Southwest Airlines 2008 Annual Report Download - page 77

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The aircraft leases generally can be renewed at
rates based on fair market value at the end of the
lease term for one to five years. Most aircraft leases
have purchase options at or near the end of the lease
term at fair market value, generally limited to a stated
percentage of the lessor’s defined cost of the aircraft.
9. Project Early Departure
Project Early Departure was a voluntary early
retirement program offered in July 2007 to eligible
Employees, in which the Company offered a cash
bonus of $25,000 plus medical/dental continuation
coverage and travel privileges based on eligibility. A
total of 608 out of approximately 8,500 eligible
Employees elected to participate in the program. The
participants’ last day of work fell between
September 30, 2007 and April 30, 2008, based on the
operational needs of particular work locations and
departments. Project Early Departure resulted in a
pre-tax, pre-profitsharing, charge of approximately
$25 million during third quarter 2007. The remaining
amount to be paid was not significant as of
December 31, 2008.
10. Derivative And Financial 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 consumed
during 2008, 2007, and 2006 represented
approximately 35.1 percent, 29.7 percent, and 28.0
percent of the Company’s operating expenses,
respectively. The primary reason that fuel and oil has
become an increasingly larger portion of the
Company’s operating expenses has been due to the
dramatic increase in all energy prices in recent years.
The Company endeavors to acquire jet fuel at the
lowest possible cost. 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 increases. The Company does not
purchase or hold any derivative financial instruments
for trading purposes.
The Company has utilized financial derivative
instruments for both short-term and long-term time
frames, and typically utilizes a mixture of purchased
call options, collar structures, and fixed price swap
agreements in its portfolio. In recent years, as fuel
prices have risen, the Company has held fuel
derivative positions that have resulted in significant
gains recognized in earnings. However, as of
December 31, 2008, the Company held a net position
of fuel derivative instruments that effectively
represented a hedge of approximately 10 percent of
its anticipated jet fuel purchases for the years from
2009 through 2013. Prior to fourth quarter 2008, the
Company had held fuel derivative instruments for a
much larger portion of its anticipated fuel purchases
for these years; however, due to the recent
precipitous decline in fuel prices, the Company
significantly reduced its hedge in order to minimize
fuel hedging losses related to further oil price
declines and to minimize the potential for the
Company to provide additional cash collateral
deposits to counterparties. The Company
accomplished this reduced hedge by entering into
additional derivative contracts—basically by selling
zero-cost collars and fixed-price swap derivatives.
This strategy enables the Company to participate in
further price declines via the sold derivatives, which
should materially offset further declines in value of
the Company’s previously purchased derivatives. If
prices rise, the Company no longer has the protection
it had in place prior to reducing its hedge.
The total net fair value of outstanding financial
derivative instruments related to the Company’s jet
fuel market price risk at December 31, 2008, was a
net liability of $992 million. The current portion of
these financial derivative instruments, or $246
million, is classified as a component of “Accrued
liabilities” in the Consolidated Balance Sheet. The
long-term portion of these financial derivative
instruments, or $746 million, is included in “Other
deferred liabilities.”
Upon proper qualification, the Company
endeavors to account for its fuel derivative
instruments as cash flow hedges, as defined in
Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended (SFAS 133). Under
SFAS 133, all derivatives designated as hedges that
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