Southwest Airlines 2010 Annual Report Download

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SOUTHWEST AIRLINES CO.
2010 ANNUAL REPORT TO SHAREHOLDERS
To our Shareholders:
With 2010 in the history books, the first decade of the new century is behind
us. For the U.S. airline industry, the past ten years will forever be known as the “lost
decade”—fewer passengers, fewer flights, fewer airplanes, and fewer aviation jobs.
Faced with the worst economic recession in aviation history, a world-wide credit crisis,
and astronomical jet fuel prices, the airline industry endured billions of lost dollars and
numerous bankruptcies and liquidations. And yet, while not immune to the economic
collapse, brutal competition, and energy price volatility, Southwest Airlines prevailed.
We emerged from the worst decade in aviation history without bankruptcy, without
furloughs, without pay cuts, and without degradation of our Customer experience.
And, 2010 marked our 38th consecutive year of profitability. What a tremendous
accomplishment for the hard-working, high-spirited Employees of Southwest Airlines.
Our 2010 net income was $459 million, or $.61 per diluted share, compared to
$99 million, or $.13 per diluted share, for 2009. Each year includes special items
(primarily noncash, mark-to-market, and other items required for a portion of the
Company’s fuel hedge portfolio). Excluding special items from each year, our 2010
profit increased 285 percent to $550 million, or a record $.74 per diluted share,
compared to $143 million, or $.19 per diluted share, for 2009.
We remained financially strong with unrestricted cash and short-term
investments of $3.5 billion as of December 31, 2010. We also had a fully-available
$600 million bank line-of-credit. Our debt-to-total capital was approximately
40 percent, and we remained the only investment grade-rated U.S. airline.
We began 2010 amid escalating fuel prices and a fragile domestic economy.
Last year at this time, I said that our 2010 net income might improve from 2009’s
meager results. Clearly, our 2010 results were much stronger than we anticipated.
Overall demand for our low fares and high quality Customer Service strengthened. In
the second half of the year, business travel rebounded considerably. We consistently
achieved record monthly load factors, ending the year with a record annual load factor
of 79.3 percent. And, boosted by our Bags Fly Free and No Change Fees, our share
of the domestic market grew to 21 percent as the largest domestic carrier in terms of
originating passengers boarded, compared to 20 percent a year ago (based on third
quarter 2010 and third quarter 2009 data, respectively, from the U.S. Department of
Transportation (DOT)).

Table of contents

  • Page 1
    ... our Bags Fly Free and No Change Fees, our share of the domestic market grew to 21 percent as the largest domestic carrier in terms of originating passengers boarded, compared to 20 percent a year ago (based on third quarter 2010 and third quarter 2009 data, respectively, from the U.S. Department of...

  • Page 2
    ...no blackout dates or seat restrictions. Our goal with the new program is to drive hundreds of millions in incremental annual revenues by winning new Customers, increasing loyalty from current Customers, increasing usage of our co-branded VISA credit card, and strengthening our hotel, rental car, and...

  • Page 3
    ... is about growth-more low fares, more Customers, more destinations, more aircraft, more jobs, and more profits. Beyond the AirTran acquisition, until earnings are expected to generate sufficient returns on capital, we plan to keep our fleet growth relatively modest. In addition, currently, we do not...

  • Page 4
    ... have proven their ability to successfully implement change. We remain among the top low-cost producers of major airlines. We have affirmed our position as America's Low-Fare Leader by not nickel-and-diming our Customers through our successful Bags Fly Free and No Change Fees campaigns. We hold the...

  • Page 5
    ... reference to the closing sale price of the common stock on the New York Stock Exchange on June 30, 2010, the last trading day of the registrant's most recently completed second fiscal quarter. Number of shares of common stock outstanding as of the close of business on February 2, 2011: 747,563,467...

  • Page 6
    ...Southwest Airlines Co. Consolidated Statement of Cash Flows ...Notes to Consolidated Financial Statements ...Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure ...Item 9A. Controls and Procedures ...Item 9B. Other Information ...PART III Item 10. Directors...

  • Page 7
    ... I Item 1. Business Company Overview Southwest Airlines Co. (the "Company" or "Southwest") is a major passenger airline that provides scheduled air transportation in the United States. The Company commenced service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities: Dallas...

  • Page 8
    .... The Company's current use of a single aircraft type, the Boeing 737, enables it to simplify scheduling, maintenance, flight operations, and training activities. The Company's point-to-point route structure includes service to and from many secondary or downtown airports such as Dallas Love Field...

  • Page 9
    ... the demand for air travel, especially from higher yield customers. In response, the Company developed short-term and long-term initiatives designed to increase unit revenues, improve the Customer experience, and control costs. During 2010, despite a moderate improvement in the U.S. economic...

  • Page 10
    ... future travel on Southwest Airlines. Business Select fares also include additional perks such as priority boarding, bonus frequent flyer credit, priority security access in select airports, and one complimentary adult beverage (for Customers of legal drinking age). Aggressive Marketing Campaign...

  • Page 11
    ... $10 to the price of a one-way fare (priority boarding privileges are already included in the purchase of a Business Select fare and are a benefit of being an A-List frequent flyer - see "Rapid Rewards Frequent Flyer Program" below). The Company's PAWS offering allows Customers to bring small cats...

  • Page 12
    ... fare, allows for thru-checking of luggage, and blends the airlines' flight schedules. Inflight Internet Connectivity In 2010, the Company entered into an equipment purchase contract with Row 44 to allow for an inflight satellite (broadband) WiFi offering, rather than the air-to-ground service used...

  • Page 13
    ...by using the Southwest Airlines Rapid Rewards Visa Signature Card. As discussed further below under "New Program," in March 2011, the Company plans to launch a new Rapid Rewards program. The Company's current Rapid Rewards frequent flyer program offers three different types of travel awards ("Awards...

  • Page 14
    ...dates. Priority Boarding Privileges. Rapid Rewards Members who fly at least 32 qualifying one-way flights within a 12-month period 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...

  • Page 15
    ... cars, gift cards, event tickets, and more. In addition to earning points for revenue flights, Rapid Rewards Members will have the ability to purchase points. The new frequent flyer program also features enhanced A-List and Companion Pass programs for the most active members, and adds a new level...

  • Page 16
    ... denied boarding compensation airlines must pay to passengers bumped from flights from $800 to $1,300; (ii) allowing passengers to make and cancel reservations within 24 hours without penalty; and (iii) strengthening the DOT's enforcement policies concerning air transportation price advertising...

  • Page 17
    ... with aircraft having 56 or fewer passenger seats, nor did it restrict the Company's intrastate Texas flights or its air service to or from points other than Dallas Love Field. In 2006, the Company entered into an agreement with the City of Dallas, the City of Fort Worth, American Airlines, Inc...

  • Page 18
    ... regulating the types of liquid items that can be carried onboard aircraft. In 2009, the TSA introduced its Secure Flight program. Secure Flight 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...

  • Page 19
    ... These factors can reduce the pricing power of the airline industry as a whole. In addition, the increased availability of fare information on the Internet allows travelers to easily compare fares and identify competitor promotions and discounts. The Company believes its low cost operating structure...

  • Page 20
    ... fees for items such as first and second checked bags, flight changes, seat selection, fuel surcharges, snacks, curb-side checkin, and telephone reservations. The Company also competes based on markets served, flight schedules, and frequent flyer opportunities. Some major U.S. airlines have...

  • Page 21
    ... 31, 2010, the Company had 34,901 active fulltime equivalent Employees, consisting of 15,069 flight, 2,464 maintenance, 15,205 ground, Customer, and fleet service, and 2,163 management, accounting, marketing, and clerical personnel. The Railway Labor Act establishes the right of airline employees to...

  • Page 22
    Additional Information About the Company The Company was incorporated in Texas in 1967. The following documents are available free of charge through the Company's website, www.southwest.com: the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and ...

  • Page 23
    ...; (iii) changes in governmental policies on fuel production, transportation, and marketing; and (iv) changes in exchange rates. Likewise, the Company's ability to react to fuel price volatility can be affected by factors outside of its control. For example, the Company's profitability is affected in...

  • Page 24
    ... many factors could 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 the Company to offer low fares, drive traffic volume, and grow market share. The Company's low cost structure has...

  • Page 25
    ... ledger, accounts payable, accounts receivable, payroll, benefits, cash management, and fixed asset systems. The Company has also invested in significant technology changes necessary to support its new Rapid Rewards frequent flyer program, enhanced southwest.com website, and WiFi implementation. In...

  • Page 26
    ... industry revenue and the volatile fuel price environment. While the Company's credit rating is "investment grade," factors such as future unfavorable economic conditions, a significant decline in demand for air travel, or instability of the credit and capital markets could result in future pressure...

  • Page 27
    ... increase the Company's costs. The airline industry is affected by many conditions that are beyond its control, which can impact the Company's business strategies. In addition to the unpredictable economic conditions and fuel costs discussed above, the Company, like the airline industry in general...

  • Page 28
    ..., pricing, routes, scheduling, Customer Service, cost structure, and codesharing and similar activities. Risk Factors Related to the Company's Proposed Acquisition of AirTran On September 26, 2010, the Company entered into a merger agreement providing for the Company's acquisition of AirTran. Set...

  • Page 29
    ... stock price and the future business and financial results of the Company. If the merger is not completed, the ongoing business of the Company may be adversely affected, and the Company will be subject to several risks, including the following: • having to pay certain costs relating to the merger...

  • Page 30
    ..., high quality Customer Service; and • potential unknown liabilities, liabilities that are significantly larger than the Company currently anticipates and unforeseen increased expenses or delays associated with the merger, including one-time cash costs to integrate AirTran's business that may...

  • Page 31
    ... debt service payments and operating lease payments, thereby reducing the availability of the Company's cash flow to fund working capital, capital expenditures, acquisitions, and other general corporate purposes; • limit the Company's ability to obtain additional financing for aircraft purchases...

  • Page 32
    ... if it does not effectively manage its expanded operations following the merger. Following the merger, the size of the business of the Company will increase significantly beyond the current size of either the Company's or AirTran's businesses. The Company's future success depends, in part, upon its...

  • Page 33
    ... the merger and the integration of AirTran's business. There are a large number of processes, policies, procedures, operations, technologies and systems that must be integrated, including purchasing, accounting and finance, sales, payroll, pricing, revenue management, reservations, frequent flyer...

  • Page 34
    ... the Company's financial results. Applicable acquisition accounting rules require that to the extent the purchase price exceeds the net fair value of AirTran's tangible and intangible assets and liabilities, the Company would record such excess as goodwill on its Consolidated Balance Sheet. Goodwill...

  • Page 35
    ... Company is evaluating substituting 737-800s in lieu of 737-700 firm orders currently scheduled for 2013 through 2016. Ground Facilities and Services The Company leases terminal passenger service facilities at each of the airports it serves, to which it has made various leasehold improvements. The...

  • Page 36
    ..., AirTran's Chairman, President and Chief Executive Officer, Arne G. Haak, AirTran's Senior Vice President of Finance, Treasurer and Chief Financial Officer, each member of the AirTran board of directors, the Company, and Guadalupe Holdings Corp. (" Merger Sub"). The Leonelli complaint generally...

  • Page 37
    ... of its currently ongoing legal proceedings or the outcome of any proposed adjustments presented to date by the IRS, individually or collectively, will have a material adverse effect on the Company's financial condition, results of operations, or cash flow. Item 4. None. (Removed and Reserved) 31

  • Page 38
    ...2011. Name Position Age Gary C. Kelly ...Robert E. Jordan ...Ron Ricks ...Michael G. Van de Ven ...Jeff Lamb ...Davis S. Ridley ...Laura H. Wright ... Chairman of the Board, President, & Chief Executive Officer Executive Vice President Strategy & Planning Executive Vice President Corporate Services...

  • Page 39
    ... has served as the Company's Senior Vice President Finance & Chief Financial Officer since July 2004. Ms. Wright also served as Vice President Finance & Treasurer from June 2001 to July 2004, Treasurer from 1998 to 2001, Assistant Treasurer from 1995 to 1998, and Director Corporate Finance from 1990...

  • Page 40
    ... Securities The Company's common stock is listed on the New York Stock Exchange and is traded under the symbol "LUV." The following table shows, for the periods indicated, the high and low sales prices per share of the Company's common stock, as reported on the NYSE Composite Tape, and the cash...

  • Page 41
    ... not necessarily indicative of future stock price performance. COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN AMONG SOUTHWEST AIRLINES CO., S&P 500 INDEX, AND AMEX AIRLINE INDEX $200 Total Cumulative Return - Dollars $150 $100 $50 Southwest Airlines Co. S&P 500 AMEX Airline $0 12/31/05 12/31...

  • Page 42
    ... the Company's Consolidated Financial Statements. This information should be read in conjunction with the Consolidated Financial Statements and related notes thereto included elsewhere herein. 2010 Year ended December 31, 2009 2008 2007 (in millions, except per share amounts) 2006 Financial Data...

  • Page 43
    Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Reconciliation of Reported Amounts to non-GAAP Financial Measures (unaudited) (in millions, except per share and per-ASM amounts) Year Ended December 31, 2010 2009 Percent Change Operating income (loss),...

  • Page 44
    ...income was achieved through better revenue management techniques and strategies, improving economic conditions which led to higher demand for air travel, capacity restraint and reallocation by both the Company and the entire airline industry, fare increases, and targeted marketing campaigns designed...

  • Page 45
    ... cars, gift cards, event tickets, and more. In addition to earning points for revenue flights, Rapid Rewards Members will have the ability to purchase points. The new frequent flyer program also features enhanced A-List and Companion Pass programs for the most active members, and adds a new level...

  • Page 46
    ...Customer service, high quality low-cost operations, all-Boeing fleets, solid low-fare brands, and strong Employee cultures. The Company believes its Bags Fly Free and No Change Fees campaigns, its new frequent flyer program, continued schedule optimization, and other revenue management efforts offer...

  • Page 47
    ... management techniques and strategies, improving economic conditions which led to higher demand for air travel versus 2009, including a new and improved website at www.southwest.com, capacity restraint and reallocation by both the Company and the entire airline industry, fare increases, and targeted...

  • Page 48
    ... based on profits that exclude the unrealized gains and/or losses the Company records for its fuel hedging program. See Note 10 to the Consolidated Financial Statements for further information on fuel hedging. Salaries, wages, and benefits expense per-ASM was 6.2 percent higher than 2009, primarily...

  • Page 49
    ... price per gallon for jet fuel, including the impact of fuel derivatives used in hedging, and including related taxes. As a result of the Company's fuel hedging program and inclusive of the impact of the accounting guidance for derivatives and hedging, the Company recognized net losses totaling...

  • Page 50
    ... to the Consolidated Financial Statements for further information. Based on its fuel hedge portfolio and market prices (as of January 18, 2011), the Company estimates its economic fuel costs, including fuel taxes, for first quarter 2011 will be approximately $2.80 per gallon. Assuming no changes to...

  • Page 51
    ... costs (such as credit card interchange fees) associated with the 16.1 percent increase in Passenger revenues. Excluding any first quarter 2011 costs incurred in connection with planning for the integration and transition related to the Company's anticipated 2011 acquisition of AirTran, the Company...

  • Page 52
    ...miles or RPMs), as the percentage of full fare bookings was down versus 2008 and the Company offered more fare sales and discounted seats in response to the decline in demand for air travel amid domestic economic conditions. However, as a result of the Company's fare discounting efforts and a number...

  • Page 53
    ... based on profits that exclude the unrealized gains and/ or losses the Company records in its fuel hedging program. See Note 10 to the Consolidated Financial Statements for further information on fuel hedging. Salaries, wages, and benefits expense per-ASM was 9.6 percent higher than 2008, primarily...

  • Page 54
    ...majority of the increase in engine costs related to the Company's 737-700 aircraft, which for the second half of 2008 and all of 2009 were accounted for under an agreement with GE Engines Services, Inc. (GE Engines) that provides for engine repairs to be done on a rate per flight hour basis. For the...

  • Page 55
    ... Consolidated Financial Statements for further information on the Company's hedging activities. Income taxes The provision for income taxes, as a percentage of income before taxes, increased to 39.6 percent in 2009 from 35.9 percent in 2008. The lower 2008 rate included a $12 million ($.01 per share...

  • Page 56
    ...further information on the Company's hedging program and counterparty deposits, see Note 10 to the Consolidated Financial Statements and "Item 7A. Quantitative and Qualitative Disclosures about Market Risk," respectively. Operating cash generated is used primarily to finance aircraft-related capital...

  • Page 57
    ...value of the Company's unencumbered aircraft totaled approximately $6.6 billion. During 2008, the City of Dallas approved the Love Field Modernization Program (LFMP), a project to reconstruct Dallas Love Field (Airport) with modern, convenient air travel facilities. Pursuant to a Program Development...

  • Page 58
    ... impact on the Company's capital resources or financial position. See Note 4 to the Consolidated Financial Statements for further information and accounting requirements related to the LFMP. Critical Accounting Policies and Estimates The Company's Consolidated Financial Statements have been prepared...

  • Page 59
    ..., or .2 percent, change in Passenger revenues recognized for 2010. Events and circumstances outside of historical fare sale activity or historical Customer travel patterns can result in actual refunds, exchanges, or forfeited tickets differing significantly from estimates. The Company evaluates its...

  • Page 60
    ... third quarter 2010, the Company changed the estimated residual values of its entire remaining fleet of owned 737-300 and 737-500 aircraft. Based on current and expected future market conditions related to these aircraft, the Company reduced the residual values of these aircraft from approximately...

  • Page 61
    .... Market price changes can be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity, political agendas, value of the U.S. dollar, and general economic conditions, among other items. The financial derivative instruments utilized by the Company primarily...

  • Page 62
    ... in the Consolidated Statement of Income in the period of the change. Ineffectiveness is inherent in hedging jet fuel with derivative positions based in other crude oil related commodities, especially given the recent volatility in the prices of refined products. Due to the volatility in markets for...

  • Page 63
    ...in the Consolidated Balance Sheet. In prior periods, due to the auction process which took place every 30-35 days for most securities, quoted market prices were readily available, which would have qualified as Level 1. However, due to events in credit markets beginning during first quarter 2008, the...

  • Page 64
    ... flyer program population for marketing/ solicitation purposes, use of the Company's logo on co-branded credit cards, and other trademarks, designs, images, etc. of the Company for use in marketing materials. This apportionment of value between free travel and marketing services is estimated based...

  • Page 65
    ... used to manage its fuel hedging program. In addition, 16 of the leased aircraft in the Company's fleet have lease payments that fluctuate based in part on changes in market interest rates. The Company purchases jet fuel at prevailing market prices, but seeks to manage market risk through execution...

  • Page 66
    ...the Consolidated Balance Sheet. Due to the terms of the Company's current fuel hedging agreements with counterparties and the types of derivatives held, in the Company's judgment, it does not have significant additional exposure to future cash collateral requirements. As an example, if market prices...

  • Page 67
    ... 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 assets are aircraft, which are long-lived. The Company's strategy...

  • Page 68
    ...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, and other highly rated financial instruments, depending on market conditions and operating...

  • Page 69
    ... 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, although the processor generally forwards the cash related to the purchase to the Company soon after...

  • Page 70
    Item 8. Financial Statements and Supplementary Data SOUTHWEST AIRLINES CO. CONSOLIDATED BALANCE SHEET (In millions, except share data) 2010 DECEMBER 31, 2009 (As adjusted-Note 3) ASSETS Current assets: Cash and cash equivalents ...Short-term investments ...Accounts and other receivables ......

  • Page 71
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF INCOME (In millions, except per share amounts) YEARS ENDED DECEMBER 31, 2010 2009 2008 OPERATING REVENUES: Passenger ...Freight ...Other ...Total operating revenues ...OPERATING EXPENSES: Salaries, wages, and benefits ...Fuel and oil ...Maintenance ...

  • Page 72
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2010, 2009, AND 2008 Retained Accumulated Capital in earnings other Common excess of (as adjusted- comprehensive Treasury Stock par value Note 3) income (loss) stock (In millions, except per share amounts...

  • Page 73
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, (In millions) 2010 2009 2008 CASH FLOWS FROM OPERATING ACTIVITIES: Net income ...Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization ...Unrealized loss on ...

  • Page 74
    ... TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2010 1. Summary of Significant Accounting Policies Basis of Presentation Southwest Airlines Co. (the "Company" or "Southwest") is a major domestic airline that provides point-to-point, low-fare service. The Consolidated Financial Statements include...

  • Page 75
    ... of flight equipment expendable parts, materials, aircraft fuel, 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, 2010, 2009...

  • Page 76
    ...its Rapid Rewards frequent flyer program. Funds received from the sale of flight segment credits are accounted for using the residual method. Under this method, the Company has determined the portion of funds received for sale of flight segment credits that relate to free travel, currently estimated...

  • Page 77
    ...Changes in certain assets and liabilities. See Note 10 for further information on hedge accounting and financial derivative instruments. The Company classifies its cash collateral provided to or held from counterparties in a "net" presentation on the Consolidated Balance Sheet against the fair value...

  • Page 78
    ... 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...

  • Page 79
    ...by the boards of directors of the respective parties, if the Merger is completed, each outstanding share of AirTran common stock will be converted into the right to receive 0.321 shares of Southwest Airlines Co. common stock, which exchange ratio may be adjusted as discussed below, and $3.75 in cash...

  • Page 80
    ... cost method of accounting for frequent flyer benefits. Under the terms of the Company's current frequent flyer program, the term partial awards refers to credits earned by Customers for flights taken that in the aggregate total less than 16, the number required to earn an award for free travel...

  • Page 81
    ...the sale of frequent flyer credits to one of its business partners. Specifically, the Company applies the residual method, which is currently allowed, but which will be prohibited under ASU No. 2009-13. ASU No. 2009-13 will be effective for annual reporting periods beginning January 1, 2011; however...

  • Page 82
    ... final purchase price of the aircraft and are reclassified as Flight equipment. During 2008, the City of Dallas approved the Love Field Modernization Program (LFMP), a project to reconstruct Dallas Love Field (Airport) with modern, convenient air travel facilities. Pursuant to a Program Development...

  • Page 83
    5. Accrued Liabilities (In millions) 2010 2009 (As adjusted-Note 3) Retirement plans (Note 16) ...Aircraft rentals ...Vacation pay ...Advances and deposits (Note 10) ...Fuel derivative contracts ...Workers compensation ...Other ...Accrued liabilities ...6. Revolving Credit Facility and Short-Term ...

  • Page 84
    ... notes for general corporate purposes, including using a portion of the proceeds to provide cash collateral for some of the Company's fuel hedging arrangements. During fourth quarter 2009, the Company entered into a fixed-to-floating interest rate swap to convert the interest on these secured notes...

  • Page 85
    ... debt balance. The ineffectiveness of the hedge transaction was immaterial. During December 2006, the Company issued $300 million senior unsecured notes due 2016. The notes bear interest at 5.75 percent, payable semi-annually in arrears, with the first payment made on June 15, 2007. The Company used...

  • Page 86
    ... obligations to which they relate are reflected as liabilities in the Consolidated Balance Sheet. Outstanding letters of credit totaled $234 million at December 31, 2010. The net book value of the assets pledged as collateral for the Company's secured borrowings, primarily aircraft and engines, was...

  • Page 87
    ... 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. Because jet fuel is not widely traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel...

  • Page 88
    .... Generally, utilizing the hedge accounting, all periodic changes in fair value of the derivatives designated as hedges that are considered to be effective, are recorded in AOCI until the underlying jet fuel is consumed. See Note 13 for further information on AOCI. The Company is exposed to the risk...

  • Page 89
    ... 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 derivatives are classified as operating cash flows in the Consolidated Statement of Cash Flows. The following table presents the location of all assets...

  • Page 90
    ... with fuel derivative instruments and hedging activities in its Consolidated Balance Sheet: (in millions) Balance Sheet Location December 31, 2010 2009 Cash collateral deposits provided to counterparty-noncurrent ... Cash collateral deposits provided to counterparty-current ...Cash collateral...

  • Page 91
    ... ineffectiveness associated with these hedges for 2010 and 2009 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 an asset of $73 million...

  • Page 92
    ... in the past. To manage credit risk, the Company selects and will periodically review counterparties based on credit ratings, limits its exposure to a single counterparty, and monitors the market position of the fuel hedging program and its relative market position with each counterparty. At...

  • Page 93
    ... as Level 2. The Company determines the value of option contracts utilizing a standard 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 financial institutions that trade...

  • Page 94
    ... accurate information available for the types of derivative contracts it holds. The Company's investments associated with its excess benefit plan consist of mutual funds that are publicly traded and for which market prices are readily available. This plan is a deferred compensation plan designed to...

  • Page 95
    ... 31, 2010 and 2009: Fair Value Measurements at Reporting Date Using Quoted Prices in Significant Significant Active Markets for Other Unobservable Identical Assets Observable Inputs Inputs (Level 1) (Level 2) (Level 3) (in millions) Description December 31, 2010 Assets Cash equivalents ...Short...

  • Page 96
    ... assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2010 and 2009: Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Auction Fuel Rate Other Derivatives Securities Securities Total...

  • Page 97
    ... Value Measurements Using Significant Unobservable Inputs (Level 3) Auction Fuel Rate Other Derivatives Securities (a) Securities Total Balance at December 31, 2008 ...Total gains or (losses) (realized or unrealized) Included in earnings ...Included in other comprehensive income ...Purchases and...

  • Page 98
    ... for 2010, 2009, and 2008, is shown below: Interest rate derivatives Accumulated other comprehensive income (loss) (In millions) Fuel hedge derivatives Other Balance at December 31, 2008 ...2009 changes in fair value ...Reclassification to earnings ...Balance at December 31, 2009 ...2010 changes...

  • Page 99
    ... Company's Board of Directors, and plans related to employment contracts with the Chairman Emeritus of the Company. The Company accounts for share-based compensation utilizing fair value. The Consolidated Statement of Income for the years ended December 31, 2010, 2009, and 2008 reflects share-based...

  • Page 100
    ... basis over the requisite service period for the entire award. None of the Company's grants include performancebased or market-based vesting conditions, as defined. The Black-Scholes option valuation model was developed for use in estimating the fair value of short-term traded options that have no...

  • Page 101
    ...11 $ 3 The total aggregate intrinsic value of options exercised for all plans during the years ended December 31, 2010, 2009, and 2008, was $4 million, $1 million, and $24 million, respectively. The total fair value of shares vesting during the years ended December 31, 2010, 2009, and 2008, was $10...

  • Page 102
    ...the Company. These shares may be issued at a price equal to 90 percent of the market value at the end of each monthly purchase period. Common Stock purchases are paid for through periodic payroll deductions. For the years ended December 31, 2010, 2009, and 2008, participants under the plan purchased...

  • Page 103
    ... status of the plan to the Company's accrued postretirement benefit cost recognized in Other non-current liabilities on the Company's Consolidated Balance Sheet at December 31, 2010 and 2009. (In millions) 2010 2009 Funded status ...Unrecognized net actuarial gain ...Unrecognized prior service cost...

  • Page 104
    ... ...Other ...Total deferred tax liabilities ...DEFERRED TAX ASSETS: Fuel derivative instruments ...Deferred gains from sale and leaseback of aircraft ...Capital and operating leases ...Accrued employee benefits ...Stock-based compensation ...State taxes ...Business partner income ...Net operating...

  • Page 105
    ... tax rate on income before income taxes differed from the federal income tax statutory rate for the following reasons: (In millions) 2010 2009 2008 Tax at statutory U.S. tax rates ...Nondeductible items ...State income taxes, net of federal benefit ...Other, net ...Total income tax provision...

  • Page 106
    Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders Southwest Airlines Co. We have audited the accompanying consolidated balance sheet of Southwest Airlines Co. as of December 31, 2010 and 2009, and the related consolidated statements of income, ...

  • Page 107
    ... balance sheet of Southwest Airlines Co. as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders' equity, and cash flows for the each of the three years in the period ended December 31, 2010 of Southwest Airlines Co. and our report dated February 7, 2011...

  • Page 108
    ... FINANCIAL DATA (unaudited) (In millions except per share amounts) THREE MONTHS ENDED March 31 June 30 Sept. 30 Dec. 31 2010 Operating revenues ...Operating income (loss) ...Income (loss) before income taxes ...Net income (loss) ...Net income (loss) per share, basic ...Net income (loss) per share...

  • Page 109
    ... 31, 2010. 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, 2010 at the reasonable assurance level. Management's Annual Report on Internal Control over...

  • Page 110
    ... headings "Compensation of Executive Officers" and "Compensation of Directors" in the Proxy Statement for the Company's 2011 Annual Meeting of Shareholders and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters...

  • Page 111
    ... "Certain Relationships and Related Transactions, and Director Independence" in the Proxy Statement for the Company's 2011 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...

  • Page 112
    ... 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: 2.1 Agreement and Plan of Merger among the Company, AirTran Holdings, Inc...

  • Page 113
    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 ...

  • Page 114
    ...incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated January 26, 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...

  • Page 115
    ... 99.1 to the Company's Current Report on Form 8-K dated May 19, 2010 (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...

  • Page 116
    ...by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 29, 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...

  • Page 117
    ... 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. 111

  • Page 118
    ... undersigned, thereunto duly authorized. SOUTHWEST AIRLINES CO. February 7, 2011 By: /s/ LAURA WRIGHT Laura Wright Senior Vice President Finance & Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons...

  • Page 119
    ... of The University of Texas M.D. Anderson Cancer Center Foundation; Compensation Committee JOHN T. MONTFORD President and Chief Executive Officer JTM Consulting, LLC-Senior Advisor for Government Relations and Global Public Policy for General Motors; Audit (Chair), Compensation, and Nominating and...

  • Page 120
    ... INFORMATION SOUTHWEST AIRLINES CO. GENERAL OFFICES P.O. Box 36611 2702 Love Field Drive Dallas, TX 75235 Telephone: 214-792-4000 FINANCIAL INFORMATION A copy of the Company's Annual Report on Form 10-K as filed with the U.S. Securities and Exchange Commission is included herein. Other financial...