SOUTHWEST AIRLINES CO 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Relevant comparative operating statistics for the three and six months ended June 30, 2021 and 2020 are included below. The Company provides these operating statistics because they are commonly used in the airline industry and, as such, allow readers to compare the Company’s performance against its results for the prior year period, as well as against the performance of the Company’s peers. In the first half of both years, most of these operating statistics were significantly impacted by the COVID-19 pandemic and decisions the Company made as a result of the pandemic. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. Three months ended June 30, 2021 2020 Change Revenue passengers carried (000s) 26,158 5,253 n.m. Enplaned passengers (000s) 32,786 6,990 n.m. Revenue passenger miles (RPMs) (in millions) (a) 27,689 5,614 n.m. Available seat miles (ASMs) (in millions) (b) 33,414 17,887 86.8 % Load factor (c) 82.9 % 31.4 % 51.5 pts. Average length of passenger haul (miles) 1,059 1,069 (0.9) % Average aircraft stage length (miles) 794 749 6.0 % Trips flown 268,820 153,088 75.6 % Seats flown (000s) (d) 41,826 23,650 76.9 % Seats per trip (e) 155.6 154.5 0.7 % Average passenger fare $ 136.46 $ 134.04 1.8 % Passenger revenue yield per RPM (cents) (f) 12.89 12.54 2.8 % Operating revenues per ASM (cents) (g) 11.99 5.63 113.0 % Passenger revenue per ASM (cents) (h) 10.68 3.94 171.1 % Operating expenses per ASM (cents) (i) 10.22 11.94 (14.4) % Operating expenses per ASM, excluding fuel (cents) 7.81 10.50 (25.6) % Operating expenses per ASM, excluding fuel and profitsharing (cents) 7.56 10.50 (28.0) % Fuel costs per gallon, including fuel tax $ 1.88 $ 1.23 52.8 % Fuel costs per gallon, including fuel tax, economic $ 1.92 $ 1.33 44.4 % Fuel consumed, in gallons (millions) 426 208 104.8 % Active fulltime equivalent Employees (j) 54,448 61,118 (10.9) % Aircraft at end of period (k) 736 737 (0.1) % 32 Six months ended June 30, 2021 2020 Change Revenue passengers carried (000s) 40,383 30,001 34.6 % Enplaned passengers (000s) 50,713 36,768 37.9 % Revenue passenger miles (RPMs) (in millions) (a) 42,565 29,549 44.0 % Available seat miles (ASMs) (in millions) (b) 56,561 53,237 6.2 % Load factor (c) 75.3 % 55.5 % 19.8 pts. Average length of passenger haul (miles) 1,054 985 7.0 % Average aircraft stage length (miles) 785 741 5.9 % Trips flown 461,221 465,481 (0.9) % Seats flown (000s) (d) 71,617 70,780 1.2 % Seats per trip (e) 155.3 152.1 2.1 % Average passenger fare $ 130.79 $ 151.63 (13.7) % Passenger revenue yield per RPM (cents) (f) 12.41 15.40 (19.4) % Operating revenues per ASM (cents) (g) 10.71 9.85 8.7 % Passenger revenue per ASM (cents) (h) 9.34 8.55 9.2 % Operating expenses per ASM (cents) (i) 9.31 12.17 (23.5) % Operating expenses per ASM, excluding fuel (cents) 7.06 10.05 (29.8) % Operating expenses per ASM, excluding fuel and profitsharing (cents) 6.87 10.05 (31.6) % Fuel costs per gallon, including fuel tax $ 1.78 $ 1.69 5.3 % Fuel costs per gallon, including fuel tax, economic $ 1.83 $ 1.72 6.4 % Fuel consumed, in gallons (millions) 712 664 7.2 % Active fulltime equivalent Employees (j) 54,448 61,118 (10.9) % Aircraft at end of period (k) 736 737 (0.1) % (a) A revenue passenger mile is one paying passenger flown one mile. Also referred to as "traffic," which is a measure of demand for a given period. (b) An available seat mile is one seat (empty or full) flown one mile. Also referred to as "capacity," which is a measure of the space available to carry passengers in a given period. (c) Revenue passenger miles divided by available seat miles. (d) Seats flown is calculated using total number of seats available by aircraft type multiplied by the total trips flown by the same aircraft type during a particular period. (e) Seats per trip is calculated by dividing seats flown by trips flown. (f) Calculated as passenger revenue divided by revenue passenger miles. Also referred to as "yield," this is the average cost paid by a paying passenger to fly one mile, which is a measure of revenue production and fares. (g) Calculated as operating revenues divided by available seat miles. Also referred to as "operating unit revenues," or "RASM," this is a measure of operating revenue production based on the total available seat miles flown during a particular period. (h) Calculated as passenger revenue divided by available seat miles. Also referred to as "passenger unit revenues," this is a measure of passenger revenue production based on the total available seat miles flown during a particular period. (i) Calculated as operating expenses divided by available seat miles. Also referred to as "unit costs," "cost per available seat mile," or "CASM" this is the average cost to fly an aircraft seat (empty or full) one mile, which is a measure of cost efficiencies. (j) Included 1,446 Employees participating in the Extended Emergency Time Off program as of June 30, 2021. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. (k) Included 39 Boeing 737 Next Generation aircraft in temporary storage as of June 30, 2021 . Also included 34 Boeing 737 MAX and 77 Boeing 737 Next Generation aircraft in long-term storage as of June 30, 2020. See Note 11 to the unaudited Condensed Consolidated Financial Statements for further information. 33 Financial Overview In late February 2020, the Company began to see a negative impact from the COVID-19 pandemic, which quickly accelerated during first quarter 2020 and continued throughout 2020. The Company continued to experience negative impacts to passenger demand and bookings early in 2021, due to the pandemic, in particular with respect to business travel, although as a result of declining COVID-19 cases throughout the United States, easing travel restrictions, lifting of business restrictions, and an increase in the numbers of persons vaccinated, domestic leisure travel demand and bookings improved during second quarter 2021. The Company's financial results in both years, on both a GAAP and Non-GAAP basis, were significantly impacted by the pandemic and resulting effect on demand and passenger bookings. In addition, GAAP results for the three and six months ended June 30, 2021 included $1.5 billion and $2.7 billion, respectively, in grants of payroll funding support ("Payroll Support") from the United States Department of Treasury ("Treasury"). See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information on payroll support programs administered through Treasury, as well as the significant impacts to the Company’s operations, financial performance, and liquidity from the COVID-19 pandemic. The Company recorded second quarter and year-to-date GAAP and non-GAAP results for 2021 and 2020 as noted in the following tables. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. Three months ended Six Months Ended (in millions, except per share amounts) June 30, June 30, GAAP 2021 2020 Percent Change 2021 2020 Percent Change Operating income (loss) $ 594 $ (1,127) n.m. $ 793 $ (1,237) n.m. Net income (loss) $ 348 $ (915) n.m. $ 463 $ (1,009) n.m. Net income (loss) per share, diluted $ 0.57 $ (1.63) n.m. $ 0.76 $ (1.87) n.m. Non-GAAP Operating loss $ (162) $ (2,154) (92.5) $ (1,431) $ (2,264) (36.8) Net loss $ (206) $ (1,501) (86.3) $ (1,221) $ (1,578) (22.6) Net loss per share, diluted $ (0.35) $ (2.67) (86.9) $ (2.07) $ (2.93) (29.4) The significant increase in GAAP Net income (loss) and Operating income (loss), and significant decrease in non-GAAP Net loss and Operating loss, year-over-year, for both the quarter and year-to-date periods noted above, was primarily due to the declining COVID-19 cases throughout the United States, easing travel restrictions, lifting of business restrictions, and an increase in the numbers of persons vaccinated, as domestic leisure travel demand and bookings improved rapidly during 2021. These impacts combined to result in a 297.6 percent increase in Operating revenues in second quarter 2021, and a 15.6 percent increase in Operating revenues for the six months ended June 30, 2021. See below and Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. COVID-19 Pandemic Impacts In response to the far-reaching impacts of the COVID-19 pandemic, the Company took, and continues to assess and modify, measures to support the well-being of both its Employees and passengers, including procedures and policies intended to maintain cleanliness on aircraft and at facilities, and mitigate the spread of the virus. The Company also continues to monitor guidelines and recommendations from the Centers for Disease Control and Prevention 34 applicable to the Company’s daily operations, and the manner in which the majority of the Company’s office and clerical Employees work on a daily basis. As detailed in Note 2 to the unaudited Condensed Consolidated Financial Statements, in connection with the major negative impact of COVID-19 on air carriers, the Company has received significant financial assistance from Treasury in the form of Payroll Support, and this assistance will continue to have a significant impact on the Company's reported GAAP financial results at least through third quarter 2021. During second quarter 2020, the Company introduced Voluntary Separation Program 2020 ("Voluntary Separation Program") and the Extended Emergency Time Off ("Extended ETO") program which helped closer align staffing to reduced flight schedules and enabled the Company to avoid involuntary furloughs and layoffs associated with the impacts of the pandemic. Employees had until July 15, 2020, to determine whether to participate in one of these programs, and approximately 15,000 Employees elected to do so. During second quarter 2021, 7,000 Employees returned from the Extended ETO program and 1,466 Employees remained on Extended ETO leave as of June 30, 2021, although most of those Employees will be recalled by September 30, 2021. In accordance with applicable accounting guidance, the Company accrued a total charge of $1.4 billion in 2020 related to the special termination benefits for Employees who had accepted the Company's offer to participate in its Voluntary Separation Program and the special benefits for Employees who participated in its Extended ETO program. The accrual is being reduced as program benefits are paid or as it becomes no longer probable that Employees will remain on leave for their elected terms. This program has allowed the Company to reduce its fixed cost structure in the near-term, while maintaining the ability to adjust to an improvement in travel demand. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. As a result of these voluntary programs, the Company's salaries, wages, and benefits costs were lowered by approximately $325 million for the three months ended June 30, 2021. Company Overview On November 18, 2020, the Federal Aviation Administration (the "FAA") issued official requirements to enable airlines to return the Boeing 737 MAX to service. The Company worked to meet the FAA's requirements by modifying certain operating procedures, implementing enhanced Pilot training requirements, installing FAA-approved flight control software updates, and completing other required maintenance tasks specific to the MAX aircraft. The Company began returning the MAX to service on March 11, 2021, after the Company met all FAA requirements and Pilots received updated, MAX-related training. Subsequently, during April 2021, the Company became aware of a Boeing production issue related to the electrical power system on a subset of MAX aircraft. Upon learning of the issue, the Company immediately removed 32 MAX aircraft from service for review. As of June 30, 2021, all MAX aircraft have received the repairs and maintenance as directed by the FAA and The Boeing Company ("Boeing"), and have been returned to service. Based on growth opportunities and ongoing fleet modernization plans for a less carbon-intensive aircraft, the Company recently entered into supplemental agreements with Boeing to increase its 2022 firm orders by 34 Boeing 737 MAX 7 ("MAX 7") aircraft (consisting of two 2022 options exercised and 32 options accelerated and exercised from later years), resulting in 234 firm orders for MAX 7 aircraft as of June 30, 2021. Additionally, the Company accelerated 10 options into 2022, 32 options into 2023, 16 options into 2024, 16 options into 2025, and added 32 new options into 2026 through 2027, bringing the total firm and option order book to 660 aircraft as of June 30, 2021. On July 1, 2021, the Company exercised three options for delivery in 2022 and intends to exercise another three options in July 2021 for 2022 delivery. Upon the planned exercise of these three additional options, the Company's 2022 firm orders will increase to 70 with 44 remaining options, and its order book with Boeing will consist of a total of 389 MAX firm orders (240 MAX 7 and 149 MAX 8) and 262 MAX options (MAX 7 or MAX 8) for years 2021 through 2031. The Company continues to expect that more than half of the MAX aircraft in its firm order book will replace a significant amount of its 461 737-700 aircraft over the next 10 to 15 years to support the modernization of its fleet, a key component of its environmental sustainability efforts. 35 The Company ended second quarter 2021 with 736 aircraft in its fleet, including 68 Boeing MAX 8 aircraft. During second quarter 2021, the Company took delivery of seven Boeing 737 MAX 8 ("MAX 8") aircraft. The Company expects delivery of one additional leased Boeing 737 MAX 8 aircraft by December 31, 2021. Also during second quarter 2021, the Company returned one leased 737-700 aircraft and expects to retire one more 737-700 aircraft in 2021, for a total of 10 retirements in 2021. As of June 30, 2021, 39 737-700 aircraft remained in temporary storage due to the prolonged period of depressed capacity levels. These aircraft are expected to have required maintenance checks completed and be returned to service by the end of this year. The Company has published its flight schedule through January 5, 2022. The Company is pursuing additional revenue opportunities that utilize idle aircraft to provide Southwest's legendary Customer Service to new, popular destinations. The Company is leveraging additional airports in or near cities where its Customer base is large, along with adding easier access to popular leisure-oriented destinations from across its domestic-focused network. These additional service points on the Company's route map are opportunities it can provide Customers now, all while better positioning the Company for a travel demand rebound. During 2021, the Company has begun service to new destinations including: • Chicago O'Hare International Airport and Sarasota Bradenton International Airport - February 14, 2021 • Colorado Springs Municipal Airport and Savannah/Hilton Head International Airport - March 11, 2021 • Houston's George Bush Intercontinental Airport and Santa Barbara Airport - April 12, 2021 • Fresno Yosemite International Airport - April 25, 2021 • Destin-Fort Walton Beach Airport - May 6, 2021 • Myrtle Beach International Airport - May 23, 2021 • Bozeman Yellowstone International Airport - May 27, 2021 • Jackson-Medgar Wiley Evers International Airport in Mississippi - June 6, 2021 The Company has also announced other new destinations and expected service commencement dates including: • Eugene Airport in Oregon - August 29, 2021 • Bellingham International Airport in Washington - November 7, 2021 • Syracuse Hancock International Airport in New York - November 14, 2021 The Company began additional service to Hawaii from Los Angeles and Las Vegas on June 6, 2021, and from Phoenix on June 27, 2021. Alongside established Hawaii service at five other California airports, these three additional gateways with nonstop service to multiple airports in the Hawaiian Islands now give Southwest Customers in more than 40 cities on the mainland low-fare connecting or same-plane access to Hawaii. The COVID-19 pandemic had a particularly negative impact on international operations and led to the Company's suspension of international operations in first quarter 2020. The Company has since resumed service to Aruba, Mexico, Costa Rica, Jamaica, the Dominican Republic, and Cuba. With the easing of government restrictions and continued increase in demand for beach and leisure destinations, the Company intends to resume service to its remaining international destinations, including Belize, the Bahamas, Turks and Caicos, and the Cayman Islands, by November 7, 2021. Thus far, the Company continues to experience typical leisure booking patterns for summer and fall 2021 travel. Based on current bookings, leisure passenger traffic and fares in July 2021 are expected to trend higher than July 2019 levels. The Company's revenue outlook for August 2021 is impacted by less holiday travel, an estimated one to two point headwind, compared with August 2019, as the Labor Day holiday weekend falls in September 2021, whereas it was split between August and September in 2019. Despite steady weekly improvements in business bookings, thus far, in July, the lag in business travel recovery is expected to continue to have a negative impact on close-in demand and average passenger fares in third quarter 2021. 36 The following table presents selected preliminary estimates of operating revenue and load factor for July and August 2021: Estimated July 2021 Estimated August 2021 Operating revenue compared with 2019 (a) Down 10% to 15% Down 12% to 17% Previous estimation Down 15% to 20% (b) Load factor ~85% ~80% Previous estimation (b) (b) (a) The Company believes that operating revenues compared with 2019 is a more relevant measure of performance than a year-over-year comparison due to the significant impacts in 2020 due to the pandemic. (b) Remains unchanged from the previously provided estimation. The Company expects its third quarter 2021 capacity to increase from second quarter 2021 levels, based on the expectation of further improvement in travel demand. The Company is in the process of adjusting its published flight schedules for September and October 2021. Including these adjustments, the following table presents capacity estimates for third quarter 2021: Estimated July 2021 Estimated August 2021 Estimated September 2021 Estimated 3Q 2021 ASMs year-over-year Up ~41% Up ~41% Up ~68% Up ~49% Previous estimation (a) Up ~39% (a) (a) ASMs compared with 2019 Down ~3% Up ~3% Comparable Comparable Previous estimation (a) Comparable (a) (a) (a) Remains unchanged from previously provided estimation. In addition, the Company currently expects its fourth quarter 2021 capacity to increase approximately 68 percent, year-over-year, and to be comparable with fourth quarter 2019. Based on current cost trends, third quarter 2021 operating expenses and unit costs, excluding fuel and oil expense, special items, and profitsharing, are expected to increase in the range of one to five percent, compared with third quarter 2019. The Company currently estimates three to four points of the unit cost increase in third quarter 2021 to be attributable to ramp up costs and premium pay being offered to Operations Employees. Another one point is attributable to lower estimated cost savings from voluntary leave programs due to higher than projected Employee recalls. The projections do not reflect the potential impact of Fuel and oil expense, special items, and profitsharing expense because the Company cannot reliably predict or estimate these items or expenses or their impact to its financial statements in future periods, especially considering the significant volatility of the Fuel and oil expense line item. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort. The Company now estimates annual 2021 cost savings from these programs to be approximately $1.0 billion. The Company expects third quarter 2021 cost savings from these programs to be approximately $150 million. To support the return of flight activity, the Company expects to recall the vast majority of its Employees early from voluntary time-off by the end of third quarter 2021, which is expected to reduce the Company's prior forecasted savings from voluntary leave programs beyond second quarter 2021. Material Changes in Results of Operations Comparison of three months ended June 30, 2021 and June 30, 2020 Operating Revenues Total operating revenues for second quarter 2021 increased by $3.0 billion, year-over-year, to $4.0 billion, driven primarily by the improvements in leisure Passenger demand and bookings throughout second quarter 2021 versus 37 the severe impacts to demand and bookings from the COVID-19 pandemic in second quarter 2020. Second quarter 2021 operating revenues per available seat mile (RASM) were 11.99 cents, and increased 113.0 percent, compared with second quarter 2020, primarily driven by the improvement in passenger demand as impacts from the COVID-19 pandemic eased, which also contributed to the Load factor increase of 51.5 points, and the passenger revenue yield increase of 2.8 percent, year-over-year. Passenger revenues for second quarter 2021 increased by $2.9 billion, year-over-year. On a unit basis, Passenger revenues increased 171.1 percent, year-over-year. The increase in Passenger revenues on both a dollar and unit basis was primarily due to travel restrictions easing and business restrictions lifting which resulted in improvements in leisure Passenger demand and bookings. Freight revenues for second quarter 2021 increased by $12 million, or 31.6 percent, compared with second quarter 2020, primarily due to increased demand as businesses reduced pandemic driven restrictions. Other revenues for second quarter 2021 increased by $123 million, or 46.2 percent, compared with second quarter 2020. The increase was primarily due to an increase in income from business partners, including Chase Bank USA, N.A. ("Chase") and the impact on spend on the Company's co-branded card, driven by an increase in consumer spending. Operating Expenses Operating expenses for second quarter 2021 increased by $1.3 billion, or 59.9 percent, compared with second quarter 2020, while capacity increased 86.8 percent over the same prior year period. The operating expense increase was primarily due to higher market jet fuel prices and the significant increase in fuel gallons consumed, coupled with significant increases in trips flown and other variable flight-driven expenses. Historically, except for changes in the price of fuel, changes in Operating expenses for airlines have been largely driven by changes in capacity, or ASMs. In second quarter 2020, ASMs were significantly impacted by the dramatic and severe drop in demand as a result of the COVID-19 pandemic which led to numerous flight cancellations and flight schedule adjustments. The Company increased capacity to match the higher demand during second quarter 2021 and incurred more variable, flight-driven expenses as a result. See "COVID-19 Pandemic Impacts" above and Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. The following table presents the Company's Operating expenses per ASM for the second quarter of 2021 and 2020, followed by explanations of these changes on a per ASM basis and dollar basis: Three months ended June 30, Per ASM change Percent change (in cents, except for percentages) 2021 2020 Salaries, wages, and benefits 5.46 ¢ 9.58 ¢ (4.12) ¢ (43.0) % Payroll support and voluntary Employee programs, net (2.22) (4.38) 2.16 (49.3) Fuel and oil 2.41 1.44 0.97 67.4 Maintenance materials and repairs 0.66 0.78 (0.12) (15.4) Landing fees and airport rentals 1.21 1.54 (0.33) (21.4) Depreciation and amortization 0.94 1.75 (0.81) (46.3) Other operating expenses, net 1.76 1.23 0.53 43.1 Total 10.22 ¢ 11.94 ¢ (1.72) ¢ (14.4) % Operating expenses per ASM for second quarter 2021 decreased by 14.4 percent, compared with second quarter 2020. Operating expenses per ASM for second quarter 2021, excluding Fuel and oil expense, profitsharing, and special items (a non-GAAP financial measure), decreased 39.3 percent, compared with second quarter 2020. On both a GAAP and non-GAAP basis, excluding Fuel and oil expense, profitsharing, and special items, the unit cost decreases in second quarter 2021 were primarily driven by the 86.8 percent increase in capacity as Trips flown increased with the improvement of travel demand, causing the Company's fixed costs to be spread over significantly 38 more ASMs. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. Salaries, wages, and benefits expense for second quarter 2021 increased by $111 million, or 6.5 percent, compared with second quarter 2020. On a per ASM basis, second quarter 2021 Salaries, wages, and benefits expense decreased 43.0 percent, compared with second quarter 2020, as the dollar increases were more than offset by the 86.8 percent increase in capacity due to a more stable and efficient flight schedule. On a dollar basis, the increase was primarily driven by a profitsharing expense accrual of $85 million in second quarter 2021, compared with no profitsharing expense accrual in second quarter 2020. Payroll support and voluntary Employee programs, net (a reduction to expense) for second quarter 2021 resulted in a decrease of $44 million, compared with second quarter 2020. On a per ASM basis, second quarter 2021 Payroll support and voluntary Employee programs, net decreased 49.3 percent, compared with second quarter 2020, as the dollar increases were more than offset by the 86.8 percent increase in capacity. On a dollar basis, the increase was primarily due to the decrease in the Payroll Support programs grant allocation of $724 million in second quarter 2021, compared with a $1.1 billion allocation in second quarter 2020, partially offset by a $307 million accrual related to the cost associated with the Voluntary Separation Program elections made prior to June 30, 2020. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. Fuel and oil expense for second quarter 2021 increased by $546 million, or 212.5 percent, compared with second quarter 2020. On a per ASM basis, second quarter 2021 Fuel and oil expense increased 67.4 percent, due primarily to higher market jet fuel prices. On a dollar basis, the majority of the increase was attributable to higher market jet fuel prices the remainder of the increase was due to a significant increase in fuel gallons consumed. The following table provides more information on the Company's economic fuel cost per gallon, including the impact of fuel hedging premium expense and fuel derivative contracts: Three months ended June 30, 2021 2020 Economic fuel costs per gallon $ 1.92 $ 1.33 Fuel hedging premium expense (in millions) $ 24 $ 24 Fuel hedging premium expense per gallon $ 0.06 $ 0.12 Fuel hedging cash settlement gains per gallon $ 0.02 $ — See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. The Company's second quarter 2021 available seat miles per gallon ("fuel efficiency") declined 8.7 percent, year-over-year, due to the return to service of more of its least fuel-efficient aircraft, the Boeing 737-700, to support higher demand. When compared with second quarter 2019, fuel efficiency improved 4.5 percent in second quarter 2021 driven primarily by the March 2021 return to service of the Company's most fuel-efficient aircraft, the MAX. The MAX is critical to the Company's efforts to modernize its fleet, reduce carbon emissions intensity, and achieve carbon neutrality by 2050. The Company expects third quarter 2021 fuel efficiency to be sequentially in line with second quarter 2021, on a nominal basis. 39 As of July 15, 2021, on an economic basis, the Company had derivative contracts in place related to expected future fuel consumption as follows: Period Maximum fuel hedged (gallons in millions) (a)(b) Remainder of 2021 641 2022 1,220 2023 655 Beyond 2023 106 (a) The Company’s hedge position includes prices at which the Company considers "catastrophic" coverage. The maximum gallons provided are not indicative of the Company's hedge coverage at every price, but represent the highest level of coverage at a single price. See Note 4 to the unaudited Condensed Consolidated Financial Statements for further information. (b) The Company's gallons that are covered by derivative contracts represent the maximum number of gallons hedged for each respective period, which may be at different strike prices and at strike prices materially higher than the current market prices. The volume of gallons covered by derivative contracts that ultimately get exercised in any given period may vary significantly from the volumes provided, as market prices and the Company's fuel consumption fluctuates. Based on the Company's available seat mile plans for annual 2021, its maximum percent of estimated fuel consumption covered by fuel derivative contracts is 75 percent. The Company believes that providing the maximum percent of fuel consumption covered by derivative contracts in future years relative to 2019 fuel gallons consumed is a more relevant measure for future coverage, due to uncertainty regarding available seat mile plans in future years. Based on 2019 fuel gallons consumed, the Company's maximum percent of fuel consumption covered by fuel derivative contracts is 59 percent in 2022, 32 percent in 2023, and 5 percent beyond 2023. As a result of applying hedge accounting in prior periods, the Company has amounts in Accumulated other comprehensive income (loss) ("AOCI") that will be recognized in earnings in future periods when the underlying fuel derivative contracts settle. The following table displays the Company's estimated fair value of remaining fuel derivative contracts (not considering the impact of the cash collateral provided to or received from counterparties—see Note 4 to the unaudited Condensed Consolidated Financial Statements for further information), as well as the deferred amounts in AOCI at June 30, 2021, and the expected future periods in which these items are expected to settle and/or be recognized in earnings (in millions): Year Fair value of fuel derivative contracts at June 30, 2021 Amount of gains deferred in AOCI at June 30, 2021 (net of tax) Remainder of 2021 $ 78 $ 16 2022 285 139 2023 119 47 Beyond 2023 20 8 Total $ 502 $ 210 Assuming no changes to the Company's current fuel derivative portfolio, but including all previous hedge activity for fuel derivatives that have not yet settled, and considering only the expected net cash receipts related to hedges that will settle, the Company is providing the below sensitivity table for third quarter 2021 and fourth quarter 2021 jet fuel prices at different crude oil assumptions as of July 15, 2021, and for expected premium costs associated with settling contracts. 40 Estimated economic fuel price per gallon, including taxes and fuel hedging premiums (e) Average Brent Crude Oil price per barrel Third Quarter 2021 (c) Fourth Quarter 2021 (d) $50 $1.40- $1.50 $1.50- $1.60 $60 $1.70- $1.80 $1.80- $1.90 Current Market (a) $2.05 - $2.15 $2.05 - $2.15 $80 $2.15 - $2.25 $2.25 - $2.35 $90 $2.30 - $2.40 $2.40 - $2.50 $100 $2.45 - $2.55 $2.55 - $2.65 Estimated fuel hedging premium expense per gallon (b) $0.05 $.05 Estimated premium costs (b) $25 million $25 million (a) Brent crude oil average market prices as of July 15, 2021, were approximately $73 and $71 per barrel for third quarter 2021 and fourth quarter 2021, respectively. (b) Fuel hedging premium expense per gallon is included in the Company's estimated economic fuel price per gallon estimates above. (c) Based on the Company's existing fuel derivative contracts and market prices as of July 15, 2021, third quarter 2021 economic fuel costs are estimated to be in the $2.05 to $2.15 per gallon range, including fuel hedging premium expense of approximately $25 million, or $.05 per gallon, and $.04 per gallon in favorable cash settlements from fuel derivative contracts. See Note Regarding Use of Non-GAAP Financial Measures. (d) Based on the Company's existing fuel derivative contracts and market prices as of July 15, 2021, fourth quarter 2021 economic fuel costs are estimated to be in the $2.05 to $2.15 per gallon range, including fuel hedging premium expense of approximately $25 million, or $.05 per gallon, and $.02 per gallon in favorable cash settlements from fuel derivative contracts. See Note Regarding Use of Non-GAAP Financial Measures. (e) The Company's current fuel derivative contracts contain a combination of instruments based in West Texas Intermediate and Brent crude oil; however, the economic fuel price per gallon sensitivities provided assume the relationship between Brent crude oil and refined products based on market prices as of July 15, 2021. Economic fuel cost projections do not reflect the potential impact of special items because the Company cannot reliably predict or estimate the hedge accounting impact associated with the volatility of the energy markets, the impact of COVID-19 cases on air travel demand, or the impact to its financial statements in future periods. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort. See Note Regarding Use of Non-GAAP Financial Measures. Maintenance materials and repairs expense for second quarter 2021 increased by $82 million, or 58.6 percent, compared with second quarter 2020. On a per ASM basis, Maintenance materials and repairs expense decreased 15.4 percent, compared with second quarter 2020, as a substantial portion of the increase in ASMs in second quarter 2021 were produced by aircraft for which a comparable level of airframe maintenance costs were not required due to timing. On a dollar basis, approximately 50 percent of the increase was due to higher engine maintenance expense due to the increase in flight hours and the majority of the remainder of the increase was due to increased operations and operating aircraft that had previously been in storage. Landing fees and airport rentals expense for second quarter 2021 increased by $128 million, or 46.5 percent, compared with second quarter 2020. On a per ASM basis, Landing fees and airport rentals expense decreased 21.4 percent, compared with second quarter 2020, as the additional space and higher airport rental rates across the network, were more than offset by the significant increase in capacity year-over-year. On a dollar basis, the increase was primarily due to higher landing fees as a result of the increased number of Trips flown in second quarter 2021 as a result of improvements in leisure passenger demand associated with the easing of the COVID-19 pandemic. Depreciation and amortization expense for second quarter 2021 increased by $2 million, or 0.6 percent, compared with second quarter 2020. On a per ASM basis, Depreciation and amortization expense decreased by 46.3 percent, compared with second quarter 2020, as the dollar increase was more than offset by the 86.8 percent increase in capacity. On a dollar basis, the increase was due to the deployment of new technology assets. 41 Other operating expenses, net, for second quarter 2021 increased by $366 million, or 166.4 percent, compared with second quarter 2020. Included within this line item was aircraft rentals expense in the amounts of $52 million and $41 million for the periods ended June 30, 2021 and 2020, respectively. On a per ASM basis, Other operating expenses, net increased 43.1 percent, compared with second quarter 2020. On a dollar and per ASM basis, the increases were primarily due to $222 million of gains from the sale-leaseback of 20 aircraft to third parties in two separate transactions during second quarter 2020, which reduced Other operating expenses, net in second quarter 2020 and were considered special items and thus excluded from the Company's non-GAAP results for the three months ended June 30, 2020. On a dollar basis, the remaining increase was primarily due to higher credit card fees driven by increases in revenue in second quarter 2021 as a result of improvements in leisure passenger demand associated with the easing of the COVID-19 pandemic. Other Other expenses (income) include interest expense, capitalized interest, interest income, and other gains and losses. Interest expense for second quarter 2021 increased by $20 million, or 20.8 percent, compared with second quarter 2020, primarily due to higher debt balances. Based on current debt outstanding and current market interest rates, the Company currently expects third quarter 2021 interest expense to be approximately $115 million. Capitalized interest for second quarter 2021 increased by $1 million, or 14.3 percent, compared with second quarter 2020, primarily due to Boeing resuming production of the Company's undelivered MAX aircraft. Interest income for second quarter 2021 decreased by $7 million, or 77.8 percent, compared with second quarter 2020, due to lower interest rates. Other (gains) losses, net, primarily includes amounts recorded as a result of the Company's hedging activities. See Note 4 to the unaudited Condensed Consolidated Financial Statements for further information on the Company's hedging activities. The following table displays the components of Other (gains) losses, net, for the three months ended June 30, 2021 and 2020: Three months ended June 30, (in millions) 2021 2020 Mark-to-market impact from fuel contracts settling in current and future periods $ (11) $ 15 Premium cost of fuel contracts not designated as hedges 10 11 Mark-to-market impact from interest rate swap agreements — 5 Mark-to-market gain on deferred compensation plan investment (17) — Other 4 1 $ (14) $ 32 Income Taxes The Company's effective tax rate was approximately 30.7 percent in second quarter 2021, compared with 26.2 percent in second quarter 2020. The higher tax rate for second quarter 2021 was primarily due to higher state taxes than previously estimated. The Company currently estimates its annual 2021 effective tax rate to be approximately 26 percent, compared with its previous guidance of approximately 23 percent, also due to the higher state taxes than previously estimated. Comparison of six months ended June 30, 2021 and June 30, 2020 Operating Revenues Passenger revenues for the six months ended June 30, 2021, increased by $733 million, or 16.1 percent, compared with the first six months of 2020. On a unit basis, Passenger revenues increased 9.2 percent, year-over-year. The increase in Passenger revenues on both a dollar and unit basis were primarily due to the improvements in leisure 42 Passenger demand and bookings in the first six months of 2021, compared with the severe impacts to demand and bookings from the COVID-19 pandemic for the majority of the first six months of 2020, including as a result of unprecedented levels of close-in trip cancellations, and significant reductions in capacity during the March through June period. Freight revenues for the six months ended June 30, 2021, increased by $15 million, or 19.5 percent, compared with the six months ended June 30, 2020, primarily due to increased demand as businesses reduced pandemic driven restrictions during 2021. Other revenues for the six months ended June 30, 2021, increased by $70 million, or 11.4 percent, year-over-year. The increase was primarily due to an increase in income from business partners, including Chase, and the impact on spend on the Company's co-branded card, driven by the increase in consumer spending resulting from the improving economy in 2021 as compared to the earliest stages of the COVID-19 pandemic. Operating Expenses Operating expenses for the six months ended June 30, 2021, decreased by $1.2 billion, or 18.7 percent, compared with the first six months of 2020, while capacity increased 6.2 percent over the same prior year period. Historically, except for changes in the price of fuel, changes in Operating expenses for airlines have been largely driven by changes in capacity, or ASMs. However, the Company's flight schedules are largely fixed once flight schedules are published, and the Company experienced significant ASM reductions in second quarter 2020 as a result of flight schedule adjustments related to the COVID-19 pandemic. The Company has experienced significant ASM increases as a result of flight schedule adjustments related to the improving economy in 2021 as compared to the earliest stages of the COVID-19 pandemic. Flight schedule adjustments are expected to result in further declines to unit costs if the increase in air travel demand continues, excluding any impacts associated with Payroll Support grants. See "COVID-19 Pandemic Impacts" above and Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. The following table presents the Company's Operating expenses per ASM for the first six months of 2021 and 2020, followed by explanations of these changes on a per ASM basis and dollar basis: Six months ended June 30, Per ASM Percent (in cents, except for percentages) 2021 2020 change change Salaries, wages, and benefits 6.00 ¢ 6.70 ¢ (0.70) ¢ (10.4) % Payroll support and voluntary Employee programs, net (3.87) (1.47) (2.40) 163.3 Fuel and oil 2.25 2.12 0.13 6.1 Maintenance materials and repairs 0.70 0.77 (0.07) (9.1) Landing fees and airport rentals 1.27 1.15 0.12 10.4 Depreciation and amortization 1.11 1.17 (0.06) (5.1) Other operating expenses, net 1.85 1.73 0.12 6.9 Total 9.31 ¢ 12.17 ¢ (2.86) ¢ (23.5) % Operating expenses per ASM for the first six months of 2021 decreased by 23.5 percent, compared with the first six months of 2020. The majority of the year-over-year unit cost decrease in the first six months of 2021 was driven by the increase in Payroll Support funding. This decrease was partially offset by an increase in market jet fuel prices and $222 million of gains from the sale-leaseback of 20 aircraft to third parties in two separate transactions during second quarter 2020, which reduced Other operating expenses, net in second quarter 2020. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. Operating expenses per ASM for the first six months of 2021, excluding Fuel and oil expense, profitsharing and special items, (a non-GAAP financial measure), decreased 10.1 percent, year-over-year. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. 43 Salaries, wages, and benefits expense for the first six months of 2021 decreased by $173 million, or 4.8 percent, compared with the first six months of 2020. On a per ASM basis, Salaries, wages, and benefits expense for the first six months of 2021 decreased 10.4 percent, compared with the first six months of 2020. On both a dollar and per ASM basis, the majority of the decreases were primarily driven by lower salaries, wages, and benefits expense, as a result of Voluntary Separation Program, Extended ETO, and other time off programs offered by the Company. The decrease was partially offset by the $109 million profitsharing expense accrual in the first six months of 2021, compared with no profitsharing expense accrual in the first six months of 2020. Payroll support and voluntary Employee programs, net (a reduction to expense) for the first six months of 2021 was an increase of $1.4 billion, compared with the first six months of 2020. On a per ASM basis, Payroll support and voluntary Employee programs, net for the first six months of 2021 increased by 163.3 percent. On both a dollar and per ASM basis, the changes were primarily due to the significant increase in Payroll Support grant proceeds received in the first half of 2021 compared with the same prior year period. This was coupled with: • The Payroll Support programs' grant allocation of $1.9 billion in the first six months of 2021, compared with a $1.1 billion allocation in the first six months of 2020; • The $307 million accrual for charges related to the Voluntary Separation Program in the first six months of 2020; • The $130 million net reduction in the Extended ETO liability in the first six months of 2021; and • The $117 million in Employee Retention Tax Credits recorded in 2021 for continuing to pay Employees' salaries during the time they were not working, as allowed under the CARES Act, and subsequent legislation. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. Fuel and oil expense for the first six months of 2021 increased by $144 million, or 12.8 percent, compared with the first six months of 2020. On a per ASM basis, Fuel and oil expense for the first six months of 2021 increased 6.1 percent, due to higher market jet fuel prices. On a dollar basis, the majority of the increase was attributable to higher market jet fuel prices, and the remainder of the increase was due to an increase in fuel gallons consumed. The following table provides more information on the Company's economic fuel cost per gallon, including the impact of fuel hedging premium expense and fuel derivative contracts: Six months ended June 30, 2021 2020 Economic fuel costs per gallon $ 1.83 $ 1.72 Fuel hedging premium expense (in millions) $ 50 $ 49 Fuel hedging premium expense per gallon $ 0.07 $ 0.07 Fuel hedging cash settlement gains per gallon $ 0.01 $ — See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. Maintenance materials and repairs expense for the first six months of 2021 decreased by $17 million, or 4.1 percent, compared with the first six months of 2020. On a per ASM basis, Maintenance materials and repairs expense decreased 9.1 percent, compared with the first six months of 2020, as a result of the timing of regular airframe maintenance checks, and deferring some of these costs by placing a portion of the fleet in storage during the COVID-19 pandemic. On a dollar basis, the majority of the decrease was due to lower engine maintenance expense due to the decrease in flight hours. Landing fees and airport rentals expense for the first six months of 2021 increased by $102 million, or 16.6 percent, compared with the first six months of 2020. On a per ASM basis, Landing fees and airport rentals expense increased 10.4 percent, compared with the first six months of 2020, as higher costs from additional space and higher 44 airport rental rates across the network were exceeded by the significant increase in capacity year-over-year. On a dollar basis, the majority of the increase was due to an increased number of Trips flown and the increase in space rental rates in the first six months of 2021. Depreciation and amortization expense for the first six months of 2021 increased by $3 million, or 0.5 percent, compared with the first six months of 2020. On a per ASM basis, Depreciation and amortization expense decreased 5.1 percent, compared with the first six months of 2020, as the dollar increase was more than offset by the 6.2 percent increase in capacity. On a dollar basis, the majority of the increase was associated with the deployment of new technology assets. Other operating expenses, net for the first six months of 2021 increased by $132 million, or 14.4 percent, compared with the first six months of 2020. Included within this line item was aircraft rentals expense in the amounts of $103 million and $98 million for the periods ended June 30, 2021 and 2020, respectively. On a per ASM basis, Other operating expenses, net increased 6.9 percent, compared with the first six months of 2020. On both a dollar and per ASM basis, the increases were primarily due to gains from the sale-leaseback of 20 aircraft to third parties in two separate transactions during second quarter 2020, which reduced Other operating expenses, net in second quarter 2020 and were considered special items and thus excluded from the Company's non-GAAP results for the six months ended June 30, 2020. Other Other expenses (income) include interest expense, capitalized interest, interest income, and other gains and losses. Interest expense for the first six months of 2021 increased by $105 million, or 84.7 percent, compared with the first six months of 2020, primarily due to higher debt balances in the first six months of 2021. Capitalized interest for the first six months of 2021 increased by $7 million, or 58.3 percent, compared with the first six months of 2020, primarily due to Boeing resuming production of the Company's undelivered MAX aircraft. Interest income for the first six months of 2021 decreased by $22 million, or 84.6 percent, compared with the first six months of 2020, due to lower interest rates. Other (gains) losses, net, primarily includes amounts recorded as a result of the Company's hedging activities. See Note 4 to the unaudited Condensed Consolidated Financial Statements for further information on the Company's hedging activities. The following table displays the components of Other (gains) losses, net, for the six months ended June 30, 2021 and 2020: Six months ended June 30, (in millions) 2021 2020 Mark-to-market impact from fuel contracts settling in current and future periods $ (9) $ 17 Premium cost of fuel contracts not designated as hedges 21 11 Mark-to-market impact from interest rate swap agreements — 29 Mark-to-market gain on deferred compensation plan investment (18) — Correction on investment gains related to prior periods (a) (60) — Other 5 3 $ (61) $ 60 (a) See Note 1 to the unaudited Condensed Consolidated Financial Statements for further information. 45 Income Taxes The Company's effective tax rate was approximately 28.4 percent for the first six months of 2021, compared with 27.0 percent for the first six months of 2020. The higher tax rate for the first six months of 2021 was primarily due to higher state taxes than previously estimated. 46 Reconciliation of Reported Amounts to Non-GAAP Financial Measures (excluding special items) (unaudited) (in millions, except per share amounts and per ASM amounts) Three months ended June 30, Percent Six months ended June 30, Percent 2021 2020 Change 2021 2020 Change Fuel and oil expense, unhedged $ 802 $ 254 $ 1,266 $ 1,100 Add: Premium cost of fuel contracts designated as hedges 14 13 29 38 Deduct: Fuel hedge gains included in Fuel and oil expense, net (13) (10) (23) (10) Fuel and oil expense, as reported $ 803 $ 257 $ 1,272 $ 1,128 Add: Fuel hedge contracts settling in the current period, but for which losses were reclassified from AOCI (a) 5 10 14 10 Add: Premium cost of fuel contracts not designated as hedges 10 11 21 11 Fuel and oil expense, excluding special items (economic) $ 818 $ 278 194.2 $ 1,307 $ 1,149 13.8 Total operating expenses, net, as reported $ 3,414 $ 2,135 $ 5,267 $ 6,479 Add: Payroll support and voluntary Employee programs, net 740 784 2,187 784 Add: Fuel hedge contracts settling in the current period, but for which losses were reclassified from AOCI (a) 5 10 14 10 Add: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a) 1 — 2 — Add: Premium cost of fuel contracts not designated as hedges 10 11 21 11 Add: Gain from aircraft sale-leaseback transactions — 222 — 222 Total operating expenses, excluding special items $ 4,170 $ 3,162 31.9 $ 7,491 $ 7,506 (0.2) Deduct: Fuel and oil expense, excluding special items (economic) (818) (278) (1,307) (1,149) Operating expenses, excluding Fuel and oil expense and special items $ 3,352 $ 2,884 16.2 $ 6,184 $ 6,357 (2.7) Deduct: Profitsharing expense (85) — (109) — Operating expenses, excluding Fuel and oil expense, special items, and profitsharing $ 3,267 $ 2,884 13.3 $ 6,075 $ 6,357 (4.4) Operating income (loss), as reported $ 594 $ (1,127) $ 793 $ (1,237) Deduct: Payroll support and voluntary Employee programs, net (740) (784) (2,187) (784) Deduct: Fuel hedge contracts settling in the current period, but for which losses were reclassified from AOCI (a) (5) (10) (14) (10) Deduct: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a) (1) — (2) — Deduct: Premium cost of fuel contracts not designated as hedges (10) (11) (21) (11) Deduct: Gain from aircraft sale-leaseback transactions — (222) — (222) Operating loss, excluding special items $ (162) $ (2,154) (92.5) $ (1,431) $ (2,264) (36.8) Other (gains) losses, net, as reported $ (14) $ 32 $ (61) $ 60 Add (Deduct): Mark-to-market impact from fuel contracts settling in current and future periods (a) 11 (15) 9 (17) Deduct: Premium cost of fuel contracts not designated as hedges (10) (11) (21) (11) Deduct: Mark-to-market impact from interest rate swap agreements — (5) — (29) Other (gains) losses, net, excluding special items $ (13) $ 1 n.m. $ (73) $ 3 n.m. 47 Three months ended June 30, Percent Six months ended June 30, Percent 2021 2020 Change 2021 2020 Change Income (loss) before income taxes, as reported $ 502 $ (1,239) $ 648 $ (1,383) Deduct: Payroll support and voluntary Employee programs, net (740) (784) (2,187) (784) Deduct: Fuel hedge contracts settling in the current period, but for which losses were reclassified from AOCI (a) (5) (10) (14) (10) Deduct: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a) (1) — (2) — Deduct: Gain from aircraft sale-leaseback transactions — (222) — (222) Add (Deduct): Mark-to-market impact from fuel contracts settling in current and future periods (a) (11) 15 (9) 17 Add: Mark-to-market impact from interest rate swap agreements — 5 — 29 Loss before income taxes, excluding special items $ (255) $ (2,235) (88.6) $ (1,564) $ (2,353) (33.5) Provision (benefit) for income taxes, as reported $ 154 $ (324) $ 185 $ (374) Deduct: Net income (loss) tax impact of fuel and special items (b) (203) (327) (528) (319) Deduct: GAAP to Non-GAAP tax rate difference (c) — (83) — (82) Benefit for income taxes, net, excluding special items $ (49) $ (734) (93.3) $ (343) $ (775) (55.7) Net income (loss), as reported $ 348 $ (915) $ 463 $ (1,009) Deduct: Payroll support and voluntary Employee programs, net (740) (784) (2,187) (784) Deduct: Fuel hedge contracts settling in the current period, but for which losses were reclassified from AOCI (a) (5) (10) (14) (10) Deduct: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a) (1) — (2) — Deduct: Gain from aircraft sale-leaseback transactions — (222) — (222) Add (Deduct): Mark-to-market impact from fuel contracts settling in current and future periods (a) (11) 15 (9) 17 Add: Mark-to-market impact from interest rate swap agreements — 5 — 29 Add: Net income (loss) tax impact of special items (b) 203 327 528 319 Add: GAAP to Non-GAAP tax rate difference (c) — 83 — 82 Net loss, excluding special items $ (206) $ (1,501) (86.3) $ (1,221) $ (1,578) (22.6) Net income (loss) per share, diluted, as reported $ 0.57 $ (1.63) $ 0.76 $ (1.87) Deduct: Impact of special items (1.21) (1.76) (3.59) (1.78) Deduct: Net impact of net income (loss) above from fuel contracts divided by dilutive shares (0.03) (0.02) (0.04) (0.02) Add: Net income (loss) tax impact of special items (b) 0.33 0.59 0.87 0.59 Add: GAAP to Non-GAAP tax rate difference (c) — 0.15 — 0.15 Deduct: GAAP to Non-GAAP diluted weighted average shares difference (d) (0.01) — (0.07) — Net loss per share, diluted, excluding special items $ (0.35) $ (2.67) (86.9) $ (2.07) $ (2.93) (29.4) Operating expenses per ASM (cents) 10.22 ¢ 11.94 ¢ 9.31 ¢ 12.17 ¢ Add: Impact of special items 2.22 5.62 3.87 1.89 Deduct: Fuel and oil expense divided by ASMs (2.41) (1.44) (2.25) (2.12) Deduct: Profitsharing expense divided by ASMs (0.25) — (0.19) — Operating expenses per ASM, excluding Fuel and oil expense, profitsharing, and special items (cents) 9.78 ¢ 16.12 ¢ (39.3) 10.74 ¢ 11.94 ¢ (10.1) 48 (a) See Note 4 to the unaudited Condensed Consolidated Financial Statements for further information. (b) Tax amounts for each individual special item are calculated at the Company's effective rate for the applicable period and totaled in this line item. (c) Adjustment related to GAAP and Non-GAAP tax rate differences, primarily due to the Payroll Support being excluded as a special item, and reflected 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. (d) Adjustment related to GAAP and Non-GAAP diluted weighted average shares difference, due to the Company being in a Net income position on a GAAP basis versus a Net loss position on a Non-GAAP basis. See Note 7 to the unaudited Condensed Consolidated Financial Statements for further information. 49 Note Regarding Use of Non-GAAP Financial Measures The Company's unaudited Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). These GAAP financial statements may include (i) unrealized noncash adjustments and reclassifications, which can be significant, as a result of accounting requirements and elections made under accounting pronouncements relating to derivative instruments and hedging and (ii) other charges and benefits the Company believes are unusual and/or infrequent in nature and thus may make comparisons to its prior or future performance difficult. As a result, the Company also provides financial information in this filing that was not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. The Company provides supplemental non-GAAP financial information (also referred to as "excluding special items"), including results that it refers to as "economic," which the Company's management utilizes to evaluate its ongoing financial performance and the Company believes provides additional insight to investors as supplemental information to its GAAP results. The non-GAAP measures provided that relate to the Company’s performance on an economic fuel cost basis include Fuel and oil expense, non-GAAP; Total operating expenses, non-GAAP; Operating expenses, non-GAAP excluding Fuel and oil expense; Operating expenses, non-GAAP excluding Fuel and oil expense and profitsharing; Operating loss, non-GAAP; Other (gains) losses, net, non-GAAP; Loss before income taxes, non-GAAP; Benefit for income taxes, net, non-GAAP; Net loss, non-GAAP; Net loss per share, diluted, non-GAAP; and Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing (cents). The Company's economic Fuel and oil expense results differ from GAAP results in that they only include the actual cash settlements from fuel hedge contracts - all reflected within Fuel and oil expense in the period of settlement. Thus, Fuel and oil expense on an economic basis has historically been utilized by the Company, as well as some of the other airlines that utilize fuel hedging, as it reflects the Company’s actual net cash outlays for fuel during the applicable period, inclusive of settled fuel derivative contracts. Any net premium costs paid related to option contracts that are designated as hedges are reflected as a component of Fuel and oil expense, for both GAAP and non-GAAP (including economic) purposes in the period of contract settlement. The Company believes these economic results provide further insight into the impact of the Company's fuel hedges on its operating performance and liquidity since they exclude the unrealized, noncash adjustments and reclassifications that are recorded in GAAP results in accordance with accounting guidance relating to derivative instruments, and they reflect all cash settlements related to fuel derivative contracts within Fuel and oil expense. This enables the Company's management, as well as investors and analysts, to consistently assess the Company's operating performance on a year-over-year or quarter-over-quarter basis after considering all efforts in place to manage fuel expense. However, because these measures are not determined in accordance with GAAP, such measures are susceptible to varying calculations, and not all companies calculate the measures in the same manner. As a result, the aforementioned measures, as presented, may not be directly comparable to similarly titled measures presented by other companies. Further information on (i) the Company's fuel hedging program, (ii) the requirements of accounting for derivative instruments, and (iii) the causes of hedge ineffectiveness and/or mark-to-market gains or losses from derivative instruments is included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 and Note 4 to the unaudited Condensed Consolidated Financial Statements. The Company’s GAAP results in the applicable periods may include other charges or benefits that are also deemed "special items," that the Company believes make its results difficult to compare to prior periods, anticipated future periods, or industry trends. Financial measures identified as non-GAAP (or as excluding special items) have been adjusted to exclude special items. For the periods presented, in addition to the items discussed above, special items include: 1. Proceeds related to the Payroll Support programs, which were used to pay a portion of Employee salaries, wages, and benefits; 2. Charges and adjustments to previously accrued amounts related to the Company's extended leave program; 50 3. Adjustments for prior period losses reclassified from AOCI associated with forward-starting interest rate swap agreements that were terminated in prior periods related to eleven 737 MAX 8 aircraft leases; 4. Gains associated with the sale-leaseback of ten Boeing 737-800 aircraft and ten Boeing 737 MAX 8 aircraft to third parties; and 5. Unrealized losses related to twelve forward-starting interest rate swap agreements. During the first six months of 2020, the interest rate swap agreements, which were related to twelve 737 MAX 8 aircraft leases (with deliveries originally scheduled between June 2020 and September 2020), were de-designated as hedges due to the scheduled delivery range no longer being probable, resulting in the mark-to-market changes being recorded to earnings. Because management believes special items can distort the trends associated with the Company’s ongoing performance as an airline, the Company believes that evaluation of its financial performance can be enhanced by a supplemental presentation of results that exclude the impact of special items in order to enhance consistency and comparativeness with results in prior periods that do not include such items and as a basis for evaluating operating results in future periods. The following measures are often provided, excluding special items, and utilized by the Company’s management, analysts, and investors to enhance comparability of year-over-year results, as well as to industry trends: Fuel and oil expense, non-GAAP; Total operating expenses, non-GAAP; Operating expenses, non-GAAP excluding Fuel and oil expense; Operating expenses, non-GAAP excluding Fuel and oil expense and profitsharing; Operating loss, non-GAAP; Other (gains) losses, net, non-GAAP; Loss before income taxes, non-GAAP; Benefit for income taxes, net, non-GAAP; Net loss, non-GAAP; Net loss per share, diluted, non-GAAP; and Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing (cents). 51 The Company has also utilized and provided average cash burn/flow and average daily core cash burn/flow which are non-GAAP financial measures. Cash burn/flow is a supplemental measure that most U.S. airlines began providing in 2020 to measure liquidity in light of the negative financial effects of the pandemic. The Company utilizes average daily core cash burn/flow to monitor the performance of its core business as a proxy for its ability to achieve sustainable break-even or positive results on a cash basis. Cash burn/flow methodology may vary by airline, and the Company's second quarter 2021 average daily core cash burn/flow may differ materially by utilizing cash burn/flow calculations that adjust for changes in working capital - including changes for Air traffic liability and cash payments for voluntary separation and extended emergency time off payments, among other items. See the Company's calculation of cash burn/flow below: Three months ended (in millions, except for Days in the period) June 30, 2021 Loss before income taxes, non-GAAP $ (255) Depreciation and amortization expense 315 Capital expenditures (95) Debt service payments (43) Core cash burn $ (78) Days in the period 91 Average daily core cash burn $ (1) Core cash burn, prior to changes in working capital $ (78) Increase in Air traffic liability 946 Payments associated with Voluntary Employee Programs (159) Cash payments for income taxes (176) Other (10) Core cash flow, adjusted for changes in working capital $ 523 Days in the period 91 Average daily core cash flow, adjusted for changes in working capital $ 6 52 Liquidity and Capital Resources The enormous impact of the COVID-19 pandemic on the U.S. travel industry created an urgent liquidity crisis for the entire airline industry, including the Company. However, due to the Company's pre-pandemic low balance sheet leverage, large base of unencumbered assets, and investment-grade credit ratings, the Company was able to quickly access additional liquidity during 2020, as Customer cancellations spiked and sales and revenues dropped while the Company continued to experience significant fixed operating expenses. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information regarding the impact of the COVID-19 pandemic and assistance obtained under Payroll Support programs. Net cash provided by operating activities was $2.0 billion for the three months ended June 30, 2021, compared with $897 million provided by operating activities in the same prior year period. For the six months ended June 30, 2021, net cash provided by operating activities was $2.7 billion, compared with $520 million provided by operating activities in the same prior year period. Operating cash inflows are primarily derived from providing air transportation to Customers. The vast majority of tickets are purchased prior to the day on which travel is provided and, in some cases, several months before the anticipated travel date. Operating cash outflows are related to the recurring expenses of airline operations. Operating cash flows for the six months ended June 30, 2021, included $2.7 billion in Payroll Support program grant proceeds, of which $1.9 billion was used to offset eligible costs, and was thus included in operating activities, as well as $45 million allocated to the value of warrants issued and thus included in financing activities. The net increase in operating cash flows was also a result of a $1.5 billion increase in Air traffic liability driven by increased ticket sales related to an increase in leisure travel demand. For the six months ended June 30, 2020, the operating cash flows were affected primarily by $2.0 billion in Payroll Support program grant proceeds received, of which $1.1 billion was used to offset eligible costs, and the $307 million accrual of expected costs for the Voluntary Separation Program. The increase in operating cash flows was also a result of a $1.4 billion increase in Air traffic liability. This increase was partially offset by the Company's Net loss (as adjusted for non-cash items) and a $90 million decrease in Accounts payable and accrued expenses due to the Company's payout in 2020 of its 2019 $667 million profitsharing distribution to Employees, a significant decline in amounts payable for passenger excise taxes and segment fees as a result of the decline in passenger ticket sales, and the suspension of collection of certain ticket taxes as dictated by the CARES Act. Net cash provided by operating activities is primarily used to finance capital expenditures, repay debt, and provide working capital. Historically, the Company has also used net cash provided by operations to fund stock repurchases and pay dividends; however these shareholder return activities have been suspended due to restrictions associated with the payroll assistance under the Payroll Support programs. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. Net cash used in investing activities totaled $469 million during the three months ended June 30, 2021, compared with $332 million provided by investing activities in the same prior year period. Net cash used in investing activities was $670 million during the six months ended June 30, 2021, compared with $327 million provided by investing activities in the same prior year period. Investing activities in both years included Capital expenditures, and changes in the balance of the Company's short-term and noncurrent investments. The Company also raised $815 million from the sale-leaseback of 20 aircraft and received $428 million of Supplier proceeds during the six months ended June 30, 2020, which the Company considers an offset to its aircraft capital expenditures. During the six months ended June 30, 2021, Capital expenditures were $190 million, compared with $336 million in the same prior year period. Capital expenditures decreased, year-over-year, largely due to a decrease in technology and facilities project expenditures and several projects being placed into service since June 30, 2020. In addition, the Company did not make progress payments on future aircraft deliveries or payments for new delivered MAX 8 aircraft during the six months ended June 30, 2021, compared to the same prior year period, when progress payments were made. See Notes 2 and 11 to the unaudited Condensed Consolidated Financial Statements for further information. As a result of previously agreed upon delivery credits provided by Boeing 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, the Company currently estimates relatively minimal aircraft capital expenditures in 2021. Therefore, the Company currently estimates its annual 2021 capital expenditures to be in the range of 53 $500 million to $600 million. Based on 70 firm orders currently planned in 2022 as discussed in "Company Overview," the Company's contractual aircraft capital expenditures for 2022 are estimated to be approximately $1.6 billion. Further, the Company's total contractual aircraft capital expenditures for all years 2021 through 2026, which represents 209 MAX firm orders (175 MAX 7 and 34 MAX 8 aircraft), are estimated to be approximately $5.7 billion. Fleet and other capital investment plans are expected to continue to evolve as the Company manages through this pandemic recovery period, and the Company intends to evaluate the exercise of its remaining 44 MAX options for 2022 as decision deadlines occur throughout the remainder of this year. Net cash provided by financing activities was $617 million during the three months ended June 30, 2021, compared with $7.2 billion provided by financing activities for the same prior year period. Net cash provided by financing activities was $1.1 billion during the six months ended June 30, 2021, compared with $9.0 billion provided by financing activities for the same year period. During the six months ended June 30, 2021, the Company borrowed $1.1 billion of loan proceeds under Payroll Support programs. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information. The Company repaid $109 million in debt and finance lease obligations during the six months ended June 30, 2021, and is scheduled to repay approximately $111 million in debt and finance lease obligations during the remainder of 2021. During the six months ended June 30, 2020, the Company borrowed $12.3 billion, through various transactions, in order to improve its liquidity position as a result of the onset of the pandemic. An additional $2.3 billion was raised from a public offering of 80,500,000 shares of common stock. These financings were partially offset by the full repayment of the $3.7 billion borrowed under the Company's Amended and Restated 364-Day Credit Agreement and the $1.0 billion drawn under the Company's Amended and Restated Revolving Credit Facility, as amended (the "Revolving Credit Facility"). The Company also repurchased $451 million of its outstanding common stock, paid $188 million in cash dividends to Shareholders, and repaid $237 million in debt and finance lease obligations during the first six months of 2020. Average core cash burn was approximately $1 million per day in second quarter 2021; however, the Company achieved positive average daily core cash flow in June 2021, of approximately $4 million. Based on current booking trends and cost outlook, the Company is hopeful to be profitable, both on a GAAP and non-GAAP basis, in third and fourth quarter 2021. Cash burn/flow is a supplemental measure that most U.S. airlines began providing in 2020 to measure liquidity in light of the negative financial effects of the pandemic. Average daily core cash burn/flow is calculated as Loss/Income before income taxes, non-GAAP, adjusted for Depreciation and amortization expense; capital expenditures; and adjusted amortizing debt service payments; divided by the number of days in the period. The Company utilizes average daily core cash burn/flow to monitor the performance of its core business as a proxy for its ability to achieve sustainable break-even or positive results on a cash basis. Given that the Company’s cash burn/flow calculation is derived from Loss/Income before income taxes, non-GAAP, the Company excludes the following items in its calculation of average core cash burn/flow: financing transactions; Payroll Support proceeds; voluntary separation and extended emergency time off program payments; and other changes in working capital. Cash burn/flow methodology varies by airline, and the Company’s average daily core cash burn/flow may differ materially by utilizing cash burn/flow calculations that adjust for changes in working capital. Utilizing an alternative cash burn/flow approach, which adjusts for changes in working capital—including changes in Air traffic liability and cash payments for voluntary separation and extended emergency time off program payments, among other items—the Company generated average core cash flow of approximately $11 million per day in June 2021, and approximately $6 million per day in second quarter 2021. Average core cash burn/flow projections do not reflect the potential impact of special items because the Company cannot reliably predict or estimate those items or expenses or their impact to its financial statements in future periods. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures including the cash burn/flow formula. The Company is a "well-known seasoned issuer" and currently has an effective shelf registration statement registering an indeterminate amount of debt and equity securities for future sales. The Company currently intends to use the proceeds from any future securities sales off this shelf registration statement for general corporate purposes. 54 The Company has access to $1.0 billion under its Revolving Credit Facility. The Revolving Credit Facility 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. Interest on the facility is based on the Company's credit ratings at the time of borrowing. At the Company's current ratings, the interest cost would be LIBOR plus a spread of 200.0 basis points. The facility contains a financial covenant to maintain total liquidity, as defined in the Revolving Credit Facility, of $1.5 billion at all times under the Revolving Credit Facility; the Company was compliant with this requirement as of June 30, 2021. There were no amounts outstanding under the Revolving Credit Facility as of June 30, 2021. Although not the case at June 30, 2021, due to the Company's significant financing activities, the Company has historically carried a working capital deficit, in which its current liabilities exceed its current assets. This is common within the airline industry and is primarily due to the nature of the Air traffic liability account, which is related to advance ticket sales, unused funds available to Customers, and loyalty deferred revenue, which are performance obligations for future Customer flights, do not require future settlement in cash, and are mostly nonrefundable. See Note 6 to the unaudited Condensed Consolidated Financial Statements for further information. The Company has various options available to meet its capital and operating commitments, including unrestricted cash and short-term investments of $16.9 billion as of June 30, 2021, and anticipated future internally generated funds from operations. However, the COVID-19 pandemic continues to evolve and could have a material adverse impact on the Company's ability to meet its capital and operating commitments. See Note 2 to the unaudited Condensed Consolidated Financial Statements for further information on the impacts of the COVID-19 pandemic. During second quarter 2021, the Company entered into supplemental agreements to its aircraft purchase agreement with Boeing to increase its 2022 firm orders by 34 Boeing 737 MAX 7 (MAX 7) aircraft (consisting of two 2022 options exercised and 32 options accelerated and exercised from later years), resulting in 234 firm orders for MAX 7 aircraft as of June 30, 2021. Additionally, the Company accelerated 10 options into 2022, 32 options into 2023, 16 options into 2024, 16 options into 2025, and added 32 new options into 2026 through 2027, bringing the total firm and option order book to 660 aircraft as of June 30, 2021. See Note 10 to the unaudited Condensed Consolidated Financial Statements for further information. The following table details information on the aircraft in the Company's fleet as of June 30, 2021: Average Age (Yrs) Number of Aircraft Number Owned Number Leased Type Seats 737-700 143 17 461 (a) 371 90 737-800 175 6 207 190 17 737 MAX 8 175 2 68 (a) 40 28 Totals 12 736 601 135 (a) Included 39 Boeing 737 Next Generation aircraft in temporary storage as of June 30, 2021. 55 Cautionary Statement Regarding Forward-Looking Statements This Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are based on, and include statements about, the Company's estimates, expectations, beliefs, intentions, and strategies for the future, and the assumptions underlying these forward-looking statements. Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include, without limitation, statements related to the following: • the Company’s financial outlook, expectations, and projected results of operations, including underlying assumptions and estimates, in particular related to expectations regarding passenger demand, depressed demand for business travel, costs associated with voluntary separation and extended leave programs, and flight-driven cost increases; • the Company’s expectations with respect to capacity and load factors, including underlying assumptions and estimates; • the Company’s expectations with respect to capital expenditures and its related underlying assumptions, in particular with respect to aircraft capital expenditures; • the Company’s fleet plans and related expectations; • the Company’s network plans and expectations; • the Company’s expectations related to fuel efficiency, including the Company’s underlying assumptions; • the Company's initiatives; • the Company’s plans, expectations, and estimates related to fuel costs, the Company’s related management of risk associated with changing jet fuel prices, and the Company’s assumptions underlying its fuel-related expectations and estimates; • the Company's expectations with respect to cash flows and liquidity, including its ability to meet its ongoing capital, operating, and other obligations, and the Company’s anticipated needs for, and sources of, funds; • the Company's assessment of market risks; and • the Company's plans and expectations related to legal and regulatory proceedings. While management believes these forward-looking statements are reasonable as and when made, forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual results may differ materially from what is expressed in or indicated by the Company's forward-looking statements or from historical experience or the Company's present expectations. Factors that could cause these differences include, among others: • any negative developments related to the COVID-19 pandemic, including, for example, with respect to (i) the duration, spread, severity, or any recurrence of the COVID-19 pandemic; (ii) any new variant strains of the underlying virus; (iii) the effectiveness, availability, and usage of vaccines; (iv) the duration and scope of governmental orders and restrictions related to COVID-19; (v) the extent of the impact of COVID-19 on overall demand for air travel and the Company's related business plans and decisions; (vi) the impact of COVID-19 on the Company's ability to retain key Employees; and (vii) the impact of COVID-19 on the Company's access to capital; • the impact of fears or actual outbreaks of other diseases, extreme or severe weather and natural disasters, actions of competitors (including, without limitation, pricing, scheduling, capacity, and network decisions, and consolidation and alliance activities), consumer perception, economic conditions, fears of terrorism or war, and other factors beyond the Company's control on consumer behavior and the Company's results of operations and business decisions, plans, strategies, and results; • the impact of labor matters on the Company’s business decisions, plans, and strategies; • the impact of governmental actions and governmental regulations on the Company's plans, strategies, financial results, and operations; 56 • the impact of fuel price changes, fuel price volatility, volatility of commodities used by the Company for hedging jet fuel, and any changes to the Company’s fuel hedging strategies and positions on the Company's business plans and results of operations; • the Company's dependence on Boeing with respect to the Company's fleet, fuel, and capital expenditure plans and expectations; • the Company's and Boeing's dependence on other third-party providers to perform in accordance with expectations in connection with the manufacture and delivery of aircraft; • the Company's dependence on other third parties, in particular with respect to its fuel supply and its corporate travel enhancements, and the impact on the Company's operations and results of operations of any third party delays or non-performance; • the impact of the Company's obligations and restrictions related to its participation in Treasury's payroll support programs and any related negative impact on the Company’s ability to retain key Employees; and • other factors as set forth in the Company's filings with the Securities and Exchange Commission, including the detailed factors discussed under the heading “Risk Factors” in the Company's Annual Report on Form 10-K for the year ended December 31, 2020, and in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2021 . Caution should be taken not to place undue reliance on the Company's forward-looking statements, which represent the Company's views only as of the date this report is filed. The Company undertakes no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 57