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SOUTHWEST AIRLINES REPORTS THIRD QUARTER RESULTS

Brooks
Retired Community Manager

DALLAS, TEXAS – October 18, 2012 – Southwest Airlines Co. (NYSE:LUV) (the “Company”) today reported its third quarter 2012 results.  Third quarter 2012 net income was $16 million, or $.02 per diluted share, which included $81 million (net) of unfavorable special items.  This compared to a net loss of $140 million, or $.18 loss per diluted share, in third quarter 2011, which included unfavorable special items totaling $262 million (net).  Excluding special items, third quarter 2012 net income was $97 million, or $.13 per diluted share, compared to $122 million, or $.15 per diluted share, in third quarter 2011.  This exceeded the First Call consensus estimate of $.12 per diluted share.  Operating income for third quarter 2012 was $51 million, compared to $225 million in third quarter 2011.  Excluding special items, operating income was $208 million for third quarter 2012, compared to $285 million for the same period last year.  Additional information regarding special items is included in this release and in the accompanying reconciliation tables.  

Gary C. Kelly, Chairman of the Board, President, and Chief Executive Officer, stated, “Our third quarter 2012 net income was $97 million, and operating income was $208 million, each excluding special items.  Our third quarter 2012 passenger revenues, unit revenues, and load factor were all third-quarter records and meaningful accomplishments; however, we need sustained revenue momentum to achieve our return on invested capital target. And, that is a priority.  While in line with the domestic industry, our third quarter 2012 year-over-year unit revenue growth was more sluggish than planned due to weaker demand, particularly in September. While the economy remains a significant concern, we are encouraged, thus far, by October’s bookings and revenue trends.  Thus far in October 2012, passenger unit revenues are running ahead of the comparable year ago period by approximately four percent.  For next year, we are excited about planned initiatives including the first phase of our new revenue management system.

“We have significant transformation work underway on five key strategic initiatives, and I am proud of our People and their results. The integration of AirTran into Southwest is our top priority and much progress was made in third quarter.  We have converted nine AirTran aircraft to the Southwest livery.  AirTran’s airport facilities at Seattle and Des Moines have been converted to Southwest; Key West, Florida will be converted next month; and Branson, Missouri is scheduled for March 2013.  Our April 2013 schedule, to be published next week, will reflect four more AirTran city conversions at Charlotte, North Carolina; Flint, Michigan; Portland, Maine; and Rochester, New York.  During third quarter 2012, AirTran ceased operations at six cities, while Southwest launched new service to Dayton, Akron-Canton, and Ronald Reagan Washington National Airport, which began the integration of AirTran in those cities.  We remain on track to launch connection of the two airlines’ networks early next year and significantly optimize the combined networks compared to third quarter 2012.  Seniority list integrations for seven of the eight impacted unions have been resolved.  We produced approximately $110 million in pre-tax synergies in the first nine months of 2012, and we plan for $400 million in pre-tax synergies in 2013 (excluding acquisition and integration expenses). I am very pleased with the AirTran integration results, thus far, and anticipate significant financial performance improvement from next year’s planned actions.

“Our operating costs grew in the third quarter, but much of the growth was investment related. In particular, we are in the early stages of restructuring and retrofitting our fleet to improve our unit costs and long-term financial performance.  This ‘fleet modernization’ effort is one of our strategic initiatives, and it, too, is expected to drive significant financial benefits beginning in 2013. We have retrofitted 147 Southwest 737-700s with our updated cabin interior and plan to complete all 372 -700 retrofits in first half 2013.   AirTran’s -700s are receiving the updated interior as the aircraft are converted to the Southwest livery.  We have added 26 737-800s to our fleet, with eight more deliveries scheduled for this year.   Our near-term plans call for keeping the fleet relatively flat taking into account our aircraft deliveries, 737 Classic retirements, and leases/subleases to Delta.  Overall, we anticipate our fleet modernization efforts will significantly benefit pre-tax results in excess of $700 million, annually, once fully implemented in 2015. 

“Third quarter 2012 economic fuel costs were $3.16 per gallon, which was in line with third quarter 2011. Crude oil and jet fuel prices have soared over the last several months, and our fourth quarter 2012 economic fuel costs are expected to hit an all-time high $3.45 per gallon (based on market prices as of October 15, 2012).  This is disappointing, especially given the weak economy, and we will need to more aggressively control costs in the next year.

“Our liquidity and balance sheet remain strong.  As of yesterday, total cash on hand and short-term investments were $3.5 billion, in addition to a fully available unsecured revolving credit line of $800 million.  Operating cash flow for the first nine months of this year was approximately $1.8 billion, resulting in strong free cash flow* of nearly $900 million.  During that time, we continued to return cash to our Shareholders with the repurchase of approximately 37 million shares of common stock for approximately $325 million and dividends totaling $22 million.  We also repaid $517 million of debt and capital lease obligations without refinancing.  Our debt levels are modest with debt-to-capital leverage near 40 percent, including off balance sheet aircraft leases.  We remain committed to our goals of enhancing Shareholder value, preserving our financial strength, and achieving our 15 percent pre-tax return on invested capital.”

Financial Results and Outlook

AirTran Airways, Inc. became a wholly-owned subsidiary of the Company on May 2, 2011. Results discussed in this release and provided in the accompanying unaudited Condensed Consolidated Financial Statements and Comparative Consolidated Operating Statistics include the results of operations and cash flows for AirTran beginning May 2, 2011, including the impact of purchase accounting.  Year-to-date 2011 results do not include AirTran’s results prior to the acquisition date.  However, the Company believes the analysis of specified financial results on a “combined basis” provides more meaningful year-over-year comparability.  Year-to-date 2011 financial information presented on a “combined basis” is the sum of the historical financial results of the Company and AirTran for periods prior to the acquisition date, but includes the impact of purchase accounting beginning May 2, 2011.  Supplemental financial information presented on a “combined basis” and the accompanying reconciliations are included in this release.

The Company’s total operating revenues in third quarter 2012 of $4.3 billion were comparable to third quarter 2011.  Operating unit revenues increased 0.6 percent from third quarter 2011.  Based on traffic and revenue trends thus far, the Company currently expects a solid year-over-year increase in operating unit revenues in fourth quarter 2012.

Total third quarter 2012 operating expenses were $4.3 billion, compared to $4.1 billion in
third quarter 2011.  Excluding special items in both periods, third quarter 2012 operating expenses increased 1.9 percent from third quarter 2011.  

Third quarter 2012 economic fuel costs were $3.16 per gallon, including $.03 per gallon in unfavorable cash settlements for fuel derivative contracts, compared to $3.18 per gallon in third quarter 2011, including $.02 per gallon in unfavorable cash settlements.   Based on market prices as of October 15, 2012, the Company expects fourth quarter 2012 economic fuel costs to be approximately $3.45
per gallon, including $.09 per gallon in unfavorable cash settlements for fuel derivative contracts. 
Fourth quarter 2012 premium costs, recorded in Other (gains) losses, are currently estimated to be approximately $3 million, compared to premium costs of $14 million in fourth quarter 2011 and
$36 million in fourth quarter 2010.  As of October 15, 2012, the fair market value of the Company’s hedge portfolio through 2016 was a net asset of approximately $196 million, compared to a net asset of approximately $133 million at September 30, 2012, and a net liability of $140 million at June 30, 2012.  Additional information regarding the Company’s fuel derivative contracts is included in the accompanying tables.

Excluding fuel, profitsharing, and special items in both periods, third quarter 2012 unit costs increased 6.2 percent from third quarter 2011. Based on current cost trends, the Company expects a similar year-over-year increase in its fourth quarter 2012 unit costs, excluding fuel, profitsharing and special items in both periods.  Third quarter 2012 profitsharing expense was $29 million, compared to $36 million in third quarter last year.

Operating income for third quarter 2012 was $51 million, compared to $225 million in
third quarter 2011.  Excluding special items, operating income was $208 million for third quarter 2012, compared to $285 million in third quarter 2011.  The Company incurred $145 million in special charges (before taxes) during third quarter 2012 primarily associated with the Boeing 717 lease/sublease agreement with Delta Air Lines, Inc. and Boeing Capital Corp.  Cumulative costs associated with the acquisition and integration of AirTran, as of September 30, 2012, totaled $310 million (before taxes).  The Company expects total acquisition and integration costs will be approximately $550 million. 

Other expenses for third quarter 2012 were $18 million, compared to $451 million in third quarter 2011.  This $433 million decrease primarily resulted from $10 million in other gains recognized in third quarter 2012, compared to $405 million in other losses recognized in third quarter 2011.  In both periods, these gains and losses primarily resulted from unrealized mark to market gains/losses associated with a portion of the Company’s fuel hedging portfolio, which are special items.  Excluding these special items, other losses were $18 million in third quarter 2012, compared to $36 million in third quarter 2011, primarily attributable to the premium costs associated with the Company’s fuel derivative contracts.  Net interest expense declined to $28 million in third quarter 2012, compared to $46 million in third quarter 2011, primarily as a result of the Company’s repayment of its $400 million notes in December 2011 and the redemption of its $385 million notes in March 2012. 

Total operating revenues for the nine months ended September 30, 2012 increased
11.8 percent year-over-year to $12.9 billion, while total operating expenses increased 12.5 percent year-over-year to $12.4 billion, resulting in operating income in the nine months ended September 30, 2012 of $532 million, versus $546 million for the same period last year.  Excluding special items, operating income was $702 million for the nine months ended September 30, 2012, compared to
$672 million for the same period last year.  Excluding special items and compared to combined results for the same period last year, total operating revenues for the nine months ended September 30, 2012 increased 3.4 percent, while total operating expenses increased 3.3 percent, resulting in a 5.2 percent increase in operating income for the nine months ended September 30, 2012. 

Net income for the nine months ended September 30, 2012 was $343 million, or $.45
per diluted share, compared to $26 million, or $.03 per diluted share, for the same period last year.  Excluding special items, net income for the nine months ended September 30, 2012 was
$352 million, or $.46 per diluted share, compared to $263 million, or $.34 per diluted share, for the same period last year. 

The Company’s return on invested capital (before taxes and excluding special items) was approximately seven percent for the twelve months ended September 30, 2012.  Additional information regarding pre-tax return on invested capital is included in the accompanying reconciliation tables.   

Awards and Recognitions

During third quarter 2012, Southwest Airlines was named to the 2012 Customer Service Hall of Fame by MSN Money.  Southwest also was honored for various efforts to be an employer of choice such as being recently named to the 2012 list of "Best Adoption Workplaces" by The Dave Thomas Foundation for Adoption and also being recognized by the Learning Spotlight Award by the Elliot Maises Learning 2012 Consortium for its commitment to employee training and development programs.  Southwest also was recognized as one of the Best Companies for Diversity Practices by Hispanic Business for diversity recruitment, retention, promotion, and supplier diversity.

Conference call

Southwest will discuss its third quarter 2012 results on a conference call at 12:30 p.m. Eastern Time today.  A live broadcast of the conference call will also be available at http://southwest.investorroom.com.

*See Note Regarding use of Non-GAAP financial measures

Cautionary Statement Regarding Forward-Looking Statements
This news release contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Specific forward-looking statements include without limitation statements related to (i) the Company’s financial targets and outlook and projected results of operations; (ii) the Company’s plans with respect to its acquisition of AirTran and related financial and operational goals and expectations, including without limitation anticipated integration timeframes and expected benefits and costs associated with the acquisition; (iii) the Company’s fleet plans, including its fleet modernization plans, and related financial goals and expectations; and (iv) the Company’s other strategic initiatives and related financial and operational goals and expectations. These forward-looking statements are based on the Company's current intent, expectations, and projections and are not guarantees of future performance.  These statements involve risks, uncertainties, assumptions, and other factors that are difficult to predict and that could cause actual results to vary materially from those expressed in or indicated by them.  Factors include, among others, (i) the impact of the economy on demand for the Company’s services and the impact of fuel prices, economic conditions, and actions of competitors on the Company’s business decisions, plans, and strategies; (ii) the Company’s ability to effectively integrate AirTran and realize the expected synergies and other benefits from the acquisition; (iii) the Company’s ability to timely and effectively implement, transition, and maintain the necessary information technology systems and infrastructure to support its operations and initiatives; (iv) the Company’s ability to timely and effectively prioritize its strategic initiatives and related expenditures; (v) changes in fuel prices, the impact of hedge accounting, and any changes to the Company’s fuel hedging strategies and positions; (vi) the Company’s dependence on third parties with respect to certain of its initiatives, in particular its fleet modernization plans; and (vii) other factors, as described in the Company's filings with the Securities and Exchange Commission, including the detailed factors discussed under the heading "Risk Factors" in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.