Southwest Airlines 2014 Annual Report Download - page 74

On September 22, 2014, Fitch affirmed the Company’s debt rating of “BBB” and revised the
rating outlook from stable to positive. The positive outlook reflects Fitch’s view that a positive rating
action could be warranted over the intermediate term should the Company continue to strengthen its
operating margins, control unit cost inflation, generate solid free cash flow, and exhibit stable or
declining leverage. Fitch also noted that the operating risks relating to the integration of AirTran are
now largely in the past as the Company was expected to effectively complete the integration process
by year-end 2014.
On October 31, 2014, Standard and Poor’s raised the Company’s credit rating to ‘BBB’ from
‘BBB-’, based on the Company’s’ improving financial profile. Standard and Poor’s noted the
Company’s improved credit ratios due to rising earnings and cash flow, and expects further
improvement over the next two years.
The Company has a large net deferred tax liability on its Consolidated Balance Sheet. The
deferral of income taxes has resulted in a significant benefit to the Company and its liquidity position.
Since the Company purchases the majority of the aircraft it acquires, it has been able to utilize
accelerated depreciation methods (including bonus depreciation) available under the Internal Revenue
Code in 2014 and in previous years, which has enabled the Company to defer the cash tax payments
associated with these depreciable assets to future years. Based on the Company’s scheduled future
aircraft deliveries from Boeing and existing tax laws in effect, the Company will continue to defer a
portion of cash income taxes to future years. The Company has paid in the past, and will continue to
pay in the future, significant cash taxes to the various taxing jurisdictions where it operates. The
Company expects to be able to continue to meet such obligations utilizing cash and investments on
hand, as well as cash generated from its ongoing operations.
Off-Balance Sheet Arrangements, Contractual Obligations, and Contingent Liabilities and
Commitments
The Company has contractual obligations and commitments primarily with regard to future
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
Sheet until the aircraft is delivered, at which time deposits previously made are deducted from the final
purchase price of the aircraft and are reclassified as Flight equipment. See Note 4 to the Consolidated
Financial Statements for a complete table of the Company’s firm orders, options, and purchase rights
with Boeing and other parties. Under the Company’s agreement with Boeing, it has the option to
substitute 737-600s for the 737-700s ordered with at least 24 months notice prior to the contractual
delivery date and can substitute 737-800s for the 737-700s with at least twelve months notice.
The leasing of aircraft (including the sale and leaseback of aircraft) provides flexibility to the
Company as a source of financing. Although the Company is responsible for all maintenance,
insurance, and expense associated with operating leased aircraft, and retains the risk of loss for these
aircraft, it has not made guarantees to the lessors regarding the residual value (or market value) of the
aircraft at the end of the lease terms. As of December 31, 2014, the Company had 190 leased aircraft,
including 78 B717s subleased to Delta. Of these leased aircraft, 174 are under operating leases,
including 76 B717s subleased to Delta. Assets and obligations under operating leases are not included
in the Company’s Consolidated Balance Sheet. Disclosure of the contractual obligations associated
with the Company’s leased aircraft is included below, as well as in Note 7 to the Consolidated
Financial Statements.
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