But Southwest has not emerged entirely unscathed. If more passengers don’t 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 company’s 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 share-higher 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. NEWSWEEK’s Jennifer Barrett spoke with Southwest’s Chief Financial Officer Gary C. Kelly about Southwest’s 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, you’ve still announced plans to add a dozen more flights.. Why?
Gary C. Kelly: In September, quite honestly, we didn’t 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 weren’t 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 didn’t choose to reduce our capacity because we weren’t certain that we needed to–it’s 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 year–increasing the workforce by 13 percent. Why?
We certainly didn’t 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. That’s who we are. We’re in the customer-service business. We certainly didn’t want to destroy that kind of value and affect people’s 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 we’re 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 we’d 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 weren’t sure when we’d 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 weren’t going to be incurring huge losses. And we didn’t 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?
It’s 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 haven’t given up on making a profit either. Things are picking up in March as they do seasonally, though we’ll probably still be behind last March’s 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 month–so we don’t 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?
It’s 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. We’ve 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. We’re still expanding at a fairly modest pace this year. We’re up to 14 planes for 2002 and that is from a conservative plan arrived at in September of 11–so we’re up three from that plan. Normally, we’d be adding 30 airplanes in a year, so we’re well below what our previous pace was. But given how tough things have been, obviously that makes sense.
What types of incentives are you offering to attract passengers?
Business travelers are not generally motivated by any promotional act we do. We have always had a strong contingent of business travelers and we continue to have that today. On the leisure front, vacationers will definitely be stimulated by pricing. We have been aggressive since late September in offering a variety of sales. Our specialty is low fares and this is an environment where actually we can do quite well. We can continue to grow even if we are only eking out a small profit–that’s certainly better than no profit. The fact that our competition is not growing–and, in fact, shrinking–that gives us the obvious boost in traffic and growth opportunities. We’re able to do this because our operating costs are so much lower.
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 don’t 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 that’s where the most volume of our competition comes from. We don’t 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.
You seem to get a lot of your revenues from online ticket sales. When did your Web site launch and how much have online ticket bookings grown since the site launched?
It launched in 1996 and it has grown to be 40 percent of our revenues for the full year of 2001. Now the current pace is closer to 50 percent, so it’s a very substantial part of our revenues.
You have declined to participate in other low-fare Web sites. Why?
We do not participate in any other online agency. The only place you can get Southwest tickets online is at Southwest.com. I think there are a variety of issues there. Certainly, controlling the costs is one. We just don’t want to be controlled by other entities. If the scenario played out that 90 percent of our tickets were sold through another source, an intermediary, than they have tremendous leverage on what they can charge you. We have always tried to be as independent as we can. That goes back to pre-Internet days. We had a relatively small percentage of our tickets sold through travel agents because we don’t pay commissions. It’s just an extension of a policy we have had for 30 years. The fact that we have such success with southwest.com really validates that strategy in my mind.
When do you think air travel might pick up again?
That’s anybody’s 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. That’s what we have to be prepared for in our industry this time around. It wouldn’t 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 that’s a lot. It’s going to take a while to build that back. It’s 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.
