Southwest Airlines 2014 Annual Report Download - page 116

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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 B717s to Delta at agreed-upon lease rates. The
first converted B717 was delivered to Delta in September 2013, and as of December 31, 2014, the
Company had delivered a total of 52 B717s to Delta. Over the expected term of the transition period
for all B717s, the Company expects to average approximately three B717 conversions per month;
however, as the Company previously announced, all B717s remaining at Southwest were grounded on
December 28, 2014. A portion of the B717 fleet that will not be delivered to Delta until the second half
of 2015 has been placed in storage until each aircraft is ready to be converted. 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
agreement to pay these conversion and maintenance costs is a “lease incentive” under applicable
accounting guidance. The sublease terms for the 76 B717s on operating lease and the two B717s on
capital lease coincide with the Company’s remaining lease terms for these aircraft from the original
lessor, which range from approximately three to nine years. The leasing of the ten B717s that are
owned by the Company is subject to certain conditions, and the lease terms are for seven years, after
which Delta will have the option to purchase the aircraft at the then-prevailing market value. The
Company accounts 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 the two capital lease aircraft
are 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 76 B717s that are 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. During 2014, the Company recorded an additional
$22 million in expense for its revised estimate of conversion costs for these B717s. The charges
108