Edgar Filing: SOUTHWEST AIRLINES CO

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, 2012

¨	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 23, 2012: 767,684,913

TABLE OF CONTENTS TO FORM 10-Q

Part I - FINANCIAL INFORMATION
	Item 1. Financial Statements
		Condensed Consolidated Balance Sheet as of March 31, 2012 and December 31, 2011
		Condensed Consolidated Statement of Comprehensive Income for the three months ended March 31, 2012 and 2011
		Condensed Consolidated Statement of Cash Flows for the three months ended March 31, 2012 and 2011
		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. Mine Safety Disclosures
	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, 2012			December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents	$	1,558		$	829
Short-term investments		2,226			2,315
Accounts and other receivables		367			299
Inventories of parts and supplies, at cost		432			401
Deferred income taxes		219			263
Prepaid expenses and other current assets		318			238
Total current assets		5,120			4,345

Property and equipment, at cost:
Flight equipment		15,600			15,542
Ground property and equipment		2,507			2,423
Deposits on flight equipment purchase contracts		444			456
		18,551			18,421
Less allowance for depreciation and amortization		6,456			6,294
		12,095			12,127
Goodwill		970			970
Other assets		641			626
	$	18,826		$	18,068

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	1,208		$	1,057
Accrued liabilities		1,024			996
Air traffic liability		2,556			1,836
Current maturities of long-term debt		259			644
Total current liabilities		5,047			4,533

Long-term debt less current maturities		3,048			3,107
Deferred income taxes		2,638			2,566
Deferred gains from sale and leaseback of aircraft		72			75
Other noncurrent liabilities		924			910
Stockholders' equity:
Common stock		808			808
Capital in excess of par value		1,225			1,222
Retained earnings		5,486			5,395
Accumulated other comprehensive loss		(57	)		(224	)
Treasury stock, at cost		(365	)		(324	)
Total stockholders' equity		7,097			6,877
	$	18,826		$	18,068


See accompanying notes.

Southwest Airlines Co.

Condensed Consolidated Statement of Comprehensive Income

(in millions, except per share amounts)

(unaudited)

	Three months ended March 31,
	2012			2011
OPERATING REVENUES:
Passenger	$	3,744		$	2,949
Freight		37			31
Other		210			123
Total operating revenues		3,991			3,103

OPERATING EXPENSES:
Salaries, wages, and benefits		1,141			954
Fuel and oil		1,510			1,038
Maintenance materials and repairs		272			199
Aircraft rentals		88			46
Landing fees and other rentals		254			201
Depreciation and amortization		201			155
Acquisition and integration		13			17
Other operating expenses		490			379
Total operating expenses		3,969			2,989

OPERATING INCOME		22			114

OTHER EXPENSES (INCOME):
Interest expense		40			43
Capitalized interest		(5	)		(3	)
Interest income		(2	)		(3	)
Other (gains) losses, net		(170	)		59
Total other expenses		(137	)		96

INCOME BEFORE INCOME TAXES		159			18
PROVISION FOR INCOME TAXES		61			13

NET INCOME	$	98		$	5

NET INCOME PER SHARE, BASIC	$	.13		$	.01

NET INCOME PER SHARE, DILUTED	$	.13		$	.01

COMPREHENSIVE INCOME	$	265		$	346

WEIGHTED AVERAGE SHARES OUTSTANDING
Basic		771			748
Diluted		772			749

Cash dividends declared per common share	$	.0045		$	.0045

See accompanying notes.

Southwest Airlines Co.

Condensed Consolidated Statement of Cash Flows

(in millions)

(unaudited)

	Three months ended March 31,
	2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	98		$	5
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		201			155
Unrealized (gain) loss on fuel derivative instruments		(201	)		10
Deferred income taxes		14			28
Amortization of deferred gains on sale and leaseback of aircraft		(3	)		(3	)
Changes in certain assets and liabilities:
Accounts and other receivables		(68	)		(87	)
Other current assets		(51	)		(92	)
Accounts payable and accrued liabilities		225			238
Air traffic liability		720			512
Cash collateral received from derivative counterparties		147			29
Other, net		143			170
Net cash provided by operating activities		1,225			965

CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of property and equipment, net		(127	)		(57	)
Purchases of short-term investments		(621	)		(1,484	)
Proceeds from sales of short-term investments		736			1,310
Net cash used in investing activities		(12	)		(231	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Employee stock plans		5			4
Proceeds from termination of interest rate derivative instrument		-			76
Payments of long-term debt and capital lease obligations		(431	)		(30	)
Payments of cash dividends		(7	)		(7	)
Repurchase of common stock		(50	)		-
Other, net		(1	)		1
Net cash provided by (used in) financing activities		(484	)		44

NET CHANGE IN CASH AND CASH EQUIVALENTS		729			778

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		829			1,261

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	1,558		$	2,039

CASH PAYMENTS FOR:
Interest, net of amount capitalized	$	47		$	34
Income taxes	$	1		$	-
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. and its subsidiaries (the “Company”) 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, 2012 and 2011 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 and elimination of significant intercompany transactions, 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 financial results. See Note 5 for further information on fuel and the Company's hedging program. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012. 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, 2011.

Certain prior period amounts have been reclassified to conform to the current presentation. In the unaudited Condensed Consolidated Statement of Comprehensive Income for the three months ended March 31, 2011, the Company has reclassified $10 million from Other revenues to Passenger revenues associated with its sale of frequent flyer benefits from its co-branded Chase® Visa credit card.

2. AIRTRAN ACQUISITION AND RELATED MATTERS

AirTran Holdings, Inc.

On May 2, 2011 (the “acquisition date”), the Company acquired all of the outstanding equity of AirTran Holdings, Inc. (“AirTran Holdings”), the former parent company of AirTran Airways, Inc. (“AirTran Airways”), in exchange for Southwest Airlines Co. common stock and cash. Throughout this Form 10-Q, the Company makes reference to AirTran, which is meant to be inclusive of the following: (i) for periods prior to the acquisition date, AirTran Holdings and its subsidiaries, including, among others, AirTran Airways; and (ii) for periods on and after the acquisition date, AirTran Holdings, LLC, the successor to AirTran Holdings, and its subsidiaries, including among others, AirTran Airways. AirTran Airways offers scheduled airline services, using Boeing 717-200 aircraft and Boeing 737-700 aircraft, throughout the United States and to select international locations. Approximately half of AirTran Airways’ flights originate or terminate at its largest hub in Atlanta, Georgia. AirTran Airways also serves a number of markets with non-stop service from smaller bases of operation in Baltimore, Maryland; Milwaukee, Wisconsin; and Orlando, Florida. The Company believes the acquisition of AirTran positions it to respond better to the economic and competitive challenges of the industry because, among other reasons: (i) it allows the Company to offer more low-fare destinations by extending its network and diversifying into new markets, including significant opportunities to and from Atlanta, the busiest airport in the United States and the largest domestic market the Company previously did not serve, (ii) it expands the Company’s presence in slot-controlled markets (New York LaGuardia and Ronald Reagan Washington National Airport), and (iii) it provides access to near-international markets in the Caribbean and Mexico.

The accompanying unaudited Condensed Consolidated Financial Statements include the results of operations and cash flows for AirTran from May 2, 2011 through March 31, 2012. For the three months ended March 31, 2012, total operating revenues of $678 million and a net loss of $11 million are attributable to AirTran and are included in the Company’s unaudited Condensed Consolidated Statement of Comprehensive Income.

Expenses related to the AirTran acquisition

The Company is expected to continue to incur substantial integration and transition expenses in connection with the AirTran acquisition, including the necessary costs associated with integrating the operations of the two companies. While the Company has assumed that a certain level of expenses will be incurred, there are many factors that could affect the total amount or the timing of these 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, exceed the financial benefits that the Company expects to achieve from the AirTran acquisition and could continue to result in the Company taking significant charges against earnings during the integration process. For the three months ended March 31, 2012, the Company incurred consolidated acquisition and integration-related costs of $13 million, primarily consisting of consulting, technology, and facility integration expenses. In the Company’s unaudited Condensed Consolidated Statement of Comprehensive Income, these costs are classified as Acquisition and integration expenses.

Recording of assets acquired and liabilities assumed

The transaction has been accounted for using the acquisition method of accounting (“purchase accounting”), which requires, among other things, that most assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. Certain estimated values are not yet finalized (see below) and are subject to change. There were no significant fair value adjustments made during the first quarter of 2012. The Company will finalize the amounts recognized as it obtains the information necessary to complete the analyses, which will be prior to May 2, 2012. The following table summarizes the assets acquired and liabilities assumed as of the acquisition date at estimated fair value:

(in millions)	May 2, 2011
Assets
Cash and cash equivalents	$	477
Restricted cash		6
Other current assets		234
Operating property and equipment		1,154
Goodwill		970
Other identified intangibles		123
Deferred income taxes		162
Other noncurrent assets		45
Liabilities
Long-term debt and capital leases, including current portion		(1,119	)
Air traffic liability		(354	)
Other liabilities assumed		(657	)
Net assets acquired	$	1,041

The recorded amounts for assets and liabilities are provisional and subject to change. However, the Company does not expect that any future adjustments will be material. The following are the more significant items that are subject to change:

·	The fair value of specific executory contracts, pending finalization of valuation efforts; and

·	The purchase price allocable to goodwill, as a result of changes to the aforementioned item.

3. ACCOUNTING CHANGES AND NEW ACCOUNTING PRONOUNCEMENTS

On May 12, 2011, the Financial Accounting Standards Board (“FASB”) ratified Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” This ASU establishes a global standard for measuring amounts at fair value, and although it did not have a material effect on the Company’s financial position or results of operations, it did change the Company’s disclosure policies for fair value. This ASU became effective for reporting periods (including interim periods) beginning after December 15, 2011, and the Company adopted this ASU for the interim period ending March 31, 2012. See Note 10.

On June 16, 2011, the FASB ratified ASU No. 2011-05, “Presentation of Comprehensive Income.” This ASU eliminates the previous option to report other comprehensive income and its components in the statement of changes in equity. Upon adoption, other comprehensive income must be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted this ASU for the interim period ending March 31, 2012, which is the period for which it became effective for calendar year-end entities, and has elected to utilize the ‘single continuous statement’ for this interim presentation. See the unaudited Condensed Consolidated Statement of Comprehensive Income.

On September 15, 2011, the FASB ratified ASU No. 2011-08, “Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” This ASU permits an entity to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. After assessing qualitative factors, if an entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, no further testing is necessary. If an entity determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then the traditional two-step goodwill impairment test must be performed. This ASU became effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, but early adoption was permitted. Although it did not early-adopt ASU No. 2011-08 during 2011, the Company will evaluate the standard when performing its future goodwill impairment tests.

On December 16, 2011, the FASB ratified ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities.” The new disclosure requirements mandate that entities disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions subject to an agreement similar to a master netting arrangement. In addition, the standard requires disclosure of collateral received and posted in connection with master netting agreements or similar arrangements. This ASU is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. This ASU will not have a material effect on the Company’s financial position or results of operations, but will change the Company’s disclosure policies for financial derivative instruments. The Company plans to adopt this ASU for the interim period ending March 31, 2013.

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,
	2012		2011
NUMERATOR:
Net income	$	98	$	5

DENOMINATOR:
Weighted-average shares
outstanding, basic		771		748
Dilutive effect of Employee stock
options		1		1
Adjusted weighted-average shares
outstanding, diluted		772		749

NET INCOME PER SHARE:
Basic	$	.13	$	.01

Diluted	$	.13	$	.01

Potentially dilutive amounts
excluded from calculations:
Stock options		44		47
5.25% Convertible Notes		6		-

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 West Texas Intermediate crude oil, Brent 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 primarily 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. Although the use of collar structures and swap agreements 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 or swap agreement settles. With the use of purchased call options and call spreads, the Company cannot be in a liability position at settlement.

The Company evaluates its hedge volumes strictly from an “economic” standpoint and thus does not consider whether the hedges have 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. The level at which the Company is hedged for a particular period is also dependent on current market prices for that period as well as the types of derivative instruments held and the strike prices of those instruments. For example, the Company may enter into “out-of-the-money” option contracts (including catastrophic protection), which may not generate intrinsic gains at settlement if market prices do not rise above the option strike price. Therefore, even though the Company may have an “economic” hedge in place for a particular period, that hedge may not produce any hedging gains and may even produce hedging losses depending on market prices, the types of instruments held, and the strike prices of those instruments.

For first quarter 2012, the Company had fuel derivatives in place for a minimal percentage of its fuel consumption. As of March 31, 2012, the Company had fuel derivative instruments in place to provide coverage on a portion of its remaining 2012 estimated fuel consumption. The following table provides information about the Company’s volume of fuel hedging for the years 2012 through 2015 on an “economic” basis considering current market prices:

	Fuel hedged as of
	March 31, 2012
Period (by year)	(gallons in millions)
Remainder of 2012		313
2013		886
2014		330
2015		336

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’s results are subject to the possibility 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 unaudited Condensed Consolidated Statement of Comprehensive Income. Likewise, if a hedge ceases to qualify for hedge accounting, any change in the fair value of derivative instruments since the last reporting period is recorded to Other (gains) losses, net, in the unaudited Condensed Consolidated Statement of Comprehensive Income 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 2011 or during the three months ended March 31, 2012.

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 fluctuations 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. 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. The Company also examines the effectiveness of each individual hedge and 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 fuel derivatives are classified as Other 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:

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(unaudited)

		Asset derivatives				Liability derivatives
	Balance Sheet	Fair value at		Fair value at		Fair value at		Fair value at
(in millions)	location	03/31/12		12/31/11		03/31/12		12/31/11
Derivatives designated as hedges*
Fuel derivative contracts (gross)	Other current assets	$	171	$	17	$	8	$	-
Fuel derivative contracts (gross)	Other assets		361		542		53		107
Fuel derivative contracts (gross)	Accrued liabilities		24		97		-		8
Fuel derivative contracts (gross)	Other noncurrent liabilities		51		93		6		24
Interest rate derivative contracts	Other assets		58		64		-		-
Interest rate derivative contracts	Accrued liabilities		-		2		-		-
Interest rate derivative contracts	Other noncurrent liabilities		-		-		123		132

Total derivatives designated as hedges		$	665	$	815	$	190	$	271

Derivatives not designated as hedges*
Fuel derivative contracts (gross)	Other current assets	$	452	$	124	$	448	$	58
Fuel derivative contracts (gross)	Other assets		400		26		557		272
Fuel derivative contracts (gross)	Accrued liabilities		135		326		284		687
Fuel derivative contracts (gross)	Other noncurrent liabilities		21		9		75		122

Total derivatives not designated as hedges		$	1,008	$	485	$	1,364	$	1,139

Total derivatives		$	1,673	$	1,300	$	1,554	$	1,410

* 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.

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

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(unaudited)

	Balance Sheet	March 31,		December 31,
(in millions)	location	2012		2011
Cash collateral deposits provided	Offset against Other
to counterparties - noncurrent	noncurrent liabilities	$	-	$	41
Cash collateral deposits provided	Offset against Accrued
to counterparties - current	liabilities		85		185
Due to third parties for fuel contracts	Accrued liabilities		25		21
Receivable from third parties for	Accounts and other
fuel contracts	receivables		1		3

The following tables present the impact of derivative instruments and their location within the unaudited Condensed Consolidated Statement of Comprehensive Income for the three months ended March 31, 2012 and 2011:

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)	2012				2011				2012				2011				2012			2011

Fuel derivative
contracts		$	(136	)*		$	(315	)*		$	23	*		$	16	*		$	32		$	34
Interest rate
derivatives			(6	)*			(7	)*			-				-				-			-

Total		$	(142	)		$	(322	)		$	23			$	16			$	32		$	34

*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)	2012		2011		on derivatives

Fuel derivative contracts	$	(208)	$	(5)	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 March 31, 2012 and 2011 of $6 million and $31 million, respectively. 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 Comprehensive Income.

The fair values of the derivative instruments, depending on the type of instrument, were determined by the use of present value methods or option value models with assumptions about commodity prices based on those observed in underlying markets or provided by third parties. Included in the Company’s cumulative net unrealized losses from fuel hedges as of March 31, 2012, were approximately $49 million in unrealized losses, net of taxes, which are expected to be realized in earnings during the twelve months subsequent to March 31, 2012. In addition, as of March 31, 2012, the Company had already recognized cumulative net gains due to ineffectiveness and derivatives that do not qualify for hedge accounting treatment totaling $57 million, net of taxes. These net gains were recognized in first quarter 2012 and prior periods, and are reflected in Retained earnings as of March 31, 2012, but the underlying derivative instruments will not expire/settle until second quarter 2012 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 all of the Company’s, including AirTran’s, interest rate cash flow hedges for all periods presented was not material.

Credit risk and collateral

Credit exposure related to fuel derivative instruments is represented by the fair value of contracts that are an asset 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, 2012, 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, 2012, at which such postings are triggered:

Counterparty (CP)

Other(a)

Total

(in millions)

Fair value of fuel derivatives

(71

)

(21

)

159

)

184

Cash collateral held from (by) CP

(85

)

(85

)

If credit rating is investment

grade, fair value of fuel

derivative level at which:

Cash is provided to CP

(40) to (340)

0 to (125)

>(50)

>(75)

>(50)

or >(740)

or >(625)

Cash is received from CP

>75

>150

>200(c)

>125(c)

>250

Aircraft or cash can be pledged

to CP as collateral

(340) to

(125) to

N/A

(740

)(d)

(625

)(d)

If credit rating is non-investment

grade, fair value of fuel derivative

level at which:

Cash is provided to CP

(40) to (340)

0 to (125)

(b)

or >(740)

or >(625)

Cash is received from CP

(b)

Aircraft can be pledged to CP

as collateral

(340) to

(125) to

N/A

(740

)

(625

)

(a) Individual counterparties with fair value of fuel derivatives <$15 million.

(b) Cash collateral is provided at 100 percent of fair value of fuel derivative contracts.

(d) The Company has the option of providing cash or pledging aircraft as collateral. No aircraft were pledged as collateral with such counterparty as of March 31, 2012.

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, 2012, $58 million had been provided to one counterparty associated with interest rate derivatives based on the Company’s outstanding net liability derivative position with that counterparty. In addition, in connection with interest rate swaps entered into by AirTran, a total of $32 million had been provided to two counterparties at March 31, 2012, as a result of net liability derivative positions with those counterparties. The outstanding interest rate net derivative positions with all other counterparties at March 31, 2012, were assets to the Company.

Applicable accounting provisions require an entity to select a policy for 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. In the accompanying unaudited Condensed Consolidated Balance Sheet, 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.

6. COMPREHENSIVE INCOME

Comprehensive income includes changes in the fair value of certain financial derivative instruments that 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, 2012 and 2011 were as follows:

		Three months ended March 31,
(in millions)		2012		2011
NET INCOME		$	98	$	5
Unrealized gain on fuel derivative instruments, net of
	deferred taxes of $99 and $207		159		331
Unrealized gain on interest rate derivative instruments
	net of deferred taxes of $4 and $4		6		7
Other, net of deferred taxes of $2 and $2			2		3
Total other comprehensive income		$	167	$	341

COMPREHENSIVE INCOME		$	265	$	346

A rollforward of the amounts included in AOCI, net of taxes, is shown below for the three months ended March 31, 2012:

												Accumulated other
	Fuel				Interest rate							comprehensive
(in millions)	derivatives				derivatives				Other			income (loss)
Balance at December 31, 2011		$	(183	)		$	(66	)		$	25		$	(224	)
Changes in fair value			136				6				2			144
Reclassification to earnings			23											23
Balance at March 31, 2012		$	(24	)		$	(60	)		$	27		$	(57	)

7. OTHER ASSETS AND LIABILITIES

	March 31,		December 31,
(in millions)	2012		2011
Derivative contracts	$	264	$	253
Intangible assets		147		155
Non-current investments		73		97
Other		157		121
Other assets	$	641	$	626

	March 31,		December 31,
(in millions)	2012		2011
Retirement plans	$	104	$	110
Aircraft rentals		88		57
Vacation pay		253		248
Health		56		56
Derivative contracts		41		85
Workers compensation		166		162
Accrued Taxes		105		68
Other		211		210
Accrued liabilities	$	1,024	$	996

	March 31,		December 31,
(in millions)	2012		2011
Postretirement obligation	$	109	$	107
Non-current leasehold interest		301		311
Construction obligation		239		202
Other		275		290
Other non-current liabilities	$	924	$	910

8. LONG-TERM DEBT

On March 1, 2002, the Company issued $385 million of 6.5% senior unsecured notes due March 1, 2012. During 2003, the Company entered into an interest rate swap agreement to effectively convert this fixed-rate debt to a floating rate. See Note 5 for further information. The notes matured and were redeemed in full on March 1, 2012, utilizing available cash on hand.

9. COMMITMENTS AND CONTINGENCIES

Commitments

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. An additional tranche of bonds is expected to be issued in the second or third quarter of 2012.

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, 2012, the Company had incurred construction costs of $239 million, classified as both an asset as a component of Ground property and equipment and a corresponding liability as a component of Other non-current liabilities in its unaudited Condensed Consolidated Balance Sheet. Upon completion of the LFMP project, the Company expects to begin depreciating the assets over their estimated useful lives, and reduce the corresponding liabilities primarily through the Company’s airport rental payments to the City of Dallas.

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.

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, 2012, 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’s Treasury Group, which reports to the Chief Financial Officer, determines the value of option contracts utilizing an 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 provided by financial institutions that trade these contracts. The option pricing model used by the Company is an industry standard model for valuing options and is the same model used by the broker/dealer community (i.e., the Company’s counterparties). The inputs to this option pricing model are the option strike price, underlying price, risk free rate of interest, time to expiration, and volatility. Because certain 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. Volatility information is obtained from external sources, but is analyzed by the Company for reasonableness and compared to similar information received from other external sources. The fair value of option contracts considers both the intrinsic value and any remaining time value associated with those derivatives that have not yet settled. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. To validate the reasonableness of the Company’s option pricing model, on a monthly basis, the Company compares its option valuations to third party valuations. If any significant differences were to be noted, they would be researched in order to determine the reason. However, historically, no significant differences have been noted. 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 non-qualified deferred compensation plan designed to hold Employee contributions in excess of limits established by Section 415 of the Internal Revenue Code of 1986, as amended. Payments under this plan are made based on the participant’s distribution election and plan balance. Assets related to the funded portion of the deferred compensation plan are held in a rabbi trust and the Company remains liable to these participants for the unfunded portion of the plan. The Company records changes in the fair value of the liability and the asset in the Company’s earnings.

All of the Company’s auction rate security instruments, totaling $68 million at March 31, 2012, 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’s Treasury Group determines the estimated fair values of these securities utilizing a discounted cash flow analysis. 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, estimates of the next time the security is expected to have a successful auction or return to full par value, forecasted reset rates based on the London Interbank Offered Rate (“LIBOR”) or the issuer’s net loan rate, and a counterparty credit spread. To validate the reasonableness of the Company’s discounted cash flow analyses, the Company compares its valuations to third party valuations on a quarterly basis.

In association with its estimate of fair value related to auction rate security instruments as of March 31, 2012, the Company has recorded a temporary unrealized decline in fair value of $13 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. The range of maturities for the Company’s auction rate securities are from 7 years to 36 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 $382 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 continues to earn interest on 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 is other than temporary, it will record a charge to earnings as appropriate.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis at March 31, 2012 and December 31, 2011:

				Fair value measurements at reporting date using:
				Quoted prices in			Significant			Significant
				active markets			other observable			unobservable
				for identical assets			inputs			inputs
Description	March 31, 2012			(Level 1)			(Level 2)			(Level 3)
Assets	(in millions)
Cash equivalents
Cash equivalents (a)	$	1,389		$	1,389		$	-		$	-
Commercial paper		140			-			140			-
Certificates of deposit		29			-			29			-
Short-term investments:
Treasury bills		1,994			1,994			-			-
Certificates of deposit		202			-			202			-
Commercial paper		30			-			30			-
Noncurrent investments (b)
Auction rate securities		68			-			-			68
Interest rate derivatives (see Note 5)		58			-			58			-
Fuel derivatives:
Swap contracts (c)		245			-			245			-
Option contracts (c)		1,140			-			-			1,140
Swap contracts (d)		56			-			56			-
Option contracts (d)		174			-			-			174
Other available-for-sale securities		48			43			-			5
Total assets	$	5,573		$	3,426		$	760		$	1,387

Liabilities
Fuel derivatives:
Swap contracts (c)	$	(371	)	$	-		$	(371	)	$	-
Option contracts (c)		(695	)		-			-			(695	)
Swap contracts (d)		(308	)		-			(308	)		-
Option contracts (d)		(57	)		-			-			(57	)
Interest rate derivatives (see Note 5)		(123	)		-			(123	)		-
Deferred compensation		(125	)		(125	)		-			-
Total liabilities	$	(1,679	)	$	(125	)	$	(802	)	$	(752	)


(a) Cash equivalents is primarily composed of money market investments.
(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 asset, and are also net of cash collateral received from counterparties. See Note 5.
(d) 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.

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(unaudited)

				Fair value measurements at reporting date using:
				Quoted prices in			Significant			Significant
				active markets			other observable			unobservable
				for identical assets			inputs			inputs
Description	December 31, 2011			(Level 1)			(Level 2)			(Level 3)
Assets	(in millions)
Cash equivalents
Cash equivalents (a)	$	774		$	774		$	-		$	-
Commercial paper		48			-			48			-
Certificates of deposit		7			-			7			-
Short-term investments:
Treasury bills		2,014			2,014			-			-
Certificates of deposit		221			-			221			-
Commercial paper		80			-			80			-
Noncurrent investments (b)
Auction rate securities		67			-			-			67
Certificates of deposit		25			-			25			-
Interest rate derivatives (see Note 5)		66			-			66			-
Fuel derivatives:
Option contracts (c)		709			-			-			709
Swap contracts (d)		180			-			180			-
Option contracts (d)		345			-			-			345
Other available-for-sale securities		43			38			-			5
Total assets	$	4,579		$	2,826		$	627		$	1,126

Liabilities
Fuel derivatives:
Swap contracts (c)	$	(65	)	$	-		$	(65	)	$	-
Option contracts (c)		(371	)		-			-			(371	)
Swap contracts (d)		(576	)		-			(576	)		-
Option contracts (d)		(266	)		-			-			(266	)
Interest rate derivatives (see Note 5)		(132	)		-			(132	)		-
Deferred Compensation		(121	)		(121	)		-			-
Total liabilities	$	(1,531	)	$	(121	)	$	(773	)	$	(637	)


(a) Cash equivalents is primarily composed of money market investments.
(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 a net asset, and are also net of cash collateral received from counterparties. See Note 5.
(d) In the unaudited Condensed Consolidated Balance Sheet, amounts are presented as a a net liability, and are also net of cash collateral provided to counterparties. See Note 5.

The Company had no transfers of assets or liabilities between any of the above levels during the three months ended March 31, 2012 or the year ended December 31, 2011. The following table presents 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, 2012:

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(unaudited)

	Fair value measurements using significant
	unobservable inputs (Level 3)
	Fuel			Auction rate			Other
(in millions)	derivatives			securities			securities		Total
Balance at December 31, 2011	$	417		$	67		$	5	$	489
Total gains (realized or unrealized)
Included in earnings		179			-			-		179
Included in other comprehensive income		204			1			-		205
Purchases		172			-			-		172
Sales		(396	)		-			-		(396	)
Settlements		(14	)		-			-		(14	)
Balance at March 31, 2012	$	562		$	68	(a)	$	5	$	635

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, 2012	$	178		$	-		$	-	$	178

(a) Included in Other assets in the unaudited Condensed Consolidated Balance Sheet.

The significant unobservable input used in the fair value measurement of the Company’s derivative option contracts is implied volatility. Holding other inputs constant, a significant increase (decrease) in implied volatility would result in a significantly higher (lower) fair value measurement for the Company’s derivative option contracts. The significant unobservable inputs used in the fair value measurement of the Company’s auction rate securities are time to principal recovery, an illiquidity premium, and counterparty credit spread. Holding other inputs constant, a significant increase (decrease) in such unobservable inputs would result in a significantly lower (higher) fair value measurement.

The following table presents a range of the unobservable inputs utilized in the fair value measurements of the Company’s assets and liabilities classified as Level 3 for the three months ended March 31, 2012:

Quantitative information about Level 3 fair value measurements
($ in millions)
	Valuation technique	Unobservable input	Period (by year)	Range
Fuel derivatives	Option model	Implied volatility	Second Quarter 2012		16%-33	%
			Third Quarter 2012		24%-37	%
			Fourth Quarter 2012		24%-38	%
			2013		22%-36	%
			2014		21%-29	%
			2015		21%-26	%
Auction rate securities	Discounted cash flow	Time to principal recovery		7yrs-8y		rs
		Illiquidity premium			2	%
		Counterparty credit spread			1%-3	%

Southwest Airlines Co.

Notes to Condensed Consolidated Financial Statements

(unaudited)

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, 2012 and 2011.

The carrying amounts and estimated fair values of the Company’s long-term debt (including current maturities), as well as the applicable fair value hierarchy tier, at March 31, 2012, are contained in the table below. The Company’s publicly held long-term debt was classified as Level 2, because the fair value for these instruments is determined utilizing observable inputs in non-active markets. Seven of the Company’s debt agreements are not publicly held. The Company has determined the estimated fair value of this debt to be Level 3 as certain inputs used to determine the fair value of these agreements are unobservable. The Company utilizes indicative pricing from counterparties and a discounted cash flow method to estimate the fair value of the Level 3 items.

	Carrying		Estimated fair		Fair value level
(in millions)	value		value		hierachy
French Credit Agreements due 2012	$	7	$	7	Level 3
5.25% Notes due 2014		373		388	Level 2
5.75% Notes due 2016		327		355	Level 2
5.25% Convertible Senior Notes due 2016		118		115	Level 2
5.125% Notes due 2017		334		357	Level 2
Fixed-rate 717 Aircraft Notes payable through 2017 - 10.38%		66		65	Level 2
French Credit Agreements due 2018		65		65	Level 3
Fixed-rate 737 Aircraft Notes payable through 2018 - 7.02%		40		41	Level 3
Term Loan Agreement due 2019 - 6.315%		262		262	Level 3
Term Loan Agreement due 2019 - 6.84%		100		107	Level 3
Term Loan Agreement due 2020 - 5.223%		478		425	Level 3
Floating-rate 737 Aircraft Notes payable through 2020 - 2.14%		589		561	Level 3
Pass Through Certificates due 2022		402		451	Level 2
7.375% Debentures due 2027		131		144	Level 2

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

Relevant comparative operating statistics for the three months ended March 31, 2012 and 2011 are included below. The Company provides these operating statistics because they are commonly used in the airline industry and, as such, allow readers to compare the Company’s performance against its results for the prior year period, as well as against the performance of the Company’s peers. As discussed in Note 2 to the unaudited Condensed Consolidated Financial Statements, these statistics include the operations of AirTran since the May 2, 2011 acquisition date, but prior to that date only include the operations of Southwest Airlines (“Southwest”).

	Three months ended March 31,
	2012			2011			Change
Revenue passengers carried		25,560,822			21,115,115			21.1	%
Enplaned passengers		31,154,453			25,599,118			21.7	%
Revenue passenger miles (RPMs) (000s)(1)		23,684,869			19,195,885			23.4	%
Available seat miles (ASMs) (000s)(2)		30,632,893			24,505,674			25.0	%
Load factor(3)		77.3	%		78.3	%		(1.0)	pts
Average length of passenger haul (miles)		927			909			2.0	%
Average aircraft stage length (miles)		685			656