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Delta Air Lines, Inc. (DAL)

Q3 2007 Earnings Call

October 16, 2007 10:00 am ET

Executives

Richard Anderson - CEO

Edward Bastian - CFO

Glen Hauenstein –EVP, Network and Revenue Management

Jill Greer - Investor Relations

Analysts

William Greene - Morgan Stanley

James Higgins - Soleil Securities

Bob McAdoo - Avondale Partners

Bill Malthurst - Bank of New York Capital

Robert Barry - Goldman Sachs

Jamie Baker – JP Morgan

Andrew Shapiro – FTN Midwest Securities

Gary Chase - Lehman Brothers

Operator

Welcome to the Delta Air Lines third quarter 2007 financial results conference call. (Operator Instructions) I would now like to turn the call over to Miss Jill Greer, Director of Investor Relations for Delta Air Lines. Please proceed, ma'am.

Jill Greer

Good morning, everyone and thank you for joining us to discuss Delta's third quarter 2007 financial results. Speaking on today's call are Richard Anderson, our Chief Executive Officer; and Ed Bastian, our President and Chief Financial Officer. Also joining us for the Q&A is Glen Hauenstein, our Executive Vice President of Network and Revenue Management.

Before we begin, please note this call is being transmitted live via the web is and being recorded. If you decide to ask a question, it will be included in both our live transmission as well as any future use of this recording. Any recording or other use or transmission of the text or audio for today's call is not allowed without Delta's express written permission.

Also 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 in a material manner 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 certain non-GAAP financial measures. You can find the reconciliation of those non-GAAP measures on our investor relations website at Delta.com. Finally, I would like to ask that when we get to the Q&A portion of the call we limit each participate to one question plus one follow-up.

Now with that, I'd like to turn the call over to our Chief Executive Officer, Richard Anderson.

Richard Anderson

Good morning and thanks to everyone for joining us today. I'm excited to have joined this very talented team at Delta. Since September 1st I have spent a great deal of time talking to our people across the system, and in doing this it is obvious why Delta's people have the reputation for being the best. It's their passion for, and dedication to, the company.

So when people ask why I have returned to the airline industry, the answer is really simple: the great people at Delta and a tremendous opportunity given the assets, route network and positioning of Delta.

As Ed will discuss in more detail, we are quite pleased with the progress and momentum that continues to build in our businesses. Our financial results announced today, over $360 million in pre-tax profit on the highest quarterly operating revenue in the company's history, is evidence in our strengthening financial performance. None of this, of course, would be possible without the endless and tireless efforts of the people of Delta Airlines. In recognition of all of their hard work, we are delighted to report that we have accrued almost $160 million in profit sharing for our employees this year.

Looking ahead, our objective will be to continue to increase profits and boost shareholder value by achieving the targets set out in our plan. We'll do this by taking advantage of the significant revenue opportunities that remain available to Delta to close the remainder of RASM gap to the industry by the end of 2008.

Our network restructuring is continuing and will drive significant additional returns not only from international expansion, such as the recently announced service to Shanghai beginning next March, but also from ramping up the investments we have made over the last several years.

In addition, with more passenger demand data for the new markets we have launched and more experience with your new scheduling and yield management software, we'll be able to more fully utilize this technology to continue to close the RASM gap and ultimately get to a premium revenue position versus the industry.

On the cost side, we'll maintain strict discipline around spending. While Delta's CASM is best in class we must focus on sustaining our cost advantage by always looking for ways to take out costs from the business. There are plenty of opportunities remaining, even with the great work that's already been done to continue to improve the cost side of our business.

Our approach to capital spending will be incredibly disciplined. We will focus on strategic aircraft acquisitions when they have a demonstrable return on equity and will support profitable international growth. We will make product improvements that either drive a true revenue advantage or demonstrable lower costs. Examples of these would be upgrading our premium product in business class internationally, and adding winglets to our aircraft to gain fuel efficiencies.

As important as improving product, providing an on-time operation is just as important to our customers. Year-to-date Delta leads the network industry in arrival within 14 performance and we expect through the end of the year that we'll continue to lead the industry in that important operating metric.

As we look over the past summer, we had difficulties in the Northeast with congested operations. Because of our leadership position at JFK, we announced last month a complete redesign of our JFK schedule which includes a reduction in the number of Delta flights operating during peak hours, up-gauging aircraft and removing propeller airplanes from the schedule.

But, there must also be broader changes to solve the problem. Accordingly, we are working closely with the Department of Transportation, the Federal Aviation Administration and the New York Port Authority to ensure the needs of our customers and our operations are best served. We believe the first critical steps are to ensure that the airports are delivering all of the capacity the FAA has published the airport can produce and to address the real need to modernize the nation's antiquated air traffic control system. We believe our official constraints on capacity or congestion pricing at the New York airports are not in the best interests of the public or the industry.

If constraints are necessary, we support the fair allocation of limited resources using the IATA international slot rules that are in place and have been in place for many years at congested airports around the world.

I would just note with respect to the operation that our on-time performance will continue through the end of the year, and we intend on being a long-term leader in that important metric.

Before I close, I would like to address a topic that has been on the minds of many of the people on this call and observers of the industry. This is true both within the broad investment community and the airline industry in general, and that's the issue of consolidation. This industry, including Delta and candidly all of the major network carriers, are products of consolidation and we fully expect that this evolution toward a more consolidated industry will continue.

I would even say that it makes sense, and could make sense for Delta if it's done thoughtfully from a position of strength, and is in the long-term best interests of Delta's shareholders and its employees. As a result, we are evaluating the best path forward for Delta. There are obvious benefits that could accrue from consolidation for our shareholders and employees.

Remember that our employees are our greatest asset. The magnitude of change that they have accomplished over the last two years is a testament to the importance that they play in the future of Delta. Their support is crucial to our continued success. As such, we will take a balanced view toward consolidation and its impact on Delta, while keeping focused on any execution risk while being certain that we do our very best to create shareholder value.

Ultimately, it's our goal to be the undisputed leader in the airline industry. To achieve that goal, we must be on the leading edge of change to keep pace in this dynamic business environment. We believe our continuing financial improvements, combined with the great employees of Delta, the route network, fleet, and cost structure give us as a strong play as the industry continues to evolve toward consolidation.

Speaking of change, we are hosting this call today from Paris. There will be a joint press conference tomorrow morning Paris time regarding an exciting new agreement we are executing with our SkyTeam partner, Air France. Stay tuned for more details about the agreement and we will be discussing tomorrow the tremendous benefits that it will bring to all of the Delta employees, our shareholders and the improvements it will bring in our international expansion strategy.

To close, we are absolutely committed to achieving the goals and improving upon the goals in our plan in strengthening Delta's leadership position in the industry. Doing this allows us to control our destinies, make the right decisions that will increase value long term for our shareholders, create a great place to work for our employees, and make Delta a great airline to fly for our customers.

So thanks, and with that I'll turn the call over to Ed to discuss the financial results for the quarter, and then the three of us will be here to answer your questions.

Ed Bastian

Thanks, Richard. Good morning, everyone and thank you for joining us today. This morning we reported a pre-tax profit of $363 million for the September quarter, excluding last year's re-org items, this was a $432 million improvement over the prior year. Net income was $220 million, or $0.56 per share, on 394 million fully diluted shares. This compares favorably to consensus of $0.42.

Due to our significant NOL carryforwards, the $143 million in tax expense for the quarter is strictly a non-cash expense. For that reason, we believe pre-tax earnings is the relevant measure to focus on to understand our year-over-year improvement.

Our operating margin was 8.7%, a more than 5 point improvement over the prior-year quarter, driven by strong revenue improvements and continued cost benefits from our restructuring. This result was slightly better than our last guidance due to a slight improvement in fuel prices and the resolution of certain state tax-related matters.

We're pleased to report these results include $79 million in profit sharing accrued for the quarter to recognize the hard work of the Delta employees. This brings our year-to-date profit sharing accrual to $160 million for the Delta people. Our results for the quarter also include two non-cash items, which when combined, largely offset each other.

First Fresh Start accounting changes drove a $50 million increase to pre-tax income; and second, we reported $50 million in share-based compensation expense. While offsetting in total, these emergence-related changes did affect various line item comparatives increasing consolidated passenger RASM by $0.0016, and increasing mainline CASM by $0.0021.

Turning to the details of our performance, the successful execution of our network and revenue initiatives continue to deliver strong returns for the business. In the September quarter we realized a net $246 million revenue improvement year over year. This factors in approximately $154 million from the cost of international and regional capacity growth.

Consolidated unit revenues improved by more than 6% on 3% higher capacity. Specifically, domestic RASM increased 6 points driven by strong demand, coupled with capacity discipline and the re-gauging of the domestic network. International RASM increased 9%, driven by strong yields in both Latin America and the Trans-Atlantic. We continue to be pleased with the way the international strategy is performing. In fact, the international routes that we added this year outperformed the first-year performance of routes that we added in the prior year.

Year-to-date through August, Delta's length of quality adjusted RASM was 96% of industry average, and we continue to believe we'll be able to close the remainder of that gap to the industry by the end of 2008. We plan to close that gap in several ways. First, because new markets can take two to three years to fully ramp up, we'll continue to realize the significant benefits from the pipeline of network initiatives that we've already implemented.

Second, we're always working to improve revenue management. Over time, we have gained experience with the complex revenue management systems we've implemented and we also have much better historical passenger demand data on the new markets launched over the last two years.

Third, as recent announcements demonstrate, we're continuing to expand our international strategy. This includes our new service to Shanghai, which will begin in March and 17 new routes by the summer of 2008. Our international strategy is also being supported by strategic additions to our fleet. During the quarter we confirmed orders for two additional Boeing 777-200 LR aircraft, which will be dedicated to our Asian expansion. This brings the total 777 LR firm orders to eight. We also still have 13 767-400 aircraft flying in the domestic markets that are available to reallocate to international flying. We intend to reconfigure six of these aircraft late this year into early 2008 and the remainder the following winter.

In addition, since July we have taken delivery of six 757-200 aircraft from the secondary market and expect to receive nine more by the spring. The aircraft will ETA certified and will primarily serve our international expansion in the Trans-Atlantic and other targeted markets. Their deployment will free up nine 767 ERs for longer haul and more profitable missions in the Middle East and Africa.

In addition, next summer we'll be taking deliveries of our first 737-700s, which will be equipped with winglets and personal in-seat entertainment. We have ten aircraft on order through 2009. These high performance aircraft will allow us to fly in specialty markets that we cannot access today. While taking future aircraft deliveries, we're still reinforcing our domestic capacity discipline. During the quarter, we returned 13 aircraft. These include three wide-body 767 ERI aircraft, one 757, three MD-80s and six RJs.

Our fleet restructuring has created substantial flexibility, funding considerable international growth with very modest capital investment, while enabling domestic capacity discipline. In addition, fleet flexibility provides a natural hedge because it enables us to vary capacity in response to today's high fuel prices or general economic weakness.

Turning to cost, we continue to exercise cost discipline to meet our unit cost targets. In the September quarter, we recognized net cost reductions of $230 million, which mainly consists of the continued benefits of our restructuring initiatives. These include reduced interest costs from lower effective interest rates and higher interest income on our improved cash position; reduced employee costs; savings from fleet, airport and contract renegotiations; and benefits from a business interruption insurance settlement. These savings are net of investments we needed to make in our JFK operations and for the rebranding initiatives we have undertaken.

Total fuel expense including fuel costs that are within the contract carrier line were higher year over year by $27 million. In the September 2007 quarter, we hedged 32% of our fuel consumption, resulting in an all-in fuel price of $2.21 per gallon. Fuel hedges drove $46 million in cash savings for the quarter. Mainline non-fuel CASM, excluding profit sharing expense, decreased by 3 points year over year to $0.065. Our planned target is to get to the mid $0.06 CASM range for non-fuel costs. This target, as you know, was developed prior to consideration of Fresh Start or share-based compensation. Without these items, our mainline non-fuel CASM for the September quarter would have been $0.0629, a 6% decline on an apples-to-apples basis, demonstrating the progress we continue to make towards achieving our goal.

Due to continued high fuel prices during the September quarter, we did implement several initiatives to ensure that we meet our planned targets for the year, which included lowering capacity for the December quarter through the return of 13 aircraft that I previously mentioned.

EBITDAR for the quarter was $810 million, which includes the impact of Fresh Start reporting and reflects a margin of 16%. This is more than $300 million higher than last year. We expect to hit our EBITDAR plan for the full year of $2.7 billion, including the impact of Fresh Start.

We have also made progress in strengthening our balance sheet and liquidity. We ended the quarter with $2.4 billion in unrestricted cash, not including our undrawn $1 billion revolver. During the quarter, we invested over $400 million in capital expenditures. Of this amount, about $375 million was for aircraft parts and mods. In addition, we paid down $1 billion in debt maturities with cash, including payment of $225 million to the PPGC in July and fully funding our $650 million obligation to Alpha in September, that was also related to the retirement settlement. During the quarter we have paid approximately $125 million in scheduled debt maturities on top of those numbers.

To fund the Alpha and PPGC obligations we recently closed two separate financing transactions which, when combined, generate more than $600 million in additional liquidity at reduced interest rates. First in late September we refinanced our spare parts loan with GE Capital which resulted in an additional $181 million in proceeds and significantly lower interest rates. Second, last week we issued $1.4 billion in new EETC debt. The proceeds were used in part to refinance approximately $1 billion in existing secured aircraft debt.

As a result of these transactions, not only did we raise more than $600 million of liquidity on the existing asset collateral, we also importantly reduced debt maturities in 2010 and 2011 by over $500 million. We are pleased with the results of these transactions, and we think they are a strong reflection of the market's continued confidence in Delta's plan.

As a result of the debt payments, our cash position at the end of the quarter dropped to $2.4 billion. However, with the closing of the 2007 EETC post-quarter close, we expect our cash balance at the end of the year to be approximately $2.9 billion. In addition, we expect our $1 billion revolver to remain undrawn, leaving us with a total available liquidity of approximately $4 billion.

Looking to fourth quarter guidance -- and I want to note that these projections include the impact of the emergence-related accounting -- we expect operating margin to be in the range of 3% to 5%. Our mainline non-fuel cost excluding profit sharing to be down 5% to 7% year over year. Not to confuse the matter in the guidance, but Fresh Start accounting and management equity did contribute 2 points of cost increase to us so thus, on an apples-to-apples basis, our non-fuel CASM for the mainline is expected, in real dollars, to be down 7% to 9% for the quarter.

Our fuel cost per gallon to be approximately $2.36 all-in, including the impact of fuel hedging. Regarding fuel hedges for the fourth quarter, we have hedged 20% of our anticipated consumption using HELIO collars with an average jet fuel equivalent cap of $2.35 per gallon.

We expect the combined impact of Fresh Start reporting and share-based compensation to contribute approximately $35 million to fourth quarter pre-tax earnings. This consists of an increase to operating revenue of $50 million, an increase in operating expenses of $55 million, and a decrease in non-operating cost of $40 million. All in, we expect Fresh Start accounting and share-based computation to contribute $33 million to our fourth quarter pre-tax earnings.

Looking at capacity, in the fourth quarter we expect systems capacity to be up 3% to 4% year over year, with consolidated domestic flat and consolidated international up 12% to 14%. Virtually all of the system capacity increase relates to flying that we've already begun in prior periods.

Looking at advanced bookings, at a system level advances booking through November are ahead of last year. Domestic advanced bookings continue to be strong, and solid demand continues to drive additional loads. On the international side, we continue to see strong demand in yields through November, with the Trans-Atlantic and Latin America markets booked well ahead of last year. In the Pacific region, our year-over-year load factor comparisons are impacted by the introduction of capacity to the Seoul market, which is performing above expectations.

Regarding CapEx for the fourth quarter, net CapEx will be approximately $280 million, which includes $260 million for aircraft, parts and mods. For the full year 2007, we expect free cash flow to be approximately $1.4 billion, which is ahead of our business plan targets by almost $300 million.

Looking out into 2008, we're in the midst of preparing our plan for next year. We are watching the domestic economy very closely and addressing the challenge presented by the recent fuel price increases. Our POR calls for a significant step forward with respect to pre-tax earnings, and we do expect significant improvement. However, the degree of that improvement needs to be calibrated in view of the higher fuel prices and our updated perspective on the economy. We're not prepared to give 2008 guidance at this time, but will do so closer to this year end.

To conclude, Delta's results for the quarter demonstrate the momentum we have in our business, and the opportunity we have to take our performance to the next level, with improving pre-tax margins and strong free cash flows. We have maintained a disciplined approach to domestic capacity, focused on profitable international growth, and are aggressively working to improve our competitive position in the industry.

Operator, at the time we are happy to start fielding questions.

Question-and-Answer Session

Operator

Your first question comes from William Greene - Morgan Stanley.

William Greene - Morgan Stanley

I'm wondering if you can add a little bit more color about the fourth quarter RASM trend? Given what fuel has done, it seems that you've got some pretty robust expectations for RASM. I'm just trying to understand why you think that would continue, given the economic backdrop?

Glen Hauenstein

Bill, I think we have a couple of things going on here. Domestic seems to remain strong through the fourth quarter, and while we do have a fuel hit, certainly on the cost side, we have some very nice currency fluctuations going on with the foreign currencies. That's really driving double-digit unit revenue increases in the Trans-Atlantic and Latin American entities right now. So we see continued strength in the domestic and then really, what we are seeing on a year-over-year business is accelerating strength in the international driving the total RASM numbers.

William Greene - Morgan Stanley

I know you haven't given 2008 guidance, but if we see further weakness, what kind of flexibility do you have on the capacity front to pull it back, relative to where we are at in the plan right now?

Ed Bastian

Bill, as a result of the restructuring, we've reduced the cost of our fleet substantially. In fact on comparative pre-restructuring levels almost $500 million a year of fleet savings. The cost impact of grounding domestic capacity, particularly regional jets, is not going to be substantial as compared to what it would have been previous to our work. So I think capacities, particularity on the domestic side, is the number one focus that we deploy.

William Greene - Morgan Stanley

But just to be clear, could we get to a situation where you'd have instead of a 3% capacity number, could it be as much as flat or slightly down, or is that too big of a change?

Ed Bastian

Again, our capacity for this year is flat for the domestic market. For mainline domestic, in fact, it's been down year over year. The only capacity growth we've got going on in domestic is the up-gauging of regionals from 50-seat to 76-seaters, as we're getting rid of those 50-seaters. So from our perspective the down gauging is working quite effectively in the domestic marketplace, and the international markets that we're going into are new territories with much, much more robust economic expectations and projections which you're seeing that in our numbers currently.

Richard Anderson

From a planning perspective, we're approaching 2008 with really a dual approach, which is to take current economic trends and assume that you see the same kind of GDP growth that we have seen in 2007. Then we will have a contingency plan that if we see an effect from the credit markets with respect to the sub-prime issues that are in the credit markets, or other sort of effects on the economy, we will be prepared and have the airline positioned to be able to take out domestic capacity to match that demand appropriately. We don't want to be in a situation where our domestic capacity is out of balance with where GDP and demand is.

Glen Hauenstein

A last comment on that is that our plan for 2008 has domestic capacity flat. Even where the environment is today, we are not planning on adding any additional domestic capacity.

Richard Anderson

Given the large sizes that we have, we have the lowest CASM cost in terms of fleet costs in the industry, to reinforce Ed's point. We have a very flexible fleet in terms of the being able to move capacity pretty quickly.

Operator

Your next question comes from James Higgins - Soleil Securities.

James Higgins - Soleil Securities

You have got a lot of cross-currents on the interest expense side. Can you give us an idea of what sort of quarterly numbers we should be looking at there, looking ahead?

Ed Bastian

You are right. We did have some moving parts in the non-operating interest line. First off, as part of the refinancing of the GE spare parts deal, we picked up a $14 million of benefit from the amortization of debt premium that was on the balance sheet from that original financing. Then in addition to that, in the second quarter we had written off about $20 million of unamortized debt issuance costs related to the replacement of the retirement of the DIP, since we replaced the DIP on an accelerated basis from what the original intent was for the life of the DIP. So the $20 million bad guy in the second quarter number is a $14 million good guy in the third quarter numbers.

Then on top of that, we obviously have better rates from our lower debt levels and better rates on our exit facility as compared to our DIP financing. The sum of those two numbers is about another $13 million on a quarter-over-quarter basis.

James Higgins - Soleil Securities

So it's another $13 million reduction?

Ed Bastian

In the third quarter. But that's the ongoing part. The $13 million is a continuing benefit. The first two items I mentioned were unique to the quarter. In the fourth quarter, we're going to see another $20 million benefit coming in on the non-op line related to the same factor that I mentioned on the GE spare parts refinancing, with the refinancing of the aircraft and the new EETC we accelerated about $20 million of debt premium, and that will flow through the non-op line as a good guy in the fourth quarter as well.

James Higgins - Soleil Securities

That's a one-time event in the fourth quarter?

Ed Bastian

That's right.

Operator

Your next question comes from Bob McAdoo - Avondale Partners.

Bob McAdoo - Avondale Partners

I am trying to get a little more flavor as to what is going on post-Labor Day. You have what I would consider nonstandard destinations beyond the big industries in Europe, Africa and some of the smaller European. I am just curious how those are going. In the peak I understand they did well. I'm curious, any kind of sense of how they are going in the fall? How are those markets doing in the fall relative to the more traditional European destinations?

Glen Hauenstein

I think the Middle East is having a banner fall. Africa is strong throughout the fall, and winter looks like it's going to be back to summer levels again. One of the great things about Africa is it is contra-seasonal. Eastern Europe is a market basket of different results with things like Kiev, markets like Kiev continuing to be extremely strong. For example, Bucharest is one of the weaker markets, so we're reexamining the level of capacity we have in the winter. That's coming off of a really wonderful summer for Bucharest. But in general the fall and winter, particularly in the Middle East and Africa and India are very, very strong. There are a few weak spots that we will be addressing as we plan next year.

Bob McAdoo - Avondale Partners

So is it safe to say that those are working and maybe counterbalancing some of the normal seasonal weakness you see in the traditional European destinations?

Glen Hauenstein

That certainly is the intent, to be able to rotate. This is the first year we have had the 767-400 fleet. We're calling it the Follow The Sun Project, where we're taking it out of Europe in the summer and then we're putting it down into Africa and into South America in the winter. We think that is going to be very accretive to the winter P&Ls.

Operator

Your next question comes from Bill Malthurst - Bank of New York Capital.

Bill Malthurst - Bank of New York Capital

Richard, you have been very public about the need for Delta to go ahead and continue to strengthen their balance sheet. I'm wondering, could you just set forth some goals as to where you would like to be and particularly in the context of maybe any new financings that might come up for let's say the ten aircraft?

If you could also comment -- and I know this question has a lot of different parts, I can appreciate that -- and just reassure the fixed income side that any announcement that comes out of Paris is not going to be to the detriment of bondholders?

Richard Anderson

I can tell that you any announcement coming out of Paris will not be to the detriment of bondholders.

With respect to the balance sheet, the industry and Delta has to get to a return on capital in the 10% to 12% range. Along the way, loading the balance sheet up with a lot of debt to fund new airplanes is something we have to be very careful about. Fortunately the work that Ed did leading the restructuring put the airline in great shape with respect to its fleet. Aside from perhaps a handful of 777s that would be very accretive to the P&L over the next few years and the 757s that we have coming in from the after-market, along with a handful of 737-700s, and the existing POR regional jet deliveries, we're pretty well set on the fleet.

So bottom line is, we want to be in a position to be able to take our cash flow and continue to be certain that we're paying down debt just like we did in the last quarter. I think you are going to see us avoid capital expenditures that are not really disciplined capital expenditures that have conservative assumptions that will produce real value over the long term. You can see the value of the debt pay down, the value that it already has on our pre-tax.

So as we look out in the next several years, in 2010, 2011 and 2012, we have some significant maturities. A lot of that is EETC debt that can be refinanced. But want to stay pretty focused on a debt-to-equity ratio in the 40% to 50% range over the long term. To do that is going to require incredible discipline on the CapEx side as we build real equity on the balance sheet.

Bill Malthurst - Bank of New York Capital

That debt-to-equity ratio, that includes any type of activities relating to consolidation?

Richard Anderson

No, that is on a standalone basis, Bill.

Bill Malthurst - Bank of New York Capital

That debt to equity also includes and incorporates what would probably be a future EETC financing to fund the ten aircraft. Would that be correct there?

Richard Anderson

We have not made a decision, Bill, as to how we're going to approach the deliveries. We're considering quite honestly whether we should pay cash for some of them.

Operator

Your next question comes from William Greene - Morgan Stanley.

William Greene - Morgan Stanley

When you are thinking about driving sort of shareholder value here you talked about consolidation, but can you offer any color on the other options that have been bantered around in the industry? From assets spin-offs, whether it's MRO, or frequent flyer, or anything like that? Also your views on dividend payments. I recognize those are board decisions but just how you are thinking about that.

Richard Anderson

First, the board is a very independent and strong board. This board was selected by the process out of the reorganization of the creditors committees so you have a lot of very sophisticated and financially astute board members who are very focused on making sure that Delta continues to operate from a position of strength. That includes making certain that we do the right thing for the shareholders.

So with that background, we have teed up the issue of whether we should own Com Air. I think you'll see us making a judgment in that regard in the next quarter or so. We have the work underway doing the internal evaluation on whether we need to really basically have our balance sheet carry that set of assets. Out of our nine regional carriers, it is the only one that we own. So you should expect us in the course of the next quarter or two, I would actually think in the next quarter, to make a judgment that regard.

With respect to the other assets, the MRO business, Delta Global Services, and Delta AirElite, given that we own those assets already, there really is an opportunity that is unique at Delta to use those assets and leverage those assets to provide some diversification, particularly if you are in an economic downturn. The MRO business is quite profitable on a fully allocated basis. It's not labor intensive, it mostly relies on expertise and the economies of scale that we have in that business.

Delta Global Services has a broad and deep client base. I think you are going to see from us, starting next year a lot more visibility into the P&Ls in those businesses, because those three businesses, we have a lot of opportunity. If we ran those things on standalone basis given the low capital base that we have, they could actually provide nice earnings diversification and contribute materially to the cash flow.

William Greene - Morgan Stanley

So just to make sure I understood that last point, are you suggesting that you would rather break them out so the market can see them?

Richard Anderson

Yes.

William Greene - Morgan Stanley

Rather than a spin out or something like that?

Richard Anderson

At this point. There's a lot of value to be created there yet particularly, in the MRO business.

William Greene - Morgan Stanley

Any views on frequent flyer?

Richard Anderson

Frequent flyer, candidly, needs to be a post-consolidation sort of decision, because you really need to have a lot of scale to make those transactions work, if you look at the one that's been successful up in Canada. So you want to be able to have all options on the table at the time you made that kind of decision, but ultimately, those are very valuable programs.

William Greene - Morgan Stanley

When you are looking at your corporate contracts and you're looking at the negotiations with corporate travel managers right now, what kind of discussions are you having in terms of the color on what they are willing to accept, perhaps, in terms of discussions about rate increases from here?

Glen Hauenstein

Historically we had some contracts that were fixed rates, and now we have gone to floating discounts off of the various structures. So essentially, most corporations as we continue to pass through rate increases primarily due to fuel, those pass right on through to our corporate clients. You saw this week the industry took another industry-wide fare increase, and that will be reflective in all of the discounts that we have with the major corporations.

Operator

Your next question comes from Bob McAdoo - Avondale Partners.

Bob McAdoo - Avondale Partners

I know you said you have got a press conference tomorrow there in Paris. Without asking you to disclose destinations and all that kind of thing, I think there is a Reuters story that has gone over here in the last hour or so which talks about a lot of the same kinds of things, about a joint venture between you guys and Air France. I'm curious not so much as to asking you about what destinations or exactly what might be coming out that way, but more if there is a joint venture announced, how does that impact our financials? How should we be thinking about that in terms of modeling, assuming there's a particular route or two out of Heathrow that do in fact get announced, how should we be thinking about it? What does that do to you and how does it flow through in terms of revenues and expenses and bottom line?

Richard Anderson

Well, we have to be careful, Bob, we're not going to preannounce.

Bob McAdoo - Avondale Partners

I'm not asking you to tell us what you are going to do exactly. But if you end up in a joint venture, how does that end up working?

Richard Anderson

It's not going to have a dramatic impact on the balance sheet, if that's your question, or the nature by which the results will be reported. It will be very positive. You can be assured it will be accretive but it will not fundamentally change the reporting structure of the entity.

Bob McAdoo - Avondale Partners

In those kind of situations, if you guys share seats on whether it is this particular one or in future joint ventures, should we just assume that you share the revenues and you share the expenses on a particular flight that may be a part of that joint venture?

Richard Anderson

I think it's fair to say that it would be more oriented toward the profit of the entities than the specific revenues and costs. They won't go into a new entity.

Glen Hauenstein

Bob, you might think about it in terms of continuing to fuel increased RASM across the Atlantic. In other words, its demonstration will come from the fact that you can leverage the two largest carriers together across the Trans-Atlantic, and the goal would be to continue to help fuel our RASM improvement across the Atlantic.

Bob McAdoo - Avondale Partners

If you have X number of round trips across the North Atlantic today, it's going to look a lot like that, but basically net-net all we need to worry about is it ought to help the RASM on that?

Ed Bastian

It will help the RASM. It will definitely help the RASM.

Richard Anderson

That's about all we can say on that right now, Bob.

Operator

Your next question comes from Robert Barry – Goldman Sachs.

Robert Barry - Goldman Sachs

There was an early question about international PRASM growth and there was a mention of significant FX benefit. Could you tell us how much of the PRASM growth in Atlantic and Latin was related to currency?

Richard Anderson

We think it's about 4 points of year-over-year PRASM increase attributable to currency.

Robert Barry - Goldman Sachs

Does any of that make it to your bottom line? Or is that just the revenue impact?

Richard Anderson

I think a fair chunk of it does, Rob.

Robert Barry - Goldman Sachs

Any ability to quantify how much?

Richard Anderson

We don't have the numbers here. We're over in Paris. You can follow up with Jill after. We'll get you that number.

Robert Barry - Goldman Sachs

There was a mention just a couple of minutes ago about the recent fare increase. In what percentage of your markets did that fare increase stick?

Glen Hauenstein

Well, it's the entire network ex the low-cost carrier network. So it's about 40% to 50% of the markets. I will fully expect that we see some traction from various low-cost carriers over the next few weeks here as fuel continues to remain certainly high in the mid-80s.

Robert Barry - Goldman Sachs

Finally, I was wondering if you could update us on the progress you're making with the regionals and in particular how you feel things are going since you took over the ground handling this summer?

Richard Anderson

Good progress. Two important things occurring there. One, we brought Don Bornhorst up, he was the CEO of Comair. We brought him up to Delta, and have pulled together all the various parts of Delta under Don to take control of all of our contract carrier relationships. That's the first important development.

The second thing is we had ASA reached an agreement with its pilots on a new contract going forward.

Third, we took over the ground handling at Atlanta, and we have begun to see improvement in the on-time performance and completion factor. It's a work in progress, but we feel pretty good about where we are given the most recent DOT numbers.

Operator

Your next question comes from Jamie Baker – JP Morgan.

Jamie Baker - JP Morgan

Richard, I'm actually seeing a headline cross here that African Airlines must merge, says industry chief. I'm guessing that's not what you were speaking about earlier. When you talk about incremental aircraft, you talked about a demonstrable return on equity. I was hoping you could quantify a bit about what sort of return you look for? This is actually a concept that seems to be lost on some of your competitors.

Richard Anderson

When you sit down to make that decision, you've got to make a decision that's based upon some reasonable assumptions over time about the cost and the revenue performance that you can assume. You have to weigh that against what happens if you are in a downturn and you have a fleet that's all covered by fixed obligations and you don't have variable capacity that's free at the bottom of your fleet.

We target a return on capital, a return on investment of somewhere around 15% when we make those decisions. Candidly, that's going to come down, Jamie, to what are you going to assume about what costs are going to be over time, and what are you going to assume about what your revenue performance is going to be over time? So you have to be careful about those input assumptions.

We target that, by the way, when we're making investment like winglets and seat reconfigurations. Ed talked about these seat reconfigurations. In many instances on the seat reconfigurations we're getting a much better product for our customer and we're able to put more seats on the airplane without affecting pitch. So when you look into each one of these investments we're making, we're targeting a 15% return on investment, and the company is very disciplined, I mean that's what Ed does so well, is make certain that when we do go and make these kinds of fleet investments, that we actually are going to see the returns, rather than just being proud of having new, shiny airplanes.

Jamie Baker - JP Morgan

When you talk about evaluating this path for consolidation, I'm curious how long the study process is likely to take?

Richard Anderson

Jamie, as you know we just now have the team together. We have got the board constituted, the board is rapidly getting very educated in the industry and up to speed. We're on it. So we're not going to give you a date, we're not going to give you a timeline, but we're looking at currently.

Jamie Baker - JP Morgan

Finally Ed, your commentary noted that you were looking through November, does that imply that December is somehow looking different, or that you just don't have the requisite visibility? Also, what is your approximate net interest run rate going forward? We goofed in our model this quarter on that metric.

Richard Anderson

It wasn't to make any implications towards December at all. It's just as you know at this point in the cycle, December looks about where we think it should be, but November gives us the best transparency.

For interest costs, let me try to grab something here for the fourth quarter. Tell you what, I don't have the page in front of me that's got the fourth quarter interest costs forecast. Why don't we have Jill get back to you?

Operator

Your next question comes from Andrew Shapiro – FTN Midwest Securities.

Andrew Shapiro - FTN Midwest Securities

Other revenues looked like they were up very strong in the quarter, though maybe it wasn't quite as strong as it initially appears, because it looks like you did restatements to both mainline and other revenues in the prior period. I would like to better understand what was driving other revenues in the quarter, and how we should think about the growth rates going forward?

Ed Bastian

Other revenues were impacted by Fresh Start accounting. I think that was about $10 million on a year-over-year basis. The other big change in the other revenue line was the breakout of the TOC, our MRO business. In-sourcing activities. We now gross them up. That was an incremental $25 million on a year-over-year basis. So even though we restated the prior year in terms of grossing up the prior year for reclassification purposes, we grew the business by $25 million this quarter over the third quarter a year ago. Those are the two largest changes in there. We have increased fees for administrative service charges, we've got some SkyMile benefits as well.

Andrew Shapiro - FTN Midwest Securities

How should we think about the growth rate going forward?

Ed Bastian

I would think that the rate you saw here for the third quarter is probably not too different than what you should expect to see going forward.

Ed Bastian

Jamie, if you are still on the line, I did identify the fourth quarter, our forecast is in the $90 million to $100 million range for the fourth quarter, if you are listening.

Operator

Your next question comes from Gary Chase – Lehman Brothers.

Gary Chase - Lehman Brothers

A couple of questions for Richard as it relates to the restructuring plan. I know you voiced support for what I would call the major pillars of the plan, anyway. Are there any tweaks that we ought to be thinking need to be made looking forward? Secondly, I have heard you make reference a couple of times now to cost opportunity, and I was wondering if you could elaborate. Do you think that is a function of offsetting inflation in the structure, or do you really believe that there is an opportunity to drive costs fundamentally lower than what was contemplated in that plan?

Richard Anderson

I think it is going to initially be offsetting inflation. We have industry-leading non-fuel CASM, and I do think that we can sustain industry-leading non-fuel CASM. There are real innovation opportunities still ahead of us. The team has done a very nice job through the restructuring process. But you have to continually find new ways of doing business that can take those costs out, and we have a pretty long list of things that we're going to be examining in the planning process for 2008, especially when you see fuel trending up the way fuel is trending up.

But in summary, I think you can count on our staying at the top of the industry in terms of network non-fuel CASM.

A couple of other points to your first question. One of the areas that we can leverage the plan even further is the reason why we're here in Paris, and Glen has done a nice job leading the effort there, but the opportunity that we have with Air France across the Trans-Atlantic could create a very powerful entity. We have anti-trust immunity with Air France and we have the number one position across the Atlantic from the U.S.

They have the strongest position in Europe in terms of the European hub. Combining those two together with anti-trust immunity could create an enormous amount of value going forward and you're going to see the beginnings of that with some of the announcements we make tomorrow.

I would say the third part is we've got to step up our focus on the premium passenger, and that focus on the premium passenger is going to be particularly important in international and in international business class. So you are going to see us continue to probably make more investment there, and make more investment in driving the premium product for more premium revenues.

I would also say that we need to continue to push on the international side of the business. Every opportunity we have to continue to do the creative expansion that we have done internationally. The team is strong here with Bob and Glen, and that continues to be a significant opportunity for the organization.

I wouldn't leave off the fact that these other businesses are really interesting businesses. This MRO business, the Delta Global Services business, and the Delta AirElite business, you could imagine those businesses with the right business plans and the continued focus on growing them as standalone businesses, you could imagine those businesses at some point contributing a pre-tax number close to $100 million over, if you built them right and you put the effort in to building those businesses collectively over the next three to five years. I think they are hidden assets on the balance sheet and airlines traditionally don't think about being in those kinds of businesses. We're in those businesses, we're already in those businesses successfully, but we have always viewed them as contra revenue. You just sort of netted them out against the department P&L. But we're going to start breaking them out and running them as standalone businesses.

So I think there's a lot of opportunity there that would provide some diversification for the kind of the monolithic revenue model we have in the industry.

Gary Chase - Lehman Brothers

Ed made mention of two things, state tax resolutions and insurance as you were going through the operating margin. Was there some operating benefit in the quarter we should think of as one-time?

Ed Bastian

The state tax is. That was the reason if you look at our performance, we guided operating margin of 6% to 8%. I think we came in at 8.7%, the lion's share of that 0.7% was from a state tax resolution that came in at the very end of the quarter. We didn't have visibility to the settlement when we gave guidance. The insurance settlement was smaller.

We have got some ongoing discussions that relate to business interruptions down from the Hurricane Rita and Wilma and Katrina from the Gulf Coast in 2005. We still have some ongoing discussions and I would expect further settlements in the future quarter or two, not sizable enough to call out. We also obviously have some other things going the other direction I didn't call out either.

Gary Chase - Lehman Brothers

Was there any story domestically on a regional level? Obviously the overall performance looked very good for the quarter. Anything stand out on the upside or the down side?

Glen Hauenstein

Well, certainly, JFK is making the most progress for us and with Jet Blue continuing to struggle there and they are perpetually raising fares, the unit revenues in JFK are rising less dramatically. The rest of the network is relatively well balanced, but that certainly is the stand out.

Richard Anderson

Just one last one that came to mind that we are looking at in terms of longer-term free cash flow, which is, do we have to take all of the airplanes that we have in the POR, the new airplanes, and whether or not there are some options on fleeting that would in fact reduce our CapEx going forward in the plan of reorganization. So we're looking pretty hard at the POR, and figuring out what we can do to free up more cash flow from the original PRO. I'm not ready to announce them yet. There may be some creative things we can do on the fleet side to avoid some of the new aircraft purchases that we had assumed in that fleet plan. So, bottom line, it's a great POR, can we really accelerate the free cash flow?

Ed Bastian

To follow-on what Richard was saying in terms of additional cost coming out on the business. We're going to be looking at on an ongoing basis, somewhere between a 3 to 5 points of additional cost coming out each year. Now some of those we're going to have to go fund new cost pressures each year, but if you are trying to put a target on the size of the benefits, we think you can still draw out of the network. Some of it relates to growth in terms of the benefit of growth, but in average it's kind of 3 to 5 points of unit cost benefit, some of that's invested back in, whether it be product or some other cost pressures.

Richard Anderson

When you think about growing the airline, modest growth requires that you that, so that you can grow the airline at the marginal unit of production. Otherwise you end up with fully allocated cost for every additional unit of capacity that you add, and you don't want to do that or you won't get the value of the marginal economics.

Operator

This concludes your presentation for today. Ladies and gentlemen, you may now disconnect. Have a wonderful day.

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Source: Delta Air Lines Q3 2007 Earnings Call Transcript
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