Southwest Airlines 2004 Annual Report Download - page 53

SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)
options. However, the amount of operating cash Öows and unleaded gasoline) and adjusted based on historical
recognized in prior periods for such excess tax deduc- variations to those like commodities. See Note 10 for
tions, as shown in the Company's Consolidated State- further information on SFAS 133 and Ñnancial deriva-
ment of Cash Flows, were $35 million, $41 million, and tive instruments.
$38 million, respectively, for 2004, 2003, and 2002. Income Taxes. The Company accounts for de-
The Company currently expects to adopt ferred income taxes utilizing Statement of Financial
SFAS 123R eÅective July 1, 2005; however, the Com- Accounting Standards No. 109 (SFAS 109), ""Ac-
pany has not yet determined which of the aforemen- counting for Income Taxes'', as amended. SFAS 109
tioned adoption methods it will use. Subject to a requires an asset and liability method, whereby deferred
complete review of the requirements of SFAS 123R, tax assets and liabilities are recognized based on the tax
based on stock options granted to Employees through eÅects of temporary diÅerences between the Ñnancial
December 31, 2004, and stock options expected to be statements and the tax bases of assets and liabilities, as
granted during 2005, the Company expects that the measured by current enacted tax rates. When appropri-
adoption of SFAS 123R on July 1, 2005, would reduce ate, in accordance with SFAS 109, the Company evalu-
both third quarter 2005 and fourth quarter 2005 net ates the need for a valuation allowance to reduce
earnings by approximately $10 million ($.01 per share, deferred tax assets.
diluted) each. See Note 13 for further information on
the Company's stock-based compensation plans. 2. Acquisition of Certain Assets
Financial Derivative Instruments. The Company In fourth quarter 2004, Southwest was selected as
accounts for Ñnancial derivative instruments utilizing the winning bidder at a bankruptcy-court approved
Statement of Financial Accounting Standards No. 133 auction for certain ATA Airlines, Inc. (ATA) assets.
(SFAS 133), ""Accounting for Derivative Instruments As part of the transaction, which was approved in
and Hedging Activities'', as amended. The Company December 2004, Southwest agreed to pay $40 million
utilizes various derivative instruments, including both for certain ATA assets, consisting of the rights to six of
crude oil and heating oil-based derivatives, to hedge a ATA's leased Chicago Midway Airport gates and the
portion of its exposure to jet fuel price increases. These rights to a leased aircraft maintenance hangar at Chi-
instruments primarily consist of purchased call options, cago Midway Airport. An initial payment of $34 mil-
collar structures, and Ñxed-price swap agreements, and lion in December 2004 is classiÑed as an intangible
are accounted for as cash-Öow hedges, as deÑned by asset and is included in ""Other assets'' in the Consoli-
SFAS 133. The Company has also entered into interest dated Balance Sheet. In addition, Southwest provided
rate swap agreements to convert a portion of its Ñxed- ATA with $40 million in debtor-in-possession Ñnanc-
rate debt to Öoating rates. These interest rate hedges are ing while ATA remains in bankruptcy, and has also
accounted for as fair value hedges, as deÑned by guaranteed the repayment of an ATA construction loan
SFAS 133. to the City of Chicago for $7 million. The $40 million
debtor-in-possession Ñnancing, which will mature no
Since the majority of the Company's Ñnancial later than September 30, 2005, is classiÑed as ""Ac-
derivative instruments are not traded on a market ex- counts and other receivables'' in the Consolidated Bal-
change, the Company estimates their fair values. De- ance Sheet, and the estimated fair value of the
pending on the type of instrument, the values are Company's guarantee of the ATA construction loan,
determined by the use of present value methods or which is not material, is classiÑed as part of ""Other
standard option value models with assumptions about deferred liabilities''. The debtor-in-possession Ñnancing
commodity prices based on those observed in underlying bears interest at a rate equal to the higher of 8 percent
markets. Also, since there is not a reliable forward or LIBOR plus 5 percent, and interest is payable to
market for jet fuel, the Company must estimate the Southwest monthly.
future prices of jet fuel in order to measure the eÅective-
ness of the hedging instruments in oÅsetting changes to Southwest and ATA also agreed on a code share
those prices, as required by SFAS 133. Forward jet fuel arrangement, which was approved by the Department of
prices are estimated through the observation of similar Transportation in January 2005. Under the agreement,
commodity futures prices (such as crude oil, heating oil, each carrier can exchange passengers on certain desig-
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