YEAR IN REVIEW
In lateFebruary 2020 , the Company began to see a negative impact from the COVID-19 pandemic, which quickly accelerated during the first quarter and continued throughout the remainder of the year. As a consequence, the Company experienced its first annual net loss in 48 years. The Company's prior trend of 47 consecutive years of profitability was a feat unmatched in theU.S. airline industry. Both GAAP and non-GAAP results, shown in the following tables, were impacted by the pandemic. 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. Year ended (in millions, except per share amounts) December 31, GAAP 2020 2019 Percent Change Operating income (loss)$ (3,816) $ 2,957 n.m. Net income (loss)$ (3,074) $ 2,300 n.m.
Net income (loss) per share, diluted
n.m. Non-GAAP Operating income (loss)$ (5,032) $ 2,957 n.m. Net income (loss)$ (3,512) $ 2,300 n.m.
Net income (loss) per share, diluted
n.m.
The COVID-19 pandemic depressed the demand for air travel and negatively impacted both GAAP and non-GAAP results year-over-year. Operating revenues for the year endedDecember 31, 2020 decreased 59.7 percent as the Company experienced load factors and yields that were considerably lower than historical levels. The Company took action to reduce capacity and swiftly cut costs, which generated a reduction in operating expenses of 33.9 percent. However, due to the fixed nature of a large portion of the Company's cost structure, especially in the short-term, the reduction in operating expenses was not enough to overcome the dramatic decline in revenues. For periods prior to second quarter 2020, the Company provided its calculation of non-GAAP return on invested capital ("ROIC") as a measure of financial performance used by management to quantify the Company's effectiveness in generating returns relative to the capital invested in the business. By second quarter 2020, the precipitous drop in passenger demand and bookings caused by COVID-19 resulted in a material and adverse effect on the Company's operating income and cash flows from operations. As a result, management ceased focus on ROIC and instead has since focused on bolstering the Company's liquidity through cost reductions, financings, sale-leaseback transactions, and securities offerings. Accordingly, the Company has chosen not to present ROIC in this Form 10-K and does not expect to present it again until and if the operating environment normalizes sufficiently to return the Company to operating income instead of operating loss.
See Notes 2 and 7 to the Consolidated Financial Statements for further information on the significant impacts to the Company's operations, financial performance, and liquidity from the COVID-19 pandemic.
2021 Outlook
Thus far in 2021, the Company experienced stalled demand in January and bookings forFebruary 2021 , primarily driven by the high level of COVID-19 cases and hospitalizations, as well as a seasonally weaker time period for leisure travel demand following the holidays. However, trip cancellations have stabilized andJanuary 2021 operating revenues are expected to improve slightly compared with the Company's previous estimations for January 53 --------------------------------------------------------------------------------
2021 operating revenues provided
Estimated EstimatedJanuary 2021 February
2021
Operating revenues year-over-year Down 65% to 70% Down 65% to 75% Previous estimation Down 65% to 75% (a) As compared with 2019 Down 65% to 70% Down 65% to 75% Load factor 50% to 55% 50% to 55% Previous estimation 45% to 55% (a) ASMs year-over-year Down ~41% Down ~46% Previous estimation Down 40% to 45% Down 40% to 45% As compared with 2019 Down ~43% Down ~45%
(a) No previous estimation provided.
The Company estimates itsMarch 2021 capacity to decrease approximately 16 percent, year-over-year, or 31 percent, compared withMarch 2019 . The Company estimates its first quarter 2021 capacity to decrease approximately 35 percent year-over-year, primarily driven by the continued negative effects of the pandemic. Excluding Fuel and oil expense and special items, first quarter 2021 operating expenses are expected to decrease in the range of 15 to 20 percent, year-over-year, primarily due to lower capacity, year-over-year, as well as an estimated$400 million of cost savings from voluntary separation and extended leave programs. See Note 2 to the Consolidated Financial Statements for further description of these programs. The year-over-year projections do not reflect the potential impact of Fuel and oil expense, special items, and profitsharing expense in both years 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.
COVID-19 Pandemic
In response to the far-reaching impacts of the COVID-19 pandemic, the Company has taken significant measures to enhance and expand upon its already generous and flexible ticketing policies, and to support the well-being of both its Employees and passengers on a daily basis. These have included, but are not limited to the following: •Travel funds created because of a flight cancellation betweenMarch 1, 2020 andSeptember 7, 2020 , will now expireSeptember 7, 2022 . •Travel funds that would otherwise have expired betweenMarch 1, 2020 andSeptember 7, 2020 , will now expireSeptember 7, 2022 . •Rapid Rewards® loyalty program members who have travel funds that were set to expire, or funds that were created betweenMarch 1, 2020 andSeptember 7, 2020 , had the option to convert those travel funds into Rapid Rewards points at the same rate as they were able to purchase a ticket with points, throughDecember 15, 2020 . •All Rapid Rewards loyalty program members with an account opened byDecember 31, 2020 received a "boost" of 15,000 tier qualifying points and 10 flight credits toward A-List and A-List Preferred status, and 25,000Companion Pass qualifying points and 25 flight credits towardCompanion Pass status. •All current A-List and A-List Preferred tier status members onApril 1, 2020 earned status has been extended throughDecember 31, 2021 . •Companion pass members earned status onApril 1, 2020 has been extended throughDecember 31, 2021 . •Enhanced aircraft cleaning procedures have been applied sinceMarch 4, 2020 . 54 -------------------------------------------------------------------------------- •Procedures and protocol have been implemented with the requirement that Employees and Customers (age two or over) must wear masks or face coverings. •Measures to support physical distancing, including messaging to Customers and Employees, and modified boarding procedures, have been implemented. •A Customer health declaration, which must be acknowledged prior to travel, has been implemented. •An Employee health declaration, which all Employees are expected to acknowledge, has been implemented. •The Company continues to offer the ability to work remotely to most of the Company's office and clerical Employees, including the vast majority of its more than 6,000 Employees at the Company's headquarters campus inDallas, Texas . The Company continues to communicate with its entire workforce on the employment of best practices andCenters for Disease Control and Prevention guidelines in the current environment while at work, especially considering that a large portion of its Employees come into direct contact with Customers on a daily basis. As detailed in Note 2 to the Consolidated Financial Statements, in connection with the major negative impact of COVID-19 on air carriers, the Company has received significant financial assistance from theU.S. Department of Treasury (the "Treasury") pursuant to the Payroll Support Program established pursuant to the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). Amounts received under the Payroll Support Program were approximately$3.4 billion and were utilized to directly offset payroll expenses incurred by the Company, including specified benefits, betweenApril 2020 andSeptember 2020 . During 2020, the Company issued a promissory note in favor of theTreasury 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. Of the approximate$3.4 billion ,$2.4 billion consists of a grant that does not require repayment. Approximately$2.3 billion of the direct payroll support of$2.4 billion was allocated on a pro-rata basis as a contra-expense line item in the Consolidated Statement of Comprehensive Income (Loss) between second and third quarters of 2020, with the remaining$40 million allocated to the value of warrants issued from the Company to theTreasury . In accordance with restrictions contained in the CARES Act, and except as permitted or required under the Payroll Support Program, the Company did not (1) conduct involuntary terminations or furloughs or (2) reduce the salaries, wages, or benefits of any Employee, in each case between the date of the Payroll Support Program agreement andSeptember 30, 2020 . InJanuary 2021 , the Company entered into definitive documentation with theTreasury for further payroll support under the Consolidated Appropriations Act, 2021 (the "Payroll Support Program Extension"). Amounts received or to be received under the Payroll Support Program Extension are expected to total approximately$1.7 billion and will be utilized to directly offset payroll expenses incurred by the Company, including specified benefits, betweenJanuary 2021 andMarch 2021 . Of this total, approximately$1.2 billion consists of a grant that will not require repayment. The Company currently expects this direct payroll support of$1.2 billion will be classified as a contra-expense line item in the unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) during first quarter 2021. The Company has issued a promissory note in favor of theTreasury in an initial amount of approximately$229 million and expects the amount to total approximately$488 million once the remaining payroll support is received. See Note 2 for further information. In accordance with restrictions contained in the Payroll Support Program Extension, and except as permitted or required under the Payroll Support Program Extension, the Company has agreed not to (1) conduct involuntary terminations or furloughs or (2) reduce the salaries, wages, or benefits of any Employee, in each case between the date of the Payroll Support Program Extension agreement andMarch 31, 2021 . During second quarter 2020, the Company introduced Voluntary Separation Program 2020 and the Extended Emergency Time Off ("Extended ETO") program which aligned staffing to reduced flight schedules and enabled the Company to avoid involuntary furloughs and layoffs through 2020. Employees had untilJuly 15, 2020 , to determine whether to participate in one of these programs, and approximately 15,000 Employees elected to do so. The Company continues to evaluate and evolve its Extended ETO program in early 2021, including offering additional 55 -------------------------------------------------------------------------------- Extended ETO opportunities of one, two, or three month durations to certain Employees who are either not currently participating in Extended ETO, or who are currently on Extended ETO set to expire in coming months. In accordance with applicable accounting guidance, the Company recorded 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 2020 and the special benefits for Employees who participated in its Extended ETO program; the accrual is being reduced as program benefits are paid. This program has allowed the Company to reduce its fixed cost structure in the near-term, while maintaining the ability to adjust to a recovery in travel demand. See Note 2 to the 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$565 million in 2020. The Company expects an incremental$600 million of annual 2021 cost savings from these two programs, for a total reduction in salaries, wages, and benefits of approximately$1.2 billion , compared with annual 2019. In addition, Employees could take Emergency Time Off ("ETO") for a calendar month, or Time Off Without Pay ("TOWOP") or Leave Without Pay ("LWOP") in smaller time increments. BetweenMarch 2020 andDecember 2020 , the ETO, TOWOP, and LWOP programs accounted for a savings of approximately$265 million .
Company Overview
As ofDecember 31, 2020 , the Company operated approximately 50 percent of the daily departures operated as ofDecember 31, 2019 , prior to the impacts of the pandemic. The Company is pursuing additional revenue opportunities that utilize idle aircraft and Employees to provideSouthwest'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 map are opportunities it can provide Customers now, all while better positioning the Company for a travel demand rebound. The Company launched service to six new destinations in 2020: •Hilo International Airport -January 19, 2020 •Cozumel International Airport -March 7, 2020 •Miami International Airport and Palm Springs International Airport -November 15, 2020 •Montrose Regional Airport (Telluride and Crested Butte) andYampa Valley Regional Airport (Steamboat Springs ) -December 19, 2020 The Company has also announced other new destinations and expected service commencement dates including: •Chicago O'Hare International Airport andSarasota Bradenton International Airport -February 14, 2021 •Colorado Springs Municipal Airport andSavannah/Hilton Head International Airport -March 11, 2021 •Houston'sGeorge Bush Intercontinental Airport andSanta Barbara Airport -April 12, 2021 •Fresno Yosemite International Airport -April 25, 2021 •Jackson-Medgar Wiley Evers International Airport inMississippi -June 6, 2021 As previously reported, the Company suspended international operations in first quarter 2020 and has resumed selected service as follows: •Mexico and theCaribbean viaCancun ,San Jose del Cabo/Los Cabos , andMontego Bay -July 1, 2020 •Puerto Vallarta,Mexico -October 8, 2020 •Punta Cana,Dominican Republic , andAruba -November 4, 2020 •Havana,Cuba -December 6, 2020 The Company also resumed service toNassau onJuly 1, 2020 , but in response to new local restrictions imposed by the Bahamian government, the Company again suspended operations effectiveJuly 22, 2020 . The Company is scheduled to resume service toCozumel, Mexico in first quarter 2021. Service to the Company's other international destinations is expected to resume pending the easing of government restrictions. The Company achieved its goal of launching global distribution system ("GDS") access for corporate travelers in 2020, now at industry-standard participation with Amadeus' GDS platform and Travelport's multiple GDS platforms: Apollo, Worldspan, and Galileo. Also, inDecember 2020 , the Company reached a full-participation GDS 56 --------------------------------------------------------------------------------
agreement with Sabre, planned to launch in the second half of 2021. The Company's enhancement of its GDS channel strategy complements its goal of distributing its everyday low fares to more corporate travelers through their preferred channel.
OnNovember 18, 2020 , theFederal Aviation Administration (the "FAA") issued official requirements to enable airlines to return the Boeing 737 MAX to service. The Company is currently working to meet theFAA 's requirements by modifying certain operating procedures, implementing enhanced Pilot training requirements, installingFAA -approved flight control software updates, and completing other required maintenance tasks specific to the MAX aircraft. The Company has scheduled the MAX return to revenue service onMarch 11, 2021 , after the Company is expected to have met allFAA requirements and all active Pilots are expected to have received updated, MAX-related training. The Company continues its fleet modernization program and expects to retire a significant amount of its Boeing 737-700 fleet over the next 10-15 years. The Company evaluates whether to adhere to or alter its aircraft retirement plans in light of the COVID-19 pandemic and other factors, including whether to retain aircraft longer or accelerate retirements and replacements. The Company plans to use the Boeing 737 MAX 8 aircraft in its fleet modernization program and believes it will also have use for smaller aircraft such as the Boeing 737 MAX 7. DuringDecember 2020 , the Company took delivery of seven new leased Boeing 737 MAX 8 aircraft from third parties. The Company recently reached an agreement with The Boeing Company (the "Boeing Agreement") to take delivery of the delayed MAX aircraft and currently expects to receive 35 MAX 8 deliveries through the end of 2021 consisting of 19 purchased aircraft and 16 leased aircraft (including the seven leases received inDecember 2020 ). Based on current delivery and retirements plans, the Company currently expects its fleet in 2021 to decrease from its fleet of 747 aircraft as ofDecember 31, 2019 . The details of the Boeing Agreement, which included the settlement of 2020 estimated damages relating to the grounding of the Company's 737 MAX 8 aircraft, are confidential. However, as a result of certain delivery credits provided in the Boeing Agreement, as well as progress payments made to date on undelivered aircraft, the Company currently estimates an immaterial amount of aircraft capital expenditures in 2021. See Note 17 to the Consolidated Financial Statements and "Liquidity and Capital Resources" for further information.
The Company and Boeing are in discussions to change the Company's aircraft order book, and the Company expects to make further adjustments to the delivery schedule. The Company offers no assurances that current estimations and timelines will not be changed.
2020 Compared with 2019
Operating Revenues
Passenger revenues for 2020 decreased by$13.1 billion , or 63.1 percent, compared with 2019. On a unit basis, Passenger revenues decreased 43.9 percent, year-over-year. The decreases in Passenger revenues on both a dollar and unit basis were primarily due to the impact of the COVID-19 pandemic, which resulted in significant reductions in capacity and a sharp decline in passenger demand and bookings during 2020. Freight revenues for 2020 decreased by$11 million , or 6.4 percent, compared with 2019, primarily due to fewer trips flown, coupled with worldwide supply chain disruptions which reduced cargo demand. This reduction was partially offset by an increase in freight only activities, as the Company transported supplies in response to the COVID-19 pandemic. Other revenues for 2020 decreased by$258 million , or 17.4 percent, compared with 2019. The decrease was primarily due to a decrease in income from business partners, includingChase Bank USA, N.A. ("Chase") and the impact on spend on the Company's co-brand card, driven by the decline in consumer spending due to economic uncertainty and widespread restrictions related to the COVID-19 pandemic. 57 --------------------------------------------------------------------------------
Operating Expenses
Operating expenses for 2020 decreased by$6.6 billion , or 33.9 percent, compared with 2019, while capacity decreased 34.2 percent over the same 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 Operating expenses are largely fixed once flight schedules are published, and the Company has experienced significant ASM reductions as a result of flight schedule adjustments related to the COVID-19 pandemic. Flight schedule adjustments are expected to drive unit cost pressure for the duration of the COVID-19 pandemic, excluding any impacts associated with grants received under the CARES Act, the Payroll Support Program Extension, or other legislation. See "COVID-19 Pandemic" above and Note 2 to the Consolidated Financial Statements for further information. The following table presents the Company's Operating expenses per ASM for 2020 and 2019, followed by explanations of these changes on a per ASM basis and dollar basis: Year ended December 31, Per ASM Percent (in cents, except for percentages) 2020 2019 change change Salaries, wages, and benefits 6.58 ¢ 5.27 ¢ 1.31 ¢ 24.9 % Payroll support and voluntary Employee programs, net (0.94) - (0.94) n.m. Fuel and oil 1.78 2.76 (0.98) (35.5) Maintenance materials and repairs 0.72 0.78 (0.06) (7.7) Landing fees and airport rentals 1.21 0.87 0.34 39.1 Depreciation and amortization 1.21 0.78 0.43 55.1 Other operating expenses, net 1.87 1.92 (0.05) (2.6) Total 12.43 ¢ 12.38 ¢ 0.05 ¢ 0.4 % Operating expenses per ASM for 2020 increased by 0.4 percent, compared with 2019. The year-over-year unit cost increase in 2020 was primarily driven by significant capacity reductions as a result of the COVID-19 pandemic. The increase was partially offset by decreases in market jet fuel prices, coupled with the funding received through the Payroll Support Program, net of an accrual made for Employees that elected to participate in Voluntary Separation Program 2020 or Extended ETO programs. See Note 2 to the Consolidated Financial Statements for further information. Operating expenses per ASM for 2020, excluding Fuel and oil expense, special items, and profitsharing (a non-GAAP financial measure), increased 28.1 percent year-over-year, primarily due to the significant reduction in capacity associated with the COVID-19 pandemic. 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 2020 decreased by$1.5 billion , or 17.9 percent, compared with 2019. On a per ASM basis, Salaries, wages, and benefits expense for 2020 increased 24.9 percent, compared with 2019. On a dollar basis, the decrease was primarily the result of no profitsharing expense accrual in 2020 due to the Company's net loss, compared with a profitsharing accrual of$667 million in 2019. On a per ASM basis, however, the dollar decrease was more than offset by the 34.2 percent decrease in capacity. Excluding profitsharing in both years, the dollar decrease was driven by lower salaries, wages, and benefits expense, as a result of Employees electing Voluntary Separation Program 2020, Extended ETO, and other time off programs offered by the Company. OnOctober 5, 2020 , the Company announced planned pay reductions for non-contract Employees and its intention to approach union leaders for concessions, in further efforts to reduce operating expenses, as there was uncertainty surrounding an extension of the Payroll Support Program. The Company conducted negotiations with various unionized Employee groups. WARN notices were subsequently issued to various groups that were unable to reach agreements on concessions. These WARN notices and pay reduction intentions were retracted after the Payroll Support Program Extension was signed into law. 58 -------------------------------------------------------------------------------- The following table sets forth the Company's unionized Employee groups with amendable contracts that are currently in negotiations on collective-bargaining agreements: Approximate Number of Employee Group Employees Representatives Amendable Date Southwest Airlines Pilots' Southwest Pilots 8,500 Association ("SWAPA") September 2020 Transportation Workers of America, AFL-CIO, Local 556 Southwest Flight Attendants 15,400 ("TWU 556")
Southwest Customer Service Agents, CustomerInternational Association of Representatives, and Source of Machinists and
Aerospace
Support Representatives 6,400 Workers, AFL-CIO
("IAM 142")
Southwest Aircraft Appearance Aircraft Mechanics Fraternal Technicians 160 Association ("AMFA") November 2020 Transportation Workers of America, AFL-CIO, Local 550 Southwest Dispatchers 390 ("TWU 550") June 2019 Southwest Meteorologists 10 TWU 550 June 2019 DuringJanuary 2021 , the Company's Flight Crew Training Instructors, represented byTransportation Workers of America , ratified a tentative collective-bargaining agreement with the Company. The newly ratified contract becomes amendable inJanuary 2022 . Payroll support and voluntary Employee programs, net for 2020 was a net decrease to expense of$967 million , compared with no amounts for 2019. On a per ASM basis, Payroll support and voluntary Employee programs, net for 2020 was a net reduction of0.94 cents . The Company recognized a$2.3 billion allocation of Payroll Support Program proceeds as a reduction to 2020 expenses as part of the CARES Act. The Company also recognized a total of$1.4 billion in expense in 2020 associated with the Voluntary Separation Program 2020 and Extended ETO elections. Given the unusual nature of each of these items, the Company has chosen to net them within a single line item in the Consolidated Statement of Income (Loss). See Note 2 to the Consolidated Financial Statements for further information. Fuel and oil expense for 2020 decreased by$2.5 billion , or 57.5 percent, compared with 2019. On a per ASM basis, Fuel and oil expense decreased 35.5 percent, compared with 2019, due to lower market jet fuel prices. On a dollar basis, the majority of the decrease was attributable to a significant decrease in fuel gallons consumed, and the remainder of the decrease was due to lower market jet fuel prices. The following table provides more information on the Company's economic fuel cost per gallon: Year ended December
31,
(per gallon) 2020
2019
Economic fuel costs per gallon$ 1.49
Fuel hedging premium expense per gallon$ 0.08 $ 0.05 Fuel hedging cash settlement gains per gallon $ -
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 continued to operate fewer of its oldest, least fuel-efficient Boeing 737-700 aircraft as a result of capacity reductions due to the COVID-19 pandemic, which, combined with lower Load factors, resulted in a year-over-year improvement of 7.4 percent in fuel efficiency in 2020. The Company currently estimates first quarter 2021 fuel efficiency to improve in the range of five to six percent, year-over-year, primarily driven by a continuation of lower utilization of its 737-700 59 --------------------------------------------------------------------------------
aircraft and the Company's continued efforts to reduce its fuel consumption through fleet modernization with the anticipated benefits of the reintroduction of the MAX aircraft.
As of
Period Maximum fuel hedged (gallons in millions) (a)(b) 2021 1,283 2022 1,220 2023 643 Beyond 2023 101 (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 11 to the Consolidated Financial Statements for further information. (b) The Company holds derivative contracts at various Brent crude oil and West Texas Intermediate ("WTI") crude oil price levels to provide protection against energy market price fluctuations. These 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. 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 11 to the Consolidated Financial Statements for further information), as well as the amount of deferred losses in AOCI atDecember 31, 2020 , and the expected future periods in which these items are expected to settle and/or be recognized in earnings (in millions): Fair value of fuel Amount of losses deferred derivative contracts in AOCI at December 31, Year at December 31, 2020 2020 (net of tax) 2021 $ 13 $ (54) 2022 71 (25) 2023 41 (13) Beyond 2023 9 - Total $ 134 $ (92) 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 first quarter 2021 and full year 2021 jet fuel prices at different crude oil assumptions as ofJanuary 21, 2021 , and for expected premium costs associated with settling contracts each period, respectively. 60 -------------------------------------------------------------------------------- Estimated economic fuel price per
gallon, including taxes and fuel
hedging
premiums (e)
Average Brent Crude Oil price per barrel First Quarter 2021 (c) Full Year 2021 (d)$40 $1.30 -$1.40 $1.25 -$1.35 $50 $1.45 -$1.55 $1.50 -$1.60 Current Market (a)$1.60 -$1.70 $1.65 -$1.75 $60 $1.65 -$1.75 $1.75 -$1.85 $70 $1.85 -$1.95 $2.05 -$2.15 $80 $1.90 -$2.00 $2.15 -$2.25
Estimated fuel hedging premium expense
per gallon (b)$0.09 (f) Estimated premium costs (b)$25 million $100 million (a) Brent crude oil average market prices as ofJanuary 21, 2021 , were approximately$56 and$55 per barrel for first quarter 2021 and full year 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 ofJanuary 21, 2021 , first quarter 2021 economic fuel costs are estimated to be in the$1.60 to$1.70 per gallon range, including fuel hedging premium expense of approximately$25 million , or$.09 per gallon, and no cash settlements from fuel derivative contracts, on a per gallon basis. See Note Regarding Use of Non-GAAP Financial Measures. (d) Based on the Company's existing fuel derivative contracts and market prices as ofJanuary 21, 2021 , annual 2021 economic fuel costs are estimated to be in the$1.65 to$1.75 per gallon range, including fuel hedging premium expense of approximately$100 million and no cash settlements from fuel derivative contracts, on a per gallon basis. See Note Regarding Use of Non-GAAP Financial Measures. (e) The Company's current fuel derivative contracts contain a combination of instruments based in WTI 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 ofJanuary 21, 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. (f) Due to continued uncertainty regarding available seat mile plans for 2021, the Company cannot reasonably provide an estimate for its full year 2021 full hedging premium expense per gallon. Maintenance materials and repairs expense for 2020 decreased by$473 million , or 38.7 percent, compared with 2019. On a per ASM basis, Maintenance materials and repairs expense decreased 7.7 percent, compared with 2019, as the dollar decrease was largely offset by the 34.2 percent decrease in capacity in response to the COVID-19 pandemic. On a dollar basis, approximately 50 percent of the decrease was due to lower engine maintenance expense due to the reduction in flight hours, approximately 25 percent of the decrease was due to the timing of regular airframe maintenance checks, and the majority of the remainder of the decrease was due to reduced operations and placing a portion of the fleet in storage. Landing fees and airport rentals expense for 2020 decreased by$123 million , or 9.0 percent, compared with 2019. On a per ASM basis, Landing fees and airport rentals expense increased 39.1 percent, compared with 2019, as the dollar decrease was more than offset by the 34.2 percent decrease in capacity in response to the COVID-19 pandemic. On a dollar basis, the majority of the decrease was due to lower landing fees as a result of the reduced number of Trips flown in 2020 as a result of the COVID-19 pandemic. Depreciation and amortization expense for 2020 increased by$36 million , or 3.0 percent, compared with 2019. On a per ASM basis, Depreciation and amortization expense increased 55.1 percent, compared with 2019, primarily as a result of the 34.2 percent decrease in capacity in response to the COVID-19 pandemic. On a dollar basis, the increase was primarily associated with the deployment of new technology assets. 61 -------------------------------------------------------------------------------- Other operating expenses, net for 2020 decreased by$1.1 billion , or 36.4 percent, compared with 2019. On a per ASM basis, Other operating expenses, net decreased 2.6 percent, compared with 2019. On both a dollar and per ASM basis, a significant portion of the decreases were due to$222 million gains from the sale-leaseback of ten 737-800 and ten 737 MAX 8 aircraft to third parties in two separate transactions in second quarter 2020, which reduced Other operating expenses for second quarter 2020. The gains were partially offset by$32 million in impairment charges associated with 20 of the Company's Boeing 737-700 aircraft that were retired in fourth quarter 2020. The gains from the sale-leaseback transactions and impairment charges were considered special items and thus excluded from the Company's non-GAAP results. 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. See Note 8 to the Company's Consolidated Financial Statements for further information. Excluding these special items, on a per ASM basis, Other operating expenses increased as the dollar decrease was more than offset by the 34.2 percent decrease in capacity in response to the COVID-19 pandemic. On a dollar basis, excluding the impact of the special items, approximately 40 percent of the decrease was due to lower credit card fees driven by a severe reduction in revenues associated with the COVID-19 pandemic, and the majority of the remainder of the decrease was from various savings as a result of supporting a reduced operation and efforts to reduce discretionary spend.
Other
Other expenses (income) include interest expense, capitalized interest, interest income, and other gains and losses.
Interest expense for 2020 increased by$231 million , or 195.8 percent, compared with 2019, primarily due to higher debt balances in 2020, and a$9 million write-off of remaining unamortized costs from the Company's 364-day term loan entered into in first quarter 2020 and repaid in full during second quarter 2020. For further information on the Company's debt transactions in 2020, see Note 7 to the Consolidated Financial Statements. Based on current debt outstanding and current market interest rates, the Company expects first quarter 2021 interest expense to be approximately$113 million .
Capitalized interest for 2020 decreased by
Interest income for 2020 decreased by
Other (gains) losses, net, primarily includes amounts recorded as a result of the Company's hedging activities. See Note 11 to the Consolidated Financial Statements for further information on the Company's hedging activities. The following table displays the components of Other (gains) losses, net, for 2020 and 2019: Year ended December 31, (in millions) 2020 2019
Mark-to-market impact from fuel contracts settling in current and future periods
$ 40 $ - Premium cost of fuel contracts not designated as hedges 34 - Mark-to-market impact from interest rate swap agreements 28 - Post-retirement curtailment charge 53 - Other 3 8 $ 158 $ 8 Income Taxes 62
-------------------------------------------------------------------------------- The Company's annual 2020 effective tax rate was 27.8 percent, higher than the federal statutory tax rate primarily due to the Company's annual net operating loss ("NOL") which, under the CARES Act, can be applied to prior tax years beginning with 2015, when the Company was subject to a higher federal statutory tax rate. The Company's estimated tax refund from its annual 2020 NOL carryback is approximately$470 million . The Company estimates its first quarter 2021 effective tax rate to be in the range of 21 to 22 percent, lower than the annual 2020 tax rate, as the NOL carryback provisions available under the CARES Act are not applicable to years beyond 2020.
2019 Compared with 2018
The Company's comparison of 2019 results to 2018 results is included in the
Company's Annual Report on Form 10-K for the fiscal year ended
63 -------------------------------------------------------------------------------- Reconciliation of Reported Amounts to Non-GAAP Financial Measures (excluding special items) (unaudited) (in millions, except per share amounts and per ASM amounts) Year ended December 31, Percent 2020 2019 Change Fuel and oil expense, unhedged$ 1,810 $ 4,299 Add: Premium cost of fuel contracts designated as hedges 64 95 Deduct: Fuel hedge gains included in Fuel and oil expense, net (25) (47) Fuel and oil expense, as reported $
1,849
25 - Add: Premium cost of fuel contracts not designated as hedges 34 -
Fuel and oil expense, excluding special items (economic)
(56.1) % Total operating expenses, as reported$ 12,864 $ 19,471 Add: Payroll support and voluntary Employee programs, net 967 -
Add: Contracts settling in the current period, but for which losses were reclassified from AOCI (a)
25 - Add: Premium cost of fuel contracts not designated as hedges 34 - Add: Gain from aircraft sale-leaseback transactions 222 - Deduct: Impairment of long-lived assets (32) - Total operating expenses, excluding special items$ 14,080 $ 19,471 (27.7) % Operating income (loss), as reported$ (3,816) $ 2,957 Deduct: Payroll support and voluntary Employee programs, net (967) -
Deduct: Contracts settling in the current period, but for which losses were reclassified from AOCI (a)
(25) -
Deduct: Premium cost of fuel contracts not designated as hedges (34)
- Deduct: Gain from aircraft sale-leaseback transactions (222) - Add: Impairment of long-lived assets 32 - Operating income (loss), excluding special items$ (5,032) $ 2,957 n.m. Other (gains) losses, net, as reported $
158
(40) -
Deduct: Premium cost of fuel contracts not designated as hedges (34)
-
Deduct: Mark-to-market impact from interest rate swap agreements
(28) - Deduct: Post-retirement curtailment charge (53) - Other (gains) losses, net, excluding special items $ 3$ 8 (62.5) % Income (loss) before income taxes, as reported$ (4,256) $ 2,957 Deduct: Payroll support and voluntary Employee programs, net (967) -
Deduct: Contracts settling in the current period, but for which losses were reclassified from AOCI (a)
(25) - Deduct: Gain from aircraft sale-leaseback transactions (222) - Add: Impairment of long-lived assets 32 -
Add: Mark-to-market impact from fuel contracts settling in current and future periods (a)
40 - Add: Mark-to-market impact from interest rate swap agreements 28 - Add: Post-retirement curtailment charge 53 -
Income (loss) before income taxes, excluding special items
n.m. 64 --------------------------------------------------------------------------------
Provision (benefit) for income taxes, as reported
-
Deduct: GAAP to Non-GAAP tax rate difference (c) (247)
-
Provision (benefit) for income taxes, net, excluding special items
$ (1,805) $ 657 n.m. Net income (loss), as reported$ (3,074)
(967)
-
Deduct: Contracts settling in the current period, but for which losses were reclassified from AOCI (a)
(25)
-
Deduct: Gain from aircraft sale-leaseback transactions (222)
-
Add: Impairment of long-lived assets 32
-
Add: Mark-to-market impact from fuel contracts settling in current and future periods (a)
40
-
Add: Mark-to-market impact from interest rate swap agreements
28
-
Add: Post-retirement curtailment charge 53
-
Add: Net income (loss) tax impact of special items, excluding GAAP to Non-GAAP tax rate difference (b)
376
-
Add: GAAP to Non-GAAP tax rate difference (c) 247
-
Net income (loss), excluding special items$ (3,512) $ 2,300 n.m.
Net income (loss) per share, diluted, as reported
$ 4.27 Deduct: Impact of special items (1.83)
-
Deduct: Net impact of net income (loss) above from fuel contracts divided by dilutive shares
(0.04)
-
Add: Net income (loss) tax impact of special items, excluding GAAP to Non-GAAP tax rate difference (b)
0.66
-
Add: GAAP to Non-GAAP tax rate difference (c) 0.43
-
Net income (loss) per share, diluted, excluding special items
$ (6.22) $ 4.27 n.m. Operating expenses per ASM (cents) 12.43 ¢ 12.38 ¢ Add: Impact of special items 1.18
-
Deduct: Fuel and oil expense divided by ASMs (1.84)
(2.76)
Deduct: Profitsharing expense divided by ASMs -
(0.43)
Operating expenses per ASM, excluding Fuel and oil expense, profitsharing, and special items (cents)
11.77 ¢ 9.19 ¢ 28.1 % (a) See Note 11 to 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. The Non-GAAP tax rate considers the appropriate tax treatment for special items and also reflects the anticipated benefit of carrying back full year 2020 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. The impact to Net income (loss) may not be equivalent to the special item multiplied by the effective tax rate, in all cases. (c) Adjustment related to GAAP and Non-GAAP tax rate differences, primarily due to the Payroll Support Program being excluded as a special item. 65 --------------------------------------------------------------------------------
Note Regarding Use of Non-GAAP Financial Measures
The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted inthe 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 income (loss), non-GAAP; Other (gains) losses, net, non-GAAP; Income (loss) before income taxes, non-GAAP; Provision (benefit) for income taxes, net, non-GAAP; Net income (loss), non-GAAP; Net income (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 Note 11 to the 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 Program under the CARES Act, which were used to pay Employee salaries, wages, and benefits; 2.Accrued charges related to the special termination benefits upon Employees accepting Voluntary Separation Program 2020 or Extended ETO as ofDecember 31, 2020 ; 3.Gains associated with the sale-leaseback of ten Boeing 737-800 aircraft and ten Boeing 737 MAX 8 aircraft to third parties; 4.A noncash impairment charge related to 20 Boeing 737-700 aircraft that were retired during 2020; 66 -------------------------------------------------------------------------------- 5.Unrealized losses related to twelve forward-starting interest rate swap agreements. During 2020, the interest rate swap agreements, which were related to twelve 737 MAX 8 aircraft leases (with deliveries originally scheduled betweenJune 2020 andSeptember 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; and 6.A post-retirement curtailment charge related to Employees who accepted Voluntary Separation Program 2020 and elected to participate in the Company's retiree medical benefits plan. 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 income (loss), non-GAAP; Other (gains) losses, net, non-GAAP; Income (loss) before income taxes, non-GAAP; Provision (benefit) for income taxes, net, non-GAAP; Net income (loss), non-GAAP; Net income (loss) per share, diluted, non-GAAP; and Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing (cents). The Company has also utilized and provided average cash burn and average daily core cash burn, which are non-GAAP financial measures. Cash burn is a supplemental measure that mostU.S. airlines began providing in 2020 to measure liquidity in light of the negative financial effects of the pandemic. For the three months endedDecember 31, 2020 , average daily core cash burn was approximately$12 million , calculated as Loss before income taxes, non-GAAP, of$1.3 billion (as provided in the Non-GAAP reconciliation below), adjusted for Depreciation and amortization expense of$316 million ; Capital expenditures of$90 million ; and adjusted amortizing debt service payments of approximately$43 million ; divided by the number of days in the period. The Company utilizes average daily core cash burn to monitor the performance of its core business as a proxy for its ability to achieve sustainable cash and profit break-even results. The following table provides the components of Loss before income taxes, non-GAAP for the three months endedDecember 31, 2020 : Three months ended (in millions) December 31, 2020 Loss before income taxes, as reported $ (1,331) Deduct: Payroll support and voluntary Employee programs, net (34)
Deduct: Contracts settling in the current period, but for which losses were reclassified from AOCI (a)
(9) Add: Impairment of long-lived assets 32 Add: Post-retirement curtailment charge 53 Loss before income taxes, excluding special items $ (1,289)
(a) See Note 11 to Consolidated Financial Statements for further information.
Given that the Company's cash burn calculation is derived from Loss before income taxes, non-GAAP, the Company excludes the following items in its calculation of average core cash burn: financing transactions; Payroll Support Program proceeds; Supplier proceeds; voluntary separation and extended emergency time off program payments; and other changes in working capital. Cash burn methodology varies by airline, and the Company's fourth quarter 2020 average daily core cash burn of$12 million may differ materially by utilizing cash burn calculations that adjust for changes in working capital. Utilizing an alternative cash burn approach, which adjusts for changes in working capital, among other items, the Company's fourth quarter 2020 daily cash burn was approximately$15 million . 67 --------------------------------------------------------------------------------
Liquidity and Capital Resources
The enormous impact of the COVID-19 pandemic on theU.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 and Note 7 to the Consolidated Financial Statements for further information regarding the impact of the COVID-19 pandemic, as well as the transactions completed and assistance obtained under the CARES Act. Much uncertainty remains about the time it will take for air travel demand to recover, and the Company continues to assess its immediate and near-term liquidity needs. The Company also continues to assess various sources and options including public and private financings to bolster its liquidity and believes that, given current market conditions, it has opportunities to do so. Net cash used in operating activities for 2020 was$1.1 billion , and net cash provided by operating activities for 2019 was$4.0 billion . 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. The operating cash flows for 2020 were affected primarily by the COVID-19 pandemic, which resulted in a significant drop in travel demand, sales, and revenues, leading to the Company's Net loss (as adjusted for noncash items), the Company's funding of its$667 million 2019 profitsharing distribution to Employees in 2020, 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. These were partially offset by$2.4 billion in Payroll Support Program grant proceeds received as part of the CARES Act, of which approximately$2.3 billion of this direct payroll support were used to offset eligible costs and thus included in operating activities, with the remaining$40 million allocated to the value of warrants issued and thus included in financing activities. These net decreases in operating activities were partially offset by a$1.6 billion increase in Air traffic liability. The increase in Air traffic liability was due to ticket sales in 2020 for future travel that have not been flown, as a result of the significant number of Customer trip cancellations associated with the COVID-19 pandemic, and growth in Rapid Rewards points earned due to multiple loyalty credit card promotions throughout 2020. The operating cash flows for 2019 were impacted primarily by the Company's results of operations, as adjusted for non-cash items as well as changes in the Air traffic liability and Accrued liabilities balances. Cash flows associated with entering into new fuel derivatives, which are classified as Other, net, operating cash flows, were net outflows of$129 million in 2020 and$131 million in 2019. See Note 11 to the Consolidated Financial Statements for further information. 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 CARES Act and the Payroll Support Program Extension. See Note 2 to the Consolidated Financial Statements for further information. Net cash used in investing activities for 2020 and 2019 was$16 million and$303 million , respectively. 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 (see Note 8 to the Consolidated Financial Statements for more details on the sale-leaseback transactions) and received$428 million of Supplier proceeds during 2020, which the Company considers an offset to its aircraft capital expenditures. See Note 17 to the Consolidated Financial Statements for further information on Supplier proceeds. During 2020, Capital expenditures were$515 million , compared with$1.0 billion in the same prior year period, the majority of which included ongoing technology projects, airport and other facility construction projects, and progress payments related to future aircraft deliveries from the manufacturer. Capital expenditures decreased, year-over-year, largely due to a decrease in technology project expenditures, progress payments, and several projects in process during 2019 but completed and placed into service during 2020. The Company more than offset its originally planned annual 2020 capital spending of approximately$1.4 billion to$1.5 billion , primarily due to no purchased aircraft deliveries from Boeing, combined with its receipt of proceeds from sale-leaseback transactions, Supplier proceeds, and the cancellation or deferral of the majority of its capital investment projects originally 68 -------------------------------------------------------------------------------- planned for 2020. See Notes 5 and 17 to the Condensed Consolidated Financial Statements for further information. As a result of certain delivery credits provided in the Boeing Agreement, as well as progress payments made to date on undelivered aircraft, the Company currently estimates an immaterial amount of aircraft capital expenditures in 2021. Therefore, the Company currently estimates its annual 2021 capital expenditures to be no more than$500 million , driven primarily by technology, facilities, and operational investments. The Company has reduced its combined 2020 and 2021 capital spending by approximately$5.5 billion , compared with planning projections prior to the pandemic. The Company continues its fleet modernization program and expects to retire a significant amount of its Boeing 737-700 fleet over the next 10-15 years. The Company evaluates whether to adhere to or alter its aircraft retirement plans in light of the COVID-19 pandemic and other factors, including whether to retain aircraft longer or accelerate retirements and replacements. The Company plans to use the Boeing 737 MAX 8 aircraft in its fleet modernization program and believes it will also have use for a smaller aircraft such as the Boeing 737 MAX 7. In light of the current environment, the Company expects to take delivery of 35 MAX 8 aircraft throughDecember 31, 2021 , including 16 leased aircraft, 7 of which were delivered inDecember 2020 . The Company and Boeing are in discussions to change the Company's aircraft order book and to formally revise the existing purchase agreement for years after 2021. As a result, the Company expects to make further adjustments to its aircraft purchase quantities, aircraft variants, delivery schedule and related capital expenditures, although no assurance can be given about the outcome of discussions. The Company cannot predict when the effects of the COVID-19 pandemic on air travel will end, but the Company expects that its capital expenditures will increase from current levels afterU.S. air travel returns to normal. Net cash provided by financing activities for 2020 was$9.7 billion , and net cash used in financing activities for 2019 was$3.0 billion . During 2020, the Company borrowed$13.6 billion , through various transactions, as explained in detail in Notes 2 and 7 to the Consolidated Financial Statements. 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 repayment in 2020 of all$3.7 billion borrowed under the Company's Amended and Restated 364-Day Credit Agreement, the full repayment of the$1.0 billion drawn under the Company's$1.0 billion revolving credit facility, and the full repayment of the$500 million 2.65% Notes due 2020. See Note 7 to Consolidated Financial Statements for further information on the Company's debt agreements. During 2019, the Company repurchased$2.0 billion of its outstanding common stock, repaid$615 million in debt and finance lease obligations, and paid$372 million in cash dividends to Shareholders. A discussion of the Company's most significant drivers impacting cash flow for 2018 are included in the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 , under Part II Item 7, Liquidity and Capital Resources. SinceMarch 2020 , the Company reduced annual 2020 spending by approximately$8 billion , compared with original plans. Average daily core cash burn was approximately$12 million in fourth quarter 2020. The Company expects average core cash burn of approximately$17 million per day in the first quarter of 2021, as a result of continued softness in demand and a seasonally weaker travel period in January andFebruary 2021 , as well as rising fuel prices. Including certain changes in working capital, the Company expects average core cash burn in first quarter 2021 to be in the range of$10 million to$15 million per day, compared with approximately$15 million per day in fourth quarter 2020. While vaccine availability should mark the beginning of the end of the pandemic, current passenger booking trends do not indicate significant improvement throughMarch 2021 . In response to current trends, the Company's capacity plans remain conservative through, at least,March 2021 , and the Company will continue to monitor bookings and adjust flight activity, accordingly. While the Company hopes to achieve cash burn break even in 2021, it is wholly dependent upon a substantial rebound in passenger traffic and revenue; and, it is difficult to predict the timing of such a rebound, especially with respect to business travel. In order to achieve cash burn break even, the Company continues to estimate operating revenues will need to recover to a range of 60 to 70 percent of 2019 levels, which is roughly double current levels. Average core cash burn 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 69 --------------------------------------------------------------------------------
Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures including the cash burn formula.
Cash burn methodology varies by airline, and the Company's average daily core cash burn may differ materially by utilizing cash burn calculations that adjust for changes in working capital. The Company's average daily core cash burn was approximately$14 million inDecember 2020 and approximately$12 million in fourth quarter 2020. Utilizing an alternative cash burn approach, which adjusts for changes in working capital-including changes in Air traffic liability and cash payments for voluntary separation and Extended ETO programs, among other items - the Company's average daily core cash burn was approximately$18 million inDecember 2020 and approximately$15 million in fourth quarter 2020. 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. The Company has access to$1.0 billion under its Amended and Restated Revolving Credit Agreement, as amended (the "Amended A&R Credit Agreement"). The Amended A&R Credit Agreement 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 Amended A&R Credit Agreement, of$1.5 billion at all times under the Amended A&R Credit Agreement; the Company was compliant with this requirement as ofDecember 31, 2020 . There were no amounts outstanding under the Amended A&R Credit Agreement as ofDecember 31, 2020 . The Company entered into the following share repurchases during 2020, which were each recorded as a treasury share purchase for purposes of calculating earnings per share. See Part II, Item 5 for further information on the Company's share repurchase authorizations. Share repurchases (in millions) Shares received Cash paid First Quarter 2020 Accelerated Share Repurchase Program 6.4 $ 366 Open Market Share Repurchases 1.9 85 Total 8.3 $ 451 OnMarch 17, 2020 , Moody's downgraded the Company's credit ratings to "Baa1" from "A3." OnMarch 18, 2020 ,Standard & Poor's downgraded the Company's credit ratings to "BBB" from "BBB+." OnApril 10, 2020 , Fitch downgraded the Company's credit ratings to "BBB+" from "A-." The downgrades of the Company's investment-grade ratings were based on the Company's increased level of credit risk as a result of the financial impacts of the COVID-19 pandemic. See Note 2 to the Consolidated Financial Statements for further information on the impacts of the COVID-19 pandemic. Although not the case atDecember 31, 2020 due to the Company's recent 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 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$13.3 billion as ofDecember 31, 2020 , 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 Consolidated Financial 70 --------------------------------------------------------------------------------
Statements for further information on the impacts of the COVID-19 pandemic. The Company will continue to consider various financing options to maximize liquidity and supplement cash requirements, as necessary.
The Company has a large net deferred tax liability on its Consolidated Balance Sheet. The deferral of income taxes has resulted in a significant benefit to the Company and its liquidity position. Since the Company purchases the majority of the aircraft it acquires, it has been able to utilize accelerated depreciation methods (including bonus depreciation) available under the Internal Revenue Code of 1986, as amended, in 2020 and in previous years, which has enabled the Company to accelerate cash tax benefits of depreciation. Based on the Company's scheduled future aircraft deliveries from Boeing and existing tax laws in effect, the Company will continue to accelerate the cash income tax benefits related to aircraft purchases. However, due to the Company's net taxable loss incurred in 2020, and a provision within the CARES Act that allows entities to carry back such 2020 losses to prior periods of up to five years, and claim refunds of federal taxes paid, the Company expects to receive a significant cash tax refund once it completes all the necessary requirements to make the appropriate filings with the Internal Revenue Service. See Note 15 to the Consolidated Financial Statements for further information. The Company has paid in the past, and will continue to pay in the future, significant cash taxes to the various taxing jurisdictions where it operates. The Company expects to be able to continue to meet such obligations utilizing cash and investments on hand, as well as cash generated from its ongoing operations. 71 --------------------------------------------------------------------------------
Off-Balance Sheet Arrangements, Contractual Obligations, and Contingent Liabilities and Commitments
The Company has contractual obligations and commitments primarily with regard to future purchases of aircraft, payment of debt, and lease arrangements. For aircraft commitments with Boeing, the Company is required to make cash deposits toward the purchase of aircraft in advance. These deposits are classified as Deposits on flight equipment purchase contracts in the Consolidated Balance Sheet until the aircraft is delivered, at which time deposits previously made are deducted from the final purchase price of the aircraft and are reclassified as Flight equipment. See Part I, Item 2 for a complete table of the Company's contractual firm deliveries and options for Boeing 737 MAX 7 and 737 MAX 8 aircraft, Note 5 to the Consolidated Financial Statements for the financial commitments related to these firm deliveries, and Note 17 to the Consolidated Financial Statements for further information about the MAX groundings and expected return to service. The leasing of aircraft (including the sale and leaseback of aircraft) provides flexibility to the Company as a source of financing. Although the Company is responsible for all maintenance, insurance, and expense associated with operating leased aircraft, and retains the risk of loss for these aircraft, it has generally not made guarantees to the lessors regarding the residual value (or market value) of the aircraft at the end of the lease terms. Assets and obligations under operating leases are included in the Company's Consolidated Balance Sheet. See Note 3 and Note 8 to the Consolidated Financial Statements for further information. Disclosure of the expected contractual obligations associated with the Company's leased aircraft is included below. As ofDecember 31, 2020 , the Company had 184 leased aircraft, including 47 Boeing 717-200 aircraft ("B717s") subleased to Delta. Of these leased aircraft, 112 are under operating leases, including 45 B717s subleased to Delta. See Note 8 to the Consolidated Financial Statements for further information on this transaction. The Company is required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral related to its fuel hedging positions. Although the letters of credit are off-balance sheet, the majority of the obligations to which they relate are reflected as liabilities in the Consolidated Balance Sheet. Outstanding letters of credit totaled$138 million atDecember 31, 2020 . 72 --------------------------------------------------------------------------------
The following table aggregates the Company's material expected contractual
obligations and commitments as of
Obligations by period (in millions) Contractual obligations 2021 2022 - 2023 2024 - 2025 Thereafter Total Long-term debt (a)$ 136 $ 1,763
340 625 469 298 1,732 Interest commitments - floating (c) 8 11 8 3 30 Facility and other operating lease 91 122 83 557 853 commitments Aircraft operating lease commitments (d) 280 350 266 599 1,495 Aircraft finance lease commitments (e) 102 192 164 156 614 Aircraft purchase commitments (f) 3,727 2,778 3,416 - 9,921 Other commitments 150 252 183 293 878 Total contractual obligations$ 4,834 $ 6,093
(a)Includes principal only. See Note 7 to the Consolidated Financial Statements for additional information. (b)Related to fixed-rate debt (either at issuance or through swaps) only. (c)Interest obligations associated with floating-rate debt is estimated utilizing forward interest rate curves as ofDecember 31, 2020 , and can be subject to significant fluctuation. (d)Includes the impact of the B717 sublease transaction entered into in 2012. See Note 8 to the Consolidated Financial Statements for additional information. (e)Includes principal and interest on finance leases. See Note 8 to the Consolidated Financial Statements for additional information. (f)This reflects firm orders for purchased MAX aircraft from Boeing; assuming a shift of the 27 MAX aircraft and 35 MAX aircraft contractually scheduled for delivery in 2019 and 2020, respectively, into 2021, due to the MAX grounding fromMarch 13, 2019 until late 2020 which consisted of$743 million from 2019 and$1.3 billion from 2020. See Note 5 to the Consolidated Financial Statements for further information. See Part I, Item 2 for a complete table of the Company's contractual firm deliveries.
Airport Projects
The Company periodically enters into commitments associated with various airport improvement projects that could impact its future liquidity needs in differing ways. These projects, which are typical within the airline industry, include the construction of new facilities and the rebuilding or modernization of existing facilities and are discussed in more detail in Note 5 to the Consolidated Financial Statements.Dallas Love Field For the rebuilding of the facilities atDallas Love Field , the Company guaranteed principal, premium, and interest on$456 million in bonds issued by theLove Field Airport Modernization Corporation ("LFAMC") that were utilized to fund the majority of the project. The amount of bonds outstanding as ofDecember 31, 2020 , was$399 million . Repayment of the bonds is through the "Facilities Payments" described below. Reimbursement of the Company for its payment of Facilities Payments is made through recurring ground rents, fees, and other revenues collected at the airport. Prior to the issuance of the bonds by the LFAMC, the Company entered into two separate funding agreements: (i) a "Facilities Agreement" pursuant to which the Company is obligated to make debt service payments on the principal and interest amounts associated with the bonds ("Facilities Payments"), less other sources of funds theCity of Dallas may apply to the repayment of the bonds (including, but not limited to, passenger facility charges collected from passengers originating from the airport); and (ii) a "Revenue Credit Agreement" pursuant to which theCity of Dallas reimburses the Company for the Facilities Payments made by the Company. 73 -------------------------------------------------------------------------------- A majority of the monies transferred from theCity of Dallas to the Company under the Revenue Credit Agreement originate from a reimbursement account created in the "Use and Lease Agreement" between theCity of Dallas and the Company. The Use and Lease Agreement is a 20-year agreement providing for, among other things, the Company's lease of space at the Airport from theCity of Dallas . The remainder of such monies transferred from theCity of Dallas to the Company under the Revenue Credit Agreement originates from (i) use and lease agreements with other airlines, (ii) various concession agreements, and (iii) other airport miscellaneous revenues. The Company's liquidity could be impacted by this project to the extent there are timing differences between the Company's payment of the Facilities Payments pursuant to the Facilities Agreement and the transfer of monies back to the Company pursuant to the Revenue Credit Agreement; however, the Company does not currently expect that to occur. The project has not had a significant impact on the Company's capital resources or financial position.Los Angeles International Airport InOctober 2017 , the Company executed a lease agreement (the "T1.5 Lease") withLos Angeles World Airports ("LAWA"), which owns and operatesLos Angeles International Airport ("LAX"). 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. Funding for the Terminal 1.5 Project is primarily through theRegional Airports Improvement Corporation (the "RAIC"), which is a quasi-governmental special purpose entity that acts as a conduit borrower under a syndicated credit facility provided by a group of lenders. A loan made under the credit facility for the Terminal 1.5 Project is being used to reimburse the Company for the site improvements and non-proprietary improvements of the Terminal 1.5 Project, and the outstanding loan will be repaid with the proceeds of LAWA's payments to purchase completed construction phases. The Company guaranteed the obligation of the RAIC under the credit facility associated with the Terminal 1.5 Project. As ofDecember 31, 2020 , the Company's outstanding guaranteed obligation under the credit facility for the Terminal 1.5 Project was$318 million . The Company's liquidity could be impacted by this project under certain circumstances; however, the Company does not expect this to occur based on its past experience with other projects. This project is not expected to have a significant impact on the Company's capital resources or financial position. Construction on the Terminal 1.5 Project began during third quarter 2017 and was substantially completed as ofDecember 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. 74 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's Consolidated Financial Statements have been prepared in accordance with GAAP. The Company's significant accounting policies are described in Note 1 to the Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires the Company's management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying footnotes. The Company's estimates and assumptions are based on historical experience and changes in the business environment. However, actual results may differ from estimates under different conditions, sometimes materially. Critical accounting policies and estimates are defined as those that both (i) are most important to the portrayal of the Company's financial condition and results and (ii) require management's most subjective judgments. The Company's critical accounting policies and estimates are described below. Revenue Recognition Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue is recognized and Air traffic liability is reduced when the service is provided (i.e., when the flight takes place). Air traffic liability primarily represents tickets sold for future travel dates, funds that are past flight date and remain unused, but are expected to be used in the future, and the Company's liability for loyalty benefits that are expected to be redeemed in the future. Air traffic liability fluctuates throughout the year based on seasonal travel patterns, fare sale activity, and activity associated with the Company's loyalty program. See Note 1 to the Consolidated Financial Statements for information about the Company's revenue recognition policies. For air travel onSouthwest , the amount of tickets that will expire unused are estimated and recognized in Passenger revenue once the scheduled flight date has passed. Estimating the amount of tickets that will expire unused involves some level of subjectivity and judgment. The majority of the Company's tickets sold are nonrefundable, which is the primary source of unused tickets. The Company has a No Show policy that applies to fares that are not canceled or changed by a Customer at least ten minutes prior to a flight's scheduled departure. See Note 1 to the Consolidated Financial Statements for further information. According to the Company's current "Contract of Carriage," all refundable tickets that are sold but not flown on the travel date can be reused for another flight up to a year from the date of sale, or some tickets can be refunded. This policy also applies to unused Customer funds that may be the result of an exchange downgrade, in which a Customer exchanges their ticket from a previously purchased flight for a lower priced ticket, with the price difference being effectively refunded through it being made available for use by the Customer towards travel up to twelve months from the date of original purchase. As a result of the COVID-19 pandemic, for all Customer travel funds created or scheduled to expirebetween March 1 and September 7, 2020 associated with flight cancellations, the Company has extended the expiration date toSeptember 7, 2022 . Further, the Company announced inAugust 2020 , that it would allow qualified travel funds to be converted to Rapid Rewards points throughDecember 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 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. Fully refundable tickets rarely expire unused. Estimates of tickets that will expire unused are based on historical experience over many years. The Company has consistently applied this accounting method to estimate revenue from unused tickets at the date of scheduled travel. Holding other factors constant, a 10 percent change in the Company's estimate of the amount of tickets that will expire unused would have resulted in a$26 million , or less than one percent, change in Passenger revenues recognized for the year endedDecember 31, 2020 . Events and circumstances outside of historical fare sale activity or historical Customer travel patterns can result in actual spoiled tickets differing significantly from estimates. The Company evaluates its estimates within a narrow range of acceptable amounts. If actual spoilage results in an amount outside of this range, estimates and assumptions are reviewed and adjustments to Air traffic liability and to Passenger revenue are recorded, as necessary. Assumptions used to generate spoilage estimates can be impacted by several factors including, but not limited to: fare increases, fare sales, changes to the Company's ticketing policies, changes to the Company's refund, exchange and unused funds policies, seat availability, and economic factors. The Company's estimation techniques have been 75 -------------------------------------------------------------------------------- consistently applied from year to year; however, as with any estimates, actual spoiled tickets may vary from estimated amounts. Given the unprecedented amount of 2020 Customer flight cancellations and the amount of travel funds available to Customers for use throughSeptember 2022 , the Company expects additional variability in the amount of spoilage revenue recorded in future periods, especially as a percentage of revenues, as the estimates of the portion of sold tickets that will expire unused may differ from historical experience and the Company's overall revenues remain well below pre-COVID-19 pandemic levels.
Impairment Accounting
The Company applies a fair value based impairment test to the carrying value of goodwill and indefinite-lived intangible assets annually onOctober 1st , or more frequently if certain events or circumstances indicate that an impairment loss may have been incurred. The Company assesses the value of goodwill and indefinite-lived intangible assets under either a qualitative or quantitative approach. Under a qualitative approach, the Company considers various market factors, including applicable key assumptions also used in the quantitative assessment listed below. These factors are analyzed to determine if events and circumstances could reasonably have affected the fair value of goodwill and indefinite-lived intangible assets. If the Company determines that it is more likely than not that an indefinite-lived intangible asset or reporting unit goodwill is impaired, the quantitative approach is used to assess the asset or reporting unit fair value and the amount of the impairment. Under a quantitative approach, the fair value of the Company's indefinite-lived intangible assets or reporting unit is calculated based on key market participant assumptions. If the indefinite-lived intangible assets' carrying value exceeds the fair value calculated using the quantitative approach, an impairment charge is recorded for the difference in fair value and carrying value. If the reporting unit carrying value exceeds the reporting unit fair value calculated using the quantitative approach, an impairment charge is recorded for the difference between fair value and carrying value, limited to the amount of goodwill in the reporting unit. When performing a quantitative impairment assessment of goodwill and indefinite-lived intangible assets, fair value is estimated based on (i) recent market transactions, where available, (ii) projected discounted cash flows (an income approach), or (iii) a combination of limited market transactions and the lease savings method (which reflects potential annual after-tax lease savings arising from owning the certain indefinite-lived intangibles rather than leasing them from another airline at market rates). Key Assumptions. Key assumptions and/or estimates made in the Company's quantitative impairment tests included the following: (i) a projection of revenues, expenses, and cash flows; (ii) terminal period revenue growth and cash flows; (iii) an estimated weighted average cost of capital; (iv) an assumed discount rate, depending on the asset, (v) a tax rate, and (vi) market purchase prices and/or lease rates for comparable assets. The Company believes these assumptions are consistent with those a hypothetical market participant would use given circumstances that were present at the time the estimates were made. However, actual results and amounts may be significantly different from the Company's estimates. Due to the drastic reduction in air travel as a result of the pandemic in 2020, the Company determined that it would perform a quantitative assessment of itsGoodwill and indefinite-lived intangible assets. Based on the result of the annual impairment tests performed as ofOctober 1, 2020 , no impairment was determined to exist forGoodwill or indefinite-lived intangible assets, as the fair values of the reporting unit and indefinite-lived intangible assets exceeded their respective carrying values. Future impairment ofGoodwill and indefinite-lived intangible assets may result from changes in assumptions, estimates, or circumstances, some of which are beyond the Company's control. Factors which could result in an impairment ofGoodwill , holding other assumptions constant, could include, but are not limited to: (i) a significant reduction in passenger demand as a result of domestic or global economic conditions; (ii) significantly higher prices for jet fuel; (iii) lower fares or passenger yields as a result of increased competition or lower demand; (iv) a significant increase in future capital expenditure commitments; and (v) significant disruptions to the Company's operations as a result of both internal and external events such as terrorist activities, actual or threatened war, labor actions by Employees, or further industry regulation. Factors which could result in an impairment of owned domestic slots, holding other assumptions constant, could include, but are not limited to: (i) a change in competition in the slotted airport; (ii) a change in governmental regulations in the slotted airport; (iii) significantly higher prices for jet fuel; and (iv) increased competition at a nearby airport. 76 -------------------------------------------------------------------------------- Long lived assets. Long-lived assets, which primarily consist of Flight equipment and related assets, are evaluated for impairment when events and circumstances indicate the assets may be impaired. Indicators include, but are not limited to: (i) a decision to permanently remove long-lived assets from operations, (ii) significant changes in the estimated useful life, (iii) significant changes in projected cash flows, (iv) significant decreases in market value and (v) changes in technology. For long-lived assets held for sale, when the carrying amount of these assets is greater than the fair value, less the cost to sell, depreciation is discontinued and an impairment loss is recorded. In evaluating the potential for impairment associated with aircraft used in operations, assets are grouped at the entire Boeing 737 fleet level, as the Company has determined this is the lowest level for which there are identifiable cash flows. Future cash flows are estimated based on projections of capacity, passenger yield, fuel, labor costs, and other relevant factors. If an impairment were to exist, the impairment loss recognized is the amount by which the fleet's carrying amount exceeds its estimated fair value. Aircraft fair values are estimated using published sources, appraisals, and bids received from third parties, as available. In 2020, the Company recorded an impairment charge of$32 million , associated with 20 of the Company's Boeing 737-700 aircraft that were retired early in fourth quarter 2020.
Fair Value Measurements and Financial Derivative Instruments
The Company utilizes unobservable (Level 3) inputs in determining the fair value of certain assets and liabilities. AtDecember 31, 2020 , these consisted of its fuel derivative option contracts, which were an asset of$134 million . The Company utilizes financial derivative instruments primarily to manage its risk associated with changing jet fuel prices. See "Quantitative and Qualitative Disclosures about Market Risk" for more information on these risk management activities, Note 11 to the Consolidated Financial Statements for more information on the Company's fuel hedging program and financial derivative instruments, and Note 12 to the Consolidated Financial Statements for more information about fair value measurements. All derivatives are required to be reflected at fair value and recorded on the Consolidated Balance Sheet. AtDecember 31, 2020 , the Company was a party to over 250 separate financial derivative instruments related to its fuel hedging program for future periods. Changes in the fair values of these instruments can vary dramatically based on changes in the underlying commodity prices. For example, during 2020, market "spot" prices for Brent crude oil peaked at a high average daily price of approximately$69 per barrel and hit a low average daily price of approximately$19 per barrel. During 2019, market spot prices ranged from a high average daily price of approximately$75 per barrel to a low average daily price of approximately$55 per barrel. Market price changes can be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity, political agendas, the value of theU.S. dollar, geopolitical events, the extent of the COVID-19 pandemic, and general economic conditions, among other items. The financial derivative instruments utilized by the Company primarily are a combination of collars, purchased call options, call spreads, put spreads, and fixed price swap agreements. The Company enters into financial derivative instruments with third party institutions in "over-the-counter" markets. Since the majority of the Company's financial derivative instruments are not traded on a market exchange, the Company estimates their fair values. Depending on the type of instrument, the values are determined by the use of present value methods or standard option value models with assumptions about commodity prices based on those observed in underlying markets. The Company determines the fair value of fuel derivative 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 quoted by its counterparties. In situations where the Company obtains inputs via quotes from its counterparties, it verifies the reasonableness of these quotes via similar quotes from another counterparty as of each date for which financial statements are prepared. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of derivative contracts it holds. Due to the fact that certain inputs used in determining the estimated fair value of its option contracts are considered unobservable (primarily implied volatility), the Company has categorized these option contracts as Level 3. Although implied volatility is not directly observable, it is derived primarily from changes in market prices, which are observable. Based on the Company's portfolio of option contracts as of 77 --------------------------------------------------------------------------------
Fair values for financial derivative instruments are estimated prior to the time that the financial derivative instruments settle. However, once settlement of the financial derivative instruments occurs and the hedged jet fuel is purchased and consumed, all values and prices are known and are recognized in the financial statements. Although the Company continues to use a prospective assessment to determine that commodities continue to qualify for hedge accounting in specific locations where the Company hedges, there are no assurances that these commodities will continue to qualify in the future. This is due to the fact that future price changes in these refined products may not be consistent with historical price changes. Increased volatility in these commodity markets for an extended period of time, especially if such volatility were to worsen, could cause the Company to lose hedge accounting altogether for the commodities used in its fuel hedging program. Further, should the anticipated fuel purchases covered by the Company's fuel hedges no longer be probable of occurring, the Company would discontinue hedge accounting. The loss of hedge accounting would create further volatility in the Company's GAAP financial results. As discussed in Note 11 to the Consolidated Financial Statements, any changes in fair value of cash flow derivatives designated as hedges are offset within AOCI until the period in which the expected future cash flow impacts earnings. Any changes in the fair value of fuel derivatives that do not qualify for hedge accounting are reflected in earnings within Other (gains) losses, net, in the period of the change. Because the Company has extensive historical experience in valuing the derivative instruments it holds, and such experience is continually evaluated against its counterparties each period when such instruments expire and are settled for cash, the Company believes it is unlikely that an independent third party would value the Company's derivative contracts at a significantly different amount than what is reflected in the Company's financial statements. In addition, the Company also has bilateral credit provisions in some of its counterparty agreements, which provide for parties (or the Company) to provide cash collateral when the fair value of fuel derivatives with a single party exceeds certain threshold levels. Since this cash collateral is based on the estimated fair value of the Company's outstanding fuel derivative contracts, this provides further validation to the Company's estimate of fair values.
Loyalty Accounting
The Company utilizes estimates in the recognition of revenues and liabilities associated with its loyalty program. These estimates primarily include the liability associated with Rapid Rewards loyalty member ("Member") account balances that are expected to be redeemed for travel or other products at a future date. Loyalty account balances include points earned through flights taken, points sold to Customers, or points earned through business partners participating in the loyalty program.
Under the Southwest Rapid Rewards loyalty program, Members earn points for every dollar spent onSouthwest base fares. The amount of points earned under the program is based on the fare and fare class purchased, with higher fare products (e.g., Business Select) earning more points than lower fare products (e.g., Wanna Get Away). Each fare class is associated with a points earning multiplier, and points for flights are calculated by multiplying the fare for the flight by the fare class multiplier. Likewise, the amount of points required to be redeemed for a flight can differ based on the fare purchased. Under the program, (i) Members are able to redeem their points for every available seat, every day, on every flight, with no blackout dates; and (ii) points do not expire. In addition, Members are able to redeem their points for items other than travel onSouthwest Airlines , such as international flights on other airlines, cruises, hotel stays, rental cars, gift cards, event tickets, and more. In addition to earning points for revenue flights and qualifying purchases withRapid Rewards Partners , Members also have the ability to purchase, gift, and transfer points, as well as the ability to donate points to selected charities. The Company utilizes the deferred revenue method of accounting for points earned through flights taken in its loyalty program. The Company also sells points and related services to business partners participating in the loyalty program. Liabilities are recorded for the relative standalone selling price of the Rapid Rewards points which are awarded each period. The liabilities recorded represent the total number of points expected to be redeemed by Members, regardless of whether the Members may have enough to qualify for a full travel award. AtDecember 31 , 78 -------------------------------------------------------------------------------- 2020, the loyalty liabilities were approximately$4.4 billion , including$1.1 billion classified within Air traffic liability and$3.3 billion classified as Air traffic liability - noncurrent. In order to determine the value of each loyalty point, certain assumptions must be made at the time of measurement, which include an allocation of passenger revenue between the flight and loyalty points earned by passengers, and the fair value of Rapid Rewards points, which are generally based on their redemption value to the Customer. See Note 6 to the Consolidated Financial Statements for further information on determining the estimated fair value of each loyalty point. The majority of the points sold to business partners are through theSouthwest co -branded credit card agreement ("Agreement") withChase Bank USA, N.A. Consideration received as part of this Agreement is subject to Accounting Standards Codification 606, Revenue From Contracts With Customers. The Agreement has the following multiple elements: travel points to be awarded, use of theSouthwest Airlines' brand and access to Rapid Rewards Member lists, advertising elements, and the Company's resource team. These elements are combined into two performance obligations, transportation and marketing, and consideration from the Agreement is allocated based on the relative selling price of each performance obligation. Significant management judgment was used to estimate the selling price of each of the performance obligations in the Agreement at inception. The objective is to determine the price at which the Company would transact a sale if the product or service was sold on a stand-alone basis. The Company determines the best estimate of selling price by considering multiple inputs and methods including, but not limited to, the estimated selling price of comparable travel, discounted cash flows, brand value, published selling prices, number of points awarded, and the number of points redeemed. The Company estimates the selling prices and volumes over the term of the Agreement in order to determine the allocation of proceeds to each of the multiple performance obligations. The Company records revenue related to air transportation when the transportation is delivered and revenue related to marketing elements when the performance obligation is satisfied. A one percent increase or decrease in the Company's estimate of the standalone selling prices, implemented as ofJanuary 1, 2020 , resulting in an allocation of proceeds to air transportation would not have had a material impact on the Company's Operating revenues for the year endedDecember 31, 2020 . Under its current program,Southwest estimates the portion of loyalty points that will not be redeemed. In estimating the spoilage, the Company takes into account the Member's past behavior, as well as several factors related to the Member's account that are expected to be indicative of the likelihood of future point redemption. These factors are typically representative of a Member's level of engagement in the loyalty program. They include, but are not limited to, tenure with the program, points accrued in the program, and points redeemed in the program. The Company believes it has obtained sufficient historical behavioral data to develop a predictive statistical model to analyze the amount of spoilage expected for all loyalty points. The Company updates this model at least annually, and applies the new spoilage rates effectiveOctober 1st each year, or more frequently if required by changes in the business. Changes in the spoilage rates applied annually in recent years have not had a material impact on Passenger revenues. For the year endedDecember 31, 2020 , based on actual redemptions of points sold to business partners and earned through flights, a hypothetical one percentage point change in the estimated spoilage rate would have resulted in a change to Passenger revenue of approximately$61 million (an increase in spoilage would have resulted in an increase in revenue and a decrease in spoilage would have resulted in a decrease in revenue). Given that Member behavior will continue to develop as the program matures, the Company expects the current estimates may change in future periods. However, the Company believes its current estimates are reasonable given current facts and circumstances. 79
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