達美航空 (DAL) 2016 Q2 法說會逐字稿

Good morning, and welcome to the Delta Air Lines June financial quarter results conference call. My name is Kyle and I will be your coordinator.

(Operator Instructions)

As a reminder, today's call is being recorded.

I would now like to turn the call over to Jill Sullivan-Greer, Vice President of Investor Relations. Please go ahead.

Good morning, everyone, and thanks for joining us for our June quarter call.

Joining us in Atlanta today are Ed Bastian, our CEO; our President, Glen Hauenstein; and our CFO, Paul Jacobson. Ed will open the call, Glen will then address our financial and revenue performance, and Paul will conclude with a review of cost performance and cash flow. To get in as many questions as possible during the Q&A, please limit yourself to one question and a brief follow-up.

Today's discussion contains forward-looking statements that represent our beliefs or expectations about future events. All forward-looking statements involve risks and uncertainties that could cause the actual results to differ materially from the forward-looking statements. Some of the factors that may cause such differences are described in Delta's SEC filings.

We'll also discuss non-GAAP financial measures. All results exclude special items, unless otherwise noted. You can find the reconciliation of our non-GAAP measures on the Investor Relations page at IR.Delta.com.

And with that, I'll turn the call over to our Chief Executive Officer, Ed Bastian.

Thanks, Jill. Good morning; thanks to everyone for joining us.

For the June quarter, we reported a $1.7 billion pre-tax profit and we generated $1.6 billion in free cash flow. We grew our earnings per share 16% to $1.47, beating consensus by $0.05. Strong cost execution and lower fuel prices allowed us to offset a decline in revenues, as we continue to face persistent unit revenue headwinds.

In this challenging revenue environment, it's more important than ever that we differentiate ourselves on service; and in this area, the Delta people have truly risen to the top. We continue to run the industry's best operation. We delivered a 99.95% completion factor for the June quarter, including 71 of the 90 days with zero main-line cancellations.

More importantly, we had 23 days of zero system cancellations on any Delta carrier, nearly 6,000 flights a day, or one out of every four days for the entire quarter. Our main line on-time rate improved 1.5 points year over year to 86.9%. This operational result is contributing to continued solid increases in customer satisfaction.

We've achieved all-time highs in our net promoter scores, and our customer complaint rate has decreased by 14% so far this year. These high levels of customer satisfaction are widening our revenue lead relative to the industry, with our system RASM index reaching 110% as of the March quarter.

Congratulations to the entire Delta team, and thank you. We recognized your outstanding efforts with another $324 million accrued towards our profit-sharing program, bringing us to $596 million accrued already this year.

Despite our strong results, we continue to face persistent headwinds on our unit revenues on a number of fronts that we are working hard to combat. Capacity is one of the biggest levers we have to move the needle on our unit revenue performance.

In May, we announced that we plan to take 1 point of capacity out of the fourth quarter. That brought our second-half capacity growth plan to below 2%. Now, with the foreign currency pressure from the steep drop in the pound, the economic uncertainty from Brexit, and continuing yield pressures in the North Atlantic, we've decided to take an additional 6 points of capacity out of the UK for the winter [IOTA] season.

We've also been working closely with our partner, Virgin Atlantic, who will be making their own capacity changes. Combined, our overall UK capacity this winter will be down 2% to 4% compared to the prior year.

For Delta, these changes, along with other network actions, will take roughly 1 point of capacity out of the system, and we now expect our fourth-quarter capacity to grow by only 1% year over year. Glen will take you through the details, but I want to stress to you that the Company is very focused on getting back to positive RASM growth.

While admittedly we have done a poor job forecasting when unit revenues will turn positive, we're working hard to achieve our goal hopefully by the end of the year. And even if ultimately it takes a little bit longer than year end, we're confident we're on the right path.

We expect July and August monthly RASM results to be weak. However, we're anticipating a marked improvement in our September monthly numbers, as we implement our capacity changes and see benefits from our domestic revenue management initiatives, an easing of foreign exchange headwinds, and an improvement in the overall pricing environment as we hit the traditional nine-month period that it takes for revenues to catch up to higher fuel prices that we began experiencing earlier this year.

And if we're not seeing the right progress in our results as we move through the fall, we're prepared to take additional actions, as you saw us announce this morning, because the reality is that the large year-on-year savings driven by lower fuel are now behind us. Market prices are essentially flat for the third quarter, and look to be higher year over year in the fourth quarter for the first time since 2012.

All that said, our results for the third quarter should be a record, as we expect to generate a pre-tax margin of 20%, consistent with what we posted a year ago. Demonstrating the sustainability of our performance is key to delivering the margin, cash flow, and return targets that we outlined for you in May.

And as we look to drive that performance longer term for the Business, we'll continue to execute on the strategy that has already delivered tremendous value for all of our stakeholders. First, we'll continue to strengthen our brand around the world. A strong brand improves customer loyalty, while driving a sustainable revenue premium and higher margins.

Second, we'll maintain our rigorous discipline around cost and capital. This provides a solid foundation for the Business day in and day out. With our sustainable revenue premium, a solid cost foundation, and modest capacity growth, we have the engine for consistent 15% plus long-term earnings growth. Finally, we'll use our strong cash flows to reinvest in the Business for the long term, fortify our balance sheet through debt and pension reductions, while also returning at least 70% of our free cash flow to our owners.

So, to conclude, our second-quarter results were strong; however, we need to get unit revenues back on a positive track, and Glen and the commercial team are executing on our plan. Longer term, our revenue premium, solid cost base, balance sheet, and cash flows provide the foundation for the earnings growth and substantial capital returns for our owners that we believe will drive value long into the future.

And with that, I'm happy to turn the call now over to Glen.

Thanks, Ed, and good morning, everyone.

While the overall revenue environment continues to present challenges, we expect to outperform our network peers on unit revenues once again in the second quarter. This is truly a testament to our entire team, who continue to provide industry-leading revenues by delivering an unparalleled level of reliability and great customer service every day.

Turning to our June quarter performance, revenues declined 2% compared to last year, including roughly $65 million of pressure from currency. We continued to see close-in domestic yield deterioration on stable corporate ticket volumes, reducing domestic corporate unit revenue trends that are down in the high-single digits. This pressure, combined with continued foreign currency impacts, and supply/demand imbalances, primarily in the trans-Atlantic and China regions, drove a 4.9% decline in system passenger revenues.

While we faced a number of headwinds in the quarter, the expansion of our ancillary revenue initiative remains a significant positive for us. Our branded fare initiative continues to see strong momentum. Total merchandising revenues for the quarter increased more than $40 million, or 13% year on year.

Comfort+ paid load factor increased by 15 points to 46% as we began selling this product in the purchase path in mid-May. We now expect Comfort+ to generate nearly $300 million of upsell revenues in the second half of 2016, with further upside in 2017 as we begin the international rollout scheduled to be complete by the end of 2017.

We now have rolled out our basic economy product to over 7,000 domestic markets, or about 50% of our domestic revenue base. We anticipate that we will have full domestic coverage sometime in 2017.

Our international rollout of this product has begun, and we are now testing the product in over 50 international markets. Our intent is to have this in all international markets during the year 2018.

Our partnership with American Express produced $90 million of incremental value in this quarter, and we expect over $300 million for the year. New card acquisitions are on a pace for another record year, and have increased 30% year to date over a record 2015.

A special thanks to the SkyMiles and American Express teams for the great success we have had in enrolling new members this year. We have a great partner in American Express, and look forward to our continued efforts to provide the leading co-brand offering to our mutual customers.

While there are areas of the Business that have great momentum, there are others that require additional work. Our entire commercial team is focused on changing the revenue trajectory and getting back to positive RASM by year end.

Let me outline for you some of the major initiatives we have under way, by region, to ensure that we can achieve our goal. Domestically, our unit revenues declined 6% on a 5% capacity growth for the June quarter. And while absolute volumes for business traffic remained solid, quite simply, they did not keep pace with Delta's growth. Yields were further pressured as traditional AP and minimum stay requirements were absent in many major US markets.

On the other hand, leisure yields are strengthening, and demand remains strong. So, going forward, our path to improving domestic RASM starts by moderating our domestic capacity growth. This will begin in our post-summer schedule that begins late August.

With continued strength in leisure demand and yields, reduced capacity growth should allow us to position our inventory towards higher-yielding, long AP leisure fares. This should provide a cushion to unit revenues that will more than offset stubbornly low business fares that are largely sold within the month.

July and August will post strong domestic margins and cash flow as we run out the remainder of our summer schedule. We are confident that we will then see substantial RASM improvement in the September time frame, and may even achieve positive domestic revenue as early as September.

In Latin America, unit revenues were down 5% in the quarter, but June achieved our first positive unit revenue results in 26 months. This result was achieved as Brazil unit revenue declines moderated to just 4% on strengthening currency and capacity reductions. Delta has removed 25% of capacity in Brazil to deal with the economic crisis.

Mexico continued to be strong for us on both leisure and business demand, and RASM during the quarter was up 4 points. Caribbean demand remained solid, and we expect favorable unit revenues beginning in 3Q, as we lap our owned and industry capacity increases. For the remainder of the year, our Latin capacity will decline 2 to 3 points, and we expect this entity to inflect in RASM consistently as early as the September quarter on reduced currency pressures, strengthening demand, and reduced capacity offering.

Moving to the Pacific, the 5% unit revenue decline in the June quarter was the result of a 4-point headwind from lower year-on-year hedge gains. Additionally, there were 2 points of negative impact from negative fuel surcharges, partly offset by the appreciation of the yen spot rate.

As a business practice, we hedge at least 50% of our net yen exposure in any given quarter; however, in 2015 we had more significant positions in place at more favorable rates than we do currently. In fact, we expect to recognize a $5 million hedge loss in the back half of this year compared to a $90 million gain last year. $70 million of that headwind will occur in the September quarter alone, accounting for nearly 1 point of negative system PRASM, and more than 7 points of impact on the Pacific unit revenues.

Excluding hedges, we achieved flat RASM in Japan in the June quarter, held by our capacity adjustments, a focus on higher-yielding US point-of-sale traffic, and recovery in the Japan point-of-sale resort markets driven by a stronger yen. The strength in Japan was partly offset by yield pressures in China.

Passenger growth in China was up 7% in the quarter, and we continued to see increasing demand for connecting traffic with our partners, China Eastern and China Southern. However, industry capacity to and from the US increased nearly 25% in the second quarter, which pressured yields. This capacity is expected to continue in the second half.

For the remainder of the year in the Pacific, we are accelerating our capacity reductions, and expect to be down roughly 7.5% in the third quarter and 5% for the winter season. We expect the combination of our planned capacity reductions, along with a stronger yen, to achieve positive RASM growth later this year, excluding the hedge impact.

Finally, in the trans-Atlantic entity, Delta's second-quarter capacity grew in line with traffic trends at 2%, while the industry increased capacity by 10%, pressuring yields. Although this drove our unit revenues down 4.5% for the quarter, the trans-Atlantic is still on track to produce one of the most profitable summers in history. That said, this area continues to be where we face the greatest challenge in our efforts to get back to positive RASM, and we are now facing even additional pressures from Brexit.

In our Continental European markets, customer growth nearly matched capacity growth of 5%, but double-digit, low-cost carrier growth pressured yields. In the second quarter, Delta and Air France-KLM began a codeshare agreement with Jet Airways. We are very optimistic about this opportunity to feed Paris, Amsterdam and London going forward; and given the contra-seasonal nature of the India market, we expect that to have a positive impact on fourth-quarter trans-Atlantic revenues.

In the UK, Delta's British pound-denominated revenue is roughly [$350 million] on an annual basis. So, when the pound devalued 12% versus the pre-Brexit levels, our revenues were reduced by [$40 million] from currency alone.

Since the leave decision, we haven't seen a material impact on volumes. But as Ed mentioned, along with our partner, Virgin Atlantic, we are taking additional capacity out of the UK for winter to address the headwinds of the region. The reduction is focused on UK-origin leisure markets.

These changes, combined with other actions we're taking, will result in our winter IOTA schedule capacity in the trans-Atlantic being down for the second consecutive year. Even with these capacity actions, we do not expect RASM in the trans-Atlantic to reflect until sometime in 2017.

At a system level, with these plans in place across all of our entities and the trends that we see today for the September quarter, we are forecasting system-unit revenues to be down between 4% and 6% on a 1% to 2% year-over-year capacity increase. We expect July and August to be at or slightly below the bottom end of that range, with September markedly better than both of those months.

Calendar placement creates noise between the months, and will be a 2-point headwind in August and a 2-point benefit to September. Additionally, September should see benefit, as currency and fuel surcharge headwinds ease and the fall capacity changes begin to be implemented.

So, to wrap everything up, while the current environment remains challenging, we continue to outperform our peer set, we have plans in place to address the challenges we face, and are executing against those plans. Where we haven't seen the desired traction in our unit revenues, we're taking actions with revenue management strategies and capacity levels; and if necessary, we will take further actions to make sure that we maintain the momentum to achieve our goal of getting to positive unit revenue by year end and ahead of our network peers.

And with that, I'd like to turn it over to my good friend, Paul Jacobson.

Thanks, Glen, and thanks to your entire team. We all appreciate the efforts and the hard work that they are undergoing.

Good morning, everyone, and appreciate you joining us this morning. Consistent cost execution again this quarter was a key contributor to Delta delivering an operating margin that was within our initial guidance range, before the 4-point headwind from the early fuel hedge settlements. While we continue to benefit from lower fuel costs, prices remain volatile, as does the global environment, and we must remain vigilant on those costs that we can control. At the same time, it is critical that we continue to invest in our product, and enhance our performance and service to our customers.

Total operating expenses declined by roughly $300 million in the quarter, driven by lower fuel expense. Non-fuel CASM was essentially flat, despite pressure from higher wages, and product and service investments. Our strong operational performance, our upgauging initiatives, and the commitment across the Organization to delivering productivity savings drove our solid cost performance again this quarter.

I'd like to thank the entire Delta team for driving another outstanding result this quarter. We have the best employees in the industry, and this strong performance was made possible by their contributions.

We expect our non-fuel unit cost, including profit sharing, to be roughly flat again in the September quarter, and increase less than 2% for the full year.

Turning to fuel, our total fuel expense declined by over $400 million, as lower market fuel prices offset higher consumption and hedge losses. We made the decision in the quarter to early-settle all of our remaining 2016 hedges, which brought in an additional $450 million of losses to the quarter. Our all-in fuel price was $1.97 per gallon, including $0.43 from those early settlements.

The refinery lost a modest $10 million for the quarter, and we expect the lower crack-spread environment, which is a positive for Delta overall, will likely result in a modest loss for the refinery for the full year. Looking ahead, we expect an all-in September quarter fuel price of $1.52 to $1.57 per gallon, which is down 15% from the prior year. With the early hedge settlements complete, we don't expect to report any additional hedge losses in 2016.

Now let me address our margin outlook. With another quarter of solid cost performance, despite persistent RASM headwinds and a moderating fuel environment, we are forecasting a September operating margin in the 19% to 21% range, which is roughly flat to last year.

Moving on to cash flow, we generated $2.6 billion of operating cash flow in the quarter. We reinvested over $1 billion back into the Business during the quarter, with spending primarily related to aircraft deliveries and modification projects. We expect capital spending will approximate $750 million in the third quarter, as we now expect our Aeromexico tender offer to close in the fourth quarter.

We will continue to take a balanced approach to the deployment of our cash, as we remain focused on long-term durability and sustainability for the business model. This is what we are driving for with each dollar we spend, whether it is going back into the Business, the balance sheet, or returned to our owners.

We ended the June quarter with net debt of $6.8 billion, down from $7.1 billion a year ago. That debt reduction saved another $34 million in interest expense this quarter. With the additional $135 million we contributed to the pension plan this quarter, we've completed our funding commitment for the year.

The progress we have made on derisking the balance sheet and paying down our debt was recognized by Fitch in the quarter with an upgrade to BBB-. We are now proud that two of the three rating agencies have provided us with this strong endorsement of our commitment to the long-term stability and viability of our business model.

With the $1.6 billion of free cash flow we generated during the quarter, we continued on the path of also increasing shareholder returns, with $103 million of dividends and just over $1 billion of share repurchases. As we announced at our May analyst meeting, our dividend will increase to $0.81 per share annually beginning in the September quarter. At current stock prices, this is just over a 2% dividend yield.

In addition, we expect to complete our current $5 billion share repurchase authorization by next May, over six months ahead of schedule, which will represent our third consecutive authorization completed ahead of time. We expect to return nearly $3.5 billion to shareholders this year, consistent with our goal of returning at least 70% of free cash flow through dividends and share repurchases.

In closing, I want to express my excitement about the opportunities ahead for our Business. We're going to continue to stretch ourselves. We're going to continue to follow through on our near-term and long-term plans. Our performance is simply remarkable against any measure, and we are focused on remaining a leading S&P 500 Company.

Jill?

We are now ready for the analyst Q&A, if you could give them their instructions?

Thank you.

(Operator Instructions)

We will take our first question from Michael Linenberg with Deutsche Bank.

Oh, yes, hi, just two quick ones. Can you just give us the breakout between domestic and international capacity growth for the third and fourth quarters?

For the fourth quarter, which is the end point, so I'll start there, we will be up about 2 to 2.5 domestic and about down 2 to 2.5 internationally.

Okay, and then do you have that for the third quarter, Glen?

For the third quarter, I do not have that. I'm going to estimate it's about plus 3.5 for domestic and minus 1 for international.

Okay, that's perfect. And then just a quick question on the Virgin Atlantic, the 49% stake. I know that runs through the non-op. In your June quarter, does that reflect their June quarter or is that a lag? I know sometimes with private companies there's a quarter lag. I just want to clarify that.

That's current, Mike.

Oh, so it is the June quarter of Virgin's numbers in your June quarter?

Yes, they can count just like we can.

Okay, perfect. Thank you.

We will take our next question from Andrew Didora with Bank of America.

Thank you for the questions. Paul, just on the -- given the 2Q CASM results and 3Q guide, is there anything from a timing or a maintenance perspective in 4Q that would prevent you from coming in significantly below your sub 2% long-term CASM goal this year?

Good morning, Andrew. We're still -- we haven't given any guidance on the fourth quarter. I would say that there isn't anything on the horizon in terms of maintenance that would cause us to deviate from that. I think we continue to run a great operation and manage through that, so our goal still is to keep it below 2%. We're not going to give any forward guidance on 4Q.

Okay, and then secondly, Paul, obviously, there's been a lot of movement in the bond market since the Brexit vote and the 10-year treasury is near record lows. Are there any significant pension implications that could end up creating a bit of a CASM headwind over the next year or so or is it too small?

Well, I think that it's a little bit too soon to tell. Obviously, our balance sheet liability is impacted by rates; we've talked about that in the past. So assuming rates don't revert back higher, we could see a higher balance sheet liability. But keep in mind that has little impact on expense and little impact -- no impact at all on our minimum funding requirements or our strategy going forward, which is much longer-term based.

Great, thanks a lot.

We'll take our next question from Duane Pfennigwerth of Evercore ISI.

Thanks, good morning. Glen, I wonder if you could playback for us what you were expecting to see with respect to the June quarter monthly, how that was different than what you expected to see and how that maybe is impacting your forecast here into the third quarter. Because I thought the idea was peak demand, July/August would soak up those excess seats and fix the close-in yield problem. But now it sounds like we're dependent much more on September and maybe a return to corporate.

I think what we didn't expect in the beginning of the year was the continuation and acceleration of the declines in the business traffic sector, so what we had anticipated is the strong demand leisure and that has borne out. The demand set for leisure is quite good and in line with our capacity offering, but it has not offset the close-in yield weakness that we've see. And so that's how it played out, and that leaves us with really no other choice but to decrease the capacity levels moving forward because we can't count on it.

As we said in the earnings call, the stubbornly low close-in yields go away, so what we need to do now is not go into a month flat. Because if we go into a month with flat RASM, we come out with a RASM that's in the minus 4, 5 range. So we have to hit that up 3 to 4 to 5 as we come into the month, knowing we're going to give away some of that yield within the month.

So that's how it played out and that's how we're looking towards September, of course. When we planned the summer capacity, that was back in the February and March time period. And while we're looking in a rear-view mirror, it will be an incredibly profitable record summer for us. So it not as disastrous as some people are characterizing it, but it's really robust, and we're going to take the necessary actions to fix it moving forward.

Thanks and then just as a follow-up, could you give us maybe capacity growth by month? It looks like it's fairly similar right now in July, August, September. And then is there any implication for 2017 from that 1% year-to-year growth in the fourth quarter? Thanks for taking the questions.

Duane, we didn't give the monthly capacity so we aren't going to lay it out, but I think you can roughly estimate where we're at today as the July/August. And the nonce capacity starts to tick down as we get out of the summer season, late August into September the numbers start to inflect the greater reductions.

We haven't given 2017 guidance out, but again if you look at our Q4 up 1%, I'd expect our Q1 probably to be in that same range. And certainly by the time we get to the planning for the spring, if conditions are the same, we're going to continue to take the same tactic on capacity.

That's very helpful, thank you.

We'll take our next question from Julie Yates with Credit Suisse.

Good morning. Thanks for taking my question. Glen, I just wanted to clarify on the PRASM cadence for the third quarter, you mentioned that July and August were looking weak. And just to help calibrate expectations, should we expect to see July RASM worsen from June's down 5% and then improve steadily, with September being the best month of the quarter?

I think that's probably exactly how you would read it.

Okay, understood. And then just to reconcile, domestic is now the worst-performing entity and that's where capacity growth is still the highest. How do we get confidence on the level of sequential improvement that you need to see in order to write the PRASM trajectory to get to positive by year end?

Right, well I think that it's also where on an absolute basis for decreasing our rate of growth the most. So we are going to be coming down about 300 to 350 basis points from where we are in peak summer versus international, which is going down about 100 basis points. So I think if we have to go further we will, but this is the next step in seeing if we can get the numbers to where we need them to be to continue to expand our margin into next year.

And Julie, this is Ed. Domestic is incredibly strong in aggregate. I realize the RASM numbers have been weak, but the bottom-line results have been phenomenal. And the premium that we continue to generate versus the competition for domestic is about a 120. So team's doing a great job domestically, but we realize in order to get the RASM improvement to match the increasing fuel prices we're going to be paying, we need to be making the adjustments that Glen talked about.

Got it. Thanks so much.

We'll take our next question from Helane Becker with Cowen and Company.

Excuse me, I'm sorry. I just choked on some water.

How are you, Helane?

Other than choking, I'm okay. I just was wondering could you update us on where you are with respect to aircraft retirements in the Pacific and how that affects capacity growth in that market for the back half of the year?

We still have six 747-400s that are flying in the Pacific that are all scheduled to be retired by year end of 2017. We're trying to accelerate that closer to September, but that would likely, in and of itself, would have a negative bias on Pacific capacity in through the year next year. It will also be a significant improvement to our P&L as we replace the aging airplanes with much more efficient equipment.

Okay, and is that included in that system capacity guidance of down 1% that you're referring to in the comments today?

Well, I may have -- you may misinterpreted what I said. The last six don't come out till the fourth quarter of next year, not this year.

Okay, got you, fourth-quarter 2017. And then on an unrelated topic, I'm just wondering the tax rate was down. I think it was maybe guidance was 34% or somehow I thought it was going to be 34% and the actual was 33%. So is that -- was there something special in there?

Good morning, Helane, it's Paul. I hope you've got your breath back here. During the quarter, we early adopted the new FASB policy on stock compensation with a benefit to our tax rate for the quarter, but we still expect our full-year tax rate to be 34%.

Got you, okay. Thank you very much for your help.

Thank you, Helane.

We'll take our next question from Hunter Keay with Wolfe Research.

Thank you very much. Good morning.

Good morning, Hunter.

So Ed, I think the last year or so has proven out that investors probably care more about fundamental behavior from airlines rather than traditional business metrics like profits, for example. So as you think about -- you have the long-term financial goals that you guys have laid out relating to ROIC cash-flow debt and earnings growth, I'm curious why you still think earnings growth is a factor. You actually highlighted that in specifically in your prepared remarks.

Do your -- so the question is do your investors tell you that is something they still want? Because it's certainly not something that other transport or industrial companies achieve or even strive for that trade at multiples that are much higher than airlines right now. So the question is why is that one metric still included in the bunch?

Not sure I follow entirely your question. Why are we focused on growing our earnings, is that your question?

Yes, I -- let me put it this way, 15% is a lot and inherent in that implies some degree of probable capacity growth to get there. So you think you talk about ROIC and debt and cash flow and people, I think all appreciate that. But just like -- you guys will probably always be a value stock, so why focus on earnings growth? Is that something you hear from your investors that's something that's important?

Yes, yes. We hear from our long-term investors that continuing to improve our all of our financial metrics, whether it's our ROIC or our earnings potential or top-line growth are all important. We realize we sit in a volatile industry and a volatile space, but our goal is to improve the sustainability and durability of the model and we think earnings growth is important, yes.

Okay, that's fine. And then Glen, you talked about corporate a little bit. We've heard other airlines talk about this issue of dilution as it relates to some of the quotes in pricing weakness. Obviously, you said volumes are pretty good. So would you categorize dilution as the biggest source of controllable factors contributing to some of the domestic PRASM weakness? And if it's not that, what would you say it is?

I think we've talked about this before, is -- it's more of the same. It's the way your approaching the time value for time-sensitive customers. And are you getting what people would be willing to pay for their time versus what the market is charging for time?

And if you look, business fares, as these quarters roll out with government, we can all look at it. But what I think you'll see is that the business fares are well below where they have been historically, and in a lot of markets where there have been little capacity, even no capacity, even negative capacity changes over the medium term.

So I hear your question and I wish I had the best answer for why that is there, but I think like everything, it's a part of the cycle. I think it has to do with lower fuel and I think as higher fuel rolls through everybody's P&Ls that there will be a lot more focus on that. But that's not -- we're a small percentage of the industry. We represent less than 20% of the total industry, so we don't have that power or predictions to be able to go out and say those things.

Okay, thank you.

Thank you.

We'll take our next question from Jamie Baker with JPMorgan.

Hi good morning, everybody.

Hi Jamie.

Glen, other revenue declined slightly from the first quarter, which seemed a bit inconsistent with seasonality. I know there's stuff in that category other than ancillary revenue. I'm just wondering what the moving pieces were that drove the decline, especially since as you noted, Comfort+ turned on in the month of May.

Hi, good morning, Jamie. It's Paul.

Hi, Paul.

One of the big items in that was lower year-over-year third-party sales from the refineries, so there's a piece of that that has to flow through gross-up revenues and net it out of expense. So with the lower crude oil prices, the product values are substantially down. So that was about $65 million of that number.

Okay, that makes perfectly good sense. Second, if we exclude the hedge impact in the second quarter, you essentially achieved a 21% operating margin and you're guiding 19% to 21% for the third quarter. I'd have to go back, I think it's eight years now, to find a time when third-quarter margins were softer, potentially softer than in the second quarter.

And look, I'm not asking you to rehash the components of the guide, the currency disclosures were certainly helpful. But it seems puzzling to me that against an industry backdrop that is so much better today than in 2008, you aren't even able to achieve normal seasonality. Is this just a blip or potentially a new normal in how we think about the seasonal margin peaks?

Jamie, this is Ed. You asked a lot in that question and I have not gone back to check to 2008; 2008 to me is a blur going back in that -- going back in time. Listen, our guide is our best estimate to where we sit now. We do not think that we're at a -- trying to forecast any type of inflection on the cycle or the margins, if that's your question. It's really where we are.

Fuel prices have bounced around a fair bit and fuel prices are up a bit in Q3 versus Q2, hedge aside. And we realize that we do have unit revenue weakness particularly in the first half of Q3 that we're recognizing. So I think that if you look at Q3 year on year, I think we're about flat, 20% pretax margin, and I think that's about all I can draw from that.

So nothing structural to suggest that in the long run, you would not continue to be a third-quarter -- a third-quarter airline so to speak, third quarter representing the absolute peak of the year?

Yes, I think the third quarter is the peak of the year. Candidly, it's June, July, and August, so that continues to be our -- that's our sweet spot.

Okay, I appreciate the disclosures. Thanks, everybody.

Sure.

We'll take our next question from Jack Atkins with Stephens.

Hi, good morning. Thanks for the time. When we think specifically about the capacity actions that you're taking, both those announced in May and those announced this morning, can you quantify specifically how those actions will impact RASM? Can you bracket that in terms of an impact?

It will improve RASM, how is that?

Okay, okay. So that when you think about your desire to get to positive RASM by year end, will you be willing to go to negative capacity growth year over year to get to that level?

No, that's not our plan.

Okay, thank you.

We will take our next question from Darryl Genovesi with UBS.

Hi guys, thanks for the time.

Sure.

Ed, Glen, you both mentioned that you think fuel is the biggest driver of higher RASM on a perspective basis, and I was just wondering how you come to that conclusion. Do you mean to imply that this move from the $27 or so rent that we saw for a short period in January up to $46, $47 today is likely to have driven a negative profit contribution from some flying in the network, either at Delta or your peers and that's likely to drive a capacity reduction? Is that the thought process?

Well, if you look historically at trends that follow and we started with fuel around $100, we got all the way down to about $25 to $27, and then now we've been moving back up into the mid to high $40s. It's very, very high R squared to go back and look at airline revenues with fuel over time. And the lag time that reduces the highest R squared is about nine months.

So that's over a very, very long period of time within the industry. I think that's what we are counting on is that on the margin when fuel was $25, there were players who were pricing their products at the incremental marginal cost of $25 fuel. That marginal cost of production has gone up substantially since the low point, and normally it would take about nine months for that to flow through to airline revenues.

Okay, thanks for that. And then just maybe to follow-up just on Hunter's question a little bit. With regard to the close-in yield weakness that we've seen, I would have thought that by this point, assuming that problem isn't actually getting worse and maybe it is, but I would have thought that at this point, the RM systems would be calibrated and thus holding on. Sorry, thus not holding on to as much inventory for late-in-the-booking-curve bookings. Is that not the case?

Well, late-in-the-booking-curve bookings, even though they are depressed, are significantly higher than early-in-the-booking-curve bookings. So you never want to turn a late-in-the-booking-curve booking away, even though they are depressed on a relative basis.

Okay, it seems like in some cases, some of these fares that are being offered very close in, are actually lower than what you can buy in it far in advance. And I've seen that myself and heard about it anecdotally. And just wonder if there was any progress being made towards splitting some of that up.

We can't comment on forward pricing, but generally, close-in yields are significantly higher than long AP yields, and so that hasn't changed.

Okay, thank you.

Thank you.

We will take our next question from Joseph DeNardi with Stifel Nicolaus.

Hi thank you. Glen, the flat PRASM or positive PRASM, is that for 4Q or the month of December? And then secondly, it sounds like the capacity actions you're taking today are entirely or exclusively focused on the UK and Brexit. If you're seeing weaker close-in yields domestically and softer corporate traffic domestically, why isn't domestic capacity coming down?

No, I think that you misread that. Domestic capacity is coming down significantly. We are decreasing our domestic offering in the fourth quarter versus the current quarter by about 300 basis points, so a very significant decrease in domestic capacity coming from us.

Okay, and then the RASM goal, is that flat for the month of December or positive for December or for the full --?

That's our goal, Joe. Our goal has been to try to get there by the end of the year and when we get there we'll let you know.

Okay, does that mean December or the fourth quarter?

We will take either.

Okay, and then Paul, next year, a year when we should expect maybe a bigger step up from the FX agreement, is there some contractual amendment coming next year, any color there?

Good morning, Joe. There's no amendment. As we announced in Investor Day, we talked about a couple year period from the overlap with the prior agreement and then the new agreement beginning in 2017. So we have talked about having some additional benefits accruing in 2017 going forward. We'll have more on that probably at Investor Day.

Okay, thank you.

We will take our next question from Savi Syth with Raymond James.

Hi, good morning. Paul, if I may ask, your -- the core cost performance, I think if you adjust for the labor, the increased pressures, it's been quite impressive. And I'm guessing FX is going to benefit of that maybe 0.5 point. But could you talk a little bit more about what's driving the, on a per (inaudible) basis, the declines that we're seeing in contract carrier maintenance? I think landing season packs services. And I'm just trying to get an understanding of does that continue into the second half in 2017 or how should we think about these offsets that you've been driving?

Sure, good morning, Savi, and thanks for those comments. The biggest driver of our cost performance has obviously been the continued upgauging and efficiency being created in the business through that, as we've talked about in the past. Our upgauging has been accruing at about a rate of about 5% a year from 2012 through 2015.

And we have with our current fleet plans about a 7% upgauge between 2016 and 2020, so clearly that has had a material benefit on our ability to drive cost efficiencies in the business. That, combined with the innovation of Gil's team and others across the operational sphere, have been a huge, huge benefit for us going forward. And we've got to continue to find ways to drive productivity in the business without impacting and, in fact, enhancing the customer and employee experience, which I think the team has done a great job of.

Thanks for that. And then for a follow-up question, and Glen, I hate to beat a dead horse on this, but I'm trying to understand on the close-in yield, if it deteriorated as you went through the quarter, and the reason I ask that is with your comment that leisure yield [trend then], I thought it was those lowest fares that are putting pressure then on the close-in yield. And if the lowest fares and leisure fares strengthen, I'm surprised that we're not seeing at least no further deterioration in those close-in yields. And so I'm wondering is this maybe some actual weakness in corporate that we're seeing?

So I think there are a couple things that we just did a poll survey, and maybe I'll let Steve talk to that. Steve, do you want to pipe in on?

Yes, our June corporate survey actually had an uptick year over year, but basically stable outlook from all of our top corporate accounts. So we see really relatively flat demand throughout the entire year so far. So again, we see a little bit on that yield pressure.

So that would say that the real component is that we have flattish corporate demand. We have corporate yields down in the 5 to 7 category, and we have capacity that's growing in excess of the rate of growth of the corporate demand set, which is also putting downward pressure on the total RASM. And those are the three components that we see.

That's very helpful, thanks. And one clarification, on the earnings growth over time, you're talking about EPS growth, right, and not necessarily just earnings?

We're talking EPS growth, that's right, Savi.

Thank you.

We're going to have time for one more question from the analysts.

We will take our final question from Dan McKenzie from Buckingham Research.

Hi, good morning, guys. Thanks for squeezing me in here. Glen, how is Delta getting to less capacity exactly from the reduced Atlantic flying? Is it less capacity with the same number of planes? Is it flying being redeployed to other markets as an optimization move? Or are some planes potentially being early retired here?

It's a little bit of all of the above. If you look at our fleet count for summer of this year versus summer of last year, it's almost flat. I think based on about 1,500 flying airplanes we were up 8. So the increased capacity has been coming on the marginal utilization because of lower fuel. And what we were seeing is we're not getting paid for that so that's coming out.

And we'll be doing a lot of more cancellations in the off peak, more cancellations in the ad hoc world, as well as gauge reductions. And maybe what we haven't committed to it yet, but some markets will not make it through.

Understood okay. And then Glen, in May you talked about seeing some green chutes in the Latin America region. And since then we've had a huge move in FX, particularly to Brazil. ANd just given what's happening with capacity and foreign exchange to the country and to the region, I wonder if you can elaborate a little bit more on the revenue road map from here in this entity? And then tied to that, is there a revenue benefit potentially from Aeromexico that could be incremental in the back half of the year?

Well, I think we've mentioned in the prepared remarks that the Latin unit revenues were up in the month of June for the first time in 26 months. So those green chutes that we saw last quarter are actually coming in. And again, being driven by strength in Mexico, and a lot of that strength may be related to the presence of Delta and Aeromexico together. Because it seems that we're getting a much higher share of some of the corporate travel to and from Mexico than we have had historically, even before our ATI-enabled joint venture goes into place. And Peter Carter is sitting next to me; maybe Peter can talk about the timing of when we believe Aeromexico will be approved.

Good morning, Dan. We expect it to be approved in the fourth quarter.

Understood, thanks, and just one final house cleaning, Paul. Has Delta been active in buying back the stock since June 30th?

Dan, good morning. We, as we talked about before, we're in the market every day buying back stock and this quarter is no different.

Thanks for the time, guys.

Thanks, Dan.

That's going to wrap up the analyst portion of the call and I will now turn it over to Kevin.

Good morning. This is Kevin Shinkle. Welcome to the media portion of the call. We'll have about 10 minutes for questions, so please limit yourself to one question and one brief follow-up. Kyle, will you please provide the instructions on how to register to ask a question?

(Operator Instructions)

We will take our next question from Jeffrey Dastin with Reuters.

Thank you for taking the question. Might you break down why trans-Atlantic flights will have one of their most profitable summers in history? Is it country, which countries and which point of origin, leisure versus corporate bookings that sort of thing?

We don't provide that level of detail, Jeffrey. Trans-Atlantic for us historically has been a strong source of profit, and as we've expanded to the UK, with our Virgin relationship, we've just built on that.

Great, thank you. And then the follow-up will be how do forward bookings to the United Kingdom for the fourth quarter compare to how they were last year? Are there more bookings a factor in the capacity tweets, not just the currency?

The currency certainly has impacted the booking point of sale, and we have seen some strength in the US point of sale to the UK as the pound has deteriorated. Likewise, we've seen some reduction in our UK point of sale coming to the US, and that's why we're making certain of the capacity adjustments combined with overall high levels of capacity in the North Atlantic, which is putting pressure on yields even before Brexit.

Great, thank you.

We will take our next question from Michael Sasso with Bloomberg News.

Yes, good morning. I'm still a little confused about the issue with close-in bookings. It sounds like demand is still okay, but that maybe some of the problem is too much capacity. Is that what I'm hearing? Could you just explain what specifically is causing those close-in yields to be lower?

Well, industry pricing is lower year over year, and that's probably the main driver of it. But when you have capacity growth and you have stable demand, that's also a negative impact to the total composition of your unit revenues, because corporate travel is, of course, the highest yielding piece of our yield curve. So it's a combination of too much capacity and too low fares.

Next question?

We'll take our next question from David Koenig with the Associated Press.

Yes, hi. I thought you might touch on this in the last answer on the analyst section, but should we expect you to drop any routes or markets entirely as part of your reduced plans for capacity in the fourth quarter? Hello?

Hello. We don't comment on future schedule changes or future pricing initiatives as a general rule.

Okay, yes, I'm not asking you to name the routes or markets, I just wonder if that's something we should expect as a possibility.

We evaluate them all the time and we add routes and delete routes from our network on a regular basis. So the answer is that we'll adjust to market conditions as we see them evolve.

Okay, thanks.

We will take our next question from Kelly Yamanouchi with The Atlanta Journal-Constitution.

Hi there. I am wondering about the UK-origin leisure markets that you mentioned, the capacity cuts will be targeted at. I was just wondering what kinds of markets are UK-origin leisure markets?

Well clearly, London is the biggest market in the UK, but London a very, very high business component. As a matter of fact, London represents about 35% of the total business to and from the US between the US and Europe. So what we're doing is we're taking potentially down frequency as an off-peak days or downgauging equipment into the regional cities. Manchester tends to be a perfect example of a much higher UK point-of-origin market than London, because there's a lot of leisure travel coming out of Manchester and those would be the types of markets that we would look at to reduce.

Kelly, this is Ed. We've grown substantially in the UK in the last several years, both we and our partner at that Virgin Atlantic. So I wouldn't be focused on a cut; this is more trimming from the overall growth. So you have to look at this over a longer time horizon. And our capacity is up substantially to the UK over any period of time. So I think this is a normal part of the ebb and flow of supply and demand.

Okay, great, thank you very much.

We'll take our next question from Ted Reed from The Street.

Had a Brexit question. My impression from what you said was that more Americans are going to UK in the summer and so there's very good summer travel. But in the winter, the UK travel to the US, the US leisure destinations is what's declining. Is that fair?

That's our best estimate Ted, yes.

When you say leisure destinations, does that mean Florida for the UK people coming in the winter, is that Florida?

Florida, Vegas.

Just broadly.

New York.

Thank you.

We'll take our next question from Edward Russell with Flightglobal.

Hi yes. On the UK cuts, I was wondering are those going to be seasonal just during the winter and off-peak periods, or are they intended to be permanent cuts?

They are just seasonal.

Okay, and then second question, what does this mean for the new routes that you've announced for 2017 into the UK, Portland, additional frequencies from Detroit and Atlanta?

There's no changes.

Thank you very much.

We will take our next question from Linda Lloyd with the Philadelphia Inquirer.

Thank you. Thank you for taking my question. With the Trainer refinery posting a loss for the second quarter, a $10 million loss in the latest quarter, and $28 million loss in the first quarter, is the refinery still a benefit to Delta? Are you still glad you bought it?

Good morning, Linda. This is Paul Jacobson. The answer is absolutely. The Trainer refinery for us has been a huge success, and as we talked about, the lower crack spread environment that exists for the entire refining complex is a tremendous benefit to the airline. So as part of the integrated fuel management strategy, we are absolutely still very pleased with that purchase and that investment.

Is there a time you envision the refinery becoming profitable again as you look out in future quarters or this year?

Well, certainly, we've had profitable years with the refinery, and that business is very cyclical. We certainly hope it doesn't come at the expense of significantly higher fuel for the airline. But you've got to remember that it's part of that integrated strategy, and we know we'll have good times and bad times with that refinery. But we're absolutely committed to it despite or irrespective of its profits.

Linda, this is Ed. Let me be really clear. We are very happy with the refinery; they are doing a great job, and yes, we expect they will continue to generate profits, as they have historically for Delta over time.

Okay, thank you very much.

Kyle, we have time for one last question.

We will take our final question from Elliott Blackburn.

Good morning. Thanks for taking the question. Just building off that last question, can you go through, considering the fact that the refinery will be adding to your fuel costs, it sounds like through the rest of the year, what does success look like more broadly for that refinery? How do you guys evaluate that refinery as a contributor?

Well Elliott, the main purpose of buying that refinery is, as articulated in all of our commentary, is then to self-supply jet fuel and increase the supply of jet fuel, which we've done very successfully. We measure the success of that refinery based on how well it operates and the team that we have there has been performing extraordinarily well. From a cost basis, from an operational reliability basis, the refinery leads all comparable indices, both in size and geography for its efficiency and its productivity.

The absolute crack spreads in the economics of that you've got to take into account the airline. And when crack spreads are down, that puts pressure on refinery profits, but it's a huge windfall for the airline as well. So we feel very good about that, and as long as it continues to operate the way it is, we view it as strongly successful.

But it seems like your peers that are also buying jet fuel benefit from that without actually having the risk of operating a refinery. So can you help me understand why the refinery itself is a unique benefit to Delta in light of that?

Well, the fact that it may or may not be a benefit to our customers doesn't have any -- or our competitors doesn't have any bearing as to whether or not we view it as a success for Delta. And we do things that are good for us, and the refinery is a great example of that.

Don't forget this was a refinery that was closed, and when we reopened it, we added 40% more supply of jet fuel into the New York harbor. That alone was a substantial benefit to Delta. And to the extent it benefits our colleagues and industry, all the better.

Thank you very much.

That does conclude our Q&A session. I would like to turn it back over to management for any additional or closing remarks.

No, that's it. That concludes everything. Thank you for joining us.

And this does conclude today's conference call. Thank you all for your participation. You may now disconnect.