form10q.htm

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

FORM 10-Q/A
Amendment No. 1

(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2009
 
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 July 20, 2009: 741,447,409

 
 

 

EXPLANATORY NOTE

This Amendment No. 1 on Form 10-Q/A (Amendment) amends and restates Southwest Airlines Co.’s (Company or Southwest) Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2009, originally filed on July 23, 2009 (Original Filing).

As disclosed in the Company’s Form 8-K dated October 15, 2009, on October 14, 2009, the Company determined that its previously issued unaudited interim condensed consolidated financial statements for the three and six month periods ended June 30, 2009, contained an error with respect to one rule within Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), as amended. Specifically, to facilitate the implementation of new hedge accounting software, in April 2009, existing hedging instruments were de-designated and re-designated as new hedges.  Included in the re-designation, however, were certain derivative instruments that were in a net written option position that did not qualify as hedges according to SFAS 133.

The result of this error was that a portion of the increase in fair value of these derivatives was deferred as part of Accumulated Other Comprehensive Income/Loss (AOCI), when in fact those increases should have been recognized in earnings in the second quarter 2009.  Recognizing these increases in earnings results in an increase in GAAP Net income of $37 million for second quarter 2009.  The net increase in fair value related to these instruments, totaling $57 million, before taxes, during second quarter 2009, relates entirely to unrealized changes in fair value as substantially all of the instruments will not settle until periods subsequent to 2009.  Since the Company classifies these unrealized noncash changes in fair value as a component of Other (gains) losses, net in the unaudited Condensed Consolidated Statement of Operations, this error had no impact on the Company’s operating income for the three or six month periods ended June 30, 2009, nor did it impact the Company's net cash flows for the same periods of 2009. The impact on the Company's unaudited Condensed Consolidated Balance Sheet is a decrease (debit) to AOCI of $35 million, an increase to Retained earnings of $37 million, a decrease to Accrued liabilities of $5 million, and an increase to Deferred income taxes of $3 million as of June 30, 2009. This error had no impact on any financial statements prior to those issued for second quarter 2009.  In light of this error, the Company’s financial statements and other financial information included in the Original Filing for second quarter 2009 are being restated in this Amendment.

The information contained in the Original Filing has been updated in this Amendment to give effect to the restatement.  This Amendment continues to speak as of the dates described herein, and with the exception of Note 13, the disclosures have not been updated to reflect any events that occurred subsequent to such dates.  With the exception of Note 13, information not affected by the restatement is unchanged and reflects the disclsoures at the time of the Original Filing.  Therefore, this Amendment should be read in conjunction with the Company’s other filings made with the Securities and Exchange Commission subsequent to the Original Filing.













SOUTHWEST AIRLINES CO.

TABLE OF CONTENTS TO FORM 10-Q/A


Part I- FINANCIAL INFORMATION
Item 1. Financial Statements
 
 
 
Notes to Condensed Consolidated 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. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
EXHIBIT INDEX


 
 

 


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

   
June 30, 2009
   
December 31, 2008
 
ASSETS
 
(As restated)
       
Current assets:
           
Cash and cash equivalents
  $ 946     $ 1,368  
Short-term investments
    1,252       435  
Accounts and other receivables
    237       209  
Inventories of parts and supplies, at cost
    200       203  
Deferred income taxes
    365       365  
Prepaid expenses and other current assets
    94       73  
Total current assets
    3,094       2,653  
                 
Property and equipment, at cost:
               
Flight equipment
    13,690       13,722  
Ground property and equipment
    1,849       1,769  
Deposits on flight equipment purchase contracts
    204       380  
      15,743       15,871  
Less allowance for depreciation and amortization
    5,082       4,831  
      10,661       11,040  
Other assets
    272       375  
    $ 14,027     $ 14,068  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
  $ 732     $ 668  
Accrued liabilities
    1,024       1,012  
Air traffic liability
    1,207       963  
Current maturities of long-term debt
    105       163  
Total current liabilities
    3,068       2,806  
                 
Long-term debt less current maturities
    3,278       3,498  
Deferred income taxes
    1,924       1,904  
Deferred gains from sale and leaseback of aircraft
    128       105  
Other deferred liabilities
    481       802  
Stockholders' equity:
               
Common stock
    808       808  
Capital in excess of par value
    1,223       1,215  
Retained earnings
    4,900       4,919  
Accumulated other comprehensive loss
    (797 )     (984 )
Treasury stock, at cost
    (986 )     (1,005 )
Total stockholders' equity
    5,148       4,953  
    $ 14,027     $ 14,068  
                 
See accompanying notes.
               
 
 

 
 

 


Southwest Airlines Co.
Condensed Consolidated Statement of Operations
(in millions, except per share amounts)
(unaudited)
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(As restated)
         
(As restated)
       
OPERATING REVENUES:
                       
Passenger
  $ 2,506     $ 2,747     $ 4,758     $ 5,161  
Freight
    29       37       58       71  
Other
    81       85       156       167  
Total operating revenues
    2,616       2,869       4,972       5,399  
OPERATING EXPENSES:
                               
Salaries, wages, and benefits
    863       839       1,699       1,639  
Fuel and oil
    726       945       1,423       1,745  
Maintenance materials and repairs
    190       191       373       333  
Aircraft rentals
    47       38       93       76  
Landing fees and other rentals
    179       159       345       330  
Depreciation and amortization
    150       148       300       293  
Other operating expenses
    338       344       666       690  
Total operating expenses
    2,493       2,664       4,899       5,106  
OPERATING INCOME
    123       205       73       293  
OTHER EXPENSES (INCOME):
                               
Interest expense
    47       32       92       60  
Capitalized interest
    (5 )     (6 )     (11 )     (14 )
Interest income
    (3 )     (5 )     (8 )     (12 )
Other (gains) losses, net
    (23 )     (345 )     -       (307 )
Total other expenses (income)
    16       (324 )     73       (273 )
                                 
INCOME BEFORE INCOME TAXES
    107       529       -       566  
PROVISION FOR INCOME TAXES
    16       208       -       211  
                                 
NET INCOME
  $ 91     $ 321     $ -     $ 355  
                                 
                                 
NET INCOME PER SHARE, BASIC
  $ .12     $ .44     $ -     $ .48  
                                 
NET INCOME PER SHARE, DILUTED
  $ .12     $ .44     $ -     $ .48  
                                 
WEIGHTED AVERAGE SHARES
                               
OUTSTANDING:
                               
Basic
    741       732       741       733  
Diluted
    741       737       741       736  
                                 
See accompanying notes.
                               





 
 

 

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

    Three months ended June 30,     Six months ended June 30,  
   
2009
   
2008
   
2009
   
2008
 
   
(As restated)
         
(As restated)
       
CASH FLOWS FROM OPERATING ACTIVITIES:
                       
Net income (loss)
  $ 91     $ 321     $ -     $ 355  
Adjustments to reconcile net income (loss) to
                               
cash provided by operating activities:
                               
Depreciation and amortization
    150       148       300       293  
Unrealized loss (gain) on fuel derivative instruments
    (3 )     (324 )     67       (290 )
Deferred income taxes
    16       135       (5 )     129  
Amortization of deferred gains on sale and
                               
leaseback of aircraft
    (4 )     (3 )     (7 )     (6 )
Share-based compensation expense
    3       5       6       9  
Excess tax benefits from share-based
                               
compensation arrangements
    (5 )     3       (1 )     3  
Changes in certain assets and liabilities:
                               
Accounts and other receivables
    (6 )     (97 )     (28 )     (167 )
Other current assets
    (28 )     (37 )     (18 )     (50 )
Accounts payable and accrued liabilities
    104       286       104       333  
Air traffic liability
    (43 )     105       244       372  
Cash collateral received from (provided to) fuel
                               
    derivative counterparties
    (125 )     1,865       (185 )     2,435  
Other, net
    (15 )     (71 )     (57 )     (116 )
Net cash provided by operating activities
    135       2,336       420       3,300  
                                 
CASH FLOWS FROM INVESTING ACTIVITIES:
                               
Purchases of property and equipment, net
    (187 )     (223 )     (272 )     (587 )
Purchases of short-term investments
    (1,394 )     (2,226 )     (3,090 )     (3,447 )
Proceeds from sales of short-term investments
    1,203       1,185       2,347       2,645  
Other, net
    1       -       1       -  
Net cash used in investing activities
    (377 )     (1,264 )     (1,014 )     (1,389 )
                                 
CASH FLOWS FROM FINANCING ACTIVITIES:
                               
Proceeds from sale and leaseback transactions
    208       -       381       -  
Issuance of Long-term debt
    332       600       332       600  
Proceeds from Employee stock plans
    4       17       8       27  
Payments of long-term debt and capital lease obligations
    (7 )     (6 )     (41 )     (25 )
Payment of revolving credit facility
    (400 )     -       (400 )     -  
Payment of credit line borrowing
    (91 )     -       (91 )     -  
Payments of cash dividends
    (3 )     (3 )     (10 )     (10 )
Repurchase of common stock
    -       -       -       (54 )
Excess tax benefits from share-based
                               
compensation arrangements
    5       (3 )     1       (3 )
Other, net
    (5 )     (6 )     (8 )     (6 )
Net cash provided by financing activities
    43       599       172       529  
                                 
NET CHANGE IN CASH AND
                               
CASH EQUIVALENTS
    (199 )     1,671       (422 )     2,440  
CASH AND CASH EQUIVALENTS AT
                               
BEGINNING OF PERIOD
    1,145       2,982       1,368       2,213  
CASH AND CASH EQUIVALENTS
                               
AT END OF PERIOD
  $ 946     $ 4,653     $ 946     $ 4,653  
                                 
CASH PAYMENTS FOR:
                               
Interest, net of amount capitalized
  $ 42     $ 16     $ 78     $ 41  
Income taxes
  $ 3     $ 7     $ 4     $ 13  
                                 
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. (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 June 30, 2009 and 2008, 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 for complete financial statements.  Financial results for the Company, and airlines in general, are seasonal in nature.  Historically, the Company’s revenues, as well as its overall financial performance, are better in its second and third fiscal quarters than in its first and fourth fiscal quarters.  However, as a result of significant fluctuations in revenues and 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 accounting requirements of Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (SFAS 133), the Company has experienced, and may continue to experience significant volatility in its results in certain fiscal periods.  See Note 5 for further information. Operating results for the three months and six months ended June 30, 2009, are not necessarily indicative of the results that may be expected for the year ended December 31, 2009.  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, 2008.

Certain prior period amounts have been reclassified to conform to the current presentation.  In the unaudited Condensed Consolidated Balance Sheet as of December 31, 2008, the Company's cash collateral deposits related to fuel derivatives that have been provided to a counterparty have been adjusted to show a “net” presentation against the fair value of the Company's fuel derivative instruments.  The entire portion of cash collateral deposits as of December 31, 2008, $240 million, has been reclassified to reduce “Other deferred liabilities.”  In the Company’s 2008 Form 10-K filing, these cash collateral deposits were presented “gross” and all were included as an increase to “Prepaid expenses and other current assets.”  This change in presentation was made in order to comply with the requirements of Financial Accounting Standards Board (FASB) Staff Position FIN 39-1 (FIN 39-1), which was required to be adopted by the Company effective January 1, 2008.  Following the Company’s 2008 Form 10-K filing on February 2, 2009, the Company became aware that the requirements of FIN 39-1 had not been properly applied to its financial derivative instruments within the financial statements.  The Company determined that the effect of this error was not material to its financial statements and disclosures taken as a whole, and decided to apply FIN 39-1 prospectively beginning with its first quarter 2009 Form 10-Q.  Also, in the unaudited Condensed Consolidated Statement of Cash Flows for the three and six months ended June 30, 2008, the Company has reclassified certain unrealized noncash gains recorded on fuel derivative instruments and the cash collateral received from counterparties to its fuel hedging program, in order to conform to the current year presentation.  These reclassifications had no impact on net cash flows provided by operations.

In preparation of the unaudited condensed consolidated financial statements, the Company reviewed, as determined necessary by the Company’s management, events that occurred after June 30, 2009, up until the original issuance of the financial statements, which occurred on July 23, 2009.  In connection with the reissuance of these financial statements on Form 10-Q/A, the Company reviewed, as determined necessary by the Company’s management, events that occurred up until the reissuance of the financial statements, which occurred on October 22, 2009.

2.   RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

The Company has determined that its previously issued unaudited interim condensed consolidated financial statements for the three and six month periods ended June 30, 2009, contained an error with respect to one rule within SFAS 133.  Specifically, to facilitate the implementation of new hedge accounting software, in April 2009, existing hedging instruments were de-designated and re-designated as new hedges.  Included in the re-designation, however, were certain derivative instruments that were in a net written option position that did not qualify as hedges according to SFAS 133.  As a result, the Company is restating its financial statements for the three and six month periods ended June 30, 2009.  The following table illustrates the correction as it is associated with certain line items in the financial statements (in millions, except per share amounts):

 
Condensed Consolidated Balance Sheet (unaudited)
                 
   
June 30, 2009
 
   
As reported
   
Adjustment
   
Restated
 
Accrued liabilities
    1,029       (5 )     1,024  
Total current liabilities
    3,073       (5 )     3,068  
Deferred income taxes
    1,921       3       1,924  
Retained earnings
    4,863       37       4,900  
Accumulated other comprehensive loss
    (762 )     (35 )     (797 )
Total stockholders' equity
    5,146       2       5,148  

Condensed Consolidated Statement of Operations (unaudited)
             
   
Three months ended June 30, 2009
 
   
As reported
   
Adjustment
   
Restated
 
Other (gains) losses, net
    34       (57 )     (23 )
Total other expenses (income)
    73       (57 )     16  
INCOME (LOSS) BEFORE INCOME TAXES
    50       57       107  
PROVISION (BENEFIT) FOR INCOME TAXES
    (4 )     20       16  
NET INCOME (LOSS)
    54       37       91  
NET INCOME (LOSS) PER SHARE, BASIC
    0.07       0.05       0.12  
NET INCOME (LOSS) PER SHARE, DILUTED
    0.07       0.05       0.12  
 

 
Condensed Consolidated Statement of Operations (unaudited)
                 
   
Six months ended June 30, 2009
 
   
As reported
   
Adjustment
   
Restated
 
Other (gains) losses, net
    57       (57 )     -  
Total other expenses (income)
    130       (57 )     73  
INCOME (LOSS) BEFORE INCOME TAXES
    (57 )     57       -  
PROVISION (BENEFIT) FOR INCOME TAXES
    (20 )     20       -  
NET INCOME (LOSS)
    (37 )     37       -  
NET INCOME (LOSS) PER SHARE, BASIC
    (0.05 )     0.05       -  
NET INCOME (LOSS) PER SHARE, DILUTED
    (0.05 )     0.05       -  

 
3.   NEW ACCOUNTING PRONOUNCEMENTS

On April 9, 2009, the Financial Accounting Standards Board (FASB) issued Staff Position SFAS 107-1 and Accounting Principles Board (APB) Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FSP 107-1 and APB 28-1).  FSP 107-1 amends FASB Statement No. 107, “Disclosures about Fair Values of Financial Instruments,” to require disclosures about fair value of financial instruments in interim financial statements as well as in annual financial statements.  APB 28-1 amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in all interim financial statements.  FSP 107-1 and APB 28-1 are effective for interim periods ending after June 15, 2009 and the Company has adopted them in second quarter 2009.  See Note 11.

On April 9, 2009, the FASB issued Staff Position SFAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (FSP 157-4).  FSP 157-4 provides additional guidance in estimating fair value under statement No. 157, “Fair Value Measurements” (SFAS 157), when the volume and level of transaction activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability.  FSP 157-4 also provides additional guidance on circumstances that may indicate a transaction is not orderly.  FSP 157-4 is effective for interim periods ending after June 15, 2009, and the Company has adopted its provisions during second quarter 2009.  FSP 157-4 did not have a significant impact on the Company’s financial position, results of operations, cash flows, or disclosures for second quarter 2009.


 
On April 9, 2009, the FASB issued Staff Position SFAS 115-2 and SFAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP 115-2).  FSP 115-2 provides guidance in determining whether impairments in debt securities are other than temporary, and modifies the presentation and disclosures surrounding such instruments.  FSP 115-2 is effective for interim periods ending after June 15, 2009, and the Company has adopted its provisions for second quarter 2009.  FSP 115-2 did not have a significant impact on the Company’s financial position, results of operations, cash flows, or disclosures for second quarter 2009.

In May 2009, the FASB issued statement No. 165, “Subsequent Events” (SFAS 165). SFAS 165 modifies the definition of what qualifies as a subsequent event—those events or transactions that occur following the balance sheet date, but before the financial statements are issued, or are available to be issued—and requires companies to disclose the date through which it has evaluated subsequent events and the basis for determining that date.  The Company adopted the provisions of SFAS 165 for second quarter 2009, in accordance with the effective date.  See Note 1.

In June 2009, the FASB issued statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (SFAS 167).  Among other items, SFAS 167 responds to concerns about the application of certain key provisions of FIN 46(R), including those regarding the transparency of the involvement with variable interest entities.  SFAS 167 is effective for calendar year companies beginning on January 1, 2010.  The Company has not yet determined the impact that adoption of SFAS 167 will have on its financial position, results of operations, cash flows, or disclosures.

4.      NET INCOME (LOSS) PER SHARE-RESTATED

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


    Three months ended June 30,     Six months ended June 30,  
   
2009
   
2008
   
2009
   
2008
 
   
(As restated)
         
(As restated)
       
NUMERATOR:
                       
Net income (loss)
  $ 91     $ 321     $ -     $ 355  
                                 
DENOMINATOR:
                               
Weighted-average shares
                               
outstanding, basic
    741       732       741       733  
Dilutive effect of Employee stock
                               
options
    -       5       -       3  
Adjusted weighted-average shares
                               
outstanding, diluted
    741       737       741       736  
                                 
NET INCOME (LOSS) PER SHARE:
                               
Basic
  $ .12     $ .44     $ -     $ .48  
                                 
Diluted
  $ .12     $ .44     $ -     $ .48  


The Company has excluded 79 million and 56 million shares, respectively, from its calculations of net income per share, diluted, for the three months ended June 30, 2009 and 2008, and has excluded 79 million and 72 million shares, respectively, from its calculations of net income per share, diluted, for the six months ended June 30, 2009 and 2008, as they represent antidilutive stock options for the respective periods presented.


 
5.      FINANCIAL DERIVATIVE INSTRUMENTS-RESTATED

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 (including related taxes) consumed during the three months ended June 30, 2009 and 2008, represented approximately 29 percent and 35 percent of the Company’s operating expenses, respectively. The Company’s operating expenses have been extremely volatile in recent years due to dramatic increases and declines in energy prices.  The Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses.  Because jet fuel is not 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 derivative financial 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), and fixed price swap agreements in its portfolio.  Generally, when prices are lower, the Company prefers to use fixed price swap agreements and purchased call options.  However, when prices are higher, the Company uses more collar structures due to the high cost of purchased call options and the increased risk associated with fixed price swaps.  Although the use of collar structures can reduce the overall cost of hedging, these instruments carry more risk than purchased call options in that the Company could end up in a liability position when the collar structure settles.  With the use of purchased call options, the Company cannot be in a liability position at settlement.

The following table provides information about the Company’s volume of fuel hedging for the first half of 2009, and its portfolio as of June 30, 2009, for future periods.  These hedge volumes are presented strictly from an “economic” standpoint and thus do not reflect whether the hedges qualified or will qualify for special hedge accounting as defined in SFAS 133.  The Company defines its “economic” hedge as the total volume of fuel derivative contracts held, including the net impact of positions that have been effectively “settled” through offsetting positions, regardless of whether those contracts qualify for hedge accounting as defined in SFAS 133.
 
 
   
Fuel hedged as
   
Approximate %
 
   
of June 30, 2009
   
of jet fuel
 
Period (by year)
 
(gallons in millions)
   
consumption
 
2009
    518       37 % *
2010
    653       47 % *
2011
    211       15 % *
2012
    93       7 % *
2013
    98       7 % *
                 
Period (by quarter for 2009)
               
First quarter 2009
    15       4 %
Second quarter 2009
    185       50 %
Third quarter 2009
    144       40 % *
Fourth quarter 2009
    174       52 % *
* Forecasted
               
 


Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges, as defined in SFAS 133.  Under SFAS 133, all derivatives designated as hedges that meet certain requirements are granted special hedge accounting treatment.  Generally, utilizing the special hedge accounting, all periodic changes in fair value of the derivatives designated as hedges that are considered to be effective, as defined, are recorded in "Accumulated other comprehensive income (loss)” (“AOCI”) until the underlying jet fuel is consumed.  See Note 6 for further information on “AOCI.”  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 special hedge accounting.  Ineffectiveness, as defined, 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 not effective, that ineffectiveness 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, in accordance with SFAS 133, 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.  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 for the three or six months ended June 30, 2009 or 2008.

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.  Factors that have and may continue to lead to ineffectiveness and unrealized gains and losses on derivative contracts include: significant fluctuation in energy prices, the number of derivative positions the Company holds, significant weather events affecting refinery capacity and the production of refined products, and the volatility of the different types of products the Company uses in hedging.  The number of instances in which the Company has discontinued hedge accounting for specific hedges and for specific refined products, such as unleaded gasoline, has increased recently, primarily due to the foregoing factors.  However, even though these derivatives may not qualify for SFAS 133 special hedge accounting, the Company continues to hold the instruments as it believes they continue to afford the Company the opportunity to minimize jet fuel costs.

SFAS 133 is a complex accounting standard 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 by SFAS 133, 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.

All cash flows associated with purchasing and selling derivatives are classified as operating cash flows in the unaudited Condensed Consolidated Statement of Cash Flows.  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 (in millions):


     
Asset Derivatives
   
Liability Derivatives
 
Derivatives designated as hedging
 
 
Fair Value at 6/30/09
   
Fair Value at 12/31/08
   
Fair Value at 6/30/09
   
Fair Value at 12/31/08
 
instruments under SFAS 133
Balance Sheet Location                 (As restated)        
Fuel derivative contracts (gross)*
Accrued liabilities
  $ 92     $ 94     $ 16     $ 19  
Fuel derivative contracts (gross)*
Other deferred liabilities
    112       40       36       522  
Interest rate derivative contracts
Other assets
    50       83       -       -  
Interest rate derivative contracts
Other deferred liabilities
    -       -       -       3  
                                   
Total derivatives designated as hedging
                                 
instruments under SFAS 133
    $ 254     $ 217     $ 52     $ 544  
                                   
Derivatives not designated as hedging
                                 
instruments under SFAS 133
                                 
Fuel derivative contracts (gross)*
Accrued liabilities
  $ 403     $ 387     $ 651     $ 708  
Fuel derivative contracts (gross)*
Other deferred liabilities
    308       266       970       530  
                                   
Total derivatives not designated as
                                 
hedging instruments under SFAS 133
    $ 711     $ 653     $ 1,621     $ 1,238  
                                   
Total derivatives
    $ 965     $ 870     $ 1,673     $ 1,782  
* Does not include the impact of cash collateral deposits provided to counterparties. See discussion
         
of credit risk and collateral following in this Note.
                               

 


In addition, the Company also had the following amounts associated with fuel derivative instruments and hedging activities in its unaudited Condensed Consolidated Balance Sheet (in millions):

 
 
Balance Sheet
 
June 30,
   
December 31,
 
 
Location
 
2009
   
2008
 
     
(As restated)
       
Cash collateral deposits provided
Offset against Other
           
to counterparty - noncurrent
deferred liabilities
    374       240  
Cash collateral deposits provided
Offset against Accrued
               
to counterparty - current
liabilities
    51       -  
Due to third parties for settled fuel contracts
Accrued liabilities
    18       16  
Net unrealized losses from fuel
Accumulated other
               
hedges, net of tax
comprehensive loss
    785       946  

The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2009 and 2008 (in millions):


Derivatives in SFAS 133 Cash Flow Hedging Relationships
             
   
Amount of (Gain) Loss Recognized in AOCI on Derivative (Effective Portion)
   
Amount of (Gain) Loss Reclassified from AOCI into Income (Effective Portion)(a)
   
Amount of (Gain) Loss Recognized in Income on Derivatives (ineffective portion) (b)
 
   
Three months ended June 30,
   
Three months ended June 30,
   
Three months ended June 30,
 
   
2009
   
2008
   
2009
   
2008
   
2009
   
2008
 
   
(As restated)
                               
Fuel derivative
                                   
contracts
  $ (7 ) *   $ (1,493 ) *   $ 96 *   $ (284 ) *   $ (25 )   $ 20  
Interest rate
                                               
derivatives
    (20 ) *     -       -       -       -       -  
                                                 
Total
  $ (27 )   $ (1,493 )   $ 96     $ (284 )   $ (25 )   $ 20  
*   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 in SFAS 133 Cash Flow Hedging Relationships
             
   
Amount of (Gain) Loss Recognized in AOCI on Derivative (Effective Portion)
   
Amount of (Gain) Loss Reclassified from AOCI into Income (Effective Portion)(a)
   
Amount of (Gain) Loss Recognized in Income on Derivatives (ineffective portion) (b)
 
   
Six months ended June 30,
   
Six months ended June 30,
   
Six months ended June 30,
 
   
2009
   
2008
   
2009
   
2008
   
2009
   
2008
 
   
(As restated)
                               
Fuel derivative
                                   
contracts
  $ 45 *   $ (1,923 ) *   $ 206 *   $ (454 ) *   $ (9 )   $ 26  
Interest rate
                                               
derivatives
    (25 ) *     -       -       -       -       -  
                                                 
Total
  $ 20     $ (1,923 )   $ 206     $ (454 )   $ (9 )   $ 26  
*   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 SFAS 133 Cash Flow Hedging Relationships
  Amount of (Gain) Loss Recognized in Income on Derivatives    
   
Three months ended June 30,
   
Location of (Gain) Loss Recognized in Income
   
2009
     
2008
   
on Derivatives
   
(As restated)
             
Fuel derivative contracts
(38
)   $
(381
)  
Other (gains) losses, net

 
Derivatives not in SFAS 133 Cash Flow Hedging Relationships
  Amount of (Gain) Loss Recognized in Income on Derivatives    
   
Six months ended June 30,
   
Location of (Gain) Loss Recognized in Income
   
2009
     
2008
   
on Derivatives
   
(As restated)
             
Fuel derivative contracts
(65
)   $
(365
)  
Other (gains) losses, net

The Company also recorded expense associated with premiums paid for fuel derivative contracts that settled/expired during the three months ended June 30, 2009 and 2008, respectively, of $37 million and $14 million, and during the six months ended June 30, 2009 and 2008, respectively, of $69 million and $27 million.  These amounts are excluded from the Company’s measurement of effectiveness for related hedges.


 
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.  Included in the Company’s total net unrealized losses from fuel hedges as of June 30, 2009, are approximately $288 million in unrealized losses, net of taxes, that are expected to be realized in earnings during the twelve months following June 30, 2009.  In addition, as of June 30, 2009, the Company had already recognized cumulative net losses due to ineffectiveness and derivatives that do not qualify for hedge accounting totaling $6 million, net of taxes.  These losses were recognized in the three months ended June 30, 2009, and prior periods, and are reflected in “Retained earnings” as of June 30, 2009, but the underlying derivative instruments will not expire/settle until subsequent periods of 2009 or future periods.

Interest rate swaps

The Company is party to interest rate swap agreements related to its $385 million 6.5% senior unsecured notes due 2012, its $350 million 5.25% senior unsecured notes due 2014, its $300 million 5.125% senior unsecured notes due 2017, and its $100 million 7.375% senior unsecured debentures due 2027.  The primary objective for the Company’s use of these interest rate hedges is to better match the repricing of its assets and liabilities.  Under each of these interest rate swap agreements, the Company pays the London InterBank Offered Rate (LIBOR) plus a margin every six months on the notional amount of the debt, and receives payments based on the fixed stated rate of the notes every six months until the date the notes become due.  These interest rate swap agreements qualify as fair value hedges, as defined by SFAS 133.  In addition, these interest rate swap agreements qualify for the “shortcut” method of accounting for hedges, as defined by SFAS 133.  Under the “shortcut” method, the hedges are assumed to be perfectly effective, and, thus, there is no ineffectiveness to be recorded in earnings.

The Company also entered into interest rate swap agreements concurrent with its entry into a twelve-year, $600 million floating-rate term loan agreement during 2008, and a ten-year, $332 million floating-rate term loan agreement during May 2009.  Under these swap agreements, which are accounted for as cash flow hedges, the interest rates on the term loans are effectively fixed for their entire term at 5.223 percent and 6.64 percent, respectively, and ineffectiveness is required to be measured each reporting period.  The fair values of the interest rate swap agreements, which are adjusted regularly, have been aggregated by counterparty for classification in the unaudited Condensed Consolidated Balance Sheet.

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 will periodically review 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 June 30, 2009, the Company had agreements with all of its 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.  Based on the Company’s current agreements with two of these counterparties, cash deposits are required to be posted whenever the net fair value of derivatives associated with those counterparties exceed specific thresholds.  If the threshold is exceeded, cash is either posted by the counterparty if the value of derivatives is an asset to the Company, or posted by the Company if the value of derivatives is a liability to the Company.

Under one of the Company’s counterparty agreements, as amended, until January 1, 2010, if the Company becomes obligated to post collateral for obligations in amounts of up to $300 million and in excess of $700 million, the Company is required to post cash collateral; however, if the Company becomes obligated to post collateral for obligations in amounts between $300 million and $700 million, the Company has pledged 20 of its Boeing 737-700 aircraft as collateral in lieu of cash.  At June 30, 2009, the fair value of fuel derivative instruments with this counterparty was a net liability of $302 million, and the Company had posted $300 million in cash collateral deposits with the counterparty, with the remaining $2 million secured by pledged aircraft.  If the fair value of fuel derivative instruments with this counterparty were in a net asset position, the counterparty would be required to post cash collateral to the Company on a dollar-for-dollar basis for amounts in excess of $40 million.  This agreement does not contain any triggers that would require additional cash to be posted by the Company outside of further changes in the fair value of the fuel derivative instruments held with the counterparty.  However, if the fair value of fuel derivative instruments with this counterparty were in a net asset position, and the counterparty’s credit rating were to be lowered to specified levels, the counterparty could be required to post cash collateral to the Company on a dollar-for-dollar basis related to the first $40 million of assets held.


 
Under another of the Company’s counterparty agreements, the Company is obligated to post collateral related to fuel derivative liabilities as follows:  (i) if the obligation is up to $125 million, the Company posts cash collateral, (ii) if the obligation is between $125 million and $625 million, the Company has pledged 29 Boeing 737-700 aircraft as collateral in lieu of cash, and (iii) if the obligation exceeds $625 million, the Company must post cash or letters of credit as collateral.  The Company pledged 29 of its Boeing 737-700 aircraft to cover the collateral posting band in clause (ii).  As of June 30, 2009, the fair value of fuel derivative instruments with this counterparty was a net liability of $399 million, and the Company had posted $125 million in cash collateral deposits to this counterparty, with the remaining $274 million secured by pledged aircraft.  This agreement also provides for the counterparty to post cash collateral to the Company on a dollar-for-dollar basis for any net positive fair value of fuel derivative instruments in excess of $150 million held by the Company from that counterparty.  This agreement does not contain any triggers that would require additional cash to be posted by the Company outside of further changes in the fair value of the fuel derivative instruments held with the counterparty.  However, if the fair value of fuel derivative instruments with this counterparty were in a net asset position, and the counterparty’s credit rating were to be lowered to specified levels, the counterparty would be required to post cash collateral to the Company on a dollar-for-dollar basis related to the first $150 million of assets held.

As of June 30, 2009, other than as described above, the Company did not have any fuel hedging agreements with counterparties in which cash collateral is required to be posted based on the Company’s current investment grade credit rating.  However, additional fuel hedging agreements contain a provision whereby each party has the right to terminate and settle all outstanding fuel contracts if the other party’s credit rating falls below investment grade.  Upon this occurrence, the party in a net liability position could subsequently be required to post cash collateral if a mutual alternative agreement could not be reached.  At June 30, 2009, the Company’s estimated fair value of fuel derivative contracts with one counterparty containing this provision was a liability of $101 million, including $29 million that will settle by the end of 2009.

Due to the Company’s current fuel hedging agreements with counterparties, in the Company’s judgment, it does not have significant exposure to future cash collateral requirements.  As an example, even if market prices for the commodities used in the Company’s fuel hedging activities were to decrease by 50 percent from market prices as of June 30, 2009, given the Company’s current fuel hedge portfolio and its investment grade credit rating, it would not have had to provide additional cash collateral to its current counterparties.

The Company classifies its cash collateral provided to counterparties in accordance with the provisions of FIN 39-1.  FIN 39-1 requires 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 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.  At June 30, 2009, of the $425 million in cash collateral deposits posted with counterparties under its bilateral collateral provisions, $374 million has been netted against noncurrent fuel derivative instruments within “Other deferred liabilities” and $51 million has been netted against current fuel derivative instruments within “Accrued liabilities” in the unaudited Condensed Consolidated Balance Sheet.


 
6.      COMPREHENSIVE INCOME (LOSS)-RESTATED

Comprehensive income (loss) includes changes in the fair value of certain financial derivative instruments, which qualify for hedge accounting, and unrealized gains and losses on certain investments.  The differences between net income (loss) and comprehensive income (loss) for the three and six months ended June 30, 2009 and 2008, were as follows:


    Three months ended June 30,  
(In millions)
 
2009
   
2008
 
   
(As restated)
       
Net income
  $ 91     $ 321  
Unrealized gain on derivative instruments,
               
net of deferred taxes of $64 and $753
    103       1,209  
Other, net of deferred taxes of $14 and ($1)
    22       (2 )
Total other comprehensive income
    125       1,207  
                 
Comprehensive income
  $ 216     $ 1,528  
                 
 
 
      Six months ended June 30,  
(In millions)
    2009       2008  
   
(As restated)
         
Net income
  $ -     $ 355  
Unrealized gain on derivative instruments,
               
net of deferred taxes of $100 and $904
    161       1,469  
Other, net of deferred taxes of $16 and ($7)
    26       (11 )
Total other comprehensive income (loss)
    187       1,458  
                 
Comprehensive income
  $ 187     $ 1,813  




 
A rollforward of the amounts included in “AOCI,” net of taxes, is shown below for the three and six months ended June 30, 2009:
 
               
Accumulated
 
   
Fuel
         
other
 
   
hedge
         
comprehensive
 
(In millions)
 
derivatives
   
Other
   
income (loss)
 
   
(As restated)
         
(As restated)
 
Balance at March 31, 2009
  $ (888 )   $ (34 )   $ (922 )
  Second quarter 2009 changes in value
    7       22       29  
  Reclassification to earnings
    96               96  
Balance at June 30, 2009
  $ (785 )   $ (12 )   $ (797 )

 
               
Accumulated
 
   
Fuel
         
other
 
   
hedge
         
comprehensive
 
(In millions)
 
derivatives
   
Other
   
income (loss)
 
   
(As restated)
         
(As restated)
 
Balance at December 31, 2008
  $ (946 )   $ (38 )   $ (984 )
  2009 changes in value
    (45 )     26       (19 )
  Reclassification to earnings
    206       -       206  
Balance at June 30, 2009
  $ (785 )   $ (12 )   $ (797 )
     

7. ACCRUED LIABILITIES-RESTATED

  
   
June 30,
   
December 31,
 
(In millions)
 
2009
   
2008
 
   
(As restated)
       
Retirement plans
  $ 97     $ 86  
Aircraft rentals
    109       118  
Vacation pay
    181       175  
Advances and deposits
    14       23  
Fuel derivative contracts
    120       246  
Deferred income taxes
    133       36  
Workers compensation
    124       122  
Other
    246       206  
Accrued liabilities
  $ 1,024     $ 1,012  



 
8.      POSTRETIREMENT BENEFITS

The following table sets forth the Company’s periodic postretirement benefit cost for each of the interim periods identified:


    Three months ended June 30,  
(In millions)
 
2009
   
2008
 
             
Service cost
  $ 4     $ 4  
Interest cost
    1       1  
Amortization of prior service cost
    1       1  
Recognized actuarial gain
    (1 )     (1 )
                 
Net periodic postretirement benefit cost
  $ 5     $ 5  



    Six months ended June 30,  
(In millions)
 
2009
   
2008
 
             
Service cost
  $ 7     $ 7  
Interest cost
    2       2  
Amortization of prior service cost
    1       1  
Recognized actuarial gain
    (1 )     (1 )
                 
Net periodic postretirement benefit cost
  $ 9     $ 9  

9.      FINANCING TRANSACTIONS

On April 29, 2009, the Company entered into a term loan agreement providing for loans to the Company aggregating up to $332 million, to be secured by mortgages on 14 of the Company’s 737-700 aircraft.  On May 6, 2009, the Company borrowed the full $332 million and secured the loan with the requisite 14 aircraft mortgages.  The loan matures on May 6, 2019, and is repayable quarterly in installments of principal beginning August 6, 2009.  The loan bears interest at the LIBO Rate (as defined in the term loan agreement) plus 3.30 percent, and interest is payable quarterly, beginning August 6, 2009.  Concurrent with its entry into the term loan agreement, the Company entered into an interest rate swap agreement that effectively fixes the interest rate on the term loan for its entire term at 6.315 percent.  The Company used the proceeds from the term loan for general corporate purposes, including the repayment of the Company’s revolving credit facility.

During May 2009, the Company fully repaid the $400 million it had previously borrowed in 2008 under its available $600 million revolving credit facility.  Therefore, as of June 30, 2009, the entire $600 million of the Company’s revolving credit facility was available for borrowing.

 

 
10.      COMMITMENTS AND CONTINGENCIES

During the first quarter and early second quarter of 2008, the Company was named as a defendant in two putative class actions on behalf of persons who purchased air travel from the Company while the Company was allegedly in violation of FAA safety regulations. Claims alleged by the plaintiffs in these two putative class actions include breach of contract, breach of warranty, fraud/misrepresentation, unjust enrichment, and negligent and reckless operation of an aircraft.  The Company believes that the class action lawsuits are without merit and intends to vigorously defend itself.  Also in connection with this incident, during the first quarter and early second quarter of 2008, the Company received four letters from Shareholders demanding the Company commence an action on behalf of the Company against members of its Board of Directors and any other allegedly culpable parties for damages resulting from an alleged breach of fiduciary duties owed by them to the Company.  In August 2008, Carbon County Employees Retirement System and Mark Cristello filed a related Shareholder derivative action in Texas state court naming certain directors and officers of the Company as individual defendants and the Company as a nominal defendant.  The derivative action claims breach of fiduciary duty and seeks recovery by the Company of alleged monetary damages sustained as a result of the purported breach of fiduciary duty, as well as costs of the action.  A Special Committee appointed by the Independent Directors of the Company has been evaluating the Shareholder demands.

The Company is from time to time subject to various other legal proceedings and claims arising in the ordinary course of business, including, but not limited to, examinations by the Internal Revenue Service (IRS).

The Company's management does not expect that the outcome in any of its currently ongoing legal proceedings or the outcome of any proposed adjustments presented to date 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, an estimated $519 million project to reconstruct Dallas Love Field with modern, convenient air travel facilities.  Pursuant to a Program Development Agreement with the City of Dallas, the Company is managing this project, and initial construction is expected to commence during late 2009, with completion scheduled for October 2014.  Bonds are expected to be issued at a later date by the Love Field Airport Modernization Corporation (a “local government corporation” under Texas law formed by the City of Dallas) that will provide funding for this project, with repayment of the bonds being made through recurring ground rents, fees, and other revenues collected by the airport.

11.      FAIR VALUE MEASUREMENTS-RESTATED

The Company adopted SFAS 157 as of January 1, 2008.  SFAS 157 establishes 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 June 30, 2009, 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, certain noncurrent investments, interest rate derivative contracts, fuel derivative contracts, and available-for-sale securities.  Cash equivalents consist of short-term, highly liquid, income-producing investments, all of which have maturities of 90 days or less, including money market funds, U.S. Government obligations, and obligations of U.S. Government backed agencies.  Short-term investments consist of short-term, highly liquid, income-producing investments, which have maturities of greater than 90 days but less than one year, including U.S. Government obligations, obligations of U.S. Government backed agencies, and certain auction rate securities.  Derivative instruments are related to the Company’s fuel hedging program and interest rate hedges.  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 derivative instruments consist of over-the-counter (OTC) contracts, which are not traded on a public exchange.  These contracts include both swaps as well as different types of option contracts.  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.  In situations where the Company obtains inputs via quotes from financial institutions, it verifies the reasonableness of these quotes via similar quotes from another financial institution as of each date for which financial statements are prepared.  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.  Due to the fact that 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’s interest rate derivative instruments also consist of OTC swap contracts.  The inputs used to determine the fair values of these contracts are obtained in quoted public markets. The Company has consistently applied these valuation techniques in all periods presented.

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.

All of the Company’s auction rate security instruments are reflected at estimated fair value in the unaudited Condensed Consolidated Balance Sheet.  At June 30, 2009, approximately $109 million of these instruments are classified as available for sale securities and $83 million are classified as trading securities. The $83 million classified as trading securities are subject to an agreement the Company entered into in December 2008, as discussed below, and are included in “Short-term investments” in the unaudited Condensed Consolidated Balance Sheet.  In periods when an auction process successfully takes place every 30-35 days, quoted market prices would be readily available, which would qualify as Level 1 under SFAS 157.  However, due to events in credit markets beginning during first quarter 2008, the auction events for most of these instruments failed, and, therefore, the Company has subsequently determined the estimated fair values of these securities utilizing a discounted cash flow analysis or other type of valuation model.  In addition, during fourth quarter 2008, the Company performed a valuation of its auction rate security instruments and considered these valuations in determining estimated fair values of other similar instruments within its portfolio.  The Company’s analyses consider, 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.  These securities were also compared, when possible, to other securities not owned by the Company, but with similar characteristics.

In association with this estimate of fair value, the Company has recorded a temporary unrealized decline in fair value of $11 million, with an offsetting entry to “AOCI.”  The Company currently believes that this temporary decline in fair value is due entirely to liquidity issues, because the underlying assets for the majority of these auction rate securities held by the Company are almost entirely backed by the U.S. Government.  In addition, for the $109 million in instruments classified as available for sale, these auction rate securities represented approximately five percent of the Company’s total cash, cash equivalent, and investment balance at June 30, 2009.  Considering the relative significance 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.  For the $83 million in instruments classified as trading securities, the Company is party to an agreement with the counterparty that allows the Company to put the instruments back to the counterparty at full par value in June 2010.  In conjunction with this agreement, the Company has applied the provisions of SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” to this put option.  Part of this agreement also contains a line of credit in which the Company can borrow up to $83 million as a loan from the counterparty that would be secured by the auction rate security instruments from that counterparty.  There were no borrowings under this provision as of June 30, 2009.  Both the put option and the auction rate instruments are being marked to market through earnings each period; however, these adjustments offset and had minimal impact on net earnings for the three and six months ended June 30, 2009.  At the time of the first failed auctions during first quarter 2008, the Company held a total of $463 million in securities.  Since that time, the Company has been able to sell $260 million of these instruments at par value in addition to the $83 million subject to the agreement to be settled at par in June 2010.

During first quarter 2009, the Company also entered into a $46 million line of credit agreement with another counterparty secured by approximately $92 million (par value) of its remaining auction rate security instruments purchased through that counterparty.  This agreement allows the Company the ability to draw against the line of credit secured by the auction rate security instruments from that counterparty.  As of June 30, 2009, the Company had no borrowings against that available line of credit.  The Company remains in discussions with its other counterparties to determine whether mutually agreeable decisions can be reached regarding the effective repurchase of its remaining securities.  The Company has continued to earn interest on virtually all of its 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.


 
The following items are measured at fair value on a recurring basis subject to the disclosure requirements of SFAS 157 at June 30, 2009:
         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices in
         
Significant
 
         
Active Markets for
   
Significant Other
   
Unobservable
 
         
Identical Assets
   
Observable Inputs
   
Inputs
 
Description
 
June 30, 2009
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Assets
 
(in millions)
 
Cash equivalents
  $ 946     $ 946     $ -     $ -  
Short-term investments
    1,252       1,222       -       103  
Noncurrent investments (a)
    89       -       -       89  
Interest rate derivatives
    50       -       50       -  
Fuel derivatives (b)
    915       -       338       577  
Other available-for-sale securities
    33       25       -       8  
Total assets
  $ 3,285     $ 2,193     $ 388     $ 777  
                                 
Liabilities
                               
Fuel derivatives (b)
  $ (1,678 )           $ (964 )   $ (714 )
(a) 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 $425 million in cash collateral provided to counterparties.
                 

 

 
The following table presents the Company’s activity for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in SFAS 157 for the three months ended June 30, 2009:


   
Fair Value Measurements Using Significant
 
   
Unobservable Inputs (Level 3)
 
   
Fuel
   
Auction Rate
   
Other
       
(in millions)
 
Derivatives
   
Securities (a)
   
Securities
   
Total
 
   
(As restated)
               
(As restated)
 
Balance at December 31, 2008
  $ (864 )   $ 200     $ 8     $ (656 )
Total gains or (losses) (realized or unrealized)
                               
  Included in earnings
    530       -       -       530  
  Included in other comprehensive income
    (80 )     -       -       (80 )
Purchases and settlements (net)
    277       (8 )     -       269  
Balance at June 30, 2009
  $ (137 )   $ 192  (b)   $ 8     $ 63  
                                 
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 June 30, 2009
  $ 523     $ -     $ -     $ 523  
                                 
(a) Includes those classified as short-term investments and noncurrent investments.
                 
(b) Includes $83 million classified as trading securities.
                         


All settlements from fuel derivative contracts that are deemed “effective,” as defined in SFAS 133, are included in “Fuel and oil” expense in the period the underlying fuel is consumed in operations.  Any “ineffectiveness” associated with derivative contracts, as defined in SFAS 133, 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 SFAS 133 and hedging.


Gains and losses (realized and unrealized) included in earnings related to other investments for the three and six months ended June 30, 2009, are reported in “Other operating expenses.”

The carrying amounts and estimated fair values of the Company’s long-term debt and fuel derivative contracts at June 30, 2009 were as follows:


(In millions)
Carrying value
 
Estimated