form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2011
 
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________

Commission File No. 1-7259
 

 
Southwest Airlines Co.
(Exact name of registrant as specified in its charter)

TEXAS
74-1563240
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
   
P.O. Box 36611, Dallas, Texas
75235-1611
(Address of principal executive offices)
(Zip Code)

Registrant's telephone number, including area code:  (214) 792-4000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes ¨ No þ
 
Number of shares of Common Stock outstanding as of the close of business on April 20, 2011: 747,958,666
 
 
 
 
 
 


 
 

 

 


TABLE OF CONTENTS TO FORM 10-Q
 
 
 
 

 

Part I- FINANCIAL INFORMATION
Item 1. Financial Statements
 
 
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. (Removed and Reserved)
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
EXHIBIT INDEX


 
 
 
 
 
 
 
 
 
 
 

 

 



SOUTHWEST AIRLINES CO.
FORM 10-Q
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Southwest Airlines Co.
Condensed Consolidated Balance Sheet
(in millions)
(unaudited)



 
 
 
   
 
 
 
 
March 31, 2011
   
December 31, 2010
 
ASSETS
 
 
   
 
 
Current assets:
 
 
   
 
 
Cash and cash equivalents
  $ 2,039     $ 1,261  
Short-term investments
    2,426       2,277  
Accounts and other receivables
    282       195  
Inventories of parts and supplies, at cost
    320       243  
Deferred income taxes
    -       214  
Prepaid expenses and other current assets
    262       89  
Total current assets
    5,329       4,279  
 
               
Property and equipment, at cost:
               
Flight equipment
    14,090       13,991  
Ground property and equipment
    2,153       2,122  
Deposits on flight equipment purchase contracts
    172       230  
 
    16,415       16,343  
Less allowance for depreciation and amortization
    5,919       5,765  
 
    10,496       10,578  
Other assets
    589       606  
 
  $ 16,414     $ 15,463  
 
               
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
  $ 916     $ 739  
Accrued liabilities
    827       863  
Air traffic liability
    1,710       1,198  
Current maturities of long-term debt
    905       505  
Total current liabilities
    4,358       3,305  
 
               
Long-term debt less current maturities
    2,428       2,875  
Deferred income taxes
    2,496       2,493  
Deferred gains from sale and leaseback of aircraft
    85       88  
Other non-current liabilities
    460       465  
Stockholders' equity:
               
Common stock
    808       808  
Capital in excess of par value
    1,186       1,183  
Retained earnings
    5,399       5,399  
Accumulated other comprehensive income (loss)
    79       (262 )
Treasury stock, at cost
    (885 )     (891 )
Total stockholders' equity
    6,587       6,237  
 
  $ 16,414     $ 15,463  
 
               
                 
See accompanying notes.
               
 
 
 
 

 

 


 
Southwest Airlines Co.
Condensed Consolidated Statement of Operations
(in millions, except per share amounts)
(unaudited)

 

 
 
 
Three months ended March 31,
 
 
 
2011
   
2010
 
 
 
 
   
 
 
OPERATING REVENUES:
 
 
   
 
 
Passenger
  $ 2,939     $ 2,495  
Freight
    31       30  
Other
    133       105  
Total operating revenues
    3,103       2,630  
 
               
OPERATING EXPENSES:
               
Salaries, wages, and benefits
    954       864  
Fuel and oil
    1,038       821  
Maintenance materials and repairs
    199       166  
Aircraft rentals
    46       47  
Landing fees and other rentals
    201       190  
Depreciation and amortization
    155       154  
Other operating expenses
    396       334  
Total operating expenses
    2,989       2,576  
 
               
OPERATING INCOME
    114       54  
 
               
OTHER EXPENSES (INCOME):
               
Interest expense
    43       41  
Capitalized interest
    (3 )     (5 )
Interest income
    (3 )     (3 )
Other (gains) losses, net
    59       4  
Total other expenses
    96       37  
 
               
INCOME BEFORE INCOME TAXES
    18       17  
PROVISION FOR INCOME TAXES
    13       6  
 
               
NET INCOME
  $ 5     $ 11  
 
               
 
               
NET INCOME PER SHARE, BASIC
  $ 0.01     $ 0.01  
 
               
NET INCOME PER SHARE, DILUTED
  $ 0.01     $ 0.01  
 
               
WEIGHTED AVERAGE SHARES
               
OUTSTANDING:
               
Basic
    748       743  
Diluted
    749       744  
 
               
Cash dividends declared per common share
  $ 0.0045     $ 0.0045  
 
               
                 
See accompanying notes.
 
 
 
 
 

 
 

 



Southwest Airlines Co.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)



 
     
 
 
Three months ended March 31,
 
 
 
2011
   
2010
 
 
 
 
   
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
   
 
 
Net income
  $ 5     $ 11  
Adjustments to reconcile net income to
               
cash provided by operating activities:
               
Depreciation and amortization
    155       154  
Unrealized loss on fuel derivative instruments
    10       21  
Deferred income taxes
    28       12  
Amortization of deferred gains on sale and
               
leaseback of aircraft
    (3 )     (3 )
Changes in certain assets and liabilities:
               
Accounts and other receivables
    (87 )     (67 )
Other current assets
    (92 )     (18 )
Accounts payable and accrued liabilities
    238       (85 )
Air traffic liability
    512       356  
Cash collateral received from fuel
               
derivative counterparties
    29       5  
Other, net
    170       (13 )
Net cash provided by operating activities
    965       373  
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of property and equipment, net
    (57 )     (139 )
Purchases of short-term investments
    (1,484 )     (1,380 )
Proceeds from sales of short-term investments
    1,310       1,197  
Net cash used in investing activities
    (231 )     (322 )
 
               
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from Employee stock plans
    4       12  
Proceeds from termination of interest rate derivatives
    76       -  
Payments of long-term debt and capital lease obligations
    (30 )     (60 )
Payments of cash dividends
    (7 )     (7 )
Other, net
    1       -  
Net cash provided by (used in) financing activities
    44       (55 )
 
               
NET CHANGE IN CASH AND CASH EQUIVALENTS
    778       (4 )
 
               
CASH AND CASH EQUIVALENTS AT
               
BEGINNING OF PERIOD
    1,261       1,114  
 
               
CASH AND CASH EQUIVALENTS
               
AT END OF PERIOD
  $ 2,039     $ 1,110  
 
               
CASH PAYMENTS FOR:
 
 
   
 
 
Interest, net of amount capitalized
  $ 34     $ 34  
Income taxes
  $ -     $ -  
 
               
                 
See accompanying notes.
 
 
 
 
 
 

 

 



Southwest Airlines Co.
Notes to Condensed Consolidated Financial Statements
(unaudited)


1.    BASIS OF PRESENTATION

The accompanying unaudited Condensed Consolidated Financial Statements of Southwest Airlines Co. (the “Company” or “Southwest”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  The unaudited Condensed Consolidated Financial Statements for the interim periods ended March 31, 2011 and 2010 include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods.  This includes all normal and recurring adjustments, but does not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements.  Financial results for the Company and airlines in general can be seasonal in nature.  In many years, the Company’s revenues, as well as its operating income and net income, have been better in its second and third fiscal quarters than in its first and fourth fiscal quarters.  Air travel is also significantly impacted by general economic conditions, the amount of disposable income available to consumers, unemployment levels, and corporate travel budgets.  These and other factors, such as the price of jet fuel in some periods, the nature of the Company’s fuel hedging program, the periodic volatility of commodities used by the Company for hedging jet fuel, and the requirements related to hedge accounting, have created, and may continue to create, significant volatility in the Company’s results in certain fiscal periods.  See Note 5 for further information on fuel and the Company’s hedging program. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011.  For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Southwest Airlines Co. Annual Report on Form 10-K for the year ended December 31, 2010.

2.    MERGER AND RELATED MATTERS
 
On September 26, 2010, the Company, AirTran Holdings, Inc. ("AirTran"), and Guadalupe Holdings Corp. ("Merger Sub") entered into an Agreement and Plan of Merger (the "Merger Agreement"), providing for the acquisition of AirTran by the Company. The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub, a wholly owned subsidiary of the Company formed for the sole purpose of effecting the merger, will be merged with and into AirTran, with AirTran continuing as the surviving corporation and as a wholly owned subsidiary of the Company (the "Merger"). Immediately following the effective time of the Merger, AirTran will merge with and into a wholly owned limited liability company subsidiary of the Company. The Company has announced that it expects the closing date of the merger to be May 2, 2011.
 
Subject to the terms and conditions of the Merger Agreement, which has been approved by the AirTran stockholders, if the Merger is completed, each outstanding share of AirTran common stock will be converted into the right to receive 0.321 shares of Southwest Airlines Co. common stock, which exchange ratio may be adjusted as discussed below, and $3.75 in cash, without interest. If the average closing price of Southwest common stock for the 20 consecutive trading day period ending on (and including) the third trading day prior to the closing of the Merger (the "Southwest Average Share Price") is greater than $12.46, then the exchange ratio will be adjusted to equal $4.00 divided by the Southwest Average Share Price, rounded to the nearest thousandth. If the Southwest Average Share Price is less than $10.90, then, subject to the next sentence, the exchange ratio will be adjusted to equal $3.50 divided by the Southwest Average Share Price, rounded to the nearest thousandth. If the Southwest Average Share Price is less than $10.90, the Company must deliver, at its election, an additional amount of cash, an additional number (or fraction) of shares of Southwest common stock, or a combination of both, such that, after giving effect to such election, the aggregate value of the Merger consideration is equal to $7.25. The exchange ratio adjustment mechanism provides at least $7.25 in value and up to $7.75 in value (based on the Southwest Average Share Price) per share of AirTran common stock.
 
 
 
 
 
 
 

 
 
 
 
Completion of the Merger is subject to certain conditions, including, among others: (i) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (ii) receipt of any other material governmental consents and approvals required to consummate the Merger, (iii) the absence of any governmental order, law, or legal restraint prohibiting the consummation of the Merger, and (iv) authorization of the listing on the New York Stock Exchange of the shares of Southwest common stock to be issued to AirTran stockholders pursuant to the Merger. The obligation of each party to consummate the Merger is also conditioned upon the accuracy of the other party's representations and warranties and the other party having performed in all material respects its obligations under the Merger Agreement.
 
The Company and AirTran may mutually agree to terminate the Merger Agreement at any time prior to the effectiveness of the Merger. In addition, either party may terminate the Merger Agreement (i) if the Merger is not consummated on or before September 26, 2011 (subject to extension by mutual agreement of the parties) or (ii) for certain other reasons, as set forth in the Merger Agreement.
 
The foregoing description of the Merger Agreement is only a summary, does not purport to be complete and is qualified in its entirety by reference to the Merger Agreement, which is attached as Exhibit 2.1 to the Company's Current Report on Form 8-K as filed with the Securities and Exchange Commission (the “SEC”) on September 27, 2010.
 
The Company is expected to incur substantial integration and transition expenses in connection with the Merger, including the necessary costs associated with integrating the operations of the two companies. While the Company has assumed that a certain level of expenses would be incurred, there are many factors that could affect the total amount or the timing of the expenses, and many of the expenses that will be incurred are, by their nature, difficult to estimate. These expenses could, particularly in the near term, result in the Company taking significant charges against earnings following the completion of the Merger. The amount and timing of such charges are currently uncertain.
 
3.    ACCOUNTING CHANGES AND NEW ACCOUNTING PRONOUNCEMENTS
 
On September 23, 2009, the Financial Accounting Standards Board (“FASB”) ratified Accounting Standards Update (“ASU”)  No. 2009-13 (formerly referred to as Emerging Issues Task Force Issue No. 08-1), “Revenue Arrangements with Multiple Deliverables.”  ASU No. 2009-13 requires the allocation of consideration among separately identified deliverables contained within an arrangement, based on their relative selling prices.  The Company utilizes current accounting guidance, also titled “Revenue Arrangements with Multiple Deliverables,” in the timing of recognition of revenue associated with the sale of frequent flyer credits to business partners.  The Company applies the residual method, which is allowed with respect to the Company’s revenue arrangements in their current form, but which will be prohibited under ASU No. 2009-13 with respect to new and modified revenue arrangements.  ASU No. 2009-13 is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after January 1, 2011. Subsequent to adoption of ASU No. 2009-13, the Company has not entered into or materially modified any of its revenue arrangements, thus ASU No. 2009-13 currently has no impact on the Company. However, ASU No. 2009-13 could have a significant impact on future results as new or materially modified revenue arrangements with certain partners are established in the normal course of business.
 
In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements” an amendment to Accounting Standards Codification Topic 820, “Fair Value Measurements and Disclosures.”  This amendment requires an entity to: (i) disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and (ii) present separate information for Level 3 activity pertaining to gross purchases, sales, issuances, and settlements.  ASU No. 2010-06 is effective for the Company for interim and annual reporting periods beginning after December 15, 2009, with one new disclosure effective after December 15, 2010. The Company early adopted this ASU in full at the interim period ended March 31, 2010.  See Note 10.
 

 
 

 
 
 
 
4.    NET INCOME PER SHARE

The following table sets forth the computation of basic and diluted net income per share (in millions except per share amounts):


 
 
Three months ended
 
 
 
March 31,
 
 
 
2011
   
2010
 
 
 
 
   
 
 
NUMERATOR:
 
 
   
 
 
Net income
  $ 5     $ 11  
 
               
DENOMINATOR:
               
Weighted-average shares
               
outstanding, basic
    748       743  
Dilutive effect of Employee stock
               
options
    1       1  
Adjusted weighted-average shares
               
outstanding, diluted
    749       744  
 
               
NET INCOME PER SHARE:
               
Basic
  $ 0.01     $ 0.01  
 
               
Diluted
  $ 0.01     $ 0.01  
 
               
Antidilutive stock options
               
excluded from calculations
    47       75  
 
               
 
               
 
 
 
 
 
 
 
 
 
 

 
 

 
5.    FINANCIAL DERIVATIVE INSTRUMENTS

Fuel Contracts

Airline operators are inherently dependent upon energy to operate and, therefore, are impacted by changes in jet fuel prices.  Furthermore, jet fuel and oil typically represent one of the largest operating expenses for airlines.  The Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses through its fuel hedging program.  Because jet fuel is not widely traded on an organized futures exchange, there are limited opportunities to hedge directly in jet fuel.  However, the Company has found that financial derivative instruments in other commodities, such as crude oil, and refined products, such as heating oil and unleaded gasoline, can be useful in decreasing its exposure to jet fuel price volatility.  The Company does not purchase or hold any financial derivative instruments for trading purposes.

The Company has used financial derivative instruments for both short-term and long-term time frames, and typically uses a mixture of purchased call options, collar structures (which include both a purchased call option and a sold put option), call spreads (which include a purchased call option and a sold call option), and fixed price swap agreements in its portfolio.

The Company evaluates its hedge volumes strictly from an “economic” standpoint and thus does not consider whether the hedges qualified or will qualify for hedge accounting.  The Company defines its “economic” hedge as the net volume of fuel derivative contracts held, including the impact of positions that have been offset through sold positions, regardless of whether those contracts qualify for hedge accounting.  For first quarter 2011, the Company had fuel derivatives in place related to approximately 40 percent of its fuel consumption.  As of March 31, 2011, the Company had fuel derivative instruments in place to provide coverage on a large portion of its remaining 2011 estimated fuel consumption at varying price levels.  The following table provides information about the Company’s volume of fuel hedging for 2011 (including first quarter actuals), as well as the years 2012 through 2014.

 
 
Fuel hedged as
 
 
of March 31, 2011
Period (by year)
 
(gallons in millions)
2011 
 
 626 
2012 
 
 470 
2013 
 
 554 
2014 
 
 458 
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
 
 
 
 
Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges.  All derivatives designated as hedges that meet certain requirements are granted hedge accounting treatment.  Generally, utilizing hedge accounting, all periodic changes in fair value of the derivatives designated as hedges that are considered to be effective are recorded in Accumulated other comprehensive income (loss) (“AOCI”) until the underlying jet fuel is consumed.  See Note 6.  The Company is exposed to the risk that periodic changes will not be effective, as defined, or that the derivatives will no longer qualify for hedge accounting.  Ineffectiveness results when the change in the fair value of the derivative instrument exceeds the change in the value of the Company’s expected future cash outlay to purchase and consume jet fuel.  To the extent that the periodic changes in the fair value of the derivatives are ineffective, the ineffective portion is recorded to Other (gains) losses, net in the statement of operations.  Likewise, if a hedge ceases to qualify for hedge accounting, any change in the fair value of derivative instruments since the last period is recorded to Other (gains) losses, net in the statement of operations in the period of the change; however, any amounts previously recorded to AOCI would remain there until such time as the original forecasted transaction occurs, at which time these amounts would be reclassified to Fuel and oil expense.  When the Company has sold derivative positions in order to effectively “close” or offset a derivative already held as part of its fuel derivative instrument portfolio, any subsequent changes in fair value of those positions are marked to market through earnings.  Likewise, any changes in fair value of those positions that were offset by entering into the sold positions are concurrently marked to market through earnings.  However, any changes in value related to hedges that were deferred as part of AOCI while designated as a hedge would remain until the originally forecasted transaction occurs.  In a situation where it becomes probable that a hedged forecasted transaction will not occur, any gains and/or losses that have been recorded to AOCI would be required to be immediately reclassified into earnings.  The Company did not have any such situations occur during 2010 or first quarter 2011.

Ineffectiveness is inherent in hedging jet fuel with derivative positions based in other crude oil related commodities.  Due to the volatility in markets for crude oil and related products, the Company is unable to predict the amount of ineffectiveness each period, including the loss of hedge accounting, which could be determined on a derivative by derivative basis or in the aggregate for a specific commodity.  This may result, and has resulted, in increased volatility in the Company’s financial results.  However, even though derivatives may not qualify for hedge accounting, the Company continues to hold the instruments as management believes derivative instruments continue to afford the Company the opportunity to stabilize jet fuel costs.

Accounting pronouncements pertaining to derivative instruments and hedging are complex with stringent requirements, including the documentation of a Company hedging strategy, statistical analysis to qualify a commodity for hedge accounting both on a historical and a prospective basis, and strict contemporaneous documentation that is required at the time each hedge is designated by the Company.  As required, the Company assesses the effectiveness of each of its individual hedges on a quarterly basis.  The Company also examines the effectiveness of its entire hedging program on a quarterly basis utilizing statistical analysis.  This analysis involves utilizing regression and other statistical analyses that compare changes in the price of jet fuel to changes in the prices of the commodities used for hedging purposes.
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
10 

 
 

 
All cash flows associated with purchasing and selling fuel derivatives are classified as Other operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows.  See Note 5 for additional information.  The following table presents the location of all assets and liabilities associated with the Company’s hedging instruments within the unaudited Condensed Consolidated Balance Sheet:
 
 
 
 
Asset Derivatives
   
Liability Derivatives
 
 
Balance Sheet
 
Fair Value at
   
Fair Value at
   
Fair Value at
   
Fair Value at
 
(in millions)
 Location
 
03/31/11
   
12/31/10
   
03/31/11
   
12/31/10
 
 
 
 
 
   
 
   
 
   
 
 
Derivatives designated as hedges
 
 
 
   
 
   
 
   
 
 
Fuel derivative contracts (gross)*
Other current assets
  $ 352     $ 151     $ 59     $ 16  
Fuel derivative contracts (gross)*
Other Assets
    868       547       128       88  
Fuel derivative contracts (gross)*
Accrued liabilities
    105       122       -       18  
Fuel derivative contracts (gross)*
Other noncurrent liabilities
    30       71       2       9  
Interest rate derivative contracts
Other assets
    23       73       -       -  
Interest rate derivative contracts
Other noncurrent liabilities
    12       -       45       4  
 
 
                               
Total derivatives designated as hedges
 
  $ 1,390     $ 964     $ 234     $ 135  
 
 
                               
Derivatives not designated as hedges
 
                               
Fuel derivative contracts (gross)*
Other current assets
  $ 432     $ 164     $ 505     $ 284  
Fuel derivative contracts (gross)*
Other assets
    332       212       619       304  
Fuel derivative contracts (gross)*
Accrued liabilities
    16       40       233       222  
Fuel derivative contracts (gross)*
Other noncurrent liabilities
    9       33       142       257  
 
 
                               
Total derivatives not designated as hedges
 
  $ 789     $ 449     $ 1,499     $ 1,067  
 
 
                               
Total derivatives
 
  $ 2,179     $ 1,413     $ 1,733     $ 1,202  
 
 
                               
* Represents the position of each trade before consideration of offsetting positions with each counterparty and does not include the impact of cash collateral deposits provided to or received from counterparties. See discussion of credit risk and collateral following in this Note.
 
   

 
 
 
 
 
 
 
 
 
 
 
11 

 
 
 
 
In addition, the Company also had the following amounts associated with fuel derivative instruments and hedging activities in its unaudited Condensed Consolidated Balance Sheet:
 
 
Balance Sheet
 
March 31,
   
December 31,
 
(in millions)
Location
 
2011
   
2010
 
Cash collateral deposits provided
Offset against Other
 
 
   
 
 
to counterparty - noncurrent
noncurrent liabilities
  $ 105     $ 125  
Cash collateral deposits provided
Offset against Accrued
               
to counterparty - current
liabilities
    119       -  
Cash collateral deposits held from
Offset against Other
               
counterparty - noncurrent
Assets
    141       60  
Cash collateral deposits held from
Offset against Other
               
counterparty - current
Current Assets
    47       -  
Due to third parties for settled fuel contracts
Accrued liabilities
    3       -  
Receivable from third parties for settled
Accounts and other
               
fuel contracts
receivables
    -       1  
Net unrealized (gains) losses from fuel
Accumulated other
               
hedges, net of tax
comprehensive (gain) loss
    (81 )     250  

The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Operations for the three months ended March 31, 2011 and 2010:

 
Derivatives in Cash Flow Hedging Relationships
 
 
(Gain) Loss
 
 
(Gain) Loss
 
(Gain) Loss
 
 
Recognized in AOCI on
 
 
Reclassified from AOCI
 
Recognized in Income
 
 
 Derivatives (effective
 
 
into Income (effective
 
on Derivatives
 
 
portion)
 
 
 portion)(a)
 
 
(ineffective portion) (b)
 
 
Three months ended
 
Three months ended
 
Three months ended
 
 
March 31,
 
March 31,
 
March 31,
(in millions)
2011 
 
2010 
 
2011 
 
2010 
 
2011 
 
2010
Fuel derivative
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
contracts
$
 (315)
*
$
 (16)
*
$
 16 
*
$
 75 
*
$
 34 
 
$
 (4)
Interest rate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
derivatives
 
 (7)
*
 
 1 
*
 
 - 
 
 
 - 
 
 
 - 
 
 
 - 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
 (322)
 
$
 (15)
 
$
 16 
 
$
 75 
 
$
 34 
 
$
 (4)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
*
Net of tax
(a)
Amounts related to fuel derivative contracts and interest rate derivatives are included in Fuel and oil and Interest expense, respectively.
(b)
Amounts are included in Other (gains) losses, net.
 
 
Derivatives not in Cash Flow Hedging Relationships
 
 
(Gain) Loss
 
 
 
 
Recognized in Income on
 
 
 
 
  Derivatives
 
 
 
 
Three months ended
 
Location of (Gain) Loss
 
 
March 31,
 
 Recognized in Income
(in millions)
 
2011 
 
2010 
 
on Derivatives
Fuel derivative contracts
 
$
 (5)
 
$
 (23)
 
Other (gains) losses, net

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during first quarter 2011 and first quarter 2010 of $31 million in each period.  These amounts are excluded from the Company’s measurement of effectiveness for related hedges and are included as a component of Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Operations.
 

 
 
12 

 
 
 
 
The fair values of the derivative instruments, depending on the type of instrument, were 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.  Included in the Company’s total net unrealized gains from fuel hedges as of March 31, 2011, were approximately $19 million in unrealized gains, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to March 31, 2011.  In addition, as of March 31, 2011, the Company had already recognized cumulative net losses due to ineffectiveness and derivatives that do not qualify for hedge accounting treatment totaling $67 million, net of taxes.  These net losses were recognized in first quarter 2011 and prior periods, and are reflected in Retained earnings as of March 31, 2011, but the underlying derivative instruments will not expire/settle until second quarter 2011 or future periods.

Interest rate swaps

The Company is party to certain interest rate swap agreements that are accounted for as either fair value hedges or cash flow hedges, as defined in the applicable accounting guidance for derivative instruments and hedging. The interest rate swap agreements accounted for as fair value hedges qualify for the “shortcut” method of accounting for hedges, which dictates that the hedges are assumed to be perfectly effective, and, thus, there is no ineffectiveness to be recorded in earnings.  For the Company’s interest rate swap agreements accounted for as cash flow hedges, ineffectiveness is required to be measured at each reporting period.  The ineffectiveness associated with these hedges for all periods presented was not material.

In January 2011, the Company terminated the fixed-to-floating interest rate swap agreements related to its $350 million 5.25% senior unsecured notes due 2014 and its $300 million 5.125% senior unsecured notes due 2017. The effect of these terminations is basically that the interest associated with these debts prospectively revert back to their original fixed rates. As a result of the gains realized on these transactions, which will be amortized over the remaining term of the corresponding notes, and based on projected interest rates at the date of termination, the Company does not believe its future interest expense associated with these notes will significantly differ from the expense it would have recorded had the notes remained at floating rates.

Credit risk and collateral

The Company’s credit exposure related to fuel derivative instruments is represented by the fair value of contracts with a net positive fair value to the Company at the reporting date.  These outstanding instruments expose the Company to credit loss in the event of nonperformance by the counterparties to the agreements.  However, the Company has not experienced any significant credit loss as a result of counterparty nonperformance in the past.  To manage credit risk, the Company selects and periodically reviews counterparties based on credit ratings, limits its exposure to a single counterparty, and monitors the market position of the fuel hedging program and its relative market position with each counterparty.  At March 31, 2011, the Company had agreements with all of its active counterparties containing early termination rights and/or bilateral collateral provisions whereby security is required if market risk exposure exceeds a specified threshold amount or credit ratings fall below certain levels.  The Company also had agreements with counterparties in which cash deposits and/or pledged aircraft are required to be posted whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds. The following table provides the fair values of fuel derivatives, amounts posted as collateral, and applicable collateral posting threshold amounts as of March 31, 2011, at which such postings are triggered:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
13 

 
 
 
 
 
 
 
Counterparty (CP)
   
 
   
 
 
(in millions)
    A       B       C       D       E    
Other(a)
   
Total
 
Fair value of fuel derivatives
  $ 258     $ (215 )   $ 35     $ 134     $ 245     $ (1 )   $ 456  
Cash collateral held from (by) CP
    185       (224 )     -       3       -       -       (36 )
If credit rating is investment
                                                       
grade, fair value of fuel
                                                       
derivative level at which:
                                                       
   Cash is provided to CP
 
0 to (300)
   
0 to (125)
   
>(75)
   
>(75)
   
>(75)
                 
 
 
or >(700)
   
or >(625)
                                         
   Cash is received from CP
 
>40
   
>150
   
>200(c)
   
>125(c)
   
>250
                 
   Aircraft can be pledged to CP
 
(300) to
   
(125) to
      N/A       N/A       N/A                  
 
    (700 )(d)     (625 )(d)                                        
If credit rating is non-investment
                                                       
grade, fair value of fuel derivative
                                                       
level at which:
                                                       
   Cash is provided to CP
 
0 to (300)
   
0 to (125)
   
(b)
   
(b)
   
(b)
                 
 
 
or >(700)
   
or >(625)
                                         
   Cash is received from CP
 
(b)
   
(b)
   
(b)
   
(b)
   
(b)
                 
   Aircraft can be pledged to CP
 
(300) to
   
(125) to
      N/A       N/A       N/A                  
 
    (700 )     (625 )                                        
 
                                                       
(a) Sum of counterparties with fair value of fuel derivatives <$5 million and no risk of the Company posting collateral.
 
(b) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.
 
(c) Thresholds may vary based on changes in credit ratings within investment grade.
 
(d) The Company has the option of providing cash or pledging aircraft as collateral. No aircraft were pledged as collateral as of March 31, 2011.
 
 
The Company also has agreements with each of its counterparties associated with its outstanding interest rate swap agreements in which cash collateral may be required based on the fair value of outstanding derivative instruments, as well as the Company’s and its counterparty’s credit ratings.  As of March 31, 2011, no cash collateral had been provided to or received from counterparties associated with the Company’s interest rate derivatives.  If the Company’s credit rating had been below investment grade as of March 31, 2011, it would have been required to provide $34 million in cash collateral to one counterparty based on its outstanding net liability derivative position with that counterparty.  The outstanding interest rate net derivative positions with all other counterparties at March 31, 2011 were assets to the Company.

Applicable accounting provisions require an entity to select a policy of how it records the offset rights to reclaim cash collateral associated with the related derivative fair value of the assets or liabilities of such derivative instruments.  Entities may either select a “net” or a “gross” presentation.  The Company has elected to present its cash collateral utilizing a net presentation, in which cash collateral amounts held or provided have been netted against the fair value of outstanding derivative instruments. The Company’s application of this policy differs depending on whether its derivative instruments are in a net asset position or a net liability position.  If its fuel derivative instruments are in a net asset position with a counterparty, cash collateral amounts held are first netted against current derivative amounts (those that will settle during the twelve months following the balance sheet date) associated with that counterparty until that balance is zero, and then any remainder would be applied against the fair value of noncurrent outstanding derivative instruments (those that will settle beyond one year following the balance sheet date).  If its fuel derivative instruments are in a net liability position with a counterparty, cash collateral amounts provided are first netted against noncurrent derivative amounts associated with that counterparty until that balance is zero, and then any remainder would be applied against the fair value of current outstanding derivative instruments.
 
 
 

 
 
14 

 
 
 
 
6.    COMPREHENSIVE INCOME

Comprehensive income includes changes in the fair value of certain financial derivative instruments, which qualify for hedge accounting, unrealized gains and losses on certain investments, and actuarial gains/losses arising from the Company’s postretirement benefit obligation.  The differences between Net income and Comprehensive income for the three months ended March 31, 2011 and 2010, were as follows:

 
 
Three months ended March 31,
 
(In millions)
 
2011
   
2010
 
 
 
 
   
 
 
 
 
 
   
 
 
Net income
  $ 5     $ 11  
Unrealized gain on fuel derivative instruments,
               
net of deferred taxes of $207 and $39
    331       59  
Unrealized gain (loss) on interest rate swaps,
               
net of deferred taxes of $4 and ($1)
    7       (1 )
Other, net of deferred taxes of $2 and $1
    3       2  
Total other comprehensive income
    341       60  
 
               
Comprehensive income
  $ 346     $ 71  
 
               

A rollforward of the amounts included in AOCI, net of taxes, is shown below for the three months ended March 31, 2011:

 
Fuel
 
Interest
   
 
 
Accumulated other
 
 
hedge
 
rate
   
 
 
comprehensive
 
(In millions)
derivatives
 
derivatives
 
Other
 
income (loss)
 
Balance at December 31, 2010
  $ (250 )   $ (34 )   $ 22     $ (262 )
Changes in fair value
    315       7       3       325  
Reclassification to earnings
    16       -       -       16  
Balance at March 31, 2011
  $ 81     $ (27 )   $ 25     $ 79  
 
 
 
 
 
 
 
 
 
15 

 
 
 
 
7.   ACCRUED LIABILITIES

 
 
March 31,
   
December 31,
 
(In millions)
 
2011
   
2010
 
 
 
 
   
 
 
Retirement plans
  $ 170     $ 171  
Aircraft rentals
    54       27  
Vacation pay
    203       200  
Advances and deposits
    31       33  
Fuel derivative contracts
    -       79  
Workers compensation
    144       142  
Other
    225       211  
Accrued liabilities
  $ 827     $ 863  

8.    INCOME TAXES
 
The Company’s effective tax rate was approximately 72 percent for the three months ended March 31, 2011.  This high rate primarily was due to a $5 million charge as a result of an Internal Revenue Service (“IRS”) settlement agreed to in first quarter 2011 related to tax years 2007 through 2009.  Additionally, a tax law change during the quarter in the State of Illinois resulted in a $2 million charge in the period.  These charges together resulted in a decrease to earnings per share, diluted, of $.01.
 
9.    COMMITMENTS AND CONTINGENCIES
 
The Company is from time to time subject to various legal proceedings and claims arising in the ordinary course of business, including, but not limited to, examinations by the IRS.  The Company's management does not expect that the outcome in any of its currently ongoing legal proceedings or the outcome of any adjustments presented by the IRS, individually or collectively, will have a material adverse effect on the Company's financial condition, results of operations, or cash flow.

During 2008, the City of Dallas approved the Love Field Modernization Program (“LFMP”), a project to reconstruct Dallas Love Field (“Airport”) with modern, convenient air travel facilities.  Pursuant to a Program Development Agreement (“PDA”) with the City of Dallas, and the Love Field Airport Modernization Corporation (or “LFAMC”, a Texas non-profit “local government corporation” established by the City to act on the City’s behalf to facilitate the development of the LFMP), the Company is managing this project.  Major construction commenced during 2010, with completion of the project scheduled for the second half of 2014.  Although subject to change, at the current time the project is expected to include the renovation of the Airport airline terminals and complete replacement of gate facilities with a new 20-gate facility, including infrastructure, systems and equipment, aircraft parking apron, fueling system, roadways and terminal curbside, baggage handling systems, passenger loading bridges and support systems, and other supporting infrastructure.
 
It is currently expected that the total amount spent on the LFMP project will be approximately $519 million.  Although the City of Dallas has received commitments from various sources that are expected to fund portions of the LFMP project, including the Federal Aviation Administration, the Transportation Security Administration, and the City’s Aviation Fund, the majority of the funds used are expected to be from the issuance of bonds.  During fourth quarter 2010, $310 million of such bonds were issued by the LFAMC, and the Company has guaranteed principal and interest payments on the bonds.  Depending on funding needs and the timing of these funds from other sources, an additional tranche of bonds will likely be issued prior to the completion of the LFMP project.
 
The Company has agreed to manage the majority of the LFMP project, and as a result, has evaluated its ongoing accounting requirements in consideration of accounting guidance provided for lessees involved in asset construction.  The Company has recorded and will continue to record an asset and corresponding obligation for the cost of the LFMP project as the construction of the facility occurs.  As of March 31, 2011, the Company had recorded construction cost incurred of $102 million as both an asset as a component of Ground property and equipment and a corresponding liability as a component of Other non-current liabilities, respectively, in its unaudited Condensed Consolidated Balance Sheet.  Upon completion of the LFMP project, it is expected the Company would begin depreciating the assets over their estimated useful lives, and would reduce the corresponding liabilities primarily through the Company’s airport rental payments to the City of Dallas.
 
 
 
 
 
 
 
 
 
 
16 

 
 

 
10.    FAIR VALUE MEASUREMENTS

Accounting standards pertaining to fair value measurements establish a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

As of March 31, 2011, the Company held certain items that are required to be measured at fair value on a recurring basis.  These included cash equivalents, short-term investments (primarily treasury bills, commercial paper, and certificates of deposit), certain noncurrent investments, interest rate derivative contracts, fuel derivative contracts, and available-for-sale securities.  The majority of the Company’s short-term investments consist of instruments classified as Level 1.  However, the Company has certificates of deposit and commercial paper that are classified as Level 2, due to the fact that the fair value for these instruments is determined utilizing observable inputs in non-active markets.  Noncurrent investments consist of certain auction rate securities, primarily those collateralized by student loan portfolios, which are guaranteed by the U.S. Government.  Other available-for-sale securities primarily consist of investments associated with the Company’s excess benefit plan.

The Company’s fuel and interest rate derivative instruments consist of over-the-counter (OTC) contracts, which are not traded on a public exchange.  Fuel derivative instruments include swaps, as well as different types of option contracts, whereas interest rate derivatives consist solely of swap agreements.  See Note 5 for further information on the Company’s derivative instruments and hedging activities.  The fair values of swap contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets.  Therefore, the Company has categorized these swap contracts as Level 2.  The Company determines the value of option contracts utilizing a standard option pricing model based on inputs that are either readily available in public markets, can be derived from information available in publicly quoted markets, or are quoted by financial institutions that trade these contracts.  Because certain of the inputs used to determine the fair value of option contracts are unobservable (principally implied volatility), the Company has categorized these option contracts as Level 3.  The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values.  The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of derivative contracts it holds.

The Company’s investments associated with its excess benefit plan consist of mutual funds that are publicly traded and for which market prices are readily available.  This plan is a deferred compensation plan designed to hold Employee contributions in excess of limits established by Section 415 of the Internal Revenue Code.  This plan is funded through qualifying Employee contributions and it impacts the Company’s earnings through changes in the fair value of plan assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
17 

 
 

 
All of the Company’s auction rate security instruments, totaling $93 million at March 31, 2011, are classified as available for sale securities and are reflected at estimated fair value in the unaudited Condensed Consolidated Balance Sheet.  In periods when an auction process successfully took place every 30-35 days, quoted market prices would be readily available, which would qualify the securities as Level 1. However, due to events in credit markets beginning during first quarter 2008, the auction events for these remaining instruments failed, and have continued to fail through the current period.  Therefore, the Company determines the estimated fair values of these securities utilizing a discounted cash flow analysis or other type of valuation model.  The Company has performed, and routinely updates, a valuation for each of its auction rate security instruments, considering, among other items, the collateralization underlying the security investments, the expected future cash flows, including the final maturity, associated with the securities, and estimates of the next time the security is expected to have a successful auction or return to full par value.

In association with its estimate of fair value related to auction rate security instruments as of March 31, 2011, the Company has recorded a temporary unrealized decline in fair value of $17 million, with an offsetting entry to AOCI.  The Company continues to believe that this decline in fair value is due entirely to market liquidity issues, because the underlying assets for the majority of these auction rate securities held by the Company are currently rated investment grade by Moody’s, Standard and Poor’s, and Fitch and are almost entirely backed by the U.S. Government.  In addition, these auction rate securities represented an immaterial portion of the Company’s total cash, cash equivalent, and investment balance at March 31, 2011.  The range of maturities for the Company’s auction rate securities are from 8 years to 37 years.  Considering the relative insignificance of these securities in comparison to the Company’s liquid assets and other sources of liquidity, the Company has no current intention of selling these securities nor does it expect to be required to sell these securities before a recovery in their cost basis.  At the time of the first failed auctions during first quarter 2008, the Company held a total of $463 million in auction rate securities and, since that time, has been able to sell $353 million of these instruments at par value.

The Company remains in discussions with its remaining counterparties to determine whether mutually agreeable decisions can be reached regarding the effective repurchase of its remaining auction rate securities.  The Company has continued to earn interest on virtually all of its outstanding auction rate security instruments.  Any future fluctuation in fair value related to these instruments that the Company deems to be temporary, including any recoveries of previous temporary write-downs, would be recorded to AOCI. If the Company determines that any future valuation adjustment was other than temporary, it would record a charge to earnings as appropriate.
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
18 

 
 
 
 
 
The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis at March 31, 2011 and December 31, 2010:
 
 
 
 
 
   
Fair Value Measurements at Reporting Date Using
 
           
Quoted Prices in
         
Significant
 
           
Active Markets
     Significant Other     Unobservable  
 
 
 
 
   
for Identical Assets
   
Observable Inputs
   
Inputs
 
Description
 
March 31, 2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
 
 
 
 
   
 
   
 
   
 
 
Assets
 
(in millions)
 
Cash equivalents
 
 
   
 
   
 
   
 
 
 
Cash equivalents (a)
  $ 1,932     $ 1,932     $ -     $ -  
 
Commercial paper
    107       -       107          
Short-term investments:
                               
 
Treasury bills
    2,150       2,150       -       -  
 
Certificates of deposit
    236       -       236       -  
 
Commercial paper
    40       -       40       -  
Noncurrent investments (b)
                               
 
Auction rate securities
    93       -       -       93  
 
Certificates of deposit
    25       -       25       -  
Interest rate derivatives (e)
    35       -       35       -  
Fuel derivatives:
                               
 
Swap contracts (c)
    42       -       42       -  
 
Option contracts (c)
    118       -       -       118  
 
Swap contracts (d)
    398       -       398       -  
 
Option contracts (d)
    1,586       -       -       1,586  
Other available-for-sale securities
    42       37       -       5  
Total assets
  $ 6,804     $ 4,119     $ 883     $ 1,802  
 
 
                               
Liabilities
                               
Fuel derivatives:
                               
 
Swap contracts (c)
  $ (315 )   $ -     $ (315 )   $ -  
 
Option contracts (c)
    (62 )     -       -       (62 )
 
Swap contracts (d)
    (770 )     -       (770 )     -  
 
Option contracts (d)
    (541 )     -       -       (541 )
Interest rate derivatives (see Note 5)
    (45 )     -       (45 )     -  
Total liabilities
  $ (1,733 )   $ -     $ (1,130 )   $ (603 )
 
 
                               
 
 
                               
(a)
 Cash equivalents is primarily composed of money market investments and treasury bills.
 
(b)
 Noncurrent investments are included in Other assets in the unaudited Condensed Consolidated Balance Sheet.
 
(c)
 In the unaudited Condensed Consolidated Balance Sheet, amounts are presented as a net liability,
 
and are also net of cash collateral provided to counterparties. See Note 5.
 
(d)
 In the unaudited Condensed Consolidated Balance Sheet, amounts are presented as a net asset,
 
and are also net of cash collateral received from and provided to counterparties. See Note 5.
 
(e)
 In the unaudited Condensed Consolidated Balance Sheet, $23 million is presented as a net asset
 
and $12 million is netted against the total liability. See Note 5.
 
 
 

 
19 

 


 
 
 
 
 
   
Fair Value Measurements at Reporting Date Using
 
 
 
 
 
   
Quoted Prices in
   
 
   
Significant
 
 
 
 
 
   
Active Markets
   
Significant Other
   
Unobservable
 
 
 
 
 
   
for Identical Assets
   
Observable Inputs
   
Inputs
 
Description
 
December 31, 2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
 
 
 
 
   
 
   
 
   
 
 
Assets
 
(in millions)
 
Cash equivalents
  $ 1,262     $ 1,261     $ 1     $ -  
Short-term investments:
                               
 
Treasury bills
    2,009       2,009       -       -  
 
Certificates of deposit
    267       -       267       -  
Noncurrent investments (a)
    93       -       -       93  
Interest rate derivatives
    73       -       73       -  
Fuel derivatives:
                               
 
Swap contracts (b)
    33       -       33       -  
 
Option contracts (b)
    233       -       -       233  
 
Swap contracts (c)
    286       -       286       -  
 
Option contracts (c)
    788       -       -       788  
Other available-for-sale securities
    39       34       -       5  
Total assets
  $ 5,083     $ 3,304     $ 660     $ 1,119  
 
 
                               
Liabilities
                               
Fuel derivatives:
                               
 
Swap contracts (b)
  $ (387 )   $ -     $ (387 )   $ -  
 
Option contracts (b)
    (119 )     -       -       (119 )
 
Swap contracts (c)
    (476 )     -       (476 )     -  
 
Option contracts (c)
    (216 )     -       -       (216 )
Interest rate derivatives
    (4 )     -       (4 )     -  
Total liabilities
  $ (1,202 )   $ -     $ (867 )   $ (335 )
 
 
                               
(a)
 Auction rate securities included in Other assets in the unaudited Condensed Consolidated Balance Sheet.
 
(b)
 In the unaudited Condensed Consolidated Balance Sheet, amounts are presented as a net liability, and are also net
  
of cash collateral provided to counterparties. See Note 5.
 
(c)
 In the unaudited Condensed Consolidated Balance Sheet, amounts are presented as a net asset, and are also net
 
of cash collateral received from counterparties. See Note 5.
 
 
 
 
 
 
 
 
20 

 
 

 
The Company had no transfers of assets or liabilities between any of the above levels during the three months ended March 31, 2011.  The following tables present the Company’s activity for items measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2011:
 
 
 
 
 
Fair Value Measurements Using Significant
 
 
 
 
 
Unobservable Inputs (Level 3)
 
 
 
Fuel
 
Auction Rate
 
Other
 
 
 
(in millions)
Derivatives
 
Securities
 
Securities
 
Total
Balance at December 31, 2010
$
 686 
 
$
 93 
 
$
 5 
 
$
 784 
Total gains or (losses) (realized or unrealized)
 
 
 
 
 
 
 
 
 
 
 
 
Included in earnings
 
 152 
 
 
 - 
 
 
 - 
 
 
 152 
 
Included in other comprehensive income
 
 493 
 
 
 - 
 
 
 - 
 
 
 493 
Purchases (b)
 
 51 
 
 
 - 
 
 
 - 
 
 
 51 
Sales (b)
 
 (233)
 
 
 - 
 
 
 - 
 
 
 (233)
Settlements
 
 (48)
 
 
 - 
 
 
 - 
 
 
 (48)
Balance at March 31, 2011
$
 1,101 
 
$
 93 
(a) 
$
 5 
 
$
 1,199 
 
 
 
 
 
 
 
 
 
 
 
 
 
The amount of total gains or (losses) for the
 
 
 
 
 
 
 
 
 
 
 
 
period included in earnings attributable to the
 
 
 
 
 
 
 
 
 
 
 
 
change in unrealized gains or losses relating to
 
 
 
 
 
 
 
 
 
 
 
 
assets still held at March 31, 2011
$
 155 
 
$
 - 
 
$
 - 
 
$
 155 
 
 
 
 
 
 
 
 
 
 
 
 
 
(a) Included in Other assets in the unaudited Condensed Consolidated Balance Sheet.
(b) Included in Other operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows.

All settlements from fuel derivative contracts that are deemed “effective” are included in Fuel and oil expense in the period the underlying fuel is consumed in operations.  Any “ineffectiveness” associated with hedges, including amounts that settled in the current period (realized), and amounts that will settle in future periods (unrealized), is recorded in earnings immediately, as a component of Other (gains) losses, net.  See Note 5 for further information on hedging.  Any gains and losses (realized and unrealized) related to other investments are reported in Other operating expenses, and were immaterial for the three months ended March 31, 2011 and 2010.
 
 
 



 
 
 
 
 
 
 
 
 

 
 
21 

 
 
 
 
The carrying amounts and estimated fair values of the Company’s long-term debt (including current maturities) at March 31, 2011 are contained in the below table.  The estimated fair values of the Company’s publicly held long-term debt were based on quoted market prices.
 
 
 
Carrying
 
Estimated fair
(In millions)
 
value
 
 value
10.5% Notes due 2011
 
$
 403 
 
$
 423 
French Credit Agreements due 2012
 
 
 14 
 
 
 14 
6.5% Notes due 2012
 
 
 397 
 
 
 414 
5.25% Notes due 2014
 
 
 350 
 
 
 375 
5.75% Notes due 2016
 
 
 306 
 
 
 331 
5.125% Notes due 2017
 
 
 300 
 
 
 314 
French Credit Agreements due 2017
 
 
 73 
 
 
 73 
Term Loan Agreement due 2019 - 6.64%
 
 
 289 
 
 
 301 
Term Loan Agreement due 2019 - 6.84%
 
 
 110 
 
 
 119 
Term Loan Agreement due 2020 - 5.223%
 
 
 513 
 
 
 471 
Pass Through Certificates due 2022
 
 
 420 
 
 
 458 
7.375% Debentures due 2027
 
 
 114 
 
 
 122 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
22 

 

 
 
Item 2.                      Management's Discussion and Analysis of Financial Condition and Results of Operations

Relevant Southwest comparative operating statistics for the three months ended March 31, 2011 and 2010 are as follows:

 
 
Three months ended March 31,
 
 
 
 
 
 
2011
 
2010
 
Change
Revenue passengers carried
 
 
21,115,115 
 
 
 
19,976,835 
 
 
 
5.7 
%
Enplaned passengers
 
 
25,599,118 
 
 
 
23,694,464 
 
 
 
8.0 
%
Revenue passenger miles (RPMs) (000s)
 
 
19,195,885 
 
 
 
17,161,713 
 
 
 
11.9 
%
Available seat miles (ASMs) (000s)
 
 
24,505,674 
 
 
 
22,619,460 
 
 
 
8.3 
%
Load factor(1)
 
 
78.3 
%
 
 
75.9 
%
 
 
2.4 
pts
Average length of passenger haul (miles)
 
 
909 
 
 
 
859 
 
 
 
5.8 
%
Average aircraft stage length (miles)
 
 
656 
 
 
 
633 
 
 
 
3.6 
%
Trips flown
 
 
273,823 
 
 
 
261,892 
 
 
 
4.6 
%
Average passenger fare
 
$
139.18 
 
 
$
124.90 
 
 
 
11.4 
%
Passenger revenue yield per RPM (cents)
 
 
15.31 
 
 
 
14.54 
 
 
 
5.3 
%
Operating revenue per ASM (cents)
 
 
12.66 
 
 
 
11.63 
 
 
 
8.9 
%
Passenger revenue per ASM (cents)
 
 
11.99 
 
 
 
11.03 
 
 
 
8.7 
%
Operating expenses per ASM (cents)
 
 
12.20 
 
 
 
11.39 
 
 
 
7.1 
%
Operating expenses per ASM, excluding fuel (cents)
 
 
7.97 
 
 
 
7.76 
 
 
 
2.7 
%
Fuel costs per gallon, including fuel tax
 
$
2.91 
 
 
$
2.49 
 
 
 
16.9 
%
Fuel costs per gallon, including fuel tax, economic
 
$
2.96 
 
 
$
2.34 
 
 
 
26.5 
%
Fuel consumed, in gallons (millions)
 
 
356 
 
 
 
329 
 
 
 
8.2 
%
Active fulltime equivalent Employees
 
 
35,452 
 
 
 
34,637 
 
 
 
2.4 
%
Aircraft in service at period-end*
 
 
550 
 
 
 
541 
 
 
 
1.7 
%
                         
* Includes leased aircraft and excludes aircraft that are not available for service or are in storage, held for sale, or for return to the lessor.
(1) Revenue passenger miles divided by available seat miles.
 
 
 
 
 
 
 
 
 
 

 
 
23 

 
 
Reconciliation of Reported Amounts to non-GAAP Financial Measures (unaudited) (in millions, except per share and per ASM amounts)

             
    Three months ended March 31,     Percent  
 
 
2011
   
2010
   
Change
 
 
 
 
   
 
   
 
 
Operating income, as reported
  $ 114     $ 54    
 
 
Add/(Deduct): Reclassification between Fuel
                 
 
 
and oil and Other (gains) losses, net,
                 
 
 
associated with current period settled contracts
    (2 )     (4 )  
 
 
Add/(Deduct): Contracts settling in the current
                 
 
 
period, but for which gains and/or (losses)
                 
 
 
have been recognized in a prior period*
    (17 )     52    
 
 
Add: Charge for AirTran integration costs, net (a)