Southwest Airlines 2013 Annual Report Download - page 105

The aircraft leases generally can be renewed for one to five years at rates based on fair market value at the
end of the lease term. Most aircraft leases have purchase options at or near the end of the lease term at fair
market value, generally limited to a stated percentage of the lessor’s defined cost of the aircraft.
During fourth quarter 2013, the Company entered into sale and leaseback transactions with a third party
aircraft lessor for the sale and leaseback of two Boeing 737-800 aircraft. The transactions were closed on the date
of delivery from Boeing, and resulted in the delivery payments being made by the aircraft lessor directly to
Boeing, and Southwest being refunded the $12 million in progress payments it had previously made to Boeing
during the period the aircraft was being constructed. These transactions resulted in deferred gains that are not
material, which are being amortized over the terms of the respective leases, which are both 11 years. Both of the
leases from these sale and leaseback transactions are accounted for as operating leases. Under the terms of the
lease agreements, the Company will continue to operate and maintain the aircraft. Payments under the lease
agreements are fixed. The lease agreements contain standard termination events, including termination upon a
breach of the Company’s obligations to make rental payments and upon any other material breach of the
Company’s obligations under the leases, and standard maintenance and return condition provisions. Upon a
termination of the lease due to a breach by the Company, the Company would be liable for standard contractual
damages, possibly including damages suffered by the lessor in connection with remarketing the aircraft or while
the aircraft is not leased to another party.
On July 9, 2012, the Company signed an agreement with Delta Air Lines, Inc. and Boeing Capital Corp. to
lease or sublease all 88 of AirTran’s Boeing 717-200 aircraft (“B717s”) to Delta. The first converted B717 was
delivered to Delta during late September 2013, and a total of 13 B717s were delivered to Delta during 2013. Over
the expected term of the transition period for all B717s, the Company expects to average approximately three
B717 conversions 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 add complexity to the Company’s operations, as Southwest has historically operated an all-
Boeing 737 fleet. From a fleet management perspective, the transition of approximately three B717s per month to
Delta 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 modification 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 its acquisition of used 737s.
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
five years to approximately 11 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 subleases 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
and the remaining unfavorable aircraft lease liability established as of the acquisition date. The charges recorded
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