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10-K 1 luv-12312015x10k.htm FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended December 31, 2015 |
| or |
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from ________ to ________ |
Commission File No. 1-7259
Southwest Airlines Co.
(Exact name of registrant as specified in its charter)
| TEXAS | 74-1563240 |
| (State or other jurisdiction of | (IRS Employer |
| incorporation or organization) | Identification No.) |
| P.O. Box 36611 | |
| Dallas, Texas | 75235-1611 |
| (Address of principal executive offices) | (Zip Code) |
Registrant's telephone number, including area code: (214) 792-4000
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of Each Exchange on Which Registered | |
| Common Stock ($1.00 par value) | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | þ | Accelerated filer | ¨ | Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $21,774,060,585 computed by reference to the closing sale price of the common stock on the New York Stock Exchange on June 30, 2015, the last trading day of the registrant’s most recently completed second fiscal quarter.
Number of shares of common stock outstanding as of the close of business on January 29, 2016: 638,070,032 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Company’s Annual Meeting of Shareholders to be held May 18, 2016, are incorporated into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
PART I
| Item 1. | Business |
Company Overview
Southwest Airlines Co. (the “Company” or “Southwest”) operates Southwest Airlines, a major passenger airline that provides scheduled air transportation in the United States and near-international markets. For the 43rd consecutive year, the Company was profitable, earning $2.2 billion in net income.
Southwest commenced service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities: Dallas, Houston, and San Antonio. The Company ended 2015 serving 97 destinations in 40 states, the District of Columbia, the Commonwealth of Puerto Rico, and seven near-international countries including Mexico, Jamaica, The Bahamas, Aruba, Dominican Republic, Costa Rica, and Belize. During 2015, the Company added its first three destinations in Central America (San Jose, Costa Rica, Belize City, Belize, and Liberia, Costa Rica) and also commenced Southwest service to a fourth destination in Mexico (Puerto Vallarta). At December 31, 2015, Southwest operated a total of 704 Boeing 737 aircraft.
During 2015, the Company also added 20 domestic nonstop destinations from Dallas Love Field. These routes were made possible by the repeal of certain federal flight restrictions at Dallas Love Field in October 2014. At year-end 2015, Southwest offered a total of 180 weekday departures to 50 nonstop destinations from Dallas Love Field. In addition, the Company added eight international nonstop destinations from a newly constructed five-gate international terminal at Houston’s William P. Hobby Airport. Based on the most recent data available from the U.S. Department of Transportation, as of June 30, 2015, Southwest was the largest domestic air carrier in the United States, as measured by the number of domestic originating passengers boarded.
Industry
The airline industry has historically been an extremely volatile industry subject to numerous challenges. Among other things, it has been cyclical, energy intensive, labor intensive, capital intensive, technology intensive, highly regulated, heavily taxed, and extremely competitive. The airline industry has also been particularly susceptible to detrimental events such as acts of terrorism, poor weather, and natural disasters.
The U.S. airline industry benefited from moderate economic growth during 2015 and was further aided by a significant drop in fuel prices. The U.S. airline industry, including Southwest, has increased available seat miles (also referred to as “capacity,” an available seat mile is one seat, empty or full, flown one mile and is a measure of space available to carry passengers in a given period), and has increased the number of seats per trip (or “gauge”) through slimline seat retrofits and the use of larger aircraft.
Company Operations
Route Structure
General
Southwest principally provides point-to-point service, rather than the “hub-and-spoke” service provided by most major U.S. airlines. The hub-and-spoke system concentrates most of an airline’s operations at a limited number of central hub cities and serves most other destinations in the system by providing one-stop or connecting service through a hub. By not concentrating operations through one or more central transfer points, Southwest’s point-to-point route structure has allowed for more direct nonstop routing than hub-and-spoke service. Approximately 74 percent of the Company's Customers flew nonstop during 2015, and, as of December 31, 2015, Southwest served 637 nonstop city pairs.
Southwest’s point-to-point service has also enabled it to provide its markets with frequent, conveniently timed flights and low fares. For example, Southwest currently offers 20 weekday roundtrips from Dallas Love Field to Houston Hobby, 14 weekday roundtrips from Los Angeles International to Oakland, 12 weekday roundtrips from Burbank to Oakland, 11 weekday roundtrips from Phoenix to Las Vegas, and ten weekday roundtrips from San Diego to San Jose.
Southwest complements its high-frequency short-haul routes with long-haul nonstop service between markets such as Los Angeles and Nashville, Las Vegas and Orlando, San Diego and Baltimore, and Houston and New York LaGuardia.
During 2015, the Company continued to incorporate the Boeing 737-800 into its fleet, which offers significantly more Customer seating capacity than Southwest’s other aircraft. This has enabled the Company to more economically serve long-haul routes, as well as high-demand, slot-controlled and gate-restricted airports, by adding seats for such routes without increasing the number of flights (a “slot” is the right of an air carrier, pursuant to regulations of the Federal Aviation Administration (“FAA”), to operate a takeoff or landing at a specific time at certain airports). For 2015, the Company’s average aircraft trip stage length was 750 miles, with an average duration of approximately 2.0 hours, as compared with an average aircraft trip stage length of 721 miles and an average duration of approximately 2.0 hours in 2014. During 2014, the Company also operated AirTran Airways (“AirTran”). AirTran’s final passenger service occurred on December 28, 2014, and it has been integrated into Southwest.
International Service
Southwest Airlines launched international service in 2014, and ended 2015 with service to 11 international destinations. The Company’s international expansion in 2015 was facilitated by the completion of construction of a new five-gate international terminal at Houston’s William P. Hobby Airport. The new terminal includes an expanded security checkpoint and an upgraded Southwest ticketing area. The Company controlled this expansion and the related financial terms pursuant to an Airport Use and Lease Agreement with the City of Houston. Additional information regarding this project is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 4 to the Consolidated Financial Statements.
Approximately $287 million of the Company’s 2015 operating revenues were attributable to foreign operations. The remainder of the Company’s 2015 operating revenues, approximately $19.5 billion, was attributable to domestic operations. Approximately $226 million of the Company’s 2014 operating revenues were attributable to foreign operations (including those attributable to both Southwest and AirTran). The remainder of the Company’s 2014 operating revenues, approximately $18.4 billion, was attributable to domestic operations. The Company's assets are not allocated to a geographic area because the Company’s tangible assets primarily consist of flight equipment, the majority of which are interchangeable and are deployed systemwide, with no individual aircraft dedicated to any specific route or region.
Cost Structure
General
A key component of the Company’s business strategy has historically been its low-cost structure, which was designed to allow it to profitably charge low fares. Adjusted for stage length, the Company has lower unit costs, on average, than the majority of major domestic carriers. The Company’s low-cost structure has historically been facilitated by Southwest’s use of a single aircraft type, the Boeing 737, its operationally efficient point-to-point route structure, and its highly productive Employees. Southwest’s use of a single aircraft type has allowed for simplified scheduling, maintenance, flight operations, and training activities. Southwest’s point-to-point route structure includes service to and from many secondary or downtown airports such as Dallas Love Field, Houston Hobby, Chicago Midway, Baltimore-Washington International, Burbank, Manchester, Oakland, San Jose, Providence, and Ft. Lauderdale-Hollywood. These conveniently located airports are typically less congested than other airlines’ hub airports, which has contributed to Southwest's ability to achieve high asset utilization because aircraft can be scheduled to minimize the amount of time they are on the ground. This, in turn, has reduced the number of aircraft and gate facilities that would otherwise be required and allows for high Employee productivity (headcount per aircraft).
Impact of Fuel Costs on the Company’s Low-Cost Structure; Fuel Initiatives
Although 2015 fuel prices were lower than 2014 fuel prices, Fuel and oil expense remained one of the Company's largest operating costs. The table below shows the Company’s average cost of jet fuel for each year beginning in 2003 and during each quarter of 2015.
| Year | Cost (Millions) | Average Cost Per Gallon | Percentage of Operating Expenses | ||||||||
| 2003 | $ | 920 | $ | 0.80 | 16.5 | % | |||||
| 2004 | $ | 1,106 | $ | 0.92 | 18.1 | % | |||||
| 2005 | $ | 1,470 | $ | 1.13 | 21.4 | % | |||||
| 2006 | $ | 2,284 | $ | 1.64 | 28.0 | % | |||||
| 2007 | $ | 2,690 | $ | 1.80 | 29.7 | % | |||||
| 2008 | $ | 3,713 | $ | 2.44 | 35.1 | % | |||||
| 2009 | $ | 3,044 | $ | 2.12 | 30.2 | % | |||||
| 2010 | $ | 3,620 | $ | 2.51 | 32.6 | % | |||||
| 2011 | $ | 5,644 | $ | 3.19 | 37.7 | % | |||||
| 2012 | $ | 6,120 | $ | 3.30 | 37.2 | % | |||||
| 2013 | $ | 5,763 | $ | 3.16 | 35.1 | % | |||||
| 2014 | $ | 5,293 | $ | 2.93 | 32.3 | % | |||||
| 2015 | $ | 3,616 | $ | 1.90 | 23.0 | % | |||||
| First Quarter 2015 | $ | 877 | $ | 2.01 | 24.1 | % | |||||
| Second Quarter 2015 | $ | 1,005 | $ | 2.03 | 25.0 | % | |||||
| Third Quarter 2015 | $ | 936 | $ | 1.98 | 22.9 | % | |||||
| Fourth Quarter 2015 | $ | 798 | $ | 1.65 | 20.2 | % |
The Company enters into fuel derivative contracts to manage its risk associated with significant increases in fuel prices; however, as is evidenced by the table above, energy prices can fluctuate significantly in a relatively short amount of time, and the cost of hedging generally increases with sustained high potential for volatility in the fuel market. Therefore, the Company continually monitors and adjusts its fuel hedge portfolio and strategies to address not only fuel price increases, but also fuel price volatility, hedge costs, and hedge collateral requirements. The Company’s fuel hedging activities are discussed in more detail below under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 10 to the Consolidated Financial Statements.
During 2015, the Company continued to focus on reducing fuel consumption and improving efficiency through fleet modernization and other fuel initiatives. The Company continued to replace its older aircraft with newer aircraft that are less maintenance intensive and more fuel efficient. For example, during 2015, the Company took delivery of 19 Boeing 737-800 aircraft and 24 Boeing 737-700 aircraft. In 2016, the Company currently expects to take delivery of an additional 36 Boeing 737-800 aircraft and 17 Boeing 737-700 aircraft. As further discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in Note 1 to the Consolidated Financial Statements, the Company recently announced its intent to accelerate the retirement of its 737-300 and 737-500 aircraft. The Company's fleet composition and delivery schedule is discussed in more detail below under "Properties - Aircraft." The Company also continued to participate in Required Navigation Performance (“RNP”) operations as part of the FAA’s Performance Based Navigation program. RNP combines the capabilities of advanced aircraft avionics, Global Positioning System satellite navigation (instead of less precise ground-based navigation), and new flight procedures to produce more efficient flight patterns and conserve fuel. The Company’s RNP activities are discussed further under “Regulation - Environmental Regulation."
The table below illustrates the Company's available seat miles produced per fuel gallon consumed over the last five years:
| Year ended December 31, | ||||||||||
| 2015 | 2014 | 2013 | 2012 | 2011 | ||||||
| Available seat miles per fuel gallon consumed | 73.9 | 72.8 | 71.7 | 69.4 | 68.3 |
Fare Structure
General
Southwest offers a relatively simple fare structure that features competitive, unrestricted, unlimited, everyday coach fares, as well as lower fares available on a restricted basis. Southwest bundles fares into three major categories: “Wanna Get Away®,” “AnytimeSM,” and “Business Select®,” with the goal of making it easier for Customers to choose the fare they prefer. All fare products include the privilege of two free checked bags (weight and size limits apply). In addition, regardless of the fare product, Southwest does not charge fees for changes to flight reservations.
| • | “Wanna Get Away” fares are generally the lowest fares and are typically subject to advance purchase requirements. They are nonrefundable but, subject to compliance with Southwest’s No Show policy, funds may be applied to future travel on Southwest without a change fee. Southwest’s No Show policy applies if a Customer has booked a nonrefundable fare anywhere in his/her itinerary and that portion of the flight is not used and not canceled or changed by the Customer at least ten minutes prior to scheduled departure. In such event, subject to certain exceptions, all unused funds on the full itinerary will be forfeited, and the remaining reservation will be canceled. The intent of the No Show policy is to promote Customer behavior that will enable Southwest to re-sell the open seat prior to departure. |
| • | “Anytime” fares are refundable and changeable, and funds may also be applied toward future travel on Southwest. Anytime fares also include a higher frequent flyer point multiplier under Southwest’s Rapid Rewards® frequent flyer program than do Wanna Get Away fares. The Company's frequent flyer program is discussed below under "Rapid Rewards Frequent Flyer Program." |
| • | “Business Select” fares are refundable and changeable, and funds may be applied toward future travel on Southwest. Business Select fares also include additional perks, when available, such as priority boarding in the first 15 boarding positions within boarding group “A,” a higher frequent flyer point multiplier than other Southwest fares (including twice as many points per dollar spent as compared with Wanna Get Away fares), “Fly By®” priority security and/or ticket counter access in participating airports, and one complimentary adult beverage coupon for the day of travel (for Customers of legal drinking age). |
Ancillary Services
The Company offers ancillary service offerings such as Southwest’s EarlyBird Check-In® and transportation of pets and unaccompanied minors, in accordance with Southwest's respective policies. EarlyBird Check-In provides Customers with automatic check-in before general boarding positions become available, improving Customers' seat selection options (priority boarding privileges are already a benefit of being an "A-List" tier member under the Company's Rapid Rewards Frequent Flyer Program). Southwest’s Pet Policy provides Customers an opportunity to bring a small cat or dog into the aircraft cabin. Southwest also has an unaccompanied minor travel policy to address the administrative costs and the extra care necessary to safely transport these Customers.
When available, Southwest also sells, at the gate, open priority boarding positions in the first 15 positions in its "A" boarding group.
Southwest offers inflight satellite-based WiFi service on all of its 737-700 and 737-800 aircraft, representing over 80 percent of Southwest’s fleet. Southwest’s Customers with small portable electronic devices are able to utilize the airline’s onboard WiFi from gate-to-gate when travelling on a Southwest WiFi-enabled airplane. Southwest was the first carrier to offer gate-to-gate connectivity. Southwest’s onboard entertainment options on WiFi-enabled aircraft for viewing on Customers’ personal wireless devices include free access to Southwest’s live and on-demand television product. The television product currently consists of 19 live channels and up to 75 on-demand recorded episodes from popular television series. Due to licensing restrictions, free live TV may not be available onboard WiFi-enabled international flights. Southwest also provides movies-on-demand, and also offers a Messaging-only option, including all WiFi-enabled stops and connections. The Messaging service allows access to iMessage and pre-downloaded apps for Viber and WhatsApp. Customers do not have to purchase WiFi to access television offerings, movies-on-demand, or the Messaging-only service.
Rapid Rewards Frequent Flyer Program
Southwest’s Rapid Rewards frequent flyer program enables program members (“Members”) to earn points for every dollar spent on Southwest 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 is based on the fare and fare class 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 so long as the Member has points-earning activity during the most recent 24 months.
Under the program, Members continue to accumulate points until the time they decide to redeem them. As a result, the program provides Members significant flexibility and options for earning and redeeming rewards. For example, Members can earn more points (and/or achieve tiered status such as A-List and Companion Pass faster) by purchasing higher fare tickets. Members also have significant flexibility in redeeming points, such as the opportunity to book in advance to take advantage of a lower fare (including many fare sales) ticket by redeeming fewer points or by being able to redeem more points and book at the last minute if seats are still available for sale. Members can also earn points through qualifying purchases with Rapid Rewards Partners (which include, for example, car rental agencies, hotels, restaurants, and retailers), as well as by using Southwest’s co-branded Chase® Visa credit card. In addition, holders of Southwest’s co-branded Chase Visa credit card are able to redeem their points for items other than travel on Southwest, 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 with Rapid Rewards Partners, Members also have the ability to purchase, gift, and transfer points, as well as the ability to donate points to selected charities.
Southwest’s Rapid Rewards frequent flyer program features tier and Companion Pass programs for the most active Members, including “A-List” and “A-List Preferred” status. Both A-List and A-List Preferred Members enjoy benefits such as “Fly By®” priority check-in and security lane access, where available, as well as dedicated phone lines, standby priority, and an earnings bonus on eligible revenue flights (25 percent for A-List and 100 percent for A-List Preferred). In addition, A-List Preferred Members enjoy free inflight WiFi on equipped flights. Members who attain A-List or A-List Preferred status receive priority boarding privileges for an entire year. When these Customers purchase travel at least 36 hours prior to flight time, they receive the best boarding pass number available (generally, an “A” boarding pass). Members who fly 100 qualifying one-way flights or earn 110,000 qualifying points in a calendar year automatically receive a Companion Pass, which provides for unlimited free travel for one year to any destination available on Southwest for a designated companion of the qualifying Member. The Member and designated companion must travel together on the same flight.
Southwest’s Rapid Rewards frequent flyer program has been designed to drive more revenue by (i) bringing in new Customers, including new Members, as well as new holders of Southwest’s co-branded Chase Visa credit card; (ii) increasing business from existing Customers; and (iii) strengthening the Company’s Rapid Rewards hotel, rental car, credit card, and retail partnerships. The program continues to exceed the Company’s expectations with respect to the number of Members added, the amount spent per Member on airfare, the number of flights taken by Members, the number of Southwest’s co-branded Chase Visa credit card holders added, the number of points sold to business partners, and the number of frequent flyer points purchased by Members. During 2015, the Company entered into an amended co-branded credit card agreement with Chase Bank USA, N.A. Additional information regarding this amended co-branded credit card agreement, including the effect of the resulting change in accounting methodology, is provided below under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 1 to the Consolidated Financial Statements.
For the Company’s 2015 consolidated results, Customers of Southwest redeemed approximately 7.3 million flight awards, accounting for approximately 12.0 percent of revenue passenger miles flown. For the Company’s 2014 consolidated results, Customers of Southwest and AirTran redeemed approximately 6.2 million flight awards, accounting for approximately 11.0 percent of revenue passenger miles flown. For the Company’s 2013 consolidated results, Customers of Southwest and AirTran redeemed approximately 5.4 million flight awards, accounting for approximately 9.5 percent of revenue passenger miles flown. The Company’s accounting policies with respect to its frequent flyer programs are discussed in more detail in Note 1 to the Consolidated Financial Statements.
Southwest.com
The Company’s Internet website, Southwest.com®, is the only avenue for Southwest Customers to purchase and manage travel online. Customers’ trips can be planned and managed directly from the southwest.com home page. Southwest.com is designed to help make the Customer's experience personal and intuitive with features such as recognizing the Customer's location to provide relevant deals, remembering recent searches to make it easy to get to trips of interest, and shopping cart functionality allowing Customers to purchase air, hotel, and car rental in one visit. The newly redesigned “My Accounts” section of the website provides a detailed view into a Customer’s travel and loyalty activity. Southwest.com highlights points of differentiation between Southwest and other air carriers, as well as the fact that southwest.com is the only place where Customers can purchase Southwest fares online. In addition, southwest.com and swabiz.com (the Company’s business travel reservation web page) are available in a translated Spanish version, which provides Customers who prefer to transact in Spanish the same level of Customer Service provided by the English versions of the websites. Additionally, Southwest offers Customers a mobile website and app to provide Customers the ability to transact with Southwest anytime they have access to their mobile device. For the year ended December 31, 2015, approximately 79.4 percent of the Company’s Passenger revenues came through its website (including revenues from SWABIZ®).
Marketing
During 2015, the Company continued to benefit from, and aggressively market, Southwest’s points of differentiation from its competitors. In October 2015, the Company premiered a new advertising campaign called TransfarencySM.. The campaign emphasizes Southwest's approach to treating Customers fairly, honestly, and respectfully, with its low fares and no unexpected bag fees, change fees, or hidden fees.
Southwest continues to be the only major U.S. airline that offers to all ticketed Customers up to two checked bags that fly free (weight and size limits apply). Through both its national and local marketing campaigns, Southwest has continued to aggressively promote this point of differentiation from its competitors with its “Bags Fly Free®” message. The Company believes its decision not to charge for first and second checked bags on Southwest, as reinforced by the Company’s related marketing campaign, has driven an increase in Southwest’s market share and a resulting net increase in revenues.
Southwest is also the only major U.S. airline that does not charge a fee on any of its fares for a Customer change in flight reservations. The Company has continued to incorporate this key point of differentiation in its marketing campaigns. The campaigns highlight the importance to Southwest of Customer Service by showing that Southwest understands plans can change and therefore does not charge a change fee. While a Customer may pay a difference in airfare, the Customer will not be charged a change fee on top of any difference in airfare.
Also unlike most of its competitors, Southwest does not impose additional fees for items such as seat selection, snacks, curb-side check-in, and telephone reservations. In addition, Southwest allows each ticketed Customer to check one stroller and one car seat free of charge, in addition to the two free checked bags.
The Company also continues to promote all of the many other reasons to fly Southwest such as its low fares, network size, Customer Service, free live television offerings, and its Rapid Rewards frequent flyer program.
In 2014, the Company launched a new visual expression of its brand by introducing a new Heart aircraft livery, airport experience, and logo. Aircraft already in the Company's fleet are scheduled to receive the newly painted livery within the aircraft's existing repainting schedule, while new aircraft will be delivered in the Heart livery. In addition, many of the future airport conversions will be integrated into existing and upcoming airport improvement projects.
Technology Initiatives
During 2015, the Company continued its commitment to technology improvements to support its ongoing operations and initiatives.
The Company is in the midst of a multi-year project to completely replace its reservation system. In 2014, the Company launched the Amadeus Altéa reservations solution to support the Company’s international service. The Company has since begun implementing Amadeus' Altéa reservations solution as the Company's future single reservation system for both domestic and international reservations. This single reservation system is expected to be implemented in 2017 and is expected to (i) provide significant incremental revenue opportunities beyond implementation; (ii) allow the
Company to offer product enhancements that will benefit Customers; (iii) give the Company a flexible and reliable foundation that will allow it to adapt more quickly and efficiently, and better respond to industry demands; and (iv) reduce the complexities associated with maintaining and operating multiple reservation systems. In August 2015, the Company achieved one of the first milestones of the single reservation system when its Customer Support & Services group (“CS&S”) began using Amadeus Group Manager for international group reservations. This enhanced functionality allows CS&S to book larger numbers of Passengers on a single reservation via streamlined booking processes.
During 2015, the Company also activated a new recovery optimization tool designed to help the Company effectively manage its increasingly complex network. The optimizing tool assists with irregular operations such as out of service events, station reduction, and station shutdown, by considering many factors including passenger and crew connections, airport curfews, equipment mismatches, and mission and maintenance requirements.
The Company intends to continue to devote significant technology resources towards, among other things, (i) the continued development of systems to improve both revenue management and network optimization capabilities, (ii) the aforementioned replacement of Southwest's existing domestic reservation system with the comprehensive Amadeus' Altéa reservations solution, and (iii) tools to improve operational management.
Regulation
The airline industry is heavily regulated, especially by the federal government, and there are a significant number of governmental agencies and legislative bodies that have the ability to directly or indirectly affect the Company and/or the airline industry financially and/or operationally. Examples of regulations affecting the Company and/or the airline industry, imposed by several of these governmental agencies and legislative bodies, are discussed below.
Economic and Operational Regulation
Consumer Protection Regulation by the U.S. Department of Transportation
The U.S. Department of Transportation (the “DOT”) regulates economic operating authority for air carriers and consumer protection for airline passengers. The Federal Aviation Authority (“FAA”), a sub-agency of the DOT, regulates aviation safety. The DOT may impose civil penalties on air carriers for violating its regulations.
To provide passenger transportation in the United States, a domestic airline is required to hold both a Certificate of Public Convenience & Necessity from the DOT and an Air Carrier Operating Certificate from the FAA. A Certificate of Public Convenience & Necessity is unlimited in duration, and the Company’s certificate generally permits it to operate among any points within the United States and its territories and possessions. Additional DOT authority, in the form of a certificate or exemption from certificate requirements, is required for a U.S. airline to serve foreign destinations either with its own aircraft or via code-sharing with another airline. Exemptions granted by the DOT to serve international markets are generally limited in duration and are subject to periodic renewal requirements. The DOT also has jurisdiction over international tariffs and pricing in certain markets. The DOT may revoke a certificate or exemption, in whole or in part, for intentional failure to comply with federal aviation statutes, regulations, orders, or the terms of the certificate itself.
The DOT’s consumer protection and enforcement activities relate to areas such as unfair and deceptive practices and unfair competition by air carriers, deceptive airline advertising (concerning, e.g., fares, ontime performance, schedules, and code-sharing), and violations of rules concerning denied boarding compensation, ticket refunds, and baggage liability requirements. The DOT is also charged with prohibiting discrimination by airlines against consumers on the basis of race, religion, national origin, or sex.
Under the above-described authority, the DOT has adopted so-called “Passenger Protection Rules,” which address a wide variety of matters including flight delays on the tarmac, chronically delayed flights, denied boarding compensation, and advertising of airfares, among others. Under the Passenger Protection Rules, U.S. passenger airlines are required to adopt contingency plans that include the following: (i) assurances that no domestic flight will remain on the airport tarmac for more than three hours and that no international flight will remain on the tarmac at a U.S. airport for more than four hours, unless the pilot-in-command determines there is a safety-related or security-related impediment to deplaning passengers, or air traffic control advises the pilot-in-command that returning to the gate or permitting passengers to disembark elsewhere would significantly disrupt airport operations; (ii) an assurance that air carriers
will provide adequate food and potable drinking water no later than two hours after the aircraft leaves the gate (in the case of departure) or touches down (in the case of arrival) if the aircraft remains on the tarmac, unless the pilot-in-command determines that safety or security considerations preclude such service; and (iii) an assurance of operable lavatories, as well as adequate medical attention, if needed. Air carriers are required to publish their contingency plans on their websites.
The Passenger Protection Rules also subject airlines to potential DOT enforcement action for unfair and deceptive practices in the event of chronically delayed domestic flights (i.e., domestic flights that operate at least ten times a month and arrive more than 30 minutes late more than 50 percent of the time during that month). In addition, airlines are required to (i) display ontime performance on their websites; (ii) adopt customer service plans, publish those plans on their website, and audit their own compliance with their plans; (iii) designate an employee to monitor the performance of their flights; (iv) provide information to passengers on how to file complaints; and (v) respond in a timely and substantive fashion to consumer complaints.
The Passenger Protection Rules also require airlines to (i) pay up to $1,350 in denied boarding compensation to each passenger involuntarily bumped from a flight; (ii) refund any checked bag fee for permanently lost luggage; (iii) prominently disclose all potential fees for optional ancillary services on their websites; and (iv) refund passenger fees paid for ancillary services if a flight cancels or oversells and a passenger is unable to take advantage of such services.
The Passenger Protection Rules also require that (i) advertised airfares include all government-mandated taxes and fees; (ii) passengers be allowed to hold a reservation for up to 24 hours without making a payment; (iii) passengers be allowed to cancel a paid reservation without penalty for 24 hours after the reservation is made, as long as the reservation is made at least seven days in advance of travel; (iv) fares may not increase after purchase; (v) baggage fees must be disclosed to the passenger at the time of booking; (vi) the same baggage allowances and fees must apply throughout a passenger’s trip; (vii) baggage fees must be disclosed on e-ticket confirmations; and (viii) passengers must be promptly notified in the event of delays of more than 30 minutes or if there is a cancellation or diversion of their flight.
The DOT has issued a proposed rule that would further expand the Passenger Protection Rules. First, the proposed rule would require airlines to share with ticket agents fee information for “basic ancillary services,” including fees for a first checked bag, second checked bag, carry-on items, and advance seat selection. Second, the proposed rule would require enhanced reporting of information to the DOT by mainline carriers for their domestic code-share partner operations. Third, the proposed rule would require ticket agencies to disclose which carriers' tickets they sell to avoid leading consumers to mistakenly believe they are searching all possible flight options when in fact other options may be available. Fourth, the proposed rule would impose a variety of additional requirements on ticket agents and air carriers, such as public disclosures of information. The Company is not able to predict the impact of any new consumer protection rules on its services, although the Company is likely to be affected to a lesser degree than most other airlines, which generally offer more ancillary products and services, and sell their services largely via ticket agencies. The DOT is expected to issue a final rule in this proceeding in 2016.
The DOT has expressed its intent to aggressively investigate alleged violations of its consumer protection rules. Airlines that violate any DOT regulation are subject to potential fines of up to $27,500 per occurrence.
The Company is also monitoring other potential rulemakings that could impact its business such as (i) an FAA proposed rule designed to tighten the utilization requirements for takeoff and landing slots operated by air carriers at the three New York City airports; (ii) a DOT proposed rule to change the metric by which the DOT computes an air carrier’s mishandled baggage performance; (iii) a DOT proposed rule to require air carriers to publicly disclose the revenues received from the sale of ancillary services to passengers; (iv) a potential DOT proposed rule to enhance accessibility for disabled passengers with respect to aircraft lavatories and in-flight entertainment; and (v) a potential DOT proposed rule to restrict passenger cell phone voice calls on aircraft.
Aviation Taxes and Fees
The statutory authority for the federal government to collect most types of aviation taxes, which are used, in part, to finance programs administered by the FAA, must be periodically reauthorized by the U.S. Congress. In 2012, Congress adopted the FAA Modernization and Reform Act of 2012, which extended most commercial aviation taxes through
September 30, 2015. In September 2015, Congress extended the expiration date for an additional six months. Congress is expected to try to enact a new FAA reauthorization bill in 2016, which may make substantive changes with respect to aviation taxes (including, possibly, airport-assessed passenger facility charges) and/or FAA offices and programs that are financed through aviation tax revenue. Congress must either adopt a new FAA reauthorization bill or pass a “status quo” extension by April 1, 2016; otherwise, a lapse in the statutory authority could affect the airlines’ and passengers’ respective tax burdens, as well as impact the FAA’s ability to fund airport grants and regulate the airline industry.
In addition to FAA-related taxes, there are additional federal taxes related to the Department of Homeland Security. These taxes do not need to be reauthorized periodically. Congress has set the Transportation Security Fee paid by passengers at $5.60 per one-way passenger trip. In December 2015, Congress enacted another statute that indexes immigration and customs fees to inflation, beginning in 2016. These two fees are paid by inbound international passengers and are used to support the operations of U.S. Customs and Border Protection (“CBP”). Finally, the U.S. Department of Agriculture’s Animal and Plant Health Inspection Service published a final regulation in October 2015 that modifies international agriculture inspection fees. Under this new rule, effective December 28, 2015, the per-passenger agriculture inspection fee is $5.00 and the per-commercial aircraft fee is $225.00.
In 2016, in addition to FAA reauthorization legislation, Congress may consider comprehensive tax reform legislation, which could result in a lower corporate tax rate and the elimination of certain tax deductions and preferences. Grants to airports and/or airport bond financing may also be affected through future legislation, which could result in higher fees, rates, and charges at many of the airports the Company serves.
Operational, Safety, and Health Regulation
The FAA has the authority to regulate safety aspects of civil aviation operations. Specifically, the Company and its third-party service providers are subject to the jurisdiction of the FAA with respect to aircraft maintenance and operations, including equipment, ground facilities, dispatch, communications, flight training personnel, and other matters affecting air safety. The FAA, acting through its own powers or through the appropriate U.S. Attorney, has the power to bring proceedings for the imposition and collection of fines for violation of the FAA regulations.
To address compliance with its regulations, the FAA requires airlines to obtain the Air Carrier Operating Certificate and other certificates, approvals, and authorities. These certificates, approvals, and authorities are subject to suspension or revocation for cause.
The FAA has rules in effect with respect to flight, duty, and rest regulations. Among other things, the rules require a ten hour minimum rest period prior to a pilot’s flight duty period; mandate that a pilot must have an opportunity for eight hours of uninterrupted sleep within the rest period; and impose pilot “flight time” and “duty time” limitations based upon report times, the number of scheduled flight segments, and other operational factors. The rules affect the Company’s staffing flexibility, which could impact the Company’s operational performance, costs, and Customer Experience.
In addition to its role as safety regulator, the FAA also operates the nation’s air traffic control system and is in the midst of implementing a multi-faceted “next generation” air traffic control system (“NextGen”). The Air Traffic Organization (“ATO”) is the operational arm of the FAA. The ATO is responsible for providing safe and efficient air navigation services to all of the United States and large portions of the Atlantic and Pacific Oceans and the Gulf of Mexico. The Company is subject to any operational changes imposed by the FAA/ATO as they relate to the “NextGen” program, as well as the day-to-day management of the air traffic control system. The FAA reauthorization discussed above under “Aviation Taxes and Fees,” as well as the annual appropriation legislation that will fund the DOT and the FAA in federal fiscal year 2017, could include provisions impacting future FAA safety-related activities and ATO operations in 2016 and beyond.
The Company is subject to various other federal, state, and local laws and regulations relating to occupational safety and health, including Occupational Safety and Health Administration and Food and Drug Administration regulations.
Security Regulation
Pursuant to the Aviation and Transportation Security Act (“ATSA”), the Transportation Security Administration (the “TSA”), a division of the U.S. Department of Homeland Security, is responsible for certain civil aviation security
matters. ATSA and subsequent TSA regulations and procedures implementing ATSA address, among other things, (i) flight deck security; (ii) the use of federal air marshals onboard flights; (iii) airport perimeter access security; (iv) airline crew security training; (v) security screening of passengers, baggage, cargo, mail, employees, and vendors; (vi) training and qualifications of security screening personnel; (vii) provision of passenger data to CBP; and (viii) background checks. Under ATSA, substantially all security officers at airports are federal employees, and significant other elements of airline and airport security are overseen and performed by federal employees, including federal security managers, federal law enforcement officers, and federal air marshals. TSA personnel and TSA-mandated security procedures can affect the Company’s operations, costs, and Customer experience. For example, as part of its security measures, the TSA regulates the types of liquid items that can be carried onboard aircraft. In addition, as part of its Secure Flight program, the TSA requires airlines to collect a passenger’s full name (as it appears on a government-issued ID), date of birth, gender, and Redress Number (if applicable). Airlines must transmit this information to Secure Flight, which uses the information to perform matching against terrorist watch lists. After matching passenger information against the watch lists, Secure Flight transmits the matching results back to airlines. This serves to identify individuals for enhanced security screening and to prevent individuals on watch lists from boarding an aircraft. It also helps prevent the misidentification of passengers who have names similar to individuals on watch lists. The TSA has also implemented enhanced security procedures as part of its enhanced, multi-layer approach to airport security, including physical pat down procedures, at security checkpoints. Such enhanced security procedures have raised privacy concerns by some air travelers.
The Company, in conjunction with the TSA and CBP, participates in TSA PreCheck™, a pre-screening initiative that allows a select group of low risk passengers to move through security checkpoints with greater efficiency and ease when traveling. Eligible passengers may use dedicated screening lanes at certain airports the Company serves for screening benefits, which include leaving on shoes, light outerwear, and belts, as well as leaving laptops and permitted liquids in carryon bags.
The Company also participates in the TSA Known Crewmember® program, which is a risk-based screening system that enables TSA security officers to positively verify the identity and employment status of flight-crew members. The program expedites flight crew member access to sterile areas of airports.
The Company works collaboratively with foreign national governments and airports to provide risk-based security measures at international departure locations.
The Company has also made significant investments to address the effect of security regulations, including investments in facilities, equipment, and technology to process Customers, checked baggage, and cargo efficiently; however, the Company is not able to predict the impact, if any, that various security measures or the lack of TSA resources at certain airports will have on Passenger revenues and the Company’s costs, either in the short-term or the long-term.
Environmental Regulation
The Company is subject to various federal laws and regulations relating to the protection of the environment, including the Clean Air Act, the Resource Conservation and Recovery Act, the Clean Water Act, the Safe Drinking Water Act, and the Comprehensive Environmental Response, Compensation and Liability Act, as well as state and local laws and regulations. These laws and regulations govern aircraft drinking water, emissions, and storm water discharges from operations, and the disposal of materials such as jet fuel, chemicals, hazardous waste, and aircraft deicing fluid. Additionally, in conjunction with airport authorities, other airlines, and state and local environmental regulatory agencies, the Company, as a normal course of business, undertakes voluntary investigation or remediation of soil or groundwater contamination at several airport sites. The Company does not believe that any environmental liability associated with these airport sites will have a material adverse effect on the Company’s operations, costs, or profitability, nor has it experienced any such liability in the past that has had a material adverse effect on its operations, costs, or profitability. Further regulatory developments pertaining to the control of engine exhaust emissions from ground support equipment could increase operating costs in the airline industry. The Company does not believe, however, that pending environmental regulatory developments in this area will have a material effect on the Company’s capital expenditures or otherwise materially adversely affect its operations, operating costs, or competitive position.
The federal government, as well as several state and local governments, the governments of other countries, and the United Nations’ International Civil Aviation Organization (“ICAO”) are considering legislative and regulatory proposals and voluntary measures to address climate change by reducing green-house gas emissions. At the federal
level, on July 1, 2015, the Environmental Protection Agency (the “EPA”) issued a proposed endangerment finding for greenhouse gas emissions from aircraft. That proposal is expected to be finalized sometime in 2016. The EPA would be required under the Clean Air Act to regulate greenhouse gases from aircraft if it determines the emissions endanger public health or the environment. In addition, along with its proposed endangerment finding, the EPA published an advance notice of proposed rulemaking summarizing international efforts to regulate aircraft emissions. ICAO could adopt a carbon dioxide standard for aircraft in 2016 and possibly a larger international framework for aviation emissions. Regardless of the method of regulation, policy changes with regards to climate change are possible, which could significantly increase operating costs in the airline industry and, as a result, adversely affect operations.
In addition to climate change, aircraft noise continues to be an environmental focus, especially as the FAA implements new flight procedures as part of its “NextGen” airspace modernization program discussed below. The Airport Noise and Capacity Act of 1990 gives airport operators the right, under certain circumstances, to implement local noise abatement programs, so long as they do not unreasonably interfere with interstate or foreign commerce or the national air transportation system. Some airports have established airport restrictions to limit noise, including restrictions on aircraft types to be used and limits on the number of hourly or daily operations or the time of operations. These types of restrictions can cause curtailments in service or increases in operating costs and can limit the ability of air carriers to expand operations at the affected airports. At the federal level, the FAA is considering changes in 2016 to enhance community engagement when developing new flight procedures, and there is a possibility that Congress may enact legislation in 2016 to address local noise concerns at one or more commercial airports in the United States.
The Company has undertaken a number of fuel conservation and carbon emission reduction initiatives such as the following:
| • | installation of blended winglets, which reduce drag and increase fuel efficiency, on all Boeing 737-700 and 737-800 aircraft in Southwest’s fleet and on a majority of Southwest’s 737-300 aircraft; |
| • | upgrading of the Company’s 737-800 fleet with newly designed, split scimitar winglets; |
| • | periodic engine washes; |
| • | use of electric ground power for aircraft air and power at the gate and for ground support equipment at select locations; |
| • | deployment of auto-throttle and vertical navigation to maintain optimum cruising speeds; |
| • | implementation of engine start procedures to support the Company's single engine taxi procedures; |
| • | adjustment of the timing of auxiliary power unit starts on originating flights to reduce auxiliary power unit usage; |
| • | implementation of fuel planning initiatives to safely reduce loading of excess fuel; |
| • | Evolve aircraft cabin interior retrofitting featuring lighter seats; |
| • | reduction of aircraft engine idle speed while on the ground, which also increases engine life; |
| • | galley refreshes with dry goods weight reduction; |
| • | Company optimized routes (flying the best wind routes to take advantage of tailwinds or to minimize headwinds); |
| • | improvements in flight planning algorithms to better match the Company's aircraft flight management system (and thereby enabling the Company to fly at the most efficient altitudes); |
| • | substitution of Pilot flight bags with lighter Electronic Flight Bag tablets; and |
| • | implementation of Real Time Descent Winds (automatic uplinking of up-to-date wind data to the aircraft allowing crews to time the descent to minimize thrust inputs). |
The Company has also participated in Required Navigation Performance (“RNP”) operations as part of the FAA’s Performance Based Navigation program, which is intended to modernize the U.S. Air Traffic Control System by addressing limitations on air transportation capacity and making more efficient use of airspace. RNP combines the
capabilities of advanced aircraft avionics, Global Positioning System ("GPS") satellite navigation (instead of less precise ground-based navigation), and new flight procedures to (i) enable aircraft to carry navigation capabilities rather than relying on airports; (ii) improve operational capabilities by opening up many new and more direct airport approach paths to produce more efficient flight patterns; and (iii) conserve fuel, improve safety, and reduce carbon emissions. By the end of 2015, Southwest had conducted over 23,000 RNP approaches, including approximately 5,000 in 2015. Southwest must rely on RNP approaches published by the FAA, and the rate of introduction of RNP approaches continues to be slower than expected, with fuel efficient RNP approaches currently available at only 46 of Southwest’s airports. In addition, even at airports with approved RNP approaches, the clearance required from air traffic controllers to perform RNP approaches is sometimes not granted. Southwest continues to work with the FAA to develop more RNP approaches and to modify air traffic control rules to support greater utilization of RNP.
As part of its commitment to corporate sustainability, the Company has published the Southwest One ReportTM describing the Company’s sustainability strategies, which include these and other efforts to reduce greenhouse gas emissions and address other environmental matters such as energy and water conservation, waste minimization, and recycling.
International Regulation
All international air service is subject to certain U.S. federal requirements and approvals, as well as the regulatory requirements of the appropriate authorities of the foreign countries involved. The Company has obtained the necessary economic authority from the DOT, as well as approvals required by the FAA and applicable foreign government entities, to conduct operations, under certain circumstances, to points outside of the continental United States currently served by the Company. Certain international authorities and approvals held by the Company are subject to periodic renewal requirements. The Company requests extensions of such authorities and approvals when and as appropriate. To the extent the Company seeks to serve additional foreign destinations in the future, or to renew its authority to serve certain routes, it may be required to obtain necessary authority from the DOT and/or approvals from the FAA, as well as any applicable foreign government entity.
Certain international route authorities are governed by bilateral air transportation agreements between the United States and foreign countries. Changes in U.S. or foreign government aviation policies could result in the alteration or termination of such agreements, diminish the value of the Company’s existing international authorities, present barriers to renewing existing or securing new authorities, or otherwise affect the Company’s international operations. Bilateral agreements between the United States and foreign countries the Company currently serves, or may serve in the future, may be subject to renegotiation from time to time. While the U.S. government has negotiated “open skies” agreements with many countries, which allow for unrestricted access between the United States and respective foreign destinations, agreements with other countries may restrict the Company’s entry and/or growth opportunities. For example, the bilateral air transport agreement currently in force between the United States and Mexico imposes limitations on the number of U.S. air carriers that may operate on city-pair routes between points in the United States and points in Mexico. These restrictions currently prevent the Company from entering certain U.S.-Mexico routes on which it would like to provide service. Although the United States and Mexican governments signed a new bilateral agreement on December 18, 2015, that would remove such restrictions and thereby provide greater market access by U.S. carriers to Mexico, that agreement does not take effect until ratification by the Mexican legislature occurs and other diplomatic procedures are completed. The Company is not able to predict if or when the new U.S.-Mexico bilateral aviation agreement will officially enter into force.
The CBP is the federal agency of the U.S. Department of Homeland Security charged with facilitating international trade, collecting import duties, and enforcing U.S. regulations with respect to trade, customs, and immigration. As the Company expands its international flight offerings, CBP and its requirements and resources will also become increasingly important considerations to the Company. For instance, with the exception of flights from a small number of foreign “preclearance” locations, arriving international flights may only land at CBP-designated airports, and CBP officers must be present and in sufficient quantities at those airports to effectively process and inspect arriving international passengers and cargo. Thus, CBP personnel and CBP-mandated procedures can affect the Company’s operations, costs, and Customer experience. The Company has made and expects to continue to make significant investments in facilities, equipment, and technologies at certain airports in order to improve the Customer experience and to assist CBP with its inspection and processing duties; however, the Company is not able to predict the impact,
if any, that various CBP measures or the lack of CBP resources will have on Company revenues and costs, either in the short-term or the long-term.
Insurance
The Company carries insurance of types customary in the airline industry and in amounts deemed adequate to protect the Company and its property and to comply both with federal regulations and certain of the Company’s credit and lease agreements. The policies principally provide coverage for public and passenger liability, property damage, cargo and baggage liability, loss or damage to aircraft, engines, and spare parts, and workers’ compensation. In addition, the Company carries a cyber-security insurance policy with regards to data protection and business interruption associated with both security breaches from malicious parties and from certain system failures.
Through the 2003 Emergency Wartime Supplemental Appropriations Act (the “Wartime Act”), the federal government has in the past provided war-risk insurance coverage to commercial carriers, including for losses from terrorism, for passengers, third parties (ground damage), and the aircraft hull. However, since the government-provided supplemental coverage from the Wartime Act was set to expire on September 30, 2014, the Company proactively canceled its government provided war-risk insurance coverage prior to that date and purchased comparable coverage via the commercial insurance marketplace. Although the Company was able to purchase comparable coverage via the commercial insurance marketplace, available commercial insurance in the future could be more expensive and/or have material differences in coverage than is currently provided and may not be adequate to protect the Company's risk of loss from future acts of terrorism.
Competition
Competition within the airline industry is intense and highly unpredictable, and Southwest currently competes with other airlines on virtually all of its scheduled routes. As a result of moderately improved economic conditions and an increased focus by airlines on costs, the airline industry has become increasingly competitive in recent years with healthier financial condition and improved profitability.
Key competitive factors within the airline industry include (i) pricing and cost structure; (ii) routes, frequent flyer programs, and schedules; and (iii) customer service, comfort, and amenities. Southwest also competes for customers with other forms of transportation, as well as alternatives to travel. In recent years, the majority of domestic airline service has been provided by Southwest and the other largest major U.S. airlines, including American Airlines, Delta Air Lines, and United Airlines. The DOT defines major U.S. airlines as those airlines with annual revenues of at least $1 billion; there are currently 13 passenger airlines offering scheduled service, including Southwest, that meet this standard.
Pricing and Cost Structure
Pricing is a significant competitive factor in the airline industry, and the availability of fare information on the Internet allows travelers to easily compare fares and identify competitor promotions and discounts. Pricing can be driven by a variety of factors. For example, airlines often discount fares to drive traffic in new markets or to stimulate traffic when necessary to improve load factors and/or cash flow. In addition, multiple airlines have been able to reduce fares because they have been able to lower their operating costs as a result of reorganization within and outside of bankruptcy. Further, some of the Company’s competitors have continued to grow and modernize their fleets and expand their networks, potentially enabling them to better control costs per available seat mile (the average cost to fly an aircraft seat (empty or full) one mile), which in turn may enable them to lower their fares.
The Company believes its low-cost operating structure continues to provide it with an advantage over many of its airline competitors by enabling it to continue to charge low fares. The Company also believes it has gained a competitive advantage by differentiating Southwest from all of its major competitors by not charging additional fees for items such as first and second checked bags, flight changes, seat selection, snacks, curb-side check-in, and telephone reservations.
Routes, Frequent Flyer Programs, and Schedules
The Company also competes with other airlines based on markets served, frequent flyer opportunities, and flight schedules. Some major airlines have more extensive route structures than Southwest, including more extensive international networks. In addition, many competitors have entered into significant commercial relationships with other airlines, such as global alliances, code-sharing, and capacity purchase agreements, which increase the airlines’
opportunities to expand their route offerings. For example, an alliance or code-sharing agreement enables an airline to offer flights that are operated by another airline and also allows the airline’s customers to book travel that includes segments on different airlines through a single reservation or ticket. As a result, depending on the nature of the specific alliance or code-sharing arrangement, a participating airline may be able to (i) offer its customers access to more destinations than it would be able to serve on its own, (ii) gain exposure in markets it does not otherwise serve, or (iii) increase the perceived frequency of its flights on certain routes. Alliance and code-sharing arrangements not only provide additional route flexibility for participating airlines, they can also allow these airlines to offer their customers more opportunities to earn and redeem frequent flyer miles or points. A capacity purchase agreement enables an airline to expand its route structure by paying another airline (e.g., a regional airline with smaller aircraft) to operate flights on its behalf in markets that it does not, or cannot, serve itself. The Company continues to evaluate and implement initiatives to better enable itself to offer additional itineraries.
Customer Service, Comfort, and Amenities
Southwest also competes with other airlines in areas of Customer Service such as ontime performance, passenger amenities, flight equipment type, and comfort. According to statistics published by the DOT, Southwest consistently ranks at or near the top among domestic carriers in Customer Satisfaction for having the lowest Customer complaint ratio. Some airlines have more seating options and associated passenger amenities than does Southwest, including first-class, business class, and other premium seating and related amenities. Additionally, some major U.S. airlines, including Southwest, are adding a significant number of new aircraft to their fleets. Such efforts could provide cost benefits to these airlines through fleet simplification, improved fuel efficiencies, and lower maintenance costs. Additionally, such new aircraft could have newer and different passenger amenities than those contained in the Company’s existing fleet.
Other Forms of Competition
The airline industry is subject to varying degrees of competition from surface transportation by automobiles, buses, and trains. Inconveniences and delays associated with air travel security measures can increase surface competition. In addition, surface competition can be significant during economic downturns when consumers cut back on discretionary spending and fewer choose to fly, or when gasoline prices are lower, making surface transportation a less expensive option. Because of the relatively high percentage of short-haul travel provided by Southwest, it is particularly exposed to competition from surface transportation in these instances. The airline industry is also subject to competition from alternatives to travel such as videoconferencing and the Internet, which can increase in the event of travel inconveniences and economic downturns. The Company is subject to the risk that air travel inconveniences and economic downturns may, in some cases, result in permanent changes to consumer behavior in favor of surface transportation and electronic communications.
Seasonality
The Company’s business is seasonal. Generally, in most markets the Company serves, demand for air travel is greater during the summer months, and therefore, revenues in the airline industry tend to be stronger in the second (April 1 - June 30) and third (July 1 - September 30) quarters of the year than in the first (January 1 - March 31) and fourth (October 1 - December 31) quarters of the year. As a result, in many cases, the Company’s results of operations reflect this seasonality. Factors that could alter this seasonality include, among others, the price of fuel, general economic conditions, extreme or severe weather, fears of terrorism or war, or changes in the competitive environment. Therefore, the Company’s quarterly operating results are not necessarily indicative of operating results for the entire year, and historical operating results in a quarterly or annual period are not necessarily indicative of future operating results.
Employees
At December 31, 2015, the Company had approximately 49,600 active fulltime equivalent Employees, consisting of 21,100 flight, 2,800 maintenance, 17,300 ground, Customer, and fleet service, and 8,400 management, technology, finance, marketing, and clerical personnel (associated with non-operational departments). Approximately 83 percent of these Employees were represented by labor unions. The Railway Labor Act establishes the right of airline employees to organize and bargain collectively. Under the Railway Labor Act, collective-bargaining agreements between an airline and a labor union generally do not expire, but instead become amendable as of an agreed date. By the amendable date, if either party wishes to modify the terms of the agreement, it must notify the other party in the manner required by
the Railway Labor Act and/or described in the agreement. After receipt of the notice, the parties must meet for direct negotiations. If no agreement is reached, either party may request the National Mediation Board to appoint a federal mediator. If no agreement is reached in mediation, the National Mediation Board may determine an impasse exists and offer binding arbitration to the parties. If either party rejects binding arbitration, a 30-day “cooling off” period begins. At the end of this 30-day period, the parties may engage in “self-help,” unless a Presidential Emergency Board is established to investigate and report on the dispute. The appointment of a Presidential Emergency Board maintains the “status quo” for an additional 60 days. If the parties do not reach agreement during this period, the parties may then engage in “self-help.” “Self-help” includes, among other things, a strike by the union or the airline’s imposition of any or all of its proposed amendments and the hiring of new employees to replace any striking workers. The following table sets forth the Company’s Employee groups and the status of the respective collective-bargaining agreements as of December 31, 2015:
| Employee Group | Approximate Number of Employees | Representatives | Status of Agreement |
| Southwest Pilots | 7,600 | Southwest Airlines Pilots’ Association (“SWAPA”) | In negotiations |
| Southwest Flight Attendants | 13,100 | Transportation Workers of America, AFL-CIO, Local 556 (“TWU 556”) | In negotiations |
| Southwest Ramp, Operations, Provisioning, Freight Agents | 11,000 | Transportation Workers of America, AFL-CIO, Local 555 (“TWU 555”) | The Company reached a tentative agreement with TWU 555 in December 2015. TWU 555 has presented the contract to its members for ratification. If ratified, the contract will become amendable in 2021. |
| Southwest Customer Service Agents, Customer Representatives | 6,300 | International Association of Machinists and Aerospace Workers, AFL-CIO (“IAM 142”) | Amendable December 2018 |
| Southwest Material Specialists (formerly known as Stock Clerks) | 300 | International Brotherhood of Teamsters, Local 19 (“IBT 19”) | In negotiations |
| Southwest Mechanics | 2,300 | Aircraft Mechanics Fraternal Association (“AMFA”) | In negotiations |
| Southwest Aircraft Appearance Technicians | 200 | AMFA | Amendable February 2017 |
| Southwest Facilities Maintenance Technicians | 40 | AMFA | In negotiations |
| Southwest Dispatchers | 300 | Transportation Workers of America, AFL-CIO, Local 550 (“TWU 550”) | Amendable November 2019 |
| Southwest Flight Simulator Technicians | 30 | International Brotherhood of Teamsters (“IBT”) | Amendable April 2019 |
| Southwest Flight Crew Training Instructors | 80 | Transportation Workers of America, AFL-CIO, Local 557 (“TWU 557”) | In negotiations |
| Southwest Meteorologists | 7 | TWU 550 | Amendable June 2019 |
| Southwest Source of Support Representatives | 90 | IAM 142 | In negotiations |
Additional Information About the Company
The Company was incorporated in Texas in 1967. The following documents are available free of charge through the Company’s website, www.southwest.com: the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports that are filed with or furnished to the Securities and Exchange Commission (“SEC”) pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934. These materials are made available through the Company’s website as soon as reasonably practicable
after they are electronically filed with, or furnished to, the SEC. In addition to its reports filed or furnished with the SEC, the Company publicly discloses material information from time to time in its press releases, at annual meetings of Shareholders, in publicly accessible conferences and Investor presentations, and through its website (principally in its Press Room and Investor Relations pages).
DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION
This Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are based on, and include statements about, the Company’s estimates, expectations, beliefs, intentions, and strategies for the future, and the assumptions underlying these forward-looking statements. Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include, without limitation, words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “will,” “should,” and similar expressions. Although management believes these forward-looking statements are reasonable as and when made, forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual results may differ materially from what is expressed in or indicated by the Company’s forward-looking statements or from historical experience or the Company’s present expectations. Known material risk factors that could cause these differences are set forth below under “Risk Factors.” Additional risks or uncertainties (i) that are not currently known to the Company, (ii) that the Company currently deems to be immaterial, or (iii) that could apply to any company, could also materially adversely affect the Company’s business, financial condition, or future results.
Caution should be taken not to place undue reliance on the Company’s forward-looking statements, which represent the Company’s views only as of the date this report is filed. The Company undertakes no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.