Southwest Airlines 2012 Annual Report Download - page 104

On July 9, 2012, the Company signed an agreement with Delta and Boeing Capital Corp. to lease or
sublease all 88 of AirTran’s Boeing 717-200 aircraft (“B717s”) to Delta, with the first delivery expected to occur
in August 2013, at a rate of approximately three B717s per month. A total of 78 of the B717s are on operating
lease, eight are owned, and two are 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 to minimize the impact of this transaction on operations, as the
B717 capacity lost is expected to be replaced through the capacity gained as a result of (i) the Company’s
extension of the retirement dates for a portion of its 737-300 and 737-500 aircraft and (ii) its receipt of new
737 deliveries from Boeing or used 737s that could be acquired.
The Company will lease and/or sublease all 88 of the B717s to Delta at agreed-upon lease rates. In
addition, the Company will pay the majority of the costs to convert the aircraft to the Delta livery and perform
certain maintenance checks prior to the delivery of each aircraft. The agreement to pay these conversion and
maintenance costs is a “lease incentive” under applicable accounting guidance. The sublease terms for the
78 B717s currently on operating lease and the two B717s currently classified as capital leases coincide with the
Company’s remaining lease terms for these aircraft from the original lessor, which range from approximately six
years to approximately twelve years. The lease terms for the eight B717s that are owned by the Company are for
a period of seven years, after which Delta will have the option to purchase the aircraft at the then-prevailing
market value. The Company will account for the lease and sublease transactions with Delta as operating leases,
except for the two aircraft classified by the Company as capital leases. The sublease of these two aircraft will be
accounted for as direct financing leases. There are no contingent payments and no significant residual value
conditions associated with the transaction.
The accounting for this transaction is based on the guidance provided for lease transactions. For the
components of this transaction finalized in third quarter 2012 and with respect to which the lease inception has
been deemed to occur, the Company recorded a charge of approximately $137 million during third quarter 2012.
The charge represents the remaining estimated cost, at the scheduled date of delivery of each B717 to Delta
(including the conversion, maintenance, and other contractual costs to be incurred), of the Company’s lease of
the 78 B717s that are currently accounted for as operating leases, net of the future sublease income from Delta.
The charges recorded by the Company for this transaction are included as a component of Acquisition and
integration costs in the Company’s Consolidated Statement of Income and are included as a component of Other,
net in Cash flows from operating activities in the Company’s Consolidated Statement of Cash Flows, and the
corresponding liability for this transaction is included as a component of Accrued liabilities and Other noncurrent
liabilities in the Company’s Consolidated Balance Sheet. See Note 2 for further information on the Company’s
Acquisition and integration costs. The Company may also incur other costs associated with this transaction, such
as contract termination costs with certain aircraft maintenance vendors. Two of these vendor maintenance
contracts have stated termination penalties totaling approximately $106 million if the Company were to terminate
such contracts; however, termination of these contracts has not occurred and any charges would only be recorded
at the time of contract termination or at the time any associated charges become probable and estimable.
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