Southwest Airlines 2003 Annual Report Download - page 60

9. CONSOLIDATION OF RESERVATIONS CENTERS
In November 2003, the Company announced the consolidation of its nine Reservations Centers into six,
effective February 28, 2004. This decision was made in response to the established shift by Customers to the
internet as a preferred way of booking travel. The Company’s website, www.southwest.com, is now
responsible for more than half of ticket bookings and, as a consequence, demand for phone contact has
dramatically decreased. The Company will close its Reservations Centers located in Dallas, Texas, Salt Lake
City, Utah, and Little Rock, Arkansas. The Company is giving the 1,900 affected Employees at these
locations the opportunity to relocate to another of the Company’s remaining six centers. As of mid-January
2004, approximately 55 percent of these Employees had notified the Company that they would not relocate.
Employees choosing to not relocate have been offered support packages, which include severance pay, flight
benefits, medical coverage, and job-search assistance, depending on length of service with the Company.
The costs associated with this decision, primarily related to Employee severance packages and relocation
expenses, will be recognized primarily in first quarter 2004, in accordance with SFAS 146.
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 in 2003, 2002, and 2001 represented
approximately 15.2, 14.9 percent, and 15.6 percent of Southwest’s operating expenses, respectively. The
Company endeavors to acquire jet fuel at the lowest possible cost. Because jet fuel is not traded on an
organized futures exchange, liquidity for hedging is limited. However, the Company has found that both
crude oil and heating oil contracts are effective commodities for hedging jet fuel. The Company has
financial derivative instruments in the form of the types of hedges it utilizes to decrease its exposure to jet
fuel price increases. The Company does not purchase or hold any derivative financial instruments for trading
purposes.
The Company utilizes financial derivative instruments for both short-term and long-term time frames when it
appears the Company can take advantage of market conditions. As of December 31, 2003, the Company had
a mixture of purchased call options, collar structures, and fixed price swap agreements in place to hedge
approximately 82 percent of its 2004 total anticipated jet fuel requirements, approximately 60 percent of its
2005 total anticipated jet fuel requirements, and portions of its 2006-2007 total anticipated jet fuel
requirements. As of December 31, 2003, the majority of the Company's first quarter 2004 hedges are
effectively heating oil-based positions in the form of option contracts. The majority of the remaining hedge
positions are crude oil-based positions.
During 2003, 2002, and 2001, the Company recognized gains in "Fuel and oil" expense of $171 million, $45
million, and $80 million, respectively, from hedging activities. At December 31, 2003 and 2002,
approximately $19 million and $13 million, respectively, due from third parties from expired derivative
contracts, is included in "Accounts and other receivables" in the accompanying Consolidated Balance Sheet.
The Company accounts for its fuel hedge derivative instruments as cash flow hedges, as defined. Therefore,
all changes in fair value that are considered to be effective are recorded in "Accumulated other
comprehensive income (loss)" until the underlying jet fuel is consumed. The fair value of the Company's
financial derivative instruments at December 31, 2003, was a net asset of approximately $251 million. The
current portion of these financial derivative instruments is classified as "Fuel hedge contracts" and the long-
term portion is classified as "Other assets" in the Consolidated Balance Sheet. The fair value of the
derivative instruments, depending on the type of instrument, was 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.
As of December 31, 2003, the Company had approximately $123 million in unrealized gains, net of tax, in
"Accumulated other comprehensive income (loss)" related to fuel hedges. Included in this total are
approximately $83 million in net unrealized gains that are expected to be realized in earnings during 2004.
Interest Rate Swaps - During second quarter 2003, the Company entered into interest rate swap agreements
relating to its $385 million 6.5% senior unsecured notes due March 1, 2012, and $375 million 5.496% Class
A-2 pass-through certificates due November 1, 2006. Under the first interest rate swap agreement, the
Company pays the London InterBank Offered Rate (LIBOR) plus a margin every six months and receives
6.5% every six months on a notional amount of $385 million until March 1, 2012. Under the second
agreement, the Company pays LIBOR plus a margin every six months and receives 5.496% every six months
on a notional amount of $375 million until November 1, 2006.