Southwest Airlines 2011 Annual Report Download

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SOUTHWEST AIRLINES CO.
2011 ANNUAL REPORT TO SHAREHOLDERS
To our Shareholders:
The year 2011 was historic for Southwest Airlines. We celebrated our 40th
anniversary of providing low-fare, high quality commercial air service. We launched
an all new, industry-leading, frequent flyer program in March. We opened three new
cities: Greenville-Spartanburg, South Carolina; Charleston, South Carolina; and
Newark, New Jersey. We closed our acquisition of AirTran Airways on May 2, growing
our fleet by 140 aircraft, and extending our route network domestically and to the
Caribbean and Mexico. In December, we unveiled our fleet modernization plans,
which include an agreement with Boeing to serve as the launch customer of the
737 MAX aircraft. And, our operations improved in 2011, closing out the year with our
highest December ontime performance in 15 years.
Moreover, we reported our 39th consecutive annual profit in a year that
endured a $1.7 billion year-over-year increase in combined economic fuel costs. Our
2011 net income was $178 million, or $.23 per diluted share, including special items
(primarily noncash, mark-to-market, and other items required for a portion of the
Company’s fuel hedge portfolio, as well as costs associated with the acquisition and
integration of AirTran). Excluding special items, our 2011 profit was $330 million, or
$.43 per diluted share.
Our financial position remains strong. Our cash and short-term investments
were $3.1 billion, as of December 31, 2011, in addition to a fully-available $800 million
bank line-of-credit. Net cash provided by operations for 2011 was $1.4 billion, and
capital expenditures were $968 million, generating more than $400 million in free
cash flow. During 2011, we repurchased approximately 27.5 million shares of
common stock for approximately $225 million, pursuant to the $500 million share
repurchase program authorized by Southwest’s Board of Directors on August 5, 2011.
We also repaid $638 million in debt during 2011. As a result, our debt-to-total capital
(including aircraft leases) was approximately 47 percent as of December 31, 2011,
down from just over 50 percent after acquiring AirTran. We remain the only
investment grade-rated U.S. airline.
In last year’s letter, I mentioned that fuel was the biggest threat to our 2011
profitability. While we were pleased to produce an annual profit, fuel was the primary
driver of a disappointing decline in our profits, compared to 2010. Fortunately, we had
an outstanding record revenue performance to help blunt the impact of a more than
30 percent increase in our economic jet fuel price per gallon in 2011. For the year, our

Table of contents

  • Page 1
    ... ANNUAL REPORT TO SHAREHOLDERS To our Shareholders: The year 2011 was historic for Southwest Airlines. We celebrated our 40th anniversary of providing low-fare, high quality commercial air service. We launched an all new, industry-leading, frequent flyer program in March. We opened three new cities...

  • Page 2
    ...to increase more than $200 million in first quarter 2012, alone (based on current and forward hedged prices and as compared to first quarter 2011 combined economic fuel expense). To combat ever-rising fuel costs, we are adapting our business to drive more revenues while staying true to low fares and...

  • Page 3
    ... available seat miles comparable to combined 2011 capacity. Our network plans for this year are conservative and geared towards boosting unit revenue performance. To date, Southwest has plans for just one new city, Atlanta, which initiated service in February with 15 daily flights. AirTran currently...

  • Page 4
    ...Kelly Chairman of the Board, President, and Chief Executive Officer March 16, 2012 NOTE: Free cash flow is calculated as operating cash flows of $1.4 billion less capital expenditures of $968 million. Additional information regarding non-GAAP, including "combined," financial measures is included in...

  • Page 5
    ... Box 36611 Dallas, Texas (Address of principal executive offices) 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 Name of Each Exchange on Which Registered Common Stock ($1.00...

  • Page 6
    ... 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 ...Item 10. Item 11. Item 12. Item 13. Item 14. PART III Directors, Executive...

  • Page 7
    ...frequent, conveniently timed flights and low fares. Point-to-point service is discussed in more detail below under "Company Operations - Route Structure." On May 2, 2011, the Company acquired all of the outstanding equity of AirTran Holdings, Inc. in exchange for common stock of the Company and cash...

  • Page 8
    ... Management." Southwest's point-to-point service has also enabled it to provide its markets with frequent, conveniently timed flights and low fares. For example, Southwest currently offers 25 weekday roundtrips from Dallas Love Field to Houston Hobby, 13 weekday roundtrips from Phoenix to Las Vegas...

  • Page 9
    ... Employees. Southwest's use of a single aircraft type has allowed for simplified 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...

  • Page 10
    ...Company's fuel hedging activities 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. Fare Structure Southwest Southwest offers a relatively simple fare...

  • Page 11
    ... an upgrade of a non-Business Class fare within 24 hours of travel. Websites Southwest.com The Company's Internet website, southwest.com, is the only avenue for Southwest Customers to purchase tickets online. During 2011, southwest.com accounted for approximately 78 percent of all Southwest bookings...

  • Page 12
    ...union contracts, will allow the Company to operate aircraft and perform maintenance operations for both Southwest and AirTran aircraft; begin conversion of AirTran's fleet to the Southwest livery and continue to convert AirTran products, gates, and services to Southwest's look; launch travel booking...

  • Page 13
    ... Rapid Rewards frequent flyer program. Under the Company's new frequent flyer program, members earn points for every dollar spent instead of credits for flight segments flown. The amount of points earned is based on the fare and fare class purchased, with higher fare products (e.g., Business Select...

  • Page 14
    ..., Southwest "A-List" and "A-List Preferred" Rapid Rewards Members booking on AirTran are eligible for free Business Class upgrades, no baggage fees, and all other benefits that AirTran's A+ Rewards members enjoy. AirTran's A+ Rewards frequent flyer program offers a number of ways to earn free travel...

  • Page 15
    ... the Company. The amount of points redeemed by Southwest's members and the number of credits redeemed by AirTran's members during 2011 for items other than air travel was not material. For frequent flyer points earned by members through flight activity, the Company currently accounts for its program...

  • Page 16
    ...weight savings onboard the aircraft, while at the same time increasing the number of seats and enhancing Customer comfort. The Company plans to begin retrofitting the Southwest current fleet of Boeing 737-700s in March 2012 and anticipates the retrofit will be completed in 2013. The Company plans to...

  • Page 17
    .... The lanes allow Business Select Customers and Rapid Rewards A-List Members direct access to the front of the line at the ticket counter and/or security checkpoint. As of December 31, 2011, Fly By Priority Lane Access was available at 56 airports. SWABIZ. SWABIZ is Southwest's business travel...

  • Page 18
    .... The Company also expects to benefit from new ancillary revenue opportunities created by its All-New Rapid Rewards frequent flyer program. AirTran currently charges fees for checked baggage, carriage of pets, liquor sales, advance seat assignments, call center services, priority seat selection...

  • Page 19
    ... key business processes by implementing an integrated tool to increase efficiency, consistency, data accuracy, and cost effectiveness. In addition, the Company has invested in significant technology necessary to support its All-New Rapid Rewards frequent flyer program, enhanced southwest.com website...

  • Page 20
    ... as unfair and deceptive practices and unfair competition by air carriers, deceptive airline advertising (e.g., fare, on-time performance, schedule, and codesharing), and violations of rules concerning denied boarding compensation, ticket refunds, and baggage liability requirements. The DOT is also...

  • Page 21
    ...to flights operated with aircraft having 56 or fewer passenger seats. The Wright Amendment also did not restrict Southwest'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...

  • Page 22
    ... from the FAA of a single operating certificate that would allow the Company to operate aircraft and perform maintenance operations for both Southwest and AirTran aircraft. In December 2011, the DOT and the FAA issued a rule to amend the FAA's existing flight, duty, and rest regulations. Among...

  • Page 23
    ... an increase in the 9/11 Fee, as well as other changes to ATSA, as part of future security-related legislation. ATSA also allows the TSA to assess an Aviation Security Infrastructure Fee ("ASIF") on each airline. Southwest's ASIF liability was originally set at $26 million per year. Effective...

  • Page 24
    ...and AirTran currently compete with other airlines on a majority of their routes. In addition, the airline industry generally has low barriers to entry. Key competitive factors within the airline industry include (i) pricing and cost structure; (ii) routes, schedules, and frequent flyer programs; and...

  • Page 25
    ... of its major competitors, Southwest does not charge additional fees for items such as first and second checked bags, flight changes, seat selection, fuel surcharges, snacks, curb-side checkin, and telephone reservations. Routes, Schedules, and Frequent Flyer Programs The Company also competes based...

  • Page 26
    ... results. Employees At December 31, 2011, the Company (including AirTran) had 45,392 active fulltime equivalent Employees, consisting of 19,647 flight, 3,135 maintenance, 20,185 ground, Customer, and fleet service, and 2,425 management, accounting, marketing, and clerical personnel. The Railway...

  • Page 27
    ... 2013 Amendable March 2014 The parties have negotiated an interim collective bargaining agreement to be effective until affected AirTran Employees are transitioned to Southwest. A key aspect of the Company's integration of AirTran is integration of Employees. In the case of an airline merger...

  • Page 28
    ...representing Southwest Pilots, the Air Line Pilots Association ("ALPA"), the union representing the pilots of AirTran, and the Company reached an agreement to integrate the two Pilot groups' seniority lists. The agreement was approved by SWAPA's Board of Directors and ALPA's Master Executive Council...

  • Page 29
    ...used to stimulate traffic. The ability to increase fares can also be limited by factors such as the low-fare reputation of both Southwest and AirTran, the portion of their Customer base that purchases travel for leisure purposes, the competitive nature of the airline industry generally, and the risk...

  • Page 30
    ...accounting on the Company's results of operations are discussed in more detail under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in Note 10 to the Consolidated Financial Statements. The Company may be unable to successfully integrate AirTran's business...

  • Page 31
    Company's operating expenses during 2011. The Company's ability to control labor costs is limited by the terms of its CBAs, and increased labor costs have impacted the Company's low-cost competitive position. As discussed further under "Management's Discussion and Analysis of Financial Condition and...

  • Page 32
    ... benefits, cash management, and fixed asset systems. The Company has also invested in significant technology changes to support its All-New Rapid Rewards frequent flyer program, introduction of the Boeing 737-800 to its fleet beginning in 2012, enhanced southwest.com website, and WiFi implementation...

  • Page 33
    ...volatile fuel price environment. During 2011, the Company's credit ratings were pressured in connection with its acquisition of AirTran. 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...

  • Page 34
    ...other use of airport facilities; limitations on route authorities; actions and decisions that create difficulties in obtaining access at slot-controlled airports; changes to environmental regulations; new or increased taxes; changes to laws that affect the services that can be offered by airlines in...

  • Page 35
    ... on competitive practices; changes in laws that increase costs for safety, security, compliance, or other Customer Service standards; changes in laws that may limit or regulate the Company's ability to promote the Company's business or fares, such as the DOT's full-fare advertising rule discussed...

  • Page 36
    ... net synergies and other anticipated benefits of the acquisition; the inability to successfully maintain passenger unit revenues upon converting AirTran into the Southwest business model; the challenges associated with operating an aircraft type new to the Company, the Boeing 717; the challenges...

  • Page 37
    ..., procedures, operations, technologies, and systems that must be integrated, including reservations, frequent flyer, ticketing/distribution, maintenance, and flight operations. While the Company has assumed that a certain level of expenses will be incurred, there are many factors beyond its control...

  • Page 38
    ... for 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; and limit the Company's flexibility in planning for, or reacting to, changes in its...

  • Page 39
    ...the Company's financial results. In accordance with applicable acquisition accounting rules, the Company recorded goodwill on its Consolidated Balance Sheet to the extent the AirTran acquisition purchase price exceeded the net fair value of AirTran's tangible and intangible assets and liabilities as...

  • Page 40
    ...Item 2. Aircraft Southwest and AirTran operated a total of 698 Boeing aircraft as of December 31, 2011, of which 192 and 7 were under operating and capital leases, respectively. The following table details information on the 698 active aircraft in the Company's combined fleet as of December 31, 2011...

  • Page 41
    ... AirTran serves are leased from the appropriate airport authority. Southwest leases the land and structures on a long-term basis for its aircraft maintenance centers (located at Dallas Love Field, Houston Hobby, Phoenix Sky Harbor, and Chicago Midway), its flight training center at Dallas Love Field...

  • Page 42
    As of December 31, 2011, Southwest operated six Customer Support and Services centers. The centers located in Chicago, Albuquerque, and Oklahoma City occupy leased space. The Company owns its Houston, Phoenix, and San Antonio centers. AirTran leases office space in Atlanta for use as a reservations ...

  • Page 43
    ... 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...

  • Page 44
    ... & Chief Commercial Officer since September 2011 and as President of AirTran Airways, Inc. since May 2011. Mr. Jordan also served as Executive Vice President Strategy & Planning from May 2008 to September 2011, Executive Vice President Strategy & Technology from September 2006 to May 2008, Senior...

  • Page 45
    ... to 1998. Mr. Ridley joined the Company in 1988 as its Director of Marketing & Sales. Laura H. Wright has served as the Company's Senior Vice President Finance & Chief Financial Officer since July 2004 and has also served as its Treasurer since November 2011. Ms. Wright also served as Vice President...

  • Page 46
    ..., and Issuer Purchases of Equity 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...

  • Page 47
    ... 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 $200 Total Cumulative Return - Dollars $150 $100 $50 Southwest Airlines...

  • Page 48
    ...Equity Securities (1) (a) (b) Total number of shares purchased Average price paid per share (c) Total number of shares purchased as part of publicly announced plans or programs (d) Maximum dollar value of shares that may yet be purchased under the plans or programs Period October 1, 2011 through...

  • Page 49
    ... with the Consolidated Financial Statements and related notes thereto included elsewhere herein. This financial information includes the operations of AirTran since the May 2, 2011 acquisition date, but prior to that date only includes the operations of Southwest. 2011 2010 Year ended December...

  • Page 50
    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, 2011 2010 Percent Change Fuel and oil expense, ...

  • Page 51
    ... 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, to consistently assess the Company's operating performance on a year-over-year...

  • Page 52
    ... Chase Visa credit card holders added, and the number of frequent flyer points purchased by program members; The addition of a larger aircraft, the Boeing 737-800, to Southwest's fleet, which is scheduled to begin in first quarter 2012 and is expected to allow the Company to profitably expand to...

  • Page 53
    ...is also planning to launch booking tools in 2012 to allow Customers of both airlines to book flights on either carrier via southwest.com or airtran.com and to integrate the frequent flyer programs of the carriers. Also, in fourth quarter 2011, the Company announced that the Southwest Airlines Pilots...

  • Page 54
    ... per share, diluted). The results in each year were significantly impacted by the Company's fuel hedge program and the accounting requirements related to the derivative instruments used in the Company's hedging activities. As a result of the fuel hedges the Company had in place during 2011-including...

  • Page 55
    ...by average fares, among other factors. See Note 1 to the Consolidated Financial Statements for further information on the Company's frequent flyer program. Other revenues for AirTran for the period following the acquisition included approximately $110 million in baggage fees collected from Customers...

  • Page 56
    ... Regarding Use of Non-GAAP Financial Measures. Excluding the results of AirTran following the acquisition, Salaries, wages, and benefits expense increased by $286 million for 2011 compared to 2010. The majority of the year-over-year increase was due to the increase in Southwest's capacity and number...

  • Page 57
    ... percent increase in the Company's average fuel cost per gallon. On a consolidated basis, as a result of the Company's fuel hedging program and inclusive of accounting for derivatives and hedging, the Company recognized net losses totaling $64 million in 2011 in Fuel and oil expense relating to fuel...

  • Page 58
    ...December 31, 2011 (net of tax) Year 2012 2013 2014 2015 ... $(189) (14) 131 28 $ (44) $ (92) (91) 23 (23) $(183) Total ... Based on forward market prices and the amounts in the above table (and excluding any other subsequent changes to the fuel hedge portfolio), the Company's jet fuel costs per...

  • Page 59
    ... aircraft lease liability created as part of purchase accounting adjustments based on the estimated fair value of AirTran's Boeing 717 leases. See Note 2 to the Consolidated Financial Statements. Excluding the impact of this amortization, year-over-year expense decreased slightly on a dollar...

  • Page 60
    ...was a result of revenue-related costs and 16 percent was due to technology and consulting costs associated with projects. On a consolidated basis for first quarter 2012, the Company currently expects Other operating expenses per ASM to increase from first quarter 2011's combined results. Through the...

  • Page 61
    ... Company's effective tax rate during interim periods of 2012 may differ significantly from this full year estimate. 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 Fuel...

  • Page 62
    ...such as Southwest's co-branded Chase Visa credit card. Operating expenses Consolidated operating expenses for 2010 increased $1.0 billion, or 10.2 percent, compared to a slight increase in capacity. Historically, except for changes in the price of fuel, changes in operating expenses for airlines are...

  • Page 63
    ... 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 due to pay scale increases as a result of increased seniority and contractual rate increases...

  • Page 64
    ... 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 expenditures and...

  • Page 65
    ... in 2017. In addition to these orders from Boeing, during July 2011, the Company executed an agreement to lease five new 737-800 aircraft from a third party. These aircraft are expected to be placed into service in mid-2012 and are expected to replace older aircraft, which are currently scheduled to...

  • Page 66
    ... 31, 2011: Obligations by period (in millions) 2013 2015 Beyond 2014 2016 2016 Contractual obligations 2012 Total Long-term debt (1) ...Interest commitments - fixed (2) ...Interest commitments - floating (3) ...Operating lease commitments (4) ...Capital lease commitments ...Aircraft purchase...

  • Page 67
    ... Love Field Modernization Program (LFMP), a project to reconstruct Dallas Love Field (Airport) with modern, convenient air travel facilities. Pursuant to a Program Development Agreement (PDA) with the City of Dallas and the Love Field Airport Modernization Corporation (or LFAMC, a Texas non-profit...

  • Page 68
    ... based on historical experience over many years. Southwest and other airlines have 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 (including AirTran's) estimate...

  • Page 69
    ...up the majority of the Company's long-lived assets. Flight equipment primarily relates to the 496 Boeing 737 aircraft and 10 Boeing 717 aircraft in the Company's (including AirTran's) fleet at December 31, 2011, which are either owned or on capital lease. The remaining 114 Boeing 737 aircraft and 78...

  • Page 70
    ... to manage its risk associated with changing jet fuel prices. See "Quantitative and Qualitative Disclosures about Market Risk" for more information on these risk management activities, and see Note 10 to the Consolidated Financial Statements for more information on the Company's fuel hedging program...

  • Page 71
    ... 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 past volatility in the prices of refined products. Due to the volatility in markets for...

  • Page 72
    ...been issued, are outstanding, and are expected to be redeemed at a future date. Frequent flyer account balances include points/credits earned through flights taken, points sold to Customers, or points/credits earned through business partners participating in the Company's frequent flyer program. 66

  • Page 73
    ... time. AirTran operates its A+ Rewards frequent flyer program, which allows Customers the opportunity to earn free roundtrip travel awards or Business Class upgrades on AirTran flights. A+ Rewards credits are earned through flights, purchases made with an AirTran Airways A+ Visa card, qualifying car...

  • Page 74
    ..., upon sale, as the related marketing services are performed or provided. The vast majority of these marketing services consist of the access granted, either monthly or quarterly, to various lists of Southwest's frequent flyer members. The estimated amount that is not associated with free travel is...

  • Page 75
    ... jet fuel purchases for each year from 2012 through 2015. 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...

  • Page 76
    ... 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...

  • Page 77
    ... short-term investments, which totaled $2.3 billion, at December 31, 2011. See Notes 1 and 10 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...

  • Page 78
    ... or cash flow associated with the Company's, including AirTran'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...

  • Page 79
    As of December 31, 2011, the Company was in compliance with all credit card processing agreements. However, 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 ...

  • Page 80
    Item 8. Financial Statements and Supplementary Data SOUTHWEST AIRLINES CO. CONSOLIDATED BALANCE SHEET (in millions, except share data) DECEMBER 31, 2011 2010 ASSETS Current assets: Cash and cash equivalents ...Short-term investments ...Accounts and other receivables ...Inventories of parts and ...

  • Page 81
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF INCOME (in millions, except per share amounts) YEAR ENDED DECEMBER 31, 2011 2010 2009 OPERATING REVENUES: Passenger ...Freight ...Other ...Total operating revenues ...OPERATING EXPENSES: Salaries, wages, and benefits ...Fuel and oil ...Maintenance ...

  • Page 82
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 2011, 2010, AND 2009 Accumulated Capital in other Common excess of Retained comprehensive Treasury Stock par value earnings income (loss) stock (in millions, except per share amounts) Total Balance at ...

  • Page 83
    ... ...Net cash used in investing activities ...CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of long-term debt ...Proceeds from credit line borrowing ...Proceeds from sale leaseback transactions ...Proceeds from Employee stock plans ...Proceeds from termination of interest rate derivative instrument...

  • Page 84
    ...the "Company") operates Southwest Airlines, a major domestic airline that provides point-to-point, low-fare service. The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries, which include AirTran Holdings, LLC. On May 2, 2011 (the "acquisition date...

  • Page 85
    ... due from credit card companies associated with sales of tickets for future travel, amounts due from business partners in the Company's frequent flyer program, and amounts due from counterparties associated with fuel derivative instruments that have settled. The allowance for doubtful accounts was...

  • Page 86
    ... earnings multiples of publicly-traded airlines; (4) weighted-average cost of capital; and (5) expected tax rate. Factors used in the valuation of goodwill include, but are not limited to, management's plans for future operations, recent operating results and discounted projected future cash flows...

  • Page 87
    ... as fuel, food, and other operational costs, but does not include any contribution to overhead or profit. Southwest and AirTran also sell frequent flyer points and/or credits and related services to companies participating in their respective frequent flyer programs. Funds received from the sale of...

  • Page 88
    ... with purchasing and selling derivatives are classified as operating cash flows in the Consolidated Statement of Cash Flows, within Changes in certain assets and liabilities. See Note 10 for further information on hedge accounting and financial derivative instruments. The Company classifies its cash...

  • Page 89
    ...' flights originate or terminate at its largest hub in Atlanta, Georgia. AirTran Airways also serves a number of markets with non-stop service from smaller bases of operation in Baltimore, Maryland; Milwaukee, Wisconsin; and Orlando, Florida. The Company believes the acquisition of AirTran positions...

  • Page 90
    ...For the year ended December 31, 2011, total operating revenues of $2.0 billion and a net loss of $23 million, respectively, are attributable to AirTran and are included in the Company's Consolidated Statement of Income. Equity transaction Each share of AirTran Holdings common stock was exchanged for...

  • Page 91
    ...The Company considered the current market for the aircraft, the maintenance condition of the aircraft and the expected proceeds from the sale of the assets, among other factors. The fair value of AirTran's frequent flyer program liability was estimated based on the weighted average equivalent ticket...

  • Page 92
    ... as follows: 2012 - $39 million, 2013 - $39 million, 2014 - $39 million, 2015 - $39 million, 2016 - $39 million, 2017 and thereafter - $155 million. The weighted-average useful life for the leasehold interest asset is 9 years and for the leasehold interest liability is 10 years, for a total weighted...

  • Page 93
    ... Company utilizes current accounting guidance, also titled "Revenue Arrangements with Multiple Deliverables," in the timing of recognition of revenue associated with the sale of frequent flyer points and/or credits to business partners. The Company applies the residual method, which is allowed with...

  • Page 94
    ... interim periods within those years, beginning on or after January 1, 2013. This ASU will not have a material effect on the Company's financial position or results of operations, but will change the Company's disclosure policies for financial derivative instruments. The Company plans to adopt this...

  • Page 95
    ..."), a project to reconstruct Dallas Love Field ("Airport") with modern, convenient air travel facilities. Pursuant to a Program Development Agreement ("PDA") with the City of Dallas, and the Love Field Airport Modernization Corporation (or "LFAMC," a Texas non-profit "local government corporation...

  • Page 96
    ... a material adverse effect on the Company's financial condition, results of operations, or cash flow. 5. Other Assets and Accrued Liabilities (in millions) December 31, 2011 December 31, 2010 Derivative contracts ...Intangible assets ...Non-current investments ...Other ...Other assets ... $253 155...

  • Page 97
    .... 7. Long-Term Debt (in millions) December 31, 2011 December 31, 2010 10.5% Notes due 2011 ...French Credit Agreements due 2012 ...6.5% Notes due 2012 ...5.25% Notes due 2014 ...5.75% Notes due 2016 ...5.25% Convertible Senior Notes due 2016 ...5.125% Notes due 2017 ...Fixed-rate 717 Aircraft Notes...

  • Page 98
    ... guidance, the embedded conversion option was effectively separated and accounted for as a free-standing derivative. A fair value calculation, utilizing similar market yields and the Company's common stock price, was performed for the debt with and without the equity to measure the equity component...

  • Page 99
    ... purposes. 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...

  • Page 100
    ... Note 10 for more information on the interest rate swap agreement. 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...

  • Page 101
    ... of purchase accounting adjustments) for the five-year period ending December 31, 2016 and thereafter, were $627 million in 2012, $188 million in 2013, $537 million in 2014, $207 million in 2015, $550 million in 2016, and $1.5 billion thereafter. 8. Leases The Company (including AirTran) had...

  • Page 102
    ... of one year at December 31, 2011, were: (in millions) Capital leases Operating leases 2012 ...2013 ...2014 ...2015 ...2016 ...Thereafter ...Total minimum lease payments ...Less amount representing interest ...Present value of minimum lease payments ...Less current portion ...Long-term portion...

  • Page 103
    ... of fuel hedging for the years 2012 through 2015 on an "economic" basis. Fuel hedged as of December 31, 2011 (gallons in millions) Period (by year) 2012 2013 2014 2015 ... 111 1,000 815 395 Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges...

  • Page 104
    ... 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...

  • Page 105
    ... settled fuel contracts ...Accounts and other receivables $ 41 185 - 21 3 $125 - 60 - 1 The following tables present the impact of derivative instruments and their location within the Consolidated Statement of Income for the years ended December 31, 2011 and 2010: Derivatives in cash flow hedging...

  • Page 106
    ... in Retained earnings as of December 31, 2011, but the underlying derivative instruments will not expire/settle until 2012 or future periods. 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...

  • Page 107
    .... To manage credit risk, the Company selects and periodically reviews 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 December 31, 2011, the...

  • Page 108
    .... 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 (OTC) contracts, which are not traded on a public exchange. Fuel derivative instruments...

  • Page 109
    ...most 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...

  • Page 110
    ......Option contracts (d) ...Other available-for-sale securities ...Total assets ...Liabilities Fuel derivatives: Swap contracts (c) ...Option contracts (c) ...Swap contracts (d) ...Option contracts (d) ...Interest rate derivatives (see Note 10) ...Deferred compensation ...Total liabilities ... $ 774...

  • Page 111
    ... contracts (b) ...Swap contracts (c) ...Option contracts (c) ...Other available-for-sale securities ...Total assets ...Liabilities Fuel derivatives: Swap contracts (b) ...Option contracts (b) ...Swap contracts (c) ...Option contracts (c) ...Interest rate derivatives ...Deferred Compensation ...Total...

  • Page 112
    ... 3) Fuel Auction rate Other derivatives securities securities Total (in millions) Balance at December 31, 2010 ...Total gains or (losses) (realized or unrealized) Included in earnings ...Included in other comprehensive income ...Purchases ...Sales ...Settlements ...Balance at December 31, 2011...

  • Page 113
    ...of publicly held long-term debt were based on quoted market prices. (in millions) Carrying value Estimated fair value French Credit Agreements due 2012 ...6.5% Notes due 2012 ...5.25% Notes due 2014 ...5.75% Notes due 2016 ...5.25% Convertible Senior Notes due 2016 ...5.125% Notes due 2017 ...Fixed...

  • Page 114
    ... collective bargaining, plans covering the Company's Board of Directors, and options granted pursuant to a prior employment contract 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...

  • Page 115
    ... to Employees under collective bargaining plans are non-qualified, granted at or above the fair value of the Company's common stock on the date of grant, and generally have terms ranging from six to twelve years. Neither Executive Officers nor members of the Company's Board of Directors are eligible...

  • Page 116
    ... expected stock price volatility. The Company estimates expected stock price volatility via observations of both historical volatility trends as well as implied future volatility observations as determined by independent third parties. No stock options were issued by the Company during 2011. For...

  • Page 117
    Aggregated information regarding Company issued stock options is summarized below: COLLECTIVE BARGAINING PLANS Wtd. Wtd. average Aggregate average remaining intrinsic Options exercise contractual value (000) price term (millions) Outstanding December 31, 2008 ...Granted ...Exercised ...Surrendered ...

  • Page 118
    ...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, 2011, 2010, and 2009, participants under the plan purchased...

  • Page 119
    ... 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, 2011 and 2010. (in millions) 2011 2010 Funded status ...Unrecognized net actuarial gain ...Unrecognized prior service cost ...Accumulated...

  • Page 120
    ...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 ...Share-based compensation ...State taxes ...Business partner income ...Net operating losses...

  • Page 121
    ..., the Company recorded a liability for unrecognized tax benefits of approximately $5 million, the majority of which related to AirTran's prior years' tax positions. If recognized, the unrecognized tax benefits at December 31, 2011, would prospectively impact the Company's effective tax rate. The...

  • Page 122
    ... of Southwest Airlines Co. as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our...

  • Page 123
    ... with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Southwest Airlines Co. as of December 31, 2011 and 2010, and the related consolidated statement of income, stockholders' equity, and cash flows for the each of the three years in...

  • Page 124
    ... ...Net income per share, diluted ...* $2,630 54 17 11 .01 .01 $3,168 363 184 112 .15 .15 $3,192 355 332 205 .27 .27 $3,114 216 213 131 .18 .18 Includes the results of AirTran for May 2011 through December 2011. See Note 2 to the Consolidated Financial Statements for further information. 118

  • Page 125
    ...'s Chief Executive Officer and Chief Financial Officer, concluded that, as of December 31, 2011, 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...

  • Page 126
    ...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...

  • Page 127
    ...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 15 to the Consolidated Financial Statements for information regarding the material features...

  • Page 128
    ... 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., and Guadalupe Holdings Corp., dated as of September...

  • Page 129
    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 130
    ... 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 dated January 26, 2011 (File No. 1-7259)). (2) Southwest Airlines Co. Amended and Restated Severance Plan for Directors...

  • Page 131
    ... the Company's Registration Statement on Form S-8 filed October 30, 2002 (File No. 333-100862)). Southwest Airlines Co. 2002 Ramp, Operations, Provisioning and Freight Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year...

  • Page 132
    ... No. PA-03729 and Aircraft General Terms Agreement, dated December 13, 2011, between The Boeing Company and the Company. (1) 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...

  • Page 133
    ...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. 127

  • Page 134
    ... undersigned, thereunto duly authorized. SOUTHWEST AIRLINES CO. February 9, 2012 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 135
    ... will be furnished to the Securities and Exchange Commission upon request. 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...

  • Page 136
    ... 10.1 and 10.2, respectively, 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...

  • Page 137
    ... 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 dated January 26, 2011 (File No. 1-7259)). (2) Southwest Airlines Co. Amended and Restated Severance Plan for Directors...

  • Page 138
    ... the Company's Registration Statement on Form S-8 filed October 30, 2002 (File No. 333-100862)). Southwest Airlines Co. 2002 Ramp, Operations, Provisioning and Freight Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year...

  • Page 139
    ... No. PA-03729 and Aircraft General Terms Agreement, dated December 13, 2011, between The Boeing Company and the Company. (1) 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...

  • Page 140
    ... Board, President, and Chief Executive Officer Southwest Airlines Co. Executive Committee (Chair) NANCY B. LOEFFLER Long-time advocate of volunteerism Chair of The University of Texas M.D. Anderson Cancer Center Foundation Compensation Committee JOHN T. MONTFORD President and Chief Executive Officer...

  • Page 141
    .... 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-6FC P.O. Box 36611 2702 Love Field Drive Dallas, Texas 75235 Telephone: 214-792-4908 STOCK EXCHANGE LISTING New...