When Herb Kelleher started Southwest Airlines in 1967, he was a pariah, a chain-smoking, Wild Turkey-swilling lawyer-entrepreneur who tried to undercut his established competitors. The airline was in legal limbo for four years because of disputes over flight routes before its first plane was allowed to take off. Four decades later, Kelleher’s upstart airline is now the country’s largest in terms of market capitalization and has posted a profit for 35 straight years. It’s the only major U.S. carrier making money right now, even as smaller airlines fold at a rate of about one a month and legacy carriers, stuck with record-setting fuel prices, stagger toward bankruptcy.

This spring, at age 77, Kelleher retired as Southwest’s chairman and scaled back his responsibilities to an advisory role, a position he’ll hold for five years. It’s a good time for him to ease up. The airline business is going through a difficult period, and Southwest was recently hit with a $10.2 million fine because it had flown planes after their required inspection dates. But Kelleher leaves Southwest in excellent shape compared with its peers. With a $10 billion market cap and ample cash reserves, it’s poised to solidify its ­position as the low-fare airline.

Condé Nast Portfolio reporter Matthew Malone met Kelleher at Southwest’s Dallas headquarters, where the executive, a longtime three-pack-a-day smoker, elbowed up to a silver ashtray the size of a turkey platter. Kelleher has never cared much about appearances, and he’s certainly not changing now. During the 90-minute interview, he smoked four Merits, kissed a Southwest intern on the cheek, and jokingly picked his nose. He also talked about the foolishness of mergers, the state of the Federal Aviation Administration, and why February is the worst damn month of the year.

Between the lackluster economy and soaring fuel prices, some say that things are downright apocalyptic for airlines these days. Is the business model simply one that doesn’t work anymore?

It’s very difficult to make it work when oil is at $130, $135 a barrel. Southwest has been protected from many of the difficulties of this time: Our fuel hedges saved us $727 million last year alone. But our revenues are down as a consequence of higher fuel costs, and I think our principal advantage at Southwest and in this milieu is the fact that we’re so strong financially. We have the lowest cost in the industry per available seat mile, the strongest balance sheet, the most equity of any carrier, so we’ve always been fit for whatever exigency confronted us. We’ve always been very conservative and made sure that we’re ready for the bad times, because they always come.

The last major round of restructurings, after 9/11, allowed the legacy carriers to cut into Southwest’s cost advantage. More restructurings and bankruptcies are on the way. Will that make the company more vulnerable?

No. As a matter of fact, I think our competitive advantage is widening. The other carriers are increasing fares and adding fees so quickly that I think that we’re regaining our low-cost-fare advantage. There’s another factor: I refer to Chapter 11 as the washateria—you go to the washateria, and you wash out all your sins and get a fresh start. Once you’ve been through it, your opportunities are narrowly constricted with respect to restructuring, because you’ve already terminated your benefit pension plans, you’ve got a reduced lease rate on your airplanes, you’ve gotten better financial terms from your lenders, and it’s very hard to come up with substantial savings the next time around.

If you had a crystal ball, what would it reveal about where the ­industry will be a year from now?

I’d love to give 10-year projections. The shorter ones are harder. It depends on where fuel prices are, but I think you’ll see fewer airlines. That process has already started, with the airlines that have ceased operations. Consolidation is something that a number of carriers think is a way to salvation. I’m not sure it is, as far as fuel prices are concerned, which is the primary issue. The Delta-Northwest merger is well on its way. They have to jump the regulatory hurdles, and then, of course, you have to work like crazy to make sure it actually works out the way you had planned.

Which carriers are the most vul­nerable to going under?

I never get into that. I don’t want to be a party to a run on the bank.

One of your last official duties as chairman was to testify before Congress about the fine that Southwest had to pay over safety inspections. Some planes were flown after their official F.A.A. inspection dates. What’s your take on that incident?

We reported ourselves to the F.A.A.—that we inadvertently and unintentionally missed these inspections, and the principal inspector said, You’ve got 10 days to do it. There may have been a technical issue, but there was never a safety issue. And there were never any planes that placed passengers at risk. I don’t mean to demean it, but in a sense it was a question of filing the wrong form, so to speak. Boeing said flying the planes was okay, and a former lead investigator for the National Transportation Safety Board said it was okay. There was no threat.

Would you do anything differently?

The appropriate route would have been to go and get an alternative means of compliance from the F.A.A., and I’m quite sure that they would have granted it. That’s what I regret, that we didn’t do that.

That whole issue became political pretty quickly, and in the middle of it, you scrapped plans to outsource some of Southwest’s maintenance to an operation in El Salvador. Why the change?

It was a question of timing. We didn’t say that we would never do it. We just said we’re not going do it now, because we don’t need to add a layer of complications with respect to a new maintainer. Outsourcing is a word that covers a multitude of different concepts, and you have to realize a lot of the talk about it is really a product of union activity, where they’d like to keep the work in the United States. From a safety standpoint, it’s perfectly safe.

Now that you’re stepping down, how much interaction will you have with the company?

Really, what I am here is C.E.O. Gary Kelly’s servant. He is a superb chief executive officer, and I would anticipate that he would ask me from time to time to get involved in some special projects. The dustup with the F.A.A. is an illustration. I really serve at his beck and call.

Is there some innovation that you think could help save this industry? Something on the horizon that you look at with great interest?

Well, no. I don’t think there’s any silver bullet. I think the carriers in the present circumstances are doing exactly what they need to do in order to survive. For the first time in my memory, they’re very busy reducing capacity, which of course will provide fewer seats. That saves fuel, and you’re able to raise fares, I think, fairly substantially. Fewer and fewer people will be flying, and in a sense that’s a sad thing for me. A lot of the American public will be deprived of the opportunity to fly. But I think the carriers have to do it. They don’t have any alternative.

How much will fares go up during the next 12 months?

The latest figures I saw, through April or May 2008, was that average fares had gone up 4.8 percent already this year. And with reductions in capacity, I wouldn’t be surprised if average fares went up by another 5 or 6 percent this year. I’m not talking about Southwest, by the way, just the legacy carriers.

The F.A.A. has been under a lot of pressure lately. What’s your view of the agency?

The F.A.A. has a splendid record. There’s no question about that. Commercial airline travel has never been safer, and it’s grown steadily safer over the past four or five years, so the end result has been superb, absolutely superb. I think reform of the air-traffic-control system is the major issue facing the F.A.A. as a whole. It’s an antiquated system, and a lot of the difficulties that we were talking about earlier for the airlines would go away if you had a modernized system that was more efficient. I’m hopeful that we’ll make steady progress toward the adoption of next-gen, as they call it—an air-traffic-control system that will be G.P.S.-oriented.

What has prevented that from hap­pening so far?

You’re stepping on a sore toe right now, because I became an apostle of that in 1993, and here we are 15 years later and we haven’t made a lot of progress. Backpackers are using G.P.S. to find out where they are in the woods. Truckers are using G.P.S. to find out which routes they should take to their destinations. Buses are using it. Private aircraft are using it. Let me see, who are the only ones who don’t have G.P.S.? Commercial airlines. Isn’t that astounding? You have to be a visionary and say, “We don’t need this today, but we’re going to need it very badly 10 or 15 years from now.”

Airlines need it, but the government has to take the steps to set it up.

If you stop to think about it, we’re really a little slice of salami in a governmental sandwich. The F.A.A. tells us what we can do with the airplane, right? You can’t push back from the gate, can’t taxi, can’t take off without the F.A.A. telling you. Our passengers on the ground are processed by the Transportation ­Security Administration. And guess who owns the airports. Governmental bodies. That’s why we have so little control over our destiny. Don’t misunderstand me—all of those things are needed. But it would be interesting if you said that all department stores are now going to have X-ray machines. You’re going to have to take your shoes off, your coat off, before you get into Macy’s. That might cut back on their patronage just a little bit.

Is there a particular day or incident from Southwest’s history that you remember most fondly?

For sheer drama, I would have to say that after litigating for four years in 31 different courts and administrative agencies, the arrival of our first airplane was a pretty dramatic event. I burst into tears when I kissed it on the nose and then went around and stuck my head in the engine, at which point a mechanic grabbed me and said that if the thrust reverser went off, it would decapitate me. I said, “You know? I really don’t give a damn.”

What’s the worst investment you ever made?

Gee, there are so many, it’s hard to pick out one. Enron, I guess. I must say, I didn’t pick Enron. It was a money manager.

So choose one: the cigarettes or the Wild Turkey.

Ha! It would be the cigarettes, and I’ll tell you why: I stop drinking Wild Turkey for a month every year in February, but I could never stop smoking for a month. I’m an addict. I acknowledge it.

Why February?

I was afraid you were gonna ask that. It’s the shortest month. [Laughter] About 20 years ago, a doctor told me, “As much as you drink on a regular basis, I think it’d be great for your liver if you took a month off.” So I said okay—February. I hate leap years! Despise them.