Southwest Airlines 2007 Annual Report Download - page 44

and third largest increases in Other operating expenses on
an absolute dollar basis were in Fuel taxes ($18 million, or
14.0 percent, primarily due to a 15.0 percent increase in the
unhedged cost of jet fuel per gallon and a 7.9 percent
increase in gallons consumed), and Personnel expenses
($16 million, or 11.9 percent, primarily representing hotel
and per diem costs for Pilots and Flight Attendants, pri-
marily due to a 6.2 percent increase in trips flown). Other
operating expenses per ASM increased 1.4 percent com-
pared to 2005, primarily due to the increase in revenue-
related costs, such as credit card processing fees, related to
the Company’s 20.2 percent increase in Passenger revenues.
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 per-
cent, primarily due to an increase in floating interest rates.
This was partially offset by the Company’s repayment
during 2006 of $607 million in debt. The majority of
the Company’s long-term debt is at floating rates. In addi-
tion, the Company issued $300 million in senior unsecured
notes during December 2006. See Note 7 to the Consol-
idated Financial Statements for more information. Capital-
ized 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 million,
or 78.7 percent, primarily due to an increase in rates earned
on cash and investments.
Other (gains) losses, net, primarily includes amounts recorded in accordance with the Company’s hedging activities
and SFAS 133. During 2006, the Company recorded losses related to the ineffectiveness of its hedges as well as the
decrease in market value of fuel derivative contracts that were marked to market because they didn’t qualify for SFAS 133
hedge accounting. The losses resulted from the decrease in the fair value of the Company’s portfolio of fuel derivative
instruments as commodity prices declined during the year. During 2005, the Company recorded significant gains related
to the ineffectiveness of its hedges as well as the increase in market value of fuel derivative contracts that were marked to
market because they didn’t qualify for SFAS 133 hedge accounting, as commodity prices increased during that year. The
following table displays the components of Other (gains) losses, net, for the years ended December 31, 2007 and 2006:
(In millions) 2006 2005
Mark-to-market impact from fuel contracts settling in future periods — included in Other (gains)
losses, net .............................................................. $ 42 $(77)
Ineffectiveness from fuel hedges settling in future periods — included in Other (gains) losses, net . . 39 (9)
Realized ineffectiveness and mark-to-market (gains) or losses — included in Other (gains) losses,
net................................................................... 20 (24)
Premium cost of fuel contracts included in Other (gains) losses, net....................... 52 35
Other ................................................................... (2) (15)
$151 $(90)
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, decreased to 36.8 percent in 2006
from 37.9 percent in 2005. The decrease in the 2006 rate
was due primarily to a $9 million net reduction related to
a revision in the State of Texas franchise tax law enacted
during 2006.
Liquidity and Capital Resources
Net cash provided by operating activities was
$2.8 billion in 2007 compared to $1.4 billion in 2006.
For the Company, operating cash inflows primarily are
derived from providing air transportation for Customers.
The vast majority of tickets are purchased prior to the day
on which travel is provided and, in some cases, several
months before the anticipated travel date. Operating cash
outflows primarily are related to the recurring expenses of
operating the airline. The operating cash flows in both
2007 and 2006 were also significantly impacted by fluc-
tuations in counterparty deposits associated with the
Company’s fuel hedging program (counterparty deposits
are reflected as an increase to Cash and a corresponding
increase to Accrued liabilities). There was an increase in
counterparty deposits of $1.5 billion for 2007, versus a
decrease of $410 million during 2006. The increase in
these deposits during 2007 was due to the significant
increase in fair value of the Company’s fuel derivative
portfolio from December 31, 2006, to December 31,
2007. The decrease during 2006 was due primarily to a
decrease in the fair value of the Company’s fuel derivative
instruments, as a result of a decline in energy commodity
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