What changed in this filing

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Item 1. Financial Statements

2021-04-27 compared with 2020-10-27 · 325 added, 527 removed, 538 unchanged (61% of the section changed)

3 unchanged sentences

(in millions)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Current assets:

43 unchanged sentences

(in millions, except per share amounts)

Three months ended September 30, Nine months ended September 30,

2020 2019 2020 2019

Three months ended March 31,

OPERATING REVENUES:

3 unchanged sentences

Total operating revenues 2,052 4,234

OPERATING EXPENSES:

OPERATING EXPENSES, NET:

Salaries, wages, and benefits 1,571 1,854

4 unchanged sentences

Depreciation and amortization 312 311

Other operating expenses, net 488 762 1,405 2,260

Total operating expenses 3,204 4,820 9,683 14,406

Other operating expenses 463 698

Total operating expenses, net 1,853 4,344

OPERATING INCOME (LOSS) 199 ( 110 )

6 unchanged sentences

INCOME (LOSS) BEFORE INCOME TAXES 146 ( 144 )

PROVISION FOR INCOME TAXES ( 385 ) 160 ( 759 ) 504

PROVISION (BENEFIT) FOR INCOME TAXES 30 ( 50 )

NET INCOME (LOSS) $ 116 $ ( 94 )

11 unchanged sentences

Balance at December 31, 2020 $ 888 $ 4,191 $ 14,777 $ ( 105 ) $ ( 10,875 ) $ 8,876

Repurchase of common stock — — — — ( 451 ) ( 451 )

Issuance of common and treasury stock pursuant to Employee stock plans — ( 8 ) — — 6 ( 2 )

Share-based compensation — 9 — — — 9

Cash dividends, $ 0.180 per share

Cumulative effect of adopting Accounting Standards Update No.

2016-01, Financial Instruments (See Note 1)

— — 19 ( 19 ) — —

Comprehensive loss — — ( 94 ) ( 125 ) — ( 219 )

Balance at March 31, 2020 $ 808 $ 1,582 $ 17,757 $ ( 186 ) $ ( 10,886 ) $ 9,075

Issuance of common stock, net of issuance costs 80 2,144 — — — 2,224

Issuance of common and treasury stock pursuant to Employee stock plans — ( 8 ) — — 8 —

1 unchanged sentence

Stock warrants — 23 — — — 23

Equity feature of convertible notes, net of issuance costs — 392 — — — 392

Comprehensive loss — — ( 915 ) 56 — ( 859 )

Balance at June 30, 2020 $ 888 $ 4,159 $ 16,842 $ ( 130 ) $ ( 10,881 ) $ 10,878

Issuance of common and treasury stock pursuant to Employee stock plans — 9 — — 4 13

Share-based compensation — 2 — — — 2

Stock warrants — 5 — — — 5

Comprehensive loss — — ( 1,157 ) 28 — ( 1,129 )

Balance at September 30, 2020 $ 888 $ 4,175 $ 15,685 $ ( 102 ) $ ( 10,877 ) $ 9,769

Common Stock Capital in excess of par value Retained earnings Accumulated other comprehensive income (loss) Treasury stock Total

Balance at December 31, 2018 $ 808 $ 1,510 $ 15,967 $ 20 $ ( 8,452 ) $ 9,853

Cumulative effect of adopting Accounting Standards Update No.

2016-12, Leases, codified in Accounting Standards Codification 842 — — 55 — — 55

Balance after adjustment for the new accounting standard $ 808 $ 1,510 $ 16,022 $ 20 $ ( 8,452 ) $ 9,908

Repurchase of common stock — — — — ( 500 ) ( 500 )

Issuance of common and treasury stock pursuant to Employee stock plans — ( 10 ) — — 6 ( 4 )

Share-based compensation — 13 — — — 13

Cash dividends, $ 0.160 per share

— — ( 89 ) — — ( 89 )

Comprehensive income — — 116 64 — 180

Balance at March 31, 2021 $ 888 $ 4,220 $ 14,912 $ ( 60 ) $ ( 10,867 ) $ 9,093

Repurchase of common stock — — — — ( 450 ) ( 450 )

Issuance of common and treasury stock pursuant to Employee stock plans — 8 — 2 10

Share-based compensation — 13 — — — 13

Cash dividends, $ 0.180 per share

— — ( 99 ) — — ( 99 )

Comprehensive income — — 741 ( 66 ) — 675

Balance at June 30, 2019 $ 808 $ 1,534 $ 16,962 $ 30 $ ( 9,394 ) $ 9,940

Common Stock Capital in excess of par value Retained earnings Accumulated other comprehensive loss Treasury stock Total

Balance at December 31, 2019 $ 808 $ 1,581 $ 17,945 $ ( 61 ) $ ( 10,441 ) $ 9,832

Repurchase of common stock — — — — ( 451 ) ( 451 )

3 unchanged sentences

— — ( 94 ) — — ( 94 )

Comprehensive income — — 659 ( 93 ) — 566

Balance at September 30, 2019 $ 808 $ 1,554 $ 17,525 $ ( 63 ) $ ( 9,893 ) $ 9,931

Comprehensive loss — — ( 94 ) ( 125 ) — ( 219 )

Balance at March 31, 2020 $ 808 $ 1,582 $ 17,757 $ ( 186 ) $ ( 10,886 ) $ 9,075

See accompanying notes.

2 unchanged sentences

(in millions)

Three months ended Nine months ended

September 30, September 30,

2020 2019 2020 2019

Three months ended

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income (loss) $ 116 $ ( 94 )

Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:

Adjustments to reconcile net income (loss) to cash used in operating activities:

Depreciation and amortization 312 311

Unrealized/realized loss on fuel derivative instruments 17 — 25 —

Unrealized/realized (gain) loss on fuel derivative instruments ( 7 ) 2

Deferred income taxes 5 ( 49 )

Gain on sale-leaseback transactions — — ( 222 ) —

Changes in certain assets and liabilities:

10 unchanged sentences

Supplier proceeds — 300

Proceeds from sale-leaseback transactions — — 815 —

Purchases of short-term investments ( 1,324 ) ( 1,029 )

2 unchanged sentences

CASH FLOWS FROM FINANCING ACTIVITIES:

Issuance of common stock — — 2,294 —

Proceeds from issuance of long-term debt — 500

1 unchanged sentence

Proceeds from revolving credit facility — 1,000

Proceeds from convertible notes — — 2,300 —

Proceeds from Payroll Support Program loan and warrants 511 —

2 unchanged sentences

Payments of long-term debt and finance lease obligations ( 67 ) ( 78 )

Payments of term loan credit facility — — ( 3,683 ) —

Payments of revolving credit facility — — ( 1,000 ) —

Payments of cash dividends — ( 188 )

Payments of terminated interest rate derivative instruments ( 31 ) — ( 31 ) —

Capitalized financing items 44 — ( 133 ) —

Other, net 7 ( 20 )

Net cash provided by (used in) financing activities 1,242 ( 690 ) 10,199 ( 2,082 )

Net cash provided by financing activities 464 1,774

NET CHANGE IN CASH AND CASH EQUIVALENTS 908 1,392

1 unchanged sentence

CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 11,971 $ 3,940

Southwest Airlines Co.

Condensed Consolidated Statement of Cash Flows

(in millions)

CASH PAYMENTS FOR:

13 unchanged sentences

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, 2020 and 2019 include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods.

The unaudited Condensed Consolidated Financial Statements for the interim periods ended March 31, 2021 and 2020 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.

1 unchanged sentence

In many years, the Company's revenues, as well as its Operating income and Net income, have been better in its second and third fiscal quarters than in its first and fourth fiscal quarters.

However, in 2020, as a result of the COVID-19 pandemic, the Company's results were not in line with such historical trends.

However, beginning in early 2020, as a result of the COVID-19 pandemic, the Company's results have not 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, unemployment levels, corporate travel budgets, extreme or severe weather and natural disasters, fears of terrorism or war, and other factors beyond the Company's control.

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, 2020, are not necessarily indicative of the results that may be expected for future quarters or for the year ended December 31, 2020.

Operating results for the three months ended March 31, 2021, are not necessarily indicative of the results that may be expected for future quarters or for the year ended December 31, 2021.

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, 2020.

In the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss), for the three months ended March 31, 2021, Payroll support and voluntary Employee programs, net, includes the correction of previously underaccrued payroll tax credits, related to fourth quarter 2020, of $ 88 million, pre-tax.

Other gains and losses, net, includes gains of $ 60 million, pre-tax, to correct investment gains related to prior periods previously recorded in Accumulated other comprehensive income (loss) ("AOCI").

In the unaudited Condensed Consolidated Statement of Stockholders' Equity, for the three months ended March 31, 2021, the Company recorded a decrease of $ 19 million, net of tax, in AOCI and a corresponding increase in Retained earnings to correct the amount of the impact of the cumulative effect of adopting Accounting Standard Update ("ASU") 2016-01, Financial Instruments in 2018.

These corrections are not considered material to prior period financial statements and are not expected to be material to the full year 2021 financial statements.

Southwest Airlines Co.

2 unchanged sentences

As a result of the rapid spread of the novel coronavirus, COVID-19, throughout the world, including into the United States, on March 11, 2020, the World Health Organization classified the virus as a pandemic.

The speed with which the effects of the COVID-19 pandemic have changed the U.S.

economic landscape, outlook, and in particular the travel industry, has been swift and unexpected.

The Company began to see a negative impact on bookings for future travel in late February 2020, which quickly accelerated during the remainder of first quarter and into second quarter, when trip cancellations outpaced new passenger bookings during the majority of March and April 2020.

The Company began proactively canceling a significant portion of its scheduled flights in March, and continued making cancellations throughout second and third quarters, as the Company grounded a significant portion of its fleet and operated a significantly reduced portion of its previously scheduled capacity.

The Company continued to experience significant negative impacts to passenger demand and bookings in third quarter 2020 due to the pandemic.

Based on these events and the uncertainty they created, the Company immediately began to focus on its liquidity, including quickly and substantially enhancing its cash holdings.

Since the beginning of 2020, the Company has raised a total of $ 18.9 billion, net of fees.

On April 20, 2020, the Company entered into definitive documentation with the United States Department of Treasury (the "Treasury") with respect to funding support pursuant to the Payroll Support Program ("Payroll Support") under the Coronavirus Aid, Relief and Economic Security Act ("CARES Act").

Payroll Support funds had to be used to pay employee wages and benefits through at least September 30, 2020.

As of September 30, 2020, the Company has received five installments of Payroll Support from the CARES Act.

The cumulative amounts received totaled $ 3.4 billion, including $ 1.6 billion received in April, $ 652 million received in both May and June, $ 326 million received in July 2020, and $ 94 million received in September 2020.

As consideration for the Payroll Support, the Company issued a promissory note (the "Note") in favor of the Treasury and entered into a warrant agreement with the Treasury (the "Warrant Agreement"), pursuant to which the Company agreed to issue warrants (each, a "Warrant") to purchase common stock of the Company to the Treasury.

As of September 30, 2020, the Company has provided a Note in the aggregate amount of $ 976 million and issued Warrants valued at a total of $ 40 million to purchase up to an aggregate of 2.7 million shares of the Company's common stock, subject to adjustment pursuant to the terms of the Warrants.

Pursuant to the terms of the Payroll Support Program agreement and the CARES Act, the Payroll Support funds could only be utilized to pay qualifying salaries, wages, and benefits, as defined in the CARES Act.

As of September 30, 2020, excluding the $ 976 million Note and value allocated to the Warrants, all Payroll Support funds received have been allocated to reduce eligible costs in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the nine months ended September 30, 2020.

The Note matures in full on April 19, 2030, and is subject to mandatory prepayment requirements in connection with certain change of control triggering events that may occur prior to its maturity.

The Company has an option to prepay the Note at any time without premium or penalty.

Amounts outstanding under the Note bear interest at a rate of 1.00 percent before April 20, 2025 and, afterwards, at a rate equal to the Secured Overnight Financing Rate or other benchmark replacement rate consistent with customary market conventions plus a margin of 2.00 percent.

The Note contains customary representations and warranties and events of default.

The Warrant Agreement sets out the Company’s obligations to issue Warrants in connection with disbursements of Payroll Support and to file a resale shelf registration statement for the Warrants and the underlying shares of common stock.

The Company has also granted the Treasury certain demand underwritten offering and piggyback registration rights with respect to the Warrants and the underlying common stock.

Each Warrant is exercisable at a strike price of $ 36.47 per share of common stock and will expire on the fifth anniversary of the issue date of such Warrant.

The Warrants will be settled through net share settlement or net cash settlement, at the Company’s option.

The Warrants include adjustments for below market issuances, payment of dividends, and other customary anti-dilution provisions.

The Warrants do not have voting rights.

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 saw a negative impact on bookings for future travel throughout 2020.

The Company proactively canceled a significant portion of its scheduled flights in March 2020 and continued adjusting capacity throughout 2020, as the Company grounded a significant portion of its fleet and operated a significantly reduced portion of its previously scheduled capacity.

The Company continued to experience significant negative impacts to passenger demand and bookings through first quarter 2021 due to the pandemic.

In April 2020, the Company entered into definitive documentation with the United States Department of Treasury ("Treasury") with respect to funding support pursuant to the Payroll Support Program ("Payroll Support") under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act").

During 2020, the Company received a total of $ 3.4 billion of relief funds under the CARES Act.

As consideration for the Payroll Support, the Company issued a promissory note in favor of Treasury and entered into a warrant agreement with Treasury, pursuant to which the Company agreed to issue warrants to purchase common stock of the Company to Treasury.

During 2020, the Company provided the promissory note in the aggregate amount of $ 976 million and issued warrants valued at a total of $ 40 million to purchase up to an aggregate of 2.7 million shares of the Company's common stock, subject to adjustment pursuant to the terms of the warrants.

Payroll Support funds were used solely to pay qualifying employee salaries, wages, and benefits.

On January 15, 2021, the Company entered into definitive documentation with Treasury with respect to funding support under the Consolidated Appropriations Act, 2021 (the "Payroll Support Program Extension").

Payroll Support Program Extension funds were used solely to pay qualifying employee wages and benefits.

As of March 31, 2021, the Company had received $ 1.7 billion associated with the Payroll Support Program Extension.

As consideration for the Payroll Support Program Extension, the Company issued a promissory note (the "PSP2 Note") in favor of Treasury and entered into a warrant agreement (the "PSP2 Warrant Agreement") with Treasury pursuant to which the Company agreed to issue warrants (each, a "PSP2 Warrant") to purchase common stock of the Company to Treasury.

As of March 31, 2021, the Company had provided a PSP2 Note in the aggregate amount of $ 488 million and issued PSP2 Warrants valued at a total of $ 23 million to purchase up to an aggregate of 1.1 million shares of the Company's common stock, subject to adjustment pursuant to the terms of the PSP2 Warrants.

Pursuant to the terms of the Payroll Support Program Extension, the payroll support funds could only be utilized to pay qualifying salaries, wages, and benefits, as defined.

As of March 31, 2021, excluding the $ 488 million PSP2 Note and value allocated to the PSP2 Warrants, all Payroll Support Program Extension funds received had been allocated to reduce eligible costs in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three months ended March 31, 2021.

On April 23, 2021, the Company received an additional $ 259 million related to the Payroll Support Program Extension, for which the Company provided Treasury consideration in the form of an increase of the PSP2 Note in an amount of $ 78 million and a PSP2 Warrant to purchase up to 168 thousand shares of the Company's common stock under the PSP2 Warrant Agreement.

The grant portion of the payroll support funds will be allocated to reduce qualifying employee salaries, wages, and benefits during second quarter 2021.

After taking into account the additional support under the Payroll Support Program Extension, the Company has received $ 2.0 billion of payroll support under the Payroll Support Program Extension, for which the Company has provided Treasury with a PSP2 Note in the aggregate amount of $ 566 million and PSP2 Warrants to purchase up to 1.2 million shares of the Company's common stock.

The PSP2 Note matures in full on January 15, 2031, and is subject to mandatory prepayment requirements in connection with certain change of control triggering events that may occur prior to its maturity.

The Company has an option to prepay the PSP2 Note at any time without premium or penalty.

Amounts outstanding under the PSP2 Note bear interest at a rate of 1.00 percent before January 15, 2026, and, afterwards, at a rate equal to the Secured Overnight Financing Rate or other benchmark replacement rate consistent with customary market conventions plus a margin of 2.00 percent.

The PSP2 Note contains customary representations and warranties and events of default.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

In addition to obtaining financing under the CARES Act and accessing the capital markets, the Company believes it has made significant progress on bolstering its liquidity through efforts including aggressively evaluating all capital spending, discretionary spending, and non-essential costs for near-term cost reductions or deferrals;

reducing the Company's published flight schedule;

placing a significant number of aircraft in storage;

implementing voluntary separation and time-off programs for Employees;

suspending all hiring and non-contract salary increases;

reducing named executive officer salaries and Board of Director cash retainer fees by 20 percent;

and modifying vendor and supplier payment terms.

The Company will continue evaluating the need for further flight schedule adjustments.

To support physical-distancing, the Company is currently limiting the number of seats sold on each flight to allow for middle seats to remain open for Customers who are not traveling together through November 2020.

Also under the terms of the Payroll Support (discussed above) and Payroll Support Program Extension, the Company is prohibited from repurchasing its common stock and from paying dividends with respect to its common stock through March 31, 2022.

The PSP2 Warrant Agreement sets out the Company’s obligations to issue PSP2 Warrants in connection with disbursements of funding support pursuant to the Payroll Support Program Extension and to file or designate a resale shelf registration statement for the PSP2 Warrants and the underlying shares of common stock.

The Company has also granted Treasury certain demand underwritten offering and piggyback registration rights with respect to the PSP2 Warrants and the underlying common stock.

Each PSP2 Warrant is exercisable at a strike price of $ 46.28 per share of common stock and will expire on the fifth anniversary of the issue date of such PSP2 Warrant.

The PSP2 Warrants will be settled through net share settlement or net cash settlement, at the Company’s option.

The PSP2 Warrants include adjustments for below market issuances, payment of dividends, and other customary anti-dilution provisions.

The PSP2 Warrants do not have voting rights.

On March 11, 2021, President Biden signed into law the American Rescue Plan Act of 2021, which includes provisions for an expected $ 14 billion of further payroll support ("PSP3 Payroll Support") for eligible U.S.

airlines (the "PSP3 Payroll Support Program").

On April 23, 2021, the Company finalized an agreement with Treasury in which the Company is expected to receive an aggregate of approximately $ 1.9 billion in PSP3 Payroll Support funds that will be used to pay qualifying employee salaries, wages, and benefits through at least September 30, 2021.

The Company received an initial installment of $ 926 million on April 23, 2021, and expects to receive the remainder of PSP3 Payroll Support funds during second quarter 2021.

As consideration for the PSP3 Payroll Support, on April 23, 2021, the Company issued a promissory note (the "PSP3 Note") in favor of Treasury and entered into a warrant agreement with Treasury (the "PSP3 Warrant Agreement"), pursuant to which the Company agreed to issue warrants (each, a "PSP3 Warrant") to purchase common stock of the Company to Treasury.

The PSP3 Note was issued for $ 248 million and the Company issued a PSP3 Warrant valued at a total of $ 9 million to purchase up to an aggregate of 424 thousand shares of the Company's common stock, subject to adjustment pursuant to the terms of the PSP3 Warrant.

Upon each subsequent disbursement of PSP3 Payroll Support to the Company after April 23, 2021, (i) the principal amount of the PSP3 Note will automatically be increased in an amount equal to 30 percent of any such disbursement and (ii) the Company will issue an additional PSP3 Warrant to Treasury in an amount equal to 10 percent of the principal amount of the increase to the PSP3 Note in connection with such disbursement of PSP3 Payroll Support, divided by the strike price of $ 58.51 (which was the closing price of the Company's common stock on March 10, 2021).

The PSP3 Payroll Support funds received can only be utilized to pay qualifying salaries, wages, and benefits, as defined.

Excluding the amounts allocated to the PSP3 Note and value allocated to the PSP3 Warrants, all PSP3 Payroll Support funds received are expected to be allocated to reduce eligible costs in the year ended December 31, 2021.

The Company currently expects the grant portion of the direct payroll support of $ 1.3 billion will be classified as a contra-expense line item in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).

On June 1, 2020, the Company announced Voluntary Separation Program 2020, a voluntary separation program that allowed eligible Employees the opportunity to voluntarily separate from the Company in exchange for severance, medical/dental coverage for a specified period of time, and travel privileges based on years of service.

Virtually all of the Company’s Employees hired before June 1, 2020 were eligible to participate in Voluntary Separation Program 2020.

Employees electing to participate in Voluntary Separation Program 2020 were required to notify the Company of their election no later than July 15, 2020--with the stipulation that all Employees electing to participate had a total of seven days from their date of initial election to rescind their election and remain employed by the Company.

As determined after the deadline to rescind such election, a total of over 4,200 Employees elected to participate in Voluntary Separation Program 2020, consisting of the following breakdown among workgroups:

1,060 from Ground Operations and Provisioning, 725 Flight Attendants, 630 Pilots, 390 from Customer Support and Services, 185 from Maintenance, 90 from other Contract groups, and 1,140 Managerial and Administrative Employees.

Voluntary Separation Program 2020 participants’ last day of work primarily fell between August 15, 2020 and September 30, 2020, as assigned by the Company based on the operational needs of particular work locations and departments, determined on an individual-by-individual basis.

In conjunction with Voluntary Separation Program 2020, the Company also offered certain contract Employees the option to take voluntary Extended Emergency Time Off ("Extended ETO"), for periods between six and 18 months, with the exception of Pilots, who could elect to take Extended ETO for periods up to five years .

Approximately 11,000 Employees participated in the Extended ETO program, and 8,164 Employees remained on Extended ETO leave as of March 31, 2021.

Employees taking Extended ETO do not perform any work for the Company and are considered inactive while on leave, but do get paid a portion of their wages and continue to receive all associated benefits, as well as accrue service credit for all benefits.

Contract employees who elected to take Extended ETO for periods between 12 and 18 months and had 10 or more years of service have been given the opportunity to convert to the Voluntary Separation Program 2020 beginning on September 1, 2020, until up to 90 days before the end of their respective Extended ETO term.

The purpose of Voluntary Separation Program 2020 and Extended ETO is to maintain a suitable sized workforce to operate at reduced capacity relative to the Company's operations prior to the COVID-19 pandemic.

In accordance with the accounting guidance in ASC Topic 712 (Compensation — Nonretirement Postemployment Benefits), the Company accrued charges related to the special termination benefits described above upon Employees accepting Voluntary Separation Program 2020 or Extended ETO offers, which will be reduced as program benefits are paid.

Costs incurred for Voluntary Separation Program 2020 and Extended ETO, which totaled $ 1.1 billion during third quarter 2020, are recorded as a component of Payroll support and voluntary Employee programs, net, in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).

Within that line item, these charges are netted against the allocation of the remainder of the Payroll Support Program funds utilized to fund salaries, wages, and benefits, which totaled $ 1.2 billion during third quarter 2020.

The Company accrued expenses totaling $ 613 million for its Extended ETO program during third quarter 2020, consisting of future wages and benefits for the Employees that will not be working.

The Company has accrued amounts up to 18 months for all Employees that elected Extended ETO, but did not include amounts related to Pilots for periods beyond February 2022, based on the uncertainty of its future capacity levels, and because it is not currently probable that such Employees will not be recalled to work beyond that timeframe.

Therefore, future adjustments to the amounts accrued as of September 30, 2020, may become necessary at a later date.

Contract employees who elected to take Extended ETO for periods between 12 and 18 months and had 10 or more years of service were given the opportunity to convert to the

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

following table for amounts accrued and amounts reduced related to Voluntary Separation Program 2020 and Extended ETO as of September 30, 2020.

(in millions) Voluntary Separation Program 2020 Extended ETO Total

Amounts accrued $ 307 $ — $ 307

Balance at June 30, 2020 307 — 307

Amounts accrued 485 613 1,098

Amounts reduced ( 173 ) ( 25 ) ( 198 )

Balance at September 30, 2020 (a) $ 619 $ 588 $ 1,207

(a) See Note 10 for the location of the Voluntary Separation Program 2020 and Extended ETO balances within the unaudited Condensed Consolidated Balance Sheet.

Voluntary Separation Program 2020 beginning on September 1, 2020, until up to 90 days before the end of their respective Extended ETO term.

The purpose of Voluntary Separation Program 2020 and Extended ETO is to maintain a reduced workforce to operate at reduced capacity relative to the Company's operations prior to the COVID-19 pandemic.

During first quarter 2021, the Company determined that it was no longer probable that a portion of the Employees remaining 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 $ 141 million credit to expense.

In addition, the Company continues to be subject to overstaffing levels in certain workgroups and locations, and offered some of the Employees on Extended ETO the opportunity to extend their leave periods by one, two, or three months.

Based on the acceptances received, the Company accrued an additional $ 26 million in expense associated with the program.

Both of these items are classified within Payroll support and voluntary Employee programs, net, in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income (Loss), and are in addition to the allocation of the Payroll Support Program Extension funds utilized to fund salaries, wages, and benefits, which totaled $ 1.2 billion during first quarter 2021.

The Company accrued expense totaling $ 620 million for its Extended ETO program in 2020, and considering the adjustments described above, as well as payments subsequently made, $ 190 million remains accrued as of March 31, 2021.

The balance consists of future wages and benefits for the Employees that will not be working during their leave.

The Company accrued amounts for up to the first 18 months from inception for all Employees that elected Extended ETO, but did not include amounts related to Pilots for periods beyond February 2022, based on the uncertainty of the Company's future capacity levels, and because it is not currently probable that such Employees will not be recalled to work beyond that timeframe.

Therefore, future adjustments to the amounts accrued may become necessary at a later date.

For both the Voluntary Support Program 2020 and Extended ETO programs combined, approximately $ 188 million of the liability balances were relieved during first quarter 2021 through payments to Employees, leaving a balance of $ 611 million as of March 31, 2021.

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, 2020, 104 aircraft remained in long-term storage, including 34 Boeing MAX 737 aircraft.

As of March 31, 2021, 66 aircraft remained in temporary or long-term storage.

Given the current expectation that these aircraft have been placed in storage temporarily, the Company has continued to record depreciation expense associated with them.

As a result of the events and impacts surrounding the COVID-19 pandemic, including the Company's net loss incurred during the nine months ended September 30, 2020, and the significant number of aircraft that have been placed in storage, the Company considered whether these conditions indicated that it was more likely than not that the Company’s $ 970 million in Goodwill and its $ 295 million in indefinite-lived intangible assets were impaired.

Upon review, the Company determined that, based on the facts and circumstances in existence as of September 30, 2020, the fair values more likely than not exceeded book values of both its reporting unit and its indefinite-lived intangible assets and therefore, no quantitative test was required.

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

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

The Company's income tax benefit recorded for the first nine months of 2020 was at a rate of 25.9 percent, which is higher than the first nine months of 2019 tax rate of 22.0 percent.

The higher effective tax rate in 2020 reflects the anticipated benefit of carrying back full year 2020 projected net losses to claim tax refunds against previous cash taxes paid relating to tax years 2015 through 2019, some of which were at higher rates than the current year.

NEW ACCOUNTING PRONOUNCEMENTS

On August 5, 2020, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No.

On January 7, 2021, the Financial Accounting Standards Board (the "FASB") issued ASU No.

2021-01, Reference Rate Reform (Topic 848).

This new standard provides optional temporary guidance for entities transitioning away from LIBOR to new reference 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 is effective immediately and may be applied (i) on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or (ii) on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued.

The Company is currently evaluating its contracts that reference LIBOR and the potential impacts of applying the optional temporary guidance under this standard.

There were no LIBOR-related contract modifications during first quarter 2021, and the Company will provide additional information about the transition to new reference rates for affected contracts and adoption of this standard at a future date, if material.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

On August 5, 2020, the FASB issued ASU No.

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):

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This standard is effective for fiscal years beginning after December 15, 2021.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Companies may elect early adoption for periods beginning no earlier than December 15, 2020, including interim periods within those fiscal years.

The FASB specified that an entity should adopt the guidance as of the beginning of its annual fiscal year.

The Company is evaluating this new standard and plans to provide additional information about its expected impact on the Company's financial statements and disclosures at a future date.

On December 18, 2019, the FASB issued ASU No.

2019-12, Income Taxes (Topic 740):

Simplifying the Accounting for Income Taxes.

This new standard eliminates certain exceptions in Accounting Standards Codification ("ASC") 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences.

It also clarifies and simplifies other aspects of the accounting for income taxes.

This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2020, with early adoption permitted in any interim period within that year.

The Company elected to early adopt this standard as of January 1, 2020.

The most significant impact to the Company is the removal of a limit on the tax benefit recognized on pre-tax losses in interim periods.

However, the early adoption as of January 1, 2020, did not have an impact on the Company's financial statements or disclosures for the first nine months of 2020.

On August 29, 2018, the FASB issued ASU No.

2018-15, Intangibles—Goodwill and Other—Internal-Use Software.

This standard requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in ASC 350-40, Accounting for Internal-Use Software, to determine which implementation costs to (i) capitalize as assets and amortize over the term of the hosting arrangement or (ii) expense as incurred.

This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and the standard was adopted and applied prospectively by the Company as of January 1, 2020, but it did not have a significant impact on the Company's financial statements and disclosures.

On August 28, 2018, the FASB issued ASU No.

2018-13, Fair Value Measurement.

This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years.

This standard requires changes to the disclosure requirements for fair value measurements for certain Level 3 items, and specifies that some of the changes must be applied prospectively, while others should be applied retrospectively.

The Company adopted the standard as of January 1, 2020, but it did not have a significant impact on the Company's financial statements or disclosures.

See Note 9 for further information on the Company's fair value measurements.

On January 26, 2017, the FASB issued ASU No.

2017-04, Simplifying the Test for Goodwill Impairment.

The new standard eliminates Step 2 from the goodwill impairment test.

An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value.

On June 16, 2016, the FASB issued ASU No.

2016-13, Measurement of Credit Losses on Financial Instruments.

The new standard requires the use of an “expected loss” model on certain types of financial instruments.

The standard also amends the impairment model for available-for-sale debt securities and requires estimated credit losses to be recorded as allowances instead of reductions to amortized cost of the securities.

The Company plans to adopt this standard as of January 1, 2022.

Upon adoption, the Company will reclassify the remaining equity component from Additional paid-in capital to Long-term debt associated with its convertible notes, and no longer record amortization of the debt discount to Interest expense.

The computation of diluted net income (loss) per share will be affected in the numerator as the Company will no longer record the debt discount amortization in Interest expense and may have to add back Interest expense to the numerator.

The denominator could also be affected as the Company will be required to use the if-converted method to calculate diluted shares.

FINANCIAL DERIVATIVE INSTRUMENTS

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Furthermore, jet fuel and oil typically represents one of the largest operating expenses for airlines.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses through its fuel hedging program.

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.

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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.

For the three and nine months ended September 30, 2020, the Company had fuel derivative instruments in place for up to 42 percent and 67 percent, respectively, of its fuel consumption.

As of September 30, 2020, the Company also had fuel derivative instruments in place to provide coverage at varying price levels.

Therefore, even though the Company may have an economic hedge in place for a particular period, that hedge may not produce any hedging

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

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.

As of March 31, 2021, the Company had fuel derivative instruments in place to provide coverage in future periods 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, 2020 Derivative underlying commodity type as of

Period (by year) (gallons in millions) (a) September 30, 2020

Remainder of 2020 325 WTI crude oil, Brent crude oil, and Heating oil

March 31, 2021 Derivative underlying commodity type as of

Period (by year) (gallons in millions) (a) March 31, 2021

Remainder of 2021 962 WTI crude oil and Brent crude oil

2022 1,220 WTI crude oil and Brent crude oil

2023 643 WTI crude oil and Brent crude oil

Beyond 2022 630 WTI crude oil and Brent crude oil

(a) Due to the types of derivatives utilized by the Company and different price levels of those contracts, these volumes represent the maximum economic hedge in place and may vary significantly as market prices and the Company's flight schedule fluctuates.

Beyond 2023 106 WTI crude oil

Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges.

All periodic changes in fair value of the derivatives designated as hedges are recorded in Accumulated other comprehensive income (loss) ("AOCI") until the underlying jet fuel is consumed.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

The Company's results are subject to the possibility that the derivatives will no longer qualify for hedge accounting, in which case any change in the fair value of derivative instruments since the last reporting period would be recorded in Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) in the period of the change;

Qualification is re-evaluated quarterly, and all periodic changes in fair value of the derivatives designated as hedges are recorded in AOCI until the underlying jet fuel is consumed.

If a derivative ceases to qualify for hedge accounting, any change in the fair value of derivative instruments since the last reporting period would be recorded in Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) in the period of the change;

however, any amounts previously recorded to AOCI would remain there until such time as the original forecasted transaction occurs, at which time these amounts would be reclassified to Fuel and oil expense.

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However, any changes in value related to hedges that were deferred as part of AOCI while designated as a hedge would remain until the originally forecasted transaction occurs.

In a situation where it becomes probable that a fuel hedged forecasted transaction will not occur, any gains and/or losses that have been recorded to AOCI will be required to be immediately reclassified into earnings.

During the first nine months of 2020, as a result of the drastic drop in demand for air travel due to the COVID-19 pandemic, the Company's forecast for 2020 and 2021 fuel purchases and consumption was significantly reduced, causing the Company to be in an estimated "over–hedged" position for second, third, and fourth quarter 2020, and full year 2021.

Therefore, the Company de–designated a portion of its fuel hedges related to these periods, and has reclassified approximately $ 22 million and $ 38 million in losses from AOCI into Other (gains) losses, net, during the three and nine months ended September 30, 2020, respectively.

The Company did not have any such situations occur during 2019.

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:

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.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

All cash flows associated with purchasing and selling fuel derivatives are classified as Other operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows.

The following table presents the location of all assets and liabilities associated with the Company’s derivative instruments within the unaudited Condensed Consolidated Balance Sheet:

Asset derivatives Liability derivatives

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Interest rate derivative contracts Other assets 6 — — —

Interest rate derivative contracts Accrued liabilities — — — 5

Interest rate derivative contracts Other noncurrent liabilities — — — 6

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Fuel derivative contracts (gross) Prepaid expenses and other current assets $ 9 $ 4 $ — $ —

Fuel derivative contracts (gross) Other assets 2 — — —

Interest rate derivative contracts Accrued liabilities — — 28 —

Total derivatives not designated as hedges $ 4 $ — $ 28 $ —

Total derivatives $ 255 $ 134 $ — $ 6

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See discussion of credit risk and collateral following in this Note 4.

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

Balance Sheet location of hedged item Carrying amount of the hedged liabilities Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged liabilities (a)

September 30, September 30,

(in millions) 2020 2019 2020 2019

Current maturities of long-term debt $ 500 $ 300 $ — $ 2

Long-term debt less current maturities — 501 18 18

$ 500 $ 801 $ 18 $ 20

(a) At September 30, 2020 and 2019, these amounts include the cumulative amount of fair value hedging adjustments remaining for which hedge accounting has been discontinued, of $ 18 million and $ 19 million, respectively.

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

Balance Sheet September 30, December 31,

Balance Sheet March 31, December 31,

(in millions) location 2021 2020

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Cash collateral deposits held from counterparties for fuel contracts - noncurrent Offset against Other assets 57 31

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

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.

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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 September 30, 2020, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.

As of March 31, 2021, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

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

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(i) (ii) (iii) = (i) + (ii) (i) (ii) (iii) = (i) + (ii)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Description Balance Sheet location Gross amounts of recognized assets Gross amounts offset in the Balance Sheet Net amounts of assets presented in the Balance Sheet Gross amounts of recognized assets Gross amounts offset in the Balance Sheet Net amounts of assets presented in the Balance Sheet

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(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.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Offsetting of derivative liabilities

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(i) (ii) (iii) = (i) + (ii) (i) (ii) (iii) = (i) + (ii)

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Description Balance Sheet location Gross amounts of recognized liabilities Gross amounts offset in the Balance Sheet Net amounts of liabilities presented in the Balance Sheet Gross amounts of recognized liabilities Gross amounts offset in the Balance Sheet Net amounts of liabilities presented in the Balance Sheet

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Fuel derivative contracts Other assets $ 57 $ ( 57 ) $ — (a) $ 31 $ ( 31 ) $ — (a)

Interest rate derivative contracts Accrued liabilities $ 28 $ — $ 28 (a) $ 5 $ — $ 5 (a)

Interest rate derivative contracts Other noncurrent liabilities $ — $ — $ — $ 6 $ — $ 6

(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.

The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019:

Location and amount recognized in income on cash flow and fair value hedging relationships

Three months ended September 30, 2020 Three months ended September 30, 2019

(in millions) Fuel and oil Other (gains)/losses, net Interest expense Fuel and oil Interest expense

Total $ 18 $ 22 $ 2 $ 19 $ 8

Loss on cash flow hedging relationships:

Commodity contracts:

Amount of loss reclassified from AOCI into income 18 22 — 19 —

Interest contracts:

Amount of loss reclassified from AOCI into income — — — — 2

Impact of fair value hedging relationships:

Interest contracts:

Hedged items — — 4 — 6

Derivatives designated as hedging instruments — — ( 2 ) — —

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Location and amount recognized in income on cash flow and fair value hedging relationships

Nine months ended September 30, 2020 Nine months ended September 30, 2019

(in millions) Fuel and oil Other (gains)/losses, net Interest expense Fuel and oil Interest expense

Three months ended March 31, 2021 Three months ended March 31, 2020

(in millions) Fuel and oil Other (gains)/losses, net Other operating expenses Fuel and oil Other (gains)/losses, net Interest expense

Total $ 16 $ 6 $ 1 $ 22 $ 2 $ 2

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Three months ended

September 30,

(in millions) 2021 2020

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Total $ ( 93 ) $ 116

Derivatives designated and qualified in cash flow hedging relationships

Loss recognized in AOCI on derivatives, net of tax

Nine months ended

September 30,

(in millions) 2020 2019

Fuel derivative contracts $ 91 $ 83

Interest rate derivatives 30 43

Total $ 121 $ 126

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Derivatives not designated as hedges

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Three months ended Location of (gain) loss recognized in income on derivatives

September 30,

(in millions) 2021 2020

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Total $ ( 5 ) $ 24

Derivatives not designated as hedges

Loss recognized in income on derivatives

Nine months ended Location of loss recognized in income on derivatives

September 30,

(in millions) 2020 2019

Fuel derivative contracts $ 2 $ — Other (gains) losses, net

Interest rate derivatives 28 — Other (gains) losses, net

Total $ 30 $ —

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three and nine months ended September 30, 2020 and 2019.

Fuel derivatives that qualify for hedge accounting are recorded to Fuel and oil expense.

Fuel derivatives that do not qualify for hedge accounting are recorded to Other (gains) and losses, net.

The following tables present the impact of premiums paid for fuel derivative contracts and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) during the period the contract settles:

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three months ended March 31, 2021 and 2020.

Gains and/or losses associated with fuel derivatives that qualify for hedge accounting are ultimately recorded to Fuel and oil expense.

Gains and/or losses associated with fuel derivatives that do not qualify for hedge accounting are recorded to Other (gains) and losses, net.

The following table presents the impact of premiums paid for fuel derivative contracts and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) during the period the contract settles:

Premium expense recognized in income on derivatives

Three months ended Location of premium expense recognized in income on derivatives

September 30,

(in millions) 2021 2020

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Fuel derivative contracts not designated as hedges 11 — Other (gains) losses, net

Premium expense recognized in income on derivatives

Nine months ended Location of premium expense recognized in income on derivatives

September 30,

(in millions) 2020 2019

Fuel derivative contracts designated as hedges $ 51 $ 75 Fuel and oil

Fuel derivative contracts not designated as hedges $ 22 $ — Other (gains) losses, net

The fair values of the derivative instruments, depending on the type of instrument, were determined by the use of present value methods or option value models with assumptions about commodity prices based on those observed in underlying markets or provided by third parties.

Included in the Company’s cumulative net unrealized losses from

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

fuel hedges as of September 30, 2020, recorded in AOCI, were approximately $ 53 million in unrealized losses, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to September 30, 2020.

Included in the Company’s cumulative net unrealized losses from fuel hedges as of March 31, 2021, recorded in AOCI, were approximately $ 19 million in net unrealized losses, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to March 31, 2021.

Interest Rate Swaps

The Company is party to certain interest rate swap agreements that are accounted for as either fair value hedges or cash flow hedges, as defined in the applicable accounting guidance for derivative instruments and hedging.

Several of the Company's interest rate swap agreements qualify for the "shortcut" method of accounting for hedges, which dictates that the hedges are assumed to be perfectly effective, and thus there is no ineffectiveness to be recorded in earnings.

During first quarter 2019, the Company entered into 12 separate forward-starting interest rate swap agreements related to a series of 12 Boeing 737 MAX 8 aircraft leases with deliveries originally scheduled between July 2019 and February 2020.

The Company is party to certain interest rate swap agreements that are accounted for as cash flow hedges, and has in the past held interest rate swap agreements that have qualified as fair value hedges, as defined in the applicable accounting guidance for derivative instruments and hedging.

Several of the Company's interest rate swap agreements qualify for the "shortcut" method of accounting for hedges, which dictated that the hedges were assumed to be perfectly effective, and, thus, there was no ineffectiveness to be recorded in earnings.

During 2019, the Company had entered into forward-starting interest rate swap agreements related to a series of 12 Boeing 737 MAX 8 aircraft leases originally scheduled to be received between July 2019 and February 2020.

These lease contracts exposed the Company to interest rate risk as the rental payments were subject to adjustment and would become fixed based on the 9-year swap rate at the time of delivery.

The primary objective of these interest rate derivatives, which qualified as cash flow hedges, was to hedge the forecasted monthly rental payments.

These swap agreements provided for a single payment at maturity based upon the change in the 9-year swap rate between the execution date and the termination date.

All 12 swap agreements were terminated during third quarter 2019, resulting in $ 32 million being "frozen" in AOCI.

As a result of the extenuating circumstances involving the MAX aircraft, which are outside the control of the Company, these amounts will be recognized in earnings when the original forecasted transaction occurs, which remains probable.

During third quarter 2019, the Company entered into 12 separate forward-starting interest rate swap agreements, related to a series of 12 Boeing 737 MAX 8 aircraft leases.

The third quarter 2019 swaps contain similar terms as the third quarter 2019 terminated swaps discussed above, except that the related 737 MAX 8 deliveries were scheduled to occur between June 2020 and September 2020.

During the first nine months of 2020, all 12 of the aircraft leases became no longer probable to be received within the scheduled delivery range.

Therefore, the 12 associated swap agreements were de-designated and $ 14 million and $ 31 million were "frozen" in AOCI during the three and nine months ended September 30, 2020, respectively.

These amounts will be recognized in earnings when the original forecasted transaction occurs, which continues to be probable.

The mark-to-market changes for these swap agreements are now being recorded in earnings, resulting in a $ 1 million unrealized gain and a $ 28 million unrealized loss to Other (gains) and losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020, respectively.

In addition, 6 of the 12 swap agreements were terminated on June 30, 2020, resulting in $ 31 million paid to the counterparty.

The remaining 6 swap agreements were terminated on September 30, 2020, resulting in $ 28 million owed to the counterparty, which was recorded as an Accrued liability within the unaudited Condensed Consolidated Balance Sheet as of September 30, 2020.

As a result of the grounding of the MAX aircraft, those deliveries were significantly delayed.

These original agreements were subsequently terminated in third quarter 2019, and the Company entered into new interest rate swap agreements based on revised expected aircraft delivery dates.

As the revised delivery dates were also not met, these subsequent agreements were subsequently de-designated as hedges and the agreements terminated.

The Company received three of the twelve aircraft in December 2020, and an additional eight aircraft in first quarter 2021.

The remaining delivery is expected during third quarter 2021.

As a result of the discontinued hedges, the Company had cumulative losses "frozen" in AOCI, which are being recognized in earnings over the 9-year lease terms of each aircraft upon delivery.

Therefore, the Company has reclassified approximately $ 1 million in losses from AOCI into Other operating expenses, in the unaudited Condensed Consolidated Statement of Income (Loss) for the three months ended March 31, 2021.

No such reclassifications occurred in 2020.

The cumulative amounts remaining in AOCI as of March 31, 2021, associated with future aircraft deliveries, was $ 62 million.

For the Company’s interest rate swap agreements that do not qualify for the "shortcut" or "critical terms match" methods of accounting, ineffectiveness is assessed at each reporting period.

If hedge accounting is achieved, all periodic changes in fair value of the interest rate swaps are recorded in AOCI.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Credit Risk and Collateral

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To manage credit risk, the Company selects and periodically reviews counterparties based on credit ratings, limits its exposure with respect to each counterparty, and monitors the market position of the fuel hedging program and its relative market position with each counterparty.

At September 30, 2020, the Company had agreements with all of its active counterparties containing early termination rights and/or bilateral collateral provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on the counterparty credit rating.

The Company also had agreements with counterparties in which cash deposits and letters of credit were required to be posted as collateral

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds.

At March 31, 2021, the Company had agreements with all of its active counterparties containing early termination rights and/or bilateral collateral provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on the counterparty's credit rating.

The Company also had agreements with counterparties in which cash deposits and letters of credit were required to be posted as collateral whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds.

In certain cases, the Company has the ability to substitute among these different forms of collateral at its discretion.

The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold amounts as of September 30, 2020, at which such postings are triggered:

The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold amounts as of March 31, 2021, at which such postings are triggered:

Counterparty (CP)

(in millions) A B C D E F Other (a) Total

(in millions) A B C D E F G Other (a) Total

Fair value of fuel derivatives $ 60 $ 28 $ 60 $ 28 $ 30 $ 21 $ 18 $ 4 $ 249

Cash collateral held from CP 72 — — — — — — — 72

Letters of credit (LC) — — — — — — — —

Option to substitute LC for cash N/A N/A ( 75 ) to ( 150 ) or >( 550 )(b)

( 125 ) to ( 150 ) or >( 550 )(c)

Option to substitute LC for cash N/A N/A (b)

If credit rating is investment

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Cash is provided to CP >( 100 )

( 75 ) to ( 150 ) or >( 550 )(d)

( 125 ) to ( 150 ) or >( 550 )(d)

Cash is received from CP > 0 (d)

Cash can be pledged to

CP as collateral ( 200 ) to ( 600 )(e)

N/A ( 150 ) to ( 550 )(b)

( 150 ) to ( 550 )(b)

Cash is received from CP > 0 (c)

If credit rating is non-investment

grade, fair value of fuel derivative level at which:

Cash is provided to CP ( 0 ) to ( 200 ) or >( 600 )

( 0 ) to ( 150 ) or >( 550 )

Cash is received from CP (f)

Cash can be pledged to

CP as collateral ( 200 ) to ( 600 )

N/A ( 150 ) to ( 550 )

( 150 ) to ( 550 )

Cash is received from CP (d)

(a) Individual counterparties with fair value of fuel derivatives < $ 4 million.

(b) The Company has the option of providing cash or letters of credit as collateral.

(d) Thresholds may vary based on changes in credit ratings within investment grade.

(e) The Company has the option of providing cash as collateral.

(f) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.

(b) The Company has the option to substitute letters of credit for 100 percent of cash collateral requirement.

(d) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts .

Southwest Airlines Co.

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Comprehensive income (loss) includes changes in the fair value of certain financial derivative instruments that qualify for hedge accounting, unrealized gains and losses on certain investments, and actuarial gains/losses arising from the Company’s postretirement benefit obligation.

The differences between Net income (loss) and Comprehensive income (loss) for the three and nine months ended September 30, 2020 and 2019 were as follows:

Three months ended September 30,

The differences between Net income (loss) and Comprehensive income (loss) for the three months ended March 31, 2021 and 2020 were as follows:

Three months ended March 31,

(in millions) 2021 2020

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Other, net of deferred taxes of ($ 13 ) and ($ 9 )

Total other comprehensive income (loss) $ 28 $ ( 93 )

COMPREHENSIVE INCOME (LOSS) $ ( 1,129 ) $ 566

Nine months ended September 30,

(in millions) 2020 2019

NET INCOME (LOSS) $ ( 2,166 ) $ 1,787

Unrealized gain (loss) on fuel derivative instruments, net of

deferred taxes of $( 6 ) and $( 18 )

( 47 ) ( 28 )

Unrealized loss on interest rate derivative instruments, net of

deferred taxes of $( 9 ) and $( 13 )

( 29 ) ( 40 )

Other, net of deferred taxes of $ 2 and $ 4

Total other comprehensive loss $ ( 41 ) $ ( 83 )

Total other comprehensive income (loss) $ 64 $ ( 125 )

COMPREHENSIVE INCOME (LOSS) $ 180 $ ( 219 )

A rollforward of the amounts included in AOCI is shown below for the three and nine months ended September 30, 2020:

(in millions) Fuel derivatives Interest rate derivatives Defined benefit plan items Other Deferred tax Accumulated other comprehensive income (loss)

Balance at June 30, 2020 $ ( 170 ) $ ( 74 ) $ 20 $ 55 $ 39 $ ( 130 )

Changes in fair value ( 21 ) 3 — 14 1 ( 3 )

Reclassification to earnings 40 — — — ( 9 ) 31

Balance at September 30, 2020 $ ( 151 ) $ ( 71 ) $ 20 $ 69 $ 31 $ ( 102 )

A rollforward of the amounts included in AOCI, net of taxes, is shown below for the three months ended March 31, 2021:

(in millions) Fuel derivatives Interest rate derivatives Defined benefit plan items Other Deferred tax Accumulated other comprehensive income (loss)

Balance at December 31, 2020 $ ( 119 ) $ ( 66 ) $ ( 43 ) $ 91 $ 32 $ ( 105 )

Cumulative effect of adopting ASU 2016-01 as of January 1, 2018 — See Note 1 — — — ( 31 ) 12 ( 19 )

Changes in fair value 109 12 — — ( 28 ) 93

Reclassification to earnings 92 1 — — ( 21 ) 72

Balance at September 30, 2020 $ ( 151 ) $ ( 71 ) $ 20 $ 69 $ 31 $ ( 102 )

Reclassification to earnings 22 1 — ( 60 ) (a) 8 ( 29 )

Balance at March 31, 2021 $ 12 $ ( 53 ) $ ( 43 ) $ — $ 24 $ ( 60 )

(a) Investment gains related to prior periods that were reclassified from AOCI into Other (gains) losses, net.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

The following tables illustrate the significant amounts reclassified out of each component of AOCI for the three and nine months ended September 30, 2020:

Three months ended September 30, 2020

(in millions) Amounts reclassified from AOCI Affected line item in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss)

AOCI components

Unrealized loss on fuel derivative instruments $ 18 Fuel and oil expense

22 Other (gains) losses, net

Total reclassifications for the period $ 31 Net of tax

Nine months ended September 30, 2020

The following tables illustrate the significant amounts reclassified out of each component of AOCI for the three months ended March 31, 2021:

Three months ended March 31, 2021

(in millions) Amounts reclassified from AOCI Affected line item in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss)

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$ 17 Net of tax

Unrealized loss on interest rate derivative instruments $ 1 Interest expense

Unrealized loss on interest rate derivative instruments $ 1 Other operating expenses

$ 1 Net of tax

Unrealized gain on deferred compensation plan investment (See Note 1) $ ( 60 ) Other (gains) losses, net

$ ( 47 ) Net of tax

Total reclassifications for the period $ ( 29 ) Net of tax

1 unchanged sentence

Revenue is categorized by revenue source as the Company believes it best depicts the nature, amount, timing, and uncertainty of revenue and cash flow.

The following table provides the components of Passenger revenue recognized for the three and nine months ended September 30, 2020 and 2019:

Three months ended September 30, Nine months ended September 30,

The following table provides the components of Passenger revenue recognized for the three months ended March 31, 2021 and March 31, 2020:

Three months ended March 31,

(in millions) 2021 2020

3 unchanged sentences

Total passenger revenues $ 1,712 $ 3,845

As of September 30, 2020, and December 31, 2019, the components of Air traffic liability and Air traffic liability - noncurrent, including contract liabilities based on tickets sold, unused funds available to the Customer, and loyalty points available for redemption, net of expected spoilage, within the unaudited Condensed Consolidated Balance Sheet were as follows:

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

As of March 31, 2021, and December 31, 2020, the components of Air traffic liability and Air traffic liability - noncurrent, including contract liabilities based on tickets sold, unused funds available to the Customer, and loyalty points available for redemption, net of expected spoilage, within the unaudited Condensed Consolidated Balance Sheet were as follows:

Balance as of

(in millions) September 30, 2020 December 31, 2019

(in millions) March 31, 2021 December 31, 2020

Air traffic liability - passenger travel and ancillary passenger services $ 3,109 $ 2,686

1 unchanged sentence

Total Air traffic liability $ 7,732 $ 7,133

Rollforwards of the Company's Air traffic liability - loyalty program for the three and nine months ended September 30, 2020 and 2019 were as follows (in millions):

Three months ended September 30, Nine months ended September 30,

2020 2019 2020 2019

The balance in Air traffic liability - passenger travel and ancillary passenger services also includes unused funds that are available for use by Customers and are not currently associated with a ticket, but represent funds effectively refunded and made available for use to purchase a ticket for a flight that occurs prior to their expiration.

These funds are typically created as a result of a prior ticket cancellation or exchange.

Rollforwards of the Company's Air traffic liability - loyalty program for the three months ended March 31, 2021 and March 31, 2020 were as follows (in millions):

Three months ended March 31,

Air traffic liability - loyalty program - beginning balance $ 4,447 $ 3,385

2 unchanged sentences

Revenue recognized from points redeemed - Other ( 12 ) ( 19 )

Unused funds converted to loyalty points 105 — 105 —

Air traffic liability - loyalty program - ending balance $ 4,623 $ 3,561

Air traffic liability includes consideration received for ticket and loyalty related performance obligations which have not been satisfied as of a given date.

Rollforwards of the amounts included in Air traffic liability as of September 30, 2020 and 2019 were as follows (in millions):

Rollforwards of the amounts included in Air traffic liability as of March 31, 2021 and March 31, 2020 were as follows (in millions):

Air traffic liability

3 unchanged sentences

Revenue from current period sales ( 982 )

Balance at September 30, 2020 $ 7,094

Balance at March 31, 2021 $ 7,732

Air traffic liability

3 unchanged sentences

Revenue from current period sales ( 1,915 )

Balance at September 30, 2019 $ 5,966

During the first and second quarters 2020, the Company experienced a significantly higher number of Customer-driven flight cancellations as a result of the COVID-19 pandemic.

Balance at March 31, 2020 $ 6,211

During 2020, the Company experienced a significantly higher number of Customer-driven flight cancellations as a result of the COVID-19 pandemic.

See Note 2 for further information.

As a result, the amount of Customer travel funds held by the Company, net of spoilage, that can be redeemed for future travel as of September 30, 2020, far exceeds previous periods and represents approximately 27 percent of the total Air traffic liability balance at September 30, 2020, as compared to approximately 1 percent of the total Air traffic liability balance at December 31, 2019.

As a result, the amount of Customer travel funds held by the Company, net of spoilage, that can be redeemed for future travel as of March 31, 2021, represents approximately 22 percent of the total Air traffic liability balance at March 31, 2021, as compared to approximately 28 percent of the total Air traffic liability balance at December 31, 2020.

Both of these recent periods represent a significantly higher portion than the approximate 2 percent of the Air traffic liability balance that Customer funds made up as of December 31, 2019.

In order to provide additional flexibility to Customers who hold these funds, the Company has significantly relaxed its previous policies with regards to the time period within which these funds can be redeemed, which is typically twelve months from the original date of purchase.

For all Customer travel funds created or expired between March 1 and September 7, 2020 associated with flight cancellations, the Company has extended the expiration date to September 7, 2022.

Further, as presented in the above tables, the Company announced in August 2020 that it will allow qualified travel funds to be converted to Rapid Rewards points through

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

December 15, 2020.

Despite the possibility that some of these travel funds may be redeemed beyond the following twelve-month period, the Company has continued to classify them as "current" in the accompanying unaudited Condensed Consolidated Balance Sheet as they remain a demand liability and the Company does not have sufficient data to enable it to accurately estimate the portion that will not be redeemed for travel in the subsequent twelve months.

For all Customer travel funds created or that would have otherwise expired between March 1 and September 7, 2020 associated with flight cancellations, the Company has extended the expiration date to September 7, 2022.

At March 31, 2021, $1.8 billion of Customer travel funds remain in Air traffic liability with a September 7, 2022 expiration date.

The Company has limited data available to predict the occurrence or timing of performance obligation satisfaction on these funds due to certain constraints including, but not limited to, consumer confidence, economic health, vaccines, and uncertainty regarding customer travel fund redemption patterns for funds that live longer than 12 months as this is unprecedented in Company history.

As a result, recognition of these travel funds as flown revenue, refunds, or spoilage revenue will likely be more volatile from period to period compared to what previous Customer behavior

may indicate, as cumulative revenue recognized is constrained to amounts that are not probable of being reversed.

Despite the possibility that some of these travel funds may be redeemed beyond the following twelve-month period, the Company has continued to classify them as "current" in the accompanying unaudited Condensed Consolidated Balance Sheet as they remain a demand liability and the Company has limited data to enable it to accurately estimate the portion that will not be redeemed for travel in the subsequent twelve months.

Recognition of revenue associated with the Company’s loyalty liability can be difficult to predict, as the number of award seats available to members is not currently restricted and they could choose to redeem their points at any time that a seat is available.

The performance obligations classified as a current liability related to the Company’s loyalty program were estimated based on expected redemptions utilizing historical redemption patterns, and forecasted flight availability, fares, and coefficients.

The entire balance classified as Air traffic liability—noncurrent relates to loyalty points that were estimated to be redeemed in periods beyond 12 months following the representative balance sheet date.

The Company expects the majority of loyalty points to be redeemed within two years.

Spoilage estimates are based on the Company's Customers' historical travel behavior, as well as assumptions about the Customers' future travel behavior.

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The Company recognized revenue related to the marketing, advertising, and other travel-related benefits of the revenue associated with various loyalty partner agreements including, but not limited to, the Agreement with Chase, within Other operating revenues.

For the three months ended September 30, 2020 and 2019, the Company recognized $ 282 million and $ 329 million, respectively.

For the nine months ended September 30, 2020 and 2019, the Company recognized $ 859 million and $ 984 million, respectively.

For the three months ended March 31, 2021 and March 31, 2020, the Company recognized $ 280 million and $ 321 million, respectively.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

NET INCOME (LOSS) PER SHARE

The following table sets forth the computation of basic and diluted net income (loss) per share (in millions, except per share amounts).

Three months ended September 30, Nine months ended September 30,

2020 2019 2020 2019

An immaterial number of shares related to the Company's restricted stock units were excluded from the denominator for both periods presented, because inclusion of such shares would be antidilutive.

Three months ended March 31,

Net income (loss) $ 116 $ ( 94 )

Weighted-average shares outstanding, basic 591 515

Dilutive effects of convertible notes (a) 16 —

Dilutive effect of stock warrants 1 —

Dilutive effect of restricted stock units 1 —

3 unchanged sentences

Diluted $ 0.19 $ ( 0.18 )

Antidilutive amounts excluded from calculations:

Convertible debt (a) 5 — 2 —

Restricted stock units 1 — 1 —

(a) See Note 8 for further information.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

FINANCING ACTIVITIES

During February 2020, the Company issued $ 500 million senior unsecured notes due 2030.

The notes bear interest at 2.625 percent.

Interest is payable semi-annually in arrears on February 10 and August 10, beginning in 2020.

On March 12, 2020, the Company entered into a new $ 1.0 billion 364-day term loan credit facility agreement (the “364-Day Credit Agreement”) with a syndicate of lenders identified in the 364-Day Credit Agreement.

The 364-Day Credit Agreement was drawn in full on the closing date.

On March 30, 2020, the Company amended and restated the 364-Day Credit Agreement (the “Amended and Restated 364-Day Credit Agreement”) with a syndicate of lenders identified in the Amended and Restated 364-Day Credit Agreement to add additional term loan commitments of approximately $ 2.3 billion, add an uncommitted accordion increase provision to permit additional term loans in an aggregate amount not to exceed approximately $ 417 million, amend the pricing, amend certain covenants, add certain covenants, and provide for the grant of a security interest in certain aircraft and related assets.

The Company drew approximately $ 2.3 billion under the Amended and Restated 364-Day Credit Agreement on April 1, 2020.

On April 24, 2020, the Company drew an additional $ 350 million under the $ 417 million accordion feature.

The Amended and Restated 364-Day Credit Agreement was originally set to mature in full on March 29, 2021.

The outstanding Amended and Restated 364-Day Credit Agreement balance was repaid in full in second quarter 2020, and the agreement has been terminated.

Concurrently with entering into the Amended and Restated 364-Day Credit Agreement on March 30, 2020, the Company also amended its existing $ 1.0 billion revolving credit facility expiring in August 2022 (the “Amended and Restated Revolving Credit Agreement”) to (i) amend the pricing and fees, (ii) amend certain covenants and provisions, (iii) add certain covenants, and (iv) provide for the grant of a security interest in certain aircraft and related assets.

In second quarter 2020, the Company repaid in full the $ 1.0 billion drawn on the Amended and Restated Revolving Credit Agreement and, as of September 30, 2020, there were no amounts outstanding under the Amended and Restated Revolving Credit Agreement.

Generally, amounts outstanding under the Amended and Restated Revolving Credit Agreement bear interest at interest rates based on either the LIBOR rate (selected by the Company for designated interest periods) or the “alternate base rate” (being the highest of (1) the Wall Street Journal prime rate, (2) one-month adjusted LIBOR (one-month LIBOR plus a statutory reserve rate) plus 1 percent, and (3) the New York Fed Bank Rate, plus 0.5 percent).

The underlying LIBOR rate is subject to a floor of 1 percent per annum and the “alternate base rate” is subject to a floor of 1 percent per annum.

The Amended and Restated Revolving Credit Agreement contains customary representations and warranties, covenants, and events of default.

The Amended and Restated Revolving Credit Agreement is secured by a pool of aircraft and related assets, each with a minimum appraised value ratio requirement.

Under the Amended and Restated Revolving Credit Agreement, the Company is required to maintain, at all times after March 31, 2021, a specified ratio of (x) adjusted net income (before interest, taxes, depreciation, amortization, and aircraft rental expense) less cash dividends to (y) interest and aircraft rental expense;

and to maintain a minimum level of liquidity of $ 2.5 billion (defined as the aggregate amount available to be borrowed under the Amended and Restated Revolving Credit Agreement plus the aggregate amount of unrestricted cash and cash equivalents of the Company).

The Amended and Restated Revolving Credit Agreement is a series of short-term borrowings;

at the end of each borrowing the Company must elect to roll the facility over into the next borrowing or pay down the facility.

The Amended and Restated Revolving Credit Agreement also has an accordion feature that would allow the Company, subject to, among other things, the procurement of incremental commitments, to increase the size of the facility to $ 1.5 billion.

On May 1, 2020, the Company completed the public offering of $ 2.3 billion aggregate principal amount of 1.250 % Convertible Senior Notes due 2025 (the “Convertible Notes”), which included the full exercise of the underwriters' option to buy an additional $ 300 million aggregate principal amount of Convertible Notes.

The Convertible Notes

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

bear interest at the rate of 1.25 percent per year and will mature on May 1, 2025.

Interest on the notes is payable semi-annually in arrears on May 1 and November 1 of each year, beginning on November 1, 2020.

Holders may convert their Convertible Notes at their option at any time prior to the close of business on the business day immediately preceding February 1, 2025, only under the following circumstances:

(1) during any calendar quarter commencing after the calendar quarter ending on June 30, 2020 (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130 percent of the conversion price on each applicable trading day;

(2) during the five business day period after any ten consecutive trading day period in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of the measurement period was less than 98 percent of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day;

or (3) upon the occurrence of specified corporate events.

On or after February 1, 2025, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their notes at any time, regardless of the foregoing circumstances.

As of September 30, 2020, conditions had not been met to convert.

Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of the Company’s common stock or a combination of cash and shares of common stock, at the Company’s election.

The Company intends, however, to settle conversions by paying cash up to the principal amount, with any excess conversion value settled in shares of common stock.

The initial conversion rate is 25.9909 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $ 38.48 per share of common stock).

The conversion rate will be subject to adjustment in some events, but will not be adjusted for any accrued and unpaid interest.

In addition, in the event of certain corporate events that occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its Convertible Notes in connection with such a corporate event in certain circumstances.

In the event of a “Fundamental Change,” as defined, the holders may require the Company to purchase for cash all or a portion of their notes at a purchase price equal to 100 percent of the principal amount of the notes, plus accrued and unpaid interest, if any.

The Company may not redeem the notes at its option prior to the maturity date.

Upon issuance, the Company bifurcated the Convertible Notes for accounting purposes between a liability component and an equity component utilizing applicable guidance.

The liability component was determined by estimating the fair value of a hypothetical issuance of an identical offering excluding the conversion feature of the Convertible Notes, which has been estimated at $ 1.9 billion, and is reflected as a component of Long-term debt in the unaudited Condensed Consolidated Balance Sheet.

The effective interest rate of this liability was 5.2 percent.

The equity component was calculated as the difference between the liability component and the face amount of the Convertible Notes, determined to be $ 403 million, and is classified within Additional paid in capital in the unaudited Condensed Consolidated Balance Sheet.

The Convertible Notes proceeds are also shown within the financing activities section in the unaudited Condensed Consolidated Statement of Cash Flows.

The amount of the equity component in the transaction also represents a discount on the liability portion of the Convertible Notes, and as such will be amortized as a non-cash component of interest expense over the 5-year term of the notes.

The costs incurred in the issuance, including underwriters' discount, totaling $ 62 million, are classified as a cash outflow within the financing activities section in the unaudited Condensed Consolidated Statement of Cash Flows, and will also be amortized to expense over the term of the notes.

Issuance costs attributable to the equity component of $ 11 million were netted with the equity component in the unaudited Condensed Consolidated Statement of Stockholders' Equity.

Because the Company intends to settle conversions by paying cash up to the principal amount of the Convertible Notes, with any excess conversion value settled in shares of common stock, the Convertible Notes are being accounted for using the treasury stock method for the purposes of Net income (loss) per share.

Using this method, the denominator will be affected when the average share price of the Company's common stock for a given period is greater than the conversion price of approximately $ 38.48 per share.

The Convertible Notes stipulated that holders

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

of the notes may not elect to convert their Convertible Notes to shares of common stock until after June 30, 2020, and therefore there was no dilutive impact related to the notes until July 1, 2020.

As consideration for the Payroll Support funding, the Company agreed to issue Warrants to the Treasury to purchase the Company's common stock in connection with each disbursement of Payroll Support to the Company.

The Company accounts for the Warrants using the treasury stock method.

Using this method, the denominator will be affected when the average share price of the Company's common stock for a given period is greater than the warrant exercise price of $ 36.47 per share.

While the Company is reporting a net loss, all potential shares are considered antidilutive and have no impact on Net income (loss) per share.

On May 4, 2020, the Company issued $ 2.0 billion of unsecured notes, consisting of $ 750 million aggregate principal amount of the Company’s 4.750 % Notes due 2023 (the “$ 750 million 2023 Notes”) and $ 1.25 billion aggregate principal amount of the Company’s 5.250 % Notes due 2025 (the “$ 1.25 billion 2025 Notes”).

Interest on both the $ 750 million 2023 Notes and the $ 1.25 billion 2025 Notes is payable semi-annually in arrears on May 4 and November 4, beginning November 4, 2020.

The proceeds from the $ 750 million 2023 Notes and $ 1.25 billion 2025 Notes were used to repay a portion of the outstanding Amended and Restated 364-Day Credit Agreement balance.

On June 8, 2020, the Company issued $ 1.8 billion of unsecured notes, consisting of $ 500 million aggregate principal amount of the Company’s 4.750 % Notes due 2023 (the “$ 500 million 2023 Notes”) and $ 1.3 billion aggregate principal amount of the Company’s 5.125 % Notes due 2027 (the “$ 1.3 billion 2027 Notes”).

The $ 500 million 2023 Notes were offered as an additional issuance of the Company's 4.750 % Notes due 2023 issued May 4, 2020.

The $ 500 million 2023 Notes were issued at a premium and this amount has been included within Capitalized financing items in the unaudited Condensed Consolidated Statement of Cash Flows.

Interest on both the $ 500 million 2023 Notes and the $ 1.3 billion 2027 Notes is payable semi-annually.

Interest on the $ 500 million 2023 Notes is payable in arrears on May 4 and November 4, beginning November 4, 2020, and interest on the $ 1.3 billion 2027 Notes is payable in arrears on June 15 and December 15, beginning December 15, 2020.

Approximately $ 1.7 billion combined proceeds of the $ 500 million 2023 Notes and the $ 1.3 billion 2027 Notes were used to repay the remaining outstanding Amended and Restated 364-Day Credit Agreement balance.

In second quarter 2020, the Company, through special purpose entities, entered into agreements with a financing institution and trusts to borrow $ 192 million secured by six Boeing 737-800 aircraft.

These borrowings, which were recorded as a financing transaction in the Company's unaudited Condensed Consolidated Statement of Cash Flows, and as debt in the accompanying unaudited Condensed Consolidated Balance Sheet, bear interest at a rate equal to the 3 month LIBOR plus 1.4 percent, payable in quarterly installments through June 30, 2028.

The special purpose entities were determined to be variable interest entities for which the Company is the primary beneficiary, and therefore were consolidated in the accompanying unaudited Condensed Consolidated Financial Statements.

On July 31, 2020, the Company issued $ 1.0 billion of unsecured notes, consisting of $ 300 million aggregate principal amount of the Company’s 5.250 % Notes due 2025 (the “$ 300 million 2025 Notes”) and $ 700 million aggregate principal amount of the Company’s 5.125 % Notes due 2027 (the “$ 700 million 2027 Notes”).

The $ 300 million 2025 Notes were offered as an additional issuance of the Company’s $ 1.25 billion 2025 Notes issued on May 4, 2020 and the $ 700 million 2027 Notes were offered as an additional issuance of the Company’s $ 1.3 billion 2027 Notes issued on June 8, 2020.

Both the $ 300 million 2025 Notes and the $ 700 million 2027 Notes were issued at a premium and this amount has been included within Capitalized financing items in the unaudited Condensed Consolidated Statement of Cash Flows.

Interest on the $ 300 million 2025 Notes is payable semi-annually in arrears on May 4 and November 4, beginning November 4, 2020, and interest on the $ 700 million 2027 notes is payable semi-annually in arrears on June 15 and December 15, beginning December 15, 2020.

In third quarter 2020, the Company entered into agreements with a financing institution to borrow $ 125 million ($ 121 million, net of fees) secured by four Boeing 737-800 aircraft.

These borrowings, which were recorded as a financing transaction in the Company's unaudited Condensed Consolidated Statement of Cash Flows, and as debt in

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

the accompanying unaudited Condensed Consolidated Balance Sheet, bear interest at a rate equal to the 3 month LIBOR plus 1.4 percent, payable in quarterly installments through September 29, 2025.

Other Financings

Common Stock Issuance

On May 1, 2020, the Company completed the public offering of 80.5 million shares of $ 1.00 par value common stock of the Company, which included the full exercise of the underwriters’ option to purchase an additional 10.5 million shares of common stock, at a public offering price of $ 28.50 per share.

Sale-Leaseback of Aircraft

In second quarter 2020, the Company entered into transactions with third parties, involving ten of the Company’s Boeing 737-800 aircraft and ten of the Company's Boeing 737 MAX 8 aircraft that qualified as sale-leaseback arrangements under applicable accounting guidance.

The Company sold the ten 737-800 aircraft to a third party for $ 405 million, then immediately leased the aircraft back for approximately ten years .

The Company sold the ten 737 MAX 8 aircraft to a third party for $ 410 million, then immediately leased the aircraft back for approximately 13 years .

As such, the aircraft were de-recognized from Property and equipment at their remaining net book values.

All of the leases from the sale-leasebacks are accounted for as operating leases, and thus are now reflected as part of the Company’s Operating lease right-of-use assets and operating lease liabilities in the accompanying unaudited Condensed Consolidated Balance Sheet.

The 737-800 and 737 MAX 8 sale-leaseback transactions resulted in a recognized gain of $ 153 million and $ 69 million, respectively, reflected within Other operating expenses, net in the accompanying unaudited Condensed Consolidated Statement of Comprehensive Income.

The 737-800 and 737 MAX 8 sale-leaseback transactions have increased the Company's future operating lease obligations by $ 18 million remaining in 2020, $ 71 million in each of the years from 2021 through 2025, and approximately $ 440 million thereafter.

As of September 30, 2020, aggregate principal maturities of debt and finance leases (not including amounts associated with interest rate swap agreements, interest on finance leases, and amortization of purchase accounting adjustments) were $ 543 million for the remainder of 2020, $ 220 million in 2021, $ 524 million in 2022, $ 1.4 billion in 2023, $ 152 million in 2024, $ 4.0 billion in 2025, and $ 4.5 billion thereafter.

Of the $ 543 million maturing in the remainder of 2020, the Company repaid its $ 500 million 2.65 % Notes due 2020 on October 5, 2020.

(a) Because the Company intends to settle conversions by paying cash up to the principal amount of the convertible notes, with any excess conversion value settled in shares of common stock, the convertible notes are being accounted for using the treasury stock method for the purposes of Net income (loss) per share.

For the three months ended March 31, 2021, the average market price of the Company's common stock exceeded this conversion price per share and as such, the common shares underlying the convertible notes were included in the diluted calculation.

See Note 8 for further information on the convertible notes.

FAIR VALUE MEASUREMENTS

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and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

As of September 30, 2020, the Company held certain items that are required to be measured at fair value on a recurring basis.

As of March 31, 2021, the Company held certain items that are required to be measured at fair value on a recurring basis.

These included cash equivalents, short-term investments (primarily treasury bills and certificates of deposit), interest rate derivative contracts, fuel derivative contracts, and available-for-sale securities.

1 unchanged sentence

However, the Company has certificates of deposit, commercial paper, and time deposits that are classified as Level 2, due to the fact that the fair value for these instruments is determined utilizing observable inputs in non-active markets.

Other available-for-sale securities primarily consist of investments associated with the Company’s excess benefit plan.

Other available-for-sale securities primarily consist of investments in equity securities with readily determinable market values associated with the Company’s excess benefit plan.

The Company’s fuel and interest rate derivative instruments consist of over-the-counter contracts, which are not traded on a public exchange.

Fuel derivative instruments currently consist solely of option contracts, whereas

Fuel derivative instruments currently consist solely of option contracts, whereas interest rate derivatives consist solely of swap agreements.

See Note 4 for further information on the Company’s

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

interest rate derivatives consist solely of swap agreements.

See Note 4 for further information on the Company’s derivative instruments and hedging activities.

derivative instruments and hedging activities.

The fair values of swap contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets.

1 unchanged sentence

The Company’s Treasury Department, which reports to the Chief Financial Officer, determines the value of option contracts utilizing an option pricing model based on inputs that are either readily available in public markets, can be derived from information available in publicly quoted markets, or are provided by financial institutions that trade these contracts.

The option pricing model used by the Company is an industry standard model for valuing options and is the same model used by the broker/dealer community (i.e., the Company’s counterparties).

The option pricing model used by the Company is an industry standard model for valuing options and is a similar model used by the broker/dealer community (i.e., the Company’s counterparties).

The inputs to this option pricing model are the option strike price, underlying price, risk free rate of interest, time to expiration, and volatility.

11 unchanged sentences

Assets related to the funded portions of the deferred compensation plans are held in a rabbi trust, and the Company remains liable to these participants for the unfunded portion of the plans.

The Company records changes in the fair value of the assets in the Company’s earnings.

The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2020, and December 31, 2019:

The Company records changes in the fair value of plan obligations and plan assets, which net to zero, within the Salaries, wages, and benefits line and Other (gains) losses line, respectively, of the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis at March 31, 2021, and December 31, 2020:

Fair value measurements at reporting date using:

Quoted prices in active markets for identical assets Significant other observable inputs Significant unobservable inputs

Description September 30, 2020 (Level 1) (Level 2) (Level 3)

Description March 31, 2021 (Level 1) (Level 2) (Level 3)

Assets (in millions)

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Option contracts (b) 249 — — 249

Interest rate derivatives (see Note 4) 6 — 6 —

Other available-for-sale securities 240 240 — —

Total assets $ 14,843 $ 13,640 $ 954 $ 249

Interest rate derivatives (see Note 4) $ ( 39 ) $ — $ ( 39 ) $ —

(a) Cash equivalents are primarily composed of money market investments.

8 unchanged sentences

Certificates of deposit 10 — 10 —

Time deposits 300 — 300 —

Short-term investments:

2 unchanged sentences

Time deposits 425 — 425 —

Interest rate derivatives (see Note 4) 2 — 2 —

Fuel derivatives:

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(a) Cash equivalents are primarily composed of money market investments.

(b) In the unaudited Condensed Consolidated Balance Sheet amounts are presented as a net asset.

(b) In the unaudited Condensed Consolidated Balance Sheet amounts are presented as an asset.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

The Company did not have any assets or liabilities measured at fair value on a nonrecurring basis during the nine months ended September 30, 2020, or the year ended December 31, 2019.

The following tables present the Company’s activity for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2020:

Fair value measurements using significant unobservable inputs (Level 3)

(in millions) Fuel derivatives

Balance at June 30, 2020 $ 107

Total gains (losses) for the period

Included in earnings ( 23 ) (a)

Included in other comprehensive income 1

Purchases 24 (b)

Balance at September 30, 2020 $ 109

The amount of total losses for the period

included in earnings attributable to the

change in unrealized gains or losses relating

to assets still held at September 30, 2020

The amount of total losses for the period

included in other comprehensive loss attributable to the

change in unrealized gains or losses relating

to assets still held at September 30, 2020

(a) Included in Other (gains) losses, net, within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).

(b) The purchase of fuel derivatives is recorded gross based on the structure of the derivative instrument and whether a contract with multiple derivatives was purchased as a single instrument or separate instruments.

The Company did not have any material assets or liabilities measured at fair value on a nonrecurring basis during the three months ended March 31, 2021, or the year ended December 31, 2020.

The following table presents the Company’s activity for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2021:

Fair value measurements using significant unobservable inputs (Level 3)

1 unchanged sentence

Balance at December 31, 2020 $ 134

Total losses for the period

Total gains (losses) for the period

Included in earnings ( 1 ) (a)

Included in other comprehensive income 117

Purchases 118 (b)

Balance at September 30, 2020 $ 109

Settlements ( 1 )

Balance at March 31, 2021 $ 249

The amount of total losses for the period

1 unchanged sentence

change in unrealized gains or losses relating

to assets still held at September 30, 2020

The amount of total losses for the period

included in other comprehensive loss attributable to the

to assets still held at March 31, 2021

The amount of total gains for the period

included in other comprehensive income attributable to the

change in unrealized gains or losses relating

to assets still held at September 30, 2020

to assets still held at March 31, 2021

(a) Included in Other (gains) losses, net, within the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss).

The significant unobservable input used in the fair value measurement of the Company’s derivative option contracts is implied volatility.

Holding other inputs constant, an increase (decrease) in implied volatility would have resulted in a higher (lower) fair value measurement, respectively, for the Company’s derivative option contracts.

The following table presents a range and weighted average of the unobservable inputs utilized in the fair value measurements of the Company’s fuel derivatives classified as Level 3 at September 30, 2020:

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Quantitative information about Level 3 fair value measurements

Valuation technique Unobservable input Period (by year) Range Weighted Average (a)

Fuel derivatives Option model Implied volatility Fourth quarter 2020 27 - 47 %

Fuel derivatives Option model Implied volatility Second quarter 2021 22 - 46 %

Third quarter 2021 30 - 40 %

Fourth quarter 2021 29 - 36 %

2022 25 - 34 %

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(a) Implied volatility weighted by the notional amount (barrels of fuel) that will settle in respective period.

The carrying amounts and estimated fair values of the Company’s short-term and long-term debt (including current maturities), as well as the applicable fair value hierarchy tier, at September 30, 2020, are presented in the table below.

The fair values of the Company’s publicly held long-term debt are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets;

therefore, the Company has categorized these agreements as Level 2.

Debt under four of the Company’s debt agreements is not publicly held.

Debt under five of the Company’s debt agreements is not publicly held.

The Company has determined the estimated fair value of this debt to be Level 3, as certain inputs used to determine the fair value of these agreements are unobservable.

The Company utilizes indicative pricing from counterparties and a discounted cash flow method to estimate the fair value of the Level 3 items.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(in millions) Carrying value Estimated fair value Fair value level hierarchy

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$ 300 $ 309 Level 2

2.75 % Notes due 2022

300 308 Level 2

Pass Through Certificates due 2022 - 6.24 %

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976 941 Level 3

1.000 % Payroll Support Program Loan due 2031

488 460 Level 3

Convertible Notes

On May 1, 2020, the Company completed the public offering of $ 2.3 billion aggregate principal amount of 1.250 % Convertible Senior Notes due 2025 (the “Convertible Notes”).

Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of the Company’s common stock or a combination of cash and shares of common stock, at the Company’s election.

The Company intends, however, to settle conversions by paying cash up to the principal amount, with any excess conversion value settled in shares of common stock.

Upon issuance, the Company bifurcated the Convertible Notes for accounting purposes between a liability component and an equity component utilizing applicable guidance.

The liability component was determined by estimating the fair value of a hypothetical issuance of an identical offering excluding the conversion feature of the Convertible Notes.

The carrying amount of the equity component was calculated as the difference between the liability component and the face amount of the Convertible Notes, which was determined to be $ 403 million.

The equity component is not remeasured as long as it continues to meet the conditions for equity classification, which it had as of March 31, 2021, and December 31, 2020.

The following table details the liability component recognized related to the Convertible Notes as of March 31, 2021, and December 31, 2020:

(in millions) March 31, 2021 December 31, 2020

Liability component:

Principal amount $ 2,300 $ 2,300

Unamortized debt discount ( 337 ) ( 355 )

Net carrying amount $ 1,963 $ 1,945

The effective interest rate on the liability component approximates 5.2 percent for the three months ended March 31, 2021.

The Company recognized $ 28 million of interest expense associated with the Convertible Notes during the three months ended March 31, 2021, including $ 19 million of non-cash amortization of the debt discount, $ 2 million of non-cash amortization of debt issuance costs, and $ 7 million of contractual coupon interest.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

unamortized debt discount and issuance costs will be recognized as non-cash interest expense over the 5 -year term of the notes, through May 1, 2025.

As of March 31, 2021, the if-converted value of the Convertible Notes exceeded the principal amount by $ 881 million, using the average stock price for the three months ended March 31, 2021.

The Convertible Notes did not meet the criteria to be converted throughout first quarter 2021.

However, the conversion criteria were subsequently met, and holders of the Convertible Notes are able to convert during the calendar quarter beginning April 1, 2021.

SUPPLEMENTAL FINANCIAL INFORMATION

(in millions) September 30, 2020 December 31, 2019

(in millions) March 31, 2021 December 31, 2020

Trade receivables $ 59 $ 46

Credit card receivables 92 35

Business partners and other suppliers 466 779

Income tax receivable 325 87

Business partners and other suppliers (a) 73 274

Taxes receivable (b) 705 740

Accounts and other receivables $ 937 $ 1,130

(in millions) September 30, 2020 December 31, 2019

(in millions) March 31, 2021 December 31, 2020

Derivative contracts $ 131 $ 90

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Other assets $ 743 $ 722

(in millions) September 30, 2020 December 31, 2019

(in millions) March 31, 2021 December 31, 2020

Accounts payable trade $ 169 $ 111

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Fuel payable 98 66

Dividends payable — 93

Other payable 357 409

Accounts payable $ 1,094 $ 931

(in millions) September 30, 2020 December 31, 2019

(in millions) March 31, 2021 December 31, 2020

Extended Emergency Time Off $ 190 $ 393

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Profitsharing and savings plans 46 25

Vendor prepayment (a) 277 600

Vacation pay 443 436

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Property and income taxes 80 84

Derivative contracts 28 5

Interest 111 49

Other 122 257

Accrued liabilities $ 1,665 $ 2,259

(in millions) September 30, 2020 December 31, 2019

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(in millions) March 31, 2021 December 31, 2020

Extended Emergency Time Off $ — $ 57

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Other noncurrent liabilities $ 1,123 $ 1,247

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

For further information on supplier receivables, see Note 12.

(a) In fourth quarter 2020, the Company received a $ 600 million prepayment from Chase for Rapid Rewards points expected to be purchased during 2021, based on cardholder activity on the Visa credit card associated with its loyalty program.

During first quarter 2021, $ 323 million was reclassified to deferred revenue in Air Traffic liability--loyalty (including $ 106 million that would have been a receivable from business partners as of March 31, 2021), and the remainder is expected to be reclassified during second quarter 2021.

(b) Both periods include approximately $ 470 million associated with a significant cash tax refund expected as a result of the CARES Act allowing entities to carry back 2020 losses to prior periods of up to five years , and claim refunds of federal taxes paid.

This amount also includes excise taxes remitted to taxing authorities for which the subsequent flights were canceled by Customers, resulting in amounts due back to the Company.

For further information on fuel derivative and interest rate derivative contracts, see Note 4.

Other Operating Expenses

Other operating expenses consist of aircraft rentals, distribution costs, advertising expenses, personnel expenses, professional fees, and other operating costs, none of which individually exceeded 10 percent of Operating expenses.

Other operating expenses consists of aircraft rentals, distribution costs, advertising expenses, personnel expenses, professional fees, and other operating costs, none of which individually exceeded 10 percent of Operating expenses for the three months ended March 31, 2021.

COMMITMENTS AND CONTINGENCIES

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In October 2017, the Company executed a lease agreement with Los Angeles World Airports ("LAWA") (the "T1.5 Lease").

Under the T1.5 Lease, the Company is overseeing and managing the design, development, financing, construction, and commissioning of a passenger processing facility between Terminal 1 and 2 (the "Terminal 1.5 Project").

The Terminal 1.5 Project is expected to include ticketing, baggage claim, passenger screening, and a bus gate at a cost not to exceed $ 464 million for site improvements and non-proprietary improvements.

Construction on the Terminal 1.5 Project began during third quarter 2017 and is estimated to be substantially completed in late 2020 or early 2021.

Under the T1.5 Lease, the Company oversaw and managed the design, development, financing, construction, and commissioning of a passenger processing facility between Terminal 1 and 2 (the "Terminal 1.5 Project").

The Terminal 1.5 Project includes ticketing, baggage claim, passenger screening, and a bus gate at a cost not to exceed $ 464 million for site improvements and non-proprietary improvements.

Construction on the Terminal 1.5 Project began during third quarter 2017 and was substantially completed at December 31, 2020;

however, the Terminal 1.5 Project will not be placed into service until second quarter 2021, at which time LAWA is expected to repay the outstanding loan and purchase the remaining completed assets for accounting purposes.

The costs incurred to fund the Terminal 1.5 Project are included within Assets Constructed for Others ("ACFO") and all amounts that have been or will be reimbursed will be included within Construction obligation on the accompanying unaudited Condensed Consolidated Balance Sheet.

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The Company guaranteed the obligation of the RAIC under the credit facility associated with the Terminal 1.5 Project.

As of September 30, 2020, the Company's outstanding remaining guaranteed obligation under the credit facility for the Terminal 1.5 Project was $ 289 million.

Construction costs recorded in ACFO for the Terminal 1.5 Project, which exclude costs associated with assets that were previously completed and placed into service, were $ 274 million and $ 164 million, as of September 30, 2020, and December 31, 2019, respectively, as some costs have been recognized as assets are placed into service.

As of March 31, 2021, the Company's outstanding guaranteed obligation under the credit facility for the Terminal 1.5 Project was $ 364 million.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

Construction costs recorded in ACFO for the Terminal 1.5 Project, which exclude costs associated with assets that were previously completed and placed into service, were $ 341 million and $ 309 million, as of March 31, 2021, and December 31, 2020, respectively.

Dallas Love Field

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The Company guaranteed principal and interest payments on bonds issued by the LFAMC.

As of September 30, 2020, $ 407 million of principal remained outstanding.

The net present value of the future principal and interest payments associated with the bonds was $ 448 million as of September 30, 2020, and was reflected as part of the Company's operating lease right–of–use assets and lease obligations in the unaudited Condensed Consolidated Balance Sheet.

As of March 31, 2021, $ 399 million of principal remained outstanding.

The net present value of the future principal and interest payments associated with the bonds was $ 438 million as of March 31, 2021, and was reflected as part of the Company's operating lease right–of–use assets and lease obligations in the unaudited Condensed Consolidated Balance Sheet.

Contractual Obligations and Contingent Liabilities and Commitments

On March 24, 2021, the Company entered into Supplemental Agreement No.

12 (the "Supplement") to its aircraft purchase agreement with The Boeing Company ("Boeing") relating to the Company's purchase of Boeing 737 MAX 7 and 737 MAX 8 aircraft.

Pursuant to the Supplement (i) the Company added 100 firm orders for the MAX 7, with the first 30 to be delivered in 2022;

(ii) the Company added 155 MAX aircraft options;

(iii) the order book was extended to include deliveries through 2031;

and (iv) the Company converted 70 MAX 8 firm orders to MAX 7 firm orders.

The Supplement also includes certain confidential credits, discounts, and other concessions provided to the Company by Boeing.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

As of March 31, 2021, based on the Supplement to its aircraft purchase agreement with Boeing, the Company had firm deliveries and options for Boeing 737 MAX 7 and 737 MAX 8 aircraft as follows:

The Boeing Company

Firm Orders MAX 8

Firm Orders MAX 7 or 8 Options Additional MAX 8s Total

2021 — 19 — 9 28 (a)

2022 30 — 42 — 72

2023 30 — 38 — 68

2024 30 — 40 — 70

2025 30 — 40 — 70

2026 15 15 40 — 70

2027 15 15 30 — 60

2028 15 15 30 — 60

2029 20 30 10 — 60

2030 15 45 — — 60

2031 — 10 — — 10

200 149 (b) 270 9 (c) 628

(a) Includes 20 737 MAX 8s delivered as of March 31, 2021, consisting of 12 owned and 8 leased aircraft.

(b) The Company has flexibility to designate firm orders or options as MAX 7 or MAX 8, upon written advance notification as stated in the contract.

(c) These 9 additional MAX 8 aircraft are leases to be acquired from various third parties, including 8 leased MAX 8 aircraft delivered in first quarter 2021.

The Company also received 7 leased MAX 8 aircraft in fourth quarter 2020, for a total of 16 MAX 8 operating leased aircraft from third parties in 2020 and 2021, combined.

Based on the Company's existing agreement with Boeing as reflected in the delivery schedule above, the Company's cash capital commitments associated with its firm orders are as follows:

none for 2021 (due to previously agreed upon delivery credits provided by The Boeing Company to the Company due to the settlement of 2020 estimated damages relating to the FAA grounding of the 737 MAX aircraft and progress payments made to date on undelivered aircraft), $ 700 million in 2022, $ 1.1 billion in 2023, $ 1.0 billion in 2024, $ 1.1 billion in 2025, $ 1.2 billion in 2026, and $ 7.2 billion thereafter.

Contingencies

The Company is from time to time subject to various legal proceedings and claims arising in the ordinary course of business, including, but not limited to, examinations by the Internal Revenue Service (the "IRS").

The Company's management does not expect that the outcome of any of its currently ongoing legal proceedings or the outcome of any adjustments presented by the IRS, individually or collectively, will have a material adverse effect on the Company's financial condition, results of operations, or cash flow.

BOEING 737 MAX AIRCRAFT GROUNDING

BOEING 737 MAX AIRCRAFT GROUNDING AND RETURN TO SERVICE

On March 13, 2019, the FAA issued an emergency order for all U.S.

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The Company immediately complied with the order and grounded all 34 MAX aircraft in its fleet.

The Company will continue to monitor the situation and any potential future accounting implications that arise.

The most significant financial impacts of this grounding to the Company thus far have been lost revenues, operating income, and operating cash flows, and delayed capital expenditures, directly associated with its grounded MAX fleet and other new aircraft that have not been able to be delivered.

In July 2019, the Boeing Company announced a $ 4.9 billion after-tax charge for "potential concessions and other considerations to customers for disruptions related to the 737 MAX grounding." In January 2020, the Boeing Company announced an additional pre-tax charge of $ 2.6 billion related to "estimated potential concessions and other considerations to customers related to the 737 MAX grounding."

During fourth quarter 2019, the Company entered into a Memorandum of Understanding with Boeing to compensate Southwest for estimated financial damages incurred during 2019 related to the grounding of the MAX.

The terms of the agreement are confidential, but are intended to provide for a substantial portion of the Company’s estimated financial damages associated with both the 34 MAX aircraft that were grounded as of March 13, 2019, as well as the 41 additional MAX aircraft the Company was scheduled to receive ( 28 owned MAX from Boeing and 13 leased MAX from third parties) from March 13, 2019 through December 31, 2019.

In accordance with applicable accounting principles, the Company will account for substantially all of the proceeds received from Boeing as a reduction in cost basis spread across both the existing 31 owned MAX in the Company’s fleet, plus the Company’s future firm aircraft deliveries as of the date of the agreement.

No material financial impacts of the agreement were realized in the Company’s earnings during the year ended December 31, 2019.

A total of $ 428 million in proceeds received in cash from Boeing are reflected within Investing Activities in the unaudited Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2020.

On November 18, 2020, the FAA rescinded the emergency order and issued official requirements to enable U.S.

airlines to return the Boeing 737 MAX to service.

The Company returned the MAX to revenue service on March 11, 2021, after the Company met all FAA requirements and Pilots received updated, MAX-related training.

The most significant financial impacts of the grounding to the Company were the lost revenues, operating income, and operating cash flows, and delayed capital expenditures, directly associated with its grounded MAX fleet and other new aircraft that were not able to be delivered.

In July 2019, The Boeing Company ("Boeing") announced a

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

$ 4.9 billion after-tax charge for "potential concessions and other considerations to customers for disruptions related to the 737 MAX grounding." In January 2020, Boeing announced an additional pre-tax charge of $ 2.6 billion related to "estimated potential concessions and other considerations to customers related to the 737 MAX grounding."

During 2019, the Company entered into a Memorandum of Understanding with Boeing to compensate Southwest for estimated financial damages incurred during 2019 related to the grounding of the MAX.

The terms of the agreement are confidential, but are intended to provide for a substantial portion of the Company’s financial damages associated with both the 34 MAX aircraft that were grounded as of March 13, 2019, as well as the 41 additional MAX aircraft the Company was scheduled to receive ( 28 owned MAX from Boeing and 13 leased MAX from third parties) from March 13, 2019 through December 31, 2019.

In accordance with applicable accounting principles, the Company will account for substantially all of the proceeds received from Boeing as a reduction in cost basis spread across both the existing 31 owned MAX in the Company’s fleet at the time, and the Company’s future firm aircraft deliveries as of the date of the agreement.

No material financial impacts of the agreement were realized in the Company’s earnings during the years ended December 31, 2019 and 2020.

During December 2020, the Company entered into an agreement with Boeing to compensate the Company for estimated financial damages incurred during 2020 related to the grounding of the MAX.

The terms of the agreement are confidential, but the compensation is in the form of credit memos taken against future payments due to Boeing as aircraft are delivered in accordance with the amended delivery schedule, or as future progress payments are due.

In accordance with applicable accounting principles, the Company has accounted for substantially all of the compensation received from Boeing as a reduction in cost basis spread across both the existing owned MAX in the Company’s fleet, and the Company’s future firm aircraft deliveries from Boeing as of the date of the agreement.

No material financial impacts of the agreement were realized in the Company’s earnings during the three months ended March 31, 2021.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1. Financial Statements