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NEWSWEEK WEB EXCLUSIVE
March 15

Though other major airlines cut their schedules after the
September 11 terrorist attacks, Southwest Airlines has announced plans to
add new flights. While other carriers eliminated thousands of jobs,
Southwest announced it would add 4,000 more employees. And as other airlines
mothballed parts of their fleets, Southwest announced plans to buy more
planes. The nations seventh largest carrier seemed nearly immune to the
damage suffered by competitors as air traffic plummeted in the aftermath of
the attacks.

BUT SOUTHWEST has not emerged entirely unscathed. If more passengers dont
fill its planes this month, the low-cost Texas-based carrier may post a loss
for the first time in its 30-year history. Lately, some analysts
have downgraded the companys stock from a buy to a hold rating after
Southwest revealed traffic was lower in the first two months of 2002 than
expected. Nonetheless, the stock is trading near $20 a sharehigher than its
pre-September 11 levels. And on Wednesday, Southwest announced it will add
five new daily flights to its schedule in June in addition to the seven new
flights already added to its schedule for April and May. Optimistic analysts
at Lehman Brothers even initiated coverage of the carrier last week with a
buy rating. NEWSWEEKs Jennifer Barrett spoke with Southwests
Chief Financial Officer Gary C. Kelly about Southwests struggle to hold onto
its profits, its passengers and its personnel.

NEWSWEEK: Southwest Airlines was the only major airline not to cut its
schedule after September 11. And though your February traffic fell 4.4
percent, youve still announced plans to add a dozen more flights.. Why?

Gary C. Kelly: In September, quite honestly, we didnt know what was going to
happen. We were grounded for three days and had to cope with a host of new
security procedures, and we werent sure what impact that would
have on our operations. Ultimately, we were able to accomplish all of the
security procedures with virtually no change on our operations other than it
taking longer to process bags and customers than it did before, so we had to
add more people to deal with that. The airplanes are still operating on time
and with the same efficiency as before. We didnt choose to reduce our
capacity because we werent certain that we needed toits very expensive to
put airplanes on the ground. We do have a very low-cost structure that
enables us to offer low fares and arguably get more passengers in tough
times like this. So we know we have that inherent strength. Plus we have a
very strong balance sheet and we had a lot of cash so we were very
well-prepared for the financial distress that afflicted the industry in the
latter part of last year. We were willing to take that chance to see if
traffic would come back and would support the levels of capacity that we
were flying. That was our thinking. And we pulled it off and actually made
a little bit of money in the fourth quarter. So that pretty much validates
that that decision was a good one.

Along the same lines, the airline industry has cut about 90,000 jobs
since September 11, but your airline has not only held onto its employees,
but plans to hire 4,000 more this yearincreasing the workforce by 13
percent. Why?

We certainly didnt want to lay off any employees after September 11. Going
on 31 years of history, we have never had a lay-off. Our employees are our
asset. Thats who we are. Were in the customer-service business. We
certainly didnt want to destroy that kind of value and affect peoples lives
in that way. We are also increasing levels at some airports to make sure we
provide the best customer service we can with our new security procedures
and were growing our fleet so we need more staff to handle our new flight
activity.

What kind of losses did you experience in the aftermath of September
11?

We were hoping wed be operating quickly [after the attack], but every hour
there were delays in resolving all the security risks they had identified.
At that point, we werent sure when wed be flying again, so that
was a scary period. From September 11 through the end of the month, we lost
about $125 million. But we were still profitable for the third quarter. And,
if you exclude the federal grants we got, we still made $32 million in
the fourth quarter, which was a huge accomplishment. We have been positive
cash flow on an operating basis since mid-October, though there was a
roughly 30-day period before that when we were losing $1 million to $2
million a day. Fortunately, we stopped that bleeding pretty quickly.

How did you manage to make a profit for the fourth quarter while
other major carriers were not?

We were very concerned that we would lose big money in the fourth quarter,
that our traffic levels would be down 50 percent from where we were before.
When you have an event like September 11, there is no way to accurately
predict what will happen next. We were just gearing ourselves up for the
worst, and fortunately, as things played out for us in the fourth quarter
leading into January, our business was much better than we feared
it might be if you go back to late September. We took every possible
precaution in September to slow down the growth of the airline and slow down
the capital spending just to make sure that we werent going to be incurring
huge losses. And we didnt incur huge losses so that encouraged us to go
ahead and cautiously resume our growth beginning in February.

But with two consecutive months of lower-than-expected passenger
traffic, can you be profitable this quarter?

Its going to be a challenge this quarter. We have not changed our message to
the public that we may not be able to turn a profit here in the first
quarter primarily because January is a very weak month seasonally and the
revenue environment overall is still weak because of the economy. But we
certainly havent given up on making a profit either. Things are picking
up in March as they do seasonally, though well probably still be behind last
Marchs load factor. That was about 72 percent. Everything is contingent upon
how well we do in March, quite frankly. Seasonally now, the
January and February timeframe is typically the weakest of the year
September is the other weak monthso we dont have real high expectations
about traffic in that time period. The question for us is: What is March
going to look like?

If passenger traffic is down, why spend the money on new planes and
new routes now?

Its hard to draw any real strategic conclusions from looking at our overall
performance. You have to look at our business on a market-to-market basis,
which is what we were doing when we decided to add more airplanes.
So we do have a number of routes that will support additional aircraft.
Chicago has been a recurring theme in 2002. Weve added new flights in and
out of Chicago. Those are unique examples in our route system where we are
confident we can put those flights in and they will generate sufficient
traffic to generate a profit hopefully in the very near future. Were still
expanding at a fairly modest pace this year. Were up to 14 planes for 2002
and that is from a conservative plan arrived at in September of 11so were up
three from that plan. Normally, wed be adding 30 airplanes in a year, so
were well below what our previous pace was. But given how tough things have
been, obviously that makes sense.


Do you see much competitive pressure from startups like Jet Blue?

No, but that is explained by pointing out that the markets that most
low-fare startups have chosen are not in Southwest markets. We just dont
overlap much at all. Most of our competition comes from traditional
carriers which make up 75 to 80 percent of all traffic. They simply dominate
the U.S., so thats where the most volume of our competition comes from. We
dont have any overlap that I am aware of with Jet Blue. We have
some overlap with Airtran and some overlap with American TransAir. But
Southwest Airlines provides about 90 percent of the low-fare offerings in
the United States as well so we are far and away the largest competitor in
low fares.


When do you think air travel might pick up again?

Thats anybodys guess. The last pattern we had in the early 1990s is that it
took a good four to five years. It was really 1994 or 1995 before traffic
levels were robust and profitable for the industry after the last
major recession. Fortunately, we did well throughout that period. With the
low cost of operations and the low fares, we had growth opportunities
because the industry was not growing. We actually had record profits
throughout that time period. But business travel is a substantial segment of
our business, about half. And businesses shrinks in recessions. One of the
easiest budgets to cut is travel. It generally will take several years for
it to recover to previous levels. Thats what we have to be prepared for in
our industry this time around. It wouldnt be shocking at all if it took
three to four years from now to recover. The capacity in the industry has
been cut roughly 15 percent that means traffic is down roughly that amount.
And thats a lot. Its going to take a while to build that back. Its doubtful
it will recover this year, maybe next year. But anything is possible. Every
cycle is different and this economy seems to be pretty resilient. If
anything the recovery is occurring faster and better than what economists
thought.
 
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