10-Q 1 luv-20220630.htm 2ND QUARTER 2022 FORM 10-Q luv-20220630
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     For the quarterly period ended June 30, 2022
 or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from ________ to ________
Commission File No. 1-7259
luv-20220630_g1.jpg

SOUTHWEST AIRLINES CO.
(Exact name of registrant as specified in its charter)
Texas74-1563240
(State or other jurisdiction of(IRS Employer
incorporation or organization)Identification No.)
P.O. Box 36611
Dallas,Texas75235-1611
(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 classTrading SymbolName of each exchange on which registered
Common Stock ($1.00 par value)LUVNew York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes  No x
    Number of shares of Common Stock outstanding as of the close of business on July 28, 2022: 593,350,161



TABLE OF CONTENTS TO FORM 10-Q

2

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

Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in millions)
(unaudited)

June 30, 2022December 31, 2021
ASSETS  
Current assets: 
Cash and cash equivalents$13,234 $12,480 
Short-term investments3,197 3,024 
Accounts and other receivables1,389 1,357 
Inventories of parts and supplies, at cost751 537 
Prepaid expenses and other current assets825 638 
Total current assets19,396 18,036 
Property and equipment, at cost:
Flight equipment21,598 21,226 
Ground property and equipment6,563 6,342 
Deposits on flight equipment purchase contracts637  
Assets constructed for others12 6 
28,810 27,574 
Less allowance for depreciation and amortization13,216 12,732 
 15,594 14,842 
Goodwill970 970 
Operating lease right-of-use assets1,495 1,590 
Other assets847 882 
 $38,302 $36,320 
LIABILITIES AND STOCKHOLDERS' EQUITY  
Current liabilities:  
Accounts payable$1,908 $1,282 
Accrued liabilities1,587 1,624 
Current operating lease liabilities242 239 
Air traffic liability6,312 5,566 
Current maturities of long-term debt1,662 453 
Total current liabilities11,711 9,164 
Long-term debt less current maturities8,877 10,274 
Air traffic liability - noncurrent2,206 2,159 
Deferred income taxes2,072 1,770 
Noncurrent operating lease liabilities1,220 1,315 
Other noncurrent liabilities1,096 1,224 
Stockholders' equity:  
Common stock888 888 
Capital in excess of par value3,966 4,224 
Retained earnings16,311 15,774 
Accumulated other comprehensive income805 388 
Treasury stock, at cost(10,850)(10,860)
Total stockholders' equity11,120 10,414 
 $38,302 $36,320 
    
See accompanying notes.
3

Southwest Airlines Co.
Condensed Consolidated Statement of Comprehensive Income
(in millions, except per share amounts)
(unaudited)

 Three months ended June 30,Six months ended June 30,
 2022202120222021
OPERATING REVENUES:    
Passenger$6,119 $3,569 $10,254 $5,282 
Freight47 50 89 92 
Other562 389 1,079 686 
Total operating revenues6,728 4,008 11,422 6,060 
OPERATING EXPENSES, NET:    
Salaries, wages, and benefits2,220 1,825 4,450 3,395 
Payroll support and voluntary Employee programs, net (740) (2,187)
Fuel and oil1,636 803 2,640 1,272 
Maintenance materials and repairs210 222 420 395 
Landing fees and airport rentals388 403 733 716 
Depreciation and amortization325 315 649 627 
Other operating expenses791 586 1,523 1,049 
Total operating expenses, net5,570 3,414 10,415 5,267 
OPERATING INCOME1,158 594 1,007 793 
OTHER EXPENSES (INCOME):  
Interest expense93 116 186 229 
Capitalized interest(11)(8)(20)(19)
Interest income(28)(2)(31)(4)
Other (gains) losses, net68 (14)212 (61)
Total other expenses (income)122 92 347 145 
INCOME BEFORE INCOME TAXES1,036 502 660 648 
PROVISION FOR INCOME TAXES276 154 178 185 
NET INCOME$760 $348 $482 $463 
NET INCOME PER SHARE, BASIC$1.29 $0.59 $0.83 $0.78 
NET INCOME PER SHARE, DILUTED$1.20 $0.57 $0.77 $0.76 
COMPREHENSIVE INCOME$674 $544 $899 $723 
WEIGHTED AVERAGE SHARES OUTSTANDING   
Basic593 591 593 591 
Diluted635 615 640 612 
See accompanying notes.
4

Southwest Airlines Co.
Condensed Consolidated Statement of Stockholders' Equity
(in millions, except per share amounts)
(unaudited)
  
Common StockCapital in excess of par valueRetained earningsAccumulated other comprehensive incomeTreasury stockTotal
Balance at December 31, 2021$888 $4,224 $15,774 $388 $(10,860)$10,414 
Cumulative effect of adopting Accounting Standards Update No. 2020-06, Debt (See Note 3)— (300)55 — — (245)
Issuance of common and treasury stock pursuant to Employee stock plans—  — — 7 7 
Share-based compensation— 16 — — — 16 
Comprehensive income— — (278)503 — 225 
Balance at March 31, 2022$888 $3,940 $15,551 $891 $(10,853)$10,417 
Issuance of common and treasury stock pursuant to Employee stock plans— 10 — — 3 13 
Share-based compensation— 16 — — — 16 
Comprehensive income (loss)— — 760 (86)— 674 
Balance at June 30, 2022$888 $3,966 $16,311 $805 $(10,850)$11,120 


  
Common StockCapital in excess of par valueRetained earningsAccumulated other comprehensive income (loss)Treasury stockTotal
Balance at December 31, 2020$888 $4,191 $14,777 $(105)$(10,875)$8,876 
Cumulative effect of adopting Accounting Standards Update No. 2016-01, Financial Instruments— — 19 (19)—  
Issuance of common and treasury stock pursuant to Employee stock plans— (8)— — 8  
Share-based compensation— 14 — — — 14 
Stock warrants— 23 — — — 23 
Comprehensive income— — 116 64 — 180 
Balance at March 31, 2021$888 $4,220 $14,912 $(60)$(10,867)$9,093 
Issuance of common and treasury stock pursuant to Employee stock plans— 11 — — 2 13 
Share-based compensation— 16 — — — 16 
Stock warrants— 22 — — — 22 
Comprehensive income (loss)— — 348 196 — 544 
Balance at June 30, 2021$888 $4,269 $15,260 $136 $(10,865)$9,688 
    See accompanying notes.
5

Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
Three months endedSix months ended
June 30,June 30,
 2022202120222021
CASH FLOWS FROM OPERATING ACTIVITIES:    
Net income$760 $348 $482 $463 
Adjustments to reconcile net income to cash provided by operating activities:   
Depreciation and amortization325 315 649 627 
Impairment of long-lived assets15  31  
Unrealized mark-to-market adjustment on available for sale securities4  7  
Unrealized/realized (gain) loss on fuel derivative instruments(20)(17)15 (23)
Deferred income taxes272 (30)174 (26)
Loss on partial extinguishment of convertible and unsecured notes43  116  
Changes in certain assets and liabilities:   
Accounts and other receivables439 (563)105 (797)
Other assets(1)16 (45)5 
Accounts payable and accrued liabilities328 989 506 923 
Air traffic liability(92)946 793 1,546 
Other liabilities(103)(64)(209)(186)
Cash collateral received from (provided to) derivative counterparties(101)48 284 86 
Other, net37 17 69 32 
Net cash provided by operating activities1,906 2,005 2,977 2,650 
CASH FLOWS FROM INVESTING ACTIVITIES:    
Capital expenditures(987)(95)(1,497)(190)
Assets constructed for others(3) (6) 
Purchases of short-term investments(1,545)(1,651)(2,470)(2,975)
Proceeds from sales of short-term and other investments980 1,277 2,280 2,495 
Net cash used in investing activities(1,555)(469)(1,693)(670)
CASH FLOWS FROM FINANCING ACTIVITIES:    
Proceeds from Payroll Support Program loan and warrants 625  1,136 
Proceeds from Employee stock plans13 13 19 26 
Payments of long-term debt and finance lease obligations(53)(43)(146)(109)
Payments for repurchases and conversions of convertible debt(178) (409) 
Other, net3 22 6 28 
Net cash provided by (used in) financing activities(215)617 (530)1,081 
NET CHANGE IN CASH AND CASH EQUIVALENTS136 2,153 754 3,061 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD13,098 11,971 12,480 11,063 
CASH AND CASH EQUIVALENTS AT END OF PERIOD$13,234 $14,124 $13,234 $14,124 
CASH PAYMENTS FOR:
Interest, net of amount capitalized$141 $150 $161 $167 
Income taxes$7 $176 $11 $177 
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:
Adoption of Accounting Standards Update 2020-06, Debt (See Note 3)$ $ $245 $ 
Right-of-use assets acquired under operating leases$3 $12 $27 $230 
Flight equipment acquired against supplier credit memo$ $207 $ $512 
Assets constructed for others$ $(341)$ $(309)
See accompanying notes.
6

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

7

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


1.    BASIS OF PRESENTATION

Southwest Airlines Co. (the "Company" or "Southwest") operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States and near-international markets. The unaudited Condensed Consolidated Financial Statements include accounts of the Company and its wholly owned subsidiaries.

The accompanying unaudited Condensed Consolidated Financial Statements of the Company and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States ("GAAP") for complete financial statements. The unaudited Condensed Consolidated Financial Statements for the interim periods ended June 30, 2022 and 2021 include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods. This includes all normal and recurring adjustments and elimination of significant intercompany transactions. Financial results for the Company and airlines in general can be seasonal in nature. In many years, the Company's revenues, as well as its Operating income and Net income, have been better in its second and third fiscal quarters than in its first and fourth fiscal quarters. However, beginning in early 2020, as a result of the COVID-19 pandemic, the Company's results have not always been in line with such historical trends. See Note 2 for further information. Air travel is also significantly impacted by general economic conditions, the amount of disposable income available to consumers and changes in consumer behavior, unemployment levels, corporate travel budgets, global pandemics such as COVID-19, extreme or severe weather and natural disasters, fears of terrorism or war, governmental actions, and other factors beyond the Company's control. These and other factors, such as the price of jet fuel in some periods, the nature of the Company's fuel hedging program, and the periodic volatility of commodities used by the Company for hedging jet fuel, have created, and may continue to create, significant volatility in the Company's financial results. See Note 4 for further information on fuel and the Company's hedging program. Operating results for the three and six months ended June 30, 2022, are not necessarily indicative of the results that may be expected for future quarters or for the year ended December 31, 2022. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2021.
8

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


2.    WORLDWIDE PANDEMIC

As a result of the rapid spread of the novel coronavirus, COVID-19, throughout the world, including into the United States, on March 11, 2020, the World Health Organization classified the virus as a pandemic. The speed with which the effects of the COVID-19 pandemic changed the U.S. economic landscape, outlook, and in particular the travel industry, was swift and unexpected. The Company experienced significant disruptions in travel and reduced bookings throughout the remainder of 2020 and for the entirety of 2021 as a result of the pandemic and subsequent variants of COVID-19. Following a significant negative impact to revenues and bookings in January and February 2022, which included increased trip cancellations and staffing challenges associated with the Omicron variant, the Company saw improvements in revenue trends in March 2022 and throughout second quarter 2022 as COVID-19 cases significantly trended downward and bookings for summer travel accelerated. The Company continues to monitor demand for air travel and proactively adjust its published flight schedules and capacity.

Since the start of the pandemic, the Company entered into definitive documentation with the United States Department of the Treasury ("Treasury") with respect to payroll funding support ("Payroll Support") pursuant to three separate Payroll Support programs: the "PSP1 Payroll Support Program" in April 2020 under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"); the "PSP2 Payroll Support Program” in January 2021 under the Consolidated Appropriations Act, 2021; and the "PSP3 Payroll Support Program" in April 2021 under the American Rescue Plan Act of 2021.

As consideration for its receipt of funding under each of these Payroll Support programs, the Company issued a promissory note in favor of Treasury (classified as a component of Long term debt less current maturities in the unaudited Condensed Consolidated Balance Sheet) and entered into a warrant agreement with Treasury (classified as a component of Stockholders' equity in the unaudited Condensed Consolidated Balance Sheet). The following table provides the details from the PSP1, PSP2 and PSP3 Payroll Support programs:

(dollars in millions, shares in thousands)GrantPromissory NoteWarrants Total Payroll Support ProceedsWarrants (shares)Warrant strike pricePromissory Note Maturity Date
PSP1$2,337 $976 $40 $3,354 2,676 
$36.47/share
April 19, 2030
PSP2$1,393 $566 $27 $1,987 1,223 
$46.28/share
January 15, 2031
PSP3 $1,310 $526 $18 $1,852 899 
$58.51/share
April 23, 2031
Total$5,040 $2,068 $85 $7,193 4,798 
In connection with the receipt of Payroll Support, the Company is subject to certain restrictions, including the elimination of share repurchases and dividends through September 30, 2022; and limits on executive compensation until April 1, 2023.

Under each of the three Payroll Support programs, funds received were used solely to pay qualifying employee salaries, wages, and benefits. All grant portions of the Payroll Support programs received had been allocated and classified as a contra-expense line item in the Company's financial statements by the end of 2021, including approximately $724 million and $1.9 billion for the three and six months ended June 30, 2021, in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income.

On June 1, 2020, the Company announced Voluntary Separation Program 2020 ("Voluntary Separation Program"), a voluntary separation program that allowed eligible Employees the opportunity to voluntarily separate from the
9

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


Company in exchange for severance, medical/dental coverage for a specified period of time, and travel privileges based on years of service. A total of over 4,200 Employees elected to participate in Voluntary Separation Program.

In conjunction with Voluntary Separation Program, the Company also offered certain contract Employees the option to take voluntary Extended Emergency Time Off ("Extended ETO"), for periods between six and 18 months, with the exception of Pilots, who could elect to take Extended ETO for periods of up to five years, all subject to early recalls. Approximately 12,000 Employees participated in the Extended ETO program in 2020 and 2021 combined. The Company had no Employees remaining on Extended ETO past March 31, 2022.

The purpose of Voluntary Separation Program and Extended ETO was to maintain a reduced workforce to operate at reduced capacity relative to the Company's operations prior to the COVID-19 pandemic. In accordance with the accounting guidance in Accounting Standards Codification ("ASC") Topic 712 (Compensation — Nonretirement Postemployment Benefits), the Company accrued charges related to the special termination benefits described above upon Employees accepting Voluntary Separation Program or Extended ETO offers. The Company accrued expenses totaling $1.4 billion for its Voluntary Separation Program and Extended ETO program in 2020, which are being reduced as program benefits are paid. For both the Voluntary Separation Program and Extended ETO programs combined, approximately $60 million of the liability balances were relieved during the first six months of 2022 through payments to Employees, leaving a balance of $269 million as of June 30, 2022. The liability associated with the Extended ETO program was fully relieved at March 31, 2022. During the first six months of 2021, the Company determined that it was no longer probable that the remaining portion of the Employees on Extended ETO would remain on such leave for their entire elected term. Therefore, a portion of the accruals previously recorded were reversed, resulting in a net $130 million credit to expense during the first six months of 2021. Both the initial charge and the partial reversal were classified within Payroll support and voluntary Employee programs, net, in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income.

In response to flight schedule adjustments due to the effects of the COVID-19 pandemic, a number of aircraft were taken out of the Company’s schedule beginning in late March 2020, and placed in short-term storage, as well as some in a longer term storage program. As of June 30, 2022, four Boeing 737-700 aircraft remained in storage, all of which were retired from the Company's fleet in July 2022.

3.    NEW ACCOUNTING PRONOUNCEMENTS
On May 3, 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. This new standard provides clarification and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (such as warrants) that remain equity classified after modification or exchange. This standard is effective for fiscal years beginning after December 15, 2021, and the standard was adopted and applied prospectively by the Company as of January 1, 2022, but the adoption and application did not have a significant impact on the Company's financial statements and disclosures, including interim periods.

On January 7, 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848). This new standard provides optional temporary guidance for entities transitioning away from London Interbank Offered Rate ("LIBOR") to new reference interest rates so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions with Topic 848. These amendments do not apply to any contract modifications made after December 31, 2022, any new hedging relationships entered into after December 31, 2022, or to existing hedging relationships evaluated for effectiveness existing as of December 31, 2022, that apply certain optional practical expedients. This standard was effective immediately and may be applied (i) on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or (ii) on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be
10

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


issued. The Company had no material LIBOR-related contract modifications during the six months ended June 30, 2022.

On August 5, 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This new standard reduced the number of accounting models for convertible debt instruments and convertible preferred stock, made targeted improvements to the disclosures for convertible instruments and earnings-per-share ("EPS") guidance, and amended the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. This standard is effective for fiscal years beginning after December 15, 2021, and the Company adopted this standard as of January 1, 2022, utilizing the modified retrospective method. Under the modified approach, the Company applied guidance to all financial instruments that were outstanding as of the beginning of the year of adoption with the cumulative effect recognized as an adjustment to the opening balance of retained earnings. Upon adoption, the Company reclassified the remaining equity component of $300 million, from Additional paid-in capital to Long-term debt associated with its 1.25% Convertible Senior Notes due 2025 (the “Convertible Notes”), and no longer records amortization of the debt discount to Interest expense. The cumulative effect from prior period amortization of the debt discount that has been recorded to Interest expense, offset by reductions to Capital in excess of par value related to the requisition of the equity component through previous repurchases, resulted in a $55 million adjustment to the opening balance of Retained earnings upon adoption. The new standard requires the use of the if-converted method to calculate diluted EPS, which is generally more dilutive, rather than the treasury stock method as was the Company's policy pre-adoption. For the three and six months ended June 30, 2022, the impacts of adopting this new standard were decreases to the Company's Net income in the amounts of $21 million, or $0.20 per diluted share, and $57 million, or $0.21 per diluted share, respectively, as a result of higher losses recognized on the Company’s extinguishment transactions following the elimination of the equity component of the Convertible Notes, partially offset by the elimination of the non-cash interest expense associated with the prior debt discount amortization. See Note 7.

11

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


4.    FINANCIAL DERIVATIVE INSTRUMENTS

Fuel Contracts
Airline operators are inherently dependent upon energy to operate and, therefore, are impacted by changes in jet fuel prices. Furthermore, jet fuel and oil typically represents one of the largest operating expenses for airlines. The Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses through its fuel hedging program. Although the Company may periodically enter into jet fuel derivatives for short-term timeframes, because jet fuel is not widely traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel for time horizons longer than approximately 24 months into the future. However, the Company has found that financial derivative instruments in other commodities, such as West Texas Intermediate ("WTI") crude oil, Brent crude oil, and refined products, such as heating oil and unleaded gasoline, can be useful in decreasing its exposure to jet fuel price volatility. The Company does not purchase or hold any financial derivative instruments for trading or speculative purposes.

The Company has used financial derivative instruments for both short-term and long-term timeframes, and primarily uses a mixture of purchased call options, collar structures (which include both a purchased call option and a sold put option), call spreads (which include a purchased call option and a sold call option), put spreads (which include a purchased put option and a sold put option), and fixed price swap agreements in its portfolio. Although the use of collar structures and swap agreements can reduce the overall cost of hedging, these instruments carry more risk than purchased call options in that the Company could end up in a liability position when the collar structure or swap agreement settles. With the use of purchased call options and call spreads, the Company cannot be in a liability position at settlement, but does not have coverage once market prices fall below the strike price of the purchased call option.

For the purpose of evaluating its net cash spend for jet fuel and for forecasting its future estimated jet fuel expense, the Company evaluates its hedge volumes strictly from an "economic" standpoint and thus does not consider whether the hedges have qualified or will qualify for hedge accounting. The Company defines its "economic" hedge as the net volume of fuel derivative contracts held, including the impact of positions that have been offset through sold positions, regardless of whether those contracts qualify for hedge accounting. The level at which the Company is economically hedged for a particular period is also dependent on current market prices for that period, as well as the types of derivative instruments held and the strike prices of those instruments. For example, the Company may enter into "out-of-the-money" option contracts (including "catastrophic" protection), which may not generate intrinsic gains at settlement if market prices do not rise above the option strike price. Therefore, even though the Company may have an economic hedge in place for a particular period, that hedge may not produce any hedging gains at settlement and may even produce hedging losses depending on market prices, the types of instruments held, and the strike prices of those instruments.
12

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



As of June 30, 2022, the Company had fuel derivative instruments in place to provide coverage at varying price levels. The following table provides information about the Company’s volume of fuel hedging on an economic basis:

Maximum fuel hedged as of
June 30, 2022Derivative underlying commodity type as of
Period (by year)(gallons in millions) (a)June 30, 2022
Remainder of 2022610 WTI crude oil, Brent crude oil, and Heating oil
2023769 WTI crude oil and Brent crude oil
2024358 WTI crude oil
(a) Due to the types of derivatives utilized by the Company and different price levels of those contracts, these volumes represent the maximum economic hedge in place and may vary significantly as market prices and the Company's flight schedule fluctuate.

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

If a derivative initially does not qualify or ceases to qualify for hedge accounting, any change in the fair value of the derivative instrument since the last reporting period would be recorded in Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income in the period of the change; however, any amounts previously recorded to AOCI would remain there until such time as the original forecasted transaction occurs, at which time these amounts would be reclassified to Fuel and oil expense. Factors that have and may continue to lead to the loss of hedge accounting include: significant fluctuation in energy prices, significant weather events affecting refinery capacity and the production of refined products, and the volatility of the different types of products the Company uses in hedging. Certain types of derivative instruments do not qualify for hedge accounting, including those that result in a net sold position (sold gallons exceeding purchased gallons). Increased volatility in certain commodity markets for an extended period of time, especially if such volatility were to worsen, could cause the Company to lose hedge accounting altogether for the commodities used in its fuel hedging program, which would create further volatility in the Company’s GAAP financial results. However, even though derivatives may not qualify for hedge accounting, the Company continues to hold the instruments as management believes derivative instruments continue to afford the Company the opportunity to stabilize jet fuel costs. When the Company has sold derivative positions in order to effectively "close" or offset a derivative already held as part of its fuel derivative instrument portfolio, any subsequent changes in fair value of those positions are marked to market through earnings. Likewise, any changes in fair value of those positions that were offset by entering into the sold positions and were de-designated as hedges are concurrently marked to market through earnings. However, any changes in value related to hedges that were deferred as part of AOCI while designated as a hedge would remain until the originally forecasted transaction occurs. In a situation where it becomes probable that a fuel hedged forecasted transaction will not occur, any gains and/or losses that have been recorded to AOCI would be required to be immediately reclassified into earnings.

During 2021, as a result of the drop in demand for air travel compared with 2019 due to the pandemic, the Company was in an estimated "over-hedged" position and was required to de-designate a portion of its fuel hedges for hedge accounting purposes. However, the impact of such de-designations was not material to 2021 financial results.

All cash flows associated with purchasing and selling fuel derivatives are classified as Other operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows. The following table presents the location of all assets and liabilities associated with the Company’s derivative instruments within the unaudited Condensed Consolidated Balance Sheet:
13

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



  Asset derivativesLiability derivatives
 Balance SheetFair value atFair value atFair value atFair value at
(in millions)location6/30/202212/31/20216/30/202212/31/2021
Derivatives designated as hedges (a)     
Fuel derivative contracts (gross)Prepaid expenses and other current assets$797 $409 $— $— 
Fuel derivative contracts (gross)Other assets372 287 — — 
Interest rate derivative contractsOther assets11 — — — 
Interest rate derivative contractsOther noncurrent liabilities— —  4 
Total derivatives designated as hedges$1,180 $696 $ $4 
Derivatives not designated as hedges (a)     
Fuel derivative contracts (gross)Prepaid expenses and other current assets$125 $— $167 $— 
Total derivatives $1,305 $696 $167 $4 
(a) Represents the position of each trade before consideration of offsetting positions with each counterparty and does not include the impact of cash collateral deposits provided to or received from counterparties. See discussion of credit risk and collateral following in this Note 4.

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

 Balance SheetJune 30,December 31,
(in millions)location20222021
Cash collateral deposits held from counterparties for fuel contracts - currentOffset against Prepaid expenses and other current assets$297 $80 
Cash collateral deposits held from counterparties for fuel contracts - noncurrentOffset against Other assets162 95 
Receivable from third parties for fuel contractsAccounts and other receivables125 8 
 
All of the Company's fuel derivative instruments and interest rate swaps are subject to agreements that follow the netting guidance in the applicable accounting standards for derivatives and hedging. The types of derivative instruments the Company has determined are subject to netting requirements in the accompanying unaudited Condensed Consolidated Balance Sheet are those in which the Company pays or receives cash for transactions with the same counterparty and in the same currency via one net payment or receipt. For cash collateral held by the Company or provided to counterparties, the Company nets such amounts against the fair value of the Company's derivative portfolio by each counterparty. The Company has elected to utilize netting for both its fuel derivative instruments and interest rate swap agreements and also classifies such amounts as either current or noncurrent, based on the net fair value position with each of the Company's counterparties in the unaudited Condensed Consolidated Balance Sheet. If its fuel derivative instruments are in a net asset position with a counterparty, cash collateral amounts held are first netted against current outstanding derivative asset amounts associated with that counterparty until that balance is zero, and then any remainder is applied against the fair value of noncurrent outstanding derivative instruments. As of June 30, 2022, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.

14

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


The Company has the following recognized financial assets and financial liabilities resulting from those transactions that meet the scope of the disclosure requirements as necessitated by applicable accounting guidance for balance sheet offsetting:

Offsetting of derivative assets
(in millions)
(i)(ii)(iii) = (i) + (ii)(i)(ii)(iii) = (i) + (ii)
June 30, 2022December 31, 2021
DescriptionBalance Sheet locationGross amounts of recognized assetsGross amounts offset in the Balance SheetNet amounts of assets presented in the Balance SheetGross amounts of recognized assetsGross amounts offset in the Balance SheetNet amounts of assets presented in the Balance Sheet
Fuel derivative contractsPrepaid expenses and other current assets$922 $(464)
(b)
$458 $409 $(80)$329 
Fuel derivative contractsOther assets$372 $(162)$210 (a)$287 $(95)$192 (a)
Interest rate derivative contractsOther assets$11 $ $11 (a)$ $ $ (a)
(a) The net amounts of derivative assets and liabilities are reconciled to the individual line item amounts presented in the unaudited Condensed Consolidated Balance Sheet in Note 9.
(b) Includes the current portion of cash collateral deposits held from counterparties and derivative liability associated with fuel contracts.


Offsetting of derivative liabilities
(in millions)
(i)(ii)(iii) = (i) + (ii)(i)(ii)(iii) = (i) + (ii)
June 30, 2022December 31, 2021
DescriptionBalance Sheet locationGross amounts of recognized liabilitiesGross amounts offset in the Balance SheetNet amounts of liabilities presented in the Balance SheetGross amounts of recognized liabilitiesGross amounts offset in the Balance SheetNet amounts of liabilities presented in the Balance Sheet
Fuel derivative contractsPrepaid expenses and other current assets$464 $(464)
(b)
$ $80 $(80)$ 
Fuel derivative contractsOther assets$162 $(162)$