Southwest Airlines 2009 Annual Report Download - page 50

The Company then adjusts for certain items, such as transportation costs, that are stated in fuel purchasing
contracts with its vendors, in order to estimate the actual price paid for jet fuel associated with each hedge. This
methodology for estimating future cash flows (i.e., jet fuel prices) has been consistently applied during 2009,
2008, and 2007, in accordance with the Company’s interpretation of applicable GAAP. The Company also has
not changed its method for either assessing or measuring hedge ineffectiveness during these periods.
The Company believes it is unlikely that materially different estimates for the fair value of financial
derivative instruments, and forward jet fuel prices, would be made or reported based on other reasonable
assumptions or conditions suggested by actual historical experience and other data available at the time estimates
were made.
Share-Based Compensation
The Company has previously awarded share-based compensation pursuant to plans covering the majority of
its Employee groups, including plans adopted via collective bargaining, a plan covering the Company’s Board of
Directors, and plans related to employment contracts with the Chairman Emeritus of the Company. During 2009,
the Company recorded share-based compensation expense of $13 million, compared to $18 million in expense
for 2008 and $37 million for 2007.
The Company recognizes the cost of Employee services received in exchange for awards of equity
instruments, based on the grant date fair value of those awards. The Company estimates the fair value of stock
option awards on the date of grant utilizing a modified Black-Scholes option pricing model. The Black-Scholes
option valuation model was developed for use in estimating the fair value of short-term traded options that have
no vesting restrictions and are fully transferable. However, certain assumptions used in the Black-Scholes model,
such as expected term, can be adjusted to incorporate the unique characteristics of the Company’s stock option
awards. Option valuation models require the input of somewhat subjective assumptions including expected stock
price volatility and expected term. In estimating expected stock price volatility at the time of a particular stock
option grant, the Company relies on observations of historical volatility trends, implied future volatility
observations as determined by independent third parties, and implied volatility from traded options on the
Company’s stock. For 2009, 2008, and 2007 option grants, the Company has consistently utilized a weighted-
average approach that calculates expected volatility using two-thirds implied volatility and one-third historical
volatility. In determining the expected term of the option grants, the Company has observed the actual terms of
prior grants with similar characteristics, the actual vesting schedule of the grant, and has assessed the expected
risk tolerance of different optionee groups.
Other assumptions required for estimating fair value with the Black-Scholes model are the expected risk-
free interest rate and expected dividend yield of the Company’s stock. The risk-free interest rates used were
actual U.S. Treasury zero-coupon rates for bonds matching the expected term of the option on the date of grant.
The expected dividend yield of the 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.
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