Southwest Airlines 2014 Annual Report Download

Download and view the complete annual report

Please find the complete 2014 Southwest Airlines annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 156

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95
  • 96
  • 97
  • 98
  • 99
  • 100
  • 101
  • 102
  • 103
  • 104
  • 105
  • 106
  • 107
  • 108
  • 109
  • 110
  • 111
  • 112
  • 113
  • 114
  • 115
  • 116
  • 117
  • 118
  • 119
  • 120
  • 121
  • 122
  • 123
  • 124
  • 125
  • 126
  • 127
  • 128
  • 129
  • 130
  • 131
  • 132
  • 133
  • 134
  • 135
  • 136
  • 137
  • 138
  • 139
  • 140
  • 141
  • 142
  • 143
  • 144
  • 145
  • 146
  • 147
  • 148
  • 149
  • 150
  • 151
  • 152
  • 153
  • 154
  • 155
  • 156

SOUTHWEST AIRLINES CO.
2014 ANNUAL REPORT TO SHAREHOLDERS
To our Shareholders:
The year 2014 was historic for Southwest Airlines, the culmination of years’ worth of
hard work. It was our 42nd consecutive year of profitability, an unprecedented feat for the
airline industry. Our 2014 net income of $1.1 billion easily surpassed the previous annual
record in 2013. Excluding special items1, Southwest’s record earnings surged over 73 percent,
compared with 2013. Along with it, Southwest’s common stock (LUV) surged 125 percent to
a year-end record $42.32 per share, making it the number one performer of the S&P 500, and
besting the previous 2001 record closing price per share by almost double. It is not dramatic to
say that Southwest was transformed in 2014 through the launch of international service; the
repeal of the Wright Amendment; the acquisition of slots at Washington Reagan National and
New York LaGuardia Airports; and the completion of the AirTran integration (which was
acquired in 2011). Other strategic initiatives launched since 2010 also helped propel our
earnings performance, including our Rapid Rewards®frequent flyer program, the addition of
the Boeing 737-800 model, and our fleet modernization program. To commemorate the
historic year, record results, and transformation, we unveiled a bold new look for our aircraft
and branding. We believe the completion of the ambitious strategy to transform, along with
the record results, positions Southwest exceptionally well for the future.
Our record 2014 net income was $1.1 billion, or $1.64 per diluted share. Excluding
special items, our record 2014 earnings were $1.4 billion, or $2.01 per diluted share.
Operating income increased 74.1 percent, compared with 2013, to a record $2.2 billion.
Excluding special items, our operating income was $2.4 billion, an increase of 64.9 percent,
compared with 2013. Our annual pre-tax return on invested capital, excluding special items
(ROIC), was 21.2 percent, an increase of 8.1 points compared with 2013, and ahead of our
minimum 15 percent target.
Total operating revenues were a record $18.6 billion, an increase of 5.1 percent compared
with 2013. The 2014 results were driven by a solid 2.0 percent increase in passenger revenue
yield and a 2.4 point increase in load factor, with capacity up just one-half percent, all compared
with 2013. Our operating revenues per available seat mile, passenger revenue yield, and load
factor were all record performances. Southwest has worked hard to optimize the combined
AirTran and Southwest route networks, with superb results. And, the revenue generated from our
strategic initiatives (AirTran acquisition, Rapid Rewards, Fleet Modernization, B737-800) has
exceeded our expectations. Finally, the strong revenue results were achieved despite the
significant mix of developmental routes generated from the AirTran integration, the Dallas Love
Field expansion, and the slots acquired at LaGuardia and Reagan National.
1Additional information regarding non-GAAP financial measures is included in the accompanying Form 10-K for the fiscal
year ended December 31, 2014.

Table of contents

  • Page 1
    ...2.0 percent increase in passenger revenue yield and a 2.4 point increase in load factor, with capacity up just one-half percent, all compared with 2013. Our operating revenues per available seat mile, passenger revenue yield, and load factor were all record performances. Southwest has worked hard to...

  • Page 2
    ... cash and short-term investments were a strong $3 billion, with a fully-available bank line-of-credit. In May 2014, our Board of Directors authorized a $1 billion share repurchase program and increased the quarterly dividend by 50 percent to $.06 per share. These actions enabled Southwest to return...

  • Page 3
    ... by offering low fares, but with great service. We did that. Our Purpose, then and now, is to connect Customers to what's important in their lives with friendly, reliable, and low-cost air travel. Today, our Vision is to become the World's Most Loved, Most Flown, and Most Profitable Airline. Air...

  • Page 4

  • Page 5
    ... closing sale price of the common stock on the New York Stock Exchange on June 30, 2014, the last trading day of the registrant's most recently completed second fiscal quarter. Number of shares of common stock outstanding as of the close of business on February 4, 2015: 675,993,892 shares DOCUMENTS...

  • Page 6

  • Page 7
    ... Southwest Airlines Co. Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information PART III Item 10. Item 11. Item 12. Item...

  • Page 8

  • Page 9
    ... to Montego Bay, Nassau, and Oranjestad. The Company also launched service to Cabo San Lucas/Los Cabos and Cancun on August 10, 2014, and to Mexico City and Punta Cana on November 2, 2014. The Company has announced plans to add its first and second destinations in Central America by adding Southwest...

  • Page 10
    ...703 miles, with an average duration of approximately 2.0 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 21 weekday roundtrips from Dallas Love Field to Houston Hobby...

  • 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
    ... in jet fuel prices during the fourth quarter of 2014, jet fuel prices are subject to significant volatility based on a variety of factors. In addition, the cost of hedging generally increases with sustained high potential for volatility in the fuel market. The Company's fuel hedging activities...

  • Page 13
    ... under Southwest's Rapid Rewards® frequent flyer program than do Wanna Get Away fares. "Business Select" fares are refundable and changeable, and funds may be applied toward future travel on Southwest. Business Select fares also include additional perks, when available, such as priority boarding in...

  • Page 14
    ...737-800 aircraft into the Southwest fleet, (iv) international capabilities and new reservation system, and (v) the continued growth of Southwest's Rapid Rewards frequent flyer program. In addition to the Company's five strategic initiatives, the Company has continued to design, implement, and manage...

  • Page 15
    ... scheduled to re-enter service as Southwest aircraft in early 2015. The Company completed the integration of booking and frequent flyer functions into southwest.com, referring all Customers who visit airtran.com to southwest.com. The Company transferred AirTran Customers' A+ Rewards account history...

  • Page 16
    ...-demand, slot-controlled, and gate-restricted airports by adding seats to such markets without increasing the number of flights; and (iii) boost fuel efficiency to reduce overall unit costs. Additionally, the Company expects the 737-800 will enable Southwest to profitably expand to new destinations...

  • Page 17
    ...if seats are still available for sale. Rapid Rewards Members can also earn points through qualifying purchases with Rapid Rewards Partners (which include, for example, car rental agencies, hotels, restaurants, and retail locations), as well as by using Southwest's co-branded Chase® Visa credit card...

  • Page 18
    ... frequent flyer program, and all remaining A+Rewards credits were converted to Rapid Rewards points. For the Company's 2014 consolidated results, Customers of Southwest and AirTran redeemed approximately 6.2 million flight awards, accounting for approximately 11.0 percent of revenue passenger miles...

  • Page 19
    ...'s Points of Differentiation from its Competitors In September 2014, the Company launched a new visual expression of its brand by introducing a new Heart aircraft livery, airport experience, and logo. From a financial perspective, the Company intends for this launch to remain cost-neutral by using...

  • Page 20
    ... bags. The Company also continues to promote all of the many other reasons to fly Southwest such as its low fares, network size, Customer Service, free live television offerings (discussed below under "Inflight WiFi and Entertainment"), and its Rapid Rewards frequent flyer program. Business Traveler...

  • Page 21
    ...No Show policy is to promote Customer behavior that will enable Southwest to re-sell the open seat prior to departure. During 2014, AirTran charged fees for checked baggage, carriage of pets, liquor sales, advance seat assignments, call center services, priority seat selection, special services such...

  • Page 22
    ..., free live TV may not be available onboard WiFi-enabled international flights. Southwest also provides movies-on-demand, which are currently priced at $5 per movie and, in December 2013, became the first airline to offer a Messaging-only option for $2 a day per device, including all WiFi-enabled...

  • Page 23
    ... and operations, (ii) Southwest's Rapid Rewards frequent flyer program, (iii) the continued incorporation of the Boeing 737-800 aircraft into the Company's fleet, (iv) enhancements to the southwest.com website, (v) WiFi implementation and live television connectivity, and (vi) new reservation system...

  • Page 24
    ... the Passenger Protection Rules. The DOT's proposed rule would, among other things, require airlines to share with ticket agents fee information for "basic ancillary services," including fees for a first checked bag, second checked bag, carry-on items, and advance seat selection. The Company is...

  • Page 25
    ... any point outside of a Wright Amendment State. In other words, a Customer could not purchase a single ticket between Dallas Love Field and any destination other than a Wright Amendment State. These restrictions did not apply to flights operated with aircraft having 56 or fewer passenger seats. The...

  • Page 26
    ...time" limitations based upon report times, the number of scheduled flight segments, and other operational factors. The rule may reduce the Company's staffing flexibility, which could impact the Company's operational performance, costs, and Customer Experience. The Company is subject to various other...

  • Page 27
    .... The program expedites flight crew member access to sterile areas of airports. The Company has made significant investments to address the effect of security regulations, including investments in facilities, equipment, and technology to process Customers, checked baggage, and cargo efficiently and...

  • Page 28
    ... system. Some airports have established airport restrictions to limit noise, including restrictions on aircraft types to be used and limits on the number of hourly or daily operations or the time of operations. These types of restrictions can cause curtailments in service or increases in operating...

  • Page 29
    ... healthier financial condition and improved profitability. Key competitive factors within the airline industry include (i) pricing and cost structure; (ii) routes, frequent flyer programs, and schedules; and (iii) customer service, comfort, and amenities. Southwest also competes for customers with...

  • Page 30
    ... second checked bags, flight 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 opportunities, and flight schedules. Some...

  • Page 31
    ...-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 simplification, improved fuel...

  • Page 32
    ...-help" includes, among other things, a strike by the union or the airline's imposition of any or all of its proposed amendments and the hiring of new employees to replace any striking workers. Following the AirTran acquisition, the various Company labor groups were covered by 18 different collective...

  • Page 33
    ...training and become Southwest Flight Attendants. Additional Information About the Company The Company was incorporated in Texas in 1967. The following documents are available free of charge through the Company's website, www.southwest.com: the Company's annual report on Form 10-K, quarterly reports...

  • Page 34
    ... timely supply of fuel; therefore, the Company's strategic plans and future profitability are likely to be impacted by the Company's ability to effectively address fuel price increases and fuel price volatility and availability. Airlines are inherently dependent upon energy to operate, and jet fuel...

  • Page 35
    ... Financial Statements. The Company is also reliant upon the readily available supply and timely delivery of jet fuel to the airports that it serves. A disruption in that supply could present significant challenges to the Company's operations, and could ultimately cause the cancellation of flights...

  • Page 36
    ... available seat mile. The Company has limited control over fuel and labor costs, as well as other costs such as regulatory compliance costs. Jet fuel and oil constituted approximately 32 percent of the Company's operating expenses during 2014, and the cost of fuel is subject to the external factors...

  • Page 37
    ... 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 better fuel efficiencies, and lower maintenance costs. Some of the Company...

  • Page 38
    ... by labor unions, making the Company particularly exposed in the event of labor-related job actions. Employment-related issues that may impact the Company's results of operations, some of which are negotiated items, include hiring/retention rates, pay rates, outsourcing costs, work rules, and...

  • Page 39
    ... strategy. 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 or sublease all 88 of AirTran's Boeing 717-200 aircraft to Delta. Deliveries...

  • Page 40
    ... revenue and an extraordinarily volatile fuel price environment. While the Company's credit rating is "investment grade," factors such as future unfavorable economic conditions, a significant decline in demand for air travel, or instability of the credit and capital markets could result in future...

  • Page 41
    ... regulations; new or increased taxes or fees, such as the July 2014 increased Transportation Security Fee discussed above under "Regulation - Aviation Taxes"; changes to laws that affect the services that can be offered by airlines in particular markets and at particular airports; restrictions...

  • Page 42
    ... respect to pricing, routes, frequent flyer programs, scheduling, capacity, Customer Service, comfort and amenities, cost structure, aircraft fleet, and codesharing and similar activities. The Company's future results will suffer if it does not effectively manage its expanded operations, including...

  • Page 43
    ... AirTran such fees on domestic flights beginning December 5, 2008. After the filing of the May 2009 complaint, various other nearly identical complaints also seeking certification as class actions were filed in federal district courts in Atlanta, Georgia; Orlando, Florida; and Las Vegas, Nevada. All...

  • Page 44
    ...global economic conditions; (ii) significantly higher prices for jet fuel; (iii) lower fares or passenger yields as a result of increased competition or lower demand; (iv) a significant increase in future capital expenditure commitments; and (v) significant disruptions to the Company's operations as...

  • Page 45
    ...553 Number Leased - 44 3 58 7 112 Type 717-200 (2) 737-300 737-500 737-700 737-800 Totals Seats 117 137 or 143 122 143 175 (1) As discussed further in Note 6 to the Consolidated Financial Statements, 163 of the Company's aircraft were pledged as collateral as of December 31, 2014. (2) The Company...

  • Page 46
    ... into an Airport Use and Lease Agreement to control the execution of this expansion and the financial terms thereof. This project provides for a new five-gate international terminal with international passenger processing facilities, expansion of the existing security checkpoint, and upgrades to the...

  • Page 47
    ... Note 4 to the Consolidated Financial Statements. As of December 31, 2014, the Company operated seven Customer Support and Services call centers. The centers located in Atlanta, San Antonio, Chicago, Albuquerque, and Oklahoma City occupy leased space. The Company owns its Houston and Phoenix centers...

  • Page 48
    ... 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 49
    ... 2004 to September 2006, Vice President Technology from 2002 to 2004, Vice President Purchasing from 2001 to 2002, Controller from 1997 to 2001, Director Revenue Accounting from 1994 to 1997, and Manager Sales Accounting from 1990 to 1994. Mr. Jordan joined the Company in 1988 as a programmer. Jeff...

  • Page 50
    ... from February 2010 to September 2012, Vice President of Financial Planning from September 2008 to February 2010, Vice President Controller from February 2006 to August 2008, Vice President Treasurer from September 2004 to February 2006, Senior Director of Investor Relations from March 2002 to...

  • Page 51
    ... II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities The Company's common stock is listed on the New York Stock Exchange ("NYSE") and is traded under the symbol "LUV." The following table shows the high and low prices per share of...

  • Page 52
    ... graph below represents 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 450 400 Total Cumulative Return - Dollars 350 300 250 200...

  • Page 53
    ....37 per share, which was the closing price of the Company's common stock on the New York Stock Exchange on November 11, 2014. The specific number of shares that the Company ultimately will repurchase under the Fourth Quarter ASR Program will be determined based generally on a discount to the volume...

  • Page 54
    ...share, diluted Cash dividends per common 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...

  • Page 55
    ...cost paid by a paying passenger to fly one mile, which is a measure of revenue production and fares. (5) Calculated as operating revenue divided by available seat miles. Also referred to as "operating unit revenues," this is a measure of operating revenue production based on the total available seat...

  • Page 56
    ...: Acquisition and integration costs Deduct: Labor ratification bonus Total operating expenses, non-GAAP Operating income, as reported Add (Deduct): Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period settled contracts Add: Contracts settling in the...

  • Page 57
    ... same aircraft). (2) Average Invested Capital is an average of the five most recent quarter end balances of debt, net present value of aircraft leases, and equity adjusted for hedge accounting. Note Regarding Use of Non-GAAP Financial Measures The Company's Consolidated Financial Statements are...

  • Page 58
    ..., 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 or quarter-over-quarter basis after considering all...

  • Page 59
    ...'s networks, fleets, systems, and People, was effectively completed in December 2014. AirTran's final passenger service occurred on December 28, 2014. The acquisition of AirTran in 2011 served to increase the Company's fleet size and expand its network into key U.S. markets, such as Atlanta and...

  • Page 60
    ... operates at a lower unit cost than other aircraft in the Company's existing fleet. International Capabilities and New Reservation System The Company launched Southwest's international service on July 1, 2014, with its inaugural flights to three Caribbean destinations, Aruba, Nassau, and Montego Bay...

  • Page 61
    ...to 44 daily departures, currently servicing 14 destinations: Atlanta, Akron/ Canton, Austin, Chicago Midway, Dallas Love Field, Houston Hobby, Fort Myers, Indianapolis, Kansas City, Milwaukee, Nashville, New Orleans, St. Louis, and Tampa Bay. At New York LaGuardia Airport, in the wake of the Company...

  • Page 62
    ... effective October 1, 2014, of approximately $55 million. See Note 1 regarding this change in accounting estimate. Based on current trends, the Company expects its first quarter 2015 passenger revenues to grow in line with the increase in its first quarter 2015 available seat mile capacity, both on...

  • Page 63
    ... benefits expense. Based on current cost trends, the Company expects its first quarter 2015 unit costs, excluding fuel, special items, and profitsharing to decrease in the one to two percent range, compared with first quarter 2014. See the previous Note Regarding Use of Non-GAAP Financial Measures...

  • Page 64
    ... of fuel hedge accounting, both the dollar and per ASM decreases were primarily attributable to lower jet fuel prices. The Company's average economic jet fuel price per gallon decreased 6.4 percent year-over-year, from $3.12 for 2013 to $2.92 for 2014. In addition, fuel efficiency improved slightly...

  • Page 65
    ... 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 66
    ... 2013. On both a dollar and per ASM basis, approximately half the increase was attributable to technology projects that have been placed into service over the last twelve months and approximately half was due to the purchase of new and used aircraft over the last twelve months. The Company currently...

  • Page 67
    ... to the Consolidated Financial Statements for further information on the Company's hedging activities. The following table displays the components of Other (gains) losses, net, for the years ended December 31, 2014, and 2013: (in millions) Mark-to-market impact from fuel contracts settling in future...

  • Page 68
    ...: Acquisition and Integration costs Total operating expenses, non-GAAP Operating income, as reported Add (Deduct): Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period settled contracts Add (Deduct): Contracts settling in the current period, but for...

  • Page 69
    ... policies for Customers that purchased travel on AirTran through southwest.com. Other revenues for 2013 included approximately $105 million in baggage fees collected from AirTran Customers, versus approximately $146 million for 2012. Operating expenses Historically, except for changes in the price...

  • Page 70
    ... attributable to a reduction in engine repairs and materials expense due to (i) retirements of the Company's 737-300 and 737-500 aircraft, and (ii) the transition of the Company's 717-200 fleet out of active service for delivery to Delta. Aircraft rentals expense for 2013 increased by $6 million...

  • Page 71
    ... operating expense for 2013 increased 1.2 percent, compared with 2012. Approximately half of both the dollar and per ASM increases were the result of increased Customer usage of WiFi onboard the Company's aircraft and approximately half were the result of higher consulting and contract programming...

  • Page 72
    ... associated with airport construction projects, denoted as Assets constructed for others. See Note 4 to the Consolidated Financial Statements for further information. During 2014, 2013, and 2012 the Company's purchases and sales of short-term and noncurrent investments resulted in net cash provided...

  • Page 73
    ... of the shares to be purchased by the Company under the Fourth Quarter ASR Program. See Part II, Item 5 for further information on the Company's share repurchase authorization and the Fourth Quarter ASR Program. On August 5, 2014, Moody's upgraded the Company's senior unsecured debt rating to "Baa2...

  • Page 74
    ...purchases of aircraft, payment of debt, and lease arrangements. For aircraft commitments with Boeing, the Company is required to make cash deposits toward the purchase of aircraft in advance. These deposits are classified as Deposits on flight equipment purchase contracts in the Consolidated Balance...

  • Page 75
    ... in place of posting cash collateral related to its fuel hedging positions. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the Consolidated Balance Sheet. Outstanding letters of credit totaled $440 million at...

  • Page 76
    ... Consolidated Financial Statements. Dallas Love Field For the rebuilding of the facilities at Dallas Love Field, the Company has guaranteed principal, premium, and interest on $456 million in bonds issued by the Love Field Airport Modernization Corporation ("LFAMC") that have been utilized to fund...

  • Page 77
    ... of the existing security checkpoint, and upgrades to the Southwest ticketing counter area. The Company and the City of Houston ("City") entered into an Airport Use and Lease Agreement ("Lease") to control the execution of this expansion and the financial terms thereof. The project is estimated to...

  • Page 78
    ... purchased ticket that was more expensive. In September 2013, Southwest implemented a No Show policy that applies to nonrefundable fares that are not canceled or changed by a Customer at least ten minutes prior to a flight's scheduled departure. See Note 1 to the Consolidated Financial Statements...

  • Page 79
    ...in a lease agreement to another carrier. However, since these aircraft are not in service for the Company, they are not included in its fleet figures as of December 31, 2014. See Note 7 to the Consolidated Financial Statements for further information. In accounting for long-lived assets, the Company...

  • Page 80
    ... lives for a given fleet type are unusual, especially given the rapid pace of technological advancement, volatile fuel prices, and recent significant transactions involving the Company's fleet. See Note 1 to the Consolidated Financial Statements for further information. The impact of this change...

  • Page 81
    ...the hedged jet fuel is purchased and consumed, all values and prices are known and are recognized in the financial statements. In some periods, because of increased volatility in energy markets, the Company has lost hedge accounting for certain types of commodities, including in the third quarter of...

  • Page 82
    ...in forecasting expected future cash flows relating to its jet fuel hedging program. These estimates are an important component used in the measurement of effectiveness for the Company's fuel hedges. The current methodology used by the Company in forecasting forward jet fuel prices is primarily based...

  • Page 83
    ... date. Frequent flyer account balances include points earned through flights taken, points sold to Customers, or points earned through business partners participating in the frequent flyer program. Under the Southwest Rapid Rewards frequent flyer program, members earn points for every dollar spent...

  • Page 84
    ... cost liability was approximately $63 million. The Company also sells frequent flyer points and related services to business partners participating in the frequent flyer program. The majority of the points sold to business partners are through the Southwest co-branded Chase Visa credit card. Funds...

  • Page 85
    ... the Company's reassessment of the current size and importance of its operations at New York's LaGuardia Airport and Washington's Ronald Reagan National Airport versus when the Company first began service to these airports in recent years. The impact of this prospective change in accounting estimate...

  • Page 86
    ...operate its aircraft fleet, and market risk in the derivatives used to manage its fuel hedging program and in the form of fixed-rate debt instruments. As of December 31, 2014, Southwest operated a total of 112 aircraft under operating and capital lease. However, except for a small number of aircraft...

  • Page 87
    types of hedging strategies. The gross fair value of outstanding financial derivative instruments related to the Company's jet fuel market price risk at December 31, 2014, was a net liability of $1.0 billion. In addition, $266 million in cash collateral deposits, $134 million in aircraft collateral,...

  • Page 88
    ... its hedging program. Financial market risk The vast majority of the Company's tangible assets are aircraft, which are long-lived. The Company's strategy is to maintain a conservative balance sheet and grow capacity steadily and profitably under the right conditions. While the Company uses financial...

  • Page 89
    ..., 2014. See Notes 1 and 11 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 paper, treasury securities, U.S. government agency securities, and...

  • Page 90
    ... to fall below investment grade by two of the three major rating agencies, and if the Company were in a net liability position with the counterparty. See Note 10 to the Consolidated Financial Statements for further information. As of December 31, 2014, $266 million in cash collateral deposits were...

  • Page 91
    are based on the Company's public debt rating and a corresponding percentage of the Company's Air traffic liability. As of December 31, 2014, the Company was in compliance with all credit card processing agreements. However, the inability to enter into credit card processing agreements would have a ...

  • Page 92
    Item 8. Financial Statements and Supplementary Data Southwest Airlines Co. Consolidated Balance Sheet (in millions, except share data) December 31, 2014 December 31, 2013 ASSETS Current assets: Cash and cash equivalents Short-term investments Accounts and other receivables Inventories of parts and...

  • Page 93
    .... Consolidated Statement of Income (in millions, except per share amounts) Year ended December 31, 2014 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...

  • Page 94
    Southwest Airlines Co. Consolidated Statement of Comprehensive Income (in millions) Year ended December 31, 2014 NET INCOME Unrealized gain (loss) on fuel derivative instruments, net of deferred taxes of ($430), $31, and $74 Unrealized gain (loss) on interest rate derivative instruments, net of ...

  • Page 95
    ..., 2014, 2013, and 2012 Capital in excess of par value Accumulated other comprehensive income (loss) Common Stock Retained earnings Treasury stock Total Balance at December 31, 2011 Repurchase of common stock Issuance of common and treasury stock pursuant to Employee stock plans Net tax benefit...

  • Page 96
    ... cash used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long-term debt Proceeds from Employee stock plans Reimbursement for assets constructed for others Proceeds from termination of interest rate derivative instrument Payments of long-term debt and capital...

  • Page 97
    ... market funds, and investment grade commercial paper issued by major corporations and financial institutions. Cash and cash equivalents are stated at cost, which approximates fair value. As of December 31, 2014, $266 million in cash collateral deposits were provided by the Company to its fuel hedge...

  • Page 98
    ... 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 program...

  • Page 99
    ...the excess of the asset book value in relation to its estimated fair value. During first quarter 2012 the Company changed the estimated retirement dates of several 737-300 and 737-500 aircraft based on revisions in the Company's fleet plan. This change, which was accounted for on a prospective basis...

  • Page 100
    ... that significantly enhance the operating performance or extend the useful lives of aircraft or engines are capitalized and amortized over the remaining life of the asset. Goodwill and intangible assets The Company applies a fair value based impairment test to the carrying value of goodwill and...

  • Page 101
    ... not limited to: fare increases, fare sales, changes to the Company's ticketing policies, changes to the Company's refund, exchange and unused funds policies, or economic factors. The Company is also required to collect certain taxes and fees from Customers on behalf of government agencies and remit...

  • Page 102
    ... direct passenger costs such as fuel, food, and other operational costs, but does not include any contribution to fixed overhead costs or profit. Southwest also sells frequent flyer points and related services to companies participating in its frequent flyer program. Funds received from the sale of...

  • Page 103
    ... 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 104
    ... 31, 2014, 2013, and 2012, respectively, and is included as a component of Depreciation and amortization expense in the accompanying Consolidated Statement of Income. Income taxes The Company accounts for deferred income taxes utilizing an asset and liability method, whereby deferred tax assets and...

  • Page 105
    ... its liability earned by Customers associated with flights points with a relative fair value approach, and (ii) the requirement that the Company discontinue use of the residual method in allocating funds from the sale of frequent flyer points to business partners in its frequent flyer program, which...

  • Page 106
    ... During the year ended December 31, 2014, the Company purchased 33 new 737-800 aircraft from Boeing and 11 used 737-700 aircraft from third parties. In addition, the Company also leased 11 737-700 aircraft from third parties, retired from service five of its older aircraft (three 737-300 and two 737...

  • Page 107
    ...of the project for accounting purposes. As such, in the Consolidated Balance Sheet, the Company is expected to record an increase in Assets constructed for others as the project is built, along with a corresponding outflow within Capital expenditures, in the Consolidated Statement of Cash Flows, and...

  • Page 108
    ... Capital expenditures, in the Consolidated Statement of Cash Flows. As of December 31, 2014, the Company had recorded construction costs related to Houston Hobby of $64 million. Los Angeles International Airport In March 2013, the Company executed a lease agreement with Los Angeles World Airports...

  • Page 109
    ..., 2014, associated with the LFMP assets in service was $20 million. The corresponding LFMP liabilities will be reduced primarily through the Company's airport rental payments to the City of Dallas as the construction costs of the project are passed through to the Company via recurring airport rates...

  • Page 110
    ...material adverse effect on the Company's financial condition, results of operations, or cash flow. 5. SUPPLEMENTAL FINANCIAL INFORMATION (in millions) Derivative contracts Intangible assets Non-current investments Other Other assets (in millions) Accounts payable trade Salaries payable Taxes payable...

  • Page 111
    ...-Term Debt AirTran Holdings previously entered into aircraft purchase financing facilities, under which a total of 22 737-700 aircraft were financed as of December 31, 2014. As of December 31, 2014, after prepaying aircraft secured term loans for eight aircraft during 2012 and the first half of 2013...

  • Page 112
    ...unamortized debt premium associated with these notes in second quarter 2014, in the amount of $5 million, which is reflected as a reduction to Interest expense in the Consolidated Statement of Income. In October 2009, AirTran Holdings completed a public offering of $115 million of convertible senior...

  • Page 113
    Other Company Long-Term Debt During November 2014, the Company issued $300 million senior unsecured notes due 2019. The notes bear interest at 2.75 percent, payable semi-annually in arrears on May 6 and November 6. Concurrently, the Company entered into a fixed-to-floating interest rate swap to ...

  • Page 114
    ... obligations to which they relate are reflected as liabilities in the Consolidated Balance Sheet. Outstanding letters of credit totaled $440 million at December 31, 2014. The net book value of the assets pledged as collateral for the Company's secured borrowings, primarily aircraft and engines, was...

  • Page 115
    ...$ 22 192 $ 2013 69 12 57 Total rental expense for operating leases, both aircraft and other, charged to operations in 2014, 2013, and 2012 was $931 million, $997 million, and $943 million, respectively. The majority of the Company's terminal operations space, as well as 174 aircraft, which includes...

  • Page 116
    .... A total of 76 of the B717s are on operating lease, ten are owned, and two are on capital lease. The Company has paid and will continue to 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...

  • Page 117
    ... 9 to the Consolidated Financial Statements for information regarding the Company's equity plans. 9. STOCK PLANS Share-based compensation The Company accounts for share-based compensation utilizing fair value. The Consolidated Statement of Income for the years ended December 31, 2014, 2013, and 2012...

  • Page 118
    ... during 2012, 2013, and 2014 and performance-based restricted stock units ("PBRSUs") to certain Employees during 2014. The fair value of RSUs and PBRSUs is based on the closing price of the Company's common stock on the date of grant. Outstanding RSUs vest over three years, subject generally to...

  • Page 119
    ... insignificant number of options outstanding as of December 31, 2014. Although the Company does not have a formal policy, upon option exercise, the Company will typically issue treasury stock, to the extent such shares are available. For other Employee plans, options vest and generally become fully...

  • Page 120
    ... $1 million, respectively. The total grant date fair value of shares vesting during the years ended December 31, 2014, 2013, and 2012, was $15 million, $16 million, and $13 million, respectively. Employee Stock Purchase Plan Under the amended 1991 Employee Stock Purchase Plan (ESPP), which has been...

  • Page 121
    ...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 or below. The Company evaluates its hedge volumes strictly from an "economic" standpoint and thus...

  • Page 122
    .... The following table provides information about the Company's volume of fuel hedging for the years 2015 through 2018 on an "economic" basis considering current market prices: Fuel hedged as of December 31, 2014 (gallons in millions) - 885 757 - Derivative underlying commodity type as of December 31...

  • Page 123
    ... during 2012, 2013, or 2014. In some situations, an entire commodity type used in hedging may cease to qualify for special hedge accounting treatment. As an example, during 2013, the Company's routine statistical analysis performed to determine which commodities qualify for special hedge accounting...

  • Page 124
    ... 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 all assets and liabilities associated with the Company's hedging instruments within the Consolidated Balance Sheet: Asset...

  • Page 125
    ...counterparties for fuel contracts- noncurrent Cash collateral deposits provided to counterparties for interest rate contracts noncurrent Due to third parties for fuel contracts Receivable from third parties for fuel contracts - current Balance Sheet location Offset against Accrued liabilities Offset...

  • Page 126
    ... amounts liabilities offset in the presented in the Balance Sheet Balance Sheet Description Fuel derivative contracts Fuel derivative contracts Fuel derivative contracts Fuel derivative contracts Interest rate derivative contracts Balance Sheet location Prepaid expenses and other current assets...

  • Page 127
    ...the Company's measurement of effectiveness for related hedges and are included as a component of Other (gains) losses, net, in the Consolidated Statement of Income. The fair values of the derivative instruments, depending on the type of instrument, were determined by the use of present value methods...

  • Page 128
    ... the acquisition date. The ineffectiveness associated with all of the Company's interest rate cash flow hedges for all periods presented was not material. In June 2012, the Company terminated the AirTran floating-to-fixed interest rate swap agreements related to its Floating-rate 737 Aircraft Notes...

  • Page 129
    ... rates as of December 31, 2014. 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. At such times, these outstanding instruments expose the Company to credit loss...

  • Page 130
    ... of fair value of fuel derivative contracts. (c) Thresholds may vary based on changes in credit ratings within investment grade. (d) The Company has the option of providing cash, letters of credit, or pledging aircraft as collateral. (e) The Company has the option of providing cash or letters of...

  • Page 131
    ... are guaranteed by the U.S. Government. 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 contracts, which are not traded on a public exchange...

  • Page 132
    ... the unfunded portion of the plan. The Company records changes in the fair value of the asset in the Company's earnings. All of the Company's auction rate security instruments, totaling $27 million (net) at December 31, 2014, are classified as available-for-sale securities and are reflected at their...

  • Page 133
    The following tables present the Company's assets and liabilities that are measured at fair value on a recurring basis at December 31, 2014, and December 31, 2013: Fair value measurements at reporting date using: Quoted prices in Significant Significant active markets other observable unobservable ...

  • Page 134
    ... investments (b) Auction rate securities Interest rate derivatives (see Note 10) Fuel derivatives: Swap contracts (c) Option contracts (c) Option contracts (d) Other available-for-sale securities Total assets Liabilities Fuel derivatives: Swap contracts (c) Option contracts (c) Swap contracts...

  • Page 135
    ... Other assets in the Consolidated Balance Sheet. Fair value measurements using significant unobservable inputs (Level 3) (in millions) Balance at December 31, 2012 Total gains or (losses) (realized or unrealized) Included in earnings Included in other comprehensive income Purchases Sales Settlements...

  • Page 136
    ... fair value of this debt to be Level 3, as certain inputs used to determine the fair value of these agreements are unobservable. The Company utilizes indicative pricing from counterparties and a discounted cash flow method to estimate the fair value of the Level 3 items. (in millions) 5.75% Notes...

  • Page 137
    ... $ 34 12 22 23 9 14 36 Affected line item in the Consolidated Statement of Comprehensive Income Fuel and oil expense Less: Tax expense Net of tax Interest expense Less: Tax expense Net of tax Net of tax 13. EMPLOYEE RETIREMENT PLANS Defined contribution plans Southwest has defined contribution...

  • Page 138
    ... 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, 2014 and 2013. (in millions) Funded status Unrecognized net actuarial gain Unrecognized prior service cost Accumulated...

  • Page 139
    ... on the amounts reported for the consolidated postretirement plans. A one percent change in all healthcare cost trend rates used in measuring the APBO at December 31, 2014, would have the following effects: (in millions) Increase (decrease) in total service and interest costs Increase (decrease) in...

  • Page 140
    ... from sale and leaseback of aircraft Capital and operating leases Construction obligation Accrued engine maintenance Accrued employee benefits State taxes Business partner income Net operating losses and credit carryforwards Other Total deferred tax assets Net deferred tax liability $ $ 2014 4,277...

  • Page 141
    ... U.S. tax rates Nondeductible items State income taxes, net of federal benefit Other, net Total income tax provision $ 2014 636 9 37 (2) 680 $ 2013 423 10 25 (3) 455 $ 2012 240 10 14 - 264 $ $ $ During 2014, the Company continued to maintain and did not adjust, a $5 million liability for...

  • Page 142
    ... in accordance with the standards of the Public Company Accounting Oversight Board (United States), Southwest Airlines Co.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring...

  • Page 143
    ... balance sheet of Southwest Airlines Co. as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2014 and our report dated February 6, 2015 expressed...

  • Page 144
    QUARTERLY FINANCIAL DATA (unaudited) Three months ended (in millions except per share amounts) March 31 June 30 Sept. 30 Dec. 31 2014 Operating revenues Operating income Income before income taxes Net income Net income per share, basic Net income per share, diluted $ 4,166 215 244 152 0.22 0.22 ...

  • Page 145
    ... public accounting firm who audited the Company's Consolidated Financial Statements included in this Form 10-K, has issued a report on the Company's internal control over financial reporting, which is included herein. Changes in Internal Control over Financial Reporting. There were no changes...

  • Page 146
    ... documents are also available upon request 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...

  • Page 147
    ... 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 9 to the Consolidated Financial Statements for information regarding the material features of the above plans. Each of the...

  • Page 148
    ... this annual report, since the required information is included in the Consolidated Financial Statements, including the notes thereto, or the circumstances requiring inclusion of such schedules are not present. 3. Exhibits: 3.1 Restated Certificate of Formation of the Company, effective May 18, 2012...

  • Page 149
    ... to Exhibits 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...

  • Page 150
    ...Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 (File No. 1-7259)). (1) 10.1(a) 10.1(b) Supplemental Agreement No. 89 to Purchase Agreement No. 1810, dated January 19, 1994, between The Boeing Company and the Company. (1) Supplemental Agreement No...

  • Page 151
    ... 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. LUV 2000 Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8 filed January 12...

  • Page 152
    ...(2) Southwest Airlines Co. Deferred Compensation Plan for Senior Leadership and NonEmployee Members of the Southwest Airlines Co. Board of Directors (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated May 13, 2014 (File No. 1-7259)). (2) Southwest Airlines Co...

  • Page 153
    ...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. 145

  • Page 154
    [THIS PAGE INTENTIONALLY LEFT BLANK]

  • Page 155
    ... Chair for Free Enterprise The University of Texas at Austin Red McCombs School of Business Former Chancellor of The University of Texas System Audit Committee, Nominating and Corporate Governance Committee (Chair), and Executive Committee JOHN G. DENISON Former Chairman of the Board Global Aero...

  • Page 156
    ...U.S. Securities and Exchange Commission, is included herein. 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-6IR P.O. Box 36611 2702 Love Field Drive Dallas, Texas...