How did Southwest's profitability change in 2006?

Net income rose to $499 million, or $.61 per diluted share, from $484 million, or $.60 per diluted share, in 2005. Operating income increased $209 million, or 28.8 percent, to $934 million, driven by higher revenues from fleet growth, improved load factors and higher fares, which more than offset a significant increase in jet fuel costs. The company noted that operating income gives a better indication of performance than net income because certain fuel derivative gains and losses under SFAS 133 are recorded below the operating income line.

What is the main cost pressure facing Southwest?

Fuel. Fuel and oil expense was $2.14 billion in 2006 versus $1.34 billion in 2005, and fuel accounted for about 26 percent of operating expenses. Fuel and oil expense per ASM rose 46.2 percent. Although hedging produced $675 million in cash settlements in 2006, the average cost per gallon still increased 48.5 percent. The company expects 2007 jet fuel expenditures to rise $400 million to $500 million compared with 2006, even including its hedge positions.

How well hedged is Southwest for 2007 and beyond?

As of mid-January 2007, fuel derivative contracts covered approximately 95 percent of expected consumption for the remainder of 2007 at about $50 per barrel, 65 percent of 2008 at about $49 per barrel, and over 50 percent of 2009 at about $51 per barrel. Coverage for 2010 through 2012 was lower, at 25 to 15 percent. The fair value of fuel derivatives was a net asset of $999 million at December 31, 2006, down from $1.7 billion a year earlier.

What labor and regulatory risks does the filing identify?

Approximately 82 percent of employees were represented by unions under ten collective bargaining agreements. The pilots' agreement with the Southwest Airlines Pilots' Association became amendable in September 2006, and discussions on a new agreement had recently begun. The Wright Amendment Reform Act of 2006 substantially repeals restrictions on Dallas Love Field in 2014 and reduces the maximum number of gates there from 32 to 20. The filing also notes that federal war-risk insurance coverage was extended to August 31, 2007, and the company cannot predict whether it will be extended further.

What is Southwest's capital allocation and growth plan?

Southwest took delivery of 36 737-700 aircraft in 2006 and plans 37 new 737-700 deliveries in 2007, for a fleet of 518 737s by year-end and an ASM capacity increase of about eight percent. Firm aircraft purchase commitments total approximately $3.1 billion. In 2006 the company repurchased 49.1 million shares for $800 million under three programs totaling $1.0 billion, and it paid quarterly dividends of $.0045 per share. Capital expenditures are primarily aircraft-related, financed partly by cash flow from operations, which was $1.4 billion in 2006.

LUV 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 1, 2007. Cited figures are marked; the original filing is the authoritative source.

Southwest Airlines Co. reported 2006 net income of $499 million^a ($.61 per diluted share), up $15 million, or 3.1 percent, from $484 million in 2005.

Operating income rose $209 million^b, or 28.8 percent, to $934 million on operating revenues of $9.09 billion, up 19.8 percent. Passenger revenue yield per RPM increased 6.9 percent and the load factor reached a company record 73.1 percent. Operating expenses rose 18.9 percent, driven primarily by jet fuel: the average cost per gallon was $1.53, up 48.5 percent from 2005, and fuel and oil expense was $2.14 billion.

Fuel hedging produced cash settlements of $675 million^c in 2006 and a reduction to fuel expense of $634 million, while net losses of $101 million in Other (gains) losses reflected hedge ineffectiveness and loss of hedge accounting. The company stated it expects 2007 jet fuel expenditures to rise between $400 million and $500 million over 2006, with about 95 percent of expected 2007 fuel consumption hedged at roughly $50 per barrel of crude oil equivalent. Southwest plans to add 37 737-700 aircraft in 2007, for a net ASM capacity increase of approximately eight percent and a fleet of 518 737s by year-end.

Cash flow from operations was $1.4 billion^d in 2006, down from $2.1 billion in 2005, and the company repurchased $800 million of common stock under $1.0 billion of authorized programs. Year-end cash and short-term investments totaled $1.8 billion. The filing also highlights risks including fuel price volatility, labor contract negotiations (the pilots' agreement became amendable in September 2006 and talks had recently begun), the Wright Amendment Reform Act of 2006 affecting Dallas Love Field, the August 2006 security restrictions that the company estimated cost more than $40 million in passenger revenue in August and September, and the December 2005 Chicago Midway accident (Flight 1248), for which the company stated it expects coverage by insurance.

02—Key points

Key Highlights

Net income of $499 million ($.61 per diluted share) in 2006, up $15 million, or 3.1 percent, from 2005; operating income of $934 million, up 28.8 percent.
Total operating revenues of $9.09 billion, up 19.8 percent, driven by a 20.2 percent increase in passenger revenues and a record 73.1 percent load factor.
Average jet fuel cost rose to $1.53 per gallon, up 48.5 percent; fuel and oil expense reached $2.14 billion, with hedging reducing fuel expense by $634 million.
Other (gains) losses included net losses of $101 million from hedge ineffectiveness and loss of hedge accounting on certain fuel derivatives.
Management expects 2007 jet fuel expenditures to increase between $400 million and $500 million over 2006, with about 95 percent of expected 2007 consumption hedged at roughly $50 per barrel.
Plans to add 37 737-700 aircraft in 2007 for an approximately eight percent increase in ASM capacity, reaching 518 737s by year-end.
Repurchased $800 million of common stock in 2006 and issued $300 million of 5.75% senior unsecured notes due 2016; cash and short-term investments totaled $1.8 billion at year-end.

03—Questions

Frequently Asked Questions

How did Southwest's profitability change in 2006?
Net income rose to $499 million, or $.61 per diluted share, from $484 million, or $.60 per diluted share, in 2005. Operating income increased $209 million, or 28.8 percent, to $934 million, driven by higher revenues from fleet growth, improved load factors and higher fares, which more than offset a significant increase in jet fuel costs. The company noted that operating income gives a better indication of performance than net income because certain fuel derivative gains and losses under SFAS 133 are recorded below the operating income line.
What is the main cost pressure facing Southwest?
Fuel. Fuel and oil expense was $2.14 billion in 2006 versus $1.34 billion in 2005, and fuel accounted for about 26 percent of operating expenses. Fuel and oil expense per ASM rose 46.2 percent. Although hedging produced $675 million in cash settlements in 2006, the average cost per gallon still increased 48.5 percent. The company expects 2007 jet fuel expenditures to rise $400 million to $500 million compared with 2006, even including its hedge positions.
How well hedged is Southwest for 2007 and beyond?
As of mid-January 2007, fuel derivative contracts covered approximately 95 percent of expected consumption for the remainder of 2007 at about $50 per barrel, 65 percent of 2008 at about $49 per barrel, and over 50 percent of 2009 at about $51 per barrel. Coverage for 2010 through 2012 was lower, at 25 to 15 percent. The fair value of fuel derivatives was a net asset of $999 million at December 31, 2006, down from $1.7 billion a year earlier.
What labor and regulatory risks does the filing identify?
Approximately 82 percent of employees were represented by unions under ten collective bargaining agreements. The pilots' agreement with the Southwest Airlines Pilots' Association became amendable in September 2006, and discussions on a new agreement had recently begun. The Wright Amendment Reform Act of 2006 substantially repeals restrictions on Dallas Love Field in 2014 and reduces the maximum number of gates there from 32 to 20. The filing also notes that federal war-risk insurance coverage was extended to August 31, 2007, and the company cannot predict whether it will be extended further.
What is Southwest's capital allocation and growth plan?
Southwest took delivery of 36 737-700 aircraft in 2006 and plans 37 new 737-700 deliveries in 2007, for a fleet of 518 737s by year-end and an ASM capacity increase of about eight percent. Firm aircraft purchase commitments total approximately $3.1 billion. In 2006 the company repurchased 49.1 million shares for $800 million under three programs totaling $1.0 billion, and it paid quarterly dividends of $.0045 per share. Capital expenditures are primarily aircraft-related, financed partly by cash flow from operations, which was $1.4 billion in 2006.

04—Continue

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