Southwest Airlines 2006 Annual Report Download - page 38

The Company has benefited from the recent decline
in energy prices and is currently 100 percent protected
with fuel derivative instruments for its first quarter 2007
jet fuel purchase requirements. These instruments are at
an average crude oil equivalent price of $50 per barrel,
and the majority of these positions effectively perform
like option contracts — allowing the Company to benefit
in most cases from energy price decreases. Based on this
protection and current market conditions, the Company
expects its first quarter 2007 jet fuel cost per gallon to be
in the $1.65 to $1.70 range, excluding the impact of any
hedge ineffectiveness and derivatives that do not qualify
for hedge accounting as defined in SFAS 133. As of mid-
January 2007, the Company had fuel derivative contracts
in place for approximately 95 percent of its expected fuel
consumption for the remainder of 2007 at approximately
$50 per barrel; 65 percent in 2008 at approximately $49
per barrel; over 50 percent in 2009 at approximately
$51 per barrel; over 25 percent in 2010 at $63 per barrel;
approximately 15 percent in 2011 at $64 per barrel, and
15 percent in 2012 at $63 per barrel.
Maintenance materials and repairs per ASM
decreased 1.9 percent compared to 2005, primarily
due to a decrease in repair events for aircraft engines.
Based on the number of scheduled repair events for both
engines and airframes in first quarter 2007, the Company
expects an increase in maintenance materials and repairs
per ASM compared to the 2006 figure of 51 cents.
Aircraft rentals per ASM decreased 10.5 percent.
The Company’s 8.8 percent increase in ASMs was gen-
erated by the 36 aircraft the Company acquired during
2006, all of which were purchased. The number of
aircraft on operating lease remained the same. The Com-
pany currently expects a similar year-over-year compar-
ison for first quarter 2007.
Landing fees and other rentals per ASM was flat
compared to 2005. The Company currently expects a
year-over-year increase in landing fees and other rentals
per ASM for first quarter 2007 primarily due to higher
rates paid for airport space.
Depreciation expense per ASM increased 1.8 per-
cent, primarily due to an increase in depreciation expense
per ASM from 36 new 737-700 aircraft purchased during
2006 and the resulting higher percentage of owned air-
craft. The Company currently expects a similar year-o-
ver-year comparison for first quarter 2007.
Other operating expenses per ASM increased
1.4 percent compared to 2005, primarily due to an
increase in revenue-related costs, such as credit card
processing fees, from the Company’s 20.2 percent
increase in passenger revenues. The Company currently
expects a similar year-over-year comparison for first
quarter 2007.
Other
“Other expenses (income)” included interest
expense, capitalized interest, interest income, and other
gains and losses. Interest expense increased by $6 million,
or 4.9 percent, primarily due to an increase in floating
interest rates. This was partially offset by the Company’s
repayment of $607 million in debt during 2006. The
majority of the Company’s long-term debt is at floating
rates. In addition, the Company issued $300 million in
senior unsecured notes during December 2006. Exclud-
ing the effect of any new debt offerings the Company may
execute during 2007, the Company expects a reduction in
interest expense compared to 2006, primarily due to a
lower average debt balance. See Note 7 to the Consol-
idated Financial Statements for more information. Cap-
italized interest increased $12 million, or 30.8 percent,
compared to 2005 due to higher 2006 progress payment
balances for scheduled future aircraft deliveries as well as
higher interest rates. Interest income increased $37 mil-
lion, or 78.7 percent, primarily due to an increase in rates
earned on cash and investments.
During 2006, the Company recognized approxi-
mately $52 million of expense related to amounts
excluded from the Company’s measurements of hedge
effectiveness (i.e., the premium cost of fuel derivative
option contracts.) Also during 2006, the Company rec-
ognized approximately $101 million of additional
expense in “Other (gains) losses, net,” related to the
ineffectiveness of its hedges and the loss of hedge
accounting for certain contracts. In the second half of
2006, both current and forward prices for the commod-
ities Southwest uses for hedging jet fuel fell significantly,
resulting in a reduction in the unrealized gains the
Company had experienced in prior periods. Of this
additional expense, approximately $42 million was unre-
alized, mark-to-market changes in the fair value of deriv-
atives due to the discontinuation of hedge accounting for
certain contracts that will settle in future periods; approx-
imately $39 million was ineffectiveness associated with
the change in value of hedges designated for future
periods; and $20 million was ineffectiveness and
mark-to-market losses related to the change in value of
contracts that settled during 2006. See Note 10 to the
consolidated financial statements for further information
on the Company’s hedging activities. For 2005, the
Company recognized approximately $35 million of
expense related to amounts excluded from the Company’s
measurements of hedge effectiveness and $110 million in
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