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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
         For the quarterly period ended June 30, 2020
  or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from ________ to ________
Commission File No. 1-7259
LUV-20200630_G1.JPG

SOUTHWEST AIRLINES CO.
(Exact name of registrant as specified in its charter)
Texas 74-1563240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
P.O. Box 36611
Dallas, Texas 75235-1611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:  (214) 792-4000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol Name of each exchange on which registered
Common Stock ($1.00 par value) LUV New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes  No x
        Number of shares of Common Stock outstanding as of the close of business on July 23, 2020: 589,872,108



TABLE OF CONTENTS TO FORM 10-Q


2


SOUTHWEST AIRLINES CO.
FORM 10-Q
PART I – FINANCIAL INFORMATION

Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in millions)
(unaudited)
June 30, 2020 December 31, 2019
ASSETS    
Current assets:  
Cash and cash equivalents $ 12,351    $ 2,548   
Short-term investments 2,106    1,524   
Accounts and other receivables 770    1,086   
Inventories of parts and supplies, at cost 422    529   
Prepaid expenses and other current assets 223    287   
Total current assets 15,872    5,974   
Property and equipment, at cost:    
Flight equipment 20,943    21,629   
Ground property and equipment 5,923    5,672   
Deposits on flight equipment purchase contracts 306    248   
Assets constructed for others 239    164   
27,411    27,713   
Less allowance for depreciation and amortization 11,164    10,688   
  16,247    17,025   
Goodwill 970    970   
Operating lease right-of-use assets 1,845    1,349   
Other assets 662    577   
  $ 35,596    $ 25,895   
LIABILITIES AND STOCKHOLDERS' EQUITY    
Current liabilities:    
Accounts payable $ 970    $ 1,574   
Accrued liabilities 2,372    1,749   
Current operating lease liabilities 336    353   
Air traffic liability 4,988    4,457   
Current maturities of long-term debt 695    819   
Total current liabilities 9,361    8,952   
Long-term debt less current maturities 8,905    1,846   
Air traffic liability - noncurrent 1,891    1,053   
Deferred income taxes 2,114    2,364   
Construction obligation 239    164   
Noncurrent operating lease liabilities 1,486    978   
Other noncurrent liabilities 722    706   
Stockholders' equity:    
Common stock 888    808   
Capital in excess of par value 4,159    1,581   
Retained earnings 16,842    17,945   
Accumulated other comprehensive loss (130)   (61)  
Treasury stock, at cost (10,881)   (10,441)  
Total stockholders' equity 10,878    9,832   
  $ 35,596    $ 25,895   
See accompanying notes.
3


Southwest Airlines Co.
Condensed Consolidated Statement of Comprehensive Income (Loss)
(in millions, except per share amounts)
(unaudited)
  Three months ended June 30, Six months ended June 30,
  2020 2019 2020 2019
OPERATING REVENUES:        
Passenger $ 704    $ 5,487    $ 4,549    $ 10,231   
Freight 38    44    77    87   
Other 266    378    616    741   
Total operating revenues 1,008    5,909    5,242    11,059   
OPERATING EXPENSES:        
Salaries, wages, and benefits 1,714    2,068    3,568    4,043   
Payroll support, voluntary separation, net (784)   —    (784)   —   
Fuel and oil 257    1,136    1,128    2,152   
Maintenance materials and repairs 140    310    412    603   
Landing fees and airport rentals 275    357    614    691   
Depreciation and amortization 313    302    624    598   
Other operating expenses, net 220    768    917    1,499   
Total operating expenses 2,135    4,941    6,479    9,586   
OPERATING INCOME (LOSS) (1,127)   968    (1,237)   1,473   
OTHER EXPENSES (INCOME):        
Interest expense 96    31    124    61   
Capitalized interest (7)   (9)   (12)   (17)  
Interest income (9)   (24)   (26)   (47)  
Other (gains) losses, net 32      60     
Total other expenses (income) 112    —    146     
INCOME (LOSS) BEFORE INCOME TAXES (1,239)   968    (1,383)   1,472   
PROVISION FOR INCOME TAXES (324)   227    (374)   344   
NET INCOME (LOSS) $ (915)   $ 741    $ (1,009)   $ 1,128   
NET INCOME (LOSS) PER SHARE, BASIC $ (1.63)   $ 1.37    $ (1.87)   $ 2.06   
NET INCOME (LOSS) PER SHARE, DILUTED $ (1.63)   $ 1.37    $ (1.87)   $ 2.06   
COMPREHENSIVE INCOME (LOSS) $ (859)   $ 675    $ (1,078)   $ 1,138   
WEIGHTED AVERAGE SHARES OUTSTANDING      
Basic 563    542    539    547   
Diluted 563    542    539    547   
See accompanying notes.
4


Southwest Airlines Co.
Condensed Consolidated Statement of Stockholders' Equity
(in millions, except per share amounts)
(unaudited)
  
Common
Stock
Capital in
excess of
par value
Retained
earnings
Accumulated
other
comprehensive
income (loss)
Treasury
stock
Total
Balance at December 31, 2019 $ 808    $ 1,581    $ 17,945    $ (61)   $ (10,441)   $ 9,832   
Repurchase of common stock —    —    —    —    (451)   (451)  
Issuance of common and treasury stock pursuant to Employee stock plans —    (8)   —    —      (2)  
Share-based compensation —      —    —    —     
Cash dividends, $0.180 per share —    —    (94)   —    —    (94)  
Comprehensive loss —    —    (94)   (125)   —    (219)  
Balance at March 31, 2020 $ 808    $ 1,582    $ 17,757    $ (186)   $ (10,886)   $ 9,075   
Issuance of common stock, net of issuance costs 80    2,144    —    —    —    2,224   
Issuance of common and treasury stock pursuant to Employee stock plans —      —    —      13   
Share-based compensation —    (2)   —    —    —    (2)  
Stock warrants —    35    —    —    —    35   
Equity feature of convertible notes, net of issuance costs —    392    —    —    —    392   
Comprehensive loss —    —    (915)   56    —    (859)  
Balance at June 30, 2020 $ 888    $ 4,159    $ 16,842    $ (130)   $ (10,881)   $ 10,878   



  
Common
Stock
Capital in
excess of
par value
Retained
earnings
Accumulated
other
comprehensive
income (loss)
Treasury
stock
Total
Balance at December 31, 2018 $ 808    $ 1,510    $ 15,967    $ 20    $ (8,452)   $ 9,853   
Cumulative effect of adopting Accounting Standards Update No. 2016-12, Leases, codified in Accounting Standards Codification 842 —    —    55    —    —    55   
Balance after adjustment for the new accounting standard $ 808    $ 1,510    $ 16,022    $ 20    $ (8,452)   $ 9,908   
Repurchase of common stock —    —    —    —    (500)   (500)  
Issuance of common and treasury stock pursuant to Employee stock plans —    (10)   —    —      (4)  
Share-based compensation —    13    —    —    —    13   
Cash dividends, $0.160 per share —    —    (89)   —    —    (89)  
Comprehensive income —    —    387    76    —    463   
Balance at March 31, 2019 $ 808    $ 1,513    $ 16,320    $ 96    $ (8,946)   $ 9,791   
Repurchase of common stock —    —    —    —    (450)   (450)  
Issuance of common and treasury stock pursuant to Employee stock plans —      —    —      10   
Share-based compensation —    13    —    —    —    13   
Cash dividends, $0.180 per share —    —    (99)   —    —    (99)  
Comprehensive income —    —    741    (66)   —    675   
Balance at June 30, 2019 $ 808    $ 1,534    $ 16,962    $ 30    $ (9,394)   $ 9,940   
        See accompanying notes.
5


Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)

Three months ended June 30, Six months ended June 30,
  2020 2019 2020 2019
CASH FLOWS FROM OPERATING ACTIVITIES:        
Net income (loss) $ (915)   $ 741    $ (1,009)   $ 1,128   
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:        
Depreciation and amortization 313    302    624    598   
Unrealized/realized (gain) loss on fuel derivative instruments   —      —   
Deferred income taxes (181)   36    (230)   50   
Gain on sale-leaseback transactions (222)   —    (222)   —   
Changes in certain assets and liabilities:        
Accounts and other receivables (119)   18    64    (204)  
Other assets 224    86    282    115   
Accounts payable and accrued liabilities 1,200    (89)   (90)   (346)  
Air traffic liability 667    (30)   1,368    914   
Other liabilities (74)   (54)   (206)   (123)  
Cash collateral received from (provided to) derivative counterparties 12    (15)     —   
Other, net (14)   (29)   (76)   (61)  
Net cash provided by operating activities 897    966    520    2,071   
CASH FLOWS FROM INVESTING ACTIVITIES:        
Capital expenditures (113)   (230)   (336)   (390)  
Supplier proceeds 128    —    428 —   
Proceeds from sale-leaseback transactions 815    —    815    —   
Purchases of short-term investments (1,316)   (550)   (2,345)   (800)  
Proceeds from sales of short-term and other investments 818    528    1,765    1,103   
Net cash provided by (used in) investing activities 332    (252)   327    (87)  
CASH FLOWS FROM FINANCING ACTIVITIES:        
Issuance of common stock 2,294    —    2,294    —   
Proceeds from issuance of long-term debt 3,997    —    4,497    —   
Proceeds from term loan credit facility 2,683    —    3,683    —   
Proceeds from revolving credit facility —    —    1,000    —   
Proceeds from convertible notes 2,300    —    2,300    —   
Proceeds from Payroll Support Program loan and warrants 885    —    885    —   
Proceeds from Employee stock plans 13    10    24    20   
Repurchase of common stock —    (450)   (451)   (950)  
Payments of long-term debt and finance lease obligations (159)   (75)   (237)   (175)  
Payments of term loan credit facility (3,683)   —    (3,683)   —   
Payments of revolving credit facility (1,000)   —    (1,000)   —   
Payments of cash dividends —    (98)   (188)   (276)  
Capitalized financing costs (171)   —    (176)   —   
Other, net 23        (11)  
Net cash provided by (used in) financing activities 7,182    (612)   8,956    (1,392)  
NET CHANGE IN CASH AND CASH EQUIVALENTS 8,411    102    9,803    592   
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 3,940    2,344    2,548    1,854   
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 12,351    $ 2,446    $ 12,351    $ 2,446   






6


Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
CASH PAYMENTS FOR:
Interest, net of amount capitalized $ 40    $ 33    $ 54    $ 48   
Income taxes $   $ 314    $ 10    $ 318   
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
Right-of-use assets acquired under operating leases $ 661    $ —    $ 686    $ —   
Assets constructed for others $ 41    $ 24    $ 75    $ 45   

See accompanying notes.
7


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 June 30, 2020 and 2019 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, in 2020, as a result of the COVID-19 pandemic, the Company's results were not 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, unemployment levels, corporate travel budgets, extreme or severe weather and natural disasters, fears of terrorism or war, 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 and six months ended June 30, 2020, are not necessarily indicative of the results that may be expected for future quarters or for the year ended December 31, 2020. 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, 2019.

Certain prior period amounts have been reclassified to conform to the current presentation. In the Consolidated Statement of Cash Flows for the six months ended June 30, 2020, the Company has reclassified debt issuance costs of $5 million from Other, net, within the financing activities section to Capitalized financing costs. 
8

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 have changed the U.S. economic landscape, outlook, and in particular the travel industry, has been swift and unexpected. The Company began to see a negative impact on bookings for future travel in late February 2020, which quickly accelerated during the remainder of first quarter and into second quarter, when trip cancellations outpaced new passenger bookings during the majority of March and April 2020. The Company began proactively canceling a significant portion of its scheduled flights in March, and continued making cancellations throughout second quarter, as the Company grounded a significant portion of its fleet and operated a fraction of its previously scheduled capacity. The Company continued to experience significant negative impacts to passenger demand and bookings in second quarter 2020 due to the pandemic.

Based on these events and the uncertainty they created, the Company immediately began to focus on its liquidity, including quickly and substantially enhancing its cash holdings. Since the beginning of 2020, the Company has raised a total of $17.3 billion, net of fees.

On April 20, 2020, the Company entered into definitive documentation with the United States Department of Treasury (the "Treasury") with respect to funding support pursuant to the Payroll Support Program ("Payroll Support") under the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"). Payroll Support funds must be used to pay employee wages and benefits through at least September 30, 2020. The Company's expected aggregate receipts under the Payroll Support total approximately $3.3 billion. As consideration for the Payroll Support, the Company issued a promissory note (the "Note") in favor of the Treasury and entered into a warrant agreement with the Treasury (the "Warrant Agreement"), pursuant to which the Company agreed to issue warrants (each, a "Warrant") to purchase common stock of the Company to the Treasury. The Note was issued in an initial amount of $459 million, and the Company issued an initial Warrant to purchase up to 1.3 million shares of the Company's common stock. In accordance with the terms of the Note and the Warrant Agreement, upon each subsequent disbursement of Payroll Support to the Company (i) the principal amount of the Note will automatically be increased in an amount equal to 30 percent of any such disbursement and (ii) the Company will issue an additional Warrant to the Treasury in an amount equal to 10 percent of the principal amount of the increase to the Note in connection with such disbursement of Payroll Support, divided by the strike price of $36.47 (which was the closing price of the Company's common stock on April 9, 2020).

Through June 30, 2020, the Company has received three of four expected installments of Payroll Support, representing 90 percent of the expected Payroll Support from the Treasury. These cumulative amounts totaled $2.9 billion, including $1.6 billion received in April and $652 million received in both May and June 2020. As of June 30, 2020, the Company has provided a Note in the aggregate amount of $850 million and issued Warrants valued at a total of $35 million to purchase up to an aggregate of 2.3 million shares of the Company's common stock, subject to adjustment pursuant to the terms of the Warrants. Pursuant to the terms of the Payroll Support Program agreement and the CARES Act, the Payroll Support funds may only be utilized to pay qualifying salaries, wages, and benefits, as defined in the CARES Act. As of June 30, 2020, excluding the $850 million Note and the $1.1 billion in Payroll Support already allocated to reduce eligible costs in second quarter 2020, approximately $957 million in Payroll Support funds remain to be allocated during third quarter 2020 and were within Accrued liabilities in the accompanying unaudited Condensed Consolidated Balance Sheet. Such funds are included as part of Cash and cash equivalents in the accompanying unaudited Condensed Consolidated Balance Sheet as of June 30, 2020. The Company expects the final 10 percent, or $326 million, of Payroll Support to be received in late July 2020, for which the Company expects to provide consideration in the form of an increase of the Note in an amount of $98 million and issue a Warrant to purchase up to 268 thousand shares of the Company's common stock, subject to adjustment pursuant to the terms of the Warrant.

The Note matures in full on April 19, 2030, and is subject to mandatory prepayment requirements in connection with certain change of control triggering events that may occur prior to its maturity. The Company has an option to prepay the Note at any time without premium or penalty. Amounts outstanding under the Note bear interest at a rate
9

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

of 1.00 percent before April 20, 2025 and, afterwards, at a rate equal to the Secured Overnight Financing Rate or other benchmark replacement rate consistent with customary market conventions plus a margin of 2.00 percent. The Note contains customary representations and warranties and events of default.

The Warrant Agreement sets out the Company’s obligations to issue Warrants in connection with disbursements of Payroll Support and to file a resale shelf registration statement for the Warrants and the underlying shares of common stock. The Company has also granted the Treasury certain demand underwritten offering and piggyback registration rights with respect to the Warrants and the underlying common stock. Each Warrant is exercisable at a strike price of $36.47 per share of common stock and will expire on the fifth anniversary of the issue date of such Warrant. The Warrants will be settled through net share settlement or net cash settlement, at the Company’s option. The Warrants include adjustments for below market issuances, payment of dividends, and other customary anti-dilution provisions. The Warrants do not have voting rights.

Although the Company has not yet decided whether it will participate in the separate secured loan program established under the CARES Act, it did sign a non-binding letter of intent, effective in June, with the Treasury with respect to a potential loan with an estimated principal amount of approximately $2.8 billion. This was the next step in the loan application process, and the Company expects to receive further information about the secured loan program in third quarter 2020.

In addition to obtaining financing under the CARES Act as well as accessing the capital markets, the Company believes it has made significant progress on bolstering its liquidity through cost reductions. These efforts include aggressively evaluating all capital spending, discretionary spending, and non-essential costs for near-term cost reductions or deferrals; reducing the Company's published flight schedule; placing a significant number of aircraft in storage; implementing voluntary time-off programs for Employees; suspending all hiring and non-contract salary increases; reducing named executive officer salaries and Board of Director cash retainer fees by 20 percent; and modifying vendor and supplier payment terms. The Company will continue evaluating the need for further flight schedule adjustments. To support physical-distancing, the Company is currently limiting the number of seats sold on each flight to allow for middle seats to remain open for Customers who are not traveling together through at least October 2020, and will evaluate the possibility of extending this policy beyond October.

On June 1, 2020, the Company announced Voluntary Separation Program 2020, 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. Virtually all of the Company’s Employees hired before June 1, 2020 were eligible to participate in the Voluntary Separation Program 2020. Employees electing to participate in Voluntary Separation Program 2020 were required to notify the Company of their election no later than July 15, 2020--with the stipulation that all Employees electing to participate had a total of seven days from their date of initial election to rescind their election and remain employed by the Company. Following the deadline to rescind such election, a total of over 4,200 Employees have elected to participate in Voluntary Separation Program 2020, consisting of the following breakdown among workgroups: 390 from Customer Support and Services, 1,060 from Ground Operations and Provisioning, 725 Flight Attendants, 640 Pilots, 185 from Maintenance, 90 from other Contract groups, and 1,145 Managerial and Administrative Employees. Voluntary Separation Program 2020 participants’ last day of work will fall between August 15, 2020 and September 30, 2020, as assigned by the Company based on the operational needs of particular work locations and departments, determined on an individual-by-individual basis.

In conjunction with Voluntary Separation Program 2020, 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. Employees taking Extended ETO do not perform any work for the Company, but do get paid a portion of their wages and continue to receive all associated benefits, as well as accrue service credit for all benefits.

The purpose of the Voluntary Separation Program 2020 and Extended ETO is to maintain a suitable sized 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 ASC Topic 712 (Compensation — Nonretirement Postemployment Benefits), the
10

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

Company accrued a charge related to the special termination benefits described above associated with Employees who had accepted the Voluntary Separation Program 2020 offer at June 30, 2020 of $307 million during second quarter 2020, all of which will be paid out in subsequent periods to these Employees. Costs incurred for Voluntary Separation Program 2020 and Extended ETO are recorded as a component of Payroll support, voluntary separation, net. The Company will record the additional special termination benefits charge associated with the Employees whose voluntary separation and Extended ETO elections were finalized during July, and were subsequently accepted by the Company, during third quarter 2020, and expects this charge to be material to third quarter results.

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. As of June 30, 2020, a portion of the Company's fleet had been placed in temporary storage, as well as some in a longer term storage program. Given the current expectation that these aircraft have been grounded temporarily, the Company has continued to record depreciation expense associated with them.

As a result of the events and impacts surrounding the COVID-19 pandemic, including the Company's net loss incurred during the six months ended June 30, 2020, and the significant number of aircraft that have been placed in storage, the Company considered whether these conditions indicated that it was more likely than not that the Company’s $970 million in Goodwill and its $295 million in indefinite-lived intangible assets were impaired. Upon review, the Company determined that, based on the facts and circumstances in existence as of June 30, 2020, the fair values more likely than not exceeded book values of both its reporting unit and its indefinite-lived intangible assets and therefore, no quantitative test was required.

In addition, the Company has assessed whether any impairment of its amortizable assets existed, and has determined that no charges were deemed necessary under applicable accounting standards as of June 30, 2020.

The Company’s assumptions about future conditions important to its assessment of potential impairment of its amortizable assets, indefinite-lived intangible assets, and goodwill, including the impacts of the COVID-19 pandemic and other ongoing impacts to its business, are subject to uncertainty, and the Company will continue to monitor these conditions in future periods as new information becomes available, and will update its analyses accordingly.

The Company's income tax benefit recorded for the first six months of 2020 was at a rate of 27.0 percent, which is higher than the first six months of 2019 tax rate of 23.4 percent. The higher effective tax rate in 2020 reflects the anticipated benefit of carrying back full year 2020 projected net losses to claim tax refunds against previous cash taxes paid relating to tax years 2015 through 2019, some of which were at higher rates than the current year.

11

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

3. NEW ACCOUNTING PRONOUNCEMENTS

On December 18, 2019, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This new standard eliminates certain exceptions in Accounting Standards Codification ("ASC") 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2020, with early adoption permitted in any interim period within that year. The Company elected to early adopt this standard as of January 1, 2020. The most significant impact to the Company is the removal of a limit on the tax benefit recognized on pre-tax losses in interim periods. However, the early adoption as of January 1, 2020, did not have an impact on the Company's financial statements or disclosures for the first six months of 2020.

On August 29, 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software. This standard requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in ASC 350-40, Accounting for Internal-Use Software, to determine which implementation costs to (i) capitalize as assets and amortize over the term of the hosting arrangement or (ii) expense as incurred. This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and the standard was adopted and applied prospectively by the Company as of January 1, 2020, but it did not have a significant impact on the Company's financial statements and disclosures.

On August 28, 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement. This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. This standard requires changes to the disclosure requirements for fair value measurements for certain Level 3 items, and specifies that some of the changes must be applied prospectively, while others should be applied retrospectively. The Company adopted the standard as of January 1, 2020, but it did not have a significant impact on the Company's financial statements or disclosures. See Note 9 for further information on the Company's fair value measurements.

On January 26, 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The new standard eliminates Step 2 from the goodwill impairment test. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and the standard was adopted and applied prospectively by the Company as of January 1, 2020, but it did not have a significant impact on the Company's financial statements and disclosures.

On June 16, 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. The new standard requires the use of an “expected loss” model on certain types of financial instruments. The standard also amends the impairment model for available-for-sale debt securities and requires estimated credit losses to be recorded as allowances instead of reductions to amortized cost of the securities. This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and the standard was adopted and applied prospectively by the Company as of January 1, 2020, but it did not have a significant impact on the Company's financial statements and disclosures.


12

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.

13

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

For the three and six months ended June 30, 2020, the Company had fuel derivative instruments in place for up to 95 percent and 79 percent, respectively, of its fuel consumption. As of June 30, 2020, the Company also 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:
Maximum fuel hedged as of
June 30, 2020 Derivative underlying commodity type as of
Period (by year) (gallons in millions) (a) June 30, 2020
Remainder of 2020 460    WTI crude oil, Brent crude oil, and Heating oil
2021 1,283    WTI crude oil and Brent crude oil
2022 1,056    WTI crude oil and Brent crude oil
Beyond 2022 529    WTI crude oil and Brent crude oil
(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 fluctuates.

Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges. All periodic changes in fair value of the derivatives designated as hedges are recorded in Accumulated other comprehensive income (loss) ("AOCI") until the underlying jet fuel is consumed. See Note 5.

The Company's results are subject to the possibility that the derivatives will no longer qualify for hedge accounting, in which case 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 will be required to be immediately reclassified into earnings. During first and second quarter 2020, as a result of the drastic drop in demand for air travel, the Company's forecast for 2020 fuel purchases and consumption was significantly reduced, causing the Company to be in an estimated "over–hedged" position for second, third, and fourth quarter 2020. Therefore, the Company de–designated a portion of its fuel hedges related to second, third, and fourth quarter 2020 and has reclassified approximately $14 million and $16 million in losses from AOCI into Other (gains) losses, net, during the three and six months ended June 30, 2020, respectively. The Company did not have any such situations occur during 2019.

14

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

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:

    Asset derivatives Liability derivatives
  Balance Sheet Fair value at Fair value at Fair value at Fair value at
(in millions) location 6/30/2020 12/31/2019 6/30/2020 12/31/2019
Derivatives designated as hedges (a)          
Fuel derivative contracts (gross) Prepaid expenses and other current assets $   $ 48    $ —    $ —   
Fuel derivative contracts (gross) Other assets 99    62    —    —   
Interest rate derivative contracts Prepaid expenses and other current assets   —    —    —   
Interest rate derivative contracts Other assets —      —    —   
Interest rate derivative contracts Accrued liabilities —    —    —     
Interest rate derivative contracts Other noncurrent liabilities —    —    14     
Total derivatives designated as hedges $ 108    $ 112    $ 14    $  
Derivatives not designated as hedges (a)          
Fuel derivative contracts (gross) Prepaid expenses and other current assets $   $ —    $ —    $ —   
Interest rate derivative contracts Accrued liabilities —    —    60    —   
Total derivatives not designated as hedges   $   $ —    $ 60    $ —   
Total derivatives   $ 109    $ 112    $ 74    $  
(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.

The following table presents the amounts recorded on the unaudited Condensed Consolidated Balance Sheet related to fair value hedges:

Balance Sheet location of hedged item Carrying amount of the hedged liabilities Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged liabilities (a)
June 30, June 30,
(in millions) 2020 2019 2020 2019
Current maturities of long-term debt $ 502    $ 300    $   $  
Long-term debt less current maturities —    500    18    18   
$ 502    $ 800    $ 20    $ 19   
(a) At June 30, 2020 and 2019, these amounts include the cumulative amount of fair value hedging adjustments remaining for which hedge accounting has been discontinued, of $18 million and $19 million, respectively.

15

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

In addition, the Company had the following amounts associated with fuel derivative instruments and hedging activities in its unaudited Condensed Consolidated Balance Sheet:

  Balance Sheet June 30, December 31,
(in millions) location 2020 2019
Cash collateral deposits held from counterparties for fuel contracts - current Offset against Prepaid expenses and other current assets $   $ 10   
Cash collateral deposits held from counterparties for fuel contracts - noncurrent Offset against Other assets 31    15   
 
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 June 30, 2020, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.

16

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:

Offsetting of derivative assets
(in millions)
(i) (ii) (iii) = (i) + (ii) (i) (ii) (iii) = (i) + (ii)
June 30, 2020 December 31, 2019
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 $   $ (1)   $   $ 48    $ (10)   $ 38   
Fuel derivative contracts Other assets $ 99    $ (31)   $ 68    (a) $ 62    $ (15)   $ 47    (a)
Interest rate derivative contracts Prepaid expenses and other current assets $   $ —    $   $ —    $ —    $ —   
Interest rate derivative contracts Other assets $ —    $ —    $ —    (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 10.

Offsetting of derivative liabilities
(in millions)
(i) (ii) (iii) = (i) + (ii) (i) (ii) (iii) = (i) + (ii)
June 30, 2020 December 31, 2019
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 $   $ (1)   $ —    $ 10    $ (10)   $ —   
Fuel derivative contracts Other assets $ 31    $ (31)   $ —    (a) $ 15    $ (15)   $ —    (a)
Interest rate derivative contracts Accrued liabilities $ 60    $ —    $ 60    (a) $   $ —    $   (a)
Interest rate derivative contracts Other noncurrent liabilities $ 14    $ —    $ 14    $   $ —    $  
(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 10.

17

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 and six months ended June 30, 2020 and 2019:
Location and amount recognized in income on cash flow and fair value hedging relationships
Three months ended
June 30, 2020
Three months ended June 30, 2019
(in millions) Fuel and oil Other (gains)/losses, net Interest expense Fuel and oil Interest expense
Total $ 14    $ 14    $   $ (2)   $  
(Gain) loss on cash flow hedging relationships:
     Commodity contracts:
Amount of (gain) loss reclassified from AOCI into income 14    14    —    (2)   —   
     Interest contracts:
Amount of loss reclassified from AOCI into income —    —      —     
Impact of fair value hedging relationships:
     Interest contracts:
          Hedged items —    —      —     
Derivatives designated as hedging instruments —    —    (2)   —    —   

Location and amount recognized in income on cash flow and fair value hedging relationships
Six months ended
June 30, 2020
Six months ended June 30, 2019
(in millions) Fuel and oil Other (gains)/losses, net Interest expense Fuel and oil Interest expense
Total $ 36    $ 16    $   $   $ 15   
Loss on cash flow hedging relationships:
Commodity contracts:
Amount of loss reclassified from AOCI into income 36    16    —      —   
Interest contracts:
Amount of loss reclassified from AOCI into income —    —      —     
Impact of fair value hedging relationships:
Interest contracts:
Hedged items —    —      —    12   
Derivatives designated as hedging instruments —    —    (4)   —     



18

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

Derivatives designated and qualified in cash flow hedging relationships
  (Gain) loss recognized in AOCI on derivatives, net of tax
  Three months ended
  June 30,
(in millions) 2020 2019
Fuel derivative contracts $ (9)   $ 54   
Interest rate derivatives —    16   
Total $ (9)   $ 70   
Derivatives designated and qualified in cash flow hedging relationships
  (Gain) loss recognized in AOCI on derivatives, net of tax
  Six months ended
  June 30,
(in millions) 2020   2019
Fuel derivative contracts $ 75    $ (12)  
Interest rate derivatives 32    27   
Total $ 107      $ 15   

Derivatives not designated as hedges
  Loss recognized
in income on derivatives
 
   
  Three months ended Location of loss
recognized in income
on derivatives
  June 30,
(in millions) 2020 2019
Fuel derivative contracts $   $ —    Other (gains) losses, net
Interest rate derivatives   —    Other (gains) losses, net
Total $   $ —   
Derivatives not designated as hedges
  Loss recognized
in income on derivatives
 
   
  Six months ended Location of loss
recognized in income
on derivatives
  June 30,
(in millions) 2020 2019
Fuel derivative contracts $   $ —    Other (gains) losses, net
Interest rate derivatives 29    —    Other (gains) losses, net
Total $ 30    $ —   

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three and six months ended June 30, 2020 and 2019. Fuel derivatives that qualify for hedge accounting are recorded to Fuel and oil expense. Fuel derivatives that do not qualify for hedge accounting are recorded to Other (gains) and losses, net. The following tables present 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:

19

Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)

  Premium expense recognized
in income on derivatives