Attached files
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
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þ
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QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the quarterly period ended September 30,
2009
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or
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¨
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TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the transition period from ________ to
________
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Commission
File No. 1-7259
Southwest
Airlines Co.
(Exact
name of registrant as specified in its charter)
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TEXAS
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74-1563240
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(State
or other jurisdiction of
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(IRS
Employer
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incorporation
or organization)
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Identification
No.)
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P.O.
Box 36611, Dallas, Texas
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75235-1611
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant's
telephone number, including area code: (214) 792-4000
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 check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) 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 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 ¨ (Do not check if a
smaller reporting
company) Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes
¨ No þ
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Number
of shares of Common Stock outstanding as of the close of business on
October 19, 2009: 741,939,911
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1
SOUTHWEST AIRLINES
CO.
TABLE OF
CONTENTS TO FORM 10-Q
SOUTHWEST
AIRLINES CO.
FORM
10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest
Airlines Co.
Condensed Consolidated Balance Sheet
(in
millions)
(unaudited)
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September
30, 2009
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December
31, 2008
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|||||||
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ASSETS
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||||||||
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Current
assets:
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||||||||
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Cash
and cash equivalents
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$ | 902 | $ | 1,368 | ||||
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Short-term
investments
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1,352 | 435 | ||||||
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Accounts
and other receivables
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225 | 209 | ||||||
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Inventories
of parts and supplies, at cost
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196 | 203 | ||||||
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Deferred
income taxes
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365 | 365 | ||||||
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Prepaid
expenses and other current assets
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87 | 73 | ||||||
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Total
current assets
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3,127 | 2,653 | ||||||
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Property
and equipment, at cost:
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||||||||
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Flight
equipment
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13,761 | 13,722 | ||||||
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Ground
property and equipment
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1,870 | 1,769 | ||||||
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Deposits
on flight equipment purchase contracts
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233 | 380 | ||||||
| 15,864 | 15,871 | |||||||
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Less
allowance for depreciation and amortization
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5,166 | 4,831 | ||||||
| 10,698 | 11,040 | |||||||
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Other
assets
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275 | 375 | ||||||
| $ | 14,100 | $ | 14,068 | |||||
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LIABILITIES
AND STOCKHOLDERS' EQUITY
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||||||||
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Current
liabilities:
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||||||||
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Accounts
payable
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$ | 694 | $ | 668 | ||||
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Accrued
liabilities
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918 | 1,012 | ||||||
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Air
traffic liability
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1,214 | 963 | ||||||
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Current
maturities of long-term debt
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198 | 163 | ||||||
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Total
current liabilities
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3,024 | 2,806 | ||||||
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Long-term
debt less current maturities
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3,378 | 3,498 | ||||||
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Deferred
income taxes
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1,947 | 1,904 | ||||||
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Deferred
gains from sale and leaseback of aircraft
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125 | 105 | ||||||
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Other
non-current liabilities
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409 | 802 | ||||||
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Stockholders'
equity:
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||||||||
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Common
stock
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808 | 808 | ||||||
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Capital
in excess of par value
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1,226 | 1,215 | ||||||
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Retained
earnings
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4,876 | 4,919 | ||||||
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Accumulated
other comprehensive loss
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(715 | ) | (984 | ) | ||||
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Treasury
stock, at cost
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(978 | ) | (1,005 | ) | ||||
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Total
stockholders' equity
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5,217 | 4,953 | ||||||
| $ | 14,100 | $ | 14,068 | |||||
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See
accompanying notes.
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||||||||
Southwest
Airlines Co.
Condensed Consolidated Statement of Operations
(in
millions, except per share amounts)
(unaudited)
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Three
months ended September 30,
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Nine
months ended September 30,
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|||||||||||||||
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2009
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2008
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2009
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2008
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|||||||||||||
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OPERATING
REVENUES:
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||||||||||||||||
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Passenger
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$ | 2,550 | $ | 2,767 | $ | 7,308 | $ | 7,927 | ||||||||
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Freight
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28 | 37 | 87 | 108 | ||||||||||||
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Other
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88 | 87 | 243 | 254 | ||||||||||||
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Total
operating revenues
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2,666 | 2,891 | 7,638 | 8,289 | ||||||||||||
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OPERATING
EXPENSES:
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||||||||||||||||
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Salaries,
wages, and benefits
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909 | 856 | 2,607 | 2,494 | ||||||||||||
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Fuel
and oil
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826 | 1,051 | 2,250 | 2,795 | ||||||||||||
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Maintenance
materials and repairs
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184 | 190 | 557 | 523 | ||||||||||||
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Aircraft
rentals
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47 | 38 | 140 | 115 | ||||||||||||
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Landing
fees and other rentals
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192 | 167 | 537 | 497 | ||||||||||||
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Depreciation
and amortization
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162 | 152 | 462 | 445 | ||||||||||||
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Other
operating expenses
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324 | 351 | 990 | 1,040 | ||||||||||||
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Total
operating expenses
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2,644 | 2,805 | 7,543 | 7,909 | ||||||||||||
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OPERATING
INCOME
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22 | 86 | 95 | 380 | ||||||||||||
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OTHER
EXPENSES (INCOME):
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||||||||||||||||
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Interest
expense
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48 | 35 | 140 | 95 | ||||||||||||
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Capitalized
interest
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(5 | ) | (6 | ) | (16 | ) | (20 | ) | ||||||||
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Interest
income
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(3 | ) | (7 | ) | (11 | ) | (18 | ) | ||||||||
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Other
(gains) losses, net
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2 | 269 | 2 | (38 | ) | |||||||||||
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Total
other expenses (income)
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42 | 291 | 115 | 19 | ||||||||||||
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INCOME
(LOSS) BEFORE INCOME TAXES
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(20 | ) | (205 | ) | (20 | ) | 361 | |||||||||
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PROVISION
(BENEFIT) FOR INCOME TAXES
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(4 | ) | (85 | ) | (4 | ) | 127 | |||||||||
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NET
INCOME (LOSS)
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$ | (16 | ) | $ | (120 | ) | $ | (16 | ) | $ | 234 | |||||
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NET
INCOME (LOSS) PER SHARE, BASIC
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$ | (.02 | ) | $ | (.16 | ) | $ | (.02 | ) | $ | .32 | |||||
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NET
INCOME (LOSS) PER SHARE, DILUTED
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$ | (.02 | ) | $ | (.16 | ) | $ | (.02 | ) | $ | .32 | |||||
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WEIGHTED
AVERAGE SHARES
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||||||||||||||||
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OUTSTANDING:
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||||||||||||||||
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Basic
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742 | 736 | 741 | 734 | ||||||||||||
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Diluted
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742 | 736 | 741 | 739 | ||||||||||||
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See
accompanying notes.
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||||||||||||||||
Southwest
Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in
millions)
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
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2009
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2008
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2009
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2008
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|||||||||||||
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CASH
FLOWS FROM OPERATING ACTIVITIES:
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||||||||||||||||
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Net
income (loss)
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$ | (16 | ) | $ | (120 | ) | $ | (16 | ) | $ | 234 | |||||
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Adjustments
to reconcile net income (loss) to
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||||||||||||||||
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cash
provided by operating activities:
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||||||||||||||||
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Depreciation
and amortization
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162 | 152 | 462 | 445 | ||||||||||||
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Unrealized
loss on fuel derivative instruments
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12 | 307 | 79 | 17 | ||||||||||||
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Deferred
income taxes
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8 | (48 | ) | 3 | 81 | |||||||||||
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Amortization
of deferred gains on sale and
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||||||||||||||||
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leaseback
of aircraft
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(4 | ) | (3 | ) | (11 | ) | (9 | ) | ||||||||
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Share-based
compensation expense
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3 | 4 | 10 | 14 | ||||||||||||
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Excess
tax benefits from share-based
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||||||||||||||||
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compensation
arrangements
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(4 | ) | 8 | (6 | ) | 11 | ||||||||||
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Changes
in certain assets and liabilities:
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||||||||||||||||
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Accounts
and other receivables
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12 | 62 | (16 | ) | (105 | ) | ||||||||||
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Other
current assets
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11 | (48 | ) | (7 | ) | (98 | ) | |||||||||
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Accounts
payable and accrued liabilities
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(147 | ) | (379 | ) | (42 | ) | (46 | ) | ||||||||
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Air
traffic liability
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6 | (28 | ) | 251 | 344 | |||||||||||
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Cash
collateral received from (provided to) fuel
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||||||||||||||||
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derivative
counterparties
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- | (1,940 | ) | (185 | ) | 495 | ||||||||||
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Other,
net
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29 | (243 | ) | (29 | ) | (359 | ) | |||||||||
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Net
cash provided by (used in) operating activities
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72 | (2,276 | ) | 493 | 1,024 | |||||||||||
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CASH
FLOWS FROM INVESTING ACTIVITIES:
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||||||||||||||||
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Purchases
of property and equipment, net
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(198 | ) | (178 | ) | (471 | ) | (765 | ) | ||||||||
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Purchases
of short-term investments
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(1,707 | ) | (794 | ) | (4,797 | ) | (4,241 | ) | ||||||||
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Proceeds
from sales of short-term investments
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1,608 | 926 | 3,955 | 3,570 | ||||||||||||
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Other,
net
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- | - | 1 | - | ||||||||||||
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Net
cash used in investing activities
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(297 | ) | (46 | ) | (1,312 | ) | (1,436 | ) | ||||||||
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CASH
FLOWS FROM FINANCING ACTIVITIES:
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||||||||||||||||
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Proceeds
from sale and leaseback transactions
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- | - | 381 | - | ||||||||||||
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Issuance
of Long-term debt
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124 | - | 456 | 600 | ||||||||||||
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Proceeds
from Employee stock plans
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4 | 85 | 11 | 113 | ||||||||||||
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Proceeds
from credit line borrowing
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83 | - | 83 | - | ||||||||||||
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Payments
of long-term debt and capital lease obligations
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(22 | ) | (15 | ) | (64 | ) | (41 | ) | ||||||||
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Payment
of revolving credit facility
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- | - | (400 | ) | - | |||||||||||
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Payment
of credit line borrowing
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- | - | (91 | ) | - | |||||||||||
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Payments
of cash dividends
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(3 | ) | (3 | ) | (13 | ) | (13 | ) | ||||||||
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Repurchase
of common stock
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- | - | - | (54 | ) | |||||||||||
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Excess
tax benefits from share-based
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||||||||||||||||
|
compensation
arrangements
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4 | (8 | ) | 6 | (11 | ) | ||||||||||
|
Other,
net
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(9 | ) | - | (16 | ) | (5 | ) | |||||||||
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Net
cash provided by financing activities
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181 | 59 | 353 | 589 | ||||||||||||
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NET
CHANGE IN CASH AND
|
||||||||||||||||
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CASH
EQUIVALENTS
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(44 | ) | (2,263 | ) | (466 | ) | 177 | |||||||||
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CASH
AND CASH EQUIVALENTS AT
|
||||||||||||||||
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BEGINNING
OF PERIOD
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946 | 4,653 | 1,368 | 2,213 | ||||||||||||
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CASH
AND CASH EQUIVALENTS
|
||||||||||||||||
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AT
END OF PERIOD
|
$ | 902 | $ | 2,390 | $ | 902 | $ | 2,390 | ||||||||
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CASH
PAYMENTS FOR:
|
||||||||||||||||
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Interest,
net of amount capitalized
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$ | 31 | $ | 39 | $ | 109 | $ | 80 | ||||||||
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Income
taxes
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$ | - | $ | 57 | $ | 4 | $ | 70 | ||||||||
|
See
accompanying notes.
|
||||||||||||||||
Southwest
Airlines Co.
Notes
to Condensed Consolidated Financial Statements
(unaudited)
1. BASIS
OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements of Southwest
Airlines Co. (Company or Southwest) have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. The unaudited
condensed consolidated financial statements for the interim periods ended
September 30, 2009 and 2008, include all adjustments which are, in the opinion
of management, necessary for a fair presentation of the results for the interim
periods. This includes all normal and recurring adjustments, but does
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. Financial
results for the Company, and airlines in general, are seasonal in
nature. Historically, the Company’s revenues, as well as its overall
financial performance, are better in its second and third fiscal quarters than
in its first and fourth fiscal quarters. However, as a result of
significant fluctuations in revenues and the price of jet fuel in some periods,
the nature of the Company’s fuel hedging program, the periodic volatility of
commodities used by the Company for hedging jet fuel, and the accounting
requirements of Financial Accounting Standards Board (FASB) Accounting Standards
Codification (ASC) Topic 815 (ASC Topic 815, originally issued as Statement of
Financial Accounting Standards No. 133, “Accounting for Derivative Instruments
and Hedging Activities,” as amended), the Company has experienced, and may
continue to experience, significant volatility in its results in certain fiscal
periods. See Note 5 for further information. Operating results for
the three months and nine months ended September 30, 2009, are not necessarily
indicative of the results that may be expected for the year ended December 31,
2009. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Southwest Airlines Co. Annual
Report on Form 10-K for the year ended December 31, 2008.
Certain
prior period amounts have been reclassified to conform to the current
presentation. In the unaudited Condensed
Consolidated Balance Sheet as of December 31, 2008, the Company's cash
collateral deposits related to fuel derivatives that have been provided to a
counterparty have been adjusted to show a “net” presentation against the
fair value of the Company's fuel derivative instruments. The entire
portion of cash collateral deposits as of December 31, 2008, $240 million, has
been reclassified to reduce “Other deferred liabilities.” In the
Company’s 2008 Form 10-K filing, these cash collateral deposits were presented
“gross” and all were included as an increase to “Prepaid expenses and other
current assets.” This change in presentation was made in order to
comply with the requirements of ASC Subtopic 210-20 (originally issued as part
of FIN 39-1, “Amendment of FASB Interpretation No. 39”), which was required to
be adopted by the Company effective January 1, 2008. Following the
Company’s 2008 Form 10-K filing on February 2, 2009, the Company became aware
that the requirements of ASC Subtopic 210-20 had not been properly applied to
its financial derivative instruments within the financial
statements. The Company determined that the effect of this error was
not material to its financial statements and disclosures taken as a whole, and
decided to apply ASC Subtopic 210-20 prospectively beginning with its first
quarter 2009 Form 10-Q. Also, in the unaudited Condensed Consolidated
Statement of Cash Flows for the three and nine months ended September 30, 2008,
the Company has reclassified certain unrealized noncash gains and/or losses
recorded on fuel derivative instruments and the cash collateral received from
counterparties to its fuel hedging program, in order to conform to the current
year presentation. These reclassifications had no impact on net cash
flows provided by operations.
In
preparing the accompanying unaudited condensed consolidated financial
statements, the Company has reviewed, as determined necessary by the Company’s
management, events that have occurred after September 30, 2009, up until the
issuance of the financial statements, which occurred on October 22,
2009.
2. NEW
ACCOUNTING PRONOUNCEMENTS
On August
28, 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-05,
“Measuring Liabilities at Fair Value” (ASU 2009-05). ASU 2009-05
provides additional guidance clarifying the measurement of liabilities at fair
value. ASU 2009-05 is effective in fourth quarter 2009 for a
calendar-year entity. The Company is currently evaluating the impact
of ASU 2009-05 on its financial position, results of operations, cash flows, and
disclosures.
On
September 23, 2009, the FASB ratified Emerging Issues Task Force Issue No. 08-1,
“Revenue Arrangements with Multiple Deliverables” (EITF 08-1). EITF
08-1 updates the current guidance pertaining to multiple-element revenue
arrangements included in ASC Subtopic 605-25, which originated primarily from
EITF 00-21, also titled “Revenue Arrangements with Multiple
Deliverables.” EITF 08-1 will be effective for annual reporting
periods beginning January 1, 2011 for calendar-year entities. The
Company is currently evaluating the impact of EITF 08-1 on its financial
position, results of operations, cash flows, and disclosures.
3. DIVIDENDS
During
the three month periods ended March 31, June 30, and September 30, 2009,
dividends of $.0045 per share were declared on the 740 million shares, 741
million shares, and 742 million shares of Common Stock then outstanding,
respectively. During the three month periods ended March 31, June 30,
and September 30, 2008, dividends of $.0045 per share were declared on the 731
million shares, 733 million shares, and 737 million shares of Common Stock then
outstanding, respectively.
4. NET
INCOME (LOSS) PER SHARE
The
following table sets forth the computation of basic and diluted net income
(loss) per share (in millions except per share amounts):
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
|||||||||||||
|
NUMERATOR:
|
||||||||||||||||
|
Net
income (loss)
|
$ | (16 | ) | $ | (120 | ) | $ | (16 | ) | $ | 234 | |||||
|
DENOMINATOR:
|
||||||||||||||||
|
Weighted-average
shares
|
||||||||||||||||
|
outstanding,
basic
|
742 | 736 | 741 | 734 | ||||||||||||
|
Dilutive
effect of Employee stock
|
||||||||||||||||
|
options
|
- | - | - | 5 | ||||||||||||
|
Adjusted
weighted-average shares
|
||||||||||||||||
|
outstanding,
diluted
|
742 | 736 | 741 | 739 | ||||||||||||
|
NET
INCOME (LOSS) PER SHARE:
|
||||||||||||||||
|
Basic
|
$ | (.02 | ) | $ | (.16 | ) | $ | (.02 | ) | $ | .32 | |||||
|
Diluted
|
$ | (.02 | ) | $ | (.16 | ) | $ | (.02 | ) | $ | .32 | |||||
The
Company has excluded 81 million and 29 million shares, respectively, from its
calculations of net income per share, diluted, for the three months ended
September 30, 2009 and 2008, and has excluded 80 million and 57 million shares,
respectively, from its calculations of net income per share, diluted, for the
nine months ended September 30, 2009 and 2008, as they represent antidilutive
stock options for the respective periods presented.
5. FINANCIAL
DERIVATIVE INSTRUMENTS
Fuel
Contracts
Airline
operators are inherently dependent upon energy to operate and, therefore, are
impacted by changes in jet fuel prices. Jet fuel and oil (including
related taxes) consumed during the three months ended September 30, 2009 and
2008, represented approximately 31 percent and 37 percent of the Company’s
operating expenses, respectively. The Company’s operating expenses have been
extremely volatile in recent years due to dramatic increases and declines in
energy prices. The Company endeavors to acquire jet fuel at the
lowest possible cost and to reduce volatility in operating expenses through its
fuel hedging program. Because jet fuel is not traded on an organized
futures exchange, there are limited opportunities to hedge directly in jet
fuel. However, the Company has found that financial derivative
instruments in other commodities, such as crude oil, and refined products such
as heating oil and unleaded gasoline, can be useful in decreasing its exposure
to jet fuel price volatility. The Company does not purchase or hold
any derivative financial instruments for trading purposes.
The
Company has used financial derivative instruments for both short-term and
long-term time frames, and typically uses a mixture of purchased call options,
collar structures (which include both a purchased call option and a sold put
option), and fixed price swap agreements in its portfolio. Generally,
when the Company perceives that prices are lower than historical or expected
future levels, the Company prefers to use fixed price swap agreements and
purchased call options. However, at times when the Company perceives
that purchased call options have become too expensive, it may use more collar
structures. Although the use of collar structures and swap agreements
can reduce the overall cost of hedging, these instruments carry more risk than
purchased call options in that the Company could end up in a liability position
when the collar structure or swap agreement settles. With the use of
purchased call options, the Company cannot be in a liability position at
settlement.
The
following table provides information about the Company’s volume of fuel hedging
for the first nine months of 2009, and its portfolio as of September 30, 2009,
for future periods. These hedge volumes are presented strictly from
an “economic” standpoint and thus do not reflect whether the hedges qualified or
will qualify for special hedge accounting as defined in ASC Topic
815. The Company defines its “economic” hedge as the net volume of
fuel derivative contracts held, including the impact of positions that have been
offset through sold positions, regardless of whether those contracts qualify for
hedge accounting as defined in ASC Topic 815.
|
Fuel
hedged as of
|
Approximate
%
|
|||||||
|
September
30, 2009
|
of
jet fuel
|
|||||||
|
Period
(by year)
|
(gallons
in millions)
|
consumption
|
||||||
|
2009
|
438 | 31 | % * | |||||
|
2010
|
938 | 66 | % * | |||||
|
2011
|
559 | 40 | % * | |||||
|
2012
|
232 | 17 | % * | |||||
|
2013
|
98 | 7 | % * | |||||
|
Period
(by quarter for 2009)
|
||||||||
|
First
quarter 2009
|
15 | 4 | % | |||||
|
Second
quarter 2009
|
185 | 50 | % | |||||
|
Third
quarter 2009
|
77 | 21 | % | |||||
|
Fourth
quarter 2009
|
161 | 47 | % * | |||||
|
*
Forecasted
|
||||||||
Upon
proper qualification, the Company accounts for its fuel derivative instruments
as cash flow hedges, as defined in ASC Topic 815. Under ASC Topic
815, all derivatives designated as hedges that meet certain requirements are
granted special hedge accounting treatment. Generally, utilizing the
special hedge accounting, all periodic changes in fair value of the derivatives
designated as hedges that are considered to be effective, as defined, are
recorded in "Accumulated other comprehensive income (loss)” (AOCI) until the
underlying jet fuel is consumed. See Note 6 for further information
on AOCI. The Company is exposed to the risk that periodic changes
will not be effective, as defined, or that the derivatives will no longer
qualify for special hedge accounting. Ineffectiveness, as defined,
results when the change in the fair value of the derivative instrument exceeds
the change in the value of the Company’s expected future cash outlay to purchase
and consume jet fuel. To the extent that the periodic changes in the
fair value of the derivatives are not effective, that ineffectiveness is
recorded to “Other (gains) losses, net” in the statement of
operations. Likewise, if a hedge ceases to qualify for hedge
accounting, any change in the fair value of derivative instruments since the
last period is recorded to “Other (gains) losses, net” in the statement of
operations in the period of the change; however, any amounts previously recorded
to AOCI would remain there until such time as the original forecasted
transaction occurs at which time these amounts would be reclassified to “Fuel
and oil” expense. In a situation where it becomes probable that a
hedged forecasted transaction will not occur, any gains and/or losses that have
been recorded to AOCI would be required to be immediately reclassified into
earnings. The Company did not have any such situations occur for the
three or nine months ended September 30, 2009 or 2008.
Ineffectiveness
is inherent in hedging jet fuel with derivative positions based in other crude
oil related commodities. Due to the volatility in markets for crude
oil and related products, the Company is unable to predict the amount of
ineffectiveness each period, including the loss of hedge accounting, which could
be determined on a derivative by derivative basis or in the aggregate for a
specific commodity. This may result, and has resulted, in increased
volatility in the Company’s financial results. Factors that have and
may continue to lead to ineffectiveness and unrealized gains and losses on
derivative contracts include: significant fluctuation in energy prices, the
number of derivative positions the Company holds, significant weather events
affecting refinery capacity and the production of refined products, and the
volatility of the different types of products the Company uses in
hedging. The number of instances in which the Company has
discontinued hedge accounting for specific hedges and for specific refined
products, such as unleaded gasoline, has increased recently, primarily due to
the foregoing factors. However, even though these derivatives may not
qualify for special hedge accounting, the Company continues to hold the
instruments as it believes they continue to afford the Company the opportunity
to somewhat stabilize jet fuel costs.
ASC Topic
815 is a complex accounting standard with stringent requirements, including the
documentation of a Company hedging strategy, statistical analysis to qualify a
commodity for hedge accounting both on a historical and a prospective basis, and
strict contemporaneous documentation that is required at the time each hedge is
designated by the Company. As required, the Company assesses the
effectiveness of each of its individual hedges on a quarterly
basis. The Company also examines the effectiveness of its entire
hedging program on a quarterly basis utilizing statistical
analysis. This analysis involves utilizing regression and other
statistical analyses that compare changes in the price of jet fuel to changes in
the prices of the commodities used for hedging purposes.
All cash
flows associated with purchasing and selling derivatives are classified as
operating cash flows in the unaudited Condensed Consolidated Statement of Cash
Flows. The following table presents the location of all assets and
liabilities associated with the Company’s hedging instruments within the
unaudited Condensed Consolidated Balance Sheet (in millions):
|
Asset
Derivatives
|
Liability
Derivatives
|
||||||||||||||||
|
Balance
Sheet Location
|
Fair
Value at 9/30/09
|
Fair
Value at 12/31/08
|
Fair
Value at 9/30/09
|
Fair
Value at 12/31/08
|
|||||||||||||
|
Derivatives
designated as hedging
|
|||||||||||||||||
|
instruments
under ASC Topic 815
|
|||||||||||||||||
|
Fuel
derivative contracts (gross)*
|
Accrued
liabilities
|
$ | 64 | $ | 94 | $ | 34 | $ | 19 | ||||||||
|
Fuel
derivative contracts (gross)*
|
Other
deferred liabilities
|
107 | 40 | 31 | 522 | ||||||||||||
|
Interest
rate derivative contracts
|
Other
assets
|
59 | 83 | - | - | ||||||||||||
|
Interest
rate derivative contracts
|
Other
deferred liabilities
|
- | - | - | 3 | ||||||||||||
|
Total
derivatives designated as hedging
|
|||||||||||||||||
|
instruments
under ASC Topic 815
|
$ | 230 | $ | 217 | $ | 65 | $ | 544 | |||||||||
|
Derivatives
not designated as hedging
|
|||||||||||||||||
|
instruments
under ASC Topic 815
|
|||||||||||||||||
|
Fuel
derivative contracts (gross)*
|
Accrued
liabilities
|
$ | 340 | $ | 387 | $ | 545 | $ | 708 | ||||||||
|
Fuel
derivative contracts (gross)*
|
Other
deferred liabilities
|
309 | 266 | 874 | 530 | ||||||||||||
|
Total
derivatives not designated as
|
|||||||||||||||||
|
hedging
instruments under ASC Topic 815
|
$ | 649 | $ | 653 | $ | 1,419 | $ | 1,238 | |||||||||
|
Total
derivatives
|
$ | 879 | $ | 870 | $ | 1,484 | $ | 1,782 | |||||||||
|
*
Does not include the impact of cash collateral deposits provided to
counterparties. See discussion
|
|||||||||||||||||
|
of
credit risk and collateral following in this Note.
|
|||||||||||||||||
In
addition, the Company also had the following amounts associated with fuel
derivative instruments and hedging activities in its unaudited Condensed
Consolidated Balance Sheet (in millions):
|
Balance
Sheet
|
September
30,
|
December
31,
|
|||||||
|
Location
|
2009
|
2008
|
|||||||
|
Cash
collateral deposits provided
|
Offset
against Other
|
||||||||
|
to
counterparty - noncurrent
|
deferred
liabilities
|
324 | 240 | ||||||
|
Cash
collateral deposits provided
|
Offset
against Accrued
|
||||||||
|
to
counterparty - current
|
liabilities
|
101 | - | ||||||
|
Due
to third parties for settled fuel contracts
|
Accrued
liabilities
|
25 | 16 | ||||||
|
Net
unrealized losses from fuel
|
Accumulated
other
|
||||||||
|
hedges,
net of tax
|
comprehensive
loss
|
724 | 946 | ||||||
The
following tables present the impact of derivative instruments and their location
within the unaudited Condensed Consolidated Statement of Operations for the
three and nine months ended September 30, 2009 and 2008 (in
millions):
|
Derivatives
in ASC Topic 815 Cash Flow Hedging Relationships
|
||||||||||||||||||||||||
|
Amount
of (Gain) Loss Recognized in AOCI on Derivatives (effective
portion)
|
Amount
of (Gain) Loss Reclassified from AOCI into Income (effective
portion)(a)
|
Amount
of (Gain) Loss Recognized in Income on Derivatives (ineffective portion)
(b)
|
||||||||||||||||||||||
|
Three
months ended September 30,
|
Three
months ended September 30,
|
Three
months ended September 30,
|
||||||||||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
2009
|
2008
|
|||||||||||||||||||
|
Fuel
derivative
|
||||||||||||||||||||||||
|
contracts
|
$ | (40 | ) * | $ | 1,403 | * | $ | 101 | * | $ | (226 | ) * | $ | (46 | ) | $ | 41 | |||||||
|
Interest
rate
|
||||||||||||||||||||||||
|
derivatives
|
6 | * | - | - | - | - | - | |||||||||||||||||
|
Total
|
$ | (34 | ) | $ | 1,403 | $ | 101 | $ | (226 | ) | $ | (46 | ) | $ | 41 | |||||||||
|
* Net
of tax
|
||||||||||||||||||||||||
|
(a)
Amounts related to fuel derivative contracts and interest rate derivatives
are included in
|
||||||||||||||||||||||||
|
Fuel
and oil and Interest expense, respectively.
|
||||||||||||||||||||||||
|
(b)
Amounts are included in Other (gains) losses, net.
|
||||||||||||||||||||||||
|
Derivatives
in ASC Topic 815 Cash Flow Hedging Relationships
|
||||||||||||||||||||||||
|
Amount
of (Gain) Loss Recognized in AOCI on Derivatives (effective
portion)
|
Amount
of (Gain) Loss Reclassified from AOCI into Income (effective
portion)(a)
|
Amount
of (Gain) Loss Recognized in Income on Derivatives (ineffective portion)
(b)
|
||||||||||||||||||||||
|
Nine
months ended September 30,
|
Nine
months ended September 30,
|
Nine
months ended September 30,
|
||||||||||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
2009
|
2008
|
|||||||||||||||||||
|
Fuel
derivative
|
||||||||||||||||||||||||
|
contracts
|
$ | (85 | ) * | $ | (520 | )* | $ | 307 | * | $ | (680 | ) * | $ | (55 | ) | $ | 67 | |||||||
|
Interest
rate
|
||||||||||||||||||||||||
|
derivatives
|
(19 | ) * | - | - | - | - | - | |||||||||||||||||
|
Total
|
$ | (104 | ) | $ | (520 | ) | $ | 307 | $ | (680 | ) | $ | (55 | ) | $ | 67 | ||||||||
|
* Net
of tax
|
||||||||||||||||||||||||
|
(a)
Amounts related to fuel derivative contracts and interest rate derivatives
are included in
|
||||||||||||||||||||||||
|
Fuel
and oil and Interest expense, respectively.
|
||||||||||||||||||||||||
|
(b)
Amounts are included in Other (gains) losses, net.
|
||||||||||||||||||||||||
|
Derivatives
not in ASC Topic 815 Cash Flow Hedging Relationships
|
||||||||
|
Amount
of (Gain) Loss Recognized in Income on Derivatives
|
||||||||
|
Three
months ended September 30,
|
Location
of (Gain) Loss Recognized in Income
|
|||||||
| 2009 | 2008 |
on
Derivatives
|
||||||
|
Fuel
derivative contracts
|
$ |
8
|
$ |
205
|
Other
(gains) losses, net
|
|||
|
Derivatives
not in ASC Topic 815 Cash Flow Hedging Relationships
|
||||||||
|
Amount
of (Gain) Loss Recognized in Income on Derivatives
|
||||||||
|
Nine months
ended September 30,
|
Location
of (Gain) Loss Recognized in Income
|
|||||||
| 2009 | 2008 |
on
Derivatives
|
||||||
|
Fuel
derivative contracts
|
$ |
(57
|
) | $ |
(161
|
) |
Other
(gains) losses, net
|
|
The
Company also recorded expense associated with premiums paid for fuel derivative
contracts that settled/expired during the three months ended September 30, 2009
and 2008, respectively, of $35 million and $20 million, and during the nine
months ended September 30, 2009 and 2008, respectively, of $104 million and $47
million. These amounts are excluded from the Company’s measurement of
effectiveness for related hedges.
The fair
value of the derivative instruments, depending on the type of instrument, was
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. Included in the Company’s total net unrealized losses from
fuel hedges as of September 30, 2009, are approximately $278 million in
unrealized losses, net of taxes, that are expected to be realized in earnings
during the twelve months following September 30, 2009. In addition,
as of September 30, 2009, the Company had already recognized cumulative net
gains due to ineffectiveness and derivatives that do not qualify for hedge
accounting totaling $16 million, net of taxes. These net gains were
recognized in the three months ended September 30, 2009, and prior periods, and
are reflected in “Retained earnings” as of September 30, 2009, but the
underlying derivative instruments will not expire/settle until the fourth
quarter of 2009 or future periods.
Interest
rate swaps
The
Company is party to interest rate swap agreements related to its $385 million
6.5% senior unsecured notes due 2012, its $350 million 5.25% senior unsecured
notes due 2014, its $300 million 5.125% senior unsecured notes due 2017, and its
$100 million 7.375% senior unsecured debentures due 2027. The primary
objective for the Company’s use of these interest rate hedges is to better match
the repricing of its assets and liabilities. Under each of these
interest rate swap agreements, the Company pays the London InterBank Offered
Rate (LIBOR) plus a margin every six months on the notional amount of the debt,
and receives payments based on the fixed stated rate of the notes every six
months until the date the notes become due. These interest rate swap
agreements qualify as fair value hedges, as defined by ASC Topic
815. In addition, these interest rate swap agreements qualify for the
“shortcut” method of accounting for hedges, as defined by ASC Topic
815. Under the “shortcut” method, the hedges are assumed to be
perfectly effective, and, thus, there is no ineffectiveness to be recorded in
earnings.
The
Company also entered into interest rate swap agreements concurrent with its
entry into a twelve-year, $600 million floating-rate term loan agreement during
2008, and a ten-year, $332 million floating-rate term loan agreement during May
2009. Under these swap agreements, which are accounted for as cash
flow hedges, the interest rates on the term loans are effectively fixed for
their entire term at 5.223 percent and 6.64 percent, respectively, and
ineffectiveness is required to be measured each reporting period. The
fair values of the interest rate swap agreements, which are adjusted regularly,
have been aggregated by counterparty for classification in the unaudited
Condensed Consolidated Balance Sheet.
Credit
risk and collateral
The
Company’s credit exposure related to fuel derivative instruments is represented
by the fair value of contracts with a net positive fair value to the Company at
the reporting date. These outstanding instruments expose the Company
to credit loss in the event of nonperformance by the counterparties to the
agreements. However, the Company has not experienced any significant
credit loss as a result of counterparty nonperformance in the
past. To manage credit risk, the Company selects and will
periodically review counterparties based on credit ratings, limits its exposure
to a single counterparty, and monitors the market position of the fuel hedging
program and its relative market position with each counterparty. At
September 30, 2009, the Company had agreements with all of its counterparties
containing early termination rights and/or bilateral collateral provisions
whereby security is required if market risk exposure exceeds a specified
threshold amount or credit ratings fall below certain levels. Based
on the Company’s current agreements with two of these counterparties, cash
deposits are required to be posted whenever the net fair value of derivatives
associated with those counterparties exceed specific thresholds. If
the threshold is exceeded, cash is either posted by the counterparty if the
value of derivatives is an asset to the Company, or posted by the Company if the
value of derivatives is a liability to the Company.
Under one
of the Company’s counterparty agreements, as amended, if the Company becomes
obligated to post collateral for obligations in amounts of up to $300 million
and in excess of $700 million, the Company is required to post cash collateral;
however, if the Company becomes obligated to post collateral for obligations in
amounts between $300 million and $700 million, the Company has pledged 20 of its
Boeing 737-700 aircraft as collateral in lieu of cash. At September
30, 2009, the fair value of fuel derivative instruments with this counterparty
was a net liability of $266 million, and the Company had posted $300 million in
cash collateral deposits with the counterparty; therefore, none of the Company’s
liability was secured by pledged aircraft. The
“over-collateralization” was due to timing of the point at which the fair value
of derivative instruments was measured and the time at which resulting
collateral levels were adjusted. If the fair value of fuel derivative
instruments with this counterparty were in a net asset position, the
counterparty would be required to post cash collateral to the Company on a
dollar-for-dollar basis for amounts in excess of $40 million. This
agreement does not contain any triggers that would require additional cash to be
posted by the Company outside of further changes in the fair value of the fuel
derivative instruments held with the counterparty. However, if the
fair value of fuel derivative instruments with this counterparty were in a net
asset position, and the counterparty’s credit rating were to be lowered to
specified levels, the counterparty could be required to post cash collateral to
the Company on a dollar-for-dollar basis related to the first $40 million of
assets held. This agreement was amended in September 2009 to extend
its expiration from January 1, 2010, until January 1, 2015.
Under
another of the Company’s counterparty agreements, the Company is obligated to
post collateral related to fuel derivative liabilities as
follows: (i) if the obligation is up to $125 million, the Company
posts cash collateral, (ii) if the obligation exceeds $125 million, in addition
to the cash collateral for the first $125 million, the Company has pledged the
value of 29 designated Boeing 737-700 aircraft as collateral in lieu of cash (up
to a maximum of $500 million), and (iii) if the obligation exceeds $125 million
plus the value of the pledged aircraft (up to the $500 million maximum), the
Company must post cash or letters of credit as collateral. The
Company pledged 29 of its Boeing 737-700 aircraft to cover the collateral
posting band in clause (ii). As of September 30, 2009, the fair value
of fuel derivative instruments with this counterparty was a net liability of
$377 million, and the Company had posted $125 million in cash collateral
deposits to this counterparty, with the remaining $252 million secured by
pledged aircraft. This agreement also provides for the counterparty
to post cash collateral to the Company on a dollar-for-dollar basis for any net
positive fair value of fuel derivative instruments in excess of $150 million
held by the Company from that counterparty. This agreement does not
contain any triggers that would require additional cash to be posted by the
Company outside of further changes in the fair value of the fuel derivative
instruments held with the counterparty. However, if the fair value of
fuel derivative instruments with this counterparty were in a net asset position,
and the counterparty’s credit rating were to be lowered to specified levels, the
counterparty would be required to post cash collateral to the Company on a
dollar-for-dollar basis related to the first $150 million of assets
held.
As of
September 30, 2009, other than as described above, the Company did not have any
fuel hedging agreements with counterparties in which cash collateral is required
to be posted based on the Company’s current investment grade credit
rating. However, additional fuel hedging agreements contain a
provision whereby each party has the right to terminate and settle all
outstanding fuel contracts if the other party’s credit rating falls below
investment grade. Upon this occurrence, the party in a net liability
position could subsequently be required to post cash collateral if a mutual
alternative agreement could not be reached. At September 30, 2009,
the Company’s estimated fair value of fuel derivative contracts with one
counterparty containing this provision was a liability of $77 million, including
$14 million that will settle by the end of 2009.
The
Company classifies its cash collateral provided to counterparties in accordance
with the provisions of ASC Subtopic 210-20. ASC Subtopic 210-20
requires an entity to select a policy of how it records the offset rights to
reclaim cash collateral associated with the related derivative fair value of the
assets or liabilities of such derivative instruments. Entities may
either select a “net” or a “gross” presentation. The Company has
elected to present its cash collateral utilizing a net presentation, in which
cash collateral amounts held or provided have been netted against the fair value
of outstanding derivative instruments. The Company’s policy differs
depending on whether its derivative instruments are in a net asset position or a
net liability position. If its fuel derivative instruments are in a
net asset position with a counterparty, cash collateral amounts held are first
netted against current derivative amounts (those that will settle during the
twelve months following the balance sheet date) associated with that
counterparty until that balance is zero, and then any remainder would be applied
against the fair value of noncurrent outstanding derivative instruments (those
that will settle beyond one year following the balance sheet
date). If its fuel derivative instruments are in a net liability
position with a counterparty, cash collateral amounts provided are first netted
against noncurrent derivative amounts associated with that counterparty until
that balance is zero, and then any remainder would be applied against the fair
value of current outstanding derivative instruments. At September 30,
2009, of the $425 million in cash collateral deposits posted with counterparties
under its bilateral collateral provisions, $324 million has been netted against
noncurrent fuel derivative instruments within “Other deferred liabilities” and
$101 million has been netted against current fuel derivative instruments within
“Accrued liabilities” in the unaudited Condensed Consolidated Balance
Sheet.
6. COMPREHENSIVE
INCOME (LOSS)
Comprehensive
income (loss) includes changes in the fair value of certain financial derivative
instruments, which qualify for hedge accounting, unrealized gains and losses on
certain investments, and actuarial gains/losses arising from the Company’s
postretirement benefit obligation. The differences between net income
(loss) and comprehensive income (loss) for the three and nine months ended
September 30, 2009 and 2008, were as follows:
| Three months ended September 30, | ||||||||
|
(In
millions)
|
2009
|
2008
|
||||||
|
Net
loss
|
$ | (16 | ) | $ | (120 | ) | ||
|
Unrealized
gain (loss) on derivative instruments,
|
||||||||
|
net
of deferred taxes of $37 and ($1,015)
|
61 | (1,629 | ) | |||||
|
Other,
net of deferred taxes of $14 and ($2)
|
21 | (3 | ) | |||||
|
Total
other comprehensive income
|
82 | (1,632 | ) | |||||
|
Comprehensive
income (loss)
|
$ | 66 | $ | (1,752 | ) | |||
| Nine months ended September 30, | ||||||||
|
(In
millions)
|
2009
|
2008
|
||||||
|
Net
income (loss)
|
$ | (16 | ) | $ | 234 | |||
|
Unrealized
gain (loss) on derivative instruments,
|
||||||||
|
net
of deferred taxes of $137 and ($111)
|
222 | (160 | ) | |||||
|
Other,
net of deferred taxes of $30 and ($9)
|
47 | (14 | ) | |||||
|
Total
other comprehensive income (loss)
|
269 | (174 | ) | |||||
|
Comprehensive
income
|
$ | 253 | $ | 60 | ||||
A
rollforward of the amounts included in AOCI, net of taxes, is shown below for
the three and nine months ended September 30, 2009:
|
Accumulated
|
||||||||||||
|
Fuel
|
other
|
|||||||||||
|
hedge
|
comprehensive
|
|||||||||||
|
(In
millions)
|
derivatives
|
Other
|
income
(loss)
|
|||||||||
|
Balance
at June 30, 2009
|
$ | (785 | ) | $ | (12 | ) | $ | (797 | ) | |||
|
Third
quarter 2009 changes in value
|
(40 | ) | 21 | (19 | ) | |||||||
|
Reclassification
to earnings
|
101 | - | 101 | |||||||||
|
Balance
at September 30, 2009
|
$ | (724 | ) | $ | 9 | $ | (715 | ) | ||||
|
Accumulated
|
||||||||||||
|
Fuel
|
other
|
|||||||||||
|
hedge
|
comprehensive
|
|||||||||||
|
(In
millions)
|
derivatives
|
Other
|
income
(loss)
|
|||||||||
|
Balance
at December 31, 2008
|
$ | (946 | ) | $ | (38 | ) | $ | (984 | ) | |||
|
2009
changes in value
|
(85 | ) | 47 | (38 | ) | |||||||
|
Reclassification
to earnings
|
307 | - | 307 | |||||||||
|
Balance
at September 30, 2009
|
$ | (724 | ) | $ | 9 | $ | (715 | ) | ||||
7. ACCRUED
LIABILITIES
|
September
30,
|
December
31,
|
|||||||
|
(In
millions)
|
2009
|
2008
|
||||||
|
Retirement
plans
|
$ | 12 | $ | 86 | ||||
|
Aircraft
rentals
|
110 | 118 | ||||||
|
Vacation
pay
|
184 | 175 | ||||||
|
Advances
and deposits
|
16 | 23 | ||||||
|
Fuel
derivative contracts
|
74 | 246 | ||||||
|
Deferred
income taxes
|
169 | 36 | ||||||
|
Workers
compensation
|
120 | 122 | ||||||
|
Other
|
233 | 206 | ||||||
|
Accrued
liabilities
|
$ | 918 | $ | 1,012 | ||||
8. POSTRETIREMENT
BENEFITS
The
Company provides postretirement benefits to qualified retirees in the form of
medical and dental coverage. Employees must meet minimum levels of
service and age requirements as set forth by the Company, or as specified in
collective bargaining agreements with specific workgroups. Employees
meeting these requirements, as defined, may use accrued unused sick time to pay
for medical and dental premiums from the age of retirement until age
65.
The
following table sets forth the Company’s periodic postretirement benefit cost
for each of the interim periods identified:
| Three months ended September 30, | ||||||||
|
(In
millions)
|
2009
|
2008
|
||||||
|
Service
cost
|
$ | 3 | $ | 4 | ||||
|
Interest
cost
|
2 | 2 | ||||||
|
Amortization
of prior service cost
|
- | - | ||||||
|
Recognized
actuarial gain
|
(6 | ) | (1 | ) | ||||
|
Net
periodic postretirement benefit cost (income)
|
$ | (1 | ) | $ | 5 | |||
| Nine months ended September 30, | ||||||||
|
(In
millions)
|
2009
|
2008
|
||||||
|
Service
cost
|
$ | 10 | $ | 11 | ||||
|
Interest
cost
|
4 | 4 | ||||||
|
Amortization
of prior service cost
|
1 | 1 | ||||||
|
Recognized
actuarial gain
|
(7 | ) | (2 | ) | ||||
|
Net
periodic postretirement benefit cost
|
$ | 8 | $ | 14 | ||||
9. FINANCING
TRANSACTIONS
On April
29, 2009, the Company entered into a term loan agreement providing for loans to
the Company aggregating up to $332 million, to be secured by mortgages on 14 of
the Company’s 737-700 aircraft. The Company has borrowed the full
$332 million and secured the loan with the requisite 14 aircraft
mortgages. The loan matures on May 6, 2019, and is repayable
quarterly in installments of principal beginning August 6, 2009. The
loan bears interest at the LIBO Rate (as defined in the term loan agreement)
plus 3.30 percent, and interest is payable quarterly, beginning August 6,
2009. Concurrent with its entry into the term loan agreement, the
Company entered into an interest rate swap agreement that effectively fixes the
interest rate on the term loan for its entire term at 6.64
percent. The Company used the proceeds from the term loan for general
corporate purposes, including the repayment of the Company’s revolving credit
facility.
On July
1, 2009, the Company entered into a term loan agreement providing for loans to
the Company aggregating up to $124 million, to be secured by mortgages on five
of the Company’s 737-700 aircraft. The Company has borrowed the full
$124 million and secured this loan with the requisite five aircraft
mortgages. The loan matures on July 1, 2019, and is repayable
semi-annually in installments of principal beginning January 1,
2010. The loan bears interest at a fixed rate of 6.84 percent, and
interest is payable semi-annually, beginning January 1, 2010. The
Company used the proceeds from the term loan for general corporate
purposes.
During
May 2009, the Company fully repaid the $400 million it had previously borrowed
in 2008 under its former $600 million revolving credit facility. On
September 29, 2009, the Company entered into a new $600 million unsecured
revolving credit facility expiring in October 2012 and terminated the previous
facility which would have expired in August 2010. At the Company’s
option, interest on the new facility can be calculated on one of several
different bases. The new facility also contains a financial covenant
requiring a minimum coverage ratio of adjusted pre-tax income to fixed
obligations, as defined. As of September 30, 2009, the Company was in
compliance with this covenant and there were no amounts outstanding under the
revolving credit facility.
10. COMMITMENTS
AND CONTINGENCIES
During
the first quarter and early second quarter of 2008, the Company was named as a
defendant in two putative class actions on behalf of persons who purchased air
travel from the Company while the Company was allegedly in violation of FAA
safety regulations. Claims alleged by the plaintiffs in these two putative class
actions include breach of contract, breach of warranty, fraud/misrepresentation,
unjust enrichment, and negligent and reckless operation of an
aircraft. The Company believes that the class action lawsuits are
without merit and intends to vigorously defend itself. Also in
connection with this incident, during the first quarter and early second quarter
of 2008, the Company received four letters from Shareholders demanding the
Company commence an action on behalf of the Company against members of its Board
of Directors and any other allegedly culpable parties for damages resulting from
an alleged breach of fiduciary duties owed by them to the Company. In
August 2008, Carbon County Employees Retirement System and Mark Cristello filed
a related Shareholder derivative action in Texas state court naming certain
directors and officers of the Company as individual defendants and the Company
as a nominal defendant. The derivative action claims breach of
fiduciary duty and seeks recovery by the Company of alleged monetary damages
sustained as a result of the purported breach of fiduciary duty, as well as
costs of the action. A Special Committee appointed by the Independent
Directors of the Company has been evaluating the Shareholder
demands. The parties have submitted to the court a proposed
settlement that has been preliminarily approved by the court.
The
Company is from time to time subject to various other legal proceedings and
claims arising in the ordinary course of business, including, but not limited
to, examinations by the Internal Revenue Service (IRS).
The
Company's management does not expect that the outcome in any of its currently
ongoing legal proceedings or the outcome of any proposed adjustments presented
to date by the IRS, individually or collectively, will have a material adverse
effect on the Company's financial condition, results of operations, or cash
flow.
During
2008, the City of Dallas approved the Love Field Modernization Program (LFMP), a
project to reconstruct Dallas Love Field (Airport) with modern, convenient air
travel facilities. Pursuant to a Program Development Agreement (PDA)
with the City of Dallas, the Company is managing this project, and major
construction is expected to commence during late 2009, with completion scheduled
for October 2014. Although subject to change, at the current time the
project is expected to include the renovation of the Airport airline terminals
and complete replacement of gate facilities with a new 20-gate facility,
including infrastructure, systems and equipment, aircraft parking apron, fueling
system, roadways and terminal curbside, baggage handling systems, passenger
loading bridges and support systems, and other supporting
infrastructure.
The PDA
authorizes the Company to spend up to $75 million, which would be reimbursed
upon the issuance of bonds that will be used as funding for
construction. As of September 30, 2009, the Company had spent a total
of $33 million of its own funds on a portion of the LFMP project, and the
Company has classified this amount as “Ground property and equipment” in its
unaudited Condensed Consolidated Balance Sheet.
The
Company has agreed to manage the majority of the LFMP project, and as a result,
will be evaluating its accounting requirements in conjunction with ASC Subtopic
840-40 (originally issued as EITF 97-10, “The Effect of Lessee Involvement in
Asset Construction”). As of the current time, the Company has not yet
made a final determination of its accounting for the LFMP. It is
currently expected that the bonds being utilized to finance the majority of the
LFMP will be issued during late 2009 or early 2010, at which time the Company
will disclose its conclusions regarding its accounting treatment for the
LFMP.
11. FAIR
VALUE MEASUREMENTS
The
Company adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value
Measurements”) as of January 1, 2008. ASC Topic 820 establishes a
three-tier fair value hierarchy, which prioritizes the inputs used in measuring
fair value. These tiers include: Level 1, defined as observable
inputs such as quoted prices in active markets; Level 2, defined as inputs other
than quoted prices in active markets that are either directly or indirectly
observable; and Level 3, defined as unobservable inputs in which little or no
market data exists, therefore requiring an entity to develop its own
assumptions.
As of
September 30, 2009, the Company held certain items that are required to be
measured at fair value on a recurring basis. These included cash
equivalents, short-term investments, certain noncurrent investments, interest
rate derivative contracts, fuel derivative contracts, and available-for-sale
securities. Cash equivalents consist of short-term, highly liquid,
income-producing investments, all of which have maturities of 90 days or less,
including money market funds, U.S. Government obligations, and obligations of
U.S. Government backed agencies. Short-term investments consist of
short-term, highly liquid, income-producing investments, which have maturities
of greater than 90 days but less than one year, including U.S. Government
obligations, obligations of U.S. Government backed agencies, and certain auction
rate securities. For all short-term investments, at each reset
period, the Company accounts for the transaction as “Proceeds from sales of
short-term investments” for the security relinquished, and a “Purchase of
short-term investments” for the security purchased, in the accompanying
unaudited Condensed Consolidated Statement of Cash Flows. Derivative
instruments are related to the Company’s fuel hedging program and interest rate
hedges. Noncurrent investments consist of certain auction rate
securities, primarily those collateralized by student loan portfolios, which are
guaranteed by the U.S. Government. Other available-for-sale
securities primarily consist of investments associated with the Company’s excess
benefit plan.
The
Company’s fuel derivative instruments consist of over-the-counter (OTC)
contracts, which are not traded on a public exchange. These contracts
include both swaps as well as different types of option
contracts. See Note 5 for further information on the Company’s
derivative instruments and hedging activities. The fair values of
swap contracts are determined based on inputs that are readily available in
public markets or can be derived from information available in publicly quoted
markets. Therefore, the Company has categorized these swap contracts
as Level 2. The Company determines the value of option contracts
utilizing a standard 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 financial institutions that trade
these contracts. In situations where the Company obtains inputs via
quotes from financial institutions, it verifies the reasonableness of these
quotes via similar quotes from another financial institution as of each date for
which financial statements are prepared. The Company also considers
counterparty credit risk and its own credit risk in its determination of all
estimated fair values. 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 of the inputs used to determine
the fair value of option contracts are unobservable (principally implied
volatility), the Company has categorized these option contracts as Level
3.
The
Company’s interest rate derivative instruments also consist of OTC swap
contracts. The inputs used to determine the fair values of these
contracts are obtained in quoted public markets. The Company has consistently
applied these valuation techniques in all periods presented.
The
Company’s investments associated with its excess benefit plan consist of mutual
funds that are publicly traded and for which market prices are readily
available.
All of
the Company’s auction rate security instruments are reflected at estimated fair
value in the unaudited Condensed Consolidated Balance Sheet. At
September 30, 2009, approximately $109 million of these instruments are
classified as available for sale securities and $83 million are classified as
trading securities. The $83 million classified as trading securities are subject
to an agreement the Company entered into in December 2008, as discussed below,
and are included in “Short-term investments” in the unaudited Condensed
Consolidated Balance Sheet. In periods when an auction process
successfully takes place every 30-35 days, quoted market prices would be readily
available, which would qualify as Level 1. However, due to events in
credit markets beginning during first quarter 2008, the auction events for most
of these instruments failed, and, therefore, the Company has subsequently
determined the estimated fair values of these securities utilizing a discounted
cash flow analysis or other type of valuation model. In addition,
during fourth quarter 2008, the Company performed a valuation of its auction
rate security instruments and considered these valuations in determining
estimated fair values of other similar instruments within its
portfolio. The Company’s analyses consider, among other items, the
collateralization underlying the security investments, the expected future cash
flows, including the final maturity, associated with the securities, and
estimates of the next time the security is expected to have a successful auction
or return to full par value. These securities were also compared,
when possible, to other securities not owned by the Company, but with similar
characteristics.
In
association with this estimate of fair value, the Company has recorded a
temporary unrealized decline in fair value of $11 million, with an offsetting
entry to AOCI. The Company currently believes that this temporary
decline in fair value is due entirely to market liquidity issues, because the
underlying assets for the majority of these auction rate securities held by the
Company are almost entirely backed by the U.S. Government. In
addition, for the $109 million in instruments classified as available for sale,
these auction rate securities represented less than five percent of the
Company’s total cash, cash equivalent, and investment balance at September 30,
2009. The range of maturities for the Company’s auction rate
securities ranges from 9 years to 38 years. Considering the relative
significance of these securities in comparison to the Company’s liquid assets
and other sources of liquidity, the Company has no current intention of selling
these securities nor does it expect to be required to sell these securities
before a recovery in their cost basis. For the $83 million in
instruments classified as trading securities, the Company is party to an
agreement with the counterparty that allows the Company to put the instruments
back to the counterparty at full par value in June 2010. In
conjunction with this agreement, the Company has applied the provisions of ASC
Topic 825 (originally issued as SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities”) to this put option. Part of this
agreement also contains a line of credit in which the Company can borrow up to
$83 million as a loan from the counterparty that would be secured by the auction
rate security instruments from that counterparty, and this line of credit was
fully drawn as of September 30, 2009. Both the put option and the
auction rate instruments are being marked to market through earnings each
period; however, these adjustments offset and had minimal impact on net earnings
for the three and nine months ended September 30, 2009. At the time
of the first failed auctions during first quarter 2008, the Company held a total
of $463 million in securities. Since that time, the Company has been
able to sell $260 million of these instruments at par value in addition to the
$83 million subject to the agreement to be settled at par in June
2010.
During
first quarter 2009, the Company also entered into a $46 million line of credit
agreement with another counterparty secured by approximately $92 million (par
value) of its remaining auction rate security instruments purchased through that
counterparty. This agreement allows the Company the ability to draw
against the line of credit secured by the auction rate security instruments from
that counterparty. As of September 30, 2009, the Company had no
borrowings against that available line of credit. The Company remains
in discussions with its other counterparties to determine whether mutually
agreeable decisions can be reached regarding the effective repurchase of its
remaining securities. The Company has continued to earn interest on
virtually all of its auction rate security instruments. Any future
fluctuation in fair value related to these instruments that the Company deems to
be temporary, including any recoveries of previous temporary write-downs, would
be recorded to AOCI. If the Company determines that any future
valuation adjustment was other than temporary, it would record a charge to
earnings as appropriate.
The
following items are measured at fair value on a recurring basis subject to the
disclosure requirements of ASC Topic 820 at September 30, 2009:
|
Fair Value Measurements at Reporting Date
Using
|
||||||||||||||||
|
Quoted
Prices in
|
Significant
|
|||||||||||||||
|
Active
Markets for
|
Significant
Other
|
Unobservable
|
||||||||||||||
|
Identical
Assets
|
Observable
Inputs
|
Inputs
|
||||||||||||||
|
Description
|
September 30, 2009
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
|
Assets
|
(in
millions)
|
|||||||||||||||
|
Cash
equivalents
|
$ | 902 | $ | 902 | $ | - | $ | - | ||||||||
|
Short-term
investments
|
1,352 | 1,249 | - | 103 | ||||||||||||
|
Noncurrent
investments (a)
|
89 | - | - | 89 | ||||||||||||
|
Interest
rate derivatives
|
59 | - | 59 | - | ||||||||||||
|
Fuel
derivatives (b)
|
1,089 | - | 286 | 803 | ||||||||||||
|
Other
available-for-sale securities
|
36 | 28 | - | 8 | ||||||||||||
|
Total
assets
|
$ | 3,527 | $ | 2,179 | $ | 345 | $ | 1,003 | ||||||||
|
Liabilities
|
||||||||||||||||
|
Fuel
derivatives (b)
|
$ | (1,753 | ) | $ | (801 | ) | $ | (952 | ) | |||||||
|
(a)
Included in "Other assets" in the unaudited Condensed Consolidated Balance
Sheet.
|
||||||||||||||||
|
(b)
In the unaudited Condensed Consolidated Balance Sheet, amounts are
presented as a net liability, and are also
|
||||||||||||||||
|
net
of $425 million in cash collateral provided to
counterparties.
|
||||||||||||||||
The
following table presents the Company’s activity for assets measured at fair
value on a recurring basis using significant unobservable inputs (Level 3) as
defined in ASC Topic 820 for the nine months ended September 30,
2009:
|
Fair Value Measurements Using
Significant
|
||||||||||||||||
|
Unobservable Inputs (Level
3)
|
||||||||||||||||
|
Fuel
|
Auction
Rate
|
Other
|
||||||||||||||
|
(in
millions)
|
Derivatives
|
Securities (a)
|
Securities
|
Total
|
||||||||||||
|
Balance
at December 31, 2008
|
$ | (864 | ) | $ | 200 | $ | 8 | $ | (656 | ) | ||||||
|
Total
gains or (losses) (realized or unrealized)
|
||||||||||||||||
|
Included
in earnings
|
525 | - | - | 525 | ||||||||||||
|
Included
in other comprehensive income
|
(138 | ) | - | - | (138 | ) | ||||||||||
|
Purchases
and settlements (net)
|
328 | (8 | ) | - | 320 | |||||||||||
|
Balance
at September 30, 2009
|
$ | (149 | ) | $ | 192 | (b) | $ | 8 | $ | 51 | ||||||
|
The
amount of total gains or (losses) for the
|
||||||||||||||||
|
period
included in earnings attributable to the
|
||||||||||||||||
|
change
in unrealized gains or losses relating to
|
||||||||||||||||
|
assets
still held at September 30, 2009
|
$ | 453 | $ | - | $ | - | $ | 453 | ||||||||
|
(a)
Includes those classified as short-term investments and noncurrent
investments.
|
||||||||||||||||
|
(b)
Includes $83 million classified as trading securities.
|
||||||||||||||||
All
settlements from fuel derivative contracts that are deemed “effective,” as
defined in ASC Topic 815, are included in “Fuel and oil” expense in the period
the underlying fuel is consumed in operations. Any “ineffectiveness”
associated with derivative contracts, as defined, including amounts that settled
in the current period (realized), and amounts that will settle in future periods
(unrealized), is recorded in earnings immediately, as a component of “Other
(gains) losses, net.” See Note 5 for further information on ASC Topic
815 and hedging.
Gains and
losses (realized and unrealized) included in earnings related to other
investments for the three and nine months ended September 30, 2009, are reported
in “Other operating expenses.”
The
carrying amounts and estimated fair values of the Company’s long-term debt and
fuel derivative contracts at September 30, 2009 are contained in the below
table. The estimated fair values of the Company’s publicly held
long-term debt were based on quoted market prices.
|
(In
millions)
|
Carrying
value
|
Estimated
fair value
|
||||||
|
10.5%
Notes due 2011
|
$ | 400 | $ | 432 | ||||
|
French
Credit Agreements due 2012
|
24 | 24 | ||||||
|
6.5%
Notes due 2012
|
403 | 425 | ||||||
|
5.25%
Notes due 2014
|
379 | 382 | ||||||
|
5.75%
Notes due 2016
|
300 | 295 | ||||||
|
5.125%
Notes due 2017
|
340 | 323 | ||||||
|
French
Credit Agreements due 2017
|
84 | 84 | ||||||
|
Term
Loan Agreement due 2019
|
326 | 339 | ||||||
|
Term
Loan Agreement due 2019
|
124 | 124 | ||||||
|
Term
Loan Agreement due 2020
|
562 | 493 | ||||||
|
Pass
Through Certificates
|
450 | 466 | ||||||
|
7.375%
Debentures due 2027
|
118 | 115 | ||||||
|
Fuel
derivative contracts*
|
(664 | ) | (664 | ) | ||||
|
*
Does not include the impact of cash collateral deposits provided to
counterparties.
|
||||||||
|
See
Note 5.
|
||||||||
12. EARLY
RETIREMENT OFFER
On April
16, 2009, the Company announced Freedom ’09, a one-time voluntary early out
program offered to eligible Employees, in which the Company offered cash
bonuses, medical/dental coverage for a specified period of time, and travel
privileges based on work group and years of service. The purpose of
this voluntary initiative and other initiatives is to right-size headcount in
conjunction with the Company’s current plans to reduce its capacity by five
percent in 2009, and to help reduce costs. Virtually all of the
Company’s Employees hired before March 31, 2008 were eligible to participate in
the program. Participants’ last day of work will fall between July
31, 2009 and April 15, 2010, as assigned by the Company based on the operational
needs of particular work locations and departments, determined on an
individual-by-individual basis. The Company did not have a target for
the number of Employees expected to accept the package.
Employees
electing to participate in Freedom ’09 were required to notify the Company of
their election by June 19, 2009. However, Employees had until July
16, 2009 to rescind their election and remain with the
Company. Following the deadline to rescind such election, a total of
1,404 Employees have remained as participants in Freedom ‘09, consisting of the
following breakdown among workgroups: 439 from Customer Support and
Services, 464 from Ground Operations and Provisioning, 113 Flight Attendants, 20
Pilots, 91 from Maintenance, and 277 Managerial and Administrative
Employees. In accordance with the accounting guidance in ASC Topic
715 (originally issued as FAS 88, “Employers’ Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits”),
the Company accrued total costs of approximately $66 million during third
quarter 2009 related to Freedom ’09—all of which are reflected in salaries,
wages, and benefits. Of this amount, approximately $32 million was
paid out to Employees who left the Company prior to September 30, 2009, and the
remaining $34 million will be paid out in subsequent periods. The
Company may need to replace some of the positions with newly hired Employees to
meet operational demands; however, the Company expects that many of the
positions will not be filled based on the Company’s recent capacity
reductions.
Item
2. Management's
Discussion and Analysis of Financial Condition and Results of
Operations
Comparative
Consolidated Operating Statistics
Relevant Southwest comparative
operating statistics for the three and nine months ended September 30, 2009 and
2008 are as follows:
|
Three
months ended September 30,
|
||||||||||||
|
2009
|
2008
|
Change
|
||||||||||
|
Revenue
passengers carried
|
22,375,593 | 22,243,013 | 0.6 | |||||||||