10-Q 1 luv-20220930.htm 3RD QUARTER 2022 FORM 10-Q luv-20220930
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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 September 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-20220930_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 October 27, 2022: 593,752,004



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)

September 30, 2022December 31, 2021
ASSETS  
Current assets: 
Cash and cash equivalents$10,443 $12,480 
Short-term investments3,230 3,024 
Accounts and other receivables1,316 1,357 
Inventories of parts and supplies, at cost776 537 
Prepaid expenses and other current assets653 638 
Total current assets16,418 18,036 
Property and equipment, at cost:
Flight equipment22,505 21,226 
Ground property and equipment6,727 6,342 
Deposits on flight equipment purchase contracts587  
Assets constructed for others19 6 
29,838 27,574 
Less allowance for depreciation and amortization13,501 12,732 
 16,337 14,842 
Goodwill970 970 
Operating lease right-of-use assets1,449 1,590 
Other assets772 882 
 $35,946 $36,320 
LIABILITIES AND STOCKHOLDERS' EQUITY  
Current liabilities:  
Accounts payable$1,553 $1,282 
Accrued liabilities1,881 1,624 
Current operating lease liabilities233 239 
Air traffic liability6,368 5,566 
Current maturities of long-term debt381 453 
Total current liabilities10,416 9,164 
Long-term debt less current maturities8,315 10,274 
Air traffic liability - noncurrent2,057 2,159 
Deferred income taxes1,995 1,770 
Noncurrent operating lease liabilities1,183 1,315 
Other noncurrent liabilities1,056 1,224 
Stockholders' equity:  
Common stock888 888 
Capital in excess of par value3,989 4,224 
Retained earnings16,588 15,774 
Accumulated other comprehensive income305 388 
Treasury stock, at cost(10,846)(10,860)
Total stockholders' equity10,924 10,414 
 $35,946 $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 September 30,Nine months ended September 30,
 2022202120222021
OPERATING REVENUES:    
Passenger$5,613 $4,227 $15,867 $9,508 
Freight44 47 133 140 
Other563 405 1,642 1,091 
Total operating revenues6,220 4,679 17,642 10,739 
OPERATING EXPENSES, NET:    
Salaries, wages, and benefits2,322 2,122 6,771 5,518 
Payroll support and voluntary Employee programs, net (776) (2,963)
Fuel and oil1,750 990 4,390 2,261 
Maintenance materials and repairs204 250 624 646 
Landing fees and airport rentals395 376 1,128 1,092 
Depreciation and amortization335 322 984 949 
Other operating expenses819 662 2,343 1,710 
Total operating expenses, net5,825 3,946 16,240 9,213 
OPERATING INCOME395 733 1,402 1,526 
OTHER EXPENSES (INCOME):  
Interest expense86 115 272 343 
Capitalized interest(11)(9)(31)(27)
Interest income(70)(2)(101)(6)
Loss on extinguishment of debt76 12 192 12 
Other (gains) losses, net(39)17 57 (44)
Total other expenses (income)42 133 389 278 
INCOME BEFORE INCOME TAXES353 600 1,013 1,248 
PROVISION FOR INCOME TAXES76 154 254 339 
NET INCOME$277 $446 $759 $909 
NET INCOME PER SHARE, BASIC$0.47 $0.75 $1.28 $1.54 
NET INCOME PER SHARE, DILUTED$0.44 $0.73 $1.21 $1.49 
COMPREHENSIVE INCOME$(223)$577 $676 $1,300 
WEIGHTED AVERAGE SHARES OUTSTANDING   
Basic593 592 593 591 
Diluted639 607 643 610 
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 
Issuance of common and treasury stock pursuant to Employee stock plans— 9 — — 4 13 
Share-based compensation— 14 — — — 14 
Comprehensive income— — 277 (500)— (223)
Balance at September 30, 2022$888 $3,989 $16,588 $305 $(10,846)$10,924 

  
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 
Issuance of common and treasury stock pursuant to Employee stock plans— 10 — — 3 13 
Share-based compensation— 14 — — — 14 
Equity feature of Convertible Notes, net of issuance costs— (42)— — — (42)
Comprehensive income— — 446 131 — 577 
Balance at September 30, 2021$888 $4,251 $15,706 $267 $(10,862)$10,250 
    See accompanying notes.
5

Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
Three months endedNine months ended
September 30,September 30,
 2022202120222021
CASH FLOWS FROM OPERATING ACTIVITIES:    
Net income$277 $446 $759 $909 
Adjustments to reconcile net income to cash provided by operating activities:   
Depreciation and amortization335 322 984 949 
Impairment of long-lived assets4  35  
Unrealized mark-to-market adjustment on available for sale securities  7  
Unrealized/realized (gain) loss on fuel derivative instruments(26)(2)(11)(25)
Deferred income taxes76 67 250 42 
Loss on extinguishment of debt76 12 192 12 
Changes in certain assets and liabilities:   
Accounts and other receivables58 (23)162 (819)
Other assets30 59 (14)64 
Accounts payable and accrued liabilities(70)(948)436 (25)
Air traffic liability(93)(442)700 1,103 
Other liabilities(83)(88)(292)(275)
Cash collateral received from (provided to) derivative counterparties(325)42 (41)128 
Other, net(25)(20)44 12 
Net cash provided by (used in) operating activities234 (575)3,211 2,075 
CASH FLOWS FROM INVESTING ACTIVITIES:    
Capital expenditures(1,072)(135)(2,568)(325)
Assets constructed for others(7)(3)(14)(3)
Purchases of short-term investments(1,743)(1,525)(4,213)(4,500)
Proceeds from sales of short-term and other investments1,702 1,251 3,982 3,747 
Net cash used in investing activities(1,120)(412)(2,813)(1,081)
CASH FLOWS FROM FINANCING ACTIVITIES:    
Proceeds from Payroll Support Program loan and warrants   1,136 
Proceeds from Employee stock plans12 13 32 39 
Payments of long-term debt and finance lease obligations(1,679)(67)(1,825)(177)
Payments for repurchases and conversions of convertible debt(239)(121)(648)(121)
Other, net1 18 6 46 
Net cash provided by (used in) financing activities(1,905)(157)(2,435)923 
NET CHANGE IN CASH AND CASH EQUIVALENTS(2,791)(1,144)(2,037)1,917 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD13,234 14,124 12,480 11,063 
CASH AND CASH EQUIVALENTS AT END OF PERIOD$10,443 $12,980 $10,443 $12,980 
CASH PAYMENTS FOR:
Interest, net of amount capitalized$42 $22 $203 $188 
Income taxes$8 $114 $19 $291 
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:
Adoption of Accounting Standards Update 2020-06, Debt (See Note 3)$ $ $245 $ 
Right-of-use assets acquired under operating leases$14 $53 $42 $283 
Flight equipment acquired against supplier credit memo$ $ $ $512 
Assets constructed for others$ $ $ $309 
Remeasurement of right-of-use asset and lease liability$ $343 $ $343 
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 September 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 nine months ended September 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.
Certain prior period amounts have been reclassified to conform to the current presentation. In the unaudited Condensed Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2021, the Company has reclassified $12 million, in both periods, from Other (gains) losses, net to Loss on extinguishment of debt.
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. Strong revenue trends, especially for leisure travel, continued throughout third quarter 2022.

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 has been 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 $763 million and $2.7 billion for the three and nine months ended September 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 $86 million of the liability balances were relieved during the first nine months of 2022 through payments to Employees, leaving a balance of $242 million as of September 30, 2022. The liability associated with the Extended ETO program was fully relieved at March 31, 2022. During the first nine 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 $140 million credit to expense during the first nine 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 September 30, 2022, no Boeing aircraft remained in short or long-term storage.

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
10

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


is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued.
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 nine months ended September 30, 2022, the impacts of adopting this new standard were decreases to the Company's Net income in the amounts of $36 million, or $0.08 per diluted share, and $94 million, or $0.22 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 September 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
September 30, 2022Derivative underlying commodity type as of
Period (by year)(gallons in millions) (a)September 30, 2022
Remainder of 2022305 WTI crude oil, Brent crude oil, and Heating oil
20231,084 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 certain derivatives may not qualify for hedge accounting, the Company continues to hold the instruments as management believes they 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)location9/30/202212/31/20219/30/202212/31/2021
Derivatives designated as hedges (a)     
Fuel derivative contracts (gross)Prepaid expenses and other current assets$371 $409 $— $— 
Fuel derivative contracts (gross)Other assets168 287 — — 
Interest rate derivative contractsOther assets14  — — 
Interest rate derivative contractsOther noncurrent liabilities— —  4 
Total derivatives designated as hedges$553 $696 $ $4 
Derivatives not designated as hedges (a)     
Fuel derivative contracts (gross)Prepaid expenses and other current assets$26 $— $29 $— 
Total derivatives $579 $696 $29 $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 SheetSeptember 30,December 31,
(in millions)location20222021
Cash c