達美航空 (DAL) 2016 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Delta Air Lines December quarter financial results conference call.

My name is Dana and I'll be your coordinator.

(Operator Instructions)

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

I would now like to turn the conference over to Jill Greer, Vice President of Investor Relations.

Please go ahead.

Thanks, Dana.

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

Joining us from Atlanta today are CEO, Ed Bastian; our President, Glen Hauenstein; and our birthday boy, Paul Jacobson.

Our entire leadership team is here in the room for the Q&A session.

Ed will open the call and give an overview of the financial performance.

Glen will then address the revenue environment and Paul will conclude with a review of our 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 our 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 discuss non-GAAP financial measures.

All results exclude special items unless otherwise noted.

You can find a 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 Ed.

Thanks, Jill.

Good morning, everyone.

Thanks for joining us.

Earlier today we reported our December quarter and full year results, including a December quarter pretax profit of $923 million, an EPS of $0.82 in line with consensus.

Normalized for the out of quarter cost and the new pilot contracts, our pretax income was $1.3 billion with a 15% pretax margin and EPS of $1.16.

This rounds out what has been a record breaking year across the board for Delta financially, operationally and for our customers.

Financially we produced $6.1 billion in pretax profits, 16.5% operating margin and a 26% pretax return on invested capital.

It looks like we'll be the only major to have grown its operation margin in 2016.

We generated $7 billion in operating cash flow and nearly $4 billion in free cash flow which we used to he reduce our adjusted net debt to $6.1 billion, achieve an investment grade credit rating and return over $3 billion to our owners.

Operationally, we ran the best operation in the industry by a wide margin and we continue to raise the bar on ourselves.

We ended 2016 with 241 days of no main line cancellations and 81 days with no system cancellations, a level of performance that no airline has ever come close to producing on our scale.

And we're doing that at the same time we're regularly keeping on time arrivals at nearly 87% and improving our bag scores by 13 -- incredible work by Gil and entire operations team.

We know that our operational reliability is a key driver of customer satisfaction and one reason why more customers than ever prefer to fly on Delta.

With our operating performance, combined with the investments we've made in our fleet, products and facilities, we've seen a consistent improvement in our Net Promoter Scores, hitting a record 44% in November.

All of this is due to the outstanding efforts of 80,000 Delta people and it's an incredible honor to recognize them with over $1 billion of profit sharing for the third year in a row.

Sharing the success of our the Company with our people is one of the things that makes Delta truly different.

The major theme at our Investor Day last month was the sustainability and durability of our business.

And with fuel and labor costs rising we must grow unit revenues in order to sustain our margins.

So we're pleased to have seen our fourth quarter unit revenues come in better than not only our original guidance but also better than the guidance we gave in mid-December.

While it's taken longer than we wanted to get here, we are cautiously optimistic that the revenue environment finally appears to have turned the corner.

And after flat RASM in the month of December we expect unit revenues to turn positive for the first quarter.

That said, we're going to remain conservative with our capacity until we see two things.

In the short term, we'll need to see a further firming of current revenue trends.

And over the medium to longer term, we will keep our capacity in check until we are you achieving our 17% to 19% operating margin target because, as we also said at Investor Day, 2017 is going to be a bit of a transition year.

While revenues are on a better trajectory, we expect margins will decline 100 to 200 basis points year-on-year in 2017 given the current forward curve and the expense of our labor cost reset.

However, we expect the margin pressures to peak in the March quarter and by the back half of this year be in a position to expand margins as our unit revenue base improves.

This should be a very good set up for 2018 and beyond.

So as we look ahead, I'm optimistic.

By executing flawlessly against our core principles, we're confident that we're on the right path to return to an improving margin trajectory later in the year.

First, we'll continue to be America's best run airline, focusing on producing the best operations every single day for our customers.

Next, we'll continue to strength our brand, improving our product and service in the eyes of our customers and generating a sustainable revenue premium versus our competition.

We'll also expand our global reach through equity stakes, joint ventures and partnerships around the world.

I'm looking forward to completing our Aeromexico tender offer in the first half of the year.

Finally, we'll maintain our solid foundation with cost and capital discipline, making sure that every dollar we spend is put to good use without burdening the business with high leverage.

Put together, this will he create the sustainable returns and cash flows that our owners expect over the long term, delivered by the very best team of airline professionals in the business.

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

Thanks, Ed, and good morning, everyone.

I want to start this morning by thanking the Delta people for taking great care of our customers every day.

It's your efforts that make Delta brand and drive our premium to the industry.

I also want to give a special thanks to our commercial team for all of their very hard work that got us to flat RASM for the month of December and should return us to positive unit revenues in the first quarter.

While total demand remained strong throughout 2016 weak business yields were prevalent and drove RASM declines.

To address this, in the December quarter we adjusted our revenue management approach and capped our capacity growth below 1%.

Following the election in November, we began seeing improvements in business demand and the firming of business yields.

These trends continued into December which was the first month in over two years that yields improved on a year-over-year basis.

As a result, our fourth quarter unit revenues were down 2.7%, better than both our initial guidance and the updated outlook we gave at Investor Day.

As we look ahead, we are encouraged by the trends that we see.

At a macro level, consumer confidence remains strong and demand remains solid.

And the outlook for corporate travel is positive.

In our most recent survey, 85% of our corporate customers expect that they will maintain or increase travel spend in the first quarter.

This figure is up 9 points from the previous outlook done last quarter and is the best outlook we have seen in two years.

In addition, we are maintaining our commitment to moderate capacity growth until we see further firming of the current revenue trends.

Our capacity will decline about 0.5 points in the first quarter of 2017.

By excluding the impact of leap year, our run rate will continue to track below 1%.

Finally, although domestic business yields have turned positive, there is still a long way to go and a great opportunity for us before they're back to historical levels.

These points combined give us confidence that we are on the right path and we expect system revenue RASM to increase 0% to 2% for the March quarter with February and March stronger than January.

Geographically, our path to positive RASM is heavily dependent on the domestic entity given it's relative weight in our network.

For the December quarter, domestic unit revenues were down 3, which is a 4 point improvement from what we saw during the third quarter and the momentum is continuing.

More than half of our domestic network is currently realising positive RASM today, up from 20% we saw during the summer period.

And our network investments continue to drive results with JFK, Los Angeles and Seattle notable bright spots for us as each posted positive RASM for the December quarter and have superior forward trends.

With the demand and yield improvement we are experiencing, we now expect domestic PRASM for the November through January period to be slightly positive versus our prior outlook of flat.

We also expect that our domestic unit revenues will be positive for the March quarter.

We will continue to be prudent about our capacity increases as we work to maintain our revenue momentum and we expect domestic capacity to be up 1.5% in the first quarter.

In addition to the benefits we anticipate from adjustments to our revenue management strategy, we will also begin lapping the domestic close in pricing weakness we started experiencing around February last year.

Internationally, we are seeing trends improve.

While there are pockets of weakness around the world, we are taking the appropriate action to ensure our results continue moving in the right direction.

International capacity was down 2% for the December quarter and will be down 4% in the first quarter of 2017.

For Latin, unit revenues improved 5% year-over-year in the December quarter, the second consecutive positive result for the region and we anticipate the momentum will continue in the first quarter.

Brazil has led the turnaround in the region but each sub-entity in Latin America has posted positive year-over-year RASM for the first time since the third quarter of 2011.

We see momentum in Latin continuing as we move through 2017.

In the Pacific, we continue to execute on our multi-year he restructuring which de-emphasizes our hub in Tokyo and continues to build on our partner hubs in Shanghai and Seoul.

As a result of these changes, the spool of new Tokyo Haneda services and a challenging capacity environment, our Pacific entity unit revenues declined 9% on 6% less capacity.

Roughly half of this RASM decline was driven by lower yen hedges on a year-over-year basis.

We expect fourth quarter of 2016 will mark the trough for our Pacific unit revenue performance as our restructuring efforts take hold and industry capacity growth moderates.

Specifically, we expect the significant capacity growth in the US to Shanghai and Beijing market, which has occurred over the last several years, to slow in 2017 as both the Chinese and the US carriers will reach their respective frequency caps this summer.

Turning to the Atlantic, our European portfolio remains challenged due to industry capacity and balance and currency headwinds.

While our Transatlantic unit revenues declined 6% for the quarter, the region still produced one of its most profitable December quarters in history.

And as we've seen the industry fair environment evolve, we have been thoughtful and proactive in our capacity adjustments and are planning 1Q 2017 Transatlantic capacity to be down 3%.

In 2017 we will continue to build on our presence in our strategically advantaged hubs in London, Paris and Amsterdam while de-emphasizing high EU point of sale markets.

And as we move into the summer season, we expect point of sale US demand to be at record levels which will help mitigate the point-of-sale European weakness.

For our international network broadly, further strengthening of the US dollar does pose some incremental risk to 2017.

However, we are well positioned to mitigate these potential headwinds through our capacity and fleet actions.

At current rates, our year-over-year foreign exchange impact in 1Q of 2017 is expected to be a $25 million headwind.

With positive RASM in our line of sight, our next priority goes to consistently producing top line growth as we return to margin expansion in the back half of this year.

To this end, it is our focus on the customer and our brand that will allow us to maintain our momentum and ultimately drive a better revenue outcome.

[Branded] fares remain a huge opportunity for us and we'll continue expanding our merchandising our suite of products that allow customers to tailor their travel experience.

This year we expect to generate an incremental $300 million in revenue from our branded fare initiatives.

Our newest product, Delta Premium Select, will debut in the first half of 2017 providing elevated service and improved amenities on Delta's longest flights.

And the expansion of basic economy will also continue in 2017.

Today, basic economy is over 40% of the domestic markets and we expect to have full domestic coverage by mid-2017.

The broader international rollout will follow and we expect to be complete with basic economy in our entire network by 2018.

We are expanding the breadth of our products in the marketplace.

We are investing in technology and commercial improvements to advance the way we offer these products.

We want to consistently have the right product at the right price at the right time for our customers.

We continue to develop our international partnerships and we were pleased to be granted antitrust immunity by the DOT for our proposed JV with Aeromexico in December.

We expect the JV will become effective on April 1. We are excited about the opportunity that this presents both characters -- both airlines in the largest business travel market between the US and Latin America.

Finally, we will continue to invest roughly 50% of cash flow back into the business to improve the customer experience.

Whether it's new aircraft in our fleet, our new all suite business class product, improvements to the sky clubs or the investments we're making in innovation like RFID or other customer facing technology, Delta continues to invest in having an industry leading product.

The opportunities to drive additional revenues are great and I could not be more excited about the business in 2017 and beyond.

And with that, I'd like to turn it over to our birthday boy and CFO, Paul Jacobson.

Thanks, Glen.

And good morning, everybody.

Thank you for joining us.

Once again, this quarter the Delta team was able to demonstrate that despite challenges and cost pressures, we have built a durable business that can deliver consistent results.

Total operating expenses increased $573 million in the quarter, primarily driven by $475 million of pressure from the new pilot contract with $380 million of that being related to the retro payment back to January 1. Nonfuel CASM increased 10.6% in the quarter, roughly 8 points of that pressure driven by the pilot agreement in the quarter.

Excluding the portion of the contract expense not related to the quarter, Delta's normalized nonfuel costs increased approximately 4%.

That said, fourth quarter saw a bit more cost escalation than we've been seeing so far this year.

In addition to the impact of the wage increases related to the ratified pilot agreement, there were timing issues in line items such as maintenance, contracted services and rents and landing fees that drove expense pressure in 4Q after having provided benefits in earlier quarters.

However, fourth quarter and our full year results are consistent with the expectations we've had all year.

For the March quarter, we expect nonfuel costs to increase 5% to 7% on a reported basis as cost pressures in 2017 will be weighted toward the first half of the year.

Normalizing 1Q 2016 costs to include the portion of the pilot contract related to that period, our nonfuel CASM is expected to increase in the 3% to 5% range in the first quarter, although we will strive to be in the low end of that range.

For the full year, we continue to expect or nonfuel unit cost to increase in the 2% to 3% range on capacity growth of 1% due to higher maintenance volumes, greater depreciation expense, reduced asset utilization and the continued investments we're making in our people.

Turning to fuel.

Our total fuel expense declined by $240 million, or about 15%, despite higher crude oil prices as we lapped hedge losses from 2015.

While crude has moved higher, crack spreads have remained low which has helped keep jet fuel prices relatively in check for the airline but pressures result at the refinery which lost $40 million for the quarter, as expected.

For 2017 we expect our fuel cost pressures will be weighted toward the first half of the year.

As you remember, during the first quarter of last year crude prices averaged $35 a barrel and hit a low of $26 in late January before they began to increase steadily from there.

So for the first quarter we expect our all-in fuel price to be in the range of $1.68 to $1.73 per gallon, which is up roughly 30% year-over-year -- hopefully the largest headwind from higher fuel we'll see all year.

With similar timing on our nonfuel cost pressures and the pace of our unit revenue improvements Glen discussed earlier, this should result in a March quarter operating margin of 11% to 13%.

As we move through the year, with our cost increases moderating and our RASM trajectory improving, we should be in a position to see margins stabilize in the second quarter and begin expanding again by the second half.

Moving on to cash flow, we generated more than $1.2 billion of operating cash flow in the quarter.

Consistent with our balanced capital deployment strategy, a little over $600 million, roughly half of that cash flow went directly back into the business for aircraft modifications, facility upgrades and technology improvements.

We expect core capital spending will be roughly $800 million in the first quarter, largely driven by aircraft related spend.

Also in the March quarter and consistent with prior years, we have already contributed $1.1 billion to the pension plan.

With the DOT grant of antitrust immunity for our proposed joint venture with Aeromexico in mid-December, we now expect the tender offer you occur in the second quarter of 2017.

While we continue to make investments in our business for the future, we're also strengthening our balance sheet as we work towards our $4 billion net adjusted debt goal for 2020.

We ended the December quarter with net debt of $6.1 billion, down roughly $500 million from year-end 2015.

We generated $640 million in free cash flow and returned $450 million of that to our shareholders in the quarter.

For the year, we generated nearly $4 billion in free cash flow, more than $3 billion of which went back to our owners after investment in the airline.

That is roughly an 80% return rate and our goal continues to be to return at least 70% of our free cash flow to our owners annually.

Looking back on 2016, it was a year in which the uniqueness of the Delta model and our disciplined approach to the business allowed us to deliver a result that was consistent with 2015 despite a lot of headwinds.

I'd like to thank each and every member of the Delta family for their hard work this year as we continue to show investors why they can rely on Delta and the Delta family.

As we move forward into 2017, we're committed to staying focused on cost and our balanced capital strategy because that is what differentiates Delta and that is what will provide for sustainability next year and over the long term.

With that, I'll turn it back to Jill.

Thanks, Ed, Glen and Paul.

We will now go to questions from the analysts.

Dana, if you can provide the instructions.

(Operator Instructions)

We'll take our first question from Jamie Baker from JPMorgan.

First question for Paul, I just wanted to delve a bit further into the comment that second half margins would show year-on-year expansion.

I think for the fourth quarter that's a no-brainer, given you booked the entire incremental pilot expense in fourth quarter 2016.

If you had spread the retro payment over the quarters in 2016, would your comment that second half margins should show expansion -- would that still be the most probable outcome?

Good morning, Jamie.

Thanks for that question.

Yes, that is what is the most probable outcome.

As we go through 2017, we're running the business on a normalized basis.

That's the run rate of the salaries and the wages.

So as we look at the effects of the pilot contract in 2016, we're trying to normalize for that flow.

And we feel confident that we'll be able to achieve that in the second half of the year, even as we look through that adjustment.

Okay.

That's helpful.

And a second question for Glen.

Where are we in terms of you achieving the 100% of domestic markets equipped, for lack of a better term, with basic economy?

And more importantly, I suppose, when you convert a market to one that does offer basic economy, what sort of RASM impact does that have?

Should we assume that it's the basic economized markets, for lack of a better term, that are contributing to that statement that you made of half of your domestic market experiencing positive RASM or is that reading too much into it?

I think that's reading too much into it.

Okay.

The huge driver in markets returning to positive unit revenues is getting momentum back in business yields.

And even if you experience a 60% sell-up rate, which is slightly higher than we've experienced in the past -- let's say 50% to make the math easy -- on an average sell-up of $40, you're not talking about a huge amount of money.

I think it's really more of a competitive tool than it is a huge value driver in the long run.

So what we're really excited about are the branded fares on the premium side, the continuation of more usage in first class, continuation of the higher branded products like Comfort Plus and our new Premium Select that we're introducing later on this year.

Got it.

Paul and Glen, thank you very much.

Appreciate it.

You're welcome.

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

Hi, guys.

It's actually Conor in for Helane.

I realize you made some cuts on the Atlantic side.

Can you just discuss what gives you confidence that the Atlantic will eventually sort itself out?

I realize that there's going to be -- there seems like there's going to be significant low cost growth for years to come.

How does Delta and those JV partners expect to mitigate any market share losses to those guys?

Thanks.

I'm not sure that we would say we're going to mitigate any share losses.

I think what we're going to do is preserve and accelerate our margins.

And I think that's where having partner hubs and becoming more and more reliant on the partner hubs where we have competitive advantages is a key to our strength moving forward.

Clearly, also in the segmentation of products we have further segmentation to do.

And I think that's one of the reasons we look at the products we're introducing in the marketplace like Premium Select.

If you look at what Norwegian flies, they don't have flatbeds.

If you look at what a lot of the ultra low cost carriers, they haven't made that investment in those types of products.

And we need to adjust to that new paradigm as high quality products for leisure customers who are willing to pay more than just standard coach fares.

So we have some adjustments to make in our model.

We will continue to work with our partners to make sure that our model is more durable.

And I think we have a very good hand in Europe in the long run.

Has there been some discussion of potentially bringing basic economy to the international side at all?

Or is it just still a domestically focused product at this point?

We, in the call today, we said that we will have it ubiquitous in our entire system by 2018.

So it will be in all of our international markets.

Great.

Thanks.

And we'll take our next question from Mike Linenberg with Deutsche Bank.

Hi.

Good morning, everybody.

Glen, I want to go back on the markets domestically.

You called out a couple airports as notable bright spots.

I think you said that they had superior sort of demand trends going forward.

You called out LAX, Seattle, JFK -- where's LaGuardia in that?

Is it New York that you're seeing or is it just specifically JFK and LaGuardia maybe isn't strong enough to warrant a call-out.

Can you comment on that?

In LaGuardia, as you know, one of the key business markets, Boston, LaGuardia, has a new entrant as extraordinarily low fares which is putting a little bit of pressure on LaGuardia as well as all of that new service from New York to Florida.

So I'd say there is a little bit more pressure on LaGuardia than there is on Kennedy right now.

Okay.

Thank you.

And then just a question for Paul.

Paul, where are you on -- I'm not sure if you have the numbers yet but with respect to the pension, where that liability, where that -- the under funding -- where that ended at year end 2016.

Can you update us on that?

Sure, Mike.

And good morning.

Good morning.

We ended 2016 with a pension liability of about $10.6 billion.

That's the unfunded liability.

That's down a little more than $0.5 billion from 2015.

The rate improvements that we saw towards the end of the year largely offset the declines that we saw through the middle part of the year.

So it's up substantially from what the peak liability would have been intra-year but the year-over-year change was moderated a little bit.

Okay.

Very good.

Thank you.

We'll take our next question from Dan McKenzie with Buckingham Research.

Hi.

Good morning.

Thanks.

If I am interpreting the press release literally, it implies essentially no sequential improvement in unit revenue in the second quarter.

From where I sit, that, of course, doesn't make sense given the value pricing that was going on in the second quarter.

So to get at your commentary, are you assuming a more conservative fuel price than is implied today by the futures for that -- for the stabilization of margins in the second quarter?

Hi, Dan.

It's Ed.

I don't know what your calculus is for the second quarter but I'd say your model's got some challenges in it so if you can take that offline.

Okay.

Well I guess the point I'm trying to make is we should continue to expect sequential improvement in unit revenue in the second quarter.

Yes.

That was what I was inferring by my comment.

Okay.

Perfect.

And then second question here, Los Angeles was highlighted at investor day for infrastructure improvement.

And I'm just wondering where you're at now just in terms of gates and where would you go with respect to gates after the improvements?

And what kind of growth does that potentially unlock for Delta at Los Angeles?

We are substantially constrained at LAX today.

We have, I believe, 15 gates currently in terminals 5 to 6. And when we get to terminals 2 and 3 we have the possibility to come close to doubling the gates [plus].

It's going to take some time as we redevelop terminals 2 and 3. That's not overnight.

And it will also take a little bit of the pressure off of the turns on the gates.

Today we turn terminals 5 and 6 to the highest level in the system and once we get a better gate spot we'll be able to reduce some of the congestion at the airport.

So we'll have more gates but doesn't necessarily mean more direct flights as a result.

But we absolutely will be increasing our footprint and our capacity at LAX over the next few years.

If I might add --

Would that be primarily --

One of the big advantages to us today is we are not co-locate with our partners in Los Angeles.

And this swap from terminals 5 and 6 to terminals 2 and 3 allows us to co-locate with our partners on a much more aggressive timeline.

So we won't be bussing people around the airport or asking them to walk outside and go between terminals.

And really that drives a significant amount of value in the short run to be able to accomplish that at a faster rate than we would otherwise do, particularly as we look to carriers like integrating with Aeromexico.

So we're very excited about that in the short run.

Okay.

Thanks, guys.

We'll take our next question from Duane Pfennigwerth with Evercore IS.

Good morning.

Thanks for taking the question.

Just from a regulatory policy perspective, obviously very early days here but maybe you could list for us your top three opportunities and risks you see.

What are the potential changes on the table that you're most excited about?

Hi, Duane, it's Ed.

There's a number of things we're excited about.

One of the things we're very excited about is the potential investment opportunities of the new administration -- talk a lot about improvement in airport facilities we've been doing, a considerable amount of investment alongside our public partners in LaGuardia, LA, Seattle, Salt Lake, Atlanta.

But the ability to continue to work with the federal government to drive improvements to the infrastructure is clearly a big deal for us.

We were very excited about the opportunity to present our case relative to the Middle Eastern situation with all the growth that those carriers have brought to this country on a subsidized basis where we were competing against governments, not other airlines.

And the opportunity to let the Trump administration know how we can do, as an industry, a better job of protecting US jobs and US opportunities going forward and also protecting trade deals and enforcing trade deals that are being violated present time.

There's tax benefits that are being discussed.

There's regulatory changes being discussed, whether it's in the RFS on RINs potentially or other means.

So there's a pretty good list of opportunities that we are -- we've already provided some input into the transition team.

And it will take some time over the next few months as things become a little more clear and individuals are staffed in the new roles.

But we're very excited.

Appreciate that.

And then just on the airport investments that you're making in the New York area, and it's tough I guess for me to know how much of this is conceptual versus committed at this point, but what is the annual investment that you've committed to at this point?

How long term are these projects and how should we be thinking about your longer term cost structure at these airports in New York?

Thanks for taking the questions.

We are -- LaGuardia, it's premature to be talking -- to be giving numbers out because we don't have signed leases in place yet and we're working with various entities there.

You're not going to see a significant spike in CapEx, if that's your question.

We're doing our best to work with various public partnership and private partnerships to minimize that.

But no question as the airport facilities come online you will see improvement in -- excuse me, an increase in the cost of the facility.

And we also think you'll see improvement in revenues and the efficiency of the facility as well.

Thank you.

We'll take our next question from Rajeev Lalwani with Morgan Stanley.

Thanks for the time.

Actually a question for Paul and kind of following up on what Duane was asking.

With all the chatter out there around border adjustment taxes, do you see the potential for maybe higher aircraft CapEx as a result of import tariffs or anything like that?

And then on corporate tax reform, what do you think the opportunity is for you either directly or indirectly if you can, Paul?

Sure.

Good morning, Rajeev.

On the first question, it's way too premature to speculate on what any specific impacts might be to the airlines.

We're following it closely as everybody else is.

I think generally speaking, tax reform is good for the airline industry.

It is a US-centric business model and one that we believe continues to be very, very important for the US infrastructure.

So we feel optimistic that we can be a net beneficiary of any tax reform and we're eager to see what the results are.

And, Glen, a quick question for you -- I guess more of a clarification.

As we look ahead, would it be fair to say that capacity is more or less going to move in tandem with margin strength?

Or should we assume that capacity kind of remains in check until you get margins to that targeted 15% to 17% range or so?

I didn't quite understand the difference between those two questions you posed.

But I think that's what you see is with a higher dollar and with competitive environment we have internationally, we've been decreasing our offering internationally in order to achieve margins.

And as we get there, we would start looking at flattening out capacity and then eventually growing it.

If that answers your question.

I guess I was asking is capacity going to stay in check until margins get higher or should we look at --

Absolutely.

That's the plan.

Okay.

Thank you, sir.

He we'll take our next question from Savi Syth with Raymond James.

Good morning.

Paul, happy birthday.

Just had a question on the cost side of things.

Outside of labor costs, could you talk about the items that are placing the greatest pressure on unit cost this year and maybe how they progress through the quarters?

Sure.

Thanks, Savi, for the birthday wishes.

A gift would be not asking a question about CASM.

(laughter)

The biggest driver, as we talked about in the call, are for the first quarter and what we saw in the fourth quarter is really timing of maintenance events.

As you know, we tend to seasonally do that a lot in the winter in the off-peak periods, but just natural progression of things as you go throughout the year.

Now what we feel like is -- as we start to normalize the business and go through the summer periods, we expect to see a lot of the continued benefits from up-gauging throughout the business to moderate some of that cost pressure in the first half and get us to the point where we feel confident that we're in the 2% to 3% range for the full year, as we talked about.

This is Ed.

If I could add to that.

I know there was some choppiness in the year as the quarters roll out but if you look at the full year of 2% to 3%, I'd say (inaudible) half of that's due to the labor reset that we've talked about and the other half is due to reduced utilization of the airline.

If you look at the reduced run rates of capacity, there's certainly a knock-on effect on non no cost.

I'd say high level, those are the two big drivers.

Got it.

Helpful.

And then just a question on the product side.

I know product segmentation has been kind of an important part of this.

I think the change in the industry as you kind of move away from having a commoditized product and I think customers have definitely benefited, improved operations and different things like that.

But I guess do you have a litmus test as to -- that we don't repeat the sins of the past where you add a lot of frills onto the product and then come a downturn you have to take that away.

How do you in your thinking about introducing food in economy on trans con and things like that, what's the litmus test on the sustainability of that and maybe demand for it?

Well, Savi, I think we respond to demand.

And I think in different parts of the economic cycle, different things are important to different customers in each segment.

And that's why I think as we continue to refine our customer segmentation, we want to continue to provide what customers are willing to pay for us.

And in this part of the economic cycle, they are with consumer confidence high, with consumer flush with cash, they are willing to pay for more frills.

And we make a mistake as an industry I think when we anticipate or try and be in the minds of consumers as opposed to responding to what's important at that point in time.

And I think as a successful airline through all parts of the cycle, we are going to have to continue to monitor what's important to customers, what they want from us at that time.

And that's what we're doing today.

So you could see in downturns where you do cut back on certain things?

Absolutely.

If fares become more relevant to customers than some of the amenities we put on, absolutely.

I don't think you box yourself into the fact to say that what customers want today is what they want five years from now.

Got it.

Thank you.

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

Thank you.

Good morning.

Glen, I know you said you're obviously optimistic about the outlook for corporate spend based on your survey but is there a practical risk that your corporate accounts may have reset their annual travel budgets a lot lower if they base it on the last couple year spend where corporate air fares were down so much?

I don't think this would be uncommon with what's happened in prior airline cycles.

So maybe you get this pop in the first half on higher spend but as the year progresses some of your maybe more midsize corporate accounts end up bumping into the ceilings of their annual travel budget because it was based off of lower dollar amount in a lower fare environment.

So is that something that you have seen before?

Is that something you're considering or planning for as we move through the year?

Hunter, I think that if you look at the travel spend on a lot of corporates, particularly in major lane segments in the domestic US that are considered to be the primary business segments, that the fares were down 30%, 40% on a historical basis.

And I don't think we have are to get a significant -- we're not expecting them to go back to the historical levels in our current plan.

This is a journey.

It's not a race.

And so I do think that if the economy holds out, which we're forecasting today that it will, and business continues to travel, which we're forecasting it will, that the opportunity to raise fares in that environment with a lower level of capacity offering from the industry is significant.

And it gets better as we move throughout the year because the fare's got to be so low for business travel by mid-year last year.

If you take one of the primary business markets, Atlanta to city X, that used to be $750 for a day trip, it got down to $119 for a day trip.

Today it's sitting at $350 for a day trip.

Could it go to $400?

Could it go to $450?

We see no propensity to decrease travel going from $750 to $100 and I don't think we'll see it on our I way back.

Okay.

Alright that's good.

Thanks.

And then sorry for the modeling question but I think this is relevance.

The other revenue is up about 11% in the fourth quarter.

How much of that was maybe refinery third party sales and how much of that is just sort of like good run rate core revenue that's going to repeat, not based on the price of oil?

Hunter, this is Paul.

The third party revenues in the refinery were about $90 million.

That was equally offset by cost in the other cash cost line.

So other revenue outlook for 2017, ballpark?

For the full year?

Yes, if you don't mind.

We can get back to you on the modeling questions.

Okay.

Thank you, Paul.

Thank you, Glen.

We'll take our next question from David Vernon with Bernstein.

Hi.

Good morning, guys, and thanks for taking the question.

I guess at a high level, I'd like to understand what your thoughts are as far as how quickly you think you can get back to that 17% to 19% margin guidance after this coming year of 100 to 200 basis points of compression.

David, it would be premature to speculate on a time frame.

We gave you our best view of 2017.

It's a year of some transition.

Our goal will be, as I said in my opening comments, I think 2018 is doing be a good year from what we can tell but it's a long ways away.

We see the trajectory starting to turn back by mid-year and that's important.

I guess internally how do you guys think about that long-term target then?

Is it a multi-year thing?

Is it an ambitious goal?

How should we be thinking about it from a modeling perspective?

It's our long-term target.

And it still is.

We're optimistic we will get ourselves there.

Okay.

And then I guess maybe just as a quick follow-up.

As you look at the --

If I could add a point, David.

Sure.

If you look at our 2016 results, we're right at the low end of that target range, 16.5%.

So it's not some wildly ambitious goal.

That's the run rate this business has been on or has been on in terms of building towards.

We had a speed bump on RASM, no question about it.

And as RASM starts to improve, I think we will continue the trajectory to get back there.

Okay.

And maybe just as a quick follow-up.

If you think of that 100 to 200 basis points of compression, how much of that would be just because fuel prices are going up and how much of that is just that timing issue of getting RASM and cost ex-fuel right?

I think there's a lot of geography given that this time last year fuel prices were $30 a barrel and today they're $55 a barrel.

So it's going to take a couple of quarters and I think that's a sizable amount of that 100 to 200 basis point compression we're talking about is front loaded to the front half of the year.

And by the second half I think we'll be on a margin expansion.

Excellent.

Thanks a lot for the time, guys.

We'll take our next question from Andrew Didora from Bank of America.

Good morning, everyone.

Glen, just a follow-up on some international commentary.

I guess we've been hearing from some other global carriers that both Pacific and Transatlantic may have been holding up a little bit better than some expected given the capacity growth out there.

In your prepared remarks it didn't hike you're seeing the same thing.

Is that a fair assessment?

And then from a corporate volume perspective, are you seeing a similar type of corporate uptick on your international routes or right now is it mostly domestic based?

Thanks.

Andrew, the entities are a bit different.

I think we probably would have, when all of this is said and up done, underperformed in the Pacific because we had the biggest restructuring going on in the Pacific.

And we did have yen year-over-year hedge -- less hedge gains.

So that had a lot of pressure on it.

The core demand is very strong.

But it's not keeping pace as an industry with all of that capacity.

We are optimistic as you get to the summer.

When you look at Japan it's very stable.

When you look at China we think there's going to be stability because we're out of the frequencies.

We think there's a really good opportunity in the back half of this year to start making up some ground on the Pacific.

As you know, we've also announced the retirement of our 747 400 hundred fleet which should be fully out by the end of this year.

That should have some impact as we take some of the seats out of the lane sectors.

That plane was built for a different network than we have today.

So we're optimistic there as well.

So we have a lot of changes in the Pacific.

And I would expect that when all is said and done that that would be the entity for us versus our competitive set that's most under pressure.

In the Atlantic we've seen strong business demand and strong business yield continue.

But, again, there's a lot of currency going on in Europe and when you look -- when you [modestly] currency that accounts for a significant portion of the declines we've seen.

It's really not a core demand.

And then just from a corporate volume perspective, are you seeing it coming back internationally as well or is it more domestic?

If you think about the nuances of what we said, we didn't say that core demand for business in the US was suffering in 2016.

As a matter of fact, it was relatively robust.

What we saw was essentially a corporate fare war that occurred for various reasons that spread throughout the domestic US network.

That did not occur in the international entities.

So the rate at which those yields could improve or recover to more historical levels is much more heavily weighted towards the US.

Fair enough.

Thanks a lot.

We'll take our next question from Joseph DeNardi with Stifel.

Thanks very much.

Glen, I was wondering if we could just talk about the sky miles program a little bit.

At the Investor Day you guys had a chart that showed total contributions from your AmEx relationship and about a $2 billion total increase from 2014 to 2021.

My understanding that -- of that incremental revenue that's about 100% margin similar to what American Airlines has disclosed.

So is it fair to say that by 2021 you'll have conservatively $2 billion in EBIT coming strictly from the sky miles AmEx relationship?

Not to box you in at all, Glen, but I feel like that's kind of a yes or no answer.

Or no comment.

Could be the third option and I think that's the one we're going to go with here.

We don't disclose the core economics of the Delta AmEx relationship.

So I'm going to take box number three and then hand it over to Ed for additional comments.

Joe, this is Ed.

I agree, we're not going to give the future margin on the AmEx.

But your top line numbers are right.

When we did the deal a couple of years ago with AmEx the goal was to double our contribution, our revenue contribution from AmEx.

We are right on pace there.

And it's safe to assume there is a very high margin contribution on those revenues.

I wouldn't say it's 100% but it's a high contribution.

Okay.

Would you say that the incremental revenue year-to-year is 100%, that all of that flows down to pretax income?

That's simply what American Airlines has disclosed as well.

I don't know what American Airlines deal is.

They sound like they got a good deal.

But I'll tell you what our deal is.

It's a high margin contribution [closer] and I'll leave it at that.

Okay.

Ultimately those miles have to be redeemed for travel.

So I don't know exactly how they're saying 100% is growth.

That revenue flows through a different bucket.

Be that as it may -- so I think what that ignores a little bit is the remainder of the revenue, say that $2 billion where you started in 2014, quite a bit of that is also very high margin.

So can you tell us -- I guess you've answered this.

Can you tell us what the margin revenue of that stream is or could you at least tell us what the marketing revenue from that program is currently?

It seems like an enormously profitable part of your business that most investors completely under-appreciate, [our] analysis suggests that you guys earned roughly $2 billion in EBIT currently just from sky miles.

So can you provide us some color around that?

We are not going to provide the details, Joe.

I'll disappoint you on that.

But what I can tell you, though, is that it's not all margin.

There is a significant cost of fulfillment.

We don't give sky miles out and not deliver the travel services.

So it's a source of revenue.

It's not a -- it's far from 100% flow-through.

I'd say on the incremental structure going forward, yes, I think there is a much higher margin complement on the go-forward given that we've already got the base program being served.

But no, on the first $2 billion it's a great program but it's nowhere close to a high margin [complement].

Okay.

Thank you.

Dana, we're going to have time for one more question from the analysts.

We'll take our final question from Darryl Genovesi from UBS.

Hi, guys.

Thanks for the time.

I guess maybe just to dig in a little bit, Glen, on some of the stuff you said on both the Atlantic and the Pacific, it sounded like you were experiencing some RASM headwinds as a result of the restructuring.

And then it also sounded like perhaps -- so I guess there's an opportunity there as that restructuring wraps up and some of these new markets start to mature.

And then also across the Atlantic it sounded like you said you're going to try to reallocate some capacity into stronger US point-of-sale markets.

Between those two, either individually or on a combined basis, is there a significant RASM tailwind to come as these prophecies play out independent of what's happening with the underlying market?

The big question mark I would say is currency.

If I had one issue that I would be a bit of cautionary issue is, if the dollar continues to appreciate that would put a little bit more pressure on foreign point-of-sale.

But core demand is strong and capacity levels seem to be in generally in a better spot this year than they were last year looking forward.

So I'm cautiously optimistic that absent of another run in the dollar, another significant run in the dollar, that as we said in the Pacific that the fourth quarter would be our low point and that we would move forward from there.

And that summer in the Transatlantic with heavy point of sale US would be a very good summer.

Okay.

If you were to just take your RASM guidance for the first quarter and assuming you come in line with the midpoint of that guidance based on normal seasonality if you just assume that there was no further improvement from there, where do you think you would end up for the year?

We're not going to speculate on a full year RASM guide.

Good shot, Darryl.

But if you look at --

(laughter) I was just asking if you were flat, what would that kind of imply.

But okay.

I get it.

And then maybe if I could squeeze one in for --

Darryl, let me just add one thing, though.

I think you do have to look at the comps and comps get considerably easier as we proceed through the year.

So that would infer an improving RASM performance relative to prior year.

Sure.

Thank you.

And then if I could squeak one last one in for Paul.

Paul, you had commented that asset utilization was down.

Is that kind of by design or would you anticipate -- if we're not in a situation where we're accelerating the SM growth looking out a few quarters or a year, would you expect the CapEx guidance to -- the longer term CapEx guidance to start to get revised down?

Good morning, Darryl.

I think the asset utilization being down is wholly consistent with the plans for the year as we talked about at Investor Day and the current revenue environment.

So I wouldn't take anything more or less out of it than that.

And we are where we expect to be in the long-term with capacity down a bit, CASM of 2% to 3% is still in that long range strategic view of what we said to be consistently up to with about 2% capacity growth.

So we feel good about our cost performance and running the business for margins and doing it the right way.

Great.

Thanks a lot and best wishes for a happy birthday.

Thank you, Darryl.

Great way to wrap up the analyst portion of the phone call.

And I will now turn it over to our Chief Communications Officer, Ned Walker.

Thanks, Jill.

As we begin the media Q&A, I'd like to ask everyone if they could have one question and follow it up with a brief follow-up question.

With that, Dana, could you review the process to get into queue to ask those questions.

(Operator Instructions)

We will take our first question from [Susan Carey].

Ask you about Aeromexico.

You say you anticipate closing your equity investment in the second quarter.

I'm wondering what regulatory approvals are still required and can you give us some kind of idea about the estimated cost of this investment.

Hi, Susan.

It's Ed.

How are you?

We are in the process of working through the remedies that are required in order to get antitrust immunity and it's a -- we have to have it done sometime -- the slot the divestitures and the JV [itself] implemented prior to being a able to close on the deal.

So I'd say we're looking at it probably a 60 to 90 day process here to get all the regulatory approvals, the divestitures in place.

Relative to cost, I don't have a current -- it's gone down given the decline in the peso.

It's in the $400 million range I think is the cost that we're [looking at].

And the regulatory approvals needed?

The regulatory approvals are in place.

We just need to comply with the requirements.

We're not waiting on additional regulatory rulings.

Thank you.

Susan, there is one -- it's Peter.

Hi, Susan.

There is one thing we are waiting for the Mexican securities authority to approve the transaction.

That's the tender.

The tender offer.

So we are waiting for that approval.

Thank you.

We do not anticipate any issues with the securities regulator.

Thank you.

And we'll take our next question from Alana Wise with Reuters.

Hi.

Good morning, everybody.

Good morning.

So my question is looking at our [seat] right now, I see that your guys' stock is down 3% this morning.

I was just wondering if there was any comment as to why you think this might be?

I could not understand what you were saying.

Can you hear me?

It's better now.

Can you ask your question again?

Sure.

So I'm looking and I see that your stock is this morning is down about 3%.

I was just hoping for any sort of comment you guys can provide and around that, why it might be, or any sort of guidance you can give on this.

The stock price was up this morning.

It's down a little bit.

The market's down today.

So we don't -- I think it's up currently.

So we're not -- we don't comment on the moves hour by hour, no.

I think our results came in generally in line with expectations so shouldn't have a significant impact on the stock.

Thank you.

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

Thank you.

I have two questions.

I guess first for Glen.

You said that basic economy is going to be 40% of domestic markets and I know you're adding a premium product in coach also.

So listening to you makes me think -- it makes me think that some day there won't be coach class as we know it or there will be hardly any coach class as we know it because of all theses various products.

Is that fair?

No, Ted.

I think actually for the foreseeable future that the main cabin is where a preponderance of our customers sit and a vast majority of our revenues reside.

So the death of the main cabin I think is pretty premature to prognosticate on that.

But what the offering is in each one of these cabins, I think about what United is doing in basic economy which is very different than what we're doing.

How this all changes as we respond to what consumers really want to buy from airlines is going to be fascinating to watch.

Thank you.

My second is for Ed.

It's mainly because I could barely hear you, Ed, when you talked about the -- what you expect from the Trump administration.

I understand it to be -- there's more business travel and there will be more support for you in these cases with the mid east carriers and Norwegian.

But I couldn't hear you.

So I'd like you to address that.

Thank you.

Sorry that you could not hear me, Ted.

There's going to be a number of opportunities for us to present our views to the new administration, which we very much look forward to.

I mentioned that we're going to have real opportunities in infrastructure, given the level of investment we've already are making in our airports and facilities and partnering with the government to do even more of that.

It's going to be a great opportunity.

I mentioned the Middle Eastern situation, how we are competing against governments, not airlines in the Middle East.

The violations, blatant violations that we see relative to subsidized air services, $50 billion of subsidies over the last of 10 years and our opportunity to have the government move to enforce its trade agreements as compared to being a victim of it as well as protect US jobs all alongside that.

And then the other item that I mentioned is the tax reform that's being discussed.

I'd see Delta certainly being a beneficiary of that.

Though it's hard to speculate as to the form it will take given it's very early.

Alright Thank you, Ed.

Okay.

Dana, we have time for two more quick questions.

I think we have one from The Wall Street Journal coming up again as well as the Philadelphia Enquirer.

We'll go to Linda Loyd with the Philadelphia Enquirer.

Thanks for taking my question.

You mentioned that the Trainer refinery lost $40 million in the fourth quarter.

What's the outlook for the refinery in 2017 and when, if at any time this year, might you expect a profit -- the refinery to turn a profit?

Hi, Linda, good morning.

This is Paul Jacobson.

The refinery we're expecting to produce a profit of around $100 million this year based on where the current crack spreads and margins look like.

We are projecting a slight profit in the first quarter based on where the current environment is.

But the refinery continues to perform well against our broad-based strategy, what we look at.

We were up there visiting with the refinery employees in December and morale remains high.

And we remain committed to that investment despite some of the challenges across the industry and the cyclicality.

Thank you.

Thanks very much.

And we have a follow-up question from Susan Carey with The Wall Street Journal.

Thanks, fellows.

Condolences on this but I have to ask.

On the Fort Lauderdale situation, have we determined at all the injured at deceased were Delta customers?

And have we seen any kind of signaling or paperwork filed for lawsuits on this situation?

Susan, it's an active investigation.

So we're pretty limited to what we can discuss.

It did happen in our terminal.

So, yes, Delta customers were impacted.

But there is -- we really can't provide much more than that.

Susan, I would suggest you talk with the FBI.

They've asked to be the coordinator for all information pertaining to the investigation.

So I'd turn it over to their PIO down in Fort Lauderdale.

Sorry, guys.

Thank you.

Thanks for the question.

Thank you Ed, Glen, Paul and Peter.

That wraps up the December 2016 quarter call.

I will be back in April for the March 2017 call.

Thanks so much, everyone.

Have a good day.

Thank you.

And that does concludes today's conference.

Thank you for your participation.

You may now disconnect.