Southwest Airlines 2014 Investor...

Southwest Airlines 2014 Investor Day November 10th Training and Operations Support Building

Our Investor Day presentations contain 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. Forward-looking statements are based on, and include statements about, the Company’s estimates, expectations, beliefs, intentions, and strategies for the future, and are not guarantees of future performance. Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include without limitation statements related to (i) the Company’s fleet plans, including its fleet modernization plans, and the Company’s related financial and operational expectations; (ii) the Company’s strategic vision and objectives and its related operational, financial, and competitive opportunities and expectations; (iii) the Company’s network plans and expectations; (iv) the Company’s financial outlook, including its projected results of operations and anticipated liquidity, and (v) the Company’s expectations related to fuel prices. Forward-looking 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) demand for the Company’s services and the impact of economic conditions, fuel prices, actions of competitors (including, without limitation, pricing, scheduling, and capacity decisions and consolidation and alliance activities), and other factors beyond the Company’s control, on the Company’s business decisions, plans, and strategies; (ii) the Company’s ability to timely and effectively prioritize its strategic initiatives and related expenditures; (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 impact of governmental regulations and other actions related to the Company’s operations; (v) the Company’s dependence on third parties with respect to certain of its initiatives; and (vi) 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, 2013.

Safe Harbor

2014 Investor Day Purpose, Vision, and Objectives Gary Kelly

Southwest Airlines’ Purpose & Vision are clearly

defined

In 2014, we…

• began flying Southwest branded aircraft outside the continental

United States

• won rights to significantly expand at Washington Reagan and

LaGuardia

• unveiled a new aircraft livery, named Heart

• opened our Training and Operations Support Building (TOPS)

• launched nonstop service from Love Field with the repeal of the

Wright Amendment

• continued modernizing our fleet with new 737-800 deliveries,

while retiring Classic 737s and AirTran’s 717s

• continued to grow our Rapid Rewards program

• delivered a 19% pre-tax ROIC1 – well beyond our target of 15%

• will complete the AirTran integration

1For the twelve months ended September 30, 2014; excluding special items. ROIC is a non-GAAP financial measure. See Appendix for reconciliation to the most comparable GAAP measure.

Our major strategic initiatives delivered significant value

AirTran acquisition

& integration

EBIT contribution: 2013: $300mm 2014: $500mm 2015: $700mm

Fleet modernization

& 737-800s

$600mm incremental

revenue since launch of program

All-New Rapid

Rewards Program

Expect hundreds of millions

incremental revenue

International

capabilities & new

reservation system

>$400mm annual pre-tax net synergies

= = =

19.0% pre-tax ROIC4

1 Excluding acquisition and integration expenses. 2 Expected. 3 Expected from inception of program through the end of 2014. 3 For the twelve months ended September 30, 2014; excluding special items. ROIC is a non-GAAP financial measure. See Appendix for reconciliation to the most comparable GAAP measure.

2

2

1

3

Financial

• +$2.6B in Revenue1

• >$400M2 in annual net synergies

• Significant contributor to ROIC and

SWA stock price performance

AirTran strengthened financial performance, expanded our

network, and accelerated international entry

Network / Fleet

• Added 52 737-700s3 and 88 717s

• +24B ASMs1 (~25 percent)

• Expansion from 72 to 93 cities

• Gained entry into ATL, DCA, near-international

and added to LGA slots

• Extended SWA Cargo to AirTran network

1As of acquisition date, May 2, 2011 2 Excluding acquisition and integration expenses 3 Expected by yearend 2014

Southwest Cities

AirTran Additions

Fleet modernization efforts and the 737-800 lowered unit costs

and improved EBIT

• Improves revenue with more seats

per departure

• Lowers unit costs by adding seats

• Reduces fuel burn & greenhouse gas

emissions

• Enhances customer experience with

updated aircraft interiors

• Perpetuates the common 737 fleet

strategy

CASM1 Benefit

(0.15)

(0.64)

(0.94)

(1.17) (1.49)

(0.99)

(0.49)

0.02

2012 2013 2014 2015

$70

$300

$500

$700

$0

$200

$400

$600

$800

2012 2013 2014 2015

Mil

lio

ns

EBIT Benefit

in c

en

ts

1Excluding special items.

Rapid Rewards program delivered significant value and is

recognized as the one of best in the industry

• Best Customer Service

Freddie Awards 2013 & 2014

• Best Affinity Credit Card

Freddie Awards 2013 & 2014

Incremental Revenue1

~$600mm

2013 2012 2014 2011

1 Incremental revenue since inception of the new Rapid Reward program.

Since launch:

• Over 50% growth in membership

• Over 150% increase in Tier

Membership (A-List & A-list

Preferred)

• Co-brand credit card portfolio and

spend has significantly

accelerated

• Over 70% growth in partners

Award-winning frequent flyer program

• Best Airline Rewards Program

US News & World Report 2014-2015

• Best Award Availability

SwitchFly Worldwide Report on Airline

Award Availability 2012 - 2014

International reservation system enabled Southwest Airlines

flights beyond the Lower 48

AUA

SJD CUN

SJO

NAS

SJU PUJ

MBJ MEX

New daily non-stop service to Puerto Vallarta, Mexico from

Orange County, California

AUA

SJD

MEX

CUN

SJO

NAS

SJU PUJ

MBJ PVR

Operate Date1: June 7, 2015

1 Pending government approvals.

Wright Amendment was repealed in October 2014

Same Heart, New Look

Our vision: to be most flown, most loved, most profitable airline

Unparalleled

Domestic Network

Superior Financial

Position

• Significant cost advantage vs network carriers

• Highly competitive costs with low cost carriers

• Aggressive management of invested capital and disciplined capital

deployment strategy

• Managed capacity growth with commitment to strong earnings and

ROIC

• Low Fares and More

• Exceptional relationship with Customers - Fans

• Passionate Employees delivering friendly Customer Service

• Industry-leading frequent flyer program

• Carry the most passengers in the U.S.

• Most daily departures in the world

• Serve 79 of the top 100 domestic cities1

• Significant growth opportunities, including near-international

Compelling

Brand Appeal

1 Based on domestic origin and destination passengers; sourced from the Department of Transportation for the twelve months ended March 31, 2014.

OPERATIONAL

EXCELLENCE

EXPERIENCE OF

OUTSTANDING

CUSTOMER SERVICE

SUPERIOR FINANCIAL

PERFORMANCE

MANAGED CAPACITY

GROWTH

Annual Objectives support our Purpose & Vision

2014 Investor Day 2015 Objectives Tammy Romo

We are focused on 4 objectives in 2015

HIGH QUALITY

GROWTH

OPPORTUNITIES

CONTINUED REVENUE

MOMENTUM

LOW COST LEADER

SUPERIOR FINANCIAL

POSITION

Strong

Return on

Investment

2015 Available Seat Mile growth is driven by more efficient

flying of our existing fleet through increased gauge and stage

length with a modest increase in trips

YoY

Trips +1%

Seats per Trip +2%

Stage length +3%

ASM Growth +6%

Majority of 2015 ASM YoY growth is funded through integration-

related tailwinds

Seats Flown +3%

2015 growth is targeted on compelling, high quality

opportunities

1 Numbers are summarized and approximate.

Expect these development markets to ramp up quickly

3%

2%

1%

0%

1%

2%

3%

4%

5%

6%

2015

International

Slot acquisitions

Dallas Love Field AS

M g

row

th (

Yo

Y)1

6%

Underutilized fleet during periods of transition and upgauging

Opportunity to regain utilization with existing fleet

560

580

600

620

640

660

680

700

720

2011 2012 2013 2014

Aircraft on property Aircraft available for service

Air

cra

ft

1 Aircraft in Company’s fleet at period end, including Boeing 717-200s not yet transitioned out of the Company’s fleet.

1

Operating revenues are estimated to grow over 50% since 2010

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

$20,000

2010 2011 2012 2013 2014E

To

tal o

pe

rati

ng

re

ve

nu

e

(in

millio

ns

)1

Operating margin,

non-GAAP 9.6% 5.4% 4.9% 8.2%

Revenue momentum is expected to continue, as is margin expansion

12-13%

Operating income, non-GAAP Operating revenue +

1 Includes AirTran as of May 2, 2011.

We are benefitting from the significant drop in fuel prices

$2.39

$3.19 $3.28

$3.12

$2.90 - $2.95

$2.00

$2.20

$2.40

$2.60

$2.80

$3.00

$3.20

$3.40

2010 2011 2012 2013 2014E

E

co

no

mic

fu

el co

st

per

gallo

n

(in

clu

din

g t

axes)1

,2

Based on the current forward curve and assuming today’s hedges,

2015 economic fuel price per gallon would be in the $2.60-$2.70

range, including fuel taxes

1 Economic fuel price per gallon is a non-GAAP financial measure. See Appendix for a reconciliation to the most comparable GAAP measure. 2 Includes AirTran as of May 2, 2011.

68.5 68.3

69.4

71.7

72.8

66.0

67.0

68.0

69.0

70.0

71.0

72.0

73.0

74.0

2010 2011 2012 2013 2014E

Consolidated Fuel Efficiency

Fuel efficiency has improved since 2010

+6.3%

A

SM

s p

er

ga

llo

n1

We expect continued fuel burn improvement in 2015

1 Includes AirTran as of May 2, 2011.

Excluding fuel, our cost trends are benefitting from our diligent

cost control efforts

Un

it c

ost

gro

wth

(Y

oY

)

(exclu

din

g f

uel, p

rofi

tsh

ari

ng

, an

d s

pecia

l it

em

s)1

,2

Excluding fuel & oil, profitsharing, and special items, 2015 CASM is

currently expected to decline 1% to 2%, as compared to 2014 1 CASM excluding fuel, profitsharing, and special items is a non-GAAP financial measure. See Appendix for a reconciliation to the most comparable GAAP measure. 2 Includes AirTran as of May 2, 2011.

6.7%

-1.1%

4.1%

1.3%

~2.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2010 2011 2012 2013 2014E

41%

18%

59%

82%

2010 2015

CL/717 NG 700/800

Fleet Modernization provides ongoing unit cost benefit

Substantial CASM benefit as seats increase.

134

12.9 134

147

2010 2015

Baseline Addl. Seat per Trip

Lower operating expense from more modern fleet.

Aircraft Mix Seats per Trip

Absent the Fleet Modernization initiative, 2015 CASM would be

approximately 10% higher

+13 seats

+23pt

100%

Southwest’s CASM is among the lowest in the industry

Source: DOT Form 41 and DOT T100 domestic mainline data for the 12 months ended June 30, 2014. Stage-length adjusted for Southwest’s average stage length.

0.0

5.0

10.0

15.0

20.0

25.0

United

Delta

Am

erican

Vir

gin

Am

eri

ca

Ala

ska

JetB

lue

Haw

aiia

n

Fro

ntier

South

west

Alle

gia

nt

Spir

it

U

nit

co

sts

We have maintained our historical industry cost advantage

Source: DOT Form 41 and DOT T100 domestic mainline data for the 12 months ended June 30, 2014. Stage-length adjusted for Southwest’s average stage length.

2010 YE 2Q 2014

32%

13%

(4%)

28%

14%

(8%) -10%

0%

10%

20%

30%

40%

Network LCC ULCC Network LCC ULCC

Rela

tiv

e c

ost

ad

van

tag

e / (

dis

ad

van

tag

e)

$0.4 $0.7

$1.0 $1.4

$1.3 $0.8

$1.1

$1.4

$2.3 $1.9

$1.8

$1.7

$0.8

$0.8

$1.0

$1.0

$0.0

$1.0

$2.0

$3.0

$4.0

$5.0

$6.0

2011 2012 2013 3Q14 4Q14 2015 -2016

2017 -2018

Beyond2018

Undrawn revolving credit facility

Short-term investments

Beginning cash

Free cash flow

Sources of liquidity and long-term debt maturities

1 Free cash flow (FCF) is a non-GAAP financial measure. See Appendix for a reconciliation to the most comparable GAAP measure. 2 2011, 2012 and 2013 debt maturities consist of payments of long-term debt and capital lease obligations, and payments of convertible debt per the Company’s cash flows from financing activities ending December 31, 2013; 2014 and

beyond include future long-term debt principal payment obligations and capital lease commitments as of December 31, 2013. 3 Total maturity from 4Q14 and beyond is calculated based on future long-term debt principal payment obligations and capital lease commitments as of September 30, 2014. 4 For the nine month period ending September 30, 2014. 5 2014 includes $68 million associated with the Company’s convertible senior notes due 2016.

1

Long-term debt maturities2

$4.8B

$4.2B

$4.9B

Total long-term debt maturity of

$2.7B3 from 4Q14 and beyond

$5.5B

4 5

(in

billio

ns)

1

$388 $716

$1,030 $1,358

$968

$1,348

$1,447

$1,340

2011 2012 2013 3Q14FCF Capex

$2,698

$1,356

$2,064

$2,477

Strong internally-generated cash flow C

as

h flo

w fro

m o

pe

ratio

ns

(in m

illion

s)

1

1 Free cash flow (FCF) is a non-GAAP financial measure. See Appendix for a reconciliation to the most comparable GAAP measure. 2 For the nine month period ending September 30, 2014.

Ca

pe

x

FC

F

2

Southwest has led the industry in returning capital to

shareholders

62%

$0

$200

$400

$600

$800

$1,000

2011 2012 2013 3Q14

Dividends Share Repurchase

59% 59% 66% % of free

cash flow

(in

millio

ns)

$239

$422

$611

$893

Our goal is to continue to return significant value to our Shareholders

1 For the nine month period ending September 30, 2014.

1

10,900

12,600 12,700 11,700 ~11,500

(4.0)

(2.0)

-

2.0

4.0

6.0

2010 2011 2012 2013 2014E

0

3,000

6,000

9,000

12,000

15,000

Adjusted Average Invested Capital ROIC vs WACC

Southwest’s ROIC1,2 (after-tax) vs. WACC Improvement (in

millio

ns)

Po

int

ch

an

ge

We have increased our ROIC to WACC spread, while aggressively

managing our invested capital

1 ROIC is a non-GAAP financial measures. See Appendix for a reconciliation to the most comparable GAAP measure. 2 Includes AirTran as of May 2, 2011.

We will continue to focus on ROIC to WACC spread in line with

best sectors within the S&P 500

Source: Third party investment firm.

Median ROIC & WACC for S&P 500 companies over the last decade.

Data for S&P 500 firms from 2004 to 2013.

0.0

2.0

4.0

6.0

ConsumerDiscretionary

Industrials S&P 500 SouthwestAirlines

2014E Ten-year average

Po

int

ch

an

ge

HIGH QUALITY

GROWTH

OPPORTUNITIES

CONTINUED REVENUE

MOMENTUM

LOW COST LEADER

SUPERIOR FINANCIAL

POSITION

ATTRACTIVE RETURN

ON INVESTMENT

Funded by low cost growth

Driven by better utilization with increased seat gauge

Strategic initiatives provide strong foundation

Goal to grow revenues at least in line with capacity

Benefitting from lower fuel prices

Expect unit costs, excluding fuel & oil, profitsharing,

and special items to decline compared to 2014

Strong Balance Sheet and strong cash flows

Manageable capital spend and debt maturities

Aggressive management of invested capital

Continued margin expansion

Pre-tax ROIC1 expected to match 2014’s pre-tax ROIC1

Continued return of significant value to Shareholders

Our 2015 objectives

1 ROIC is a non-GAAP financial measures. See Appendix for a reconciliation to the most comparable GAAP measure.

Non-GAAP Reconciliation

(1) Net of profitsharing impact on charges incurred through March 31, 2011. The Company amended its profitsharing plan during second quarter 2011 to defer the profitsharing impact of acquisition and integration costs incurred from

April 1, 2011 through December 31, 2013. The profitsharing impact will be realized in 2014 and beyond.

2009 2010 2011 2012 2013

Fuel and oil expense, unhedged 2,577$ 3,296$ 5,580$ 5,963$ 5,645$

Add (Deduct): Fuel hedge (gains) losses incuded in Fuel and oil expense 467 324 64 157 118

Fuel and oil expense, as reported 3,044 3,620 5,644 6,120 5,763

Deduct: Net impact from fuel contracts (222) (172) - (32) (84)

Fuel and oil expense, non-GAAP (economic) 2,822$ 3,448$ 5,644$ 6,088$ 5,679$

Total operating expenses, as reported 10,088$ 11,116$ 14,965$ 16,465$ 16,421$

Deduct: Net impact from fuel contracts (222) (172) - (32) (84)

Deduct: Charge from voluntary early out program, net (56) - - - -

Deduct: Charge for Acquisition and integration costs, net (1) - (7) (132) (183) (86)

Deduct: Asset impairment, net - - (14) - -

Total operating expenses, non-GAAP 9,810 10,937 14,819 16,250 16,251

Deduct: Profitsharing (42) (158) (99) (121) (228)

Deduct: Fuel and oil expense, non-GAAP (economic) (2,822) (3,448) (5,644) (6,088) (5,679)

Total operating expenses, excluding fuel, profitsharing, and special items 6,946 7,331 9,076 10,041 10,344

Costs(in millions)

Non-GAAP Reconciliation

(1) Net of profitsharing impact on charges incurred through March 31, 2011. The Company amended its profitsharing plan during second quarter 2011 to defer the profitsharing impact of acquisition and integration costs incurred from

April 1, 2011 through December 31, 2013. The profitsharing impact will be realized in 2014 and beyond.

(4) Cost of Equity is determined using the Capital Asset Pricing Model (CAPM) assuming a 6% Equity Market Risk Premium (EMRP), the 10 year risk free rate, and the historical adjusted beta for Southwest Airlines. Cost of Debt is

determined using historical cost of adjusted debt, which includes net present value of aircraft leases.

(2) Net adjustment related to presumption that all aircraft in fleet are owned (i.e., the impact of eliminating aircraft rent expense and replacing with estimated depreciation expense for those same aircraft).

(3) Average invested capital represents a five quarter average of debt, net present value of aircraft leases, and equity.

2010 2011 2012 2013

Operating Income, as reported 988$ 693$ 623$ 1,278$

Add: Net Income from fuel contracts 172 - 32 84

Add: Acquisition and integration costs, net (1) 7 132 183 86

Add: Asset impairment, net - 14 - -

Operating Income, non-GAAP 1,167 825 838 1,448

Net adjustment for aircraft leases (2) 84 129 117 143

Adjustment for fuel hedge accounting (134) (107) (36) (60)

Adjusted Operating Income, non-GAAP 1,117 847 919 1,531

Average invested capital (3) 10,431$ 12,439$ 12,575$ 11,664$

Equity adjustment for fuel hedge accounting 434 184 145 50

Adjusted average invested capital 10,865 12,623 12,720 11,714

ROIC, pre-tax 10.3% 6.7% 7.2% 13.1%

ROIC, after-tax 6.3% 4.1% 4.5% 8.1%

Weighted average cost of capital (4) 6.7% 5.6% 6.2% 7.8%

Net cash provided by operating activities 1,561$ 1,356$ 2,064$ 2,477$

Capital expenditures (493) (968) (1,348) (1,447)

Free cash flow 1,068$ 388$ 716$ 1,030$

ROIC and Free Cash Flows(in millions unless otherwise noted)

Southwest Airlines 2014 Investor...

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