Southwest Airlines 2012 Annual Report Download

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SOUTHWEST AIRLINES CO.
2012 ANNUAL REPORT TO SHAREHOLDERS
To our Shareholders:
The year 2012 represented our 40th consecutive year of profitability—a
remarkable feat unmatched in the U.S. aviation industry. Our profits were boosted by
an outstanding record revenue performance. Our critical strategic initiatives
contributed significantly to the 52 percent surge in cash flow from operations in 2012.
In 2012, we added Southwest Airlines service to two new states, Georgia and Iowa,
and six new airports: Hartsfield-Jackson Atlanta International, Akron-Canton
Regional, Dayton International, Des Moines International, Key West International, and
Ronald Reagan Washington National. Our 2012 operational performance was superb,
with Southwest achieving 83.1 percent ontime for the year and recording the best
baggage handling in our history.
Our 2012 net income was $421 million, or $.56 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 2012 profits
increased 26 percent year-over-year to $417 million, or $.56 per diluted share.
We remain focused on preserving our financial strength and enhancing
Shareholder value. In May 2012, our Board of Directors authorized an increase in our
previous share repurchase authorization to $1 billion, and a 122 percent increase in
our quarterly dividend. These actions, coupled with the generation of a healthy
$716 million in free cash flow1during 2012, enabled us to return $422 million to
Shareholders through stock repurchases ($400 million) and dividends ($22 million). In
2012, we repurchased approximately 46 million shares of common stock at an
average price per share of $8.78, which compares favorably to yesterday’s closing
price of $12.64. In addition, yesterday’s stock price represents an increase of over
50 percent from a year ago. We repaid $578 million in debt and capital lease
obligations during 2012. As a result, our debt-to-total capital ratio (including aircraft
leases) declined to approximately 41 percent at yearend. As of December 31, 2012,
our cash and short-term investments were a strong $3 billion, with a fully-available
$800 million bank line-of-credit. We remain the only investment grade-rated U.S.
airline.
1Free cash flow is calculated as operating cash flows of $2.064 billion less capital expenditures of $1.348 billion.
Additional information regarding non-GAAP financial measures is included in the accompanying Form 10-K for the
fiscal year ended December 31, 2012.

Table of contents

  • Page 1
    ..., with a fully-available $800 million bank line-of-credit. We remain the only investment grade-rated U.S. airline. Free cash flow is calculated as operating cash flows of $2.064 billion less capital expenditures of $1.348 billion. Additional information regarding non-GAAP financial measures is...

  • Page 2
    ...Dulles, Des Moines, and Key West to Southwest operations. While AirTran discontinued service to 14 cities that proved unsustainable with high fuel prices, we launched AirTran service to Austin, Orange County, Mexico City, and Cabo San Lucas. As of April 2013, the 97 cities collectively served in the...

  • Page 3
    ... Ten. As measured by the number of originating domestic passengers boarded and based on data available from the U.S. Department of Transportation (DOT), as of Sept. 30, 2012. 2 From the 2012 yearend DOT Air Travel Consumer Report issued February 2013. Top ranking is for Southwest Airlines only. 3

  • Page 4
    ... our Brand, Culture, Customer Service, Operational Excellence, and consecutive annual profits. We remain one of the lowest cost producers among major airlines, and, unlike many of our competitors, we have maintained a strong Balance Sheet while returning significant value to our Shareholders. I am...

  • Page 5
    ... recently completed second fiscal quarter. Number of shares of common stock outstanding as of the close of business on February 4, 2013: 728,096,579 shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the Definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held May...

  • Page 6

  • Page 7
    ... 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 5. Item 10. Item 11. Item 12. Item 13. Item 14. PART III Directors, Executive Officers, and...

  • Page 8

  • Page 9
    .... Southwest principally provides point-to-point, rather than hub-and-spoke, service. This has enabled it to maximize the use of key assets, including aircraft, gates, and Employees, and has also facilitated its ability to provide its markets with frequent, conveniently timed flights and low fares...

  • Page 10
    ...1.8 hours. 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, 14...

  • Page 11
    .... 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, Chicago...

  • Page 12
    ... fare they prefer. • "Wanna Get Away" fares are generally the lowest fares and are subject to advance purchase requirements. They are nonrefundable, but funds may be applied to future travel on Southwest. As discussed below under "Operating Strategies and Initiatives - Ancillary Services and Fees...

  • Page 13
    ... or through 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 and manage travel online. Any part of a Customer's trip can be planned directly from the...

  • Page 14
    ...During 2012, AirTran added Mexico City and Cabo San Lucas to its route network and added new international service from Denver, Colorado; Chicago, Illinois; Austin, Texas; San Antonio, Texas; and Orange County, California. The Company began converting AirTran 737-700 aircraft to the Southwest livery...

  • Page 15
    ... Washington National Airport) service; it expands the Company's service in other key domestic markets, including Baltimore, Milwaukee, and Orlando and adds destinations to its route system; it increases the Company's share of current domestic market share (as measured by available seat miles or...

  • Page 16
    ...Visa credit card; (ii) increasing business from existing Customers; and (iii) strengthening the Company's Rapid Rewards hotel, rental car, credit card, and retail partnerships. To date, the new program has exceeded the Company's expectations with respect to the number of frequent flyer members added...

  • Page 17
    ... frequent flyer program offers a number of ways to earn free travel, including bonus earnings for Business Class travel. AirTran Customers may earn either free travel or Business Class upgrades or, under certain circumstances, free travel on other airlines. A+ Rewards members can earn a credit...

  • Page 18
    ...-demand, slot-controlled, and gate-restricted airports by adding seats to such markets without increasing the number of flights (a "slot" is the right of an air carrier, pursuant to regulations of the FAA, to operate a takeoff or landing at a specific time at certain airports); and (iii) boost fuel...

  • Page 19
    ... high fuel prices. As part of the Company's network optimization efforts, during 2013 the Company also intends to improve its operational network efficiency by tightening its scheduled aircraft flying hours per day and turn times. These changes are designed to better utilize available aircraft time...

  • Page 20
    ... has driven an increase in Southwest's market share and a resulting net increase in revenues. Southwest is also the only major U.S. airline that does not impose a fee on any of its fares for a Customer change in flight plans. The Company has continued to incorporate this key point of differentiation...

  • Page 21
    ...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, 2012, Fly By Priority Lane Access was available at 58 airports. SWABIZ. SWABIZ is Southwest's business travel reservation...

  • Page 22
    ... Rapid Rewards frequent flyer program, enhanced southwest.com website, WiFi implementation, live television connectivity, and its introduction of the Boeing 737-800 aircraft into the Southwest fleet. Additionally, the Company implemented a new TRAX maintenance inventory management system during 2012...

  • Page 23
    ...activities relate to areas such 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...

  • Page 24
    ... most other airlines, which generally offer more ancillary products and services. In July 2011, the DOT proposed new rules that would require airlines to report more information to the DOT on the amount and types of ancillary fees collected from passengers, as well as the number of checked bags and...

  • Page 25
    ...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 26
    ... and procedures implementing ATSA address, among other things, (i) flight deck security; (ii) the use of federal air marshals onboard flights; (iii) airport perimeter access security; (iv) airline crew security training; (v) security screening of passengers, baggage, cargo, mail, employees, and...

  • Page 27
    ... as fuel providers pass on any additional costs to fuel consumers. Regardless of the method of regulation, policy changes with regards to climate change are possible, which could significantly increase operating costs in the airline industry and, as a result, adversely affect operations. The Airport...

  • Page 28
    ... fees for items such as first and second checked bags, flights changes, seat selection, fuel surcharges, snacks, curb-side checkin, and telephone reservations. Routes, Frequent Flyer Programs, and Schedules The Company also competes with other airlines based on markets served, frequent flyer...

  • Page 29
    ... does Southwest, including first-class, business class, and other premium seating and related amenities. Additionally, some major U.S. airlines have announced plans to add a significant number of new aircraft to their fleets. Such efforts could provide cost benefits to these airlines through fleet...

  • Page 30
    ... Amendable November 2014 Amendable October 2013 Amendable December 2015 Southwest Flight Simulator Technicians International Brotherhood of Teamsters ("IBT") Southwest Flight Crew Training Instructors AirTran Pilots Transportation Workers of America, AFL-CIO, Local 557 ("TWU 557") Air Line Pilots...

  • Page 31
    ... 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 any amendments to those reports that are filed with or furnished to the Securities and Exchange Commission...

  • Page 32
    ... to operate; therefore, even a small change in market fuel prices can significantly affect profitability. Fuel prices are volatile and unpredictable, in part, because of many external factors that are beyond the Company's control. For example, fuel prices can be impacted by political and economic...

  • Page 33
    ...it has enabled Southwest to historically offer low fares, drive traffic volume, and grow market share. The Company's low-cost structure has become increasingly important as a result of the Company's decision to control capacity growth in response to high fuel prices and uncertain economic conditions...

  • Page 34
    ... enabling them to better control costs per available seat mile. In addition, some competitors have announced plans to add a significant number of new aircraft to their fleets, which could potentially decrease their operating costs through fleet simplification, better fuel efficiencies, and lower...

  • Page 35
    ..., benefits, cash management, and fixed asset systems. The Company has also invested in significant technology changes to support other initiatives such as Southwest's All-New Rapid Rewards frequent flyer program, introduction of the Boeing 737-800 to its fleet, enhanced southwest.com website, WiFi...

  • Page 36
    ..., currently outweigh the risks associated with its single aircraft supplier strategy. In order to enable Southwest to sustain the benefits associated with operating a single aircraft type, in July 2012 the Company entered into an agreement with Delta Air Lines, Inc. and Boeing Capital Corp. to lease...

  • Page 37
    ... 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 instability of the credit and capital markets could result in future pressure on credit ratings, which could negatively...

  • Page 38
    ... 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 39
    ... actions of other carriers with respect to pricing, routes, frequent flyer programs, scheduling, capacity, Customer Service, comfort and amenities, cost structure, aircraft fleet, and codesharing and similar activities. Risk Factors Related to the Company's Acquisition and Integration of AirTran The...

  • Page 40
    ... integrating the operations of Southwest and AirTran. There are a large number of processes, policies, procedures, operations, technologies, and systems that must be integrated, including reservations, frequent flyer, ticketing/distribution, maintenance, and flight operations. While the Company has...

  • Page 41
    ...2, 2011 short period Federal tax return in first quarter 2012, AirTran had Federal net operating loss carryforwards ("NOLs") of approximately $560 million available to offset future taxable income, expiring between 2017 and 2031. Although the Company is limited in the amount of NOLs that can be used...

  • Page 42
    ...significant future impairment charges and negatively affect 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...

  • Page 43
    ... Southwest and AirTran operated a total of 694 Boeing aircraft as of December 31, 2012, of which 187 and two were under operating and capital leases, respectively. The following table details information on the 694 active aircraft in the Company's combined fleet as of December 31, 2012: Average Age...

  • Page 44
    ... the Consolidated Financial Statements. As of December 31, 2012, Southwest operated six Customer Support and Services centers. The centers located in San Antonio, Chicago, Albuquerque, and Oklahoma City occupy leased space. The Company owns its Houston and Phoenix centers. The Company opened its new...

  • Page 45
    ... bag fee and the airlines' capacity and pricing decisions. On June 30, 2010, the plaintiffs filed a motion to certify a class, which AirTran and Delta have opposed. The Court has not yet ruled on the class certification motion. The original period for fact and expert discovery was scheduled to end...

  • Page 46
    ...as the Company's Executive Vice President & Chief Legal & Regulatory Officer since September 2011. Mr. Ricks also served as Corporate Secretary from May 2008 to January 2013, Executive Vice President Corporate Services from May 2008 to September 2011, Executive Vice President Law, Airports, & Public...

  • Page 47
    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. 39

  • Page 48
    ...declaring dividends on a quarterly basis for the foreseeable future; however, 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...

  • Page 49
    ...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, 2012, with the cumulative total return during such period of the Standard...

  • Page 50
    ... 31, 2012 ...Total ... Average Total number price of shares paid per purchased share - 8,135,598 - 8,135,598 $ - Total number of shares purchased as part of publicly announced plans or programs - 8,135,598 - 8,135,598 $ 9.22 $ - (1) In January 2008, the Company's Board of Directors authorized the...

  • Page 51
    ... share ...Total assets at period-end ...Long-term obligations at period-end ...Stockholders' equity at period-end ...Operating Data: Revenue passengers carried ...Enplaned passengers ...Revenue passenger miles (RPMs) (000s) (1) ...Available seat miles (ASMs) (000s) (2) ...Load factor (3) ...Average...

  • Page 52
    ... share and per ASM amounts) Year ended December 31, 2012 Fuel and oil expense, unhedged ...Add: Fuel hedge losses included in Fuel and oil expense ...Fuel and oil expense, as reported ...Deduct: Net impact from fuel contracts ...Fuel and oil expense, non-GAAP ...Total operating expenses, as reported...

  • Page 53
    ... 10 to the Consolidated Financial Statements. In addition to its "economic" financial measures, as defined above, the Company has also provided other non-GAAP financial measures as a result of items that the Company believes are not indicative of its ongoing operations. These include 2012, 2011, and...

  • Page 54
    ... per member on airfare, the number of flights taken by members, the number of Southwest's co-branded Chase® Visa credit card holders added, the number of points sold to business partners, and the number of frequent flyer points purchased by program members. Fleet modernization. The Company entered...

  • Page 55
    ... it will increase the amount Customers pay for its Early Bird product from $10 per one-way ticket to $12.50 per one-way ticket, effective by the end of the first quarter of 2013. The Company also announced, beginning in February 2013, it will increase the fees charged for certain checked baggage. On...

  • Page 56
    ... on outstanding Customer Service, high quality low-cost operations, solid low-fare brands, and strong Employee cultures. At the current time, the Company plans to continue its route network and schedule optimization efforts, but does not intend to grow its overall fleet size for 2013. The Company...

  • Page 57
    ..., for which Customers pay a service charge to automatically receive an assigned boarding position before general checkin begins, and service charges for pets was offset by an increase in the portion of the commissions earned from programs the Company sponsors with certain business partners that were...

  • Page 58
    ... the Consolidated Financial Statements for further information on fuel hedging. On a consolidated basis, Salaries, wages, and benefits expense per ASM for 2012 increased 1.9 percent compared to 2011. The majority of the per-ASM increase was due to an increase in active full-time equivalent employees...

  • Page 59
    ... not qualify for hedge accounting, which impacts are recorded as a component of Other (gains) losses, net. See Note 10 to the Consolidated Financial Statements. As of January 18, 2013, on an economic basis, the Company had derivative contracts in place related to expected future fuel consumption at...

  • Page 60
    ... with the ineffectiveness of fuel hedges or fuel derivatives that are marked to market because they do not qualify for hedge accounting. See Note 10 to the Consolidated Financial Statements for further information. Assuming no changes to the Company's current fuel derivative portfolio, but including...

  • Page 61
    ... 2 to the Consolidated Financial Statements for further information on purchase accounting. The majority of the decrease was due to a decrease in operating leased aircraft from 192 at December 2011 to 187 at December 2012. On a per-ASM basis, the Company's Aircraft rentals expense for 2012 increased...

  • Page 62
    ... quarter 2012's results. See Note 2 to the Consolidated Financial Statements. Capitalized interest for 2012 increased by $9 million, or 75.0 percent, compared to 2011, primarily due to an increase in average progress payment balances for scheduled future aircraft deliveries. Interest income for 2012...

  • Page 63
    ... share and per ASM amounts) Year ended December 31, 2011 Fuel and oil expense, unhedged ...Add: Fuel hedge losses included in Fuel and oil expense ...Fuel and oil expense, as reported ...Deduct: Net impact from fuel contracts ...Fuel and oil expense, non-GAAP ...Total operating expenses, as reported...

  • Page 64
    ... demand for air travel versus 2010, and at times, targeted marketing campaigns in which the Company differentiated its product and service from competitors. Consolidated Freight revenues for 2011 increased by $14 million, or 11.2 percent, versus 2010, primarily due to higher average rates charged...

  • Page 65
    ... Statements for further information on Southwest's frequent flyer program. Other revenues for AirTran for the period following the acquisition in 2011 included approximately $110 million in baggage fees collected from Customers. Operating expenses Consolidated Operating expenses for 2011 increased...

  • Page 66
    ... 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 67
    ... Rapid Rewards frequent flyer program. On a per-ASM basis, consolidated Depreciation and amortization expense decreased by 7.8 percent compared to 2010, primarily due to the majority of AirTran's fleet as of December 31, 2011 being on operating leases. On a consolidated basis for 2011, the Company...

  • Page 68
    ... 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 69
    ...as liabilities in the Consolidated Balance Sheet. Outstanding letters of credit totaled $208 million at December 31, 2012. The Company is a "well-known seasoned issuer" and has an effective shelf registration statement registering an indeterminate amount of debt or equity securities for future sales...

  • Page 70
    ... be, funded with cash. The Company believes that its current liquidity position, including unrestricted cash and short-term investments of $3.0 billion as of December 31, 2012, anticipated future internally generated funds from operations, and its fully available, unsecured revolving credit facility...

  • Page 71
    ... parking apron, fueling system, roadways and terminal curbside, baggage handling systems, passenger loading bridges and support systems, and other supporting infrastructure. Major construction commenced during 2010. New ticketing and checkin areas opened during fourth quarter 2012 and 12 new gates...

  • Page 72
    ... dates and estimated future refunds and exchanges of tickets sold for past travel dates. The balance in Air traffic liability, which includes a portion of the Company's liability associated with its frequent flyer program, fluctuates throughout the year based on seasonal travel patterns, fare sale...

  • Page 73
    ... quarter 2012, 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, as well as a significant change in the way the Company expects to utilize the fleet...

  • Page 74
    ...occurs and the hedged jet fuel is purchased and consumed, all values and prices are known and are recognized in the financial statements. In some historical periods, because of increased volatility in energy markets, the Company has in fact lost hedge accounting for a certain type of commodity, such...

  • Page 75
    ...uses for mitigation of fuel price volatility. The discontinuation of hedge accounting for specific hedges and for specific refined products, such as unleaded gasoline, can also be a result of these factors. Depending on the level at which the Company is hedged at any point in time, as the fair value...

  • Page 76
    ... date, and frequent flyer awards or certificates that have 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...

  • Page 77
    ...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 or an AirTran A+ Rewards Chase...

  • Page 78
    ..., 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 79
    ... 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...

  • Page 80
    ... on the market price of West Texas intermediate crude oil (WTI). In some periods, the spread between WTI and jet fuel has widened beyond historic norms, which has led to more ineffectiveness when measuring the Company's hedges. During those time periods, jet fuel prices have more closely correlated...

  • Page 81
    ...with changing interest rates due to the short-term nature of its invested cash, which totaled $1.1 billion, and short-term investments, which totaled $1.9 billion, at December 31, 2012. See Notes 1 and 10 to the Consolidated Financial Statements for further information. The Company currently invests...

  • Page 82
    ... 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 83
    Item 8. Financial Statements and Supplementary Data SOUTHWEST AIRLINES CO. CONSOLIDATED BALANCE SHEET (in millions, except share data) December 31, 2012 2011 ASSETS Current assets: Cash and cash equivalents ...Short-term investments ...Accounts and other receivables ...Inventories of parts and ...

  • Page 84
    ..., except per share amounts) YEAR ENDED DECEMBER 31, 2012 2011 2010 OPERATING REVENUES: Passenger ...Freight ...Other ...Total operating revenues ...OPERATING EXPENSES: Salaries, wages, and benefits ...Fuel and oil ...Maintenance materials and repairs ...Aircraft rentals ...Landing fees and other...

  • Page 85
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in millions) YEAR ENDED DECEMBER 31, 2012 2011 2010 NET INCOME ...OTHER COMPREHENSIVE INCOME, NET OF TAX: Unrealized gain on fuel derivative instruments, net of deferred taxes of $74, $42, and $205 ...Unrealized loss on interest ...

  • Page 86
    SOUTHWEST AIRLINES CO. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in millions, except per share amounts) YEAR ENDED DECEMBER 31, 2012, 2011, AND 2010 Capital in excess of par value Accumulated other comprehensive income (loss) Common Stock Retained earnings Treasury stock Total Balance at ...

  • Page 87
    ...: Proceeds from Employee stock plans ...Proceeds from termination of interest rate derivative instrument ...Payments of long-term debt and capital lease obligations ...Payments of convertible debt obligations ...Payment of credit line borrowing obligations ...Payments of cash dividends ...Repurchase...

  • Page 88
    ... sale of frequent flyer points directly to Customers and the redemption of those points for flights. Proceeds from the sale of Auction Rate Securities of $29 million have been reclassified from Operating Activities to Investing Activities, to correct the Consolidated Statement of Cash Flows for 2011...

  • Page 89
    ... the Consolidated Balance Sheet. Accounts and other receivables Accounts and other receivables are carried at cost. They primarily consist of amounts due from credit card companies associated with sales of tickets for future travel, amounts due from business partners in the Company's frequent flyer...

  • Page 90
    ... 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. These factors are...

  • Page 91
    ... of frequent flyer points and/or flight credits, was approximately $814 million. This liability is included as part of Air Traffic liability in the Company's Consolidated Balance Sheet. In March 2011, Southwest launched its All-New Rapid Rewards frequent flyer program. Under the new program, members...

  • Page 92
    ... those balances for award travel under the prior program rules for a period of time. The transition method used by the Company in moving Members to the new program resulted in no material changes in the Company's estimation of its existing frequent flyer liabilities as of the launch date. Although...

  • Page 93
    ... 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 94
    ... in Note 1, on May 2, 2011, the Company acquired AirTran. AirTran Airways offers scheduled airline services, using Boeing 717-200 aircraft and Boeing 737-700 aircraft, throughout the United States and to select international locations. In July 2012, the Company announced that the Boeing 717-200...

  • Page 95
    .... The Company incurred consolidated acquisition and integration-related costs for the years ended December 31, 2012, 2011, and 2010, of $183 million, $134 million, and $8 million, respectively, primarily consisting of consulting, financial advisory fees, severance, flight crew training, seniority...

  • Page 96
    ...further information on the lease/sublease transaction. Based on the expected retirement dates and current and expected future market conditions related to its owned 737-300 and 737-500 aircraft, the Company reduced the residual values of these aircraft from approximately ten percent of original cost...

  • Page 97
    ...2013, $967 million in 2014, $1.2 billion in 2015, $1.3 billion in 2016, $1.4 billion in 2017, and $6.5 billion thereafter. 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...

  • Page 98
    ..., in its Consolidated Balance Sheet. Upon completion of the LFMP project, the Company expects to begin depreciating the assets over their estimated useful lives, and reduce the corresponding liabilities primarily through the Company's airport rental payments to the City of Dallas. Contingencies The...

  • Page 99
    ... ...Non-current lease-related obligations ...Airport construction obligation ...Other deferred compensation ...Other ...Other non-current liabilities ... December 31, 2012 $ 148 376 331 141 128 1,124 December 31, 2011 $ 107 311 202 125 165 910 $ $ Other Operating Expenses Other operating...

  • Page 100
    ... senior notes into cash and shares of common stock at their option at any time. As such, the Company has classified $68 million, which is the cash portion the Company would be required to pay upon conversion, as current maturities in the Consolidated Balance Sheet. The 5.25% convertible senior...

  • Page 101
    ... 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 102
    ... interest rate swap agreement and termination. 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...

  • Page 103
    ...Company's terminal operations space, as well as 187 aircraft, were under operating leases at December 31, 2012. For aircraft operating leases and for terminal operations leases, expense is included in Aircraft rentals and in Landing fees and other rentals, respectively, in the Consolidated Statement...

  • Page 104
    ... currently classified as capital leases. The B717s would add complexity to Southwest's operations, as it has historically operated an all-Boeing 737 fleet. From a fleet management perspective, the transition of approximately three B717s per month to Delta beginning in August 2013 allows the Company...

  • Page 105
    ...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 may be exposed to price changes beyond a certain market price. The Company evaluates its hedge...

  • Page 106
    ...as market prices fluctuate. Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges. All derivatives designated as hedges that meet certain requirements are granted hedge accounting treatment. Generally, utilizing hedge accounting, all periodic changes...

  • Page 107
    ... 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 hedging instruments within the Consolidated Balance Sheet: Asset derivatives Liability derivatives Fair value Fair value Fair value...

  • Page 108
    ...Prepaid settlement for fuel contracts-current ...Prepaid expenses 15 - The following tables present the impact of derivative instruments and their location within the Consolidated Statement of Income for the years ended December 31, 2012 and 2011: Derivatives in cash flow hedging relationships (Gain...

  • Page 109
    ...with the original debt payment schedule. The release of amounts deferred in AOCI related to these interest rate swap agreements was not material during 2012 and is not expected to have a material effect on the Company's future results of operations. In December 2012, the Company terminated the fixed...

  • Page 110
    ... 2016 was approximately 2.78 percent, based on actual and forward rates as of December 31, 2012. 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. These outstanding...

  • Page 111
    ...Company. Applicable accounting provisions require an entity to select a policy for how it records the offset rights to reclaim cash collateral associated with the related derivative fair value of the assets or liabilities of such derivative instruments. In the accompanying Consolidated Balance Sheet...

  • Page 112
    ... 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 non-qualified deferred compensation plan designed to hold Employee...

  • Page 113
    ...regarding the effective repurchase of its remaining auction rate securities. The Company continues to earn interest on its outstanding auction rate security instruments. Any future fluctuation in fair value related to these instruments that the Company deems to be temporary, including any recoveries...

  • Page 114
    ...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 ...(a) (b) (c) (d) December 31, 2012...

  • Page 115
    ... ...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 ... December 31, 2011 Fair value measurements at reporting date using: Quoted prices in...

  • Page 116
    ... rate securities $ 67 - - - (31) - 36(a) $ $ Other securities 5 - - - - - 5 $ $ Total 489 (62) 22 1,003 (1,112) (80) 260 $ 27 $ - $ - $ 27 (a) Included in Other assets in the Consolidated Balance Sheet. (b) The purchase and sale of fuel derivatives are recorded gross based on the structure...

  • Page 117
    ...year) 2013 2014 2015 2016 2017 Range 15%-34% 20%-32% 20%-27% 20%-24% 20%-22% 6yrs-8yrs 3%-5% 1%-3% Auction rate securities Discounted cash flow Time to principal recovery Illiquidity premium Counterparty credit spread The carrying amounts and estimated fair values of the Company's long-term debt...

  • Page 118
    ... 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 ended December 31, 2012, 2011, and...

  • Page 119
    ... average grant price of $8.21 in 2012 and 33 thousand shares at weighted average grant price of $12.26 in 2011 to members of its Board of Directors. The fair value of RSUs and unrestricted stock grants is based on the closing price of the Company's common stock on the date of grant. Outstanding...

  • Page 120
    ... for use in estimating the fair value of short-term traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of subjective assumptions including expected stock price volatility. The Company estimates expected stock price...

  • Page 121
    ...grant date fair value of shares vesting during the years ended December 31, 2012, 2011, and 2010, was $13 million, $13 million, and $10 million, respectively. Employee Stock Purchase Plan Under the amended 1991 Employee Stock Purchase Plan (ESPP), which has been approved by Shareholders, the Company...

  • Page 122
    ... 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, 2012 and 2011. (in millions) Funded status ...$ Unrecognized net actuarial gain ...Unrecognized prior service cost...

  • Page 123
    ...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: 2012(2) Wtd-average discount rate...

  • Page 124
    ...tax liabilities ...DEFERRED TAX ASSETS: Fuel derivative instruments ...Deferred gains from sale and leaseback of aircraft ...Capital and operating leases ...Accrued engine maintenance ...Accrued employee benefits ...State taxes ...Business partner income ...Net operating losses and credit carrybacks...

  • Page 125
    ... federal statutory tax rate, these NOL's result in a deferred tax asset of $81 million, as of December 31, 2012, which represents the expected future tax benefit of the NOL's, and which is netted against the Company's Deferred income tax liability in the Consolidated Balance Sheet. These NOL's will...

  • Page 126
    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, 2012 and 2011, and the related consolidated statements of income, ...

  • Page 127
    ... control over financial reporting as of December 31, 2012, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Southwest Airlines Co. as of December 31, 2012 and 2011...

  • Page 128
    QUARTERLY FINANCIAL DATA (unaudited) THREE MONTHS ENDED June 30 Sept. 30 4,616 $ 460 368 228 .30 .30 June 30 (in millions except per share amounts) March 31 Dec. 31 4,173 91 125 78 .11 .11 Dec. 31 2012 Operating revenues ...$ Operating income ...Income before income taxes ...Net income ...Net ...

  • Page 129
    ... Executive Officer and Chief Financial Officer, concluded that, as of December 31, 2012, 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...

  • Page 130
    ... Officer of the Company. In consideration for her services, Ms. Wright will be paid $40,000 per month. In addition, provided that Ms. Wright executes and delivers a binding general release of claims in favor of the Company and its affiliates on or prior to July 31, 2013, the Company will pay...

  • Page 131
    ... headings "Compensation of Executive Officers" and "Compensation of Directors" in the Proxy Statement for the Company's 2013 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 132
    ... 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 14 to the Consolidated Financial Statements for information...

  • Page 133
    ...the quarter ended June 30, 2012 (File No. 1-7259)). Amended and Restated Bylaws of the Company, effective November 19, 2009 (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated November 19, 2009 (File No. 1-7259)). Specimen certificate representing common stock...

  • Page 134
    ... 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 135
    ... 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. 1998 SAEA Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.17 to Southwest's Annual Report on Form 10-K for the year...

  • Page 136
    ... 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 ended December 31, 2002 (File No. 1-7259)). Southwest Airlines Co. 2002 Customer Service/Reservations Non...

  • Page 137
    ...the Company's Annual Report on Form 10-K for the year ended December 31, 2011 (File No. 1-7259)). (1) Advisory and Non-Compete/Non-Solicitation Agreement, dated February 5, 2013, between the Company and Laura Wright. (2) Southwest Airlines Co. Senior Executive Short Term Incentive Plan (incorporated...

  • Page 138
    ... duly authorized. SOUTHWEST AIRLINES CO. February 6, 2013 By: /s/ TAMMY ROMO Tammy Romo 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 on February 6, 2013, on...

  • Page 139
    ... Chairman of the Board, President, and Chief Executive Officer Southwest Airlines Co. Executive Committee (Chair) NANCY B. LOEFFLER Consultant for Frost Bank and member of Frost Bank Advisory Board Long-time advocate of volunteerism Compensation Committee Managing Director Diversified Search LLC...

  • Page 140
    ... 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...