Southwest Airlines 2008 Annual Report Download - page 57

Company’s common stock over the expected term of
the option on the date of grant was estimated based
on the Company’s current dividend yield, and
adjusted for anticipated future changes.
Vesting terms for the Company’s stock option
plans differ based on the type of grant made and the
group to which the options are granted. For grants
made to Employees under collective bargaining
plans, vesting has ranged in length from immediate
vesting to vesting periods in accordance with the
period covered by the respective collective
bargaining agreement. For grants to other Employees,
options generally vest and become fully exercisable
over three, five, or ten years of continued
employment, depending upon the grant type. For
grants in any of the Company’s plans that are subject
to graded vesting over a service period, the Company
recognizes expense on a straight-line basis over the
requisite service period for the entire award. None of
the Company’s grants include performance-based or
market-based vesting conditions, as defined.
The Company believes it is unlikely that
materially different estimates for the assumptions
used in estimating the fair value of stock options
granted would be made based on the conditions
suggested by actual historical experience and other
data available at the time estimates were made.
Fair value measurements
The Company adopted the provisions of
Statement of Financial Accounting Standards
No. 157 (SFAS 157) effective January 1, 2008. The
Company has determined that it utilizes unobservable
(Level 3) inputs in determining the fair value of
certain assets and liabilities. At December 31, 2008,
these included auction rate security investments,
valued at $200 million, a portion of its fuel derivative
option contracts, which were a net liability of $864
million, and $8 million in other investments.
All of the Company’s auction rate security
instruments are reflected at estimated fair value in the
Consolidated Balance Sheet. At December 31, 2008,
approximately $109 million of these instruments are
classified as available for sale securities and $91
million are classified as trading securities. In prior
periods, due to the auction process which took place
every 30-35 days for most securities, quoted market
prices were readily available, which would have
qualified as Level 1 under SFAS 157. 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
determined the estimated fair values of these
securities utilizing a discounted cash flow analysis or
other type of valuation model as of December 31,
2008. In addition, the Company obtained an
independent valuation of a selected number of
auction rate security instruments and has 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. Due to these events, the
Company reclassified these instruments as Level 3
during first quarter 2008.
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 “Accumulated other comprehensive income
(loss).” Given the quality and backing of the
Company’s auction rate securities held, the fact that
the Company has not yet recorded a loss on the sale
of any of these instruments, and the fact that it has
been able to periodically sell instruments in the
periodic auction process, it believes it can continue to
account for the estimated reduction in fair value of its
remaining securities as temporary. These conclusions
will also continue to be evaluated and challenged in
subsequent periods. The Company currently believes
that this temporary decline in fair value is due
entirely to liquidity issues, because the underlying
assets for the majority of securities 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 approximately six percent of the
Company’s total cash, cash equivalent, and
investment balance at December 31, 2008, which it
believes allows it sufficient time for the securities to
return to full value. For the $91 million in
instruments classified as trading securities, the
Company has entered into an agreement with the
counterparty that allows the Company to put the
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