Southwest Airlines 2006 Annual Report Download - page 36

believes expenditures for jet fuel could increase between
$400 million and $500 million compared to 2006, even
including the effects of fuel derivative contracts the Com-
pany has in place as of January 2007. The Company’s fuel
derivative contracts in place for 2007 provide protection
for nearly 95 percent of the Company’s expected jet fuel
consumption at an average price of approximately $50 per
barrel of crude oil. The Company once again hopes to
overcome the impact of higher anticipated 2007 fuel
prices and other cost pressures through improved reve-
nues and continued focus on non-fuel costs.
As Southwest moves into 2007, the Company
believes its low-cost competitive advantage, protective
fuel hedging position, excellent Employees, and strong
balance sheet will allow Southwest to respond quickly to
potential industry consolidation and to favorable market
opportunities. The Company plans to add 37 new
737-700 aircraft to its fleet in 2007, resulting in a net
available seat mile (ASM) capacity increase of approx-
imately eight percent. Based on these deliveries, the
Company’s fleet will total 518 737s by the end of 2007.
Results of Operations
2006 Compared With 2005
The Company’s consolidated net income for 2006
was $499 million ($.61 per share, diluted), as compared
to 2005 net income of $484 million ($.60 per share,
diluted), an increase of $15 million, or 3.1 percent.
Operating income for 2006 was $934 million, an increase
of $209 million, or 28.8 percent, compared to 2005. The
2006 increase in operating income was primarily due to
higher revenues from the Company’s fleet growth,
improved load factors, and higher fares, which more than
offset a significant increase in the cost of jet fuel. The
Company believes operating income provides a better
indication of the Company’s financial performance for
both 2006 and 2005 than does net income. This is due to
the fact that, generally, certain gains and losses, recorded
in accordance with Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instru-
ments and Hedging Activities, as amended (SFAS 133),
that relate to fuel derivatives expiring in future periods,
are included in “Other (gains) losses,” which is below
the operating income line, in both periods. In 2006, these
adjustments, which are related to the ineffectiveness of
hedges and the loss of hedge accounting for certain fuel
derivatives and are included in “Other (gains) losses,”
totaled net losses of $101 million. For 2005, these
adjustments totaled net gains of $110 million.
Operating Revenues
Consolidated operating revenues increased $1.5 bil-
lion, or 19.8 percent, primarily due to a $1.5 billion, or
20.2 percent, increase in passenger revenues. The
increase in passenger revenues primarily was due to an
increase in capacity, an increase in RPM yield, and an
increase in load factor. Approximately 45 percent of the
increase in passenger revenue was due to the Company’s
8.8 percent increase in available seat miles compared to
2005. The Company increased available seat miles as a
result of the addition of 36 aircraft (all 737-700 aircraft).
Approximately 35 percent of the increase in passenger
revenue was due to the 6.9 percent increase in passenger
yields. Average passenger fares increased 11.4 percent
compared to 2005, primarily due to less fare discounting
because of the strong demand for air travel coupled with
the availability of fewer seats as a result of industrywide
domestic capacity reductions. The remainder of the pas-
senger revenue increase primarily was due to the 2.4 point
increase in the Company’s load factor compared to 2005.
The 73.1 percent load factor for 2006 represented the
highest annual load factor in the Company’s history.
The airline revenue environment changed signifi-
cantly from the first half of 2006 to the second half of the
year. The Company believes this was due to both reduced
demand related to domestic economic factors, as well as
the effects of the increased carryon baggage restrictions
put in place following the terrorist plot uncovered by
London authorities in August 2006. The airline revenue
environment regained some momentum during late
fourth quarter 2006, and, despite growing capacity
10 percent during the quarter, the Company achieved
a record load factor of 70.2 percent at healthy yields,
which resulted in a steady unit revenue growth rate of
4.2 percent. Based upon traffic and bookings to date, the
Company expects 2007 first quarter unit revenue growth
to exceed first quarter 2006’s 9.15 cents per ASM.
Consolidated freight revenues increased slightly ver-
sus 2005. An $18 million, or 17.1 percent, increase in
freight and cargo revenues, primarily as a result of higher
rates charged, was almost entirely offset by lower mail
revenues. The lower mail revenues were primarily due to
the Company’s decision to discontinue carrying mail for
the U.S. Postal Service effective as of the end of second
quarter 2006. Due to this mid-year decision in 2006, the
Company expects a year-over-year decrease in freight
revenue for the first half of 2007. “Other revenues”
increased $30 million, or 17.4 percent, compared to
2005, primarily from higher commissions earned from
programs the Company sponsors with certain business
partners, such as the Company sponsored Chase»Visa
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