Southwest Airlines 2007 Annual Report Download - page 52

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 vest-
ing conditions, as defined.
As of December 31, 2007, the Company had
$37 million in remaining unrecognized compensation
cost related to past grants of stock options, which is
expected to be recognized over a weighted-average period
of 2.25 years. The total recognition period for the
remaining unrecognized compensation cost was approx-
imately eight years; however, the majority of this cost will
be recognized over the next two years, in accordance with
vesting provisions. The majority of the $37 million in
share-based compensation expense reflected in the Con-
solidated Statement of Income for the year ended Decem-
ber 31, 2007, was related to options granted prior to the
adoption of SFAS 123R. Based on Employee stock
options expected to vest during 2008, and the Company’s
expectation of future grants, the Company expects the
expense related to share-based compensation to once
again decrease during 2008 compared to 2007 expense.
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.
Recent Accounting Developments
In September 2006, the FASB issued statement
No. 157, “Fair Value Measurements”,(SFAS 157).
SFAS 157 defines fair value, establishes a framework
for measuring fair value in accordance with accounting
principles generally accepted in the United States, and
expands disclosures about fair value measurements. The
Company is subject to the provisions of SFAS 157 begin-
ning January 1, 2008. The Company has not yet deter-
mined whether SFAS 157 will have a material impact on
its financial condition, results of operations, or cash flow.
However, the Company believes it will likely be required
to provide additional disclosures as part of future financial
statements, beginning with first quarter 2008.
In February 2007, the FASB issued Statement
No. 159, “The Fair Value Option for Financial Assets
and Financial Liabilities” (Statement 159). Statement
159 allows entities the option to measure eligible finan-
cial instruments at fair value as of specified dates. Such
election, which may be applied on an instrument by
instrument basis, is typically irrevocable once elected.
Statement 159 is effective for fiscal years beginning after
November 15, 2007. The Company does not believe
Statement 159 will result in a material adverse effect
on its financial condition, results of operations, or cash
flow.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk
Southwest has interest rate risk in its floating rate
debt obligations and interest rate swaps, and has com-
modity price risk in jet fuel required to operate its aircraft
fleet. The Company purchases jet fuel at prevailing mar-
ket prices, but seeks to manage market risk through
execution of a documented hedging strategy. Southwest
has market sensitive instruments in the form of fixed rate
debt instruments and financial derivative instruments
used to hedge its exposure to jet fuel price increases.
The Company also operates 95 aircraft under operating
and capital leases. However, leases are not considered
market sensitive financial instruments and, therefore, are
not included in the interest rate sensitivity analysis below.
Commitments related to leases are disclosed in Note 8 to
the Consolidated Financial Statements. The Company
does not purchase or hold any derivative financial instru-
ments for trading purposes. See Note 10 to the Consol-
idated Financial Statements for information on the
Company’s accounting for its hedging program and for
further details on the Company’s financial derivative
instruments.
Fuel Hedging
The Company utilizes financial derivative instru-
ments, on both a short-term and a long-term basis, as a
form of insurance against significant increases in fuel
prices. The Company believes there is significant risk in
not hedging against the possibility of such fuel price
increases. The Company expects to consume approxi-
mately 1.5 billion gallons of jet fuel in 2008. Based on this
usage, a change in jet fuel prices of just one cent per gallon
would impact the Company’s “Fuel and oil expense” by
approximately $15 million per year, excluding any impact
of the Company’s derivative instruments.
The fair values of outstanding financial derivative
instruments related to the Company’s jet fuel market
price risk at December 31, 2007, were net assets of
$2.4 billion. The current portion of these financial deriv-
ative instruments, or $1.1 billion, is classified as “Fuel
derivative contracts” in the Consolidated Balance Sheet.
The long-term portion of these financial derivative
instruments, or $1.3 billion, is included in “Other assets.”
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