Notes to Condensed Consolidated Financial Statements
(unaudited)
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
1. BASIS OF PRESENTATION
Southwest Airlines Co. (the "Company" or "Southwest") operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States and near-international markets. The unaudited Condensed Consolidated Financial Statements include accounts of the Company and its wholly owned subsidiaries.
The accompanying unaudited Condensed Consolidated Financial Statements of the Company and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States ("GAAP") for complete financial statements. The unaudited Condensed Consolidated Financial Statements for the interim periods ended March 31, 2022 and 2021 include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods. This includes all normal and recurring adjustments and elimination of significant intercompany transactions. Financial results for the Company and airlines in general can be seasonal in nature. In many years, the Company's revenues, as well as its Operating income and Net income, have been better in its second and third fiscal quarters than in its first and fourth fiscal quarters. However, beginning in early 2020, as a result of the COVID-19 pandemic, the Company's results have not always been in line with such historical trends. See Note 2 for further information. Air travel is also significantly impacted by general economic conditions, the amount of disposable income available to consumers and changes in consumer behavior, unemployment levels, corporate travel budgets, global pandemics such as COVID-19, extreme or severe weather and natural disasters, fears of terrorism or war, governmental actions, and other factors beyond the Company's control. These and other factors, such as the price of jet fuel in some periods, the nature of the Company's fuel hedging program, and the periodic volatility of commodities used by the Company for hedging jet fuel, have created, and may continue to create, significant volatility in the Company's financial results. See Note 4 for further information on fuel and the Company's hedging program. Operating results for the three months ended March 31, 2022, are not necessarily indicative of the results that may be expected for future quarters or for the year ended December 31, 2022. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2021.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
2. WORLDWIDE PANDEMIC
As a result of the rapid spread of the novel coronavirus, COVID-19, throughout the world, including into the United States, on March 11, 2020, the World Health Organization classified the virus as a pandemic. The speed with which the effects of the COVID-19 pandemic changed the U.S. economic landscape, outlook, and in particular the travel industry, was swift and unexpected. The Company experienced significant disruptions in travel and reduced bookings throughout the remainder of 2020 and for the entirety of 2021 as a result of the pandemic and subsequent variants of COVID-19. Following a significant negative impact to revenues and bookings in January and February 2022, which included increased trip cancellations and staffing challenges associated with the Omicron variant, the Company saw improvements in revenue trends in March 2022 as COVID-19 cases significantly trended downward. The Company continues to monitor demand for air travel and proactively adjust its published flight schedules and capacity.
Since the start of the pandemic, the Company entered into definitive documentation with the United States Department of the Treasury ("Treasury") with respect to payroll funding support ("Payroll Support") pursuant to three separate Payroll Support programs: the "PSP1 Payroll Support Program" in April 2020 under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"); the "PSP2 Payroll Support Program” in January 2021 under the Consolidated Appropriations Act, 2021; and the "PSP3 Payroll Support Program" in April 2021 under the American Rescue Plan Act of 2021.
As consideration for each of these Payroll Support programs, the Company issued a promissory note in favor of Treasury and entered into a warrant agreement with Treasury. The following table provides the details from the PSP1, PSP2 and PSP3 Payroll Support programs:
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(dollars in millions, shares in thousands) | Grant | Promissory Note | Warrants | Total Payroll Support Proceeds | Warrants (shares) | Warrant strike price | Promissory Note Maturity Date |
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PSP1 | $ | 2,337 | | $ | 976 | | $ | 40 | | $ | 3,354 | | 2,676 | | $36.47/share | April 19, 2030 |
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PSP2 | $ | 1,393 | | $ | 566 | | $ | 27 | | $ | 1,987 | | 1,223 | | $46.28/share | January 15, 2031 |
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PSP3 | $ | 1,310 | | $ | 526 | | $ | 18 | | $ | 1,852 | | 899 | | $58.51/share | April 23, 2031 |
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Total | $ | 5,040 | | $ | 2,068 | | $ | 85 | | $ | 7,193 | | 4,798 | | | |
In connection with the receipt of Payroll Support, the Company is subject to certain restrictions, including the elimination of share repurchases and dividends through September 30, 2022; and limits on executive compensation until April 1, 2023.
Under each of the three Payroll Support programs, funds received were used solely to pay qualifying employee salaries, wages, and benefits. All grant portions of the Payroll Support programs received had been allocated and classified as a contra-expense line item in the Company's financial statements by the end of 2021, including approximately $1.2 billion for the three months ended March 31, 2021 in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).
On June 1, 2020, the Company announced Voluntary Separation Program 2020 ("Voluntary Separation Program"), a voluntary separation program that allowed eligible Employees the opportunity to voluntarily separate from the Company in exchange for severance, medical/dental coverage for a specified period of time, and travel privileges based on years of service. A total of over 4,200 Employees elected to participate in Voluntary Separation Program.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
In conjunction with Voluntary Separation Program, the Company also offered certain contract Employees the option to take voluntary Extended Emergency Time Off ("Extended ETO"), for periods between six and 18 months, with the exception of Pilots, who could elect to take Extended ETO for periods up to five years, all subject to early recalls. Approximately 12,000 Employees participated in the Extended ETO program in 2020 and 2021 combined. The Company had no Employees remaining on Extended ETO as of March 31, 2022.
The purpose of Voluntary Separation Program and Extended ETO was to maintain a reduced workforce to operate at reduced capacity relative to the Company's operations prior to the COVID-19 pandemic. In accordance with the accounting guidance in Accounting Standards Codification ("ASC") Topic 712 (Compensation — Nonretirement Postemployment Benefits), the Company accrued charges related to the special termination benefits described above upon Employees accepting Voluntary Separation Program or Extended ETO offers. The Company accrued expenses totaling $1.4 billion for its Voluntary Separation Program and Extended ETO program in 2020, which are being reduced as program benefits are paid. For both the Voluntary Separation Program and Extended ETO programs combined, approximately $32 million of the liability balances were relieved during the first three months of 2022 through payments to Employees, leaving a balance of $296 million as of March 31, 2022, all of which relates to the Voluntary Separation Program. During first quarter 2021, the Company determined that it was no longer probable that the remaining portion of the Employees on Extended ETO would remain on such leave for their entire elected term. Therefore, a portion of the accruals previously recorded were reversed, resulting in a net $115 million credit to expense during first quarter 2021. Both the initial charge and the partial reversal were classified within Payroll support and voluntary Employee programs, net, in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).
In response to flight schedule adjustments due to the effects of the COVID-19 pandemic, a number of aircraft were taken out of the Company’s schedule beginning in late March 2020, and placed in short-term storage, as well as some in a longer term storage program. As of March 31, 2022, four aircraft remained in storage, and given the expectation that this storage was temporary in nature, the Company has continued to record depreciation expense associated with them.
3. NEW ACCOUNTING PRONOUNCEMENTS
On May 3, 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. This new standard provides clarification and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (such as warrants) that remain equity classified after modification or exchange. This standard is effective for fiscal years beginning after December 15, 2021, and the standard was adopted and applied prospectively by the Company as of January 1, 2022, but the adoption and application did not have a significant impact on the Company's financial statements and disclosures, including interim periods.
On January 7, 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848). This new standard provides optional temporary guidance for entities transitioning away from London Interbank Offered Rate ("LIBOR") to new reference interest rates so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions with Topic 848. These amendments do not apply to any contract modifications made after December 31, 2022, any new hedging relationships entered into after December 31, 2022, or to existing hedging relationships evaluated for effectiveness existing as of December 31, 2022, that apply certain optional practical expedients. This standard was effective immediately and may be applied (i) on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or (ii) on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued. The Company had no material LIBOR-related contract modifications during the three months ended March 31, 2022.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
On August 5, 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This new standard reduced the number of accounting models for convertible debt instruments and convertible preferred stock, made targeted improvements to the disclosures for convertible instruments and earnings-per-share ("EPS") guidance, and amended the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. This standard is effective for fiscal years beginning after December 15, 2021, and the Company adopted this standard as of January 1, 2022, utilizing the modified retrospective method. Under the modified approach, the Company applied guidance to all financial instruments that were outstanding as of the beginning of the year of adoption with the cumulative effect recognized as an adjustment to the opening balance of retained earnings. Upon adoption, the Company reclassified the remaining equity component of $300 million, from Additional paid-in capital to Long-term debt associated with its 1.25% Convertible Senior Notes due 2025 (the “Convertible Notes”), and no longer records amortization of the debt discount to Interest expense. The cumulative effect from prior period amortization of the debt discount that has been recorded to Interest expense, offset by reductions to Capital in excess of par value related to the requisition of the equity component through previous repurchases, resulted in a $55 million adjustment to the opening balance of Retained earnings upon adoption. The new standard requires the use of the if-converted method to calculate diluted EPS, which is generally more dilutive, rather than the treasury stock method as was the Company's policy pre-adoption. The first quarter 2022 impact of adopting this new standard was an increase to the Company's Net loss in the amount of $36 million, or $0.06 per diluted share, as a result of higher losses recognized on the Company’s extinguishment transactions following the elimination of the equity component of the Convertible Notes, partially offset by the elimination of the non-cash interest expense associated with the prior debt discount amortization. See Note 7.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
4. FINANCIAL DERIVATIVE INSTRUMENTS
Fuel Contracts
Airline operators are inherently dependent upon energy to operate and, therefore, are impacted by changes in jet fuel prices. Furthermore, jet fuel and oil typically represents one of the largest operating expenses for airlines. The Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses through its fuel hedging program. Although the Company may periodically enter into jet fuel derivatives for short-term timeframes, because jet fuel is not widely traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel for time horizons longer than approximately 24 months into the future. However, the Company has found that financial derivative instruments in other commodities, such as West Texas Intermediate ("WTI") crude oil, Brent crude oil, and refined products, such as heating oil and unleaded gasoline, can be useful in decreasing its exposure to jet fuel price volatility. The Company does not purchase or hold any financial derivative instruments for trading or speculative purposes.
The Company has used financial derivative instruments for both short-term and long-term timeframes, and primarily uses a mixture of purchased call options, collar structures (which include both a purchased call option and a sold put option), call spreads (which include a purchased call option and a sold call option), put spreads (which include a purchased put option and a sold put option), and fixed price swap agreements in its portfolio. Although the use of collar structures and swap agreements can reduce the overall cost of hedging, these instruments carry more risk than purchased call options in that the Company could end up in a liability position when the collar structure or swap agreement settles. With the use of purchased call options and call spreads, the Company cannot be in a liability position at settlement, but does not have coverage once market prices fall below the strike price of the purchased call option.
For the purpose of evaluating its net cash spend for jet fuel and for forecasting its future estimated jet fuel expense, the Company evaluates its hedge volumes strictly from an "economic" standpoint and thus does not consider whether the hedges have qualified or will qualify for hedge accounting. The Company defines its "economic" hedge as the net volume of fuel derivative contracts held, including the impact of positions that have been offset through sold positions, regardless of whether those contracts qualify for hedge accounting. The level at which the Company is economically hedged for a particular period is also dependent on current market prices for that period, as well as the types of derivative instruments held and the strike prices of those instruments. For example, the Company may enter into "out-of-the-money" option contracts (including "catastrophic" protection), which may not generate intrinsic gains at settlement if market prices do not rise above the option strike price. Therefore, even though the Company may have an economic hedge in place for a particular period, that hedge may not produce any hedging gains at settlement and may even produce hedging losses depending on market prices, the types of instruments held, and the strike prices of those instruments.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
As of March 31, 2022, the Company had fuel derivative instruments in place to provide coverage at varying price levels. The following table provides information about the Company’s volume of fuel hedging on an economic basis:
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| | Maximum fuel hedged as of | | | |
| | March 31, 2022 | | Derivative underlying commodity type as of | |
Period (by year) | | (gallons in millions) (a) | | March 31, 2022 | |
Remainder of 2022 | | 915 | | | WTI crude oil and Brent crude oil | |
2023 | | 769 | | | WTI crude oil and Brent crude oil | |
2024 | | 358 | | | WTI crude oil and Brent crude oil | |
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(a) Due to the types of derivatives utilized by the Company and different price levels of those contracts, these volumes represent the maximum economic hedge in place and may vary significantly as market prices and the Company's flight schedule fluctuate.
Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges. Qualification is re-evaluated quarterly, and all periodic changes in fair value of the derivatives designated as hedges are recorded in Accumulated other comprehensive income ("AOCI") until the underlying jet fuel is consumed. See Note 5.
If a derivative ceases to qualify for hedge accounting, any change in the fair value of derivative instruments since the last reporting period would be recorded in Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) in the period of the change; however, any amounts previously recorded to AOCI would remain there until such time as the original forecasted transaction occurs, at which time these amounts would be reclassified to Fuel and oil expense. Factors that have and may continue to lead to the loss of hedge accounting include: significant fluctuation in energy prices, significant weather events affecting refinery capacity and the production of refined products, and the volatility of the different types of products the Company uses in hedging. Increased volatility in these commodity markets for an extended period of time, especially if such volatility were to worsen, could cause the Company to lose hedge accounting altogether for the commodities used in its fuel hedging program, which would create further volatility in the Company’s GAAP financial results. However, even though derivatives may not qualify for hedge accounting, the Company continues to hold the instruments as management believes derivative instruments continue to afford the Company the opportunity to stabilize jet fuel costs. When the Company has sold derivative positions in order to effectively "close" or offset a derivative already held as part of its fuel derivative instrument portfolio, any subsequent changes in fair value of those positions are marked to market through earnings. Likewise, any changes in fair value of those positions that were offset by entering into the sold positions and were de-designated as hedges are concurrently marked to market through earnings. However, any changes in value related to hedges that were deferred as part of AOCI while designated as a hedge would remain until the originally forecasted transaction occurs. In a situation where it becomes probable that a fuel hedged forecasted transaction will not occur, any gains and/or losses that have been recorded to AOCI would be required to be immediately reclassified into earnings.
During 2021, as a result of the drop in demand for air travel compared with 2019 due to the pandemic, the Company was in an estimated "over-hedged" position and was required to de-designate a portion of its fuel hedges for hedge accounting purposes. However, the impact of such de-designations was not material to 2021 financial results.
All cash flows associated with purchasing and selling fuel derivatives are classified as Other operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows. The following table presents the location of all assets and liabilities associated with the Company’s derivative instruments within the unaudited Condensed Consolidated Balance Sheet:
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
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| | | | Asset derivatives | | Liability derivatives |
| | Balance Sheet | | Fair value at | | Fair value at | | Fair value at | | Fair value at |
(in millions) | | location | | 3/31/2022 | | 12/31/2021 | | 3/31/2022 | | 12/31/2021 |
Derivatives designated as hedges (a) | | | | | | | | | | |
Fuel derivative contracts (gross) | | Prepaid expenses and other current assets | | $ | 849 | | | $ | 409 | | | $ | — | | | $ | — | |
Fuel derivative contracts (gross) | | Other assets | | 470 | | | 287 | | | — | | | — | |
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Interest rate derivative contracts | | Other assets | | 3 | | | — | | | — | | | — | |
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Interest rate derivative contracts | | Other noncurrent liabilities | | — | | | — | | | 1 | | | 4 | |
Total derivatives designated as hedges | | $ | 1,322 | | | $ | 696 | | | $ | 1 | | | $ | 4 | |
Derivatives not designated as hedges (a) | | | | | | | | | | |
Fuel derivative contracts (gross) | | Prepaid expenses and other current assets | | $ | — | | | $ | — | | | $ | 46 | | | $ | — | |
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Total derivatives | | | | $ | 1,322 | | | $ | 696 | | | $ | 47 | | | $ | 4 | |
(a) Represents the position of each trade before consideration of offsetting positions with each counterparty and does not include the impact of cash collateral deposits provided to or received from counterparties. See discussion of credit risk and collateral following in this Note 4.
In addition, the Company had the following amounts associated with fuel derivative instruments and hedging activities in its unaudited Condensed Consolidated Balance Sheet:
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| | Balance Sheet | | March 31, | | December 31, |
(in millions) | | location | | 2022 | | 2021 |
Cash collateral deposits held from counterparties for fuel contracts - current | | Offset against Prepaid expenses and other current assets | | $ | 410 | | | $ | 80 | |
Cash collateral deposits held from counterparties for fuel contracts - noncurrent | | Offset against Other assets | | 150 | | | 95 | |
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Receivable from third parties for fuel contracts | | Accounts and other receivables | | 111 | | | 8 | |
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All of the Company's fuel derivative instruments and interest rate swaps are subject to agreements that follow the netting guidance in the applicable accounting standards for derivatives and hedging. The types of derivative instruments the Company has determined are subject to netting requirements in the accompanying unaudited Condensed Consolidated Balance Sheet are those in which the Company pays or receives cash for transactions with the same counterparty and in the same currency via one net payment or receipt. For cash collateral held by the Company or provided to counterparties, the Company nets such amounts against the fair value of the Company's derivative portfolio by each counterparty. The Company has elected to utilize netting for both its fuel derivative instruments and interest rate swap agreements and also classifies such amounts as either current or noncurrent, based on the net fair value position with each of the Company's counterparties in the unaudited Condensed Consolidated Balance Sheet. If its fuel derivative instruments are in a net asset position with a counterparty, cash collateral amounts held are first netted against current outstanding derivative asset amounts associated with that counterparty until that balance is zero, and then any remainder is applied against the fair value of noncurrent outstanding derivative instruments. As of March 31, 2022, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
The Company has the following recognized financial assets and financial liabilities resulting from those transactions that meet the scope of the disclosure requirements as necessitated by applicable accounting guidance for balance sheet offsetting:
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Offsetting of derivative assets | |
(in millions) | |
| | | | (i) | | (ii) | | (iii) = (i) + (ii) | | (i) | | (ii) | | (iii) = (i) + (ii) | |
| | | | March 31, 2022 | | December 31, 2021 | |
Description | | Balance Sheet location | | Gross amounts of recognized assets | | Gross amounts offset in the Balance Sheet | | Net amounts of assets presented in the Balance Sheet | | Gross amounts of recognized assets | | Gross amounts offset in the Balance Sheet | | Net amounts of assets presented in the Balance Sheet | |
Fuel derivative contracts | | Prepaid expenses and other current assets | | $ | 849 | | | $ | (456) | | (b) | $ | 393 | | | $ | 409 | | | $ | (80) | | | $ | 329 | | |
Fuel derivative contracts | | Other assets | | $ | 470 | | | $ | (150) | | | $ | 320 | | (a) | $ | 287 | | | $ | (95) | | | $ | 192 | | (a) |
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Interest rate derivative contracts | | Other assets | | $ | 3 | | | $ | — | | | $ | 3 | | (a) | $ | — | | | $ | — | | | $ | — | | (a) |
(a) The net amounts of derivative assets and liabilities are reconciled to the individual line item amounts presented in the unaudited Condensed Consolidated Balance Sheet in Note 9.
(b) Includes the current portion of cash collateral deposits held from counterparties and derivative liability associated with fuel contracts.
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Offsetting of derivative liabilities | |
(in millions) | |
| | | | (i) | | (ii) | | (iii) = (i) + (ii) | | (i) | | (ii) | | (iii) = (i) + (ii) | |
| | | | March 31, 2022 | | December 31, 2021 | |
Description | | Balance Sheet location | | Gross amounts of recognized liabilities | | Gross amounts offset in the Balance Sheet | | Net amounts of liabilities presented in the Balance Sheet | | Gross amounts of recognized liabilities | | Gross amounts offset in the Balance Sheet | | Net amounts of liabilities presented in the Balance Sheet | |
Fuel derivative contracts | | Prepaid expenses and other current assets | | $ | 456 | | | $ | (456) | | (b) | $ | — | | | $ | 80 | | | $ | (80) | | | $ | — | | |
Fuel derivative contracts | | Other assets | | $ | 150 | | | $ | (150) | | | $ | — | | (a) | $ | 95 | | | $ | (95) | | | $ | — | | (a) |
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Interest rate derivative contracts | | Other noncurrent liabilities | | $ | 1 | | | $ | — | | | $ | 1 | | | $ | 4 | | | $ | — | | | $ | 4 | | |
(a) The net amounts of derivative assets and liabilities are reconciled to the individual line item amounts presented in the unaudited Condensed Consolidated Balance Sheet in Note 9.
(b) Includes the current portion of cash collateral deposits held from counterparties and derivative liability associated with fuel contracts.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three months ended March 31, 2022 and 2021:
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Location and amount recognized in income on cash flow and fair value hedging relationships |
| | Three months ended March 31, 2022 | | Three months ended March 31, 2021 |
(in millions) | | Fuel and oil | | Other (gains)/losses, net | | Other operating expenses | | Fuel and oil | | Other (gains)/losses, net | | Interest expense |
Total | | $ | (203) | | | $ | — | | | $ | 2 | | | $ | 16 | | | $ | 6 | | | $ | 1 | |
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(Gain) loss on cash flow hedging relationships: | | | | | | | | | | | | |
Commodity contracts: | | | | | | | | | | | | |
Amount of (gain) loss reclassified from AOCI into income | | (203) | | | — | | | — | | | 16 | | | 6 | | | — | |
Interest contracts: | | | | | | | | | | | | |
Amount of loss reclassified from AOCI into income | | — | | | — | | | 2 | | | — | | | — | | | 1 | |
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Derivatives designated and qualified in cash flow hedging relationships | | | |
| Gain recognized in AOCI on derivatives, net of tax |
| Three months ended |
| March 31, |
(in millions) | 2022 | | 2021 |
Fuel derivative contracts | $ | 654 | | | $ | 84 | |
Interest rate derivatives | 4 | | | 9 | |
Total | $ | 658 | | | $ | 93 | |
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Derivatives not designated as hedges |
| (Gain) loss recognized in income on derivatives | | |
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| Three months ended | | Location of (gain) loss recognized in income on derivatives |
| March 31, | |
(in millions) | 2022 | | 2021 | |
Fuel derivative contracts | $ | 34 | | | $ | (5) | | | Other (gains) losses, net |
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The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three months ended March 31, 2022 and 2021. Gains and/or losses associated with fuel derivatives that qualify for hedge accounting are ultimately recorded to Fuel and oil expense. Gains and/or losses associated with fuel derivatives that do not qualify for hedge accounting are recorded to Other (gains) and losses, net. The following
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
table presents the impact of premiums paid for fuel derivative contracts and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) during the period the contract settles:
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| Premium expense recognized in income on derivatives | | |
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| Three months ended | | Location of premium expense recognized in income on derivatives |
| March 31, | |
(in millions) | 2022 | | 2021 | |
Fuel derivative contracts designated as hedges | $ | 26 | | | $ | 14 | | | Fuel and oil |
Fuel derivative contracts not designated as hedges | — | | | 11 | | | Other (gains) losses, net |
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The fair values of the derivative instruments, depending on the type of instrument, were determined by the use of present value methods or option value models with assumptions about commodity prices based on those observed in underlying markets or provided by third parties. Included in the Company’s cumulative unrealized gains from fuel hedges as of March 31, 2022, recorded in AOCI, were approximately $578 million in unrealized gains, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to March 31, 2022.
Interest Rate Swaps
The Company is party to certain interest rate swap agreements that are accounted for as cash flow hedges, and has in the past held interest rate swap agreements that have qualified as fair value hedges, as defined in the applicable accounting guidance for derivative instruments and hedging. Several of the Company's interest rate swap agreements qualify for the "shortcut" or "critical terms match" methods of accounting for hedges, which dictate that the hedges were assumed to be perfectly effective at origination, and, thus, there was no ineffectiveness to be recorded in earnings.
For the Company’s interest rate swap agreements that do not qualify for the "shortcut" or "critical terms match" methods of accounting, ineffectiveness is assessed at each reporting period. If hedge accounting is achieved, all periodic changes in fair value of the interest rate swaps are recorded in AOCI.
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 in the event of nonperformance by the counterparties to the agreements. However, the Company has not experienced any significant credit loss as a result of counterparty nonperformance in the past. To manage credit risk, the Company selects and periodically reviews counterparties based on credit ratings, limits its exposure with respect to each counterparty, and monitors the market position of the fuel hedging program and its relative market position with each counterparty. At March 31, 2022, the Company had agreements with all of its active counterparties containing early termination rights and/or bilateral collateral provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on the counterparty's credit rating. The Company also had agreements with counterparties in which cash deposits and letters of credit were required to be posted as collateral whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds. In certain cases, the Company has the ability to substitute among these different forms of collateral at its discretion.
The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold amounts as of March 31, 2022, at which such postings are triggered:
| | | | | | | | |
| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Counterparty (CP) | | |
(in millions) | A | | B | | | | C | | D | | E | | F | | G | | Other (a) | | Total |
Fair value of fuel derivatives | $ | 315 | | | $ | 161 | | | | | $ | 303 | | | $ | 124 | | | $ | 146 | | | $ | 96 | | | $ | 101 | | | $ | 27 | | | $ | 1,273 | |
Cash collateral held from CP | 341 | | | 25 | | | | | 84 | | | 19 | | | 58 | | | 33 | | | — | | | — | | | 560 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Option to substitute LC for cash | N/A | | N/A | | | | (b) | | (b)
| | (b) | | N/A | | (b) | | | | |
If credit rating is investment grade, fair value of fuel derivative level at which: | | | | | | | | | | | | | | | | | | | |
Cash is provided to CP | >(100) | | >(50) | | | | >(75) | | >(125)
| | >(40) | | >(65) | | >(100) | | | | |
Cash is received from CP | >0(c) | | >150(c) | | | | >250(c) | | >125(c) | | >100(c) | | >70(c) | | >100(c) | | | | |
| | | | | | | | | | | | | | | | | | | |
If credit rating is non-investment grade, fair value of fuel derivative level at which: | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Cash is received from CP | (d) | | (d) | | | | (d) | | (d) | | (d) | | (d) | | (d) | | | | |
| | | | | | | | | | | | | | | | | | | |
(a) Individual counterparties with fair value of fuel derivatives < $16 million.
(b) The Company has the option to substitute letters of credit for 100 percent of cash collateral requirement.
(c) Thresholds may vary based on changes in credit ratings within investment grade.
(d) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.
| | | | | | | | |
| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
5. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes changes in the fair value of certain financial derivative instruments that qualify for hedge accounting, unrealized gains and losses on certain investments, and actuarial gains/losses arising from the Company’s postretirement benefit obligation. The differences between Net income (loss) and Comprehensive income (loss) for the three months ended March 31, 2022 and 2021 were as follows:
| | | | | | | | | | | |
| Three months ended March 31, |
(in millions) | 2022 | | 2021 |
NET INCOME (LOSS) | $ | (278) | | | $ | 116 | |
Unrealized gain on fuel derivative instruments, net of deferred taxes of $151 and $30 | 498 | | | 101 | |
Unrealized gain on interest rate derivative instruments, net of deferred taxes of $2 and $3 | 5 | | | 10 | |
Other, net of deferred taxes of $— and ($13) | — | | | (47) | |
Total other comprehensive income | $ | 503 | | | $ | 64 | |
COMPREHENSIVE INCOME | $ | 225 | | | $ | 180 | |
A rollforward of the amounts included in AOCI, net of taxes, is shown below for the three months ended March 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | Fuel derivatives | | Interest rate derivatives | | Defined benefit plan items | | | | Deferred tax | | Accumulated other comprehensive income |
Balance at December 31, 2021 | $ | 492 | | | $ | (57) | | | $ | 66 | | | | | $ | (113) | | | $ | 388 | |
Changes in fair value | 852 | | | 5 | | | — | | | | | (199) | | | 658 | |
Reclassification to earnings | (203) | | | 2 | | | — | | | | | 46 | | | (155) | |
Balance at March 31, 2022 | $ | 1,141 | | | $ | (50) | | | $ | 66 | | | | | $ | (266) | | | $ | 891 | |
The following table illustrates the significant amounts reclassified out of each component of AOCI for the three months ended March 31, 2022:
| | | | | | | | | | | | | | |
Three months ended March 31, 2022 |
| | | | |
(in millions) | | Amounts reclassified from AOCI | | Affected line item in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) |
AOCI components | | |
Unrealized gain on fuel derivative instruments | | $ | (203) | | | Fuel and oil expense |
| | | | |
| | (47) | | | Less: Tax expense |
| | $ | (156) | | | Net of tax |
Unrealized loss on interest rate derivative instruments | | $ | 2 | | | Interest expense |
| | 1 | | | Less: Tax expense |
| | $ | 1 | | | Net of tax |
| | | | |
| | | | |
| | | | |
| | | | |
Total reclassifications for the period | | $ | (155) | | | Net of tax |
6. REVENUE
Passenger Revenues
The Company’s contracts with its Customers primarily consist of its tickets sold, which are initially deferred as Air traffic liability. Passenger revenue associated with tickets is recognized when the performance obligation to the Customer is satisfied, which is primarily when travel is provided.
Revenue is categorized by revenue source as the Company believes it best depicts the nature, amount, timing, and uncertainty of revenue and cash flow. The following table provides the components of Passenger revenue recognized for the three months ended March 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | |
| Three months ended March 31, | | |
(in millions) | 2022 | | 2021 | | | | |
Passenger non-loyalty | $ | 3,364 | | | $ | 1,354 | | | | | |
Passenger loyalty - air transportation | 624 | | | 278 | | | | | |
Passenger ancillary sold separately | 147 | | | 80 | | | | | |
Total passenger revenues | $ | 4,135 | | | $ | 1,712 | | | | | |
As of March 31, 2022, and December 31, 2021, the components of Air traffic liability, including contract liabilities based on tickets sold and unused flight credits available to the Customer, both of which are net of recorded breakage, and loyalty points available for redemption, within the unaudited Condensed Consolidated Balance Sheet were as follows:
| | | | | | | | | | | |
| Balance as of |
(in millions) | March 31, 2022 | | December 31, 2021 |
Air traffic liability - passenger travel and ancillary passenger services | $ | 3,726 | | | $ | 2,936 | |
Air traffic liability - loyalty program | 4,884 | | | 4,789 | |
Total Air traffic liability | $ | 8,610 | | | $ | 7,725 | |
The balance in Air traffic liability - passenger travel and ancillary passenger services also includes unused funds that are available for use by Customers and are not currently associated with a ticket, although they remain reusable, for a period of time, in the form of a flight credit that can be applied towards the purchase of future travel. These flight credits are typically created as a result of a prior ticket cancellation or exchange. Rollforwards of the Company's Air traffic liability - loyalty program for the three months ended March 31, 2022 and 2021 were as follows (in millions):
| | | | | | | | | | | | | | | | | | | | | |
| Three months ended March 31, | | | | |
| 2022 | | 2021 | | | | | | | | |
Air traffic liability - loyalty program - beginning balance | $ | 4,789 | | | $ | 4,447 | | | | | | | | | |
Amounts deferred associated with points awarded | 736 | | | 466 | | | | | | | | | |
Revenue recognized from points redeemed - Passenger | (624) | | | (278) | | | | | | | | | |
Revenue recognized from points redeemed - Other | (17) | | | (12) | | | | | | | | | |
| | | | | | | | | | | |
Air traffic liability - loyalty program - ending balance | $ | 4,884 | | | $ | 4,623 | | | | | | | | | |
Air traffic liability includes consideration received for ticket and loyalty related performance obligations which have not been satisfied as of a given date. Rollforwards of the amounts included in Air traffic liability as of March 31, 2022 and 2021 were as follows (in millions):
| | | | | |
| Air traffic liability |
| |
Balance at December 31, 2021 | $ | 7,725 | |
Current period sales (passenger travel, ancillary services, flight loyalty, and partner loyalty) | 5,038 | |
Revenue from amounts included in contract liability opening balances | (1,881) | |
Revenue from current period sales | (2,272) | |
Balance at March 31, 2022 | $ | 8,610 | |
| | | | | |
| Air traffic liability |
| |
Balance at December 31, 2020 | $ | 7,133 | |
Current period sales (passenger travel, ancillary services, flight loyalty, and partner loyalty) | 2,324 | |
Revenue from amounts included in contract liability opening balances | (743) | |
Revenue from current period sales | (982) | |
Balance at March 31, 2021 | $ | 7,732 | |
During 2020 and in parts of 2021, the Company experienced a significantly higher number of Customer-driven flight cancellations as a result of the COVID-19 pandemic. See Note 2 for further information. As a result, the amount of Customer travel funds held in Air traffic liability that are estimated to be redeemed for future travel as of March 31, 2022, remains much higher than historical levels. The amount of such Customer funds represents approximately 9 percent and 16 percent of the total Air traffic liability balance at March 31, 2022, and December 31, 2021, respectively, compared to approximately 2 percent of the Air traffic liability balance as of December 31, 2019. In order to provide additional flexibility to Customers who hold these funds, the Company significantly relaxed its previous policies with regards to the time period within which these funds can be redeemed, which is typically twelve months from the original date of purchase. For all Customer travel funds created or that would have otherwise expired between March 1 and September 7, 2020 associated with flight cancellations, the Company extended the expiration date to September 7, 2022. At March 31, 2022, $1.2 billion of extended Customer travel funds with a September 7, 2022 expiration date remain in Air traffic liability, although the Company has estimated that a portion of those will not be redeemed. As a result, recognition of these travel funds as flown revenue, refunds, or breakage revenue will likely be more volatile over the remaining life of these funds and may not be comparable to historical trends.
Recognition of revenue associated with the Company’s loyalty liability can be difficult to predict, as the number of award seats available to members is not currently restricted and they could choose to redeem their points at any time that a seat is available. The performance obligations classified as a current liability related to the Company’s loyalty program were estimated based on expected redemptions utilizing historical redemption patterns, and forecasted flight availability and fares. The entire balance classified as Air traffic liability—noncurrent relates to loyalty points that were estimated to be redeemed in periods beyond the twelve months following the representative balance sheet date. Based on historical experience as well as current forecasted redemptions, the Company expects the majority of loyalty points to be redeemed within approximately two years of the date the points are issued.
All performance obligations related to freight services sold are completed within twelve months or less; therefore, the Company has elected to not disclose the amount of the remaining transaction price and its expected timing of recognition for freight shipments.
Other revenues primarily consist of marketing royalties associated with the Company’s co-branded Chase® Visa credit card, but also include commissions and advertising associated with Southwest.com®. All amounts classified as Other revenues are paid monthly, coinciding with the Company fulfilling its deliverables; therefore, the Company has elected to not disclose the amount of the remaining transaction price and its expected timing of recognition for such services provided.
The Company recognized revenue related to the marketing, advertising, and other travel-related benefits of the revenue associated with various loyalty partner agreements including, but not limited to, the Agreement with Chase,
within Other operating revenues. For the three months ended March 31, 2022 and 2021, the Company recognized $486 million and $280 million, respectively.
The Company is also required to collect certain taxes and fees from Customers on behalf of government agencies and remit these back to the applicable governmental entity on a periodic basis. These taxes and fees include foreign and U.S. federal transportation taxes, federal security charges, and airport passenger facility charges. These items are collected from Customers at the time they purchase their tickets, are excluded from the contract transaction price, and are therefore not included in Passenger revenue. The Company records a liability upon collection from the Customer and relieves the liability when payments are remitted to the applicable governmental agency.
7. NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted net income (loss) per share (in millions, except per share amounts). For the three months ended March 31, 2022, 47 million shares related to the Convertible Notes and an immaterial number of shares related to the Company's restricted stock units and stock warrants were excluded from the denominator because inclusion of such shares would be antidilutive. An immaterial number of shares related to the Company's restricted stock units were excluded from the denominator for the three months ended March 31, 2021, because inclusion of such shares would be antidilutive.
| | | | | | | | | | | | | | | | | | |
| Three months ended March 31, | | | |
| 2022 | | 2021 | | | | | |
NUMERATOR: | | | | | | | | |
Net income (loss) | $ | (278) | | | $ | 116 | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
DENOMINATOR: | | | | | | | | |
Weighted-average shares outstanding, basic | 592 | | | 591 | | | | | | |
Dilutive effects of Convertible Notes | — | | (a) | 16 | | (b) | | | | |
Dilutive effect of stock warrants | — | | | 1 | | | | | | |
Dilutive effect of restricted stock units | — | | | 1 | | | | | | |
Adjusted weighted-average shares outstanding, diluted | 592 | | | 609 | | | | | | |
| | | | | | | | |
NET INCOME (LOSS) PER SHARE: | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Basic | $ | (0.47) | | | $ | 0.20 | | | | | | |
Diluted | $ | (0.47) | | | $ | 0.19 | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
(a) As of January 1, 2022, the Company adopted ASU 2020-06 using the modified retrospective method. The standard requires the Company to apply the if-converted method for purposes of Net income (loss) per share. Using this method, the numerator is affected by adding back interest expense and the denominator is affected by including the effect of potential share settlement, if the effect is more dilutive, regardless of the type of settlement. As a result, the Company will include all shares issuable upon conversion in the denominator if the Company has Net income for the period. For the three months ended March 31, 2022, the Company incurred a Net loss, thus all shares are considered antidilutive and have been excluded from the denominator. See Notes 3 and 11 for further information regarding the new standard and the Convertible Notes.
(b) Prior to the adoption of ASU 2020-06, the Convertible Notes were accounted for using the treasury stock method for the purposes of Net income (loss) per share. For the three months ended March 31, 2021, the average market price of the Company's common stock exceeded the conversion price per share of $38.48 and as such, the common shares underlying the Convertible Notes were included in the diluted calculation.
| | | | | | | | |
| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
8. FAIR VALUE MEASUREMENTS
Accounting standards pertaining to fair value measurements establish a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
As of March 31, 2022, the Company held certain items that are required to be measured at fair value on a recurring basis. These included cash equivalents, short-term investments (primarily treasury bills and certificates of deposit), interest rate derivative contracts, fuel derivative contracts, and available-for-sale securities. The majority of the Company’s short-term investments consist of instruments classified as Level 1. However, the Company has certificates of deposit, commercial paper, and time deposits that are classified as Level 2, due to the fact that the fair value for these instruments is determined utilizing observable inputs in non-active markets. Equity securities primarily consist of investments with readily determinable market values 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. Fuel derivative instruments currently consist solely of option contracts, whereas interest rate derivatives consist solely of swap agreements. See Note 4 for further information on the Company’s derivative instruments and hedging activities. The fair values of swap contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. Therefore, the Company has categorized these swap contracts as Level 2. The Company’s Treasury Department, which reports to the Chief Financial Officer, determines the value of option contracts utilizing an option pricing model based on inputs that are either readily available in public markets, can be derived from information available in publicly quoted markets, or are provided by financial institutions that trade these contracts. The option pricing model used by the Company is an industry standard model for valuing options and is a similar model used by the broker/dealer community (i.e., the Company’s counterparties). The inputs to this option pricing model are the option strike price, underlying price, risk free rate of interest, time to expiration, and volatility. Because certain inputs used to determine the fair value of option contracts are unobservable (principally implied volatility), the Company has categorized these option contracts as Level 3. Volatility information is obtained from external sources, but is analyzed by the Company for reasonableness and compared to similar information received from other external sources. The fair value of option contracts considers both the intrinsic value and any remaining time value associated with those derivatives that have not yet settled. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. To validate the reasonableness of the Company’s option pricing model, on a monthly basis, the Company compares its option valuations to third party valuations. If any significant differences were to be noted, they would be researched in order to determine the reason. However, historically, no significant differences have been noted. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of derivative contracts it holds.
Included in Other available-for-sale securities are the Company’s investments associated with its deferred compensation plans, which consist of mutual funds that are publicly traded and for which market prices are readily available. These plans are non-qualified deferred compensation plans designed to hold contributions in excess of limits established by the Internal Revenue Code of 1986, as amended. The distribution timing and payment amounts under these plans are made based on the participant’s distribution election and plan balance. Assets related to the funded portions of the deferred compensation plans are held in a rabbi trust, and the Company remains liable to these participants for the unfunded portion of the plans. The Company records changes in the fair value of plan obligations and plan assets, which net to zero, within the Salaries, wages, and benefits line and Other (gains) losses line, respectively, of the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).
| | | | | | | | |
| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis at March 31, 2022, and December 31, 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fair value measurements at reporting date using: |
| | | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
Description | | March 31, 2022 | | (Level 1) | | (Level 2) | | (Level 3) |
Assets | | (in millions) |
Cash equivalents: | | | | | | | | |
Cash equivalents (a) | | $ | 12,478 | | | $ | 12,478 | | | $ | — | | | $ | — | |
Commercial paper | | 270 | | | — | | | 270 | | | — | |
| | | | | | | | |
| | | | | | | | |
Time deposits | | 350 | | | — | | | 350 | | | — | |
Short-term investments: | | | | | | | | |
Treasury bills | | 2,292 | | | 2,292 | | | — | | | — | |
| | | | | | | | |
Certificates of deposit | | 25 | | | — | | | 25 | | | — | |
Time deposits | | 325 | | | — | | | 325 | | | — | |
| | | | | | | | |
Fuel derivatives: | | | | | | | | |
Option contracts (b) | | 1,319 | | | — | | | — | | | 1,319 | |
Interest rate derivatives (see Note 4) | | 3 | | | — | | | 3 | | | — | |
Equity Securities | | 261 | | | 261 | | | — | | | — | |
Total assets | | $ | 17,323 | | | $ | 15,031 | | | $ | 973 | | | $ | 1,319 | |
Liabilities | | | | | | | | |
Fuel derivatives: | | | | | | | | |
Option contracts (b) | | $ | (46) | | | $ | — | | | $ | — | | | $ | (46) | |
Interest rate derivatives (see Note 4) | | (1) | | | — | | | (1) | | | — | |
Total liabilities | | $ | (47) | | | $ | — | | | $ | (1) | | | $ | (46) | |
| | | | | | | | |
(a) Cash equivalents are primarily composed of money market investments.
(b) In the unaudited Condensed Consolidated Balance Sheet amounts are presented as a net asset. See Note 4.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fair value measurements at reporting date using: |
| | | | Quoted prices in active markets for identical assets | | Significant other observable inputs | | Significant unobservable inputs |
Description | | December 31, 2021 | | (Level 1) | | (Level 2) | | (Level 3) |
Assets | | (in millions) |
Cash equivalents: | | | | | | | | |
Cash equivalents (a) | | $ | 12,340 | | | $ | 12,340 | | | $ | — | | | $ | — | |
Commercial paper | | 90 | | | — | | | 90 | | | — | |
| | | | | | | | |
Time deposits | | 50 | | | — | | | 50 | | | — | |
Short-term investments: | | | | | | | | |
Treasury bills | | 2,399 | | | 2,399 | | | — | | | — | |
| | | | | | | | |
Time deposits | | 625 | | | — | | | 625 | | | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Fuel derivatives: | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Option contracts (b) | | 696 | | | — | | | — | | | 696 | |
| | | | | | | | |
| | | | | | | | |
Equity Securities | | 288 | | | 288 | | | — | | | — | |
Total assets | | $ | 16,488 | | | $ | 15,027 | | | $ | 765 | | | $ | 696 | |
Liabilities | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Interest rate derivatives (see Note 4) | | $ | (4) | | | $ | — | | | $ | (4) | | | $ | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
(a) Cash equivalents are primarily composed of money market investments.
(b) In the unaudited Condensed Consolidated Balance Sheet amounts are presented as an asset. See Note 4.
The Company did not have any material assets or liabilities measured at fair value on a nonrecurring basis during the three months ended March 31, 2022, or the year ended December 31, 2021. The following table presents the Company’s activity for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2022:
| | | | | | | | | | | |
Fair value measurements using significant unobservable inputs (Level 3) | | | |
(in millions) | Fuel derivatives | | | | |
Balance at December 31, 2021 | $ | 696 | | | | | |
Total gains (losses) for the period | | | | | |
Included in earnings | (34) | | (a) | | | |
Included in other comprehensive income | 852 | | | | | |
| | | | | |
Sales | (12) | | (b) | | | |
Settlements | (229) | | | | | |
Balance at March 31, 2022 | $ | 1,273 | | | | | |
The amount of total losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2022 | $ | (34) | | (a) | | | |
The amount of total gains for the period included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2022 | $ | 719 | | | | | |
(a) Included in Other (gains) losses, net, within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).
(b) The sale of fuel derivatives is recorded gross based on the structure of the derivative instrument and whether a contract with multiple derivatives was purchased as a single instrument or separate instruments.
The significant unobservable input used in the fair value measurement of the Company’s derivative option contracts is implied volatility. Holding other inputs constant, an increase (decrease) in implied volatility would have resulted in a higher (lower) fair value measurement, respectively, for the Company’s derivative option contracts.
The following table presents a range and weighted average of the unobservable inputs utilized in the fair value measurements of the Company’s fuel derivatives classified as Level 3 at March 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Quantitative information about Level 3 fair value measurements |
| | Valuation technique | | Unobservable input | | Period (by year) | | Range | | Weighted Average (a) |
Fuel derivatives | | Option model | | Implied volatility | | Second quarter 2022 | | 47-73% | | 57 | % |
| | | | | | Third quarter 2022 | | 47-67% | | 54 | % |
| | | | | | Fourth quarter 2022 | | 42-59% | | 49 | % |
| | | | | | 2023 | | 32-51% | | 43 | % |
| | | | | | 2024 | | 27-42% | | 33 | % |
| | | | | | | | | | |
(a) Implied volatility weighted by the notional amount (barrels of fuel) that will settle in respective period.
The carrying amounts and estimated fair values of the Company’s short-term and long-term debt (including current maturities), as well as the applicable fair value hierarchy tier, at March 31, 2022, are presented in the table below. The fair values of the Company’s publicly held long-term debt are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets; therefore, the Company has categorized these agreements as Level 2. All privately held debt agreements are categorized as Level 3. The Company has determined the estimated fair value of this debt to be Level 3, as certain inputs used to
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
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.
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(in millions) | Carrying value | | Estimated fair value | | Fair value level hierarchy |
2.75% Notes due November 2022 | $ | 300 | | | $ | 301 | | | Level 2 |
Pass Through Certificates due August 2022 - 6.19% | 33 | | | 33 | | | Level 2 |
4.75% Notes due 2023 | 1,250 | | | 1,280 | | | Level 2 |
1.25% Convertible Notes due 2025 | 1,933 | | | 2,644 | | | Level 2 |
5.25% Notes due 2025 | 1,550 | | | 1,627 | | | Level 2 |
| | | | | |
3.00% Notes due 2026 | 300 | | | 295 | | | Level 2 |
| | | | | |
3.45% Notes due 2027 | 300 | | | 297 | | | Level 2 |
5.125% Notes due 2027 | 1,970 | | | 2,106 | | | Level 2 |
7.375% Debentures due 2027 | 116 | | | 131 | | | Level 2 |
| | | | | |
2.625% Notes due 2030 | 500 | | | 459 | | | Level 2 |
1.000% PSP1 due 2030 | 976 | | | 919 | | | Level 3 |
1.000% PSP2 due 2031 | 566 | | | 523 | | | Level 3 |
1.000% PSP3 due 2031 | 526 | | | 483 | | | Level 3 |
9. SUPPLEMENTAL FINANCIAL INFORMATION
| | | | | | | | | | | | |
(in millions) | March 31, 2022 | | December 31, 2021 | |
Trade receivables | $ | 70 | | | $ | 58 | | |
Credit card receivables | 217 | | | 83 | | |
Business partners and other suppliers | 497 | | | 432 | | |
Taxes receivable | 698 | | | 699 | | |
Fuel hedging and receivables | 111 | | | 8 | | |
Other | 99 | | | 77 | | |
Accounts and other receivables | $ | 1,692 | | | $ | 1,357 | | |
| | | | | | | | | | | | |
(in millions) | March 31, 2022 | | December 31, 2021 | |
Derivative contracts | $ | 323 | | | $ | 192 | | |
Intangible assets, net | 295 | | | 295 | | |
| | | | |
| | | | |
Other | 360 | | | 395 | | |
Other assets | $ | 978 | | | $ | 882 | | |
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(in millions) | March 31, 2022 | | December 31, 2021 | |
Accounts payable trade | $ | 320 | | | $ | 156 | | |
Salaries payable | 259 | | | 287 | | |
Taxes payable excluding income taxes | 319 | | | 200 | | |
Aircraft maintenance payable | 53 | | | 42 | | |
Fuel payable | 208 | | | 170 | | |
| | | | |
Other payable | 489 | | | 427 | | |
Accounts payable | $ | 1,648 | | | $ | 1,282 | | |
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
| | | | | | | | | | | | |
(in millions) | March 31, 2022 | | December 31, 2021 | |
| | | | |
| | | | |
Voluntary Separation Program | $ | 85 | | | $ | 92 | | |
Profitsharing and savings plans | 65 | | | 262 | | |
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| | | | |
| | | | |
Vacation pay | 456 | | | 451 | | |
| | | | |
Health | 153 | | | 152 | | |
| | | | |
Workers compensation | 138 | | | 141 | | |
Property and income taxes | 61 | | | 65 | | |
Interest | 107 | | | 46 | | |
Deferred supplier payments (a) | — | | | 80 | | |
Other | 295 | | | 335 | | |
Accrued liabilities | $ | 1,360 | | | $ | 1,624 | | |
| | | | | | | | | | | | |
(in millions) | March 31, 2022 | | December 31, 2021 | |
| | | | |
Voluntary Separation Program | $ | 211 | | | $ | 233 | | |
Postretirement obligation | 333 | | | 330 | | |
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Other deferred compensation | 334 | | | 369 | | |
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Other | 282 | | | 292 | | |
Other noncurrent liabilities | $ | 1,160 | | | $ | 1,224 | | |
(a) Represents amounts owed at December 31, 2021 for aircraft deliveries received that will be relieved via future payments to supplier.
For further information on fuel derivative and interest rate derivative contracts, see Note 4.
Other Operating Expenses
Other operating expenses consist of aircraft rentals, distribution costs, advertising expenses, personnel expenses, professional fees, and other operating costs, none of which individually exceeded 10 percent of Operating expenses.
10. COMMITMENTS AND CONTINGENCIES
Dallas Love Field
During 2008, the City of Dallas approved the Love Field Modernization Project ("LFMP"), a project to reconstruct Dallas Love Field with modern, convenient air travel facilities. Pursuant to a Program Development Agreement with the City of Dallas and the Love Field Airport Modernization Corporation (or the "LFAMC," a Texas non-profit "local government corporation" established by the City of Dallas to act on the City of Dallas' behalf to facilitate the development of the LFMP), the Company managed this project. Major construction was effectively completed in 2014. During second quarter 2017, the City of Dallas approved using the remaining bond funds for additional terminal construction projects, which were effectively completed in 2018.
Although the City of Dallas received commitments from various sources that helped to fund portions of the LFMP project, including the Federal Aviation Administration ("FAA"), the Transportation Security Administration, and the City of Dallas' Aviation Fund, the majority of the funds used were from the issuance of bonds. The Company guaranteed principal and interest payments on bonds issued by the LFAMC (the "Series 2010" bonds and the "Series 2012" bonds). Given the Company’s guarantee associated with the bonds issued to fund LFMP, the remaining debt service amount was considered a minimum lease payment under the adoption of ASC Topic 842, Leases, and therefore was recorded as a lease liability with a corresponding right-of-use asset within the Company’s unaudited Condensed Consolidated Balance Sheet.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
All of the outstanding Series 2010 bonds, in the principal amount of $310 million, were redeemed by LFAMC on September 28, 2021 (Redemption Date) at the redemption price plus accrued interest of $7 million. The source of the funds used to pay the principal and interest on the Series 2010 bonds was proceeds from the sale of LFAMC General Airport Revenue Bonds, Series 2021, which also occurred on the Redemption Date. As the Series 2010 bonds have been fully repaid following the Redemption Date, the Company's guarantee associated with the Series 2010 bonds no longer exists. This refinancing transaction was considered a lease modification in accordance with applicable guidance, and the Company's obligation was remeasured as of the transaction date. This remeasurement resulted in a reduction of the Company's right-of-use asset and lease liability in the amount of $343 million.
As of March 31, 2022, $79 million of principal remained outstanding associated with the Series 2012 bonds. The net present value of the future principal and interest payments associated with the Series 2012 bonds was $89 million as of March 31, 2022, and was reflected as part of the Company's operating lease right-of-use assets and lease obligations in the unaudited Condensed Consolidated Balance Sheet.
Contractual Obligations and Contingent Liabilities and Commitments
Based on growth opportunities and ongoing fleet modernization plans for more fuel efficient aircraft, during first quarter 2022, the Company exercised 15 Boeing 737-8 ("-8") options for delivery in 2022 and 12 Boeing 737-7 ("-7") options for delivery in 2023. Fleet and capacity plans will continue to evolve as the Company manages through the COVID-19 recovery period, and it will continue to evaluate its remaining Boeing 737 MAX ("MAX") options for 2022. However, with its cost-effective order book, the Company retains significant flexibility to manage its fleet size, including opportunities to accelerate fleet modernization efforts if growth opportunities do not materialize. Additional information regarding the Company's delivery schedule is included in the following table as of March 31, 2022:
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| | | The Boeing Company | | | | | | | |
| | | -7 Firm Orders | | -8 Firm Orders | | | -7 or -8 Options | | | | | Total | | |
2022 | | | 72 | | | 15 | | | | 27 | | | | | | 114 | | | |
2023 | | | 64 | | | — | | | | 26 | | | | | | 90 | | | |
2024 | | | 30 | | | — | | | | 56 | | | | | | 86 | | | |
2025 | | | 30 | | | — | | | | 56 | | | | | | 86 | | | |
2026 | | | 15 | | | 15 | | | | 40 | | | | | | 70 | | | |
2027 | | | 15 | | | 15 | | | | 6 | | | | | | 36 | | | |
2028 | | | 15 | | | 15 | | | | — | | | | | | 30 | | | |
2029 | | | 20 | | | 30 | | | | — | | | | | | 50 | | | |
2030 | | | 15 | | | 45 | | | | — | | | | | | 60 | | | |
2031 | | | — | | | 10 | | | | — | | | | | | 10 | | | |
| | | 276 | (a) | 145 | | (b) | 211 | | | | | 632 | | |
(a) The delivery schedule for the -7 is dependent on the FAA issuing required certifications and approvals to Boeing and the Company. The FAA will ultimately determine the timing of the -7 certification and entry into service, and the Company therefore offers no assurance that current estimations and timelines are correct. The Company entered into an agreement with Boeing in April 2022 to replace the majority of its -7 firm orders with -8 firm orders in the short-term, among other adjustments to its near-term order book.
(b) The Company has flexibility to designate firm orders or options as -7s or -8s, upon written advance notification as stated in the contract.
Based on the Company's existing agreement with Boeing, capital commitments associated with its firm orders as of March 31, 2022, were: $2.1 billion remaining in 2022, $1.9 billion in 2023, $1.0 billion in 2024, $839 million in 2025, $975 million in 2026, $1.0 billion in 2027, and $6.0 billion thereafter. In addition, subsequent to March 31, 2022, and through May 2, 2022, due to the current status of the -7 certification, the Company converted 40 2022 -7 firm orders into 2022 -8 orders, moved one 2022 -7 firm order into 2023, and accelerated one 2023 -8 option into
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
2022. In April 2022, the Company also exercised 16 -8 options for delivery in 2022, exercised 2 -7 options for delivery in 2023, accelerated and exercised 10 2023 -8 options into 2022, and shifted 10 2022 MAX firm orders into 2023. Combined, the Company's aircraft order book activity subsequent to March 31, 2022, has resulted in additional capital commitments associated with firm orders of $689 million and $188 million in 2022 and 2023, respectively.
Contingencies
The Company is from time to time subject to various legal proceedings and claims arising in the ordinary course of business, including, but not limited to, examinations by the Internal Revenue Service ("IRS"). The Company's management does not expect that the outcome of any of its currently ongoing legal proceedings or the outcome of any adjustments presented by the IRS, individually or collectively, will have a material adverse effect on the Company's financial condition, results of operations, or cash flow.
11. FINANCING ACTIVITIES
On May 1, 2020, the Company completed the public offering of $2.3 billion aggregate principal amount of Convertible Notes. The Convertible Notes bear interest at a rate of 1.25% and will mature on May 1, 2025. Interest on the notes is payable semi-annually in arrears on May 1 and November 1, beginning November 1, 2020.
Holders may convert their Convertible Notes at their option at any time prior to the close of business on the business day immediately preceding February 1, 2025, in the event certain conditions are met, as stated in the offering documents. As of March 31, 2022, the conditions were not met to convert.
Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of the Company’s common stock or a combination of cash and shares of common stock, at the Company’s election. The Company intends to settle conversions by paying cash up to the principal amount of the Convertible Notes, with any excess conversion value settled in cash or shares of common stock. The initial conversion rate is 25.9909 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $38.48 per share of common stock).
Upon issuance, the Company bifurcated the Convertible Notes for accounting purposes between a liability component and an equity component utilizing applicable guidance. The liability component was determined by estimating the fair value of a hypothetical issuance of an identical offering excluding the conversion feature of the Convertible Notes. The initial carrying amount of the equity component was calculated as the difference between the liability component and the face amount of the Convertible Notes.
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| Southwest Airlines Co. Notes to Condensed Consolidated Financial Statements (unaudited) | |
The Company adopted ASU 2020-06, as of January 1, 2022, utilizing the modified retrospective method approach. See Note 3 for further information. Upon adoption, the Company reclassified the remaining equity component, of $300 million, from Additional paid-in capital to Long-term debt associated with its Convertible Notes, and no longer records amortization of the debt discount to Interest expense. The following table details the equity and liability component recognized related to the Convertible Notes, prior to and following the adoption of ASU 2020-06:
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(in millions) | March 31, 2022 | | December 31, 2021 |
Equity component: | | | |
Carrying amount of Convertible Notes | $ | — | | | $ | 311 | |
Carrying amount of issuance costs | — | | | (11) | |
Net carrying amount | $ | — | | | $ | 300 | |
Liability component: | | | |
Principal amount | $ | 1,933 | | | $ | 2,097 | |
Unamortized debt discount | — | | | (255) | |
Net carrying amount | $ | 1,933 | | | $ | 1,842 | |
The Company recognized interest expense associated with the Convertible Notes as follows:
| | | | | | | | | | | |
| Three months ended March 31, |
(in millions) | 2022 | | 2021 |
Non-cash amortization of the debt discount | $ | — | | | $ | 19 | |
Non-cash amortization of debt issuance costs | 3 | | | 2 | |
Contractual coupon interest | 6 | | | 7 | |
Total interest expense | $ | 9 | | | $ | 28 | |
The unamortized debt issuance costs have historically been recognized as non-cash interest expense based on the 5-year term of the notes, through May 1, 2025, less amounts that were or will be required to be accelerated immediately upon conversion or repurchases. The Company had no changes to conversion terms, contingencies, or exercise prices during the three months ended March 31, 2022.
During the three months ended March 31, 2022, the Company paid $323 million in debt and finance lease obligations, including the extinguishment of $164 million in principal of the Convertible Notes for $230 million in cash. The Company accounted for these repurchases as a partial debt extinguishment, which resulted in (i) a loss of $69 million reflected in Other (gains) losses, net, and (ii) a $3 million reduction in remaining unamortized debt issuance costs in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three months ended March 31, 2022. In addition the Company recorded the extinguishment of $30 million in principal of its 5.125% Notes due 2027 for a cash payment of $34 million, which resulted in a loss of $3 million reflected in Other (gains) losses, net, during the three months ended March 31, 2022.