Southwest Airlines 2007 Annual Report Download - page 42

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See Note 10 to the Consolidated Financial Statements for further information on the Company’s hedging activities.
Income Taxes
The provision for income taxes, as a percentage of
income before taxes, increased to 39.0 percent in 2007
from 36.8 percent in 2006. The higher 2007 rate
included an $11 million ($.01 per share, diluted) net
addition related to a revision in Illinois income tax laws
enacted in 2007. The 2006 rate included a $9 million net
reduction related to a revision in the State of Texas
franchise tax law enacted during 2006. The Company
currently expects its 2008 effective tax rate to be between
36 and 37 percent. The lower expected 2008 rate is
primarily due to the January 2008 reversal of the 2007
Illinois tax law change, that resulted in the $11 million
tax increase. The Company currently expects to reverse
the $11 million net charge during first quarter 2008.
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 due primarily 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. In both
2006 and 2005, the Company recognized adjustments
related to the ineffectiveness of hedges and the loss of
hedge accounting for certain fuel derivatives, which are
included in “Other (gains) losses.” For 2006, these
adjustments totaled net losses of $101 million. For
2005, these adjustments totaled net gains of $110 million.
Operating Revenues
Consolidated operating revenues increased
$1.5 billion, or 19.8 percent, almost entirely due to a
$1.5 billion, or 20.2 percent, increase in passenger rev-
enues. The increase in passenger revenues was due pri-
marily 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
737-700 aircraft. Approximately 35 percent of the
increase in passenger revenue was due to a 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 strong demand
for air travel coupled with the availability of fewer seats as
a result of industrywide domestic capacity reductions.
The remainder of the passenger revenue increase was due
primarily to the 2.4 point increase in the Company’s load
factor compared to 2005.
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 unit revenue growth rate of
4.2 percent.
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 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. “Other revenues” increased $30 million, or
17.4 percent, compared to 2005, primarily from higher
commissions earned from programs the Company spon-
sors with certain business partners, such as the Company
sponsored Chase»Visa card.
Operating Expenses
Consolidated operating expenses for 2006 increased $1.3 billion, or 18.9 percent, compared to the 8.8 percent
increase in capacity. Historically, changes in operating expenses for airlines are typically driven by changes in capacity, or
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