Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

YEAR IN REVIEW

For the 47th consecutive year, the Company was profitable, recording GAAP and non-GAAP results for 2019 and 2018 as noted in the following tables. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures.

		Year ended
(in millions, except per share amounts)		December 31,
GAAP		2019				2018				Percent Change
Operating income		$	2,957			$	3,206			(7.8)
Net income		$	2,300			$	2,465			(6.7)
Net income per share, diluted		$	4.27			$	4.29			(0.5)
Non-GAAP
Operating income		$	2,957			$	3,167			(6.6)
Net income		$	2,300			$	2,435			(5.5)
Net income per share, diluted		$	4.27			$	4.24			0.7

Net income for the year ended December 31, 2019, was $2.3 billion, a 6.7 percent decrease year-over-year, as compared to 2018 Net income of $2.5 billion. Diluted earnings per share for 2019 was $4.27, as compared with $4.29 for 2018. For the year ended December 31, 2019, Non-GAAP Net income was also $2.3 billion, a 5.5 percent decrease year-over-year. Non-GAAP diluted earnings per share for 2019 was also $4.27, as compared with $4.24 for 2018. The decrease in GAAP Net income was primarily due to the impact of the Federal Aviation Administration ("FAA") grounding of the Boeing 737 MAX aircraft ("MAX"), unscheduled maintenance disruptions in first quarter 2019, and the U.S. government shutdown in first quarter 2019. The decrease in GAAP Net income also resulted from an 8.4 percent increase in Salaries, wages, and benefits expense, which included a discretionary, special $124 million pre-tax profitsharing award which was accrued in fourth quarter 2019, coupled with a 6.1 percent increase in Other operating expenses. These increases were partially offset by a 2.1 percent increase in Operating revenues, and a 5.8 percent decrease in Fuel and oil expense. See below for further information. Operating income for the year ended December 31, 2019, was $3.0 billion, a decrease of 7.8 percent year-over-year, and non-GAAP Operating income was also $3.0 billion, a 6.6 percent decrease year-over-year.

Boeing 737 MAX Grounding

The estimated 2019 Operating income reduction attributable to the MAX groundings from March 13, 2019, through the end of the year, was $828 million. The Company reached a confidential agreement (the “Boeing settlement”) with The Boeing Company on compensation related to estimated 2019 financial damages due to the grounding of the MAX. The terms of the Boeing settlement are confidential, but are intended to provide for a substantial portion of the Company's financial damages in 2019 associated with the MAX grounding. The Boeing settlement did not impact 2019 earnings, as substantially all of the compensation will be accounted for as a reduction of the cost basis for both owned MAX aircraft and future purchased MAX aircraft, which is expected to reduce depreciation expense in future years. The Company’s Board of Directors authorized a discretionary, special $124 million pre-tax profitsharing award for Boeing compensation which was accrued in fourth quarter 2019. The Company continues to engage in discussions with Boeing regarding compensation for 2020 damages related to the MAX groundings; however, no settlement assumptions have been factored into the Company's 2020 outlook. Based on continued uncertainty around the timing of MAX return to service, the Company has proactively removed the MAX from its flight schedule through June 6, 2020. Based on recent guidance from Boeing estimating that the ungrounding of the MAX will be mid-2020, the Company will likely extend MAX-related flight schedule adjustments further to provide operational reliability and a dependable flight schedule

for our Customers booking their summer travel. See Note 16 to the Consolidated Financial Statements for further information.

For the twelve months ended December 31, 2019, the Company's earnings performance, combined with its actions to manage invested capital, produced a 22.9 percent pre-tax non-GAAP return on invested capital ("ROIC"), or 17.8 percent on an after-tax basis, compared with the Company's pre-tax ROIC of 23.6 percent, or 18.4 percent on an after-tax basis, for the twelve months ended December 31, 2018. As a result of not paying for its scheduled MAX aircraft deliveries following the grounding in March 2019, the Company's cash balance at December 31, 2019, was higher than projected. However, the Company has not factored any amounts for excess cash into its invested capital and ROIC calculations for any of the periods presented. The primary cause of the year-over-year decline in pre-tax ROIC was the decrease in Operating income for the twelve months ended December 31, 2019, compared with the twelve months ended December 31, 2018. See the Company's calculation of ROIC in the accompanying reconciliation tables as well as the Note Regarding Use of Non-GAAP Financial Measures.

During 2019, the Company continued to return value to its Shareholders. The Company returned $2.4 billion to Shareholders through $372 million in dividend payments and $2.0 billion through four separate accelerated share repurchase programs and other open market share repurchases. During November 2019, the Company launched the Fourth Quarter 2019 ASR Program by advancing $550 million to a financial institution in a privately negotiated transaction. The Company subsequently received 7.3 million shares of common stock in December 2019, representing an estimated 75 percent of the shares to be purchased by the Company under the Fourth Quarter 2019 ASR Program, and subsequently received an additional 1.8 million shares in January 2020 in further partial settlement of the Fourth Quarter 2019 ASR Program. The specific number of shares that the Company ultimately will repurchase under the Fourth Quarter 2019 ASR Program will be determined based generally on a discount to the volume-weighted average price per share of the Company's common stock during a calculation period to be completed no later than February 13, 2020. The Company also entered into an additional open market share repurchase plan for the purchase of up to an additional $50 million of its shares of common stock depending on market prices. These purchases will be recorded as treasury share repurchases for purposes of calculating earnings per share. See "Liquidity and Capital Resources" below for further information on the Company's 2019 share repurchases. The Company has $1.35 billion remaining under its May 2019 $2.0 billion share repurchase authorization. See Part II, Item 5 for further information on the Company's share repurchase authorizations.

Company Overview

As of December 31, 2019, the Company served 101 destinations across 40 states and ten near-international countries and currently operates over 4,000 departures a day. The Company began service to Hawaii in March 2019 from Oakland to Honolulu, and from San Jose, California in May 2019. On November 10, 2019, the Company began service between Sacramento and Honolulu, as well as interisland service between Honolulu and Lihue. The Company currently operates 18 flights daily between Hawaii and the mainland, and 34 interisland flights daily amongst the Hawaiian Islands. By April 20, 2020, the Company is scheduled to offer 28 daily departures between California and Hawaii, and 38 daily departures among the Hawaiian Islands. The Company began service from Oakland and San Jose to both Lihue and Kona, and new interisland service between Honolulu and Hilo, and Kona and Kahului, in January 2020. The Company also is scheduled to begin service from San Diego to Kahului on Maui on April 14, 2020, and from San Diego to Honolulu on April 20, 2020. In 2019, the Company also announced plans to begin service from Houston Hobby to Cozumel, Mexico in March 2020, subject to government approvals. The Company ceased services at Benito Juárez Mexico City International Airport on March 30, 2019. Also in 2019, the Company decided to close its operations at Newark Liberty International Airport and consolidate its New York City presence at New York LaGuardia Airport.

During 2019, the Company took delivery of three new MAX aircraft from third parties. These deliveries occurred prior to the March 13, 2019, FAA emergency order issued for all U.S. airlines to ground all MAX aircraft. All 34 of the Company's MAX aircraft have remained grounded since March 13, 2019. Upon a rescission of the FAA order to ground the MAX, the Company currently estimates it will take at least a couple of months to comply with applicable FAA directives, including all necessary Pilot training. Based on continued uncertainty around the timing of MAX return to service, the Company has proactively removed the MAX from its flight schedule through June 6, 2020 and will likely

extend MAX-related flight schedule adjustments. The FAA will determine the timing of MAX return to service, and the Company offers no assurances that current estimations and timelines are correct. The Company continues to be focused on proactively managing cancellations, minimizing operational disruptions, reaccommodating Customers, and minimizing the impact on its ontime performance.

As of December 31, 2019, the Company had firm orders in place with Boeing for 219 737 MAX 8 aircraft and 30 737 MAX 7 aircraft. As previously disclosed, Boeing is not currently delivering new MAX aircraft and, therefore, not meeting its contractual delivery schedule. The Company had 41 MAX aircraft on order from Boeing or third parties from 2019 that have yet to be delivered, one of which contractually shifted to 2021. As a result of the MAX groundings, the Company deferred the planned retirement of seven of its owned Boeing 737-700 aircraft to future years. The Company retired one 737-700 aircraft during third quarter 2019 and an additional three 737-700 aircraft during fourth quarter 2019. The Company also returned two leased 737-700 aircraft during fourth quarter 2019. See Part I, Item 2 and Note 16 to the Consolidated Financial Statements for further information.

Based on the Company's MAX-related flight schedule adjustments through June 6, 2020, the Company currently expects its first quarter 2020 ASMs to decrease in the range of 1.5 to 2.5 percent, compared with first quarter 2019. Based on continued uncertainty regarding the MAX return to service that could materially impact current and future flight schedules, the Company is unable to provide annual 2020 available seat mile guidance at this time.

During 2019, the following events took place regarding the Company's unionized Employee groups in contract negotiations:

•	The Company's Mechanics and Related Employees, represented by Aircraft Mechanics Fraternal Association, ratified a new collective-bargaining agreement with the Company. The newly ratified contract becomes amendable in August 2024.

•	The Company's Flight Simulator Technicians, represented by International Brotherhood of Teamsters, ratified a new collective-bargaining agreement with the Company. The newly ratified contract becomes amendable in May 2024.

•	The Company's Material Specialists, represented by International Brotherhood of Teamsters Local 19, ratified a new collective-bargaining agreement with the Company. The newly ratified contract becomes amendable in April 2024.

2019 Compared with 2018

Operating Revenues

Passenger revenues for 2019 increased by $321 million, or 1.6 percent, compared with 2018. On a unit basis, Passenger revenues increased 3.2 percent, year-over-year, largely driven by a 3.1 percent increase in Passenger revenue yield and a slight increase in Load factor, year-over-year, to 83.5 percent. The Company's capacity decreased 1.6 percent in 2019, as compared with 2018. The increase in Passenger revenue yield was the result of an increase in average fare. In addition, prior year results included negative revenue effects from its Flight 1380 accident in April 2018. On April 17, 2018, Southwest Airlines Flight 1380 from New York-LaGuardia to Dallas Love Field suffered an uncontained failure of its port CFM56-7B engine, resulting in a Customer fatality. The nominal dollar increase was partially offset by several unexpected events during 2019 that contributed to a negative revenue impact, including the MAX groundings, unscheduled maintenance disruptions in first quarter, and the U.S. government shutdown in first quarter.

Freight revenues for 2019 decreased by $3 million, or 1.7 percent, compared with 2018, primarily due to decreased demand. Based on current trends, the Company currently expects Freight revenues in first quarter 2020 to increase, compared with first quarter 2019.

Other revenues for 2019 increased by $145 million, or 10.9 percent, compared with 2018. The increase was primarily due to an increase in revenues associated with cardholder spend on the Company's co-branded Chase® Visa credit card, driven by the Company's bonus point offers in the second, third, and fourth quarters of 2019, and the success of its

Companion Pass promotion in first quarter 2019 for new Cardholders. The Company currently expects Other revenues in first quarter 2020 to increase, compared with first quarter 2019.

Operating unit revenues for 2019 increased by 3.7 percent, compared with 2018. Currently, passenger booking and revenue trends remain healthy, and the Company expects first quarter 2020 RASM to increase in the range of 3.5 to 5.5 percent, compared with first quarter 2019. The Company's outlook for first quarter 2020 year-over-year RASM includes an estimated 1.5 point benefit—approximately one point due to the negative impact to passenger bookings from the U.S. government shutdown during first quarter 2019 and approximately one-half point related to unscheduled maintenance disruptions and related flight cancellations during first quarter 2019. Additionally, first quarter 2020 year-over-year RASM is expected to benefit by approximately two points due to the removal of MAX flights from the Company's schedule, which will result in lower first quarter 2020 capacity.

Operating Expenses

Operating expenses for 2019 increased by $712 million, or 3.8 percent, compared with 2018, while capacity decreased 1.6 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 experienced lower than expected ASMs during 2019 due to the MAX groundings. Flight cancellations are expected to drive unit cost pressure for the duration of the MAX groundings. The following table presents the Company's Operating expenses per ASM for 2019 and 2018, 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)	2019				2018				change				change
Salaries, wages, and benefits		5.27	¢			4.79	¢			0.48	¢		10.0	%
Fuel and oil	2.76				2.89				(0.13		)		(4.5	)
Maintenance materials and repairs	0.78				0.69				0.09				13.0
Landing fees and airport rentals	0.87				0.83				0.04				4.8
Depreciation and amortization	0.78				0.75				0.03				4.0
Other operating expenses	1.92				1.79				0.13				7.3
Total		12.38	¢			11.74	¢			0.64	¢		5.5	%

Operating expenses per ASM for 2019 increased by 5.5 percent, compared with 2018, primarily as a result of higher Salaries, wages, and benefits expense. See below for further information. Operating expenses per ASM for 2019, excluding Fuel and oil expense and special items (a non-GAAP financial measure), increased 8.5 percent year-over-year, also primarily as a result of higher Salaries, wages, and benefits expense. 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. Based on current trends, the Company expects its first quarter 2020 unit costs, excluding Fuel and oil expense and profitsharing expense, to increase in the range of 6.0 to 8.0 percent, year-over-year. This outlook includes an estimated seven point year-over-year unit cost headwind in first quarter 2020 driven by lower first quarter 2020 capacity as a result of the ongoing MAX groundings, which includes the impact of unabsorbed overhead that will be utilized upon the MAX return to service. It also includes one to two points of inflation primarily due to higher salaries, wages, and benefits; maintenance expense; and operating expenses related to investments in technology and facilities. This inflation will be substantially offset in first quarter 2020 due to the non-recurring first quarter 2019 costs associated with the Company's ratified labor agreement with its Mechanics and costs associated with unscheduled maintenance disruptions and related flight cancellations.

Salaries, wages, and benefits expense for 2019 increased by $644 million, or 8.4 percent, compared with 2018. On a per ASM basis, Salaries, wages, and benefits expense for 2019 increased 10.0 percent, compared with 2018. On both a dollar and per ASM basis, the majority of the increases were the result of higher salaries expense, driven by annual wage rate increases as well as increased headcount. In addition, the Company's Board of Directors authorized a

discretionary, special $124 million pre-tax profitsharing award for Boeing compensation which was accrued in fourth quarter 2019. Based on current cost trends and anticipated capacity, the Company expects first quarter 2020 Salaries, wages, and benefits expense per ASM, excluding profitsharing expense, to increase, compared with first quarter 2019.

During 2019, the Company conducted negotiations with various unionized Employee groups. The following table sets forth the Company’s unionized Employee groups with amendable contracts that are currently in negotiations on collective-bargaining agreements:

Employee Group	Approximate Number of Employees	Representatives	Amendable Date
Southwest Flight Attendants	16,000	Transportation Workers of America, AFL-CIO, Local 556 ("TWU 556")	November 2018
Southwest Customer Service Agents, Customer Representatives, and Source of Support Representatives	7,200	International Association of Machinists and Aerospace Workers, AFL-CIO ("IAM 142")	December 2018
Southwest Dispatchers	400	Transportation Workers of America, AFL-CIO, Local 550 ("TWU 550")	June 2019
Southwest Flight Crew Training Instructors	130	Transportation Workers of America, AFL-CIO, Local 557 ("TWU 557")	January 2020
Southwest Meteorologists	10	TWU 550	June 2019

In addition to the above, the Southwest Airlines Pilots' Association (“SWAPA”), which represents the Company's approximately 9,300 Pilots, has notified the Company of its request to begin discussions on a new agreement, prior to the current contract amendable date of September 1, 2020. The Company and SWAPA are scheduled for initial discussions in first quarter 2020.

Fuel and oil expense for 2019 decreased by $269 million, or 5.8 percent, compared with 2018. On a per ASM basis, Fuel and oil expense decreased 4.5 percent, compared with 2018. On both a dollar and per ASM basis, the decreases were primarily attributable to lower market jet fuel prices. The Company's 2019 average economic jet fuel cost per gallon decreased 5.0 percent, year-over-year, to $2.09 from $2.20. 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. These figures include $.05 per gallon in premium expense and $.02 per gallon in favorable cash settlements from fuel derivative contracts in 2019, compared with $.06 per gallon in premium expense and $.07 per gallon in favorable cash settlements from fuel derivative contracts in 2018. The decreases were partially offset by a decline in the Company's fuel efficiency during 2019, compared with 2018, when measured on the basis of ASMs generated per gallon of fuel. The decline in fuel efficiency was primarily due to the removal of the Company's most fuel efficient aircraft from its schedule as a result of the MAX groundings.

As of January 17, 2020, on an economic basis, the Company had derivative contracts in place related to expected future fuel consumption as follows:

Period	Maximum percent of estimated fuel consumption covered by fuel derivative contracts at varying West Texas Intermediate/Brent Crude Oil, Heating Oil, and Gulf Coast Jet Fuel-equivalent price levels (a)
2020	59%
2021	54%
2022	31%
Beyond 2022	less than 5%

(a) The Company’s hedge position can vary significantly at different price levels, including prices at which the Company considers "catastrophic" coverage. The percentages 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 10 to the Consolidated Financial Statements for further information.

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 10 to the Consolidated Financial Statements for further information), as well as the amount of deferred gains/losses in AOCI at December 31, 2019, and the expected future periods in which these items are expected to settle and/or be recognized in earnings (in millions):

Year		Fair value of fuel derivative contracts at December 31, 2019				Amount of losses deferred in AOCI at December 31, 2019 (net of tax)
2020		$	48			$	(36	)
2021		33				(43		)
2022		27				(17		)
Beyond 2022		2				—
Total		$	110			$	(96	)

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 2020 and full year 2020 jet fuel prices at different crude oil assumptions as of January 17, 2020, and for expected premium costs associated with settling contracts each period, respectively.

	Estimated economic fuel price per gallon, including taxes and fuel hedging premiums (e)
Average Brent Crude Oil price per barrel	First Quarter 2020 (c)		Full Year 2020 (d)
$55	$1.85 - $1.95		$1.80 - $1.90
$60	$1.95 - $2.05		$1.95 - $2.05
Current Market (a)	$2.05 - $2.15		$2.00 - $2.10
$70	$2.15 - $2.25		$2.20 - $2.30
$80	$2.25 - $2.35		$2.35 - $2.45
$90	$2.35 - $2.45		$2.50 - $2.60
Estimated fuel hedging premium expense per gallon (b)	$0.05		$0.04

(a) Brent crude oil average market prices as of January 17, 2020, were approximately $64 and $62 per barrel for first quarter 2020 and full year 2020, respectively.

(b) Fuel hedging premium expense per gallon is included in the Company's estimated economic fuel price per gallon estimates above.

(c) Based on the Company's existing fuel derivative contracts and market prices as of January 17, 2020, first quarter 2020 GAAP and economic fuel costs are estimated to be in the $2.05 to $2.15 per gallon range, including fuel hedging premium expense of approximately $24 million, or $.05 per gallon, and an estimated $.01 per gallon in favorable cash settlements from fuel derivative contracts. See Note Regarding Use of Non-GAAP Financial Measures for additional information.

(d) Based on the Company's existing fuel derivative contracts and market prices as of January 17, 2020, annual 2020 GAAP and economic fuel costs are estimated to be in the $2.00 to $2.10 per gallon range, including fuel hedging premium expense of approximately $97 million, or $.04 per gallon, and no cash settlements from fuel derivative contracts, on a per gallon basis. See Note Regarding Use of Non-GAAP Financial Measures for additional information.

(e) The Company's current hedge positions contain a combination of instruments based in West Texas Intermediate and Brent crude oil; however, the economic fuel price per gallon sensitivities provided assume the relationship between Brent crude oil and refined products based on market prices as of January 17, 2020.

Maintenance materials and repairs expense for 2019 increased by $116 million, or 10.5 percent, compared with 2018. On a per ASM basis, Maintenance materials and repairs expense increased 13.0 percent, compared with 2018. On both a dollar and per ASM basis, the majority of the increases were due to the timing and scope of regular airframe maintenance checks. The Company currently expects Maintenance materials and repairs expense per ASM for first quarter 2020 to increase, compared with first quarter 2019.

Landing fees and airport rentals expense for 2019 increased by $29 million, or 2.2 percent, compared with 2018. On a per ASM basis, Landing fees and airport rentals expense increased 4.8 percent, compared with 2018. On both a dollar and per ASM basis, the majority of the increases were due to an increase in space rental rates and usage at various stations throughout the network, partially offset by higher settlements and credits from various airports received in 2019. The Company currently expects Landing fees and airport rentals expense per ASM for first quarter 2020 to increase, compared with first quarter 2019.

Depreciation and amortization expense for 2019 increased by $18 million, or 1.5 percent, compared with 2018. On a per ASM basis, Depreciation and amortization expense increased 4.0 percent, compared with 2018. On both a dollar and per ASM basis, the majority of the increases were associated with the deployment of new technology assets. Based on the application of 2019 Boeing settlement proceeds against the cost basis of owned 737 MAX aircraft in the Company's fleet, the Company estimates an approximate $5 million benefit to depreciation expense for 2020. See Note 16 to the Consolidated Financial Statements for further information. The Company currently expects Depreciation and amortization expense per ASM for first quarter 2020 to increase, compared with first quarter 2019.

Other operating expenses for 2019 increased by $174 million, or 6.1 percent, compared with 2018. On a per ASM basis, Other operating expenses increased 7.3 percent, compared with 2018. On both a dollar and per ASM basis, the increases in Other operating expenses were partially due to a $25 million gain recognized during first quarter 2018 from the sale of 39 Boeing 737-300 aircraft and a number of spare engines to a third party, which reduced Other operating expenses for first quarter 2018. This gain on sale of retired Boeing 737-300 aircraft was considered a special item 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. Excluding this item, approximately 40 percent of the increases were due to technology project-related expenses, approximately 20 percent of the increases were due to insurance recoveries from the impacts of irregular operations, which were received in first quarter 2018 and reduced Other operating expenses for first quarter 2018, and the biggest portion of the remainder was due to expenses related to the grounding of the MAX aircraft, such as additional compensation issued to inconvenienced Passengers associated with flight cancellations. The Company currently expects Other operating expenses per ASM for first quarter 2020 to increase, compared with first quarter 2019.

Other

Other expenses (income) include interest expense, capitalized interest, interest income, and other gains and losses. Total other expenses (income) for 2019 decreased by $42 million primarily due to higher interest income as a result of higher interest rates, and lower interest expense as a result of lower debt balances.

Income Taxes

The Company's effective tax rate was 22.2 percent for 2019, compared with 22.1 percent for 2018. The Company currently projects the first quarter and full year 2020 effective tax rate to be in the 23 to 24 percent range based on currently forecasted financial results.

2018 Compared with 2017

The Company's comparison of 2018 results to 2017 results is included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018, under Part II Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

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
	2019				2018				Change
Fuel and oil expense, unhedged	$	4,299			$	4,649
Add: Premium cost of fuel contracts	95				135
Deduct: Fuel hedge gains included in Fuel and oil expense, net	(47		)		(168		)
Fuel and oil expense, as reported	$	4,347			$	4,616
Add: Contracts settling in the current period, but for which the impact has been recognized in a prior period (a)	—				14
Fuel and oil expense, excluding special items (economic)	$	4,347			$	4,630			(6.1	)%
Total operating expenses, as reported	$	19,471			$	18,759
Add: Contracts settling in the current period, but for which the impact has been recognized in a prior period (a)	—				14
Add: Gain on sale of retired Boeing 737-300 aircraft	—				25
Total operating expenses, excluding special items	$	19,471			$	18,798			3.6	%
Operating income, as reported	$	2,957			$	3,206
Deduct: Contracts settling in the current period, but for which the impact has been recognized in a prior period (a)	—				(14		)
Deduct: Gain on sale of retired Boeing 737-300 aircraft	—				(25		)
Operating income, excluding special items	$	2,957			$	3,167			(6.6	)%
Net income, as reported	$	2,300			$	2,465
Deduct: Contracts settling in the current period, but for which the impact has been recognized in a prior period (a)	—				(14		)
Deduct: Gain on sale of retired Boeing 737-300 aircraft	—				(25		)
Add: Net income tax impact of special items (b)	—				9
Net income, excluding special items	$	2,300			$	2,435			(5.5	)%
Net income per share, diluted, as reported	$	4.27			$	4.29
Deduct: Impact from fuel contracts	—				(0.02		)
Deduct: Impact of special items	—				(0.04		)
Add: Net income tax impact of special items (b)	—				0.01
Net income per share, diluted, excluding special items	$	4.27			$	4.24			0.7	%
Operating expenses per ASM (cents)		12.38	¢			11.74	¢
Deduct: Fuel and oil expense divided by ASMs	(2.76		)		(2.89		)
Add: Impact of special items	—				0.02
Deduct: Profitsharing expense divided by ASMs	(0.43		)		(0.34		)
Operating expenses per ASM, excluding Fuel and oil expense, special items, and profitsharing (cents)		9.19	¢			8.53	¢		7.7	%

(a) As a result of prior hedge ineffectiveness.

(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.

Non-GAAP Return on Invested Capital (ROIC) (in millions) (unaudited)

	Year Ended				Year Ended				Year Ended
	December 31, 2019				December 31, 2018				December 31, 2017
Operating income, as reported	$	2,957			$	3,206			$	3,407
Net impact from fuel contracts	—				(14		)		(156		)
Lease termination expense	—				—				33
Boeing 737-300 aircraft grounding charge	—				—				63
Gain on sale of retired Boeing 737-300 aircraft	—				(25		)		—
Operating income, non-GAAP	2,957				3,167				3,347
Net adjustment for aircraft leases (a)	120				99				110
Adjusted operating income, non-GAAP (A)	$	3,077			$	3,266			$	3,457
Non-GAAP tax rate (B)	22.2		%	(d)	22.1		%	(e)	36.1		%	(f)
Net operating profit after-tax, NOPAT (A (1-B) = C)*	$	2,394			$	2,545			$	2,210
Debt, including finance leases (b)	$	3,070			$	3,521			$	3,259
Equity (b)	9,869				9,853				8,194
Net present value of aircraft operating leases (b)	512				584				785
Average invested capital	$	13,451			$	13,958			$	12,238
Equity adjustment for hedge accounting (c)	2				(144		)		296
Adjusted average invested capital (D)	$	13,453			$	13,814			$	12,534
Non-GAAP ROIC, pre-tax (A/D)	22.9		%		23.6		%		27.6		%
Non-GAAP ROIC, after-tax (C/D)	17.8		%		18.4		%		17.6		%

(a) Net adjustment related to presumption that all aircraft in fleet are owned (i.e., the impact of eliminating aircraft rent expense and replacing with estimated depreciation expense for those same aircraft). The Company makes this adjustment to enhance comparability to other entities that have different capital structures by utilizing alternative financing decisions.

(b) Calculated as an average of the five most recent quarter end balances or remaining obligations. The Net present value of aircraft operating leases represents the assumption that all aircraft in the Company’s fleet are owned, as it reflects the remaining contractual commitments discounted at the Company's estimated incremental borrowing rate as of the time each individual lease was signed.

(c) The Equity adjustment for hedge accounting in the denominator adjusts for the cumulative impacts, in AOCI and Retained earnings, of gains and/or losses associated with hedge accounting related to fuel hedge derivatives that will settle in future periods. The current period impact of these gains and/or losses is reflected in the Net impact from fuel contracts in the numerator.

(d) The GAAP annual tax rate as of December 31, 2019, was 22.2 percent, and the annual Non-GAAP tax rate was also 22.2 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information.

(e) The GAAP annual tax rate as of December 31, 2018, was 22.1 percent, and the annual Non-GAAP tax rate was also 22.1 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information.

(f) The GAAP annual tax rate as of December 31, 2017, was a 2.8 percent tax benefit due to the significant impact the Tax Cuts and Jobs Act legislation enacted in December 2017 had on corporate tax rates, and the annual Non-GAAP tax rate was 36.1 percent. See Note Regarding Use of Non-GAAP Financial Measures for additional information.

Note Regarding Use of Non-GAAP Financial Measures

The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). These GAAP financial statements may include (i) unrealized noncash adjustments and reclassifications, which can be significant, as a result of accounting requirements and elections made under accounting pronouncements relating to derivative instruments and hedging and (ii) other charges and benefits the Company believes are unusual and/or infrequent in nature and thus may make comparisons to its prior or future performance difficult.

As a result, the Company also provides financial information in this filing that was not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. The Company provides supplemental non-GAAP financial information (also referred to as "excluding special items"), including results that it refers to as "economic," which the Company's management utilizes to evaluate its ongoing financial performance and the Company believes provides additional insight to investors as supplemental information to its GAAP results. The non-GAAP measures provided that relate to the Company’s performance on an economic fuel cost basis include Fuel and oil expense, non-GAAP; Total operating expenses, non-GAAP; Operating income, non-GAAP; Net income, non-GAAP; Net income per share, diluted, non-GAAP; Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing; Adjusted operating income, non-GAAP; and Income tax rate, non-GAAP. 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 on 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 2 and Note 10 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.	A gain recognized in first quarter 2018, associated with the sale of 39 Boeing 737-300 ("Classic") aircraft and a number of spare engines to a third party. These aircraft were previously retired as part of the Company's exit of its Classic fleet. The gain was not anticipated, and the Company associates it with the grounding charge recorded in third quarter 2017;

2.

Lease termination costs recorded as a result of the Company acquiring 13 of its Classic aircraft off operating leases as part of the Company’s strategic effort to remove its Classic aircraft from operations on or before September 29, 2017, in the most economically advantageous manner possible. The Company had not budgeted for these early lease termination costs, as they were subject to negotiations being concluded with the third

party lessors. The Company recorded the fair value of the aircraft acquired off operating leases, as well as any associated remaining obligations to the balance sheet as debt; and

3.

An Aircraft grounding charge recorded in third quarter 2017, as a result of the Company grounding its remaining Classic aircraft on September 29, 2017. The loss was a result of the remaining net lease payments due and certain lease return requirements that could have to be performed on these leased aircraft prior to their return to the lessors as of the cease-use date. The Company had not budgeted for the lease return requirements, as they were subject to negotiation with third party lessors.

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: Total operating expenses, non-GAAP; Operating income, non-GAAP; Net income, non-GAAP; Net income per share, diluted, non-GAAP; Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing; Adjusted operating income, non-GAAP; and Income tax rate, non-GAAP.

The Company has also provided its calculation of return on invested capital, which is a measure of financial performance used by management to evaluate its investment returns on capital. Return on invested capital is not a substitute for financial results as reported in accordance with GAAP, and should not be utilized in place of such GAAP results. Although return on invested capital is not a measure defined by GAAP, it is calculated by the Company, in part, using non-GAAP financial measures. Those non-GAAP financial measures are utilized for the same reasons as those noted above for Net income, non-GAAP and Operating income, non-GAAP. The comparable GAAP measures include charges or benefits that are deemed "special items" that the Company believes make its results difficult to compare to prior periods, anticipated future periods, or industry trends, and the Company’s profitability targets and estimates, both internally and externally, are based on non-GAAP results since in the vast majority of cases the "special items" cannot be reliably predicted or estimated. The Company believes non-GAAP return on invested capital is a meaningful measure because it quantifies the Company's effectiveness in generating returns relative to the capital it has invested in its business. Although return on invested capital is commonly used as a measure of capital efficiency, definitions of return on invested capital differ; therefore, the Company is providing an explanation of its calculation for non-GAAP return on invested capital in the accompanying reconciliation, in order to allow investors to compare and contrast its calculation to the calculations provided by other companies.

Liquidity and Capital Resources

Net cash provided by operating activities for 2019 and 2018 was $4.0 billion and $4.9 billion, respectively. 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 2019 and 2018 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. Operating cash flows also can be significantly impacted by the Company’s fuel and interest rate hedge positions and the corresponding cash collateral requirements associated with those positions. The Company has the ability to post aircraft in lieu of cash collateral in certain situations. See Note 10 to the Consolidated Financial Statements for further information. During 2019, the Company had net cash inflows of $25 million in cash collateral from derivative counterparties. During 2018, the Company had net cash outflows of $15 million in cash collateral to derivative counterparties. Cash flows associated with entering into new fuel derivatives, which are also classified as Other, net, operating cash flows, were net outflows of $131 million in 2019 and $63 million in 2018. Net cash provided by operating activities is primarily used to finance capital expenditures, repay debt, fund stock repurchases, pay dividends, and provide working capital.

Net cash used in investing activities for 2019 and 2018 was $303 million and $2.0 billion, respectively. Investing activities in 2019 and 2018 included Capital expenditures, Supplier proceeds, and changes in the balance of the

Company's short-term and noncurrent investments. During 2019, Capital expenditures were $1.0 billion, the majority of which included ongoing technology projects, airport and other facility construction projects, and progress payments related to new aircraft to be delivered to the Company. This was below initial expectations for 2019 due to the MAX grounding and resulting delay in Boeing deliveries. The Company received $400 million of Supplier proceeds, which the Company considers an offset to its annual 2019 aircraft capital expenditures. See Note 16 to the Consolidated Financial Statements for further information. During 2018, Capital expenditures were $1.9 billion, the majority of which were payments for new aircraft delivered to the Company. During 2019, the Company's purchases and sales of short-term and noncurrent investments resulted in net cash inflows of $324 million, as compared with net cash outflows of $67 million for 2018. Boeing currently has 27 MAX 8 aircraft produced and in storage for the Company. Assuming these aircraft and no others are delivered in 2020, the Company currently estimates its annual 2020 capital expenditures to be in the range of $1.4 billion to $1.5 billion, including progress payments for future deliveries, and considering supplier proceeds to be received in 2020. These expected proceeds are included in Accounts and other receivables on the Company's Consolidated Balance Sheet as of December 31, 2019, and the Company considers them to be a reduction to its annual 2020 aircraft capital expenditures.

Net cash used in financing activities for 2019 and 2018 was $3.0 billion and $2.5 billion, respectively. During 2019, the Company repaid $615 million in debt and finance lease obligations, compared with $342 million during 2018. During 2018, the Company received a reimbursement from the City of Houston for $116 million for the investment and updates made at Houston William P. Hobby Airport. The Company repurchased $2.0 billion of its outstanding common stock through authorized share repurchases during both 2019 and 2018. The Company also paid $372 million in dividends to Shareholders during 2019, compared with $332 million in 2018. Although the Company currently intends to continue paying dividends on a quarterly basis for the foreseeable future, the Company's Board of Directors may change the timing, amount, and payment of dividends on the basis of results of operations, financial condition, cash requirements, future prospects, and other factors deemed relevant by the Board of Directors.

The Company's 2017 results are included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018, under Part II Item 7, Liquidity and Capital Resources.

The Company is a "well-known seasoned issuer" and 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 a $1.0 billion unsecured revolving credit facility expiring in August 2022. The revolving 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 100.0 basis points. The facility contains a financial covenant requiring a minimum coverage ratio of adjusted pre-tax income to fixed obligations, as defined. As of December 31, 2019, the Company was in compliance with this covenant and there were no amounts outstanding under the revolving credit facility.

The Company entered into the following share repurchases during 2019, 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 2019 Accelerated Share Repurchase Program		9.38		$	500
Second Quarter 2019 Accelerated Share Repurchase Program		7.82		400
Third Quarter 2019 Accelerated Share Repurchase Program		9.49		500
Fourth Quarter 2019 Accelerated Share Repurchase Program		9.11	(a)	550
Open Market Share Repurchases		0.95		50
Total		36.75		$	2,000

(a) Final settlement of the Fourth Quarter 2019 ASR Program is scheduled to occur in February 2020. The specific number of shares that the Company ultimately will repurchase under the Fourth Quarter 2019 ASR Program will be determined based generally on a discount to the volume-weighted average price per share of the Company's common stock during a calculation period to be completed no later than February 13, 2020.

On February 14, 2019, Fitch upgraded the Company's investment grade credit ratings to "A-" from "BBB+." The upgrade of the Company's investment grade rating was based on the Company's low fundamental level of credit risk as demonstrated by its track record of generating positive free cash flow, its solid financial flexibility, strong balance sheet, and commitment to conservative financial policies. The Company maintained its investment grade credit ratings of "A3" with Moody's and "BBB+" with Standard & Poor's.

The Company routinely carries 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 5 to the Consolidated Financial Statements for further information. The Company believes that its current liquidity position, including unrestricted cash and short-term investments of $4.1 billion as of December 31, 2019, anticipated future internally generated funds from operations, and its fully available, unsecured revolving credit facility of $1.0 billion that expires in August 2022, will enable it to meet its future known obligations in the ordinary course of business. However, if a liquidity need were to arise, the Company believes it has access to financing arrangements because of its investment grade credit ratings, large value of unencumbered assets, and modest leverage, which should enable it to meet its ongoing capital, operating, and other liquidity requirements. The Company will continue to consider various borrowing or leasing 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 2019 and in previous years, which has enabled the Company to defer the cash tax payments associated with these depreciable assets to future years. Based on the Company’s scheduled future aircraft deliveries from Boeing and existing tax laws in effect, the Company will continue to defer a portion of cash income taxes to future years. 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.

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 4 to the Consolidated Financial Statements for the financial commitments related to these firm deliveries, and Note 16 to the Consolidated Financial Statements for further information about the MAX groundings. Because of the MAX groundings, Boeing is not currently delivering new MAX aircraft and, therefore, not meeting its contractual delivery schedule. As a result, 27 firm orders for purchased MAX aircraft originally scheduled for delivery in 2019 have shifted into 2020 commitments and one firm order originally scheduled for delivery in 2019 has shifted to 2021. In addition, commitments for 13 MAX leases from third parties have shifted into 2020. The FAA will ultimately determine the timing of the MAX return to service, and the Company therefore offers no assurances that current estimations and timelines are correct.

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 2 and Note 7 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 of December 31, 2019, the Company had 189 leased aircraft, including 67 Boeing 717-200 aircraft ("B717s") subleased to Delta. Of these leased aircraft, 117 are under operating leases, including 65 B717s subleased to Delta. See Note 7 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 $148 million at December 31, 2019.

The following table aggregates the Company’s material expected contractual obligations and commitments as of December 31, 2019:

		Obligations by period (in millions)
Contractual obligations		2020				2021 - 2022				2023 - 2024				Thereafter				Total
Long-term debt (a)		$	734			$	480			$	43			$	776			$	2,033
Interest commitments - fixed (b)		52				83				53				67				255
Interest commitments - floating (c)		18				8				6				4				36
Facility and other operating lease commitments		107				131				88				580				906
Aircraft operating lease commitments (d)		285				267				117				81				750
Aircraft finance lease commitments (e)		107				200				184				230				721
Aircraft purchase commitments (f)		2,106				2,862				3,495				1,509				9,972
Other commitments		217				227				108				320				872
Total contractual obligations		$	3,626			$	4,258			$	4,094			$	3,567			$	15,545

(a)	Includes principal only. See Note 6 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 (either at issuance or through swaps) is estimated utilizing forward interest rate curves as of December 31, 2019, and can be subject to significant fluctuation.

(d)	Includes the impact of the B717 lease/sublease transaction entered into in 2012. See Note 7 to the Consolidated Financial Statements for additional information.

(e)	Includes principal and interest on finance leases. See Note 7 to the Consolidated Financial Statements for additional information.

(f)

This reflects firm orders for purchased MAX aircraft from Boeing; shifting the 28 MAX aircraft originally scheduled for delivery in 2019 into 2020 and 2021 as MAX deliveries were suspended as of March 13, 2019, and the timeline of future deliveries is uncertain. The FAA will ultimately determine the timing of the MAX return to service, and the Company therefore offers no assurances that current estimation and timelines of aircraft purchase commitments are correct. See Part I, Item 2 for a complete table of the Company’s contractual firm deliveries.

Airport Projects

The Company has commitments associated with various airport improvement projects that will impact its future liquidity needs in differing ways. These projects include the construction of new facilities and the rebuilding or modernization of existing facilities and are discussed in more detail in Note 4 to the Consolidated Financial Statements.

Dallas Love Field

For the rebuilding of the facilities at Dallas Love Field, the Company guaranteed principal, premium, and interest on $456 million in bonds issued by the Love Field Airport Modernization Corporation ("LFAMC") that were utilized to fund the majority of the project. The amount of bonds outstanding as of December 31, 2019, was $407 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 the City 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 the City of Dallas reimburses the Company for the Facilities Payments made by the Company.

A majority of the monies transferred from the City of Dallas to the Company under the Revenue Credit Agreement originate from a reimbursement account created in the "Use and Lease Agreement" between the City 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 the City of Dallas. The remainder of such monies transferred from the City 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

In October 2017, the Company executed a lease agreement (the "T1.5 Lease") with Los Angeles World Airports ("LAWA"), which owns and operates Los Angeles International Airport ("LAX"). Under the T1.5 Lease, the Company is overseeing and managing the design, development, financing, construction, and commissioning of a passenger processing facility between Terminal 1 and 2 (the "Terminal 1.5 Project"). The Terminal 1.5 Project is expected to include ticketing, baggage claim, passenger screening, and a bus gate at a cost not to exceed $479 million for site improvements and non-proprietary improvements.

Funding for the Terminal 1.5 Project is primarily through the Regional 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 fund the development of this 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 T1.5 Lease. As of December 31, 2019, the Company's outstanding guaranteed obligation under the credit facility for the Terminal 1.5 Project was $176 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 is estimated to be completed during 2020.

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 on Southwest, 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. 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 $61 million, or less than one percent, change in Passenger revenues recognized for the year ended December 31, 2019.

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 consistently applied from year to year; however, as with any estimates, actual spoiled tickets may vary from estimated amounts.

The Company believes it is unlikely that materially different estimates for future spoiled tickets would be reported based on other reasonable assumptions or conditions suggested by actual historical experience and other data available at the time estimates were made.

Accounting for Long-Lived Assets

Flight equipment and related assets make up the majority of the Company’s long-lived assets. Flight equipment primarily relates to the 695 Boeing 737 aircraft in the Company’s fleet at December 31, 2019, which are either owned or on finance lease. The remaining 52 Boeing 737 aircraft in the Company’s fleet at December 31, 2019, are operated under operating leases. The Company also has 67 B717 aircraft, which are leased/subleased to Delta. As these aircraft were not in service for the Company, they were not included in the fleet count as of December 31, 2019 or 2018. The Company also includes Assets constructed for others in its long-lived assets. These are airport improvement projects in which the Company is considered to have control of the asset during the construction period. Once construction is effectively completed, the sale-leaseback model would apply when control passes from the lessee to the lessor. In accounting for long-lived assets, the Company must make estimates about the expected useful lives of the assets, the expected residual values of the assets, and the potential for impairment based on the fair value of the assets and their future expected cash flows.

The following table shows a breakdown of the Company’s long-lived asset groups, along with information about estimated useful lives and residual values for new assets generally purchased from the manufacturer:

		Estimated useful life		Estimated residual value
Airframes and engines		25 years		15 percent
Spare aircraft engines		25 years		20 percent
Aircraft parts		Fleet life		4 percent
Ground property and equipment		5 to 30 years		0 to 10 percent

In estimating the lives and expected residual values of its aircraft, the Company primarily has relied upon actual experience with the same or similar aircraft types, current and projected future market information provided by independent third parties, and recommendations from Boeing. Flight equipment estimated useful lives are based on the number of "cycles" flown (one take-off and landing) as well as the aircraft age. The Company has made a conversion of cycles into years based on both historical and anticipated future utilization of the aircraft. Subsequent revisions to these estimates could be caused by changes to aircraft maintenance programs, changes in utilization of the aircraft (actual cycles during a given period of time), governmental regulations on aging aircraft, and changing market prices of new and used aircraft of the same or similar types. The Company evaluates its estimates and assumptions each reporting period and, when warranted, adjusts these estimates and assumptions. Generally, these adjustments are accounted for on a prospective basis through depreciation and amortization expense. See Note 1 to the Consolidated Financial Statements for further information.

The Company believes it is unlikely that materially different estimates for expected lives, expected residual values, and impairment evaluations would be made or reported based on other reasonable assumptions or conditions suggested by actual historical experience and other data available at the time estimates were made.

Fair Value Measurements and Financial Derivative Instruments

The Company utilizes unobservable (Level 3) inputs in determining the fair value of certain assets and liabilities. At December 31, 2019, these consisted of its fuel derivative option contracts, which were an asset of $110 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 10 to the Consolidated Financial Statements for more information on the Company’s fuel hedging program and financial derivative instruments, and Note 11 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. At December 31, 2019, 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 2019, market "spot" prices for Brent crude oil peaked at a high of approximately $75 per barrel and hit a low price of approximately $55 per barrel. During 2018, market spot prices ranged from a high of approximately $86 per barrel to a low of approximately $50 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 the U.S. dollar, geopolitical events, 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 December 31, 2019, a 10 percent change in implied volatility, holding all other factors constant, would have resulted in a change in the fair value of this portfolio of less than $12 million.

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, which would create further volatility in the Company’s GAAP financial results.

As discussed in Note 10 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 on Southwest 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 on Southwest 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 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.

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. At December 31, 2019, the loyalty liabilities

were approximately $3.4 billion, including $2.3 billion classified within Air traffic liability and $1.1 million 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 the following:

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Allocation of Passenger Revenue - Revenues from Passengers, related to travel, who also earn Rapid Rewards Points have been allocated between flight (recognized as revenue when transportation is provided) and Rapid Rewards Points (deferred until points are redeemed) based on each obligation’s relative standalone selling price. The Company utilizes historical earning patterns to assist in this allocation.

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Fair Value of Rapid Rewards Points - Determined from the base fare value of tickets which were purchased using prior point redemptions for travel and other products and services, which the Company believes to be indicative of the fair value of points as perceived by Customers and representative of the value of each point at the time of redemption. The Company’s booking site allows a Customer to toggle between fares utilizing either cash or point redemptions, which provides the Customer with an approximation of the equivalent value of their points. The value can differ, however, based on demand, the amount of time prior to the flight, and other factors. The fare mix during the period measured represents a constraint, which could result in the assumptions above changing at the measurement date, as fare classes can have different coefficients used to determine the total loyalty points needed to purchase an award ticket. The mixture of these fare classes and changes in the coefficients used by the Company could cause the fair value per point to increase or decrease.

The majority of the points sold to business partners are through the Southwest co-branded credit card agreement ("Agreement") with Chase 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 the Southwest 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 of January 1, 2019, resulting in an allocation of proceeds to air transportation would have changed the Company's Operating revenues by approximately $7 million for the year ended December 31, 2019.

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 effective October 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 ended December 31, 2019, 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 $124 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.