Southwest Airlines 2002 Annual Report Download - page 46

SOUTHWEST AIRLINES CO. 2002 10-K | 27
derivative instruments, depending on the type of
instrument, were determined by use of present
value methods or standard option value models
with assumptions about commodity prices based
on those observed in underlying markets. An
immediate ten percent increase or decrease in
underlying fuel-related commodity prices from the
December 31, 2002, prices would correspond-
ingly change the fair value of the commodity
derivative instruments in place by approximately
$135 million. Changes in the related commodity
derivative instrument cash flows may change by
more or less than this amount based upon
further fluctuations in futures prices as well as
related income tax effects. This sensitivity
analysis uses industry standard valuation models
and holds all inputs constant at December 31,
2002, levels, except underlying futures prices.
Financial market risk
Airline operators are inherently capital
intensive as the vast majority of the Company’s
assets are expensive aircraft, which are long-
lived. The Company’s strategy is to capitalize
conservatively and grow capacity steadily and
profitably. While the Company uses financial
leverage, it has maintained a strong balance
sheet and an “A” credit rating on its senior
unsecured fixed-rate debt with Standard & Poor’s
and Fitch ratings agencies, and a “Baa1” credit
rating with Moody’s rating agency. The
Company’s Aircraft Secured Notes and French
Credit Agreements do not give rise to significant
fair value risk but do give rise to interest rate risk
because these borrowings are floating-rate debt.
Although there is interest rate risk associated
with these secured borrowings, the risk is
somewhat mitigated by the fact that the
Company may prepay this debt on any of the
semi-annual principal and interest payment
dates. See Note 6 and Note 7 to the
Consolidated Financial Statements for more
information on the material terms of the
Company’s short-term and long-term debt.
As disclosed in Note 7 to the Consolidated
Financial Statements, the Company had
outstanding senior unsecured notes totaling
$785 million at December 31, 2002. In addition,
as disclosed in Note 7, the Company had
outstanding long-term fixed-rate debt totaling
$585.7 million in the form of Pass-Through
Certificates (Certificates), which are secured by
aircraft the Company owns. The total of the
Company’s long-term unsecured notes repre-
sented 11.7 percent of total noncurrent assets at
December 31, 2002. The unsecured long-term
debt currently has a weighted-average maturity of
8.2 years at fixed rates averaging 7.3 percent at
December 31, 2002, which is comparable to
average rates prevailing for similar debt instru-
ments over the last ten years. The Certificates
bear interest at a combined weighted-average
rate of 5.5 percent. The Company does not have
significant exposure to changing interest rates on
its unsecured long-term debt or its Certificates
because the interest rates are fixed and the
financial leverage is modest.
The Company also has some risk associated
with changing interest rates due to the short-term
nature of its invested cash, which was
$1.82 billion at December 31, 2002. The
Company invests available cash in certificates of
deposit, highly rated money markets, and invest-
ment grade commercial paper that generally have
maturities of three months or less; therefore, the
returns earned on these investments parallel
closely with floating interest rates. The Company
has not undertaken any additional actions to
cover interest rate market risk and is not a party
to any other material market interest rate risk
management activities.
A hypothetical ten percent change in market
interest rates as of December 31, 2002, would
not have a material effect on the fair value of the
Company’s fixed-rate debt instruments. See
Note 9 to the Consolidated Financial Statements
for further information on the fair value of the
Company’s financial instruments. A change in
market interest rates could, however, have a
corresponding effect on the Company’s earnings
and cash flows associated with its Aircraft
Secured Notes, French Credit Agreements, and
invested cash because of the floating-rate nature