Southwest Airlines Co. (LUV) Earnings Call Transcript & Summary

Welcome to Southwest Airlines virtual shareholder meeting. You may not record or rebroadcast any portion of this meeting without Southwest Airlines' consent. Please note that this meeting will be recorded and will be available within 48 hours following the meeting in the Investor Relations section of southwest.com. I will now turn the call over to Mr. Gary Kelly.

Thank you, Olivia. And good morning, everyone, and welcome to the Southwest Airlines' 2020 Annual Meeting of Shareholders. I'm Gary Kelly, Chairman of the Board and CEO of Southwest Airlines. Before we begin, please note the agenda for today's meeting is shown on the screen in front of you. The proxy statement, annual report and rules of conduct for the meeting are posted at the bottom right of the screen in the Meeting Materials section. If you've not read the rules of conduct, please take a minute to read them. These are the rules we're going to follow this morning. Please also note that there will be 2 opportunities for appropriate shareholder questions to be addressed. Our independent auditors will be available to address questions as part of Item 5 of the agenda, and I will address questions after we close the polls for voting. If you're a shareholder and would like to submit a question, you may submit it by typing your question in the Ask a Question section of your screen. When submitting a question, indicate whether it is an auditor question or a company question and please include your name and e-mail address. The meeting will now come to order, and the polls are open for voting. If you're a shareholder or hold a proxy for a shareholder and would like to vote, you may click on the Vote Here button above the Meeting Materials section on your screen. The polls will be closed after all proposals to be voted on have been presented, as indicated in the meeting agenda. Before we address the official business of the meeting, I'd like to take this opportunity to welcome our other members of the Board of Directors who, like you, are participating online this morning: David Biegler, Veronica Biggins, Doug Brooks, Bill Cunningham, John Denison, Tom Gilligan, Grace Lieblein, Nancy Loeffler, John Montford and Ron Ricks. And next, I'd like to welcome our President, Tom Nealon; our Chief Operating Officer, Mike Van de Ven; our Executive Vice President, Bob Jordan; Tammy Romo; Mark Shaw; Andrew Watterson; and Greg Wells. In addition, Ryan Martinez, our Managing Director of Investor Relations, is present to facilitate the question-and-answer portions of this meeting. I'll now move on to the formal business of this meeting. Richard Leza joins us online, and he's been appointed to act as inspector of election on behalf of Broadridge Financial Solutions. And I'd now like to introduce Marilyn Post, who is our Corporate Secretary, and Marilyn is going to report on some formal matters related to the holding of this meeting.

Thank you, Gary. I can report that I have received an affidavit of distribution from Broadridge Financial Solutions, certifying that the notice and other proxy materials for this meeting were distributed to all shareholders of record commencing on April 9, 2020. A list of our shareholders of record can be accessed by selecting the link at the bottom right of your screen, just below the Meeting Materials box. It will remain available for shareholder inspection during the meeting. And the list has also been available for inspection at the company's offices for at least 10 days prior to this meeting. In addition, the inspector of election has signed an oath of office and has determined that the holders of more than a majority of the shares entitled to vote at this meeting are present in person or by proxy. This is sufficient for a quorum to conduct business.

Thank you, Marilyn. I declare that this meeting is duly constituted and convened. As stated in the notice of the meeting, there are 6 proposals to be voted on today, each of which is identified in the proxy statement. Proposal 1 is the election of directors. Proposal 2 is the advisory vote to approve named executive officer compensation. Proposal 3 is the ratification of the selection of Ernst & Young LLP as the company's independent auditors for the fiscal year ending December 31, 2020. Proposal 4 is the advisory vote on a shareholder proposal to require an independent Board Chairman. Proposal 5 is the advisory vote on a shareholder proposal to permit shareholder action by written consent. Proposal 6 is the advisory vote on a shareholder proposal requesting an annual report disclosing information regarding the company's lobbying policies and activities. Each of these proposals is discussed in detail in the proxy statement. Regarding Proposal #3, ratification of the selection of Ernst & Young as the company's independent auditors for the fiscal year ending December 31, 2020, Ernst & Young also served as the company's independent auditors for fiscal year 2019. Mr. Bill Guess, our Ernst & Young Audit Partner; and Ms. Lindsay Goodreau, Senior Manager at Ernst & Young, are present and have been given the opportunity to make a statement if they so desire. They're also available to respond to appropriate questions. Ernst & Young has already informed me they do not desire to make a statement, so we will move on to any questions for Ernst & Young. So Mr. Martinez, are there any questions for Ernst & Young?

There are no questions for Ernst & Young.

Thank you. As stated in our rules of conduct, each shareholder proposal presenter will have 3 minutes to present their proposal, and the presenter must limit their presentation to the substance of their proposal. With respect to Proposal #4, regarding an advisory vote on a shareholder proposal to require an independent Board Chairman, the shareholder proponent or their authorized representative is now invited to present that proposal.

Hello. This is John Chevedden. Can you hear me okay?

Yes, sir. You're coming in loud and clear.

Oh, okay. There's a pause there. Okay. This is Proposal 4, independent Board Chairman, sponsored by Kenneth Steiner. Shareholders request that our Board of Directors adopt a policy and amend our governing documents as necessary to require the Chair of the Board of Directors, whenever possible, to be an independent member of the Board. Although it'd be better to have an immediate transition to an independent Board Chairman, the Board would have the discretion to phase in this policy for the next Chief Executive Officer transition. This proposal topic won 52% supported Boeing in April of this year. This proposal topic also won 50-plus support at 5 major U.S. companies in 1 year, including 73% support at Netflix. The Southwest lead director, William Cunningham, is no substitute for an independent Board Chairman. Mr. Cunningham may soon beat Herbert Kelleher as the oldest director to serve on the Southwest Board. Mr. Cunningham has 20 years long tenure as a Southwest director. Long tenure can take a toll on director independence at shareholder expense. Independence is the most important attribute in a lead director. And earlier, Southwest Airlines annual meeting proxy said Mr. Cunningham had top corporate governance at the University of Texas, which supposedly enables him to bring valuable governance expertise to Southwest. However, Mr. Cunningham is also the Chairman and Chief -- and an Executive Pay Committee member at Lincoln National Corporation. And Lincoln National paid its CEO a whopping $22 million in 1 year. And at Lincoln National, shareholders played a key role, instead of the directors, in improving the governance of the company where a vacuum existed. At Lincoln National, 3 shareholder proposals since 2016 played a key role in the adoption of a shareholder right to call a special meeting, initiating shareholder proxy access and initiating a simple majority vote standard. An independent Chairman is best positioned to build up the oversight capabilities of our directors while our CEO addresses the challenging day-to-day issues facing the company. The roles of the Chairman of the Board and the CEO are fundamentally different and should not be held by the same person. There should be a clear division of the responsibility between these 2 positions to ensure a balance of power and authority on the Board. It is particularly important to have an independent Board Chairman with Southwest facing the COVID-19 crisis and the Boeing 737 MAX crisis. There's no other airline so dependent on the 737 MAX. Please vote yes, independent Board Chairman, Proposal 4.

Thank you, sir. With respect to Proposal #5, regarding an advisory vote on a shareholder proposal to permit shareholder action by written consent, the shareholder proponent or their authorized representative is now invited to present that proposal.

Hello. This is John Chevedden. You can hear me okay?

Yes, sir. Loud and clear.

Okay. Proposal 5, adopt a mainstream shareholder right -- written consent. I'm the sponsor on this proposal. Shareholders request that our Board of Directors take the steps necessary to permit written consent by shareholders entitled to cast a minimum number of votes that would be necessary to authorize an action at a meeting at which all shareholders entitled to vote thereon were present and voting. Hundreds of major companies enable shareholder action by written consent. This proposal topic won majority shareholder support at 13 large companies in a single year. This included 67% support at both Allstate and Sprint. This proposal topic also won 63% support at Cigna in 2019. This proposal topic would have received higher votes than 63% to 67% at these companies if more shareholders had access to independent proxy voting advice. The right for shareholders to act by written consent is gaining acceptance as a more important right than the right to call a special meeting. This also seems to be the conclusion of the Intel Corporation's shareholder vote at the 2019 Intel annual meeting. The directors at Intel apparently thought they could divert shareholder attention away from written consent by making it less difficult for shareholders to call a special meeting. However, Intel shareholders responded with greater shareholder support for written consent in 2019 compared to 2018. After a 45% vote for a written consent shareholder proposal, The Bank of New York Mellon said it adopted written consent in 2019. Southwest management resorted to sham arguments as an excuse to do nothing on this important topic. The 2018 Southwest airlines proxy misleadingly gave the impression that one Southwest shareholder alone could effectively use written consent. Another sham argument was that it is important to Southwest Airlines that all shareholders participate. However, Southwest cited no special effort to contact the 22% of shares that typically do not vote at annual meetings. Why is it important to contact all shareholders when management handpicks the shareholders it targets for its special engagement efforts. Please vote yes, adopt a mainstream shareholder right -- written consent, proposal 5.

Thank you, sir. With respect to proposal #6 regarding an advisory vote on a shareholder proposal requesting an annual report disclosing information regarding the company's lobbying policies and activities, the shareholder proponent or their authorized representative is now invited to present their proposal.

Good morning. Can you hear me?

Yes, sir. Good morning.

Hello. My name is Edgar Hernandez, and I am with the Service Employees International Union; and prior to the COVID-19 pandemic, a frequent Southwest customer. On behalf of the Service Employees International Union Pension Plan Master Trust, I move item #6 that calls for an annual report on lobbying activities by Southwest in the form of a comprehensive disclosure of its lobbying activities. The proposal asks Southwest to disclose policies and procedures governing lobbying, payments by Southwest used for direct or indirect lobbying as well as grassroots lobbying communications, membership in and payments to tax-exempt organizations that write and endorse model legislation, and the Board -- and then the Board and its management's decision-making process for making those payments. In our view, full disclosure would: one, help to safeguard Southwest's reputation given that Southwest has taken lobbying positions inconsistent with passengers' interest and has contributed to an organization whose activities are inconsistent with Southwest's commitments to diversity and inclusion; two, promote greater alignment of lobbying activities with Southwest's stated values and long-term value creation; and three, it would not impose any excessive administrative burden on Southwest. Reputational damage has been identified as one of the top risks facing the airline industry. Also, a reputation caveat can have real financial consequences. Estimates peg the value of a corporate reputation at over 1/3 of market capitalization, and one researcher concluded that reputation drives between 3% and 7.5% of annual revenues. A company's poor reputation can also make it harder to attract the best employees. In our view, comprehensive disclosure regarding recipients, payments and decision-making processes would enhance oversight of direct and indirect lobbying activities and promote Southwest's alignment with a progressed focus on doing right by its customers. And furthermore, Southwest's filing in regarding its relationship with the American Legislative Exchange Council, ALEC, a not-for-profit that drives and promotes model legislation, whose meetings Southwest has sponsored. ALEC activities are not aligned with Southwest's stated commitment to diversity and inclusion. And they recently announced a partnership with the Alliance for Defending Freedom, which opposes gay marriage and successfully sued to overturn Colorado's anti-discrimination law by presenting a baker who refused to bake a cake for a gay wedding. Leading companies such as Google, Comcast, Coca-Cola and Honeywell have ended their relationship with ALEC. For these reasons noted above, we urge you to vote for Item #6 that calls on an annual report on lobbying activities by Southwest. Thank you.

Thank you very much. While we allow time for shareholders to complete their voting, I'd like to remind you that the question-and-answer portion of the meeting may include financial information not prepared in accordance with GAAP, so please see the Investor Relations section of southwest.com for reconciliations of these results to GAAP results. Additionally, some of the statements may be made considering forward-looking statements, and the company cautions investors that actual results could differ materially from the results discussed today. So please see the Annual Meeting of Shareholders' page in the Investor Relations section of southwest.com for a description of factors that could impact forward-looking statements. We'll now pause for another minute or 2 to allow for voting to wrap up and to allow me to survey the questions that have been submitted. [Voting]

I hereby declare the polls closed. And let's now turn to the question-and-answer portion of today's meeting. Shareholders have had opportunities to submit questions this morning through the virtual meeting website. Mr. Martinez has informed me that we have received a number of excellent questions. If we're not able to address your question that you submitted this morning, you're welcome to contact our Investor Relations department after today's meeting. And I'll now turn the call over to Ryan.

Thank you, Gary. We have received several great questions from shareholders so far during the meeting. So we'll get to as many as we can here. And I'll group similar questions into common themes. So the first, we've gotten a few questions around one topic, and that is the Southwest Promise. So what are we doing to keep employees and customers safe? And how long are we willing to limit selling middle seats?

Well, first of all, I think it's just an opportunity to reiterate that our top priority is a safe environment for our customers, certainly, but also for our employees. In order to reinforce that priority, we recently published what we refer to as the Southwest Promise, and we did that on May 1. So you can see that on southwest.com. It includes a detailed list of our safety measures, along with an excellent video that I'm very proud of. We have 20 million customers that received an e-mail outlining these efforts. And our travelers will continue to receive reinforcement of our promise and pre-trip e-mail, an e-mail series that they get before they fly, and we will, again, continue to reinforce the Southwest Promise with the media. So we're doing a number of things. In terms of our airport environment, we are recommending that the TSA undertake temperature checks at the screening checkpoint. We're requiring customer-facing employees to wear face coverings or masks. We are also requiring customers to wear face coverings or masks. If the customer arrives and they don't have a mask, we'll provide those. We've added Flexiglass face guard shields at our ticket counters, at our gates and also at our cargo facilities. Cleaning, of course, is very important always, but certainly in this environment. We've got an enhanced overnight cleaning process. We're wiping down all the high-use areas in the aircraft, the alleys, cockpits in between flights, and that's with hospital-grade disinfectants. Every month, every aircraft receives an additional application of a disinfectant through the use of an electrostatic mister with an antimicrobial mist. And it covers all surfaces throughout the aircraft. In total, we're spending 6 to 7 hours a day cleaning airplanes. We've implemented social distancing techniques within the airport and especially at the gate during the boarding process. We've limited our boarding groups now to 10 rather than previously using 30. Once you get on board the airplane, we have HEPA filters on every airplane, providing hospital-like air quality. And we're also limiting the bookings, and therefore, the number of customers onboard the aircraft, which will allow for all middle seats to be open and unoccupied. So you won't see full flights on Southwest, at least through the end of July. And if we do have more demand for that flight, we'll also add additional flights to meet that demand. Overall, we're obviously very mindful of the environment. We're following CDC recommendations very closely. Those can change, and we'll continue to monitor that. And we're thinking about all of this in sort of a 30- and 60- and 90-day time period.

Okay. On the topic of cash and liquidity, we have a few questions. Are we in good shape with where we are now? How much cash is enough? And could we possibly avoid the need for the government loan offered to Southwest?

I think the short answer to that is yes. I'm very, very pleased with our cash position. I mentioned that health and safety is our top priority, while having cash is a close second. Fortunately, Southwest has long been a financially strong company. We started this year with higher-than-normal levels of liquidity. Normally, we would be carrying about $1 billion less in cash. And so fortunately, we started the year with a surplus. We started the year with $4 billion. Our debt has been very modest. We started this year with the lowest percentage of debt to total capital in our history, coming in at 24%, simply meaning that since we've now needed additional capital, we've had the means to go into the capital markets and raise a significant amount of cash. So far, we've actually raised $15.7 billion, and $13.9 billion of that has been received thus far. As of today, we have $13 billion of cash in the bank. Again, that is well beyond what we would normally carry. And our finance team calculates that at current loss rates, that would carry us for at least 20 months. And again, I would predict that we have many, many more months of cash available than that because I do think things will continue to improve. The good news is, again, we've had access to the capital markets. I do want to thank the administration, in particular, Secretary Mnuchin, Secretary Chao, leadership in Congress for swiftly moving to provide our country with liquidity. The CARES Act was bold. It was big, and it was exactly what was needed. Without that, I doubt that the capital markets would be open, quite frankly. So we did apply for and received our portion of the grant under the CARES Act, known as the Payroll Support Program. That is $3.2 billion. And there's another component of that CARES Act, which is the federal loan program. And I believe our allocation under that program is $2.8 billion. We've applied for it. We've not committed to take that money, and we have until September 30 to make that decision. So we've got a very strong balance sheet still. Our debt to total capital is, even with all the money that's been raised this year, is still less than 50%. And I know our finance team is looking at more opportunities to improve the quality of the debt that we have with some refinancings. So they'll continue to be very busy. But I'm very proud of our treasury team and our finance team. They've just done a phenomenal job. And of course, we can't do anything like that without tremendous support from our legal team. But the company is in very good shape. I think we -- among all of our competitors, we have the strongest liquidity. $13 billion in cash that I mentioned does not include a fully available line of credit for another $1 billion on top of that. So they've done a fine job. And again, our thanks to previous years of leadership to make sure that we've stayed financially strong and have us in such a great position.

Okay. So Gary, on the topic of losses, what are the strategies Southwest needs to take to be profitable again, both after COVID-19 and once the 737 MAX returns?

Well, yes, of course, that's the big news and the big change this year. We had a record year in 2019 that, again, put us in the strong position coming into this year. We had excellent performance in January and February and had no signs of any weakness until late February. And then things deteriorated extremely rapidly. Nothing like it in our history. So by the end of March, our load factors had fallen to roughly 5%. And our business was down 98 -- 97%, 98% on a year-over-year basis. So with that kind of a drop in traffic, as you can imagine, we're suffering significant losses. The month of April, we lost -- in terms of cash, not including the payroll support we got from the government, not quite $1 billion. And obviously, that is not sustainable. So May will be better. We will lose less, in other words. And I would hope that we lose less yet again in June and July. So we've taken a number of steps to cut our spending, first and foremost, in this environment. And in total, we've cut over $6 billion through an array of items, including cutting capital projects, deferring aircraft deliveries. We've cut our schedule by 65% here in May. Fuel prices have declined sharply, which has certainly been a great help to us. But there have been an array of actions taken there. Our named executive officers have all reduced their pay by 20%. And as an example, with those officers, their pay is at risk to the tune of 90% anyway, and that is beyond the base pay that was cut by 20%. And obviously, we're prepared to do more if we need to. Finally, we're obviously very people-intensive in the airline business. And we've -- with the reduced level of activity, we have a number of employees who don't have all that much to do, as an example, as we cut our flight activity. So we've offered voluntary leaves, and that is saving the company also a great deal of money. So now we turn to restoring confidence with customers. And we just want -- we want to make sure that we're available for them when they need to fly. The federal government has required us to remain open for business. They consider us essential. We have 103 service points on the Southwest route map. Other than our international destinations, which we have temporarily suspended service, we have not closed any locations and have no plans to close any of our locations. And we'll be offering low fares with no change fees, no back fees and a safe environment for our customers when they're ready to fly.

So Gary, on the 737 MAX, we've been without the aircraft since March 2019. How does the current situation affect the return to service time line? And what's our relationship like with Boeing and regarding further compensation?

Well, first of all, no one, of course, can be happy with the MAX situation, especially since it's gone on for so long. Now that we find ourselves in the midst of this COVID-19 crisis, we have too many airplanes right now. So Mike Van de Ven, our Chief Operating Officer, is here with me and may want to comment. But as of last count, Mike, I think we had roughly 400 of our fleet of 750-ish airplanes idled, either with short-term parking or a longer-term storage program that Mike's teams have created. We're still wanting to get the MAX back into service. The MAX airplane is superior to the next-generation 737 that we're currently operating. It burns less fuel. It's an excellent airplane. And certainly in this environment, we would love to retire some of our older aircraft, avoid some expensive maintenance and a substitute with the newer airplanes. But Mike, would you like to give an update on where we are with Boeing with the MAX and a 2020 Boeing settlement?

Yes. Sure, Gary. So pre-COVID, we were very interested in getting those airplanes back up into service as fast as we could because they were our opportunity to grow and meet demand. But post-COVID, I think, Gary, you just -- you covered it perfectly. They're our most cost-effective airplanes in terms of fuel and in terms of maintenance. They've got a great noise footprint. They're just fantastic airplanes. And so when the airplane is returned to service, the ones that we own, via 34 MAXes that we own, we'd like to try to get them into active fleet as quickly as possible and take out of the fleet some of our less effective airplanes. Boeing -- we settled with Boeing in our 2019 damages. There are some damages in 2020. We are in the process of discussing those with them. In addition, Boeing has, I think 25 airplanes built for us in our configuration at Moses Lake. And we have got an agreement with them between 2020 and 2021 to take no more than 48 airplanes from them. And we're working on what that delivery schedule would look like for us at that period of time.

So we're very committed to the MAX. I think Mike is assuming that the MAX will be ungrounded in the third quarter. And we would need roughly a quarter to ready ourselves to operate, unground our 34 airplanes. Mike mentioned that Boeing has 27 built for us. And so hopefully, we would be flying in the fourth quarter of this year with the MAX.

Thank you. Excellent. And you actually hit on a couple of other questions in there, too. So we knocked a few of those out. Switching gears for a second. What has been the response from unions and employees to the current crisis?

Well, let's talk about our employees first. We're 60,000-strong. And obviously, one of the great sources of pride for all of us in Southwest is that through our almost 50-year history, we have never had a furlough. We've never had a layoff. We've never had a pay cut. We've had crises before. And I have to admit, I don't think we've ever seen anything like this one. So I think there is -- I think there's a rational concern about the environment today. You see record numbers of unemployment claims. The country is in recession. I think everyone realizes that this is a really tough circumstance. And to see the response by our people, the resolve, the resilience, the belief in the company and the desire to serve each other and our customers is just absolutely inspiring. So I'm very proud of our people. They've continued to serve through all of this. And it just -- they absolutely performed flawlessly, in my opinion. And many of our employees, of course, are represented by various unions. And we've always had dialogue with our unions. They have engaged. I think we all recognize that these are very challenging times. What we're working on together right now is a voluntary separation program for those employees who are ready to leave the company, either they're nearing retirement, ready for retirement, whatever the case may be, also working together with them on extended leaves, where they wouldn't separate from the company, but they would come back. We have not approached the unions for concessions. We have a commitment with -- through the CARES Act that we would not furlough anyone through September 30, which I'm delighted to provide that commitment because we don't want to furlough anyone anyway. With the losses that we have currently, if they don't improve, we would have to take some kind of action. But furloughs and layoffs would be the last thing that we would want to entertain. And as I've told our people, we can't guarantee ever that we won't have furloughs, but we're going to do everything we possibly can to avoid them. So I'm pleased with how the unions have responded. And I think -- I'm absolutely inspired by the way the people at Southwest Airlines have responded to this crisis.

Well, Gary, we've covered a lot of ground. We have time for one more question, and there's a couple of topics here regarding the Board of Directors. I just want to remind everyone, if you didn't get a question in or something else comes up, you can always call Investor Relations at (214) 792-4415. So for the last questions, Gary, what was the selection process for our newest member of the Board of Directors? And what are the Board's plans to promote diversity and inclusion at Southwest?

Well, our proxy, I think, does a very nice job of describing our philosophy and our goals and our guidelines that we use in terms of our Board makeup, experience, diversity. We obviously value diversity in the truest sense of the word. So in the case of Grace Lieblein, who was the most recent Board member that we recruited, we had an extensive search process with diversity and always is a key consideration. And there was an extensive interviewing process by a select group from the Board of Directors and also from the leadership of the company. And Grace rose to the top, and we were obviously blessed to have her join our Board, and she's been a terrific addition.

Great. Thank you.

Okay. Back to the business of the meeting. Marilyn, will you please report on the preliminary results of the voting?

Yes, sir. The following results are from the preliminary report of the inspector of election. With respect to Proposal #1, each of the 11 director nominees has received votes in favor of their election, constituting over 95% of the votes cast for or against their election. And each nominee for director has, therefore, been duly elected. With respect to proposals 2 and 3, such proposals have each received votes in favor of their approval, constituting over 96% of the votes cast for or against such proposals, which means that each of such proposals has also passed. With respect to Proposal 4, such proposal has not received a majority vote in favor. With respect to Proposal 5, such proposal has not received the majority vote in favor. And finally, with respect to Proposal 6, such proposal also has not received the majority vote in favor.

Thank you, Marilyn. The final results will be reported by the company on Form 8-K. There being no further business to come before this meeting, I declare this Annual Meeting of Shareholders adjourned. And thank you for attending today's meeting.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.