LUV-12.31.2014-10K


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

FORM 10-K

(Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2014
 
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
 
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
 
Name of Each Exchange on Which Registered
Common Stock ($1.00 par value)
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ
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  þ    No  ¨
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨




Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
þ
 
Accelerated filer
 
¨
 
Non-accelerated filer
 
¨
 
Smaller reporting company
 
¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  þ
The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $18,358,439,198 computed by reference to the closing sale price of the common stock on the New York Stock Exchange on June 30, 2014, the last trading day of the registrant’s most recently completed second fiscal quarter.
Number of shares of common stock outstanding as of the close of business on February 4, 2015: 675,993,892 shares

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Company’s Annual Meeting of Shareholders to be held May 13, 2015, are incorporated into Part III of this Annual Report on Form 10-K.
 





TABLE OF CONTENTS

 
 
 
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
PART II
 
Item 5.
Item 6.
Item 7.
 
 
 
Item 7A.
Item 8.
 
 
 
 
 
 
Item 9.
Item 9A.
Item 9B.
 
 
 
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
PART IV
 
Item 15.


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PART I 

Item 1.
Business
Company Overview

Southwest Airlines Co. (the “Company”) operates Southwest Airlines (“Southwest”), a major passenger airline that provides scheduled air transportation in the United States and near-international markets. During 2014, the Company also operated AirTran Airways (“AirTran”). AirTran’s final passenger service occurred on December 28, 2014, and the Company reached a major milestone by effectively completing the integration of AirTran into Southwest. In addition, for the 42nd consecutive year, the Company was profitable, earning $1.1 billion in net income.
Southwest commenced service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities: Dallas, Houston, and San Antonio. The Company ended 2014 serving 93 destinations in 40 states, the District of Columbia, the Commonwealth of Puerto Rico, and five near-international countries including Mexico (Cancun, Mexico City, and Cabo San Lucas/Los Cabos), Jamaica (Montego Bay), The Bahamas (Nassau), Aruba (Oranjestad), and Dominican Republic (Punta Cana). Southwest’s launch of international service occurred on July 1, 2014, with service to Montego Bay, Nassau, and Oranjestad. The Company also launched service to Cabo San Lucas/Los Cabos and Cancun on August 10, 2014, and to Mexico City and Punta Cana on November 2, 2014. The Company has announced plans to add its first and second destinations in Central America by adding Southwest service to San Jose, Costa Rica beginning in March 2015 and to Belize City, Belize beginning in October 2015, each subject to government approval. The Company has also announced plans to commence Southwest service to Puerto Vallarta, Mexico in June 2015, subject to government approval. At December 31, 2014, Southwest operated a total of 665 Boeing 737 aircraft.
During 2014, the Company significantly increased Southwest service at New York LaGuardia Airport and Washington Reagan National Airport as a result of the acquisition of slots divested by AMR Corporation, the parent company of American Airlines, Inc., as part of AMR’s merger with US Airways Group, Inc. (a “slot” is the right of an air carrier, pursuant to regulations of the Federal Aviation Administration (“FAA”), to operate a takeoff or landing at a specific time at certain airports). Further, at Dallas Love Field, the Company began serving seven new nonstop destinations on October 13, 2014, eight new nonstop destinations on November 2, 2014, and two new nonstop destinations on January 6, 2015. These routes were made possible by the repeal of certain federal flight restrictions at Dallas Love Field on October 13, 2014. Additional information regarding these restrictions is discussed in more detail below under “Economic and Operational Regulation - The Wright Amendment.”
Based on the most recent data available from the U.S. Department of Transportation, as of September 30, 2014, Southwest was the largest domestic air carrier in the United States, as measured by the number of domestic originating passengers boarded.
Industry
The airline industry has historically been an extremely volatile industry subject to numerous challenges. Among other things, it has been cyclical, energy intensive, labor intensive, capital intensive, technology intensive, highly regulated, heavily taxed, and extremely competitive. The airline industry has also been particularly susceptible to detrimental events such as acts of terrorism (for example, 9/11), poor weather, and natural disasters. In addition, in recent years the industry was significantly affected by an uncertain economy, high and volatile fuel prices, and government sequestration and shutdown. These factors contributed to unpredictable demand for air travel and related cost and pricing challenges. Reflecting the numerous industry challenges, many U.S. airlines ceased operations or reorganized through bankruptcy.
Although the U.S. economy has experienced a moderate recovery since emerging from a recession in 2009 and the U.S. airline industry has showed measurable improvement during 2013 and 2014, slow economic growth and lingering economic uncertainty have led to continued industry restraint with respect to overall capacity (number of available seat miles). Although many U.S. air carriers, including Southwest, experienced relatively flat to modest year-over-year increases in capacity during 2014, overall domestic airline industry capacity in 2014 remained below pre-recession levels. Leaner flight schedules over the past several years, along with industry consolidation, have contributed to improvements in industry load factors (percentage of seats filled by fare-paying passengers) and yields (revenue

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production per passenger mile). With the continued recovery of the U.S. economy, the airline industry has modestly increased scheduled domestic capacity.
Company Operations
Route Structure
General
Southwest principally provides point-to-point service, rather than the “hub-and-spoke” service provided by most major U.S. airlines. The hub-and-spoke system concentrates most of an airline’s operations at a limited number of central hub cities and serves most other destinations in the system by providing one-stop or connecting service through a hub. By not concentrating operations through one or more central transfer points, Southwest’s point-to-point route structure has allowed for more direct nonstop routing than hub-and-spoke service. For 2014, approximately 73 percent of the Company's Customers flew nonstop, and the average aircraft trip stage length was 721 miles, with an average duration of approximately 2.0 hours. For 2013, approximately 72 percent of the Company's Customers flew nonstop, and average aircraft trip stage length was 703 miles, with an average duration of approximately 2.0 hours.
Southwest’s point-to-point service has also enabled it to provide its markets with frequent, conveniently timed flights and low fares. For example, Southwest currently offers 21 weekday roundtrips from Dallas Love Field to Houston Hobby, nine weekday roundtrips from Washington Reagan to Chicago Midway, 11 weekday roundtrips from Phoenix to Las Vegas, and 14 weekday roundtrips from Los Angeles International to Oakland. Southwest complements these high-frequency routes with long-haul nonstop service between markets such as Los Angeles and Nashville, Las Vegas and Orlando, San Diego and Baltimore, and Houston and New York LaGuardia. As of December 31, 2014, Southwest served 581 nonstop city pairs.
International Service
In 2014, the Company fully converted AirTran international service into Southwest service. The Company began selling its first international itineraries to be flown by Southwest aircraft in January 2014, and Southwest’s launch of international service occurred on July 1, 2014, with service to Jamaica (Montego Bay), The Bahamas (Nassau), and Aruba (Oranjestad). Southwest commenced international service to Mexico (Cabo San Lucas/Los Cabos and Cancun) on August 10, 2014, and to Mexico City and Dominican Republic (Punta Cana) on November 2, 2014. The Company has announced plans to add its first and second destinations in Central America by commencing Southwest service to San Jose, Costa Rica in March 2015 and to Belize City, Belize in October 2015, each subject to government approval. The Company has also announced plans to commence Southwest service to Puerto Vallarta, Mexico in June 2015, subject to government approval.
As part of the Company's near-international service efforts, the Company has agreed with the City of Houston (“City”) to expand the City's existing William P. Hobby airport facility. Pursuant to the agreement, the Company and the City have entered into an Airport Use and Lease Agreement to control the execution of this expansion and its financial terms. This project provides for a new five-gate international terminal with international passenger processing facilities, expansion of the existing security checkpoint, and upgrades to the Southwest ticketing area. Construction began during third quarter 2013 and is estimated to be completed during the second half of 2015. In December 2014, the Company announced plans to commence Southwest service at the new Houston Hobby terminal facility in October 2015 to four destinations in Mexico (Cancun, Cabo San Lucas/Los Cabos, Puerto Vallarta, and Mexico City), to Belize City, Belize, and to San Jose, Costa Rica, each subject to government approval. Additional information regarding this project is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.
The Company has also agreed with Broward County, Florida, which owns and operates Fort Lauderdale-Hollywood International Airport, to oversee and manage the design and construction of the airport’s Terminal 1 Modernization Project. In addition to significant improvements to the existing Terminal 1, the project includes the design and construction of a new five-gate Concourse A with an international processing facility. Construction is expected to begin in mid to late 2015. Additional information regarding this project is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.

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The Company’s 2014 operating revenues attributable to foreign operations (including those attributable to both Southwest and AirTran) were approximately $226 million. The remainder of the Company’s 2014 operating revenues, approximately $18.4 billion, were attributable to domestic operations. The Company’s 2013 operating revenues attributable to foreign operations (all of which were attributable to AirTran) were approximately $212 million. The remainder of the Company’s 2013 operating revenues, approximately $17.5 billion, were attributable to domestic operations. The Company’s tangible assets primarily consist of flight equipment, the majority of which are interchangeable and are deployed systemwide, with no individual aircraft dedicated to any specific route or region; therefore, the Company’s assets are not allocated to a geographic area. For a discussion of the risks related to the Company’s foreign operations, see “Risk Factors - The Company’s future results will suffer if it does not effectively manage its expanded operations, including its international operations.”
Cost Structure
General
A key component of the Company’s business strategy has historically been its low-cost structure, which was designed to allow Southwest to profitably charge low fares. Adjusted for stage length, Southwest has lower unit costs, on average, than the vast majority of major domestic carriers. The Company’s low-cost structure has historically been facilitated by Southwest’s use of a single aircraft type, the Boeing 737, an operationally efficient point-to-point route structure, and highly productive Employees. Southwest’s use of a single aircraft type has allowed for simplified scheduling, maintenance, flight operations, and training activities. Southwest’s point-to-point route structure includes service to and from many secondary or downtown airports such as Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Burbank, Manchester, Oakland, San Jose, Providence, and Ft. Lauderdale-Hollywood. These conveniently located airports are typically less congested than other airlines’ hub airports, which has contributed to Southwest's ability to achieve high asset utilization because aircraft can be scheduled to minimize the amount of time they are on the ground. This, in turn, has reduced the number of aircraft and gate facilities that would otherwise be required and allows for high Employee productivity (headcount per aircraft).
The Company believes that its fleet modernization initiatives, as well as the continued addition of the larger Boeing 737-800 to the Southwest fleet, will have a favorable impact on the Company’s unit costs. These strategic initiatives are discussed in more detail below under “Operating Strategies and Initiatives - Fleet Modernization” and “Operating Strategies and Initiatives - Continued Incorporation of the Larger Boeing 737-800 into the Southwest Fleet.”
Impact of Fuel Costs on the Company’s Low-Cost Structure
Although 2014 fuel prices were lower than levels experienced in 2013, and dropped significantly late in 2014, Fuel and oil expense remains one of the Company's largest operating costs. The table below shows the Company’s average cost of jet fuel and oil over the past twelve years and during each quarter of 2014.

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Year
 
Cost
(Millions)
 
Average
Cost Per
Gallon
 
Percentage of    
Operating
Expenses
2003
 
$
920

 
$
0.80

 
16.5
%
2004
 
$
1,106

 
$
0.92

 
18.1
%
2005
 
$
1,470

 
$
1.13

 
21.4
%
2006
 
$
2,284

 
$
1.64

 
28.0
%
2007
 
$
2,690

 
$
1.80

 
29.7
%
2008
 
$
3,713

 
$
2.44

 
35.1
%
2009
 
$
3,044

 
$
2.12

 
30.2
%
2010
 
$
3,620

 
$
2.51

 
32.6
%
2011
 
$
5,644

 
$
3.19

 
37.7
%
2012
 
$
6,120

 
$
3.30

 
37.2
%
2013
 
$
5,763

 
$
3.16

 
35.1
%
2014
 
$
5,293

 
$
2.93

 
32.3
%
First Quarter 2014
 
$
1,314

 
$
3.10

 
33.3
%
Second Quarter 2014
 
$
1,425

 
$
3.03

 
33.6
%
Third Quarter 2014
 
$
1,386

 
$
2.97

 
33.1
%
Fourth Quarter 2014
 
$
1,167

 
$
2.63

 
29.1
%
The Company enters into fuel derivative contracts to manage its risk associated with significant increases in fuel prices; however, because energy prices can fluctuate significantly in a relatively short amount of time, the Company must also continually monitor and adjust its fuel hedge portfolio and strategies to address not only fuel price increases, but also fuel price volatility and hedge collateral requirements. As evidenced by the extreme decline in jet fuel prices during the fourth quarter of 2014, jet fuel prices are subject to significant volatility based on a variety of factors. In addition, the cost of hedging generally increases with sustained high potential for volatility in the fuel market. The Company’s fuel hedging activities are discussed in more detail below under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 10 to the Consolidated Financial Statements.
Fare Structure
Southwest
Southwest offers a relatively simple fare structure that features competitive, unrestricted, unlimited, everyday coach fares, as well as lower fares available on a restricted basis. Southwest bundles fares into three major categories: “Wanna Get Away®,” “AnytimeSM,” and “Business Select®,” with the goal of making it easier for Customers to choose the fare they prefer. All fare products include the privilege of two free checked bags. In addition, regardless of the fare product, Southwest does not charge fees for changes to flight reservations.
“Wanna Get Away” fares are generally the lowest fares and are subject to advance purchase requirements. They are nonrefundable but, subject to compliance with Southwest’s No Show policy, funds may be applied to future travel on Southwest. As discussed below under “Operating Strategies and Initiatives - Ancillary Services and Fees,” Southwest has a No Show policy associated with Wanna Get Away tickets that are not canceled or changed at least ten minutes prior to a flight’s scheduled departure.
“Anytime” fares are refundable and changeable, and funds may also be applied toward future travel on Southwest. Anytime fares also include a higher frequent flyer point multiplier under Southwest’s Rapid Rewards® frequent flyer program than do Wanna Get Away fares.
“Business Select” fares are refundable and changeable, and funds may be applied toward future travel on Southwest. Business Select fares also include additional perks, when available, such as priority boarding in the first 15 boarding positions within boarding group “A,” a higher frequent flyer point multiplier than other Southwest fares (including twice as many points per dollar spent as compared with Wanna Get Away fares), “Fly By®” priority security and ticket counter access in select airports, and one complimentary adult beverage coupon for the day of travel (for Customers of legal drinking age).

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AirTran
During 2014, AirTran offered a user-friendly fare structure that featured a variety of competitive fares and products. Unlike Southwest, AirTran offered a Business Class product. With the exception of Business Class fares, all AirTran fares were nonrefundable, but could be changed prior to departure, subject to payment of a service charge. AirTran Business Class fares were refundable and changeable and included additional perks such as priority boarding, oversized seats with additional leg room, bonus frequent flyer credit, no first or second bag fees, and complimentary cocktails onboard. In addition, AirTran’s Business Class product could be purchased separately or through an upgrade of a non-Business Class fare within 24 hours of travel.
Websites
The Company’s Internet website, southwest.com®, is the only avenue for Southwest Customers to purchase and manage travel online. Any part of a Customer’s trip can be planned directly from the southwest.com home page. Southwest.com is designed to help make the Customer's experience personal and intuitive with features such as recognizing the Customer's location to provide relevant deals, remembering recent searches to make it easy to get to trips of interest, and shopping cart functionality allowing Customers to purchase air, hotel, and car all at once. Southwest.com highlights points of differentiation between Southwest and other air carriers, as well as the fact that southwest.com is the only place where Customers can purchase Southwest fares online. In addition, southwest.com and swabiz.com (the Company’s business travel reservation web page) are available in a translated Spanish version, which provides Customers who prefer to transact in Spanish the same level of Customer Service provided by the English versions of the websites. Additionally, as discussed further below under "Other Initiatives - Mobile App and Website and Mobile Boarding Passes," Southwest offers Customers a mobile website and app to provide Customers the ability to transact with Southwest anytime they have access to their mobile device. The Company launched a new southwest.com home page in September 2014 to reflect the new visual expression of its brand. See “Other Initiatives - New Livery and Branding and Aggressive Promotion of the Company’s Points of Differentiation from its Competitors” for further information about the Company’s new visual expression of its brand.
The Internet website, airtran.com, was an integral part of AirTran’s distribution network during the majority of 2014. In November 2014, the Company completed the integration of booking functions into southwest.com, referring all Customers who visit airtran.com to southwest.com. For the year ended December 31, 2014, approximately 80 percent of the Company’s Passenger revenues came through its websites (including revenues from SWABIZ®).
Operating Strategies and Initiatives
During 2014, the Company continued to focus on five strategic initiatives: (i) the integration of Southwest’s and AirTran’s network and operations, (ii) fleet modernization, (iii) the continued incorporation of the larger Boeing 737-800 aircraft into the Southwest fleet, (iv) international capabilities and new reservation system, and (v) the continued growth of Southwest's Rapid Rewards frequent flyer program. In addition to the Company’s five strategic initiatives, the Company has continued to design, implement, and manage other initiatives to increase revenues, improve cost controls, and attract and retain Customers.
Strategic Initiatives
Integration of Southwest’s and AirTran’s Network and Operations
During 2014, the Company effectively completed the process of integrating AirTran into Southwest’s operations and accomplished the following key integration milestones:
The Company converted AirTran international service to Southwest beginning with the launch of Southwest international service on July 1, 2014, with service to Jamaica (Montego Bay), The Bahamas (Nassau), and Aruba (Oranjestad). Southwest service to Mexico (Cabo San Lucas/Los Cabos and Cancun) commenced on August 10, 2014, and service to Mexico City and Dominican Republic (Punta Cana) began on November 2, 2014, establishing a Southwest presence in all cities in Southwest’s and AirTran’s combined network. AirTran’s final passenger service occurred on December 28, 2014.

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The Company continued to transfer AirTran Employees to Southwest. As of December 31, 2014, all AirTran Employees had been converted to Southwest Employees.
The Company removed the remaining 66 AirTran Boeing 717-200 aircraft from service, enabling the Company to once again operate an all-Boeing 737 fleet, with the expected efficiencies associated with operating a single aircraft type.
The Company continued to convert AirTran 737-700 aircraft to the Southwest livery. As of December 31, 2014, 47 out of a total of 52 AirTran 737-700 aircraft had completed the conversion process and re-entered service as Southwest aircraft. The remaining five AirTran 737-700 aircraft have been removed from service to begin the conversion process and are scheduled to re-enter service as Southwest aircraft in early 2015.
The Company completed the integration of booking and frequent flyer functions into southwest.com, referring all Customers who visit airtran.com to southwest.com. The Company transferred AirTran Customers’ A+ Rewards account history and any A+ Rewards credits that had not expired as of November 1, 2014, into Southwest Rapid Rewards accounts.
Fleet Modernization
As discussed below, the Company has multiple efforts underway to replace its older aircraft with newer aircraft that are less maintenance intensive and more fuel efficient and that also have a greater range. The Company expects its long-term fleet modernization plan to provide substantial flexibility to manage its fleet needs in a variety of economic conditions. The Company’s future aircraft delivery schedule is set forth in more detail below under “Properties - Aircraft.”
The Boeing 737 MAX. The Company is scheduled to be the launch customer for the new Boeing 737 MAX aircraft, which is designed to be more fuel efficient and environmentally friendly than the Company’s current Boeing aircraft. The Company has placed firm orders for 170 of the Boeing 737 MAX 8 aircraft and expects to begin to take delivery in 2017. Additionally, in 2013 the Company placed a firm order for 30 of the Boeing 737 MAX 7 aircraft and expects to begin to take delivery in 2019. The Company also has options to purchase an additional 191 Boeing 737 MAX aircraft during the period from 2021 through 2027. The Company believes the 737 MAX will (i) have the lowest operating unit costs in the single-aisle segment and (ii) benefit the Company with an engine/airframe combination that is uniquely designed to optimize operating performance of the Company’s fleet.
The Boeing Next-Generation 737. The Company has also expanded its orders for the Boeing Next-Generation 737 aircraft. From 2012 through 2014, the Company purchased 78 Boeing Next-Generation 737-800 aircraft and leased, from third parties, seven Boeing 737-800 aircraft. Additionally, during the same time period, the Company acquired 24 pre-owned 737-700 aircraft from third parties. Including the 737 MAX firm orders described above, the Company has overall total firm orders with Boeing of 275 aircraft for 2015 through 2024. Additionally, for 2015 and 2016, combined, as of December 31, 2014, the Company had agreed to acquire an additional 20 pre-owned 737-700 aircraft from third parties, 14 of which are expected to be leased aircraft. The orders from Boeing and acquisitions from third parties are intended to predominately serve as replacement aircraft for older 737-300 and 737-500 aircraft continuing to be retired from the Company’s fleet and for 717-200 aircraft that the Company has transitioned out of its fleet. The Company also has options with Boeing to purchase an additional 35 Boeing 737 Next-Generation aircraft during the period from 2016 through 2018.
Transition of Boeing 717 Aircraft. Pursuant to an agreement with Delta Air Lines, Inc. and Boeing Capital Corp., during 2014, the Company continued transitioning AirTran’s Boeing 717-200 aircraft out of the Company’s fleet for delivery to Delta. Deliveries to Delta began in September 2013 and are expected to continue at the rate of approximately three aircraft per month. As of December 31, 2014, all 88 of AirTran’s Boeing 717-200 aircraft had been removed from service and 52 had been delivered to Delta. From a fleet management perspective, this transition allows the Company to minimize the impact of this transaction on operations, as the Boeing 717 capacity lost is expected to be replaced through the capacity gained as a result of (i) the Company’s extension of the retirement dates for a portion of its 737-300 and 737-500 aircraft and (ii) deliveries from Boeing of new 737 aircraft or deliveries of used 737 aircraft from other sources. Transitioning the Boeing 717 aircraft out of the Company’s fleet avoids added complexity to the Company’s operations, as the Company has historically operated an all-Boeing 737 fleet. Replacement of the Boeing

9



717 aircraft capacity with Boeing 737 capacity provides revenue opportunities with more seats per aircraft, while costing approximately the same amount to fly on a per-trip basis as the smaller Boeing 717 aircraft.
Continued Incorporation of the Larger Boeing 737-800 into the Southwest Fleet
To further support its fleet modernization efforts, during 2014, the Company continued to incorporate the Boeing 737-800 into the Southwest fleet. The 737-800’s all coach seating configuration of 175 offers significantly more Customer seating capacity than Southwest’s other aircraft. In addition to the 737-800’s added seating capacity, its configuration includes The Boeing Company’s Sky Interior, which features a quieter cabin, improved operational security features, and LED reading and ceiling lighting. In addition, the domestic airline industry has experienced a decline in short-haul flying since 2000, and the 737-800 allows the Company to adjust its route network to allow for more long-haul flying. The Company expects the 737-800 will continue to enable it to (i) more economically serve long-haul routes; (ii) improve scheduling flexibility and more economically serve high-demand, slot-controlled, and gate-restricted airports by adding seats to such markets without increasing the number of flights; and (iii) boost fuel efficiency to reduce overall unit costs. Additionally, the Company expects the 737-800 will enable Southwest to profitably expand to new destinations, including extended routes over water, and potentially fly to more distant markets such as Hawaii, Alaska, Canada, and other near-international locations. The Company has taken delivery of 85 Boeing 737-800 aircraft from 2012 through 2014 and currently expects to take delivery of an additional 19 Boeing 737-800s during 2015. The Company’s fleet composition and delivery schedule is discussed in more detail below under “Properties - Aircraft.”
International Capabilities and New Reservation System
In January 2014, the Company launched an international reservation system and, as discussed above under “Company Operations - International Service,” began selling its inaugural international daily nonstop service to be flown by Southwest aircraft beginning July 1, 2014. The Company worked with Amadeus IT Group to launch Amadeus’ Altéa reservations solution to support the Company’s international service.
After the successful launch of the Amadeus Altéa international reservation system, the Company announced in May 2014 that it selected Amadeus' Altéa reservations solution as the Company's future single reservation system for both domestic and international reservations. This single reservation system is expected to be delivered over a multi-year period. 
Continued Growth of Southwest’s Rapid Rewards Frequent Flyer Program
Southwest’s Rapid Rewards frequent flyer program enables members to earn points for every dollar spent. The amount of points earned under the program is based on the fare and fare class purchased, with higher fare products (e.g., Business Select) earning more points than lower fare products (e.g., Wanna Get Away). Each fare class is associated with a points earning multiplier, and points for flights are calculated by multiplying the fare for the flight by the fare class multiplier. Likewise, the amount of points required to be redeemed for a flight is based on the fare and fare class purchased. Under the program (i) members are able to redeem their points for every available seat, every day, on every flight, with no blackout dates; and (ii) points do not expire so long as the Rapid Rewards Member has points-earning activity during the most recent 24 months.
Under the program, members continue to accumulate points until the time they decide to redeem them. As a result, the program provides members significant flexibility and options for earning and redeeming rewards. For example, members can earn more points (and/or achieve tiered status such as A-List and Companion Pass faster) by purchasing higher fare tickets. Members also have significant flexibility in redeeming points, such as the opportunity to book in advance to take advantage of a lower fare (including many fare sales) ticket by redeeming fewer points or by being able to redeem more points and book at the last minute if seats are still available for sale. Rapid Rewards Members can also earn points through qualifying purchases with Rapid Rewards Partners (which include, for example, car rental agencies, hotels, restaurants, and retail locations), as well as by using Southwest’s co-branded Chase® Visa credit card. In addition, holders of Southwest’s co-branded Chase Visa credit card are able to redeem their points for items other than travel on Southwest, such as international flights on other airlines, cruises, hotel stays, rental cars, gift cards, event tickets, and more. In addition to earning points for revenue flights and qualifying purchases with Rapid Rewards Partners, Rapid Rewards Members also have the ability to purchase points.

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Southwest’s Rapid Rewards frequent flyer program features tier and Companion Pass programs for the most active members, including “A-List” and “A-List Preferred” status. Both A-List and A-List Preferred Members enjoy benefits such as “Fly By®” priority checkin and security lane access, where available, as well as dedicated phone lines, standby priority, and an earnings bonus on eligible revenue flights (25 percent for A-List and 100 percent for A-List Preferred). In addition, A-List Preferred Members enjoy free inflight WiFi on equipped flights. Rapid Rewards Members who attain A-List or A-List Preferred status receive priority boarding privileges for an entire year. When these Customers purchase travel at least 36 hours prior to flight time, they receive the best boarding pass number available (generally, an “A” boarding pass). Rapid Rewards Members who fly 100 qualifying one-way flights or earn 110,000 qualifying points in a calendar year automatically receive a Companion Pass, which provides for unlimited free travel for one year to any destination available on Southwest for a designated companion of the qualifying Rapid Rewards Member. The Rapid Rewards Member and designated companion must travel together on the same flight.
Southwest’s Rapid Rewards frequent flyer program has been designed to drive more revenue by (i) bringing in new Customers, including new Rapid Rewards Members, as well as new holders of Southwest’s co-branded Chase Visa credit card; (ii) increasing business from existing Customers; and (iii) strengthening the Company’s Rapid Rewards hotel, rental car, credit card, and retail partnerships. To date, the program has exceeded the Company’s expectations with respect to the number of frequent flyer members added, the amount spent per member on airfare, the number of flights taken by members, the number of Southwest’s co-branded Chase Visa credit card holders added, the number of points sold to business partners, and the number of frequent flyer points purchased by program members.
During 2014, AirTran’s A+ Rewards frequent flyer program offered a number of ways to earn free travel, including bonus earnings for Business Class travel. A+ Rewards members could earn a credit for each one-way trip flown or 1.5 credits for one-way Business Class travel. A+ Rewards credits could also be earned for purchases made with an AirTran A+ Rewards Chase Visa credit card. The last day to earn or redeem A+Rewards credits in AirTran’s A+ Rewards frequent flyer program was on November 1, 2014. After that time, the program ended and all remaining A+ Rewards accounts were converted to Southwest’s Rapid Rewards frequent flyer program, and all remaining A+Rewards credits were converted to Rapid Rewards points. 
For the Company’s 2014 consolidated results, Customers of Southwest and AirTran redeemed approximately 6.2 million flight awards, accounting for approximately 11.0 percent of revenue passenger miles flown. For the Company’s 2013 consolidated results, Customers of Southwest and AirTran redeemed approximately 5.4 million flight awards, accounting for approximately 9.5 percent of revenue passenger miles flown. For the Company’s 2012 consolidated results, Customers of Southwest and AirTran redeemed approximately 4.5 million flight awards, accounting for approximately 9.0 percent of revenue passenger miles flown. The Company’s accounting policies with respect to its frequent flyer programs are discussed in more detail in Note 1 to the Consolidated Financial Statements.
Other Initiatives
Network Optimization and Revenue Management
The Company uses profitability management tools to manage capacity and route expansion though optimization of its flight schedule to, among other things, better match demand in certain markets. Using its profitability management tools, the Company continually adjusts the Company’s network through the addition of new markets and routes, the adjustment of frequencies in existing markets, and the exiting of certain unsustainable markets and redeployment of aircraft to other markets. As part of its continuing network optimization efforts, the Company ceased operations in Branson, Missouri; Key West, Florida; and Jackson, Mississippi in June 2014. The Company believes the continued optimization and alignment of its flight schedule can continue to yield significant synergies and other benefits. Over the next several years, the Company also plans to develop new systems to improve both revenue management and network optimization capabilities.
Cost Containment
Over the last several years, the Company has undertaken a number of cost-containment projects for the purpose of preserving Southwest’s low-cost advantage and low-fare brand. These have included the fleet modernization and network optimization strategies discussed above. Among other things, fleet modernization has contributed to lower maintenance and repair expenses, and network optimization is enabling Employee scheduling efficiencies.

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In addition, these cost-containment projects have included various fuel conservation and carbon emission reduction initiatives such as the following:
installation of blended winglets, which reduce drag and increase fuel efficiency, on all Boeing 737-700 and 737-800 aircraft in Southwest’s fleet and on a majority of Southwest’s 737-300 aircraft;
upgrading of the Company’s 737-800 fleet during the 2014-2015 timeframe with newly designed, split scimitar winglets;
periodic engine washes;
use of electric ground power for aircraft air and power at the gate and for ground support equipment at select locations;
deployment of auto-throttle and vertical navigation to maintain optimum cruising speeds;
implementation of new engine start procedures to support the introduction of new single engine taxi procedures;
adjustment of the timing of auxiliary power unit starts on originating flights to reduce auxiliary power unit usage;
fuel planning initiatives to safely reduce loading of excess fuel;
Evolve aircraft cabin interior retrofit featuring lighter seats;
reduced aircraft engine idle speed while on the ground, which also increases engine life;
galley refresh with dry goods weight reduction;
Company Optimized Routes (flying the best wind routes to take advantage of tailwinds or to minimize headwinds);
improved flight planning algorithms to better match aircraft Flight Management System (flying at the most efficient altitude);
substitution of Pilot flight bags with lighter Electronic Flight Bag tablets; and
Real Time Descent Winds (automatic uplink of up-to-date wind data to the aircraft allowing crews to time the descent to minimize thrust inputs).
The Company has also participated in Required Navigation Performance (“RNP”) operations as part of the FAA’s Performance Based Navigation program, which is intended to modernize the U.S. Air Traffic Control System by addressing limitations on air transportation capacity and making more efficient use of airspace. RNP combines the capabilities of advanced aircraft avionics, Global Positioning System ("GPS") satellite navigation (instead of less precise ground-based navigation), and new flight procedures to (i) enable aircraft to carry navigation capabilities rather than relying on airports; (ii) improve operational capabilities by opening up many new and more direct airport approach paths to produce more efficient flight patterns; and (iii) conserve fuel, improve safety, and reduce carbon emissions. Southwest began conducting GPS approach procedures during the first quarter of 2010, completed RNP training of nearly 6,000 pilots in November 2010, and commenced RNP procedures in revenue service in January 2011. By the end of 2014, Southwest had conducted over 18,000 RNP approaches, including approximately 4,500 in 2014. Southwest must rely on RNP approaches published by the FAA, and the rate of introduction of RNP approaches continues to be slower than expected, with fuel efficient RNP approaches currently available at only 46 airports. In addition, even at airports with approved RNP approaches, the clearance required from air traffic controllers to perform RNP approaches is sometimes not granted. Southwest continues to work with the FAA to develop more RNP approaches and to modify air traffic control rules to support greater utilization of RNP.
New Livery and Branding and Aggressive Promotion of the Company’s Points of Differentiation from its Competitors
In September 2014, the Company launched a new visual expression of its brand by introducing a new Heart aircraft livery, airport experience, and logo. From a financial perspective, the Company intends for this launch to remain cost-neutral by using a phased roll-out across both its fleet and its network. Aircraft already in the Company's fleet are scheduled to receive the newly painted livery within the aircraft's existing repainting schedule, while new aircraft will

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be delivered in the Heart livery. In addition, many of the future airport conversions will be integrated into existing and upcoming airport improvement projects.
During 2014, the Company continued to benefit from, and aggressively market, Southwest’s points of differentiation from its competitors. For example, Southwest continues to be the only major U.S. airline that does not impose additional fees for first and second checked bags. Through both its national and local marketing campaigns, Southwest has continued to aggressively promote this point of differentiation from its competitors with its “Bags Fly Free®” message. The Company believes its decision not to charge for first and second checked bags on Southwest, as reinforced by the Company’s related marketing campaign, has driven an increase in Southwest’s market share and a resulting net increase in revenues.
Southwest is also the only major U.S. airline that does not impose a fee on any of its fares for a Customer change in flight reservations. The Company has continued to incorporate this key point of differentiation in its marketing campaigns. The campaigns highlight the importance to Southwest of Customer Service by showing that Southwest understands plans can change and therefore does not charge a change fee. While a Customer may pay a difference in airfare, the Customer will not be charged a change fee on top of any difference in airfare.
Also unlike most of its competitors, Southwest does not impose additional fees for items such as seat selection, fuel surcharges, snacks, curb-side checkin, and telephone reservations. In addition, Southwest allows each ticketed Customer to check one stroller and one car seat free of charge, in addition to the two free checked bags.
The Company also continues to promote all of the many other reasons to fly Southwest such as its low fares, network size, Customer Service, free live television offerings (discussed below under “Inflight WiFi and Entertainment”), and its Rapid Rewards frequent flyer program.
Business Traveler Amenities
Southwest offers several products that have been designed to attract business/full fare travelers.
Business Select. As discussed above, Southwest’s “Business Select” fare includes perks such as priority boarding in the first 15 boarding positions within boarding group “A" when available, a higher frequent flyer point multiplier than other Southwest fares (including twice as many points per dollar spent as compared with Wanna Get Away fares), “Fly By®” priority ticket counter and security checkpoint access in select airports, and one complimentary adult beverage coupon for the day of travel (for Customers of legal drinking age).
Fly By® Priority Lanes. Southwest provides Fly By Priority Lane access for its Business Select Customers and Rapid Rewards A-List Members at many of its airports. Fly By Priority Lanes are priority access lanes located at select ticket counters and security checkpoints. The lanes allow Business Select Customers and Rapid Rewards A-List Members direct access to the front of the line at the ticket counter and/or security checkpoint. As of December 31, 2014, Fly By Priority Lane access was available at 78 airports served by Southwest.
SWABIZ. SWABIZ is Southwest’s business travel reservation web page. SWABIZ allows business travelers to plan, book, and purchase Ticketless Travel on Southwest and to efficiently obtain their lowest fares and maximum frequent flyer credit.
In addition, as discussed below under “Inflight WiFi and Entertainment,” Southwest has continued to install equipment on its fleet to provide access to WiFi connectivity and live television utilizing the Customer's mobile device.
Ancillary Services and Fees
During 2014, the Company continued to experience revenue benefits from service offerings such as Southwest’s EarlyBird Check-In® and Pets Are Welcome on Southwest (P.A.W.S.) products. EarlyBird Check-In provides Customers with automatic checkin so Customers are checked in 12 hours before general boarding positions become available, improving Customers' seat selection options. Customers can purchase EarlyBird Check-In for an additional $12.50 each way (priority boarding privileges are already a benefit of being an A-List frequent flyer - see “Operating Strategies and Initiatives - Continued Growth of Southwest’s Rapid Rewards Frequent Flyer Program” above). Southwest’s P.A.W.S. offering allows Customers to bring a small cat or dog into the aircraft cabin for a $95 one-way fare. Southwest also charges an additional $50 per one-way trip for unaccompanied minor travel to address the administrative costs and the extra care necessary to safely transport these Customers. The Company also expects to continue to benefit from ancillary revenue opportunities created by Southwest’s Rapid Rewards frequent flyer program.

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Southwest sells open priority boarding positions in the first 15 boarding positions within boarding group “A” systemwide at the gate for a $40 charge per flight based on availability (priority boarding positions in the first 15 boarding positions within boarding group “A”, when available, are already included in the purchase of a Business Select fare - see “Other Initiatives - Business Traveler Amenities” above), which provides another priority boarding choice for its Customers in addition to Southwest’s “Business Select” product and EarlyBird Check-In.
Southwest has a No Show policy that applies to nonrefundable fares that are not canceled or changed by a Customer at least ten minutes prior to a flight's scheduled departure. If a Customer has booked a nonrefundable fare anywhere in his/her itinerary and that portion of the flight is not used and not canceled or changed by the Customer at least ten minutes prior to scheduled departure, all unused funds on the full itinerary will be forfeited, and the remaining reservation will be canceled. This policy does not apply to military fares, senior fares, or travel during certain irregular operations, including severe weather conditions. The No Show policy does not impact Customers who simply cancel a Wanna Get Away or DING! ® fare at least ten minutes prior to scheduled departure; in this case, Customers may reuse their funds toward future travel on Southwest, without a change fee. Customers who are traveling on a fully refundable itinerary that does not contain a Wanna Get Away or DING! fare have the option of either requesting a refund or holding funds for future travel. Southwest's intent with its No Show policy is to promote Customer behavior that will enable Southwest to re-sell the open seat prior to departure.
During 2014, AirTran charged fees for checked baggage, carriage of pets, liquor sales, advance seat assignments, call center services, priority seat selection, special services such as the transportation of unaccompanied minors, and extension or transfer of A+ Miles Rewards (in addition to fees for the purchase of A+ Miles Rewards).
Inflight WiFi and Entertainment
Southwest offers inflight satellite-based WiFi service on all of its 737-700 and 737-800 aircraft, representing approximately 80 percent of Southwest’s fleet. Southwest’s arrangement with its WiFi provider enables the Company to control the pricing of the WiFi service, which is currently $8 a day per device, including WiFi-enabled stops and connections. Southwest’s Customers with small portable electronic devices are able to utilize the airline’s onboard WiFi from gate-to-gate when travelling on a Southwest WiFi-enabled airplane. Southwest was the first carrier to offer gate-to-gate connectivity.
Southwest has grown the onboard entertainment options on WiFi-enabled aircraft for viewing on Customers’ personal wireless devices to include free access to Southwest’s live and on-demand television product. The television product currently consists of 19 live channels and up to 75 on-demand recorded episodes from popular television series. Due to licensing restrictions, free live TV may not be available onboard WiFi-enabled international flights. 
Southwest also provides movies-on-demand, which are currently priced at $5 per movie and, in December 2013, became the first airline to offer a Messaging-only option for $2 a day per device, including all WiFi-enabled stops and connections. The Messaging service allows access to iMessage and pre-downloaded apps for Viber and WhatsApp.
Customers do not have to purchase WiFi to access television offerings, movies-on-demand, or the Messaging-only service.
Proactive Customer Communications
The Company’s Automated Outbound Messaging (“AOM”) service enables it to (i) proactively deliver customized automated voice, text, and e-mail messages to Southwest domestic Customers when there has been a change in their flight status as a result of a cancellation or flight delay (of 30 minutes or more), as well as potential disruptions to Southwest’s scheduled service; and (ii) give Southwest domestic Customers the option to connect to a Customer Representative or rebook online in the case of cancelled flights. Southwest domestic Customers who book their travel on southwest.com have the option to receive these notifications via telephone (landline or mobile), SMS (text message), or email. In addition to providing flight information to Southwest domestic Customers using their preferred contact method, if applicable, the Company directs Southwest domestic Customers to rebook their flights online via southwest.com/rebook. The AOM strategy is designed to increase proactive Customer outreach and accommodations, reduce Customer inconvenience, uphold regulatory requirements, mitigate costs, and provide a better overall travel experience. Customers with international reservations are able to sign up for text messaging and email alerts, via Southwest’s Flight Status Notification (“FSN”) service on southwest.com, when there has been a change in their flight status as a result of cancellation or flight delay (of 30 minutes or more). Through the Company’s coordinated technology

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initiatives, it expects to combine its AOM and FSN products into one streamlined messaging platform for domestic and international flight notifications.
Mobile App and Website and Mobile Boarding Passes
In 2014, Southwest released several updates to its mobile app and website, including the introduction of an updated homepage that allows Customers to quickly view information like flight status, boarding position, and gate information. Travel information is updated in the app beginning 24 hours prior to a flight allowing Customers to checkin and access their mobile boarding pass from the homepage. During 2014, Southwest also completed the rollout of its mobile boarding pass to all U.S. airports that Southwest serves. In addition, Southwest refreshed the look and feel of the app to align with the new visual expression of its brand discussed above under “Other Initiatives - New Livery and Branding and Aggressive Promotion of the Company’s Points of Differentiation from its Competitors.” Additional features and updates are expected in 2015 as mobile demand continues to grow.
Management Information Systems
The Company has continued its commitment to technology improvements to support its ongoing operations and initiatives. The Company has invested in significant technology necessary to support several of its initiatives, including (i) the implementation of connecting capabilities between the Southwest and AirTran reservation systems, which helped enable the Company to fully complete the process of integrating Southwest’s and AirTran’s network and operations, (ii) Southwest’s Rapid Rewards frequent flyer program, (iii) the continued incorporation of the Boeing 737-800 aircraft into the Company’s fleet, (iv) enhancements to the southwest.com website, (v) WiFi implementation and live television connectivity, and (vi) new reservation system technology to support Southwest's international itineraries. In addition, during 2014, the Company selected Amadeus' Altéa reservations solution as the Company's future single reservation system for both domestic and international reservations. This single reservation system is expected to be delivered over a multi-year period. 
The Company intends to continue to devote significant technology resources towards, among other things, (i) the development of new systems to improve both revenue management and network optimization capabilities, (ii) replacement of Southwest's existing domestic reservation system with the comprehensive Amadeus' Altéa reservations solution, and (iii) a new suite of operational tools that the Company expects will improve operational management.
Regulation
The airline industry is heavily regulated, especially by the federal government, and there are a significant number of governmental agencies and legislative bodies that have the ability to directly or indirectly affect the Company and/or the airline industry financially and/or operationally. Examples of regulations affecting the Company and/or the airline industry, imposed by several of these governmental agencies and legislative bodies, are discussed below.
Economic and Operational Regulation
Consumer Protection Regulation by the U.S. Department of Transportation
The U.S. Department of Transportation (the “DOT”) regulates aviation safety, as well as economic operating authority and consumer protection. The DOT may impose civil penalties on air carriers for violating its regulations.
To provide passenger transportation in the United States, a domestic airline is required to hold both a Certificate of Public Convenience & Necessity from the DOT and an Air Carrier Operating Certificate from the FAA, an agency within the DOT. A Certificate of Public Convenience & Necessity is unlimited in duration, and the Company’s certificate generally permits it to operate among any points within the United States and its territories and possessions. Additional DOT authority, in the form of a certificate or exemption from certificate requirements, is required for a U.S. airline to serve foreign destinations either with its own aircraft or via codesharing with another airline. The DOT also has jurisdiction over international tariffs and pricing in certain markets. The DOT may revoke a certificate or exemption, in whole or in part, for intentional failure to comply with federal aviation statutes, regulations, orders, or the terms of the certificate itself.
The DOT’s consumer protection and enforcement activities relate to areas such as unfair and deceptive practices and unfair competition by air carriers, deceptive airline advertising (e.g., fare, ontime performance, schedule, and

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codesharing), and violations of rules concerning denied boarding compensation, ticket refunds, and baggage liability requirements. The DOT is also charged with prohibiting discrimination by airlines against consumers on the basis of race, religion, national origin, or sex.
Under the above-described authority, the DOT has adopted so-called “Passenger Protection Rules,” which address a wide variety of matters including flight delays on the tarmac, chronically delayed flights, denied boarding compensation, and advertising of airfares, among others. Under the Passenger Protection Rules, U.S. passenger airlines are required to adopt contingency plans that include the following: (i) assurances that no domestic flight will remain on the airport tarmac for more than three hours and that no international flight will remain on the tarmac at a U.S. airport for more than four hours, unless the pilot-in-command determines there is a safety-related or security-related impediment to deplaning passengers, or air traffic control advises the pilot-in-command that returning to the gate or permitting passengers to disembark elsewhere would significantly disrupt airport operations; (ii) an assurance that air carriers will provide adequate food and potable drinking water no later than two hours after the aircraft leaves the gate (in the case of departure) or touches down (in the case of arrival) if the aircraft remains on the tarmac, unless the pilot-in-command determines that safety or security considerations preclude such service; and (iii) an assurance of operable lavatories, as well as adequate medical attention, if needed. Air carriers are required to publish their contingency plans on their websites.
The Passenger Protection Rules also subject airlines to potential DOT enforcement action for unfair and deceptive practices in the event of chronically delayed domestic flights (i.e., domestic flights that operate at least ten times a month and arrive more than 30 minutes late more than 50 percent of the time during that month). In addition, airlines are required to (i) display ontime performance on their websites; (ii) adopt customer service plans, publish those plans on their website, and audit their own compliance with their plans; (iii) designate an employee to monitor the performance of their flights; (iv) provide information to passengers on how to file complaints; and (v) respond in a timely and substantive fashion to consumer complaints. Airlines that violate the Passenger Protection Rules are subject to potential fines of up to $27,500 per occurrence or per passenger, the maximum allowed for violating any aviation consumer rule.
The Passenger Protection Rules also require airlines to (i) pay up to $1,300 in denied boarding compensation to passengers involuntarily bumped from flights; (ii) refund any checked bag fee for permanently lost luggage; (iii) prominently disclose all potential fees for optional services on their websites; and (iv) refund passenger fees paid for ancillary services if a flight cancels or oversells and a passenger is unable to take advantage of such services.
The Passenger Protection Rules also require that (i) advertised airfares include all government-mandated taxes and fees; (ii) passengers be allowed to hold a reservation for up to 24 hours without making a payment; (iii) passengers be allowed to cancel a paid reservation without penalty for 24 hours after the reservation is made, as long as the reservation is made at least seven days in advance of travel; (iv) fares may not increase after purchase; (v) baggage fees must be disclosed to the passenger at the time of booking; (vi) the same baggage allowances and fees must apply throughout a passenger’s trip; (vii) baggage fees must be disclosed on e-ticket confirmations; and (viii) passengers must be promptly notified in the event of delays of more than 30 minutes or if there is a cancellation or diversion of their flight.
In May 2014, the DOT issued a proposed rule that would further expand the Passenger Protection Rules. The DOT’s proposed rule would, among other things, require airlines to share with ticket agents fee information for “basic ancillary services,” including fees for a first checked bag, second checked bag, carry-on items, and advance seat selection. The Company is not able to predict the impact of such a requirement on its services, although the Company is likely to be affected to a lesser degree than most other airlines, which generally offer more ancillary products and services. The DOT may issue a final rule in this proceeding in 2015. The DOT has expressed its intent to aggressively investigate alleged violations of the Passenger Protection Rules. The DOT has also proposed rules to require airlines to report more information to the DOT on the amount and types of their ancillary fees. These proposals may be made final in 2015.
Aviation Taxes
The statutory authority for the federal government to collect most types of aviation taxes, which are used, in part, to finance programs administered by the FAA, must be periodically reauthorized by the U.S. Congress. In 2012, Congress adopted the FAA Modernization and Reform Act of 2012, which extended most commercial aviation taxes

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through September 30, 2015. Congress is expected to try to enact a new FAA reauthorization bill in 2015, which may make substantive changes with respect to aviation taxes (including, possibly, airport-assessed passenger facility charges) and/or FAA offices and programs that are financed through aviation tax revenue. Congress must either adopt a new FAA reauthorization bill or pass a “status quo” extension by October 1, 2015; otherwise, a lapse in the statutory authority could affect the airlines’ and passengers’ respective tax burdens, as well as impact the FAA’s ability to fund airport grants and regulate the airline industry.
In addition to FAA-related taxes, there are additional federal taxes related to the Department of Homeland Security. These taxes do not need to be reauthorized periodically. However, in an effort to reduce the federal deficit and generate more government revenue, Congress approved legislation in December 2013 to generate more net federal revenue by (i) increasing the Transportation Security Fee paid by passengers from $2.50 per passenger segment to $5.60 per one-way passenger trip, effective July 2014; and (ii) eliminating a duplicative security fee paid by airlines directly, called the Aviation Security Infrastructure Fee, effective October 2014. In December 2014, Congress capped the Transportation Security Fee at $11.20 per round-trip.
In 2015, Congress may consider comprehensive tax reform legislation, which could result in a lower corporate tax rate and the elimination of certain tax deductions and preferences, as well as separate legislation that could increase one or more of the passenger-paid fees used to support the operations of U.S. Customs and Border Protection (“CBP”). Grants to airports and/or airport bond financing may also be affected through future legislation, which could result in higher fees, rates, and charges at many of the airports the Company serves.
The Wright Amendment
Section 29 of the International Air Transportation Competition Act of 1979, as amended (commonly known as the “Wright Amendment”), prohibited the carriage of nonstop and through passengers on commercial flights between Dallas Love Field and all states outside of Texas, with the exception of the following states (the “Wright Amendment States”): Alabama, Arkansas, Kansas, Louisiana, Mississippi, Missouri, New Mexico, and Oklahoma. Originally, the Wright Amendment permitted an airline to offer flights between Dallas Love Field and the Wright Amendment States only to the extent the airline did not offer or provide any through service or ticketing with another air carrier at Dallas Love Field and did not market service to or from Dallas Love Field and any point outside of a Wright Amendment State. In other words, a Customer could not purchase a single ticket between Dallas Love Field and any destination other than a Wright Amendment State. These restrictions did not apply to flights operated with aircraft having 56 or fewer passenger seats. The Wright Amendment also did not restrict the Company’s intrastate Texas flights or its air service to or from points other than Dallas Love Field.
In 2006, the Company entered into an agreement with the City of Dallas, the City of Fort Worth, American Airlines, Inc., and the DFW International Airport Board, pursuant to which the five parties sought enactment of legislation to amend the Wright Amendment. Congress responded by passing the Wright Amendment Reform Act of 2006, which immediately repealed the original through service and ticketing restrictions by allowing the purchase of a single ticket between Dallas Love Field and any destination (while still requiring the Customer to make a stop in a Wright Amendment State), and reduced the maximum number of gates available for commercial air service at Dallas Love Field from 32 to 20. The Wright Amendment Reform Act also provided for the repeal, on October 13, 2014, of the Wright Amendment federal flight restrictions at Dallas Love Field, for travel to destinations within the 50 States and to the District of Columbia. Accordingly, the Company became, and remains, authorized to fly to any U.S. destination from Dallas Love Field unless such destination is restricted or otherwise limited by law. Nonstop international service to or from Dallas Love Field will continue to be prohibited. The Company currently operates out of 16 gates it leases at Dallas Love Field. As discussed further in "Management's Discussion and Analysis of Financial Condition and Results of Operations," in January 2015, the Company announced a long-term sublease agreement that will transfer usage of two additional gates, giving the Company 18 gates at Dallas Love Field.
Operational, Safety, and Health Regulation
The FAA has the authority to regulate safety aspects of civil aviation operations. Specifically, the Company and its third-party service providers are subject to the jurisdiction of the FAA with respect to aircraft maintenance and operations, including equipment, ground facilities, dispatch, communications, flight training personnel, and other matters affecting air safety. The FAA, acting through its own powers or through the appropriate U.S. Attorney, has the power to bring proceedings for the imposition and collection of fines for violation of the FAA regulations.

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To address compliance with its regulations, the FAA requires airlines to obtain an Air Carrier Operating Certificate and other certificates, approvals, and authorities. These certificates, approvals, and authorities are subject to suspension or revocation for cause.
In January 2014, a new FAA rule went into effect amending the FAA’s flight, duty, and rest regulations. Among other things, the rule requires a ten hour minimum rest period prior to a pilot’s flight duty period; mandates that a pilot must have an opportunity for eight hours of uninterrupted sleep within the rest period; and imposes pilot “flight time” and “duty time” limitations based upon report times, the number of scheduled flight segments, and other operational factors. The rule may reduce the Company’s staffing flexibility, which could impact the Company’s operational performance, costs, and Customer Experience.
The Company is subject to various other federal, state, and local laws and regulations relating to occupational safety and health, including Occupational Safety and Health Administration and Food and Drug Administration regulations.
Security Regulation
Pursuant to the Aviation and Transportation Security Act (“ATSA”), the Transportation Security Administration (the “TSA”), a division of the U.S. Department of Homeland Security, is responsible for certain civil aviation security matters. ATSA and subsequent TSA regulations and procedures implementing ATSA address, among other things, (i) flight deck security; (ii) the use of federal air marshals onboard flights; (iii) airport perimeter access security; (iv) airline crew security training; (v) security screening of passengers, baggage, cargo, mail, employees, and vendors; (vi) training and qualifications of security screening personnel; (vii) provision of passenger data to CBP; and (viii) background checks. Under ATSA, substantially all security officers at airports are federal employees, and significant other elements of airline and airport security are overseen and performed by federal employees, including federal security managers, federal law enforcement officers, and federal air marshals. TSA personnel and TSA-mandated security procedures can affect the Company’s operations, costs, and Customer experience. For example, in 2006, the TSA implemented security measures regulating the types of liquid items that can be carried onboard aircraft. In 2009, the TSA introduced its Secure Flight program. Secure Flight requires airlines to collect a passenger’s full name (as it appears on a government-issued ID), date of birth, gender, and Redress Number (if applicable). Airlines must transmit this information to Secure Flight, which uses the information to perform matching against terrorist watch lists. After matching passenger information against the watch lists, Secure Flight transmits the matching results back to airlines. This serves to identify individuals for enhanced security screening and to prevent individuals on watch lists from boarding an aircraft. It also helps prevent the misidentification of passengers who have names similar to individuals on watch lists. The TSA has also implemented enhanced security procedures as part of its enhanced, multi-layer approach to airport security, including physical pat down procedures, at security checkpoints. Such enhanced security procedures have raised privacy concerns by some air travelers.
Since November 2013, the Company, in conjunction with the TSA and CBP, has participated in TSA PreCheck™, a pre-screening initiative that allows a select group of low risk passengers the ability to move through security checkpoints with greater efficiency and ease when traveling. Eligible passengers may use dedicated screening lanes at certain airports that the Company serves for screening benefits, which include leaving on shoes, light outerwear, and belts, as well as leaving laptops and compliant liquids in carryon bags.
The Company also participates in the TSA Known Crewmember® program, which is a risk-based screening system that enables TSA security officers to positively verify the identity and employment status of flight-crew members. The program expedites flight crew member access to sterile areas of airports.
The Company has made significant investments to address the effect of security regulations, including investments in facilities, equipment, and technology to process Customers, checked baggage, and cargo efficiently and restore the airport experience; however, the Company is not able to predict the impact, if any, that various security measures or the lack of TSA resources at certain airports will have on Passenger revenues and the Company’s costs, either in the short-term or the long-term.
Environmental Regulation
The Company is subject to various federal laws and regulations relating to the protection of the environment, including the Clean Air Act, the Resource Conservation and Recovery Act, the Clean Water Act, the Safe Drinking

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Water Act, and the Comprehensive Environmental Response, Compensation and Liability Act, as well as state and local laws and regulations. These laws and regulations govern aircraft drinking water, emissions from operations, and the discharge or disposal of materials such as jet fuel, chemicals, hazardous waste, and aircraft deicing fluid. Additionally, in conjunction with airport authorities, other airlines, and state and local environmental regulatory agencies, the Company, as a normal course of business, undertakes voluntary investigation or remediation of soil or groundwater contamination at several airport sites. The Company does not believe that any environmental liability associated with these airport sites will have a material adverse effect on the Company’s operations, costs, or profitability, nor has it experienced any such liability in the past that has had a material adverse effect on its operations, costs, or profitability. Further regulatory developments pertaining to the control of engine exhaust emissions from ground support equipment could increase operating costs in the airline industry. The Company does not believe, however, that pending environmental regulatory developments in this area will have a material effect on the Company’s capital expenditures or otherwise materially adversely affect its operations, operating costs, or competitive position.
The federal government, as well as several state and local governments, the governments of other countries, and the United Nations’ International Civil Aviation Organization (the “ICAO”) are considering legislative and regulatory proposals and voluntary measures to address climate change by reducing green-house gas emissions. At the federal level, the Environmental Protection Agency (the “EPA”) announced in September 2014 that it will propose an endangerment finding for greenhouse gas emissions from aircraft sometime in 2015. The EPA would be required under the Clean Air Act to regulate greenhouse gases from aircraft if it determines the emissions endanger public health or the environment. In addition, along with its proposed endangerment finding, the EPA said that it will also issue an advance notice of proposed rulemaking summarizing international efforts to regulate aircraft emissions. The ICAO could adopt a carbon dioxide standard for aircraft by 2016 and possibly a larger international framework for aviation emissions as world governments continue to negotiate a new global climate accord. Regardless of the method of regulation, policy changes with regards to climate change are possible, which could significantly increase operating costs in the airline industry and, as a result, adversely affect operations.
The Airport Noise and Capacity Act of 1990 gives airport operators the right, under certain circumstances, to implement local noise abatement programs, so long as they do not unreasonably interfere with interstate or foreign commerce or the national air transportation system. Some airports have established airport restrictions to limit noise, including restrictions on aircraft types to be used and limits on the number of hourly or daily operations or the time of operations. These types of restrictions can cause curtailments in service or increases in operating costs and could limit the ability of air carriers to expand operations at the affected airports.
As part of its commitment to corporate sustainability, the Company has published the Southwest One ReportTM describing the Company’s sustainability strategies, which include efforts to reduce greenhouse gas emissions and address other environmental matters such as energy and water conservation, waste minimization, and recycling. As discussed above under “Operating Strategies and Initiatives - Cost Containment,” the Company has also committed significant resources towards implementation of RNP procedures, which are designed to conserve fuel and reduce carbon emissions. In addition, the Company’s “Green Team” targets areas of environmental improvement in all aspects of the Company’s business, while at the same time remaining true to the Company’s low-cost philosophy.
International Regulation
All international air service is subject to certain federal requirements and approvals, as well as the regulatory requirements of the appropriate authorities of the foreign countries involved. The Company has obtained the necessary economic authority from the DOT, as well as FAA approvals, to conduct operations, under certain circumstances, to points outside of the continental United States. To the extent the Company seeks to serve additional foreign destinations in the future, it will be required to obtain necessary authority from the DOT and approvals from the FAA, as well as any applicable foreign government or other authority.
Moreover, CBP is the federal agency of the U.S. Department of Homeland Security charged with facilitating international trade, collecting import duties, and enforcing U.S. regulations with respect to trade, customs, and immigration. As the Company expands its international flight offerings, CBP requirements and resources will become increasingly important considerations to the Company. For instance, with the exception of flights from a small number of foreign “preclearance” locations, arriving international flights may only land at CBP-designated airports, and CBP officers must be present and in sufficient quantities at those airports to effectively process and inspect arriving international passengers and cargo. Thus, CBP personnel and CBP-mandated procedures can affect the Company’s

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operations, costs, and Customer experience. The Company will make significant investments in facilities, equipment, and technologies at certain airports in order to improve the Customer experience and to assist CBP with its inspection and processing duties; however, the Company is not able to predict the impact, if any, that various CBP measures or the lack of CBP resources will have on Company revenues and costs, either in the short-term or the long-term.
Insurance
The Company carries insurance of types customary in the airline industry and in amounts deemed adequate to protect the Company and its property and to comply both with federal regulations and certain of the Company’s credit and lease agreements. The policies principally provide coverage for public and passenger liability, property damage, cargo and baggage liability, loss or damage to aircraft, engines, and spare parts, and workers’ compensation. In addition, the Company currently carries a cyber-security insurance policy with regards to data protection and business interruption associated with both security breaches from malicious parties or from certain system failures.
Through the 2003 Emergency Wartime Supplemental Appropriations Act (the “Wartime Act”), the federal government has in the past provided war-risk insurance coverage to commercial carriers, including for losses from terrorism, for passengers, third parties (ground damage), and the aircraft hull. However, since the government-provided supplemental coverage from the Wartime Act was set to expire on September 30, 2014, the Company proactively canceled its government provided war-risk insurance coverage on May 15, 2014, and effective the same date, purchased comparable coverage via the commercial insurance marketplace. Although the Company was able to purchase comparable coverage via the commercial insurance marketplace, available commercial insurance in the future could be more expensive and/or have material differences in coverage than is currently provided and may not be adequate to protect the Company's risk of loss from future acts of terrorism.
Competition
Competition within the airline industry is intense and highly unpredictable, and Southwest currently competes with other airlines on virtually all of Southwest's scheduled routes. As a result of improved economic conditions and an increased focus by airlines on costs, the airline industry has become increasingly competitive in recent years with healthier financial condition and improved profitability.
Key competitive factors within the airline industry include (i) pricing and cost structure; (ii) routes, frequent flyer programs, and schedules; and (iii) customer service, comfort, and amenities. Southwest also competes for customers with other forms of transportation, as well as alternatives to travel. In recent years, the majority of domestic airline service has been provided by Southwest and the other largest major U.S. airlines, including American Airlines, Delta Air Lines, United Airlines, and US Airways. In 2013, the parent company of American Airlines emerged from bankruptcy and merged with US Airways Group, Inc. The merged entity is the parent company of the following operating carriers: American Airlines, American Eagle Airlines (branded as Envoy beginning in 2014), US Airways, US Airways Shuttle, and US Airways Express. The DOT defines the major U.S. airlines as those airlines with annual revenues of at least $1 billion; there are currently 15 passenger airlines offering scheduled service, including Southwest, meeting this standard.
Pricing and Cost Structure
Pricing is a significant competitive factor in the airline industry, and the availability of fare information on the Internet allows travelers to easily compare fares and identify competitor promotions and discounts. Pricing can be driven by a variety of factors. For example, airlines often discount fares to drive traffic in new markets or to stimulate traffic when necessary to improve load factors and/or cash flow. In addition, multiple airlines have been able to reduce fares because they have been able to lower their operating costs as a result of reorganization within and outside of bankruptcy. Further, some of the Company’s competitors have continued to grow and modernize their fleets and expand their networks, potentially enabling them to better control costs per available seat mile (the average cost to fly an aircraft seat (empty or full) one mile), which in turn may enable them to lower their fares. These factors can reduce the pricing power of the Company and the airline industry as a whole.
The Company believes its low-cost operating structure continues to provide it with an advantage over many of its airline competitors by enabling Southwest to continue to charge low fares. The Company also believes it has gained a competitive advantage by differentiating Southwest from all of its major competitors by not charging additional fees

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for items such as first and second checked bags, flight changes, seat selection, fuel surcharges, snacks, curb-side checkin, and telephone reservations.
Routes, Frequent Flyer Programs, and Schedules
The Company also competes with other airlines based on markets served, frequent flyer opportunities, and flight schedules. Some major airlines have more extensive route structures than Southwest, including more extensive international networks. In addition, many competitors have entered into significant commercial relationships with other airlines, such as global alliances, codesharing, and capacity purchase agreements, which increase the airlines’ opportunities to expand their route offerings. For example, an alliance or codesharing agreement enables an airline to offer flights that are operated by another airline and also allows the airline’s customers to book travel that includes segments on different airlines through a single reservation or ticket. As a result, depending on the nature of the specific alliance or codesharing arrangement, a participating airline may be able to (i) offer its customers access to more destinations than it would be able to serve on its own, (ii) gain exposure in markets it does not otherwise serve, or (iii) increase the perceived frequency of its flights on certain routes. Alliance and codesharing arrangements not only provide additional route flexibility for participating airlines, they can also allow these airlines to offer their customers more opportunities to earn and redeem frequent flyer miles or points. A capacity purchase agreement enables an airline to expand its route structure by paying another airline (e.g., a regional airline with smaller aircraft) to operate flights on its behalf in markets that it does not, or cannot, serve itself. The Company continues to evaluate and implement initiatives to better enable Southwest to offer additional itineraries. In addition, the Company’s acquisition of AirTran enabled the Company to (i) expand its presence in key markets Southwest already served, (ii) grow the Company’s presence in key markets Southwest did not previously serve, (iii) extend service to smaller domestic cities Southwest did not previously serve, and (iv) provide access to the Commonwealth of Puerto Rico and key near-international markets in the Caribbean and Mexico.
Customer Service, Comfort, and Amenities
Southwest also competes with other airlines in areas of Customer Service such as ontime performance, passenger amenities, flight equipment type, and comfort. According to statistics published by the DOT, Southwest consistently ranks at or near the top among domestic carriers in Customer Satisfaction for having the lowest Customer complaint ratio. Some airlines have more seating options and associated passenger amenities than does Southwest, including first-class, business class, and other premium seating and related amenities. Additionally, some major U.S. airlines have announced plans to add a significant number of new aircraft to their fleets. Such efforts could provide cost benefits to these airlines through fleet simplification, improved fuel efficiencies, and lower maintenance costs. Additionally, such new aircraft could have newer and different passenger amenities than those contained in the Company’s existing fleet. The Company is addressing this competitive factor with its fleet modernization initiatives, which are discussed above under “Operating Strategies and Initiatives - Fleet Modernization” and “Operating Strategies and Initiatives - Continued Incorporation of the Larger Boeing 737-800 into the Southwest Fleet.”
Other Forms of Competition
The airline industry is subject to varying degrees of competition from surface transportation by automobiles, buses, and trains. Inconveniences and delays associated with air travel security measures can increase surface competition. In addition, surface competition can be significant during economic downturns when consumers cut back on discretionary spending and fewer choose to fly, or when gasoline prices are lower, making surface transportation a less expensive option. Because of the relatively high percentage of short-haul travel provided by Southwest, it is particularly exposed to competition from surface transportation in these instances. The airline industry is also subject to competition from alternatives to travel such as videoconferencing and the Internet, which can increase in the event of travel inconveniences and economic downturns. The Company is subject to the risk that air travel inconveniences and economic downturns may, in some cases, result in permanent changes to consumer behavior in favor of surface transportation and electronic communications.
Seasonality
The Company’s business is seasonal. Generally, in most markets the Company serves, demand for air travel is greater during the summer months, and therefore, revenues in the airline industry tend to be stronger in the second (April 1 - June 30) and third (July 1 - September 30) quarters of the year than in the first (January 1 - March 31) and

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fourth (October 1 - December 31) quarters of the year. As a result, in many cases, the Company’s results of operations reflect this seasonality. Factors that could alter this seasonality include, among others, the price of fuel, general economic conditions, extreme or severe weather, fears of terrorism or war, or changes in the competitive environment. Therefore, the Company’s quarterly operating results are not necessarily indicative of operating results for the entire year and historical operating results in a quarterly or annual period are not necessarily indicative of future operating results.
Employees
At December 31, 2014, the Company had 46,278 active fulltime equivalent Employees, consisting of 20,013 flight, 2,632 maintenance, 15,739 ground, Customer, and fleet service, and 7,894 management, technology, finance, marketing, and clerical personnel (associated with non-operational departments). Approximately 83 percent of these Employees were represented by labor unions. The Railway Labor Act establishes the right of airline employees to organize and bargain collectively. Under the Railway Labor Act, collective-bargaining agreements between an airline and a labor union generally do not expire, but instead become amendable as of an agreed date. By the amendable date, if either party wishes to modify the terms of the agreement, it must notify the other party in the manner required by the Railway Labor Act and/or described in the agreement. After receipt of the notice, the parties must meet for direct negotiations. If no agreement is reached, either party may request the National Mediation Board to appoint a federal mediator. If no agreement is reached in mediation, the National Mediation Board may determine an impasse exists and offer binding arbitration to the parties. If either party rejects binding arbitration, a 30-day “cooling off” period begins. At the end of this 30-day period, the parties may engage in “self-help,” unless a Presidential Emergency Board is established to investigate and report on the dispute. The appointment of a Presidential Emergency Board maintains the “status quo” for an additional 60 days. If the parties do not reach agreement during this period, the parties may then engage in “self-help.” “Self-help” includes, among other things, a strike by the union or the airline’s imposition of any or all of its proposed amendments and the hiring of new employees to replace any striking workers. Following the AirTran acquisition, the various Company labor groups were covered by 18 different collective-bargaining agreements (“CBAs”). AirTran Employees in certain labor groups have fully transitioned to Southwest Employees under a single contract. The following table sets forth the Company’s Employee groups and the status of the respective CBAs as of December 31, 2014:


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Employee Group
Approximate Number of Employees
Representatives
Status of Agreement
Southwest Pilots
7,500
Southwest Airlines Pilots’ Association (“SWAPA”)
In negotiations
Southwest Flight Attendants
11,850
Transportation Workers of America, AFL-CIO, Local 556 (“TWU 556”)
In negotiations
Southwest Ramp, Operations, Provisioning, Freight Agents
10,000
Transportation Workers of America, AFL-CIO, Local 555 (“TWU 555”)
In negotiations
Southwest Customer Service Agents, Customer Representatives
5,800
International Association of Machinists and Aerospace Workers, AFL-CIO (“IAM 142”)
Amendable December 2018
Southwest Material Specialists (formerly known as Stock Clerks)
250
International Brotherhood of Teamsters, Local 19 (“IBT 19”)
In negotiations
Southwest Mechanics
2,100
Aircraft Mechanics Fraternal Association (“AMFA”)
In negotiations
Southwest Aircraft Appearance Technicians
200
AMFA
Amendable February 2017
Southwest Facilities Maintenance Technicians
40
AMFA
In negotiations
Southwest Dispatchers
250
Transportation Workers of America, AFL-CIO, Local 550 (“TWU 550”)
Amendable November 2015
Southwest Flight Simulator Technicians
30
International Brotherhood of Teamsters (“IBT”)
Amendable October 2015
Southwest Flight Crew Training Instructors
70
Transportation Workers of America, AFL-CIO, Local 557 (“TWU 557”)
Amendable December 2015
Southwest Meteorologists
6
TWU 550
In November 2014, the Southwest Meteorologists voted in favor of union representation.
AirTran Flight Attendants
350
Association of Flight Attendants-CWA (“AFA”)
The parties have negotiated an interim collective bargaining agreement to be effective until affected former AirTran Employees complete Southwest training and become Southwest Flight Attendants.

Additional Information About the Company
The Company was incorporated in Texas in 1967. The following documents are available free of charge through the Company’s website, www.southwest.com: the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports that are filed with or furnished to the Securities and Exchange Commission (“SEC”) pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934. These materials are made available through the Company’s website as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC. In addition to its reports filed or furnished with the SEC, the Company publicly discloses material information from time to time in its press releases, at annual meetings of Shareholders, in publicly accessible conferences and investor presentations, and through its website (principally in its Press Room and Investor Relations pages).


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DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION
This Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are based on, and include statements about, the Company’s estimates, expectations, beliefs, intentions, and strategies for the future, and the assumptions underlying these forward-looking statements. Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include, without limitation, words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “will,” “should,” and similar expressions. Although management believes these forward-looking statements are reasonable as and when made, forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual results may differ materially from what is expressed in or indicated by the Company’s forward-looking statements or from historical experience or the Company’s present expectations. Known material risk factors that could cause these differences are set forth below under “Risk Factors.” Additional risks or uncertainties (i) that are not currently known to the Company, (ii) that the Company currently deems to be immaterial, or (iii) that could apply to any company, could also materially adversely affect the Company’s business, financial condition, or future results.
Caution should be taken not to place undue reliance on the Company’s forward-looking statements, which represent the Company’s views only as of the date this report is filed. The Company undertakes no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.
Item 1A.
Risk Factors
The airline industry is particularly sensitive to changes in economic conditions; in the event of unfavorable economic conditions or economic uncertainty, the Company’s results of operations could be negatively affected, which could require the Company to adjust its business strategies.
The airline industry, which is subject to relatively high fixed costs and highly variable and unpredictable demand, is particularly sensitive to changes in economic conditions. Historically, unfavorable U.S. economic conditions have driven changes in travel patterns and have resulted in reduced spending for both leisure and business travel. For some consumers, leisure travel is a discretionary expense, and short-haul travelers, in particular, have the option to replace air travel with surface travel. Businesses are able to forego air travel by using communication alternatives such as videoconferencing and the Internet or may be more likely to purchase less expensive tickets to reduce costs, which can result in a decrease in average revenue per seat. Unfavorable economic conditions have also historically hampered the ability of airlines to raise fares to counteract increased fuel, labor, and other costs. Although the U.S. economy has experienced a moderate recovery since emerging from a recession in 2009, any future U.S. or global economic uncertainty could negatively affect the Company’s results of operations and could cause the Company to adjust its business strategies.
The Company’s business has been significantly impacted by high and/or volatile fuel prices and the Company’s operations are subject to disruption based on the timely supply of fuel; therefore, the Company’s strategic plans and future profitability are likely to be impacted by the Company’s ability to effectively address fuel price increases and fuel price volatility and availability.
Airlines are inherently dependent upon energy to operate, and jet fuel and oil represented approximately 32 percent of the Company’s operating expenses for 2014. Although the cost of fuel has declined in recent months, it continues to be unpredictable, and even a small change in market fuel prices can significantly affect profitability. Furthermore, volatility in fuel prices can be due to many external factors that are beyond the Company’s control. For example, fuel prices can be impacted by political and economic factors, such as (i) dependency on foreign imports of crude oil and the potential for hostilities or other conflicts in oil producing areas; (ii) limited domestic refining or pipeline capacity; (iii) worldwide demand for fuel, particularly in developing countries, which can result in inflated energy prices; (iv) changes in U.S. governmental policies on fuel production, transportation, taxes, and marketing; and (v) changes in currency exchange rates.
The Company’s ability to effectively address fuel price increases can be limited by its ability to increase fares, which can be difficult in challenging economic environments when low fares are often used to stimulate traffic. The

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ability to increase fares can also be limited by factors such as the historical low-fare reputation of Southwest, the portion of its Customer base that purchases travel for leisure purposes, the competitive nature of the airline industry generally, and the risk that higher fares will drive a decrease in demand.
The Company attempts to manage its risk associated with changing jet fuel prices by utilizing over-the-counter fuel derivative instruments to hedge a portion of its future jet fuel purchases. However, because energy prices can fluctuate significantly in a relatively short amount of time, and due to the fact that the Company uses a variety of different derivative instruments and at different price points, the Company is subject to the risk that the fuel derivatives it uses will not provide adequate protection against significant increases in fuel prices and could in fact result in additional volatility in the Company’s earnings. The Company is also subject to the risk that cash collateral may be required to be posted to fuel hedge counterparties, which could have a significant impact on the Company’s financial position and liquidity.
In addition, the Company is subject to the risk that its fuel derivatives will not be effective or that they will no longer qualify for hedge accounting under applicable accounting standards, which could create additional earnings volatility. Adjustments in the Company’s overall fuel hedging strategy, as well as the ability of the commodities used in fuel hedging to qualify for special hedge accounting, are likely to continue to affect the Company’s results of operations. In addition, there can be no assurance that the Company will be able to cost-effectively hedge against increases in fuel prices.
The Company’s fuel hedging arrangements and the various potential impacts of hedge accounting on the Company’s financial position, cash flows, and results of operations are discussed in more detail under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and in Note 1 and Note 10 to the Consolidated Financial Statements.
The Company is also reliant upon the readily available supply and timely delivery of jet fuel to the airports that it serves. A disruption in that supply could present significant challenges to the Company’s operations, and could ultimately cause the cancellation of flights and/or the inability of the Company to provide service to a particular airport.
The Company’s low-cost structure has historically been one of its primary competitive advantages, and many factors have affected and could continue to affect the Company’s ability to control its costs.
The Company’s low-cost structure has historically been one of its primary competitive advantages, as it has enabled Southwest to historically offer low fares, drive traffic volume, and grow market share. The Company’s low-cost structure has become increasingly important as a result of the Company’s decision to limit capacity growth in recent years in response to high fuel prices and uncertain economic conditions. While the Company has in the past at times been able to cover increasing costs through growth, the combination of capacity control and increasing costs in recent years has contributed to an increase in the Company’s costs per available seat mile.
The Company has limited control over fuel and labor costs, as well as other costs such as regulatory compliance costs. Jet fuel and oil constituted approximately 32 percent of the Company’s operating expenses during 2014, and the cost of fuel is subject to the external factors discussed in the second Risk Factor above. Salaries, wages, and benefits constituted approximately 33 percent of the Company’s operating expenses during 2014. The Company’s ability to control labor costs is limited by the terms of its CBAs, and increased labor costs have negatively impacted the Company’s low-cost competitive position. As discussed further under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Company’s unionized workforce, which makes up the majority of its Employees, has had pay scale increases as a result of contractual rate increases. Furthermore, as indicated above under “Business-Employees,” the majority of Southwest’s unionized Employees, including its Pilots, Mechanics, Ramp, Operations, Provisioning, and Freight Agents, Flight Attendants, Material Specialists, and Facilities Maintenance Technicians are in unions currently in negotiations for labor agreements, which could continue to put pressure on the Company’s labor costs. In addition, the Company anticipates that the combination of the various Southwest and AirTran labor contracts and frontline workforces will increase labor costs over their historical levels. As discussed above under “Business-Regulation,” the airline industry is heavily regulated, and the Company’s regulatory compliance costs are subject to potentially significant increases from time to time based on actions by the regulatory agencies. Additionally, when other airlines reduce their capacity, airport costs are then allocated among a fewer number of total flights, which can result in increased landing fees and other costs for the Company. The Company is also reliant upon third party

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vendors and service providers, and its low-cost advantage is also dependent in part on its ability to obtain and maintain commercially reasonable terms with those parties.
As discussed above under “Business-Insurance,” the Company carries insurance of types customary in the airline industry and, in the past, has also been provided supplemental, first-party, war-risk insurance coverage by the federal government. Since the government-provided supplemental coverage from the Wartime Act was set to expire on September 30, 2014, the Company proactively canceled its government provided war-risk insurance coverage on May 15, 2014, and effective the same date, purchased comparable coverage via the commercial insurance marketplace. Although the Company was able to purchase comparable coverage via the commercial insurance marketplace, available commercial insurance in the future could be more expensive and/or have material differences in coverage than is currently provided and may not be adequate to protect against the Company's risk of loss from future acts of terrorism. In addition, an accident or other incident involving Southwest aircraft could result in costs in excess of its related insurance coverage, which costs could be substantial. Any aircraft accident or other incident, even if fully insured, could also have a material adverse effect on the public’s perception of the Company.
The Company cannot guarantee it will be able to maintain or improve upon its current level of low-cost advantage over many of its airline competitors. Some of the Company’s competitors have achieved substantially lower employee pay scales through bankruptcy than the Company. Additionally, in recent years, in response to high fuel prices and economic uncertainty, some of the Company’s competitors implemented additional efficiency and cost reduction measures, such as capacity cuts and headcount reductions, which have reduced the Company’s cost advantage. Further, other competitors have continued to grow their fleets and expand their networks, potentially enabling them to better control costs per available seat mile. In addition, some competitors have announced plans to add a significant number of new aircraft to their fleets, which could potentially decrease their operating costs through better fuel efficiencies, and lower maintenance costs. Some of the Company’s competitors have taken advantage of reorganization in bankruptcy, and even the threat of bankruptcy, not only to lower employee pay scales, but also to decrease operating costs through renegotiated supply and financing agreements. In addition, some airlines have consolidated and reported significant expected cost synergies.
The Company is increasingly dependent on technology to operate its business and continues to implement substantial changes to its information systems; any failure or disruption in the Company’s information systems could materially adversely affect its operations.
The Company is increasingly dependent on the use of complex technology and systems to run its ongoing operations. In addition, technology is critical to the success of the Company’s strategic initiatives. In recent years the Company has been committed to technology improvements to support its ongoing operations and initiatives and, as discussed above under “Business - Management Information Systems,” the Company has invested in significant technology changes to support its initiatives. For example, during 2014, the Company selected Amadeus' Altéa reservations solution as the Company's future single reservation system for both domestic and international reservations. This single reservation system is expected to be delivered over a multi-year period. The Company intends to continue to devote significant technology resources towards, among other things, (i) the development of new systems to improve both revenue management and network optimization capabilities, (ii) replacement of Southwest's existing domestic reservation system with the comprehensive Amadeus' Altéa reservations solution, and (iii) a new suite of operational tools that the Company expects will improve operational management.
Integration of complex systems and technology presents significant challenges in terms of costs, human resources, and development of effective internal controls. Integration also presents the risk of operational or security inadequacy or interruption, which could materially affect the Company’s ability to effectively operate its business. The Company is also reliant upon third party performance for timely and effective completion of many of its technology initiatives.
In the ordinary course of business, the Company’s systems will continue to require modification and refinements to address growth and changing business requirements, including requirements related to international operations. In addition, the Company’s systems may require modification to enable the Company to comply with changing regulatory requirements. For example, in connection with the increase to the Transportation Security Fee discussed above under “Regulation - Aviation Taxes,” modifications and refinements to the Company’s systems were required in connection with both the July 2014 implementation of the Transportation Security Fee increase and amendments to this increase

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in December 2014. In addition, software was developed for Pilot scheduling in response to the DOT’s and FAA’s flight, duty, and rest regulations that went into effect in January 2014. Modifications and refinements to the Company’s systems have been and are expected to continue to be expensive to implement and may divert management’s attention from other key initiatives. In addition, the Company’s operations could be adversely affected, or it could face imposition of regulatory penalties, if it is unable to timely or effectively modify its systems as necessary.
The Company may occasionally experience system interruptions and delays that make its websites and services unavailable or slow to respond, which could prevent the Company from efficiently processing Customer transactions or providing services. This in turn could reduce the Company’s operating revenues and the attractiveness of its services. The Company’s computer and communications systems and operations could be damaged or interrupted by catastrophic events such as fires, floods, earthquakes, tornadoes and hurricanes, power loss, computer and telecommunications failures, acts of war or terrorism, computer viruses, security breaches, and similar events or disruptions. Any of these events could cause system interruptions, delays, and loss of critical data, and could prevent the Company from processing Customer transactions or providing services, which could make the Company’s business and services less attractive and subject the Company to liability. Any of these events could damage the Company’s reputation and be expensive to remedy.
The Company’s business is labor intensive; therefore, the Company would be adversely affected if it were unable to maintain satisfactory relations with its Employees or its Employees’ Representatives or if the Company were unable to employ sufficient numbers of qualified Employees to maintain its operations.
The airline business is labor intensive. Salaries, wages, and benefits represented approximately 33 percent of the Company’s operating expenses for the year ended December 31, 2014. In addition, as of December 31, 2014, approximately 83 percent of the Company’s Employees were represented for collective bargaining purposes by labor unions, making the Company particularly exposed in the event of labor-related job actions. Employment-related issues that may impact the Company’s results of operations, some of which are negotiated items, include hiring/retention rates, pay rates, outsourcing costs, work rules, and health care costs. The Company has historically maintained positive relationships with its Employees and its Employees’ Representatives. However, as indicated above under “Business-Employees,” the majority of Southwest’s unionized Employees, including its Pilots; Mechanics; Ramp, Operations, Provisioning, and Freight Agents; Flight Attendants; Material Specialists; and Facilities Maintenance Technicians, are in unions currently in negotiations for labor agreements, which could continue to put pressure on the Company’s labor costs. Increasing labor costs, whether or not combined with curtailed growth, could negatively impact the Company’s competitive position.
The Company’s success also depends on its ability to attract and retain skilled personnel. Competition for skilled personnel may intensify if overall industry capacity increases and/or if high levels of current personnel reach retirement age. The Company may be required to increase existing levels of compensation to retain or supplement its skilled workforce. The inability to recruit and retain skilled personnel or the unexpected loss of key skilled personnel could adversely affect the Company’s operations.
The Company is currently dependent on single aircraft and engine suppliers, as well as single suppliers of certain other parts; therefore, the Company would be materially adversely affected if it were unable to obtain additional equipment or support from any of these suppliers or in the event of a mechanical or regulatory issue associated with their equipment.
The Company is dependent on Boeing as its sole supplier for aircraft and many of its aircraft parts and is dependent on other suppliers for certain other aircraft parts. Although the Company is able to purchase some aircraft from parties other than Boeing, most of its purchases are directly from Boeing. Therefore, if the Company were unable to acquire additional aircraft from Boeing, or if Boeing were unable or unwilling to make timely deliveries of aircraft or to provide adequate support for its products, the Company’s operations would be materially adversely affected. In addition, the Company would be materially adversely affected in the event of a mechanical or regulatory issue associated with the Boeing 737 aircraft type, whether as a result of downtime for part or all of the Company’s fleet or because of a negative perception by the flying public. The Company believes, however, that its years of experience with the Boeing 737 aircraft type, as well as the efficiencies Southwest has historically achieved by operating with a single aircraft type, currently outweigh the risks associated with its single aircraft supplier strategy. To enable Southwest to sustain the benefits associated with operating a single aircraft type, in July 2012 the Company entered into an agreement with

27



Delta Air Lines, Inc. and Boeing Capital Corp. to lease or sublease all 88 of AirTran’s Boeing 717-200 aircraft to Delta. Deliveries to Delta began in September 2013 at the rate of approximately three aircraft per month. As of December 31, 2014, all 88 of AirTran’s Boeing 717-200 aircraft had been removed from service and 52 had been delivered to Delta. The Company is also dependent on sole suppliers for aircraft engines and certain other aircraft parts and would therefore also be materially adversely affected in the event of the unavailability of, or a mechanical or regulatory issue associated with, engines and other parts.
Any failure of the Company to maintain the security of certain Customer-related information could result in damage to the Company’s reputation and could be costly to remediate.
The Company must receive information related to its Customers in order to run its business, and the Company’s online operations depend upon the secure transmission of information over public networks, including information permitting cashless payments. This information is subject to the risk of intrusion, tampering, and theft. Although the Company maintains systems to prevent this from occurring, these systems require ongoing monitoring and updating as technologies change, and security could be compromised, confidential information could be misappropriated, or system disruptions could occur. The Company must also provide certain confidential, proprietary, and personal information to third parties in the ordinary course of its business. While the Company seeks to obtain assurances that these third parties will protect this information, there is a risk the confidentiality of data held by third parties could be breached. A compromise of the Company’s security systems could adversely affect the Company’s reputation and disrupt its operations and could also result in litigation against the Company or the imposition of penalties. In addition, it could be costly to remediate. Although the Company has not experienced cyber incidents that are individually, or in the aggregate, material, the Company has experienced cyber attacks in the past, which have thus far been mitigated by preventive and detective measures put in place by the Company.
The Company’s results of operations could be adversely impacted if it is unable to grow or to timely and effectively implement its revenue and other initiatives.
Southwest has historically been regarded as a growth airline; however, less than satisfactory returns on capital caused by the combination of a difficult economic environment and growing jet fuel costs led to the Company’s decision to limit organic growth in recent years. In addition, organic growth has become increasingly difficult, because (i) the number of opportunities for domestic expansion has declined; (ii) the Company's international network is small and not yet developed; and (iii) the Company has faced an increased presence of other low-cost, low-fare carriers. As a result, the Company has become increasingly reliant on the success of revenue initiatives to help offset increasing costs and to continue to improve Customer Service. The timely and effective implementation of these initiatives has involved, and will continue to involve, significant investments by the Company of time and money and could be negatively affected by (i) the Company’s ability to timely and effectively implement, transition, and maintain related information technology systems and infrastructure; (ii) the Company’s ability to effectively balance its investment of incremental operating expenses and capital expenditures related to its initiatives against the need to effectively control costs; and (iii) the Company’s dependence on third parties to assist with implementation of its initiatives. The Company cannot ensure the timing of implementation of certain of its initiatives or that they will be successful or profitable either over the short or long-term.
Instability of credit, capital, and energy markets can result in pressure on the Company’s credit ratings and can also negatively affect the Company’s ability to obtain financing on acceptable terms and the Company’s liquidity generally.
During the recession in 2009, the Company’s credit ratings were pressured by weak industry revenue and an extraordinarily volatile fuel price environment. While the Company’s credit rating is “investment grade,” factors such as future unfavorable economic conditions, a significant decline in demand for air travel, or instability of the credit and capital markets could result in future pressure on credit ratings, which could negatively affect (i) the Company’s ability to obtain financing on acceptable terms, (ii) the Company’s liquidity generally, and (iii) the availability and cost of insurance. A credit rating downgrade could subject the Company to credit rating triggers related to its credit card transaction processing agreements, the pricing related to any funds drawn under its revolving credit facility, and some of its hedging counterparty agreements. The potential effect of credit rating downgrades is discussed in more detail below under “Quantitative and Qualitative Disclosures About Market Risk.”

28



The airline industry has faced on-going security concerns and related cost burdens; further threatened or actual terrorist attacks, or other hostilities, could significantly harm the airline industry and the Company’s operations.
Terrorist attacks and threatened attacks have from time to time materially adversely affected the demand for air travel and also have resulted in increased safety and security costs for the Company and the airline industry generally. Safety measures create delays and inconveniences and can, in particular, reduce the Company’s competitiveness against surface transportation for short-haul routes. Additional terrorist attacks, even if not made directly on the airline industry, or the fear of such attacks or other hostilities (including elevated national threat warnings or selective cancellation or redirection of flights due to terror threats) would likely have a further significant negative impact on the Company and the airline industry.
Airport capacity constraints and air traffic control inefficiencies could limit the Company’s growth; changes in or additional governmental regulation could increase the Company’s operating costs or otherwise limit the Company’s ability to conduct business.
Almost all commercial service airports are owned and/or operated by units of local or state governments. Airlines are largely dependent on these governmental entities to provide adequate airport facilities and capacity at an affordable cost. Similarly, the federal government singularly controls all U.S. airspace, and airlines are completely dependent on the FAA operating that airspace in a safe and efficient manner. The air traffic control system, which is operated by the FAA, could continue to face airspace and/or airport congestion challenges in the future, which could limit the Company’s opportunities for growth. As discussed above under “Business - Regulation,” airlines are also subject to other extensive regulatory requirements. These requirements often impose substantial costs on airlines. The Company’s initiatives and results of operations could be negatively affected by changes in law and future actions taken by domestic and foreign governmental agencies having jurisdiction over its operations, including, but not limited to:
increases in airport rates and charges;
limitations on airport gate capacity or use of other airport facilities;
limitations on route authorities;
actions and decisions that create difficulties in obtaining access at slot-controlled airports;
actions and decisions that create difficulties in obtaining operating permits and approvals;
changes to environmental regulations;
new or increased taxes or fees, such as the July 2014 increased Transportation Security Fee discussed above under “Regulation - Aviation Taxes”;
changes to laws that affect the services that can be offered by airlines in particular markets and at particular airports;
restrictions on competitive practices;
changes in laws that increase costs for safety, security, compliance, or other Customer Service standards, such as the FAA regulations with respect to Pilot flight/duty time limitations and rest requirements discussed above under “Business - Regulation”;
changes in laws that may limit the Company's ability to enter into fuel derivative contracts to hedge against increases in fuel prices;
changes in laws that may limit or regulate the Company’s ability to promote the Company’s business or fares; and
the adoption of more restrictive locally-imposed noise regulations.
Because expenses of a flight do not vary significantly with the number of passengers carried, a relatively small change in the number of passengers can have a disproportionate effect on an airline’s operating and financial results. Therefore, any general reduction in airline passenger traffic as a result of any of the factors listed above could adversely affect the Company’s results of operations. In addition, in instances where the airline industry shrinks, many airport operating costs are essentially unchanged and must be shared by the remaining operating carriers, which can therefore increase the Company’s costs.

29



The airline industry is affected by many conditions that are beyond its control, which can impact the Company’s business strategies and results of operations.
In addition to the unpredictable economic conditions and fuel costs discussed above, the Company, like the airline industry in general, is affected by conditions that are largely unforeseeable and outside of its control, including, among others:
adverse weather and natural disasters;
outbreaks of disease;
changes in consumer preferences, perceptions, spending patterns, or demographic trends (including, without limitation, changes in government travel patterns due to government shutdowns or sequestration);
actual or potential disruptions in the air traffic control system (including, without limitation, as a result of potential FAA budget cuts due to government shutdowns or sequestration);
changes in the competitive environment due to industry consolidation, industry bankruptcies, and other factors;
air traffic congestion and other air traffic control issues; and
actual or threatened war, terrorist attacks, and political instability.
The airline industry is intensely competitive.
As discussed in more detail above under “Business - Competition,” the airline industry is intensely competitive. The Company’s primary competitors include other major domestic airlines, as well as regional and new entrant airlines, surface transportation, and alternatives to transportation such as videoconferencing and the Internet. The Company’s revenues are sensitive to the actions of other carriers with respect to pricing, routes, frequent flyer programs, scheduling, capacity, Customer Service, comfort and amenities, cost structure, aircraft fleet, and codesharing and similar activities.
The Company’s future results will suffer if it does not effectively manage its expanded operations, including its international operations.
As the Company expands its international flight offerings, the U.S. Customs and Border Protection (“CBP”) will become an increasingly important federal agency. CBP personnel and CBP-mandated procedures can affect the Company’s operations, costs, and Customer experience. The Company will make significant investments in facilities, equipment, and technologies at certain airports in order to improve the Customer experience and to assist CBP with its inspection and processing duties; however, the Company is not able to predict the impact, if any, that various CBP measures or the lack of CBP resources will have on Company revenues and costs, either in the short-term or the long-term.
International flying requires the Company to modify certain processes, as the airport environment is dramatically different in certain international locations with respect to, among other things, common-use ticket counters and gate areas, local operating requirements, and cultural preferences. In addition, international flying exposes the Company to certain foreign currency risks to the extent the Company chooses to, or is required to, transact in currencies other than the U.S. dollar. To the extent the Company seeks to serve additional foreign destinations in the future, it will be required to obtain necessary authority from the DOT and approvals from the FAA, as well as any applicable foreign government or other authority.
The Company’s expansion of its operations into non-U.S. jurisdictions also expands the scope of the laws to which the Company is subject, both domestically and internationally. In addition, operations in non-U.S. jurisdictions are in many cases subject to the laws of those jurisdictions rather than U.S. laws. Laws in some jurisdictions differ in significant respects from those in the United States, and these differences can affect the Company’s ability to react to changes in its business, and its rights or ability to enforce rights may be different than would be expected under U.S. law. Furthermore, enforcement of laws in some jurisdictions can be inconsistent and unpredictable, which can affect both the Company’s ability to enforce its rights and to undertake activities that it believes are beneficial to its business. As a result, the Company’s ability to generate revenue and its expenses in non-U.S. jurisdictions may differ from what would be expected if U.S. law governed these operations. Although the Company has policies and procedures in place

30



that are designed to promote compliance with the laws of the jurisdictions in which it operates, a violation by the Company’s Employees, contractors, or agents or other intermediaries, could nonetheless occur. Any violation (or alleged or perceived violation), even if prohibited by the Company’s policies, could have an adverse effect on the Company’s reputation and/or its results of operations.
AirTran is currently subject to pending antitrust litigation, and if judgment were to be rendered against AirTran in the litigation, such judgment could adversely affect the Company’s operating results.
A complaint alleging violations of federal antitrust laws and seeking certification as a class action was filed against Delta Air Lines, Inc. and AirTran in the United States District Court for the Northern District of Georgia in Atlanta on May 22, 2009. The complaint alleged, among other things, that AirTran attempted to monopolize air travel in violation of Section 2 of the Sherman Act, and conspired with Delta in imposing $15-per-bag fees for the first item of checked luggage in violation of Section 1 of the Sherman Act. The initial complaint sought treble damages on behalf of a putative class of persons or entities in the United States who directly paid Delta and/or AirTran such fees on domestic flights beginning December 5, 2008. After the filing of the May 2009 complaint, various other nearly identical complaints also seeking certification as class actions were filed in federal district courts in Atlanta, Georgia; Orlando, Florida; and Las Vegas, Nevada. All of the cases were consolidated before a single federal district court judge in Atlanta. A Consolidated Amended Complaint was filed in the consolidated action on February 1, 2010, which broadened the allegations to add claims that Delta and AirTran conspired to reduce capacity on competitive routes and to raise prices in violation of Section 1 of the Sherman Act. In addition to treble damages for the amount of first baggage fees paid to AirTran and to Delta, the Consolidated Amended Complaint seeks injunctive relief against a broad range of alleged anticompetitive activities, as well as attorneys' fees. On August 2, 2010, the Court dismissed plaintiffs' claims that AirTran and Delta had violated Section 2 of the Sherman Act; the Court let stand the claims of a conspiracy with respect to the imposition of a first bag fee and the airlines' capacity and pricing decisions. On June 30, 2010, the plaintiffs filed a motion to certify a class, which AirTran and Delta have opposed. The parties have submitted briefs on class certification, and AirTran filed a motion to exclude the class certification reports of plaintiffs’ expert. The Court has not yet ruled on the class certification motion or the related motion to exclude plaintiffs’ expert. The parties engaged in extensive discovery, which was extended due to discovery disputes between plaintiffs and Delta, but discovery has now closed. On June 18, 2012, the parties filed a Stipulation and Order that plaintiffs have abandoned their claim that AirTran and Delta conspired to reduce capacity. On August 31, 2012, AirTran and Delta moved for summary judgment on all of plaintiffs' remaining claims, but discovery disputes between plaintiffs and Delta have delayed further briefing on summary judgment. On December 2, 2013, plaintiffs moved for discovery sanctions against Delta, and the Court has suspended further briefing on (i) the motion for summary judgment, (ii) the motion for class certification, and (iii) the motion to strike plaintiffs’ expert on class certification, until the sanctions motion is resolved. On May 14, 2014, the Court referred the sanctions dispute to a special master, the special master has issued a series of reports and recommendations, and plaintiffs and Delta have submitted objections to the special master’s report and recommendations. While AirTran has denied all allegations of wrongdoing, including those in the Consolidated Amended Complaint, and intends to defend vigorously any and all such allegations, results of legal proceedings such as this one cannot be predicted with certainty. Regardless of its merit, this litigation and any potential future claims against the Company or AirTran may be both time consuming and disruptive to the Company’s operations and cause significant expense and diversion of management attention. Should AirTran and the Company fail to prevail in this or other matters, the Company may be faced with significant monetary damages or injunctive relief that could materially adversely affect its business and might materially affect its financial condition and operating results.
The application of the acquisition method of accounting resulted in the Company recording a significant amount of goodwill in connection with the acquisition of AirTran, which could result in significant future impairment charges and negatively affect the Company’s financial results.
In accordance with applicable acquisition accounting rules, the Company recorded goodwill on its Consolidated Balance Sheet to the extent the AirTran acquisition purchase price exceeded the net fair value of AirTran’s tangible and intangible assets and liabilities as of the acquisition date. Goodwill is not amortized, but is tested for impairment at least annually. Future impairment of Goodwill could be recorded in the Company's results of operations as a result of changes in assumptions, estimates, or circumstances, some of which are beyond the Company’s control. Factors which could result in an impairment, holding other assumptions constant, could include, but are not limited to: (i) reduced passenger demand as a result of domestic or global economic conditions; (ii) significantly higher prices for

31



jet fuel; (iii) lower fares or passenger yields as a result of increased competition or lower demand; (iv) a significant increase in future capital expenditure commitments; and (v) significant disruptions to the Company’s operations as a result of both internal and external events such as terrorist activities, actual or threatened war, labor actions by Employees, or further industry regulation. The Company can provide no assurance that a significant impairment charge will not occur in one or more future periods. Any such charges may materially negatively affect the Company’s financial results. See Note 1 to the Consolidated Financial Statements for further information.

Item 1B.        Unresolved Staff Comments
None.



32




Item 2.        Properties
Aircraft
Southwest operated a total of 665 Boeing 737 aircraft as of December 31, 2014, of which 98 and 14 were under operating and capital leases, respectively. The following table details information on the 665 aircraft as of December 31, 2014:
Type
 
Seats
 
Average
Age
(Yrs)
 
Number of
Aircraft
 
Number
Owned (1)
 
Number
Leased
717-200 (2)
 
117
 

 

 

 

737-300
 
137 or 143
 
21

 
120

 
76

 
44

737-500
 
122
 
23

 
13

 
10

 
3

737-700
 
143
 
10

 
447

 
389

 
58

737-800
 
175
 
1

 
85

 
78

 
7

Totals
 
 
 
 
 
665

 
553

 
112

 
(1)
As discussed further in Note 6 to the Consolidated Financial Statements, 163 of the Company's aircraft were pledged as collateral as of December 31, 2014.
(2)
The Company removed 36 B717s from service which were awaiting conversion at December 31, 2014.

As of December 31, 2014, the Company had firm deliveries and options for Boeing 737-700, 737-800, 737 MAX 7, and 737 MAX 8 aircraft as follows:

 
The Boeing Company
737 NG
 
 
The Boeing Company
737 MAX
 
 
-700
Firm
Orders
 
-800
Firm
Orders
Options
Additional -700 A/C
 
-7
Firm
Orders
-8
Firm
Orders
 
Options
 
Total

2015

 
19


16

 


 

 
35

2016
31

 

11

4

 


 

 
46

2017
15

 

12


 

14

 

 
41

2018
10

 

12


 

13

 

 
35

2019

 



 
15

10

 

 
25

2020

 



 
14

22

 

 
36

2021

 



 
1

33

 
18

 
52

2022

 



 

30

 
19

 
49

2023

 



 

24

 
23

 
47

2024

 



 

24

 
23

 
47

2025

 



 


 
36

 
36

2026

 



 


 
36

 
36

2027

 



 


 
36

 
36

Total
56

(1)
19

35

20

 
30

170

(2)
191

 
521


(1) The Company has flexibility to substitute 737-800s in lieu of 737-700 firm orders.
(2) The Company has flexibility to substitute MAX 7 in lieu of  MAX 8 firm orders beginning in 2019.
Ground Facilities and Services
Southwest either leases or pays a usage fee for terminal passenger service facilities at each of the airports it serves, to which various leasehold improvements have been made. The Company leases the land and structures on a long-term basis for its aircraft maintenance centers (located at Dallas Love Field, Houston Hobby, Phoenix Sky Harbor,

33



Chicago Midway, Hartsfield-Jackson Atlanta International Airport and Orlando International Airport), its flight training center at Dallas Love Field (which houses ten 737 simulators), and its main corporate headquarters building, also located at Dallas Love Field. The Company also leases a warehouse and engine repair facility in Atlanta. During 2013 the Company completed construction of a new, owned, energy-efficient, modern building designed to house certain operational and training functions, including its 24-hour operations. This additional headquarters building is located across the street from the Company’s current headquarters building on land owned by the Company.
As part of the Company's expansion of international service, the Company has agreed with the City of Houston (“City”) to expand the existing Houston Hobby airport facility. Pursuant to the agreement, the Company and the City have entered into an Airport Use and Lease Agreement to control the execution of this expansion and the financial terms thereof. This project provides for a new five-gate international terminal with international passenger processing facilities, expansion of the existing security checkpoint, and upgrades to the Southwest ticketing area. Construction began during third quarter 2013 and is estimated to be completed during the second half of 2015. Additional information regarding this project is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.
The Company has also agreed with Broward County, Florida, which owns and operates Fort Lauderdale-Hollywood International Airport, to oversee and manage the design and construction of the airport’s Terminal 1 Modernization Project. In addition to significant improvements to the existing Terminal 1, the project includes the design and construction of a new five-gate Concourse A with an international processing facility. Construction is expected to begin in mid to late 2015. Additional information regarding this project is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.
In March 2013, the Company executed a lease agreement with Los Angeles World Airports, which owns and operates Los Angeles International Airport. Under the lease agreement, which was amended in June 2014, the Company will oversee and manage the design, development, financing, construction and commissioning of the airport's Terminal 1 Modernization Project. Construction on the project began during fourth quarter 2014. Additional information regarding this project is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.
During 2008, the City of Dallas approved the Love Field Modernization Program (“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 (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 is managing this project. Major construction commenced during 2010. New ticketing and checkin areas opened during fourth quarter 2012, 12 new gates and new concessions opened in 2013, and the remaining gates opened during October 2014. The majority of the project had been completed as of December 31, 2014, and consists of the complete replacement of gate facilities with a new 20-gate facility, including infrastructure, systems and equipment, aircraft parking apron, fueling system, roadways and terminal curbside, baggage handling systems, passenger loading bridges and support systems, and other supporting infrastructure. The LFMP is discussed in more detail below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.
As of December 31, 2014, the Company operated seven Customer Support and Services call centers. The centers located in Atlanta, San Antonio, Chicago, Albuquerque, and Oklahoma City occupy leased space. The Company owns its Houston and Phoenix centers.
The Company performs substantially all line maintenance on its aircraft and provides ground support services at most of the airports it serves. However, the Company has arrangements with certain aircraft maintenance firms for major component inspections and repairs for its airframes and engines, which comprise the majority of the Company’s annual aircraft maintenance costs.


34



Item 3. Legal Proceedings
A complaint alleging violations of federal antitrust laws and seeking certification as a class action was filed against Delta Air Lines, Inc. and AirTran in the United States District Court for the Northern District of Georgia in Atlanta on May 22, 2009. The complaint alleged, among other things, that AirTran attempted to monopolize air travel in violation of Section 2 of the Sherman Act, and conspired with Delta in imposing $15-per-bag fees for the first item of checked luggage in violation of Section 1 of the Sherman Act. The initial complaint sought treble damages on behalf of a putative class of persons or entities in the United States who directly paid Delta and/or AirTran such fees on domestic flights beginning December 5, 2008. After the filing of the May 2009 complaint, various other nearly identical complaints also seeking certification as class actions were filed in federal district courts in Atlanta, Georgia; Orlando, Florida; and Las Vegas, Nevada. All of the cases were consolidated before a single federal district court judge in Atlanta. A Consolidated Amended Complaint was filed in the consolidated action on February 1, 2010, which broadened the allegations to add claims that Delta and AirTran conspired to reduce capacity on competitive routes and to raise prices in violation of Section 1 of the Sherman Act. In addition to treble damages for the amount of first baggage fees paid to AirTran and to Delta, the Consolidated Amended Complaint seeks injunctive relief against a broad range of alleged anticompetitive activities, as well as attorneys' fees. On August 2, 2010, the Court dismissed plaintiffs' claims that AirTran and Delta had violated Section 2 of the Sherman Act; the Court let stand the claims of a conspiracy with respect to the imposition of a first bag fee and the airlines' capacity and pricing decisions. On June 30, 2010, the plaintiffs filed a motion to certify a class, which AirTran and Delta have opposed. The parties have submitted briefs on class certification, and AirTran filed a motion to exclude the class certification reports of plaintiffs’ expert. The Court has not yet ruled on the class certification motion or the related motion to exclude plaintiffs’ expert. The parties engaged in extensive discovery, which was extended due to discovery disputes between plaintiffs and Delta, but discovery has now closed. On June 18, 2012, the parties filed a Stipulation and Order that plaintiffs have abandoned their claim that AirTran and Delta conspired to reduce capacity. On August 31, 2012, AirTran and Delta moved for summary judgment on all of plaintiffs' remaining claims, but discovery disputes between plaintiffs and Delta have delayed further briefing on summary judgment. On December 2, 2013, plaintiffs moved for discovery sanctions against Delta, and the Court has suspended further briefing on (i) the motion for summary judgment, (ii) the motion for class certification, and (iii) the motion to strike plaintiffs’ expert on class certification, until the sanctions motion is resolved. On May 14, 2014, the Court referred the sanctions dispute to a special master, the special master has issued a series of reports and recommendations, and plaintiffs and Delta have submitted objections to the special master’s report and recommendations.  AirTran denies all allegations of wrongdoing, including those in the Consolidated Amended Complaint, and intends to defend vigorously any and all such allegations.
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.
The Company’s management does not expect that the outcome in any of its currently ongoing legal proceedings or the outcome of any proposed adjustments presented to date by the Internal Revenue Service, individually or collectively, will have a material adverse effect on the Company’s financial condition, results of operations, or cash flow.


35



Item 4. Mine Safety Disclosures
  
Not applicable.



36



EXECUTIVE OFFICERS OF THE REGISTRANT
The following information regarding the Company’s executive officers is as of February 1, 2015.
 
Name
Position
Age  
Gary C. Kelly
Chairman of the Board, President, & Chief Executive Officer
59
Robert E. Jordan
Executive Vice President & Chief Commercial Officer
54
Jeff Lamb
Executive Vice President & Chief People & Administrative Officer
52
Ron Ricks
Executive Vice President & Chief Legal & Regulatory Officer
65
Michael G. Van de Ven
Executive Vice President & Chief Operating Officer
53
Tammy Romo
Senior Vice President Finance & Chief Financial Officer
52
Set forth below is a description of the background of each of the Company’s executive officers.
Gary C. Kelly has served as the Company’s Chairman of the Board since May 2008, as its President since July 2008, and as its Chief Executive Officer since July 2004. Mr. Kelly also served as Executive Vice President & Chief Financial Officer from June 2001 to July 2004 and Vice President Finance & Chief Financial Officer from 1989 to 2001. Mr. Kelly joined the Company in 1986 as its Controller.
Robert E. Jordan has served as the Company’s Executive Vice President & Chief Commercial Officer since September 2011 and as President of AirTran Airways, Inc. since May 2011. Mr. Jordan also served as Executive Vice President Strategy & Planning from May 2008 to September 2011, Executive Vice President Strategy & Technology from September 2006 to May 2008, Senior Vice President Enterprise Spend Management from August 2004 to September 2006, Vice President Technology from 2002 to 2004, Vice President Purchasing from 2001 to 2002, Controller from 1997 to 2001, Director Revenue Accounting from 1994 to 1997, and Manager Sales Accounting from 1990 to 1994. Mr. Jordan joined the Company in 1988 as a programmer.
Jeff Lamb has served as the Company’s Executive Vice President & Chief People & Administrative Officer since September 2011. Mr. Lamb also served as Senior Vice President Administration & Chief People Officer from October 2007 to September 2011, Vice President People & Leadership Development from February 2006 to October 2007, and as Senior Director People Development from December 2004 until February 2006.
Ron Ricks has served as the Company’s Executive Vice President & Chief Legal & Regulatory Officer since September 2011. Mr. Ricks also served as Corporate Secretary from May 2008 to January 2013, Executive Vice President Corporate Services from May 2008 to September 2011, Executive Vice President Law, Airports, & Public Affairs from September 2006 to May 2008, and Senior Vice President Law, Airports, & Public Affairs from August 2004 until September 2006. Mr. Ricks joined the Company in 1986 as its Vice President Governmental Affairs.
Michael G. Van de Ven has served as the Company’s Executive Vice President & Chief Operating Officer since May 2008. Mr. Van de Ven also served as Chief of Operations from September 2006 to May 2008, Executive Vice President Aircraft Operations from November 2005 through August 2006, Senior Vice President Planning from August 2004 to November 2005, Vice President Financial Planning & Analysis from 2001 to 2004, Senior Director Financial Planning & Analysis from 2000 to 2001, and Director Financial Planning & Analysis from 1997 to 2000. Mr. Van de Ven joined the Company in 1993 as its Director Internal Audit.

Tammy Romo has served as the Company’s Senior Vice President Finance & Chief Financial Officer since September 2012. Ms. Romo also served as Senior Vice President of Planning from February 2010 to September 2012, Vice President of Financial Planning from September 2008 to February 2010, Vice President Controller from February 2006 to August 2008, Vice President Treasurer from September 2004 to February 2006, Senior Director of Investor Relations from March 2002 to September 2004, Director of Investor Relations from December 1994 to March 2002, Manager of Investor Relations from September 1994 to December 1994, and Manager of Financial Reporting from September 1991 to September 1994.


37



PART II

Item 5.        Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

The Company’s common stock is listed on the New York Stock Exchange ("NYSE") and is traded under the symbol “LUV.” The following table shows the high and low prices per share of the Company’s common stock, as reported on the NYSE Composite Tape, and the cash dividends per share declared on the Company’s common stock.
 
Period
 
Dividend  
 
High  
 
Low    
2014
 
 
 
 
 
 
1st Quarter
 
$
0.04000

 
$
24.17

 
$
18.78

2nd Quarter
 
0.06000

 
27.70

 
22.35

3rd Quarter
 
0.06000

 
35.49

 
25.86

4th Quarter
 
0.06000

 
43.19

 
28.40

2013
 
 
 
 
 
 
1st Quarter
 
$
0.01000

 
$
13.58

 
$
10.36

2nd Quarter
 
0.04000

 
14.56

 
12.45

3rd Quarter
 
0.04000

 
14.82

 
12.58

4th Quarter
 
0.04000

 
19.00

 
14.48


The Company currently intends to continue declaring dividends on a quarterly basis for the foreseeable future; however, the Company’s Board of Directors may elect to alter the timing, amount, and payment of dividends on the basis of operational results, financial condition, cash requirements, future prospects, and other factors deemed relevant by the Board. As of January 30, 2015, there were approximately 13,762 holders of record of the Company’s common stock.


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Stock Performance Graph

The following Performance Graph and related information shall not be deemed “soliciting material” or “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934.

The following graph compares the cumulative total shareholder return on the Company’s common stock over the five-year period ended December 31, 2014, with the cumulative total return during such period of the Standard and Poor’s 500 Stock Index and the NYSE ARCA Airline Index. The comparison assumes $100 was invested on December 31, 2009, in the Company’s common stock and in each of the foregoing indices and assumes reinvestment of dividends. The stock performance shown on the graph below represents historical stock performance and is not necessarily indicative of future stock price performance.

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN AMONG SOUTHWEST AIRLINES CO., S&P 500 INDEX, AND NYSE ARCA AIRLINE INDEX
 
 
12/31/2009
 
12/31/2010
 
12/31/2011
 
12/31/2012
 
12/31/2013
 
12/31/2014
Southwest Airlines Co.
 
$
100

 
$
114

 
$
75

 
$
90

 
$
167

 
$
377

S&P 500
 
$
100

 
$
115

 
$
117

 
$
136

 
$
179

 
$
204

NYSE ARCA Airline
 
$
100

 
$
141

 
$
98

 
$
135

 
$
214

 
$
320




39



Issuer Repurchases
 
Issuer Purchases of Equity Securities (1)
 
 
 
(a)
 
(b)
 
(c)
 
(d)
 
 
 
 
 
 
 
Total number of
 
Maximum dollar
 
 
 
 
 
 
 
shares purchased
 
value of shares that
 
 
 
Total number
 
Average
 
as part of publicly
 
may yet be purchased
 
 
 
of shares
 
price paid
 
announced plans
 
under the plans
 
Period
 
purchased
 
per share
 
or programs
 
or programs
 
October 1, 2014 through
  October 31, 2014
 
1,107,489

 
$

(2
)
1,107,489

 
$
580,356,300

 
November 1, 2014 through
  November 30, 2014
 
3,810,008

 
$

(3
)
3,810,008

 
$
380,356,300

(3
)
December 1, 2014 through
  December 31, 2014
 

 
$

 

 
$
380,356,300

 
Total
 
4,917,497

 
 
 
4,917,497

 
 
 

(1)
In May 2014, the Company’s Board of Directors authorized the repurchase of up to $1 billion of the Company’s common stock. Repurchases are made in accordance with applicable securities laws in open market, private, or in accelerated repurchase transactions from time to time, depending on market conditions, and may be discontinued at any time.
(2)
Under an accelerated share repurchase program entered into by the Company with a third party financial institution in third quarter 2014 ("Third Quarter ASR Program"), the Company paid $200 million and received an initial delivery of 5,040,323 shares during third quarter 2014, representing an estimated 75 percent of the shares to be purchased by the Company under the Third Quarter ASR Program based on a price of $29.76 per share, which was the closing price of the Company’s common stock on the New York Stock Exchange on August 15, 2014. Final settlement of this Third Quarter ASR Program occurred in October 2014 and was determined based generally on a discount to the volume-weighted average price per share of the Company's common stock during a calculation period completed in October 2014. Upon settlement, the third party financial institution delivered 1,107,489 additional shares of the Company’s common stock to the Company. In total, the average purchase price per share for the 6,147,812 shares repurchased under the Third Quarter ASR Program, upon completion of the Third Quarter ASR Program in October 2014, was $32.53.
(3)
Under an accelerated share repurchase program entered into by the Company with a third party financial institution in fourth quarter 2014 ("Fourth Quarter ASR Program"), the Company paid $200 million and received an initial delivery of 3,810,008 shares during fourth quarter 2014, representing an estimated 75 percent of the shares to be purchased by the Company under the Fourth Quarter ASR Program based on a price of $39.37 per share, which was the closing price of the Company’s common stock on the New York Stock Exchange on November 11, 2014. The specific number of shares that the Company ultimately will repurchase under the Fourth Quarter ASR Program will be determined based generally on a discount to the volume-weighted average price per share of the Company’s common stock during a calculation period to be completed in first quarter 2015. At settlement, under certain circumstances, the third party financial institution may be required to deliver additional shares of common stock to the Company, or under certain circumstances, the Company may be required to deliver shares of its common stock or may elect to make a cash payment to the third party financial institution.

Item 6.         Selected Financial Data

The following financial information, for the five years ended December 31, 2014, has been derived from the Company’s Consolidated Financial Statements. This information should be viewed in conjunction with the Consolidated Financial Statements and related notes thereto included elsewhere herein. This financial information includes the operations of AirTran since the May 2, 2011, acquisition date. Any financial information presented prior to that date includes only the operations of Southwest unless otherwise indicated. The Company provides the operating data below because these statistics are commonly used in the airline industry and, therefore, allow readers to compare the Company’s performance against its results for prior periods, as well as against the performance of the Company’s peers.
 

40



  
 
Year ended December 31,
 
 
2014
 
2013
 
2012
 
2011
 
2010
Financial Data (in millions, except per share amounts):
 
 
 
 
 
 
 
 
 
 
Operating revenues
 
$
18,605

 
$
17,699

 
$
17,088

 
$
15,658

 
$
12,104

Operating expenses
 
16,380

 
16,421

 
16,465

 
14,965

 
11,116

Operating income
 
2,225

 
1,278

 
623

 
693

 
988

Other expenses (income) net
 
409

 
69

 
(62
)
 
370

 
243

Income before taxes
 
1,816

 
1,209

 
685

 
323

 
745

Provision for income taxes
 
680

 
455

 
264

 
145

 
286

Net income
 
$
1,136

 
$
754

 
$
421

 
$
178

 
$
459

Net income per share, basic
 
$
1.65

 
$
1.06

 
$
0.56

 
$
0.23

 
$
0.62

Net income per share, diluted
 
$
1.64

 
$
1.05

 
$
0.56

 
$
0.23

 
$
0.61

Cash dividends per common share
 
$
0.2200

 
$
0.1300

 
$
0.0345

 
$
0.0180

 
$
0.0180

Total assets at period-end
 
$
20,200

 
$
19,345

 
$
18,596

 
$
18,068

 
$
15,463

Long-term obligations at period-end
 
$
2,434

 
$
2,191

 
$
2,883

 
$
3,107

 
$
2,875

Stockholders’ equity at period-end
 
$
6,775

 
$
7,336

 
$
6,992

 
$
6,877

 
$
6,237

Operating Data:
 
 
 
 
 
 
 
 
 
 
Revenue passengers carried
 
110,496,912

 
108,075,976

 
109,346,509

 
103,973,759

 
88,191,322

Enplaned passengers
 
135,767,188

 
133,155,030

 
133,978,100

 
127,551,012

 
106,227,521

Revenue passenger miles (RPMs) (000s) (1)
 
108,035,133

 
104,348,216

 
102,874,979

 
97,582,530

 
78,046,967

Available seat miles (ASMs) (000s) (2)
 
131,003,957

 
130,344,072

 
128,137,110

 
120,578,736

 
98,437,092

Load factor (3)
 
82.5
%
 
80.1
%
 
80.3
%
 
80.9
%
 
79.3
%
Average length of passenger haul (miles)
 
978

 
966

 
941

 
939

 
885

Average aircraft stage length (miles)
 
721

 
703

 
693

 
679

 
648

Trips flown
 
1,255,502

 
1,312,785

 
1,361,558

 
1,317,977

 
1,114,451

Average passenger fare
 
$
159.80

 
$
154.72

 
$
147.17

 
$
141.90

 
$
130.27

Passenger revenue yield per RPM (cents) (4)
 
16.34

 
16.02

 
15.64

 
15.12

 
14.72

Operating revenue per ASM (cents) (5)
 
14.20

 
13.58

 
13.34

 
12.99

 
12.30

Passenger revenue per ASM (cents) (6)
 
13.48

 
12.83

 
12.56

 
12.24

 
11.67

Operating expenses per ASM (cents) (7)
 
12.50

 
12.60

 
12.85

 
12.41

 
11.29

Operating expenses per ASM, excluding fuel (cents)
 
8.46

 
8.18

 
8.07

 
7.73

 
7.61

Operating expenses per ASM, excluding fuel and
profitsharing (cents)
 
8.19

 
8.01

 
7.98

 
7.65

 
7.45

Fuel costs per gallon, including fuel tax
 
$
2.93

 
$
3.16

 
$
3.30

 
$
3.19

 
$
2.51

Fuel costs per gallon, including fuel tax, economic
 
$
2.92

 
$
3.12

 
$
3.28

 
$
3.19

 
$
2.39

Fuel consumed, in gallons (millions)
 
1,801

 
1,818

 
1,847

 
1,764

 
1,437

Active fulltime equivalent Employees
 
46,278

 
44,831

 
45,861

 
45,392

 
34,901

Aircraft at end of period (8)
 
665

 
681

 
694

 
698

 
548

 
(1)
A revenue passenger mile is one paying passenger flown one mile. Also referred to as “traffic,” which is a measure of demand for a given period.
(2)
An available seat mile is one seat (empty or full) flown one mile. Also referred to as “capacity,” which is a measure of the space available to carry passengers in a given period.
(3)
Revenue passenger miles divided by available seat miles.
(4)
Calculated as passenger revenue divided by revenue passenger miles. Also referred to as “yield,” this is the average cost paid by a paying passenger to fly one mile, which is a measure of revenue production and fares.
(5)
Calculated as operating revenue divided by available seat miles. Also referred to as “operating unit revenues,” this is a measure of operating revenue production based on the total available seat miles flown during a particular period.
(6)
Calculated as passenger revenue divided by available seat miles. Also referred to as “passenger unit revenues,” this is a measure of passenger revenue production based on the total available seat miles flown during a particular period.
(7)
Calculated as operating expenses divided by available seat miles. Also referred to as “unit costs” or “cost per available seat mile,” this is the average cost to fly an aircraft seat (empty or full) one mile, which is a measure of cost efficiencies.
(8)
Aircraft in the Company's fleet at end of period, less Boeing 717-200s removed from service in preparation for transition out of the fleet.

41



Item 7.        Management's Discussion and Analysis of Financial Condition and Results of Operations

Reconciliation of Reported Amounts to non-GAAP Financial Measures (unaudited) (in millions, except per share and per ASM amounts)
 
Year ended December 31,
 
Percent
 
2014
 
2013
 
Change
Fuel and oil expense, unhedged
$
5,321

 
$
5,645

 
 
Add (Deduct): Fuel hedge losses (gains) included in Fuel and oil expense
(28
)
 
118

 
 
Fuel and oil expense, as reported
$
5,293

 
$
5,763

 
 
Deduct: Net impact from fuel contracts
(28
)
 
(84
)
 
 
Fuel and oil expense, non-GAAP
$
5,265

 
$
5,679

 
(7.3
)%
 
 
 
 
 
 
Total operating expenses, as reported
$
16,380

 
$
16,421

 
 
Add (Deduct): Reclassification between Fuel and oil and Other (gains) losses, net,
  associated with current period settled contracts
(4
)
 
3

 
 
Deduct: Contracts settling in the current period, but for which gains have been
  recognized in a prior period*
(24
)
 
(87
)
 
 
Deduct: Acquisition and integration costs
(126
)
 
(86
)
 
 
Deduct: Labor ratification bonus
(9
)
 

 
 
Total operating expenses, non-GAAP
$
16,217

 
$
16,251

 
(0.2
)%
 
 
 
 
 
 
Operating income, as reported
$
2,225

 
$
1,278

 
 
Add (Deduct): Reclassification between Fuel and oil and Other (gains) losses, net,
  associated with current period settled contracts
4

 
(3
)
 
 
Add: Contracts settling in the current period, but for which gains have been recognized in
  a prior period*
24

 
87

 
 
Add: Acquisition and integration costs
126

 
86

 
 
Add: Labor ratification bonus
9

 

 
 
Operating income, non-GAAP
$
2,388

 
$
1,448

 
64.9
 %
 
 
 
 
 
 
Net income, as reported
$
1,136

 
$
754

 
 
Add (Deduct): Mark-to-market impact from fuel contracts settling in future periods
251

 
(103
)
 
 
Add: Ineffectiveness from fuel hedges settling in future periods
5

 
11

 
 
Add: Other net impact of fuel contracts settling in the current or a prior period
  (excluding reclassifications)
24

 
87

 
 
Income tax impact of fuel contracts
(104
)
 
2

 
 
Add: Acquisition and integration costs (a)
79

 
54

 
 
Add: Labor ratification bonus (a)
6

 

 
 
Net income, non-GAAP
$
1,397

 
$
805

 
73.5
 %
 
 
 
 
 
 
Net income per share, diluted, as reported
$
1.64

 
$
1.05

 
 
Add: Net impact to net income above from fuel contracts divided by
  dilutive shares (a)
0.25

 

 
 
Add: Impact of special items, net (a)
0.12

 
0.07

 
 
Net income per share, diluted, non-GAAP
$
2.01

 
$
1.12

 
79.5
 %
 
 
 
 
 
 
Operating expenses per ASM (Cents)

12.50
¢
 

12.60
¢
 
 
Deduct: Fuel expense divided by ASMs
(4.04
)
 
(4.42
)
 
 
Deduct: Impact of special items
(0.10
)
 
(0.07
)
 
 
Operating expenses per ASM, non-GAAP, excluding fuel and special items (cents)

8.36
¢
 

8.11
¢
 
3.1
 %
* As a result of prior hedge ineffectiveness and/or contracts marked to market through earnings.
(a) Amounts net of tax.


42



Return on Invested Capital (ROIC) (in millions) (unaudited)

 
Year Ended
 
Year Ended
 
Year Ended
 
December 31, 2014
 
December 31, 2013
 
December 31, 2012
Operating Income, as reported
$
2,225

 
$
1,278

 
$
623

Add: Net impact from fuel contracts
28

 
84

 
32

Add: Acquisition and integration costs
126

 
86

 
183

Add: Labor ratification bonus
9

 

 

Operating Income, non-GAAP
$
2,388

 
$
1,448

 
$
838

Net adjustment for aircraft leases (1)
133

 
143

 
117

Adjustment for fuel hedge premium expense
(62
)
 
(60
)
 
(36
)
Adjusted Operating Income, non-GAAP
$
2,459

 
$
1,531

 
$
919

 
 
 
 
 
 
Average invested capital (2)
$
11,470

 
$
11,664

 
$
12,580

Equity adjustment for hedge accounting
104

 
50

 
145

Adjusted average invested capital
$
11,574

 
$
11,714

 
$
12,725

 
 
 
 
 
 
ROIC, pre-tax
21.2
%
 
13.1
%
 
7.2
%

(1) Net adjustment related to presumption that all aircraft in fleet are owned (i.e., the impact of eliminating aircraft rent expense and replacing with estimated depreciation expense for those same aircraft).
(2) Average Invested Capital is an average of the five most recent quarter end balances of debt, net present value of aircraft leases, and equity adjusted for hedge accounting.

Note Regarding Use of Non-GAAP Financial Measures

The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). These GAAP financial statements include (i) unrealized non-cash adjustments and reclassifications, which can be significant, as a result of accounting requirements and elections made under accounting pronouncements relating to derivative instruments and hedging and (ii) other charges the Company believes are not indicative of its ongoing operational performance.

As a result, the Company also provides financial information in this filing that was not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. The Company provides supplemental non-GAAP financial information, including results that it refers to as "economic," which the Company's management utilizes to evaluate its ongoing financial performance and the Company believes provides greater transparency to investors as supplemental information to its GAAP results. The Company's economic financial results differ from GAAP results in that they only include the actual cash settlements from fuel hedge contracts - all reflected within Fuel and oil expense in the period of settlement. Thus, Fuel and oil expense on an economic basis reflects the Company’s actual net cash outlays for fuel during the applicable period, inclusive of settled fuel derivative contracts. Any net premium costs paid related to option contracts are reflected as a component of Other (gains) losses, net, for both GAAP and non-GAAP (including economic) purposes in the period of contract settlement. The Company believes these economic results provide a better measure of the impact of the Company's fuel hedges on its operating performance and liquidity since they exclude the unrealized, non-cash adjustments and reclassifications that are recorded in GAAP results in accordance with accounting guidance relating to derivative instruments, and they reflect all cash settlements related to fuel derivative contracts within Fuel and oil expense. This enables the Company's management, as well as investors, to consistently assess the Company's operating performance on a year-over-year or quarter-over-quarter basis after considering all efforts in place to manage fuel expense. However, because these measures are not determined in accordance with GAAP, such measures are susceptible to varying calculations and not all companies calculate the measures in the same manner. As a result, the aforementioned measures, as presented, may not be directly comparable to similarly titled measures presented by other companies.


43



Further information on (i) the Company's fuel hedging program, (ii) the requirements of accounting for derivative instruments, and (iii) the causes of hedge ineffectiveness and/or mark-to-market gains or losses from derivative instruments is included in Note 10 to the Consolidated Financial Statements.

In addition to its “economic” financial measures, as defined above, the Company has also provided other non-GAAP financial measures, including results that it refers to as "excluding special items," as a result of items that the Company believes are not indicative of its ongoing operations. These include expenses associated with the Company’s acquisition and integration of AirTran and collective bargaining contract ratification bonuses. The Company believes that evaluation of its financial performance can be enhanced by a presentation of results that exclude the impact of these items in order to evaluate the results on a comparative basis with results in prior periods that do not include such items and as a basis for evaluating operating results in future periods. As a result of the Company’s acquisition of AirTran, which closed on May 2, 2011, the Company has incurred substantial charges associated with integration of the two companies. Given that the AirTran integration process had been effectively completed as of December 31, 2014, the Company does not anticipate significant future integration expenditure requirements. While the Company cannot predict the exact timing or amounts of such charges, it does expect to treat these charges as special items in its future presentation of non-GAAP results.
 
The Company has also provided return on invested capital, which is a non-GAAP financial measure. The Company believes return on invested capital is a meaningful measure because it quantifies how well the Company generates operating income relative to the capital it has invested in its business. Although return on invested capital is commonly used as a measure of capital efficiency, definitions of return on invested capital may differ; therefore, the Company is providing an explanation of its calculation for return on invested capital (before taxes and excluding special items) in the accompanying reconciliation.

YEAR IN REVIEW

For the 42nd consecutive year, the Company was profitable, recording GAAP and non-GAAP results for 2014 and 2013 as follows:
 
 
Year ended
 
 
(in millions, except per share amounts)
 
December 31,
 
 
GAAP
 
2014
 
2013
 
Percent Change
Operating income
 
$
2,225

 
$
1,278

 
74.1
Net income
 
$
1,136

 
$
754

 
50.7
Net income per share, diluted
 
$
1.64

 
$
1.05

 
56.2
 
 
 

 
 

 
 
Non-GAAP
 
 
 
 
 
 
Operating income
 
$
2,388

 
$
1,448

 
64.9
Net income
 
$
1,397

 
$
805

 
73.5
Net income per share, diluted
 
$
2.01

 
$
1.12

 
79.5
See the previous Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures.

Year ended December 31, 2014 net income was a Company record $1.1 billion, or $1.64 per diluted share, a 50.7 percent increase year-over-year. This increase primarily was due to a 5.1 percent increase in Operating revenues, driven by strong demand for air travel and successful execution of the Company's strategic initiatives. Operating expenses remained relatively flat, also as a result of benefits from the Company's strategic initiatives and from lower fuel prices, which offset an increase in Salaries, Wages, and Benefits expense driven by the Company's record Employee Profitsharing expense of $355 million. Excluding special items in both years, which consisted primarily of Acquisition and integration costs associated with the AirTran acquisition and unrealized non-cash adjustments and reclassifications associated with hedge accounting, non-GAAP Net income was a record $1.4 billion, or $2.01 per diluted share, a 73.5 percent increase year-over-year. Year ended December 31, 2014 Operating income was $2.2 billion and non-GAAP

44



Operating income was $2.4 billion. Both GAAP and non-GAAP annual Operating income results for 2014 were Company records and significantly surpassed the prior year performance.

During 2014, the Company continued to return significant value to its Shareholders through four separate accelerated share repurchase programs, the buyback of its common shares on the open market, and $139 million in dividend payments. See Part II, Item 5 for further information on the Company's share repurchase authorization.

For the twelve months ended December 31, 2014, the Company's exceptional earnings performance, combined with its actions to prudently manage invested capital, produced a 21.2 percent pre-tax Return on invested capital, excluding special items ("ROIC"). This represented a significant increase compared with the Company's ROIC of 13.1 percent for the twelve months ended December 31, 2013. The increase in ROIC was achieved primarily through successful execution of the Company's strategic initiatives and declining fuel prices, especially during the second half of 2014.

The integration of AirTran
The Company's over three year long integration of Southwest's and AirTran's networks, fleets, systems, and People, was effectively completed in December 2014. AirTran's final passenger service occurred on December 28, 2014. The acquisition of AirTran in 2011 served to increase the Company’s fleet size and expand its network into key U.S. markets, such as Atlanta and Washington, D.C. As a result of the acquisition, the Company estimates it achieved approximately $500 million in net, pre-tax synergies during 2014 (excluding acquisition and integration expenses). In addition, the acquisition also aided the Company's expansion into near-international locations, such as the Caribbean and Mexico, which led to the historic launch of Southwest international service during second quarter 2014, and marked a significant achievement in the integration process. As of December 31, 2014, all 52 AirTran 737-700 aircraft either have been converted to the Southwest livery or have entered the conversion process and are expected to enter Southwest service during first quarter 2015.

Fleet modernization
The Company is scheduled to be the launch customer for Boeing’s new, more fuel-efficient 737 MAX 8 aircraft, which is expected to enter service in 2017. The 737 MAX 8 is expected to reduce fuel burn and CO2 emissions 20 percent, compared with the original Next-Generation 737s when they first entered service. Southwest is also scheduled to be the launch customer for the Boeing 737 MAX 7 series aircraft, with deliveries expected to begin in 2019. Currently the Company has firm orders in place for 170 MAX 8 aircraft and 30 MAX 7 aircraft. During 2014, the Company retired five Classic (three 737-300 and two 737-500) aircraft from its fleet and intends to continue to replace these aircraft as well as the 717-200 aircraft through its current order book with Boeing and through the purchase and lease of additional pre-owned 737-700 aircraft from third parties. Following AirTran's final passenger service on December 28, 2014, the Company removed all remaining Boeing 717-200 aircraft from service. As of December 31, 2014, 52 of AirTran's 88 Boeing 717-200 aircraft had been delivered to Delta pursuant to a lease/sublease agreement and 36 717-200 aircraft were undergoing or awaiting conversion in preparation for delivery to Delta. See Note 7 to the Consolidated Financial Statements for further information. 

The continued incorporation of a larger aircraft, the Boeing 737-800, into Southwest’s fleet
To further support its fleet modernization efforts, the Company received a total of 33 Boeing 737-800s during 2014. As of December 31, 2014, the Company's fleet included 85 737-800s. The Boeing 737-800 (i) is better suited for certain potential new destinations, including near-international locations, (ii) provides the Company with the opportunity to generate additional revenue by replacing current aircraft on specified routes and locations that are restricted due to space constraints or slot controls, and (iii) operates at a lower unit cost than other aircraft in the Company’s existing fleet.

International Capabilities and New Reservation System
The Company launched Southwest's international service on July 1, 2014, with its inaugural flights to three Caribbean destinations, Aruba, Nassau, and Montego Bay, followed by service to Cabo San Lucas/Los Cabos and Cancun which commenced on August 10, 2014, and service to the two remaining AirTran international destinations, Mexico City and Punta Cana, which commenced on November 2, 2014. During third quarter 2014, the Company filed

45



an application with the U.S. Department of Transportation to add its first destination in Central America with daily roundtrip service between Baltimore/Washington Thurgood Marshall International Airport (BWI) and Juan Santamaria International Airport (SJO) in San Jose, Costa Rica, beginning March 7, 2015. In addition, during fourth quarter 2014, the Company filed applications with the U.S. Department of Transportation to provide daily, nonstop service between John Wayne Airport, Orange County (SNA) and Licenciado Gustavo Diaz Ordaz International Airport (PVR) in Puerto Vallarta, Mexico, beginning June 7, 2015, as well as daily nonstop service between Houston's William P. Hobby Airport and Philip S. W. Goldson International Airport in Belize City, Belize beginning in October 2015. The service to Belize, as well as additional service to San Jose, Costa Rica and four destinations in Mexico (Cancun, Cabo San Lucas/Los Cabos, Puerto Vallarta, and Mexico City), is anticipated to be served from the Company's expected opening of a new five-gate international terminal with international passenger processing facilities at Houston Hobby airport, which is expected to be completed during the second half of 2015. See Note 4 to the Consolidated Financial Statements for further information.
After the successful launch of Amadeus' Altéa international reservation system, the Company announced in May 2014 that it selected Amadeus' Altéa reservations solution as the Company's future single reservation system for both domestic and international reservations. This single reservation system is expected to be delivered over a multi-year period.
Southwest’s Rapid Rewards frequent flyer program
Southwest launched its current Rapid Rewards frequent flyer program in March 2011, under which members earn points for every dollar spent. The results of the program have exceeded the Company’s expectations with respect to the number of new frequent flyer members, the amount spent per member on airfare, the number of flights taken by members, the number of Southwest’s co-branded Chase® Visa credit card holders added, the number of points sold to business partners, and the number of frequent flyer points purchased by program members.

Company Overview

During 2014, the Company took several steps designed to enhance its existing service in cities across the network or to connect existing cities with new service not previously offered by Southwest, most notably:
At Washington Reagan National Airport, the Company acquired 54 additional slots (for 27 additional daily roundtrip flights) during first quarter 2014, which were divested in connection with the merger between AMR Corporation, the parent company of American Airlines, Inc., and US Airways Group, Inc., increasing Southwest's service at Reagan from 17 daily departures to 44 daily departures, currently servicing 14 destinations: Atlanta, Akron/Canton, Austin, Chicago Midway, Dallas Love Field, Houston Hobby, Fort Myers, Indianapolis, Kansas City, Milwaukee, Nashville, New Orleans, St. Louis, and Tampa Bay.
At New York LaGuardia Airport, in the wake of the Company's acquisition of twelve additional slots (for six additional daily roundtrip flights) announced in fourth quarter 2013, the Company increased service between LaGuardia and Nashville, Houston (Hobby), Chicago (Midway), and Akron-Canton which commenced in May 2014.
With the repeal of the Wright Amendment federal flight restrictions at Dallas Love Field on October 13, 2014, to destinations within the 50 States and to the District of Columbia, Southwest commenced service to seven new nonstop destinations from Love Field. Service from Love Field to eight additional nonstop destinations commenced on November 2, 2014, and service to two additional nonstop destinations began on January 6, 2015. This brings the total number of nonstop destinations out of Love Field to 33 compared with 16 prior to the repeal. Additionally, in January 2015, the Company announced that beginning in April 2015, it will offer daily nonstop flights to nine new cities from Dallas Love Field, including Memphis, Milwaukee, and Seattle, and will increase the number of nonstop flights to recently introduced destinations added after the October 2014 expiration of the Wright Amendment restrictions on long-haul flying at Love Field. The new flights will be made possible through a long-term sublease agreement that will transfer usage of two gates in the newly rebuilt 20-gate facility from United Airlines to Southwest.

46



At the current time, the Company plans to continue its route network and schedule optimization efforts. For 2015, the Company continues to manage to a baseline of roughly 700 aircraft and an approximate six percent year-over-year increase in ASMs, primarily due to more efficient flying of its existing fleet through increased aircraft gauge and stage length, with a modest increase in trips.
2014 compared with 2013

Operating Revenues

Passenger revenues for 2014 increased $937 million, or 5.6 percent, compared with 2013. Holding other factors constant, approximately half of the increase in Passenger revenues was attributable to the 2.4 point increase in load factor and the majority of the remaining increase was attributable to higher passenger yields, both driven by strong Customer demand for air travel and successful execution of the Company's strategic initiatives. Passenger revenue included an increase due to a change in estimate, which was recorded on a prospective basis and effective October 1, 2014, of approximately $55 million. See Note 1 regarding this change in accounting estimate. Based on current trends, the Company expects its first quarter 2015 passenger revenues to grow in line with the increase in its first quarter 2015 available seat mile capacity, both on a year-over-year basis. The Company currently estimates its first quarter and full year 2015 available seat mile capacity to increase, year-over-year, in the six to seven percent range.

Freight revenues for 2014 increased by $11 million, or 6.7 percent, compared with 2013, primarily due to benefits from new and maturing markets as a result of the AirTran integration. The Company currently expects Freight revenues in first quarter 2015 to increase approximately six percent, compared with first quarter 2014.

Other revenues for 2014 decreased by $42 million, or 5.2 percent, compared with 2013, primarily due to a decline in ancillary revenues. The majority of the decline in ancillary revenues was due to the adoption of Southwest's more Customer-friendly fee policies for Customers who purchase travel on AirTran through southwest.com, and the overall reduction in AirTran flights as a result of the integration process. This decline was partially offset by an increase in certain Southwest specific ancillary revenues, such as EarlyBird Check-in® and A1-15 select boarding positions sold at the gate. The Company currently expects Other revenues in first quarter 2015 to decrease, compared with first quarter 2014, similar to the year-over-year decrease in fourth quarter 2014.

Operating expenses

Operating expenses for 2014 decreased by $41 million, or 0.2 percent, compared with 2013, while capacity increased 0.5 percent over the same period. Historically, except for changes in the price of fuel, changes in most Operating expenses for airlines are driven by changes in capacity, or ASMs. The following table presents the Company's Operating expenses per ASM for 2014 and 2013, followed by explanations of these changes on a per ASM basis and/or on a dollar basis:

 
Year ended December 31,
 
Per ASM
 
Percent
(in cents, except for percentages)
2014
 
2013
 
change
 
change
Salaries, wages, and benefits

4.14
¢
 

3.86
¢
 

0.28
 ¢
 
7.3
 %
Fuel and oil
4.04

 
4.42

 
(0.38
)
 
(8.6
)
Maintenance materials and repairs
0.75

 
0.83

 
(0.08
)
 
(9.6
)
Aircraft rentals
0.22

 
0.28

 
(0.06
)
 
(21.4
)
Landing fees and other rentals
0.85

 
0.85

 

 

Depreciation and amortization
0.72

 
0.66

 
0.06

 
9.1

Acquisition and integration
0.10

 
0.07

 
0.03

 
42.9

Other operating expenses
1.68

 
1.63

 
0.05

 
3.1

Total

12.50
¢
 

12.60
¢
 

(0.10
 
(0.8
)%


47



Operating expenses per ASM for 2014 decreased 0.8 percent, compared with 2013, primarily due to a decrease in Fuel and oil expense, partially offset by an increase in Salaries, wages, and benefits expense. On a non-GAAP basis, Operating expenses per ASM for 2014, excluding fuel and special items, increased 3.1 percent year-over-year primarily due to higher Salaries, wages, and benefits expense. Based on current cost trends, the Company expects its first quarter 2015 unit costs, excluding fuel, special items, and profitsharing to decrease in the one to two percent range, compared with first quarter 2014. See the previous Note Regarding Use of Non-GAAP Financial Measures.
      
Salaries, wages, and benefits expense for 2014 increased by $399 million, or 7.9 percent, compared with 2013. Salaries, wages, and benefits expense per ASM for 2014 increased 7.3 percent, compared with 2013. On both a dollar and per ASM basis, approximately 60 percent of these increases were the result of higher salaries primarily due to increased training, additional headcount, and contractual increases. The majority of the remaining increase was the result of higher profitsharing expense due to increased profits in 2014. The Company’s profitsharing expense is based on profits that exclude the unrealized gains and/or losses the Company records for its fuel hedging program. Additionally, pursuant to the terms of the Company's ProfitSharing Plan (the "Plan"), acquisition and integration costs were excluded from the calculation of profitsharing expense from April 1, 2011, through December 31, 2013. These costs, totaling $385 million, are being amortized on a pro rata basis as a reduction of operating profits, as defined by the Plan, from 2014 through 2018. In addition, Acquisition and integration costs incurred during 2014 and in future periods will reduce operating profits, as defined, in the calculation of profitsharing. Based on current cost trends, the Company expects first quarter 2015 Salaries, wages, and benefits expense per ASM, excluding profitsharing, to increase, compared with fourth quarter 2014.

The Company and its Customer Service Agents and Customer Representatives, represented by the International Association of Machinists and Aerospace Workers ("IAM"), reached an agreement in favor of a new four year contract during fourth quarter 2014. The following table sets forth the Company’s unionized Employee groups that are currently in negotiations on collective-bargaining agreements:
 
Employee Group
Approximate Number of Employees
Representatives
Amendable Date
Southwest Pilots
7,500
Southwest Airlines Pilots’ Association (“SWAPA”)
August 2012
Southwest Flight Attendants
11,850
Transportation Workers of America, AFL-CIO, Local 556 (“TWU 556”)
May 2013
Southwest Ramp, Operations, Provisioning, Freight Agents
10,000
Transportation Workers of America, AFL-CIO, Local 555 (“TWU 555”)
June 2011
Southwest Material Specialists (formerly known as Stock Clerks)
250
International Brotherhood of Teamsters, Local 19 (“IBT 19”)
August 2013
Southwest Mechanics
2,100
Aircraft Mechanics Fraternal Association (“AMFA”)
August 2012
Southwest Facilities Maintenance Technicians
40
AMFA
N/A

Fuel and oil expense for 2014 decreased by $470 million, or 8.2 percent, compared with 2013. On a per ASM basis, Fuel and oil expense for 2014 decreased 8.6 percent, compared with 2013. Excluding the impact of fuel hedge accounting, both the dollar and per ASM decreases were primarily attributable to lower jet fuel prices. The Company's average economic jet fuel price per gallon decreased 6.4 percent year-over-year, from $3.12 for 2013 to $2.92 for 2014. In addition, fuel efficiency improved slightly due to the Company's fleet modernization efforts, as fuel gallons consumed decreased 0.9 percent, compared with 2013, while year-over-year capacity increased 0.5 percent. As a result of the Company's fuel hedging program, the Company recognized net gains totaling $28 million in Fuel and oil expense for 2014, compared to net losses totaling $118 million for 2013. These totals include cash settlements realized from the settlement of fuel derivative contracts totaling $56 million received from counterparties for 2014, compared to $34 million paid to counterparties for 2013, although such totals exclude gains and/or losses recognized from hedge ineffectiveness and from derivatives that do not qualify for hedge accounting. These impacts are recorded as a component of Other (gains) losses, net. See Note 10 to the Consolidated Financial Statements.


48



As of January 16, 2015, as a result of the significant decline in fuel prices during the second half of 2014, the Company had reduced its fuel hedging position for future years, and the Company had derivative contracts in place, on an economic basis, related to expected future fuel consumption as follows:

 
 
Average percent of estimated fuel consumption covered by
 
 
fuel derivative contracts at varying WTI/Brent Crude Oil,
Period
 
Heating Oil, and Gulf Coast Jet Fuel-equivalent price levels
2015 (1)
 
2016
 
Approx. 10%
2017
 
Approx. 30%
2018 (1)
 

(1) In response to the precipitous decline in oil and jet fuel prices during the second half of 2014, the Company took action to offset its 2015 and 2018 fuel derivative portfolios and is now effectively unhedged at current price levels. While the Company still holds derivative contracts as of December 31, 2014, that will settle during 2015 and 2018, the majority of the losses associated with those contracts are substantially locked in. However, if market prices were to increase or decrease significantly related to the 2015 positions prior to these contracts settling, the losses incurred at settlement could be slightly lower or higher than currently expected amounts during that period. 

As a result of applying hedge accounting in prior periods, a portion of the amounts in Accumulated other comprehensive income (loss) (“AOCI”) are considered "frozen," and these amounts will be recognized in earnings in future periods when the underlying fuel derivative contracts settle. The following table displays the Company's estimated fair value of remaining fuel derivative contracts (not considering the impact of the cash collateral provided to or received from counterparties (See Note 10 to the Consolidated Financial Statements for further information), as well as the amount of deferred gains/losses in AOCI at December 31, 2014, and the expected future periods in which these items are expected to settle and/or be recognized in earnings (in millions):

Year
 
Fair value of fuel
derivative contracts
at December 31, 2014
 
Amount of losses deferred
in AOCI at December 31,
2014 (net of tax)
2015
 
$
(242
)
 
$
(219
)
2016
 
(472
)
 
(347
)
2017
 
(287
)
 
(157
)
2018
 

 
(17
)
Total
 
$
(1,001
)
 
$
(740
)

Based on forward market prices and the amounts in the above table (and excluding any other subsequent changes to the fuel hedge portfolio), the Company's jet fuel costs per gallon could exceed market (i.e., unhedged) prices during some of these future periods. This is based primarily on expected future cash settlements associated with fuel derivatives, but excludes any impact associated with the ineffectiveness of fuel hedges or fuel derivatives that are marked to market because they do not qualify for hedge accounting. See Note 10 to the Consolidated Financial Statements for further information. Assuming no changes to the Company's current fuel derivative portfolio, but including all previous hedge activity for fuel derivatives that have not yet settled, and considering only the expected net cash payments related to hedges that will settle, the Company is providing a sensitivity table for first quarter 2015, and full year 2015, jet fuel prices at different crude oil assumptions as of January 16, 2015, and for expected premium costs associated with settling contracts each period, respectively.


49



 
Estimated economic jet fuel price per gallon,
including taxes
Average Brent Crude Oil
price per barrel
1Q 2015 (2)
Full Year 2015 (2)
$30
$1.15 - $1.20
$1.15 - $1.25
$40
$1.50 - $1.55
$1.45 - $1.55
Current Market (1)
$1.85 - $1.90
$1.95 - $2.05
$60
$2.15 - $2.20
$2.10 - $2.20
$70
$2.45 - $2.50
$2.40 - $2.50
Estimated Fuel Hedge Premium Expense (3)
$25 - $30 million
$120 - $130 million

(1) Brent crude oil average market prices as of January 16, 2015, were approximately $51 and $55 per barrel for first quarter 2015 and full year 2015, respectively.

(2) The economic fuel price per gallon sensitivities provided assume the relationship between Brent crude oil and refined products based on market prices as of January 16, 2015.

(3) Fuel hedge premium expense is recognized as a component of Other (gains) losses, net.

Maintenance materials and repairs expense for 2014 decreased by $102 million, or 9.4 percent, compared with 2013. On a per ASM basis, Maintenance materials and repairs expense for 2014 decreased 9.6 percent, compared with 2013. On both a dollar and per ASM basis, approximately 70 percent of the decrease was attributable to the completion of the Evolve aircraft interior retrofit program during 2013, and the majority of the remaining decrease was attributable to lower engine and avionics repair expense as a result of the 717-200 aircraft transitioning out of the Company's fleet. The Company currently expects Maintenance materials and repairs expense per ASM for first quarter 2015 to be comparable to fourth quarter 2014.
 
Aircraft rentals expense for 2014 decreased by $66 million, or 18.3 percent, compared with 2013. On a per ASM basis, Aircraft rentals expense decreased 21.4 percent, compared with 2013. On both a dollar and per ASM basis, the decrease primarily was due to the transition of leased 717-200 aircraft out of the Company's fleet for conversion and delivery to Delta. The Company currently expects Aircraft rentals expense per ASM for first quarter 2015 to decrease, compared with fourth quarter 2014.

Landing fees and other rentals expense for 2014 increased by $8 million, or 0.7 percent, compared with 2013. On a per ASM basis, Landing fees and other rentals expense for 2014 were flat, compared with 2013. The dollar increase was primarily due to heavier landing weights for the -800 aircraft. The Company currently expects Landing fees and other rentals expense per ASM for first quarter 2015 to increase, compared with first quarter 2014.

Depreciation and amortization expense for 2014 increased by $71 million, or 8.2 percent, compared with 2013. On a per ASM basis, Depreciation and amortization expense increased 9.1 percent, compared with 2013. On both a dollar and per ASM basis, approximately half the increase was attributable to technology projects that have been placed into service over the last twelve months and approximately half was due to the purchase of new and used aircraft over the last twelve months. The Company currently expects Depreciation and amortization expense per ASM for first quarter 2015 to increase slightly, compared with first quarter 2014.

The Company incurred $126 million in Acquisition and integration costs in 2014, which primarily consisted of expense associated with the removal of the remaining B717 fleet from service during December 2014 (See Note 7 for further information), B717 fleet conversion costs, fleet integration, Employee training, facility integration, and technology integration projects. During 2013, the Company recorded $86 million in Acquisition and integration expense, which primarily consisted of B717 fleet conversion costs, fleet integration, Employee training, technology integration projects, and facility integration expenses.


50



Other operating expenses for 2014 increased by $79 million, or 3.7 percent, compared with 2013. On a per ASM basis, Other operating expenses for 2014 increased 3.1 percent, compared with 2013. On both a dollar and per ASM basis, approximately 40 percent of the increase was the result of higher contract programming and consulting expenses, 20 percent of the increase was the result of maintenance agreement contract rate increases, and the remainder of the increase was due to individually insignificant items. The Company currently expects Other operating expenses per ASM for first quarter 2015 to be comparable with fourth quarter 2014.

Through the 2003 Emergency Wartime Supplemental Appropriations Act, the federal government has provided renewable, supplemental, first-party war-risk insurance coverage to commercial carriers. The government-provided supplemental coverage from the Wartime Act expired on September 30, 2014. However, the Company proactively canceled its FAA provided War Risk Insurance coverage on May 15, 2014, and effective the same date, purchased comparable coverage via the commercial insurance marketplace.

Other

Other (gains) losses, net, primarily includes amounts recorded as a result of the Company's hedging activities. See Note 10 to the Consolidated Financial Statements for further information on the Company's hedging activities. The following table displays the components of Other (gains) losses, net, for the years ended December 31, 2014, and 2013:
 
Year ended December 31,
(in millions)
2014
 
2013
Mark-to-market impact from fuel contracts settling in future periods
$
251

 
$
(103
)
Ineffectiveness from fuel hedges settling in future periods
5

 
11

Realized ineffectiveness and mark-to-market (gains) or losses
(4
)
 
3

Premium cost of fuel contracts
62

 
60

Other
(5
)
 
(3
)
 
$
309

 
$
(32
)

Income Taxes

The Company's effective tax rate was approximately 37.4 percent for 2014, compared with 37.6 percent for 2013. On a non-GAAP basis, the Company currently projects a full year 2015 effective tax rate of approximately 37 to 39 percent based on forecasted financial results. However, the Company’s effective tax rate during interim periods of 2015 may differ significantly from this full-year estimate.

51




Reconciliation of Reported Amounts to non-GAAP Financial Measures (unaudited) (in millions, except per share and per ASM amounts)
 
 
Year ended
December 31,
 
Percent
Change    
 
 
2013
 
2012
 
Fuel and oil expense, unhedged
 
$
5,645

 
$
5,963

 
 
Add: Fuel hedge losses included in Fuel and oil expense
 
118

 
157

 
 
Fuel and oil expense, as reported
 
$
5,763


$
6,120

 
 
Deduct: Net impact from fuel contracts
 
(84
)
 
(32
)
 
 
Fuel and oil expense, non-GAAP
 
$
5,679


$
6,088

 
(6.7
)%
 
 
 
 
 
 
 
Total operating expenses, as reported
 
$
16,421

 
$
16,465

 
 
Add (Deduct): Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period
  settled contracts
 
3

 
(42
)
 
 
Add (Deduct): Contracts settling in the current period, but for which gains and/or (losses) have been recognized in
  a prior period*
 
(87
)
 
10

 
 
Deduct: Acquisition and Integration costs
 
(86
)
 
(183
)
 
 
Total operating expenses, non-GAAP
 
$
16,251


$
16,250

 
 %
 
 
 
 
 
 
 
Operating income, as reported
 
$
1,278

 
$
623

 
 
Add (Deduct): Reclassification between Fuel and oil and Other (gains) losses, net, associated with current period
  settled contracts
 
(3
)
 
42

 
 
Add (Deduct): Contracts settling in the current period, but for which gains and/or (losses) have been recognized in
  a prior period*
 
87

 
(10
)
 
 
Add: Acquisition and Integration costs
 
86

 
183

 
 
Operating income, non-GAAP
 
$
1,448


$
838

 
72.8
 %
 
 
 
 
 
 
 
Net income, as reported
 
$
754