Southwest Airlines 2003 Annual Report Download - page 54

As required, the pro forma disclosures above include options granted since January 1, 1995. Consequently,
the effects of applying SFAS 123 for providing pro forma disclosures may not be representative of the effects
on reported net income for future years until all options outstanding are included in the pro forma
disclosures. For purposes of pro forma disclosures, the estimated fair value of stock-based compensation
plans and other options is amortized to expense primarily over the vesting period. See Note 13 for further
discussion of the Company’s stock-based Employee compensation.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition
and Disclosure”. SFAS No. 148 amends the transition and disclosure provisions of SFAS No. 123. Among
other items, SFAS 148 allows companies adopting SFAS 123 to utilize one of three alternative transition
methods, one of which was a “prospective method”, as defined, that was only available if adopted during
2003. To date, the Company has not adopted SFAS 123 utilizing any of the transition methods of SFAS 148.
The FASB currently is working on a project to develop a new standard for accounting for stock-based
compensation. Tentative decisions by the FASB indicate that expensing of stock options will be required
beginning January 1, 2005. The FASB expects to issue an exposure draft, which will be subject to public
comment, in first quarter 2004 and issue its final standard in the second half of 2004. See Note 13 for further
information on the Company’s stock-based compensation plans.
FINANCIAL DERIVATIVE INSTRUMENTS On January 1, 2001, the Company adopted Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities", as amended, which governs the way it accounts for financial derivative instruments. The Company
utilizes various derivative instruments, including both crude oil and heating oil-based derivatives, to hedge a
portion of its exposure to jet fuel price increases. These instruments consist primarily of purchased call options,
collar structures, and fixed price swap agreements. The Company has also entered into interest rate swap
agreements to convert a portion of its fixed-rate debt to floating rates.
Since the majority of the Company’s financial derivative instruments are not traded on a market exchange,
the Company estimates their fair values. Depending on the type of instrument, the values are 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. Also, since there is not a reliable forward market for jet fuel,
the Company must estimate the future prices of jet fuel in order to measure the effectiveness of the hedging
instruments in offsetting changes to those prices, as required by SFAS 133. Forward jet fuel prices are
estimated through the observation of similar commodity futures prices (such as crude oil and heating oil) and
adjusted based on historical variations to those like commodities. See Notes 2 and 10 for further information
on SFAS 133 and financial derivative instruments.
(In millions, except per share amounts) 2003 2002 2001
Net income, as reported 442$ 241$ 511$
Add: Stock-based Employee compensation
expense included in reported income,
net of related tax effects - - -
Deduct: Total stock-based Employee
compensation expense determined under
fair value based methods for all awards,
net of related tax effects (57) (53) (25
)
Pro forma net income 385$ 188$ 486$
Net income per share
Basic, as reported .56$ .31$ .67$
Basic, pro forma .49$ .24$ .64$
Diluted, as reported .54$ .30$ .63$
Diluted, pro forma .48$ .23$ .61$