single fleet type could also
add complexity to the Company’s operations, present operational and compliance risks, and materially
increase the Company’s costs. Any of these events would have a material, adverse effect on the
Company’s business, operating results, and financial condition. The Company could also be materially

88

adversely affected if the pricing or operational attributes of its aircraft were to become less
competitive. See Note 16 for further information.

The Company is also dependent on sole or limited suppliers for aircraft engines and certain other
aircraft parts and services and would, therefore, also be materially adversely impacted in the event of
the unavailability of, inadequate support for, 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, which typically are for five to seven years, but none
of which are more than ten years in length. Some of these agreements automatically renew on an
annual basis, unless either party objects to such extension. The Company believes the financial benefits
generated by the exclusivity aspects of these arrangements outweigh the risks involved with such
agreements.

2. NEW ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING CHANGES

the Financial Accounting Standards Board (the “FASB”)

On August 29, 2018,
issued ASU
No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software. This new standard requires a
customer in a cloud computing arrangement that is a service contract to follow the internal-use
to determine which
software guidance in ASC 350-40, Accounting for Internal-Use Software,
implementation costs to (i) capitalize as assets and amortize over the term of the hosting arrangement
or (ii) expense as incurred. This new standard is effective for public business entities in fiscal years
beginning after December 15, 2019, and for interim periods within those fiscal years. Entities have the
option to apply this standard prospectively to all implementation costs incurred after the date of
adoption or retrospectively. The Company will be adopting this ASU prospectively as of January 1,
2020. The adoption of the new standard will impact the presentation of these costs as prepaid assets
(versus Property and equipment under the existing guidance), however the impacts are not expected to
be material.

On August 28, 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement. This standard is
effective for public business entities in fiscal years beginning after December 15, 2019, and for interim
periods within those fiscal years. This new standard requires changes to the disclosure requirements for
fair value measurements for certain Level 3 items, and specifies that some of the changes must be
applied prospectively, while others should be applied retrospectively. The Company will be adopting
this ASU as of January 1, 2020. While the Company is still evaluating this new standard, it does not
expect it to have a significant impact on its financial statement disclosures. See Note 11 for further
information on the Company’s fair value measurements.

On August 28, 2017, the FASB issued the New Hedging Standard. The New Hedging Standard
amended 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 New Hedging Standard also simplified the application of hedge accounting in
certain situations. The New Hedging Standard was 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 elected to early adopt the New Hedging Standard as of January 1, 2018, utilizing

89

a modified retrospective approach, as required. The most significant impacts of the New Hedging
Standard on the Company’s accounting were the elimination of the requirement to separately measure
and record ineffectiveness for all cash flow hedges in a hedging relationship, as well as a change in
classification of premium expense associated with option contracts. Such premium expense for the
Company’s fuel hedges was previously reflected as a component of Other (gains) losses, net, in the
Consolidated Statement of Income, but under the New Hedging Standard is reflected as a component
of the line item to which the hedge relates, which is Fuel and oil expense. As such, premium expense
for the year ended December 31, 2017, was reclassified in order to be comparative with current period
results in the accompanying Consolidated Statement of Income. The impact of the cumulative effect of
the adjustment to move the reporting of ineffectiveness as of January 1, 2018, to AOCI from Retained
earnings, was a $20 million loss, net of taxes. The adoption and resulting reclassification had no impact
on the Company’s Net income, earnings per share, or cash flows. As a result of the adoption of the
New Hedging Standard, however, the Company incurred no gains or losses due to ineffectiveness in
Other (gains) losses, net, in the Consolidated Statement of Income, during 2018.

On February 25, 2016, the FASB issued the New Lease Standard. The New Lease Standard 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, as defined in the New Lease Standard) at the lease commencement date
and recognize expenses on the income statement in a similar manner to the legacy guidance in
ASC 840, Leases (“ASC 840”).

The Company adopted the provisions of the New Lease Standard effective January 1, 2019, using the
modified retrospective adoption method, utilizing the simplified transition option available in the New
Lease Standard, which allows entities to continue to apply the legacy guidance in ASC 840, including
its disclosure requirements, in the comparative periods presented in the year of adoption. The Company
elected the package of practical expedients available under the transition provisions of the New Lease
Standard, including (i) not reassessing whether expired or existing contracts contain leases, (ii) not
reassessing lease classification, and (iii) not revaluing initial direct costs for existing leases.

In addition, the New Lease Standard eliminated the previous build-to-suit lease accounting guidance
and resulted in derecognition of build-to-suit assets and liabilities that remained on the balance sheet
after the end of the construction period, including the related deferred taxes. However, given the
Company’s guarantee associated with the bonds issued to fund the Dallas Love Field Modernization
Program (the “LFMP”), the remaining debt service amount as of the adoption date was considered a
minimum rental payment under the New Lease Standard, and therefore was recorded as a lease liability
with a corresponding right-of-use asset on the Consolidated Balance Sheet that will be reduced through
debt service payments made in 2019 and beyond. See Note 7 for disclosures related to the New Lease
Standard, and Note 4 for further information on the Company’s build-to-suit projects.

90

The following table provides the Consolidated Balance Sheet impact of applying the New Lease
Standard effective as of January 1, 2019. The impact to the Company’s results of operations and cash
flows was not significant:

(in millions)

Prepaid expenses and other current assets
Flight equipment
Assets constructed for others
Less allowance for depreciation and amortization
Operating lease right-of-use assets
Other assets

Total assets

Accounts payable
Accrued liabilities
Current operating lease liabilities
Current maturities of long-term debt
Long-term debt less current maturities
Deferred income taxes
Construction obligation
Noncurrent operating lease liabilities
Other noncurrent liabilities
Retained earnings

Balance as of January 1, 2019
Balances
added under
New Lease
Standard

Balances
removed
under prior
accounting

Net impact of
New Lease
Standard

$

$

$

$

$

$

1
—
1,669
(166)
—
121

1,625

8
37
—
—
—
(17)
1,602
—
60
(65)

— $

(110)
—
(2)
1,466
—

1,354

$

— $
—
355
(14)
(96)
—
—
1,119
—
(10)

1,354

$

(1)
(110)
(1,669)
164
1,466
(121)

(271)

(8)
(37)
355
(14)
(96)
17
(1,602)
1,119
(60)
55

(271)

Total liabilities and stockholders’ equity

$

1,625

$

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,
2018

2017

2019

NUMERATOR:
Net income

DENOMINATOR:

$

2,300

$

2,465

$

3,357

Weighted-average shares outstanding, basic
Dilutive effect of restricted stock units
Adjusted weighted-average shares outstanding, diluted

538
1
539

573
1
574

NET INCOME PER SHARE:

Basic

Diluted

$

$

4.28

4.27

$

$

4.30

4.29

$

$

91

601
2
603

5.58

5.57

4. COMMITMENTS AND CONTINGENCIES

Commitments

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, 2019, the Company leased three new 737 MAX 8 aircraft. The Company has firm orders
in place with Boeing for 219 737 MAX 8 aircraft and 30 737 MAX 7 aircraft, as well as options for
115 737 MAX 8 aircraft as of December 31, 2019. All 34 of the Company’s Boeing 737 MAX 8
aircraft have remained grounded since March 13, 2019, upon the FAA emergency order for all
U.S. airlines to ground all MAX aircraft. See Note 16 to the Consolidated Financial Statements for
further information. In addition, MAX deliveries were suspended as of March 13, 2019, and the
timeline of future deliveries is uncertain. The FAA will ultimately determine the timing of MAX return
to service, and the Company therefore offers no assurances that current estimations and timelines are
correct. Based on the Company’s current contractual obligations and shifting 40 MAX aircraft
originally scheduled for delivery in 2019 into 2020 and one into 2021, the Company’s capital
commitments associated with these contractual firm orders and additional aircraft are as follows:
$2.1 billion in 2020, $1.7 billion in 2021, $1.2 billion in 2022, $1.6 billion in 2023, $1.9 billion in
2024, and $1.5 billion thereafter.

The Company adopted the provisions of the New Lease Standard effective January 1, 2019, using the
modified retrospective adoption method. The New Lease Standard eliminated the previous build-to-suit
lease accounting guidance and resulted in the derecognition of build-to-suit assets and liabilities that
remained on the balance sheet after the end of the construction period. See Note 2 for further information.
Descriptions of the Company’s recently completed and current build-to-suit projects follows.

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 (“FLL”), to oversee and manage
the design and construction of the airport’s Terminal 1 Modernization Project. In addition to significant
improvements to the existing Terminal 1, the project included the design and construction of a
new five-gate Concourse A with an international processing facility. Funding for the project came
directly from Broward County aviation sources, but flowed 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 was substantially complete and operational as of the end of third quarter
2018. As construction was completed prior to adoption of the New Lease Standard, the Company
derecognized the FLL related Assets constructed for others (“ACFO”) and Construction obligation
within the Consolidated Balance Sheet as of January 1, 2019.

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 oversaw and managed
the design, development, financing, construction, and commissioning of the airport’s Terminal 1
Modernization Project. Construction on the Terminal 1 Modernization Project began during 2014 and
was substantially complete and operational during fourth quarter 2018. As construction was completed
prior to adoption of the New Lease Standard, the Company derecognized the LAX T1 Lease related
ACFO and Construction obligation within the Consolidated Balance Sheet as of January 1, 2019.

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In October 2017, the Company executed a separate lease agreement with LAWA (the “T1.5 Lease”).
Under the T1.5 Lease, the Company is overseeing and managing 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. 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 role
in the project, it is considered the owner of the Terminal 1.5 Project for accounting purposes under the
New Lease Standard. As a result, the costs incurred to fund the Terminal 1.5 Project 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. Upon completion of the
Terminal 1.5 Project, the Company will perform an evaluation to determine the treatment of these
associated assets and liabilities.

Funding for the Terminal 1.5 Project
is primarily through the Regional Airports Improvement
Corporation (the “RAIC”), which is a quasi-governmental special purpose entity that acts as a conduit
borrower under a syndicated credit facility provided by a group of lenders. A loan made under the
credit facility for the Terminal 1.5 Project is being used to reimburse the Company for the site
improvements and non-proprietary improvements of the Terminal 1.5 Project, and the outstanding loan
will be repaid with the proceeds of LAWA’s payments to purchase completed construction phases. The
Company guaranteed the obligation of the RAIC under the credit facility associated with the T1.5
Lease. As of December 31, 2019, the Company’s outstanding guaranteed obligation under the credit
facility for the Terminal 1.5 Project was $176 million.

Dallas Love Field

During 2008, the City of Dallas approved the 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 the “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. Major construction was
effectively completed in 2014. During second quarter 2017, the City of Dallas approved using the
remaining bond funds for additional terminal construction projects, which were effectively completed
in 2018. As construction was completed prior to adoption of the New Lease Standard, the Company
derecognized the LFMP Terminal related ACFO and Construction obligation within the Consolidated
Balance Sheet as of January 1, 2019.

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, 2019, $407 million of principal remained outstanding. The net present value of the
future principal and interest payments associated with the bonds was $444 million as of December 31,
2019, and was reflected as part of the Company’s operating lease right-of-use assets and lease
obligations in the Consolidated Balance Sheet. See Notes 2 and 7 for further information.

During 2015, the City of Dallas issued additional bonds for the construction of a new parking garage at
Dallas Love Field, which was completed and operational in fourth quarter 2018. As construction was

93

completed prior to adoption of the New Lease Standard, the Company derecognized the LFMP Parking
Garage related ACFO and Construction obligation within the Consolidated Balance Sheet as of
January 1, 2019. The Company has not guaranteed the principal or interest payments on these bonds.

Construction costs recorded in ACFO for the Company’s various projects as of December 31, 2019,
and December 31, 2018, were as follows:

(in millions)

FLL Terminal
LAX Terminal 1
LAX Terminal 1.5
LFMP Terminal
LFMP Parking Garage
HOU International Terminal

December 31, 2019
ACFO,
Net (a)

Construction
Obligation

ACFO

December 31, 2018
ACFO,
Net (a)

Construction
Obligation

ACFO

$

(b)

(c)

$

— $
—
164
—
—
—

164 $

— $
—
164
—
—
—

164 $

— $
—
164
—
—
—

164 $

313 $
485
99
545
200
126

304 $
459
99
460
200
115

308
476
99
502
200
116

1,768 $

1,637 $

1,701

(a) Net of accumulated depreciation.
(b) Project still in progress.
(c) 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.

5. REVENUE

Passenger Revenues

The Company’s contracts with its Customers primarily consist of its tickets sold, which are initially
deferred as Air traffic liability. Passenger revenue associated with tickets is recognized when the
performance obligation to the Customer is satisfied, which is primarily when travel is provided.

Revenue is categorized by revenue source as the Company believes it best depicts the nature, amount,
timing, and uncertainty of revenue and cash flow. The following table provides the components of
Passenger revenue recognized for the years ended December 31, 2019, 2018, and 2017:

(in millions)

Passenger non-loyalty
Passenger loyalty - air transportation
Passenger ancillary sold separately

Total passenger revenues

Year ended December 31,
2018

2017

2019

$

$

$

17,578
2,487
711

$

17,506
2,307
642

20,776

$

20,455

$

16,934
2,263
566

19,763

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Passenger non-loyalty includes all revenues recognized from Passengers related to flights paid for
primarily with cash or credit card. All Customers purchasing a ticket on Southwest Airlines are
generally able to check up to two bags at no extra charge (with certain exceptions as stated in the
Company’s published Contract of Carriage), and the Company also does not charge a fee for a
Customer to make a change to their flight after initial purchase, although fare differences may apply.
Passenger loyalty—air transportation primarily consists of the revenue recognized associated with
award flights taken by loyalty program members upon redemption of loyalty points. Passenger
ancillary sold separately includes any revenue recognized associated with ancillary fees charged
separately, such as in-flight purchases, EarlyBird Check-In®, and Upgraded Boarding.

In order to determine the value of each loyalty point, certain assumptions must be made at the time of
measurement, which include the following:

•

•

Allocation of Passenger Revenue - Revenues from Passengers, related to travel, who also
earn Rapid Rewards Points have been allocated between flight (recognized as revenue when
transportation is provided) and Rapid Rewards Points (deferred until points are redeemed)
based on each obligation’s relative standalone selling price. The Company utilizes historical
earning patterns to assist in this allocation.

Fair Value of Rapid Rewards Points - Determined from the base fare value of tickets which
were purchased using prior point redemptions for travel and other products and services,
which the Company believes to be indicative of the fair value of points as perceived by
Customers and representative of the value of each point at the time of redemption. The
Company’s booking site allows a Customer to toggle between fares utilizing either cash or
point redemptions, which provides the Customer with an approximation of the equivalent
value of their points. The value can differ, however, based on demand, the amount of time
prior to the flight, and other factors. The fare mix during the period measured represents a
constraint, which could result in the assumptions above changing at the measurement date, as
fare classes can have different coefficients used to determine the total loyalty points needed
to purchase an award ticket. The mixture of these fare classes and changes in the coefficients
used by the Company could cause the fair value per point to increase or decrease.

For points that are expected to remain unused, the Company recognizes spoilage in proportion to the
pattern of points used by the Customer, which approximates the average period over which the
population of Rapid Reward Members redeem their points. The Company utilizes historical behavioral
data to develop a predictive statistical model to analyze the amount of spoilage expected for points sold
to business partners and earned through flight. The Company continues to evaluate expected spoilage
annually and applies appropriate adjustments in the fourth quarter of each year, or other times, if
changes in Customer behavior are detected. Changes to spoilage estimates impact revenue recognition
prospectively. Due to the size of the Company’s liability for loyalty benefits, changes in Customer
behavior and/or expected future redemption patterns could result in significant variations in Passenger
revenue.

The Company allocates consideration received to performance obligations based on the relative fair
value of those obligations. The Company has a co-branded credit card agreement (“Agreement”) with
Chase Bank USA, N.A. (“Chase”), through which the Company sells loyalty points and certain
marketing components, which consist of the use of Southwest Airlines’ brand and access to Rapid
Rewards Member lists, licensing and advertising elements, and the use of the Company’s resource

95

team. 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 two performance obligations identified in the
Agreement, which have been characterized as a transportation component and a marketing component.
The allocations utilized are reviewed to determine if adjustment is necessary any time there is a
modification to the Agreement. The Company records Passenger revenue related to loyalty point
redemptions for air travel when the travel is delivered, and the marketing elements are recognized as
Other revenue when the performance obligations related to those services are satisfied, which is
generally the same period consideration is received from Chase.

As performance obligations to Customers are satisfied, the related revenue is recognized. The events
that result in revenue recognition that are associated with performance obligations identified as a part
of the Rapid Rewards Program are as follows:

•

•

Tickets and Rapid Rewards Points - When a flight occurs, the related performance
obligation is satisfied and the related value provided by the Customer, whether from
purchased tickets or Rapid Rewards Points, is recognized as revenue.

Loyalty points redeemed for goods and/or services other than travel - Rapid Rewards
Members have the option to redeem points for goods and services offered through a third
party vendor, who acts as principal. The performance obligation related to the purchase of
these goods and services is satisfied when the good and/or service is delivered to the
Customer.

• Marketing Royalties - As part of its Agreement with Chase, Southwest provides certain
deliverables, including use of the Southwest Airlines’ brand, access to Rapid Rewards
Member lists, advertising elements, and the Company’s resource team. These performance
obligations are satisfied each month that the Agreement is active.

As of the years ended December 31, 2019 and 2018, the components of Air traffic liability, including
contract liabilities based on tickets sold, unused funds available to the Customer, and loyalty points
available for redemption, net of expected spoilage, within the Consolidated Balance Sheet were as
follows:

(in millions)

Air traffic liability - passenger travel and ancillary passenger services

Air traffic liability - loyalty program

Total Air traffic liability

Balance as of
December 31, 2019 December 31, 2018

$

$

2,125 $

3,385

5,510 $

2,059

3,011

5,070

The balance in Air traffic liability - passenger travel and ancillary passenger services also includes
unused funds that are available for use by Customers and are not currently associated with a ticket, but
represent funds effectively refunded and made available for use to purchase a ticket for a flight that
occurs prior to their expiration. These funds are typically created as a result of a prior ticket
cancellation or exchange. These performance obligations are expected to have a duration of twelve
months or less; therefore, the Company has elected to not disclose the amount of the remaining
transaction price and its expected timing of recognition for passenger tickets. Recognition of revenue
associated with the Company’s loyalty liability can be difficult to predict, as the number of award seats
available to members is not currently restricted and they could choose to redeem their points at any

96

time that a seat is available. The performance obligations classified as a current liability related to the
Company’s loyalty program were estimated based on expected redemptions utilizing historical
redemption patterns, and forecasted flight availability, fares, and coefficients. The entire balance
classified as Air traffic liability—noncurrent relates to loyalty points that were estimated to be
redeemed in periods beyond 12 months following the representative balance sheet date. The Company
expects the majority of loyalty points to be redeemed within two years. Rollforwards of the Company’s
Air traffic liability—loyalty program for the years ended December 31, 2019 and 2018 were as follows
(in millions):

Year ended December 31,

2019

2018

Air traffic liability - loyalty program - beginning balance

$

Amounts deferred associated with points awarded

Revenue recognized from points redeemed - Passenger

Revenue recognized from points redeemed - Other

$

3,011

2,941

(2,487)

(80)

2,667

2,717

(2,307)

(66)

Air traffic liability - loyalty program - ending balance

$

3,385

$

3,011

Air traffic liability includes consideration received for ticket and loyalty related performance
obligations which have not been satisfied as of a given date. Rollforwards of the amounts included in
Air traffic liability as of December 31, 2019 and 2018 were as follows (in millions):

Balance at December 31, 2018

Current period sales (passenger travel, ancillary services, flight loyalty, and partner loyalty)

Revenue from amounts included in contract liability opening balances

Revenue from current period sales

Balance at December 31, 2019

Balance at December 31, 2017

Current period sales (passenger travel, ancillary services, flight loyalty, and partner loyalty)

Revenue from amounts included in contract liability opening balances

Revenue from current period sales

Balance at December 31, 2018

$

$

$

Air traffic
liability

5,070

21,296

(3,816)

(17,040)

5,510

Air traffic
liability

4,565

21,026

(3,479)

(17,042)

$

5,070

All performance obligations related to freight services sold are completed within twelve months or
less; therefore, the Company has elected to not disclose the amount of the remaining transaction price
and its expected timing of recognition for freight shipments.

Other revenues primarily consist of marketing royalties associated with the Company’s co-branded
Chase® Visa credit card, but also include commissions and advertising associated with
Southwest.com®. All amounts classified as Other revenues are paid monthly, coinciding with the
Company fulfilling its deliverables; therefore, the Company has elected to not disclose the amount of
the remaining transaction price and its expected timing of recognition for such services provided.

97

The Company recognized revenue related to the marketing, advertising, and other travel-related
benefits of the revenue associated with various loyalty partner agreements including, but not limited to,
the Agreement with Chase, within Other operating revenues. For the years ended December 31, 2019,
2018, and 2017 the Company recognized $1.3 billion, $1.1 billion, and $1.0 billion, respectively.

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, are excluded from the contract transaction price, and are therefore 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.

6. LONG-TERM DEBT

(in millions)

December 31, 2019 December 31, 2018

2.75% Notes due November 2019

$

— $

Term Loan Agreement payable through May 2019 - 6.315%

Term Loan Agreement payable through July 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 - 3.03%

3.00% Notes due 2026

3.45% Notes due 2027

7.375% Debentures due 2027

Finance leases

Less current maturities

Less debt discount and issuance costs

—

—

500

134

20

300

197

178

300

300

122

627

$

$

2,678 $

819

13

1,846 $

300

23

10

492

187

67

300

250

197

300

300

125

845

3,396

606

19

2,771

AirTran Holdings is party to aircraft purchase financing facilities, and as of December 31, 2019, three
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-
annual or three-month period, as applicable. As of December 31, 2019, the weighted average interest
rate was 3.49 percent. Principal and interest under the notes are payable semi-annually or every three
months as applicable. As of December 31, 2019, the remaining debt outstanding may be prepaid
without penalty under all aircraft loans provided under such facilities. The remaining notes mature in
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.

98

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.

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.

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 began on 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 3.03 percent, and interest is payable semi-annually in installments.

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.
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 November
2019. The notes bore interest at 2.75 percent, payable semi-annually in arrears. 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. The notes matured and were redeemed in full on
November 6, 2019, utilizing available cash on hand.

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 bore interest at a fixed rate of 4.84 percent. The loan matured and was paid out in
full on July 1, 2019, utilizing available cash on hand.

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 bore 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. The loan matured and was paid out in full on May 6, 2019, utilizing available cash on hand.

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 being repaid via
quarterly installments of principal and interest that began on August 9, 2008. The loans bear interest at

99

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 are
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 became 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 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.

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 $148 million at December 31, 2019.

The Company has access to a $1.0 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, 2019, the Company was in
compliance with this covenant and there were no amounts outstanding under the revolving credit
facility.

The net book value of the assets pledged as collateral for the Company’s secured borrowings, primarily
aircraft, was $990 million at December 31, 2019. In addition, the Company has pledged a total of up to
12 of its Boeing 737-700 and 37 of its Boeing 737-800 aircraft at a net book value of $1.2 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.

100

As of December 31, 2019, aggregate annual principal maturities of debt and finance leases (not
including amounts associated with interest rate swap agreements, interest on finance leases, and
amortization of purchase accounting adjustments) for the five-year period ending December 31, 2024,
and thereafter, were $819 million in 2020, $170 million in 2021, $475 million in 2022, $103 million in
2023, $103 million in 2024, and $990 million thereafter.

7. LEASES

The Company enters into leases for aircraft, property, and other types of equipment in the normal
course of business. The accounting for these leases follows the requirements of the New Lease
Standard, which the Company adopted as of January 1, 2019. See Note 2 for further information.

As of December 31, 2019, the Company held aircraft leases with remaining terms ranging from one month
to 12 years. The aircraft leases generally can be renewed for one to six years at rates based on fair market
value at the end of the lease term. Residual value guarantees included in the Company’s lease agreements
are not material. On July 9, 2012, the Company signed an agreement with Delta Air Lines, Inc. and Boeing
Capital Corp. to lease or sublease 88 AirTran Airways, Inc. Boeing 717-200 aircraft (“B717s”) to Delta at
agreed-upon lease rates. Three operating leases expired during 2018. Of the 85 B717s remaining at the
beginning of 2019, ten owned B717s were sold in 2019. The proceeds from the sale, which were not
material, were netted within Capital expenditures in the Consolidated Statement of Cash Flows. Excluding
the eight aircraft for which operating leases expired during 2019, the following remained: 65 on operating
leases and two on finance leases. The sublease terms for the 65 B717s on operating lease and the two B717s
on finance lease coincide with the Company’s remaining lease terms for these aircraft from the original
lessor, which have remaining lease terms ranging from approximately one month to five years. The
Company’s future sublease income associated with the 65 B717s on operating lease as of December 31,
2019 was as follows: $78 million in 2020, $41 million in 2021, $17 million in 2022, $7 million in 2023, and
$1 million in 2024. The two B717s classified by the Company as finance leases are accounted for as direct
financing leases, and the remaining 65 subleases are accounted for as operating leases. There
are no contingent payments and no significant residual value conditions associated with the transaction.

At each airport where the Company conducts flight operations, the Company has lease agreements,
generally with a governmental unit or authority, for the use of airport terminals, airfields, office space,
cargo warehouses, gates, and/or maintenance facilities. These leases are classified as operating lease
agreements and have lease terms remaining ranging from one month to 27 years. Certain leases can be
renewed from one to ten years. The majority of the airport terminal leases contain certain provisions
for periodic adjustments to rates that depend upon airport operating costs or use of the facilities, and
are reset at least annually. Due to the nature and variability of the rates, the majority of these leases are
not recorded on the Consolidated Balance Sheet.

The Company also leases certain technology assets, fuel storage tanks, and various other equipment
that qualify as leases under the New Lease Standard. The remaining lease terms range from two
months to seven years. Certain leases can be renewed from six months to five years.

101

Lease-related assets and liabilities recorded on the Consolidated Balance Sheet were as follows:

(in millions)

Assets
Operating
Finance

Total lease assets

Liabilities
Current

Operating
Finance
Noncurrent
Operating
Finance

Total lease liabilities

Balance Sheet location

December 31, 2019

Operating lease right-of-use assets (net)
Property and equipment (net of allowance
for depreciation and amortization of $455)

Current operating lease liabilities
Current maturities of long-term debt

Noncurrent operating lease liabilities
Long-term debt less current maturities

$

$

$

$

1,349

779

2,128

353
85

978
542

1,958

The components of lease costs, included in the Consolidated Statement of Comprehensive Income,
were as follows:

(in millions)

Statement of Comprehensive
Income location

Year ended
December 31, 2019

Operating lease cost - aircraft (a)

Other operating expenses

Operating lease cost - other

Short-term lease cost

Variable lease cost

Finance lease cost:

Landing fees and airport rentals, and Other
operating expenses

Other operating expenses

Landing fees and airport rentals, and Other
operating expenses

Amortization of lease liabilities

Depreciation and amortization

Interest on lease liabilities

Interest expense

Total net finance lease cost

$

$

(a) Net of sublease income of $97 million for the year ended December 31, 2019.

182

89

4

1,377

116

26

142

102

Supplemental cash flow information related to leases, included in the Consolidated Statement of Cash
Flows, was as follows:

(in millions)

Cash paid for amounts included in the measurement of lease liabilities:

Operating cash flows for operating leases

Operating cash flows for finance leases

Financing cash flows for finance leases

Right-of-use assets obtained in exchange for lease obligations:

Operating leases

Finance leases

Year ended
December 31, 2019

$

379

26

85

230

1

As of December 31, 2019, maturities of lease liabilities were as follows:

(in millions)

Operating leases

Finance leases

2020

2021

2022

2023

2024

Thereafter

Total lease payments

Less imputed interest

Total lease obligations

Less current obligations

Long-term lease obligations

$

$

$

$

392

257

141

113

92

661

1,656

$

(325)

1,331

(353)

978

$

107

102

98

94

90

230

721

(94)

627

(85)

542

The table below presents additional information related to the Company’s leases as of December 31,
2019:

Weighted average remaining lease term

Operating leases

Finance leases

Weighted average discount rate

Operating leases (a)

Finance leases

9 years

8 years

3.7%

3.8%

(a) Upon adoption of the New Lease Standard, the incremental borrowing rate used for existing leases was
established as of January 1, 2019.

As of December 31, 2019, the Company had additional operating lease commitments that had not yet
commenced of approximately $543 million for 16 Boeing 737 MAX 8 aircraft contractually to be
delivered in 2020, each with lease terms that range from eight to nine years.

103

Disclosures related to periods prior to the adoption of the New Lease Standard

As of December 31, 2018, the Company’s fleet included 51 aircraft on operating lease and 72 aircraft
on capital lease. Amounts applicable to these aircraft on capital lease that were included in property
and equipment were $1.3 billion for flight equipment and $304 million in accumulated amortization.

Total rental expense for operating leases, both aircraft and other, charged to operations in 2018 and
2017 was $935 million and $939 million, respectively. The majority of the Company’s terminal
operations space, as well as 124 aircraft, including 73 B717s subleased to Delta, were under operating
leases at December 31, 2018. For aircraft operating leases and for terminal operating leases and other
real estate leases, expense is recorded on a straight–line basis and included in Other operating expenses
and in Landing fees and airport rentals, respectively, in the Consolidated Statement of Income. The
majority of the Company’s terminal operations space 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, 2018, were:

(in millions)

2019

2020

2021

2022

2023

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

Subleases

Operating
leases, net

$

$

348

357

244

172

146

474

$

(92)

(78)

(41)

(17)

(7)

(1)

256

279

203

155

139

473

$

1,741

$

(236)

$

1,505

$

$

$

111

109

105

100

97

335

857

126

731

85

646

(a) Excludes lease incentive obligation of $114 million.

In 2017, the Company recorded a charge of $63 million, within Other operating expenses in the
accompanying Consolidated Statement of Income, 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. As of December 31, 2018, the remaining amounts associated with the cease-use liability had been
paid in full.

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, 2019, the
Company had 60 million shares of common stock reserved for issuance pursuant to Employee equity

104

plans (of which 27 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, 2019, 2018, and 2017, reflects share-based compensation expense of $55 million,
$46 million, and $37 million, respectively. The total tax benefit recognized in earnings from share-
based compensation arrangements for the years ended December 31, 2019, 2018, and 2017, was not
material. As of December 31, 2019, there was $64 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”), which
has been approved by Shareholders,
the Company granted restricted stock units (“RSUs”) and
performance-based restricted stock units (“PBRSUs”) to certain Employees during 2019, 2018, and
2017. Outstanding RSUs vest over three years, subject generally to the individual’s continued
to the Company’s
employment or service. The PBRSUs granted in February 2017 are subject
performance with respect to a three-year simple average of Return on Invested Capital, before taxes
and excluding special items, for the defined performance period and are also subject generally to the
individual’s continued employment or service. The PBRSUs granted in January 2018 and January 2019
are subject to the Company’s performance with respect to a three-year simple average of Return on
Invested Capital, after taxes and excluding special items, for the defined performance period and are
also subject generally to the individual’s continued employment or service. The number of PBRSUs
vesting on the vesting date will be interpolated based on the Company’s Return on Invested Capital
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.

105

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

Outstanding December 31, 2016

Granted

Vested

Surrendered

Outstanding December 31, 2017

Granted

Vested

Surrendered

Outstanding December 31, 2018, Unvested

Granted

Vested

Surrendered

Outstanding December 31, 2019, Unvested

(a) Includes 235 thousand PBRSUs
(b) Includes 308 thousand PBRSUs
(c) Includes 387 thousand PBRSUs

All Restricted Stock Units

Units (000)

Wtd. Average
Fair Value
(per share)

1,439

$

717 (a)

(806)

(56)

1,294

782 (b)

(670)

(64)

1,342

994 (c)

(744)

(47)

1,545

36.52

52.73

30.23

43.86

45.32

60.80

45.11

47.05

52.56

57.49

42.42

57.72

57.65

In addition, the Company granted approximately 31 thousand shares of unrestricted stock at a weighted
average grant price of $52.01 in 2019, approximately 28 thousand shares at a weighted average grant
price of $53.01 in 2018, and approximately 26 thousand shares at a weighted average grant price of
$57.04 in 2017, to members of its Board of Directors.

A remaining balance of up to 20 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 and Restated 1991 Employee Stock Purchase Plan (“ESPP”), which has been
approved by Shareholders, the Company is authorized to issue up to a remaining balance of 7 million
shares of the 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.

106

The following table provides information about the Company’s ESPP activity during 2019, 2018, and
2017:

Employee Stock Purchase Plan

Year ended

December 31, 2017

December 31, 2018

December 31, 2019

Total number
of shares
purchased
(in thousands)

Average
price paid
per share

(a)
Weighted-average
fair value of each
purchase right
under the ESPP

544

661

821

$

$

$

50.13

50.73

47.60

$

$

$

5.57

5.64

5.29

(a) The weighted-average fair value of each purchase right under the ESPP granted is equal to a ten percent
discount from the market value of the Common Stock at the end of each monthly purchase period.

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 represents 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 timeframes,
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.

107

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
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 2019, the Company had fuel derivative instruments in place for up to 73 percent of its fuel
consumption. As of December 31, 2019, the Company also had fuel derivative instruments in place to
provide coverage at varying price levels, but up to a maximum of approximately 59 percent of its 2020
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:

Period (by year)

2020

2021

2022

Beyond 2022

Maximum fuel hedged as of
December 31, 2019
(gallons in millions) (a)

1,301

1,169

603

32

Derivative underlying commodity type as of
December 31, 2019

WTI crude oil, Brent crude oil, and Heating oil

WTI crude and Brent crude oil

WTI crude and Brent 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. All periodic changes in fair value of the derivatives designated as hedges are recorded in AOCI
until the underlying jet fuel is consumed. See Note 12.

The Company’s results are subject to the possibility that the derivatives will no longer qualify for
hedge accounting, in which case any change in the fair value of derivative instruments since the last
reporting period would be recorded in 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. Factors that have and may continue to lead to the loss of hedge
accounting include: significant fluctuation in energy prices, 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. 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. However, even though derivatives may not
qualify for hedge accounting, the Company continues to hold the instruments as management believes

108

derivative instruments continue to afford the Company the opportunity to stabilize jet fuel costs. 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 have been recorded to AOCI would be required to be
immediately reclassified into earnings. The Company did not have any such situations occur during
2019, 2018, or 2017.

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. This statistical analysis involves utilizing regression analyses that compare changes in the
price of jet fuel to changes in the prices of the commodities used for hedging purposes.

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 (a)

Balance Sheet
location

Asset derivatives

Liability derivatives

Fair value
at
12/31/2019

Fair value
at
12/31/2018

Fair value
at
12/31/2019

Fair value
at
12/31/2018

Fuel derivative contracts (gross)

Prepaid expenses and
other current assets

$

48 $

43 $

— $

Fuel derivative contracts (gross)

Other assets

Interest rate derivative contracts

Other assets

Interest rate derivative contracts

Accrued liabilities

Interest rate derivative contracts

Other noncurrent
liabilities

62

2

—

—

95

—

—

—

—

—

5

1

Total derivatives designated as hedges

$

112 $

138 $

6 $

—

—

—

2

12

14

(a) 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.

109

The following table presents the amounts recorded on the Consolidated Balance Sheet related to fair
value hedges:

Balance Sheet location of
hedged item

(in millions)

Current maturities of long-term

debt

Long-term debt less current

maturities

Carrying amount of the
hedged liabilities
December 31,

2019

2018

Cumulative amount of fair value hedging
adjustment included in the carrying
amount of the hedged liabilities (a)
December 31,

2019

2018

$

$

500 $

—

500 $

— $

791

791 $

— $

19

19 $

—

11

11

(a) At December 31, 2019 and 2018, these amounts include the cumulative amount of fair value
hedging adjustments remaining for which hedge accounting has been discontinued of $19 million and
$20 million, respectively.

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

(in millions)

Cash collateral deposits held from counterparties

for fuel contracts - current

Cash collateral deposits held from counterparties

for fuel contracts - noncurrent

Balance Sheet
location

December 31,
2019

December 31,
2018

Offset against Prepaid
expenses and other
current assets

$

Offset against Other
assets

10

$

15

—

—

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. 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 asset 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. No cash collateral deposits were provided by or held by the Company based on
its outstanding interest rate swap agreements.

110

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, 2019

(iii) = (i) + (ii)

(i)

(ii)
December 31, 2018

(iii) = (i) + (ii)

Gross amounts
of recognized
assets

Gross amounts
offset in the
Balance Sheet

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

$

$

$

48

$

(10) $

38

$

43

$

— $

43

62

$

(15) $

47 (a) $

95

$

— $

95 (a)

2

$

— $

2 (a) $

— $

— $

— (a)

Description

Fuel
derivative
contracts

Fuel
derivative
contracts

Interest rate
derivative
contracts

Balance Sheet
location

Prepaid
expenses and
other current
assets

Other assets

Other assets

(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 15.

Offsetting of derivative liabilities
(in millions)

(i)

(ii)
December 31, 2019

(iii) = (i) + (ii)

(i)

(ii)
December 31, 2018

(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

$

$

$

$

10

$

(10) $

— $

— $

— $

—

15 $

(15) $

— (a) $

— $

— $

— (a)

5

$

— $

1

$

— $

5

1

$

$

2

$

— $

12

$

— $

2

12

Description

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

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 15.

111

The following tables present the impact of derivative instruments and their location within the
Consolidated Statement of Income for the year ended December 31, 2019 and 2018:

Location and amount recognized in income on cash flow and fair value hedging relationships

(in millions)

Total

(Gain) loss on cash flow hedging relationships:

Commodity contracts:

Amount of (gain) loss reclassified from

AOCI into income

Interest contracts:

Amount of loss reclassified from AOCI

into income

Impact of fair value hedging relationships:

Interest contracts:
Hedged items
Derivatives designated as hedging

instruments

Year ended
December 31, 2019

Year ended
December 31, 2018

Fuel and
oil

Interest
expense

Fuel and
oil

Interest
expense

$

48

$

29

$

(33) $

37

48

—

—

—

—

5

22

2

(33)

—

—

—

—

6

23

8

Derivatives designated and qualified in cash flow hedging relationships

(in millions)

Fuel derivative contracts
Interest rate derivatives

Total

Derivatives not designated as hedges

(in millions)

(Gain) loss recognized in
AOCI on derivatives,
net of tax
Year ended
December 31,

2019

2018

$

$

90
29

119

$

$

1
(1)

—

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

2019

2018

Location of (gain) loss
recognized in income
on derivatives

Interest rate derivatives

$

— $

(2)

Interest Expense

The Company also recorded expense associated with premiums paid for fuel derivative contracts that
settled/expired during 2019, 2018, and 2017 of $95 million, $135 million, and $136 million,

112

respectively. These amounts are recognized through changes in fair value within AOCI for designated
hedges, and are ultimately recorded as a component of Fuel and oil in the Consolidated Statement of
Income during the period the contracts settle.

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 losses from fuel hedges as of December 31, 2019, recorded in AOCI, were
approximately $36 million in unrealized losses, net of taxes, which are expected to be realized in
earnings during the twelve months subsequent to December 31, 2019.

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” or “critical terms match” methods of
accounting, ineffectiveness is assessed at each reporting period. If hedge accounting is achieved, all
periodic changes in fair value of the interest rate swaps are recorded in AOCI. The ineffectiveness
associated with all of the Company’s 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 $4 million are fair value hedges, cash flow hedges, and interest rate derivatives not
utilizing hedge accounting, and are classified as components of Other assets, 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 a fixed-to-floating interest rate swap agreement
in place associated with its
$500 million 2.65 percent Notes due 2020 that is accounted for as a fair value hedge. As a result of the
fixed-to-floating interest rate swap agreement in place, the average floating rate recognized during
2019 was approximately 3.01 percent on the $500 million Notes.

The Company has a floating-to-fixed interest rate swap agreement associated with its $600 million
floating-rate term loan agreement due 2020 that is accounted for as a cash flow hedge. The interest rate
hedge has fixed the interest rate on the $600 million floating-rate term loan agreement at 5.223 percent
until maturity.

There are also two 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
in 2020, AirTran Holdings pays fixed rates between 4.35 percent and 4.50 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, 2019, was $13 million. The mark-to-market impact
associated with these hedges for all periods presented was not material.

113

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, 2019, 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. In certain cases, the Company has the
ability to substitute among these different forms of collateral in its discretion. The following table
provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral
posting threshold amounts as of December 31, 2019, at which such postings are triggered:

(in millions)

A

B

Counterparty (CP)
D

C

$

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

22 $
25
—
—

16 $
—
—
—

36 $
—
—
—

E

Other(a)

Total

12 $
—
—
—

8 $
—
—
—

16 $
—
—
—

110
25
—
—

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

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

N/A
N/A

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

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

N/A

(d)

>(100)
>0(e)
(200) to
(600)(f)

>(50)
>150(e)
N/A

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

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

>(40)

>100(e)
N/A

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

(g)

(g)
N/A

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

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

(g)

(g)
N/A

(a) Individual counterparties with fair value of fuel derivatives <$7 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 requirements.

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

114

(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, 2019, 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, commercial
paper, and time deposits 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 currently consist solely 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 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

115

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, 2019, and December 31, 2018:

Description

Assets

Cash equivalents

December 31, 2019

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)

$

1,999 $

1,999 $

— $

Commercial paper

Certificates of deposit

Short-term investments:

Treasury bills

Certificates of deposit

Time deposits

Interest rate derivatives

(see Note 10)

Fuel derivatives:

Option contracts (b)
Other available-for-sale

securities

Total assets

Liabilities

Interest rate derivatives

(see Note 10)

$

$

535

14

1,196

268

60

2

110

197

4,381 $

—

—

1,196

—

—

—

—

197

3,392 $

535

14

—

268

60

2

—

—

879 $

—

—

—

—

—

—

—

110

—

110

(6) $

— $

(6) $

—

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

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

116

Description

Assets
Cash equivalents

Cash equivalents (a)
Commercial paper
Certificates of deposit
Short-term investments:
Treasury bills
Certificates of deposit
Time deposits
Fuel derivatives:

Option contracts (b)
Other available-for-sale

securities

Total assets

Liabilities
Interest rate derivatives (see

Note 10)

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)

December 31, 2018

(in millions)

1,392 $
—
—

1,582
—
—

—

127

1,392 $
454
8

1,582
228
25

138

127

— $
454
8

—
228
25

—

—

3,954 $

3,101 $

715 $

—
—
—

—
—
—

138

—

138

(14) $

— $

(14) $

—

$

$

$

(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.

The Company had no transfers of assets or liabilities between any of the above levels during the years
ended December 31, 2019 or 2018. The Company did not have any assets or liabilities measured at fair
value on a nonrecurring basis as of December 31, 2019 or 2018. 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 2019 and 2018:

Fair value measurements using significant unobservable inputs (Level 3)

(in millions)

Balance at December 31, 2018

Total losses (realized or unrealized) included in other

comprehensive income

Purchases

Sales

Settlements

Balance at December 31, 2019

$

$

Fuel
derivatives

138

(112)

133 (a)

(2) (a)

(47)

110

(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 was purchased as a single instrument or separate instruments.

117

Fair value measurements using significant unobservable inputs (Level 3)

(in millions)

Balance at December 31, 2017

Total losses (realized or unrealized) included in other

comprehensive income

Purchases

Sales

Settlements

Balance at December 31, 2018

$

$

Fuel
derivatives

248

(1)

66 (a)

(4) (a)

(171)

138

(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 was purchased as a single instrument or separate instruments.

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, 2019:

Quantitative information about Level 3 fair value measurements

Valuation technique

Unobservable input

Period (by year)

Fuel derivatives

Option model

Implied volatility

2020

2021

2022

Beyond 2022

Range

13-34%

17-23%

17-19%

18-19%

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, 2019, 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 three 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.

118

(in millions)

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 - 3.03%

3.00% Notes due 2026

3.45% Notes due 2027

7.375% Debentures due 2027

Carrying value

Estimated fair
value

Fair value level
hierarchy

$

$

500

134

20

300

197

178

300

300

122

503

134

20

304

208

178

308

317

150

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
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 2019 and 2018:

(in millions)

Fuel
derivatives

Interest
rate
derivatives

Defined
benefit plan
items

Other

Deferred
tax
impact

Accumulated other
comprehensive
income (loss)

Balance at December 31, 2017

$

3 $

(7) $

(9) $ 33 $

(8) $

ASU 2017-12 adoption

adjustment (a)

ASU 2018-02 stranded AOCI
adoption adjustment (b)

Changes in fair value

Reclassification to earnings

(26)

—

—

(33)

—

—

1

6

—

—

67

—

—

—

(8)

—

6

2

(14)

7

Balance at December 31, 2018

$

(56) $

— $

58 $ 25 $

(7) $

Changes in fair value

Reclassification to earnings

(117)

48

(38)

5

(38)

—

34

—

37

(12)

Balance at December 31, 2019

$

(125) $

(33) $

20 $ 59 $

18 $

12

(20)

2

46

(20)

20

(122)

41

(61)

(a) The Company adopted the New Hedging Standard as of January 1, 2018. See Note 2 for further information on this
adoption.

(b) The Company adopted the Reclassification of Certain Tax Effects from AOCI as of January 1, 2018, which allowed the
Company to reclassify to Retained earnings any tax effects stranded in AOCI as a result of the Tax Cuts and Jobs Act enacted
in December 2017.

119

The following table illustrates the significant amounts reclassified out of each component of AOCI for
the year ended December 31, 2019:

Year ended December 31, 2019

(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

$

$

$

$

$

48 Fuel and oil expense

11 Less: Tax expense

37 Net of tax

5

Interest expense

1 Less: Tax expense

4 Net of tax

41 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.

Amounts associated with the Company’s defined contribution plans expensed in 2019, 2018, and 2017,
reflected as a component of Salaries, wages, and benefits, were $1.2 billion, $1.0 billion, and
$1.0 billion, 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.

120

The following table shows the change in the accumulated postretirement benefit obligation (“APBO”)
for the years ended December 31, 2019 and 2018:

(in millions)

APBO at beginning of period

Service cost

Interest cost

Benefits paid

Actuarial (gain)/loss

Plan amendments

APBO at end of period

2019

2018

$

232

$

17

10

(9)

38

—

$

288

$

275

18

9

(5)

(69)

4

232

During 2019, the Company recorded a $38 million actuarial loss as an increase to the APBO with an
offset to AOCI. This actuarial loss is reflected above and resulted from changes in certain key
assumptions used to determine the Company’s year-end obligation. The assumption change that
resulted in the largest portion of the actuarial loss was the change in the discount rate used.

All plans are unfunded, and benefits are paid as they become due. Estimated future benefit payments
expected to be paid are $9 million in 2020, $10 million in 2021, $12 million in 2022, $13 million in
2023, $15 million in 2024, and $107 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, 2019 and 2018.

(in millions)

Funded status

Unrecognized net actuarial gain

Unrecognized prior service cost

Accumulated other comprehensive income

Cost recognized on Consolidated Balance Sheet

2019

2018

(288)

$

(24)

4

20

(232)

(64)

5

59

(288)

$

(232)

$

$

The consolidated periodic postretirement benefit cost for the years ended December 31, 2019, 2018,
and 2017, included the following:

(in millions)

Service cost

Interest cost

Amortization of prior service cost

Amortization of net gain

Net periodic postretirement benefit cost

$

$

121

2019

2018

2017

$

18

$

17

10

1

(2)

26

$

9

3

—

30

$

18

11

3

—

32

Service cost is recognized within Salaries, wages, and benefits expense, and all other costs are
recognized in Other (gains) losses, net in the Consolidated Statement of Income. 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, 2019, 2018, and 2017:

Weighted-average discount rate

Assumed healthcare cost trend rate (a)

2019

2018

2017

3.30%

7.13%

4.35%

7.13%

3.65%

7.08%

(a) The assumed healthcare cost trend rate is expected to be 6.79% for 2020, then decline gradually to 5.19% by
2027 and remain level thereafter.

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 2019 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 components of deferred tax assets and liabilities at December 31, 2019 and 2018, are as
follows:

(in millions)

DEFERRED TAX LIABILITIES:

Accelerated depreciation

Operating lease right-of-use assets

Other

Total deferred tax liabilities

DEFERRED TAX ASSETS:

Construction obligation

Accrued employee benefits

Rapid rewards loyalty liability

Operating lease liabilities

Other

Total deferred tax assets

Net deferred tax liability

122

2019

2018

$

3,096 $

3,395

293

93

3,482

38

346

305

308

121

1,118

$

2,364 $

—

92

3,487

355

329

267

—

109

1,060

2,427

The provision (benefit) for income taxes is composed of the following:

(in millions)

CURRENT:

Federal

State

Total current

DEFERRED:

Federal

State

Change in federal statutory tax rate (a)

Total deferred

2019

2018

2017

$

610 $

338 $

102

712

(18)

(6)

(31)

(55)

60

398

299

2

—

301

$

657 $

699 $

904

72

976

200

2

(1,270)

(1,068)

(92)

(a) The Tax Cuts and Jobs Act was enacted in December 2017, which reduced the U.S. federal
corporate tax rate from the previous rate of 35 percent to 21 percent.

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 (a)

Other, net

Total income tax provision (benefit)

2019

2018

2017

$

$

621 $

664 $

76

(31)

(9)

49

—

(14)

657 $

699 $

1,143

50

(1,270)

(15)

(92)

(a) The Tax Cuts and Jobs Act was enacted in December 2017, which reduced the U.S. federal
corporate tax rate from the previous rate of 35 percent to 21 percent.

The only periods subject to examination for the Company’s federal tax return are the 2018 and 2019
tax years. The Company is also subject to various examinations from state and local income tax
jurisdictions in the ordinary course of business. These examinations are not expected to have a material
effect on the financial results of the Company.

123

15. SUPPLEMENTAL FINANCIAL INFORMATION

(in millions)

Trade receivables

Credit card receivables

Business partners and other suppliers

Income tax receivable

Other

Accounts and other receivables

(in millions)

Derivative contracts

Intangible assets, net

Finance lease receivable
Other

Other assets

(in millions)

Accounts payable trade

Salaries payable

Taxes payable excluding income taxes

Aircraft maintenance payable

Fuel payable

Other payable

Accounts payable

(in millions)

Profitsharing and savings plans

Vacation pay

Health

Workers compensation

Property and income taxes

Other

Accrued liabilities

(in millions)

Postretirement obligation

Other deferred compensation

Other

Other noncurrent liabilities

December 31, 2019 December 31, 2018

$

$

53 $

112

779

87

55

1,086 $

57

107

319

22

63

568

December 31, 2019 December 31, 2018

$

$

49 $

296

—
232

577 $

95

400

61
164

720

December 31, 2019 December 31, 2018

$

$

304 $

231

227

162

129

521

263

216

220

69

122

526

1,574 $

1,416

December 31, 2019 December 31, 2018

$

$

695 $

434

120

166

79

255

580

403

107

166

68

425

1,749 $

1,749

December 31, 2019 December 31, 2018

$

$

288 $

313

105

706 $

232

247

171

650

For further information on supplier receivables, see Note 16. For further information on fuel derivative
and interest rate derivative contracts, see Note 10.

124

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.

16. BOEING 737 MAX AIRCRAFT GROUNDING

On March 13, 2019, the FAA issued an emergency order for all U.S. airlines to ground all Boeing
MAX aircraft. The Company immediately complied with the order and grounded all 34 MAX aircraft
in its fleet. The Company will continue to monitor the situation and any potential future accounting
implications that arise. The most significant financial impacts of this grounding to the Company thus
far have been lost revenues, operating income, and operating cash flows, and delayed capital
expenditures, directly associated with its grounded MAX fleet and other new aircraft that have not
been able to be delivered. In July 2019, the Boeing Company announced a $4.9 billion after-tax charge
for “potential concessions and other considerations to customers for disruptions related to the 737
MAX grounding.” In January 2020, the Boeing Company announced an additional pre-tax charge of
$2.6 billion related to “estimated potential concessions and other considerations to customers related to
the 737 MAX grounding.”

During fourth quarter 2019, the Company entered into a Memorandum of Understanding with Boeing
to compensate Southwest for financial damages incurred during 2019 related to the grounding of the
MAX. The terms of the agreement are confidential, but are intended to provide for a substantial portion
of the Company’s financial damages associated with both the 34 MAX aircraft that were grounded as
of March 13, 2019, as well as the 41 additional MAX aircraft the Company was scheduled to receive
(28 owned MAX from Boeing and 13 leased MAX from third parties) from March 13, 2019 through
December 31, 2019. In accordance with applicable accounting principles, the Company will account
for substantially all of the proceeds received from Boeing as a reduction in cost basis spread across
both the existing 31 owned MAX in the Company’s fleet, plus the Company’s future firm aircraft
deliveries as of the date of the agreement. No material financial impacts of the agreement were realized
in the Company’s earnings during fourth quarter or the year ended December 31, 2019. Amounts
received in cash from Boeing are reflected within Investing Activities in the Consolidated Statement of
Cash Flows for the year ended December 31, 2019. Amounts agreed to but not yet received are
recorded within Accounts and Other Receivables and are also reflected as a Supplemental Noncash
Transaction in the Consolidated Statement of Cash Flows. Approximately $86 million of the amount
agreed to has been allocated as a reduction of Flight equipment (for aircraft already in the Company’s
MAX fleet) and the remainder has been reflected as a reduction of Deposits on flight equipment
purchase contracts, within the Consolidated Balance Sheet as of December 31, 2019.

125

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, 2019 and 2018,
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, 2019, 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, 2019 and 2018, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended December 31, 2019, 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, 2019, 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 3, 2020 expressed an unqualified opinion thereon.

Adoption of New Accounting Standards

As discussed in Note 2 to the consolidated financial statements, the Company changed its method of
accounting for its leases in 2019 due to the modified retrospective adoption of ASU 2016-02, Leases
(Topic 842), and the Company changed its method of accounting for financial derivative instruments in
2018 due to the modified retrospective adoption of ASU 2017-12, Targeted Improvements to
Accounting for Hedging Activities.

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.

Critical audit matters

The critical audit matters communicated below are matters arising from the current period audit of the
financial statements that were communicated or required to be communicated to the audit committee

126

and that: (1) relate to accounts or disclosures that are material to the financial statements and
(2) involved our especially challenging, subjective, or complex judgments. The communication of
critical audit matters does not alter in any way our opinion on the financial statements, taken as a
whole, and we are not, by communicating the critical audit matters below, providing separate opinions
on the critical audit matters or on the accounts or disclosures to which they relate.

Description of
the Matter

Southwest Rapid Rewards loyalty program spoilage

As explained in Notes 1 and 5 to the consolidated financial statements, the Company recognizes
revenue associated with award flights taken by Southwest Rapid Rewards loyalty program
members upon the redemption of loyalty points. The Company estimates the portion of loyalty
points that will not be redeemed (spoilage) in estimating the revenue to recognize each period.
The Company uses a predictive statistical model that considers the member’s past behavior, as
well as several other factors related to the member’s account that management believes are
expected to be indicative of the likelihood of future point redemption, to estimate the amount of
spoilage. These factors include, but are not limited to, tenure with the program, points accrued
in the program, and points redeemed in the program.

Auditing the Company’s estimate of spoilage for loyalty points requires significant judgment
due to the complexity of the predictive statistical model and the subjectivity related to the
assumptions that are used by management to estimate the likelihood of a member’s future point
redemption. Additionally, due to the magnitude of the Company’s liability for loyalty benefits,
changes in customer behavior and/or expected future redemption patterns could result in
significant variations in the amount of passenger revenue recognized.

How We
Addressed the
Matter in Our
Audit

We obtained an understanding, evaluated the design and tested the operating effectiveness of
controls over management’s determination of the spoilage estimate, including the statistical
model, significant underlying assumptions selected by management and the data inputs used in
the statistical model.

Description of
the Matter

To test the Company’s use of the predictive statistical model, among other procedures, we
involved our internal specialists to assist in our evaluation of the Company’s methodology and
the predictive factors described above. Our internal specialists also performed corroborative
calculations of the resulting estimated spoilage rates. Additionally, we tested the completeness
and accuracy of the data used in the predictive statistical model.

Valuation of financial derivative instruments

As explained in Notes 1, 10, and 11 to the financial statements, the Company’s fuel derivative
instruments consist of over-the-counter contracts, which are not traded on a public exchange
and require the Company to estimate their fair values. The fair value of fuel derivative option
contracts are determined using option pricing models with inputs about commodity prices,
strike prices, risk-free interest rates, term 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 fair value measures.
The Company analyzes volatility information for reasonableness and compares it to similar
information received from external sources. The fair value of the option contracts considers
both the intrinsic value and any remaining time value associated with the derivatives that have
not settled. Auditing the fair value measurement of fuel option contracts is complex and
requires significant judgment in order to evaluate the application of the option pricing model
and evaluating the unobservable input of implied volatility used in the fair value measurement
of the Company’s fuel option contracts.

127

How We
Addressed
the Matter
in Our
Audit

We obtained an understanding, evaluated the design and tested the operating effectiveness of
controls over the Company’s process to calculate the fair value of fuel option derivative contracts,
including controls that related to the volatility input.

Among other procedures, we involved internal valuation specialists to assist in the testing of the
significant inputs in the option pricing model by comparing the market data inputs, including
volatility, to external sources. With the support of our specialists, we also tested the application of
the option pricing model by performing independent
and the computational accuracy of
corroborative calculations. Additionally, we compared the Company’s fuel option contract
valuations to the counterparty valuations, which were independently obtained as part of our audit
procedures.

/s/ Ernst & Young LLP

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

Dallas, Texas
February 3, 2020

128

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,
2019, 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, 2019, 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, 2019 and 2018, 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, 2019,
and the related notes (collectively referred to as the “financial statements”) of the Company and our
report dated February 3, 2020 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

129

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 3, 2020

130

QUARTERLY FINANCIAL DATA

(unaudited)

(in millions except per share amounts)

March 31

Three months ended
Sept. 30
June 30

Dec. 31

2019

2018

Operating revenues

Operating income

Income before income taxes

Net income

Net income per share, basic

Net income per share, diluted

Operating revenues

Operating income

Income before income taxes

Net income

Net income per share, basic

Net income per share, diluted

$

5,149

$

5,909

$

5,639

$

5,729

505

504

387

0.70

0.70

968

968

741

1.37

1.37

819

819

659

1.24

1.23

665

666

514(a)

0.98(a)

0.98(a)

March 31

June 30

Sept. 30

Dec. 31

$

4,944

$

5,742

$

5,575

$

5,704

616

602

463

0.79

0.79

972

960

733

1.27

1.27

798

786

615

1.08

1.08

820

817

654

1.17

1.17

(a) In addition to the ongoing impact of the Boeing 737 MAX aircraft (“MAX”) grounding that impacted all four
quarters of 2019, fourth quarter 2019 also included the impact of the pre-tax $124 million discretionary, special
profitsharing award accrual authorized by the Company’s Board of Directors during fourth quarter 2019 for
compensation received from Boeing related to the Company’s estimated 2019 financial damages related to the
grounding of the Boeing 737 MAX. See Note 16 to the Consolidated Financial Statements for further information
on the MAX groundings. The impact of this accrual resulted in a decrease to Net income of approximately
$97 million and reduced Basic and Diluted net income per share by approximately $.18 for the fourth quarter
2019.

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

131

effectiveness of the Company’s disclosure controls and procedures as of December 31, 2019. 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, 2019, at the
reasonable assurance level.

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, 2019. 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, 2019, 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 an attestation 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, 2019, that have materially affected, or are reasonably likely to materially
affect, the Company’s internal control over financial reporting.

Item 9B.

Other Information

None.

132

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 2020 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 “Information about
our Executive Officers” in Part I of this Form 10-K and is incorporated herein by reference.

Section 16(a) Compliance

If applicable, the information required by this Item 10 regarding compliance with Section 16(a) of the
Exchange Act will be set forth under the heading “Delinquent Section 16(a) Reports” in the Proxy
Statement for the Company’s 2020 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
2020 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 2020
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 2020 Annual Meeting of
Shareholders and is incorporated herein by reference.

133

Securities Authorized for Issuance under Equity Compensation Plans

The following table provides information as of December 31, 2019, regarding compensation plans
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)

1,545,172 (1) $

— (2)

27,426,634 (3)

1,800

1,546,972

$

$

9.00

— (2)

—

27,426,634

Plan Category

Equity Compensation Plans
Approved by Security Holders
Equity Compensation Plans not
Approved by Security Holders

Total

(1) Restricted share units settleable in shares of the Company’s common stock.
(2) Restricted share units discussed in footnote (1) above do not have a weighted average exercise price

because the restricted share units do not have an exercise price upon vesting.

(3) Of

these shares,

issuance under

(i) 7,348,212 shares remained available for

the Company’s
tax-qualified employee stock purchase plan; and (ii) 20,078,422 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
1,152,529 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 2020
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 2020 Annual Meeting of
Shareholders and is incorporated herein by reference.

for

134

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

4.5

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)).

Description of Common Stock.

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.

135

10.1

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 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

136

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 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

137

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));
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

138

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 (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

139

(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)); Supplemental Agreement No. 104
(incorporated by reference to Exhibit 10.1 to the Company’s Quarterly
Report on Form 10-Q for the quarter ended March 31, 2018 (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)).

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

140

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

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 (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

141

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)); Supplemental Agreement No. 8
(incorporated by reference to Exhibit 10.16(a) to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2017 (File
No. 1-7259)); Supplemental Agreement No. 9 (incorporated by reference
to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended March 31, 2018 (File No. 1-7259)); Supplemental
Agreement No. 10 (incorporated by reference to Exhibit 10.3 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended
March 31, 2018 (File No. 1-7259)); Supplemental Letter Agreement No.
03729-LA-1808800 (incorporated by reference to Exhibit 10.16(a) to the
Company’s Annual Report on Form 10-K for the year ended
December 31, 2018 (File No. 1-7259)) (1)

Supplemental Agreement No. 11 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)

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)

XBRL Instance Document - The instance document does not appear in the
Interactive Data File because its XBRL tags are embedded within the
Inline XBRL document.

Inline XBRL Taxonomy Extension Schema Document.

Inline XBRL Taxonomy Extension Calculation Linkbase Document.

Inline XBRL Taxonomy Extension Definition Linkbase Document.

Inline XBRL Taxonomy Extension Label Linkbase Document.

Inline XBRL Taxonomy Extension Presentation Linkbase Document.

142

10.16 (a)

10.17

10.18

10.19

21

23

31.1

31.2

32

101.INS

101.SCH

101.CAL

101.DEF

101.LAB

101.PRE

104

Cover Page Interactive Data File (formatted as Inline XBRL and
contained in Exhibit 101).

(1) Certain confidential information contained in this agreement has been omitted because it (i) is not

material and (ii) would likely cause competitive harm to the Company if publicly disclosed.

(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.

143

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 3, 2020

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 & 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 3, 2020, 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

144

BOARD OF DIRECTORS

DAVID W. BIEGLER

GARY C. KELLY

Former 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 Director
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 DESIGNATION
COLLEEN C. BARRETT
President Emeritus
Southwest Airlines Co.

IN MEMORIAM
HERBERT D. KELLEHER
Chairman of the Board (1978-2008)
Chairman Emeritus (2008-2019)
Southwest Airlines Co.

CORPORATE INFORMATION

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

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 2020 Annual Meeting will be held as a virtual-only
meeting.
Date: Thursday, May 21, 2020
Time: 10:00 a.m. Central Daylight Time
Virtual Shareholder Meeting:
www.virtualshareholdermeeting.com/LUV2020

2019 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 eleventh 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 2019 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 network plans and expectations, including factors and
assumptions underlying the Company’s plans and expectations, in particular COVID-19; (ii) the Company’s financial outlook,
plans, strategies, goals, and projected results of operations, including factors and assumptions underlying the Company’s
projections, in particular COVID-19; and (iii) the Company’s plans, expectations, and priorities in connection with the return
of the MAX to service. 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) the impact of fears or actual outbreaks of disease or pandemics, changes in consumer behavior, economic
conditions, governmental actions, extreme or severe weather and natural disasters, fears of terrorism or war, actions of
competitors, fuel prices, and other factors beyond the Company’s control, on consumer behavior and the Company’s results of
operations and business decisions, plans, strategies, and results; (ii) the Company’s dependence on Boeing and the FAA with
respect to the timing of the return of the 737 MAX to service and any related changes to the Company’s operational and
financial assumptions and decisions; (iii) 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; (iv) the impact of
labor matters on the Company’s business decisions, plans, and strategies; and (v) 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, 2019.