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Delta Air Lines, Inc. (NYSE:DAL)

Q2 2008 Earnings Call

July 16, 2008 10:00 am ET

Executives

Richard Anderson – CEO

Edward Bastian – President & CFO

Shannon Mutschler – GM IR

Analysts

Mike Linenberg – Merrill Lynch

Daniel McKenzie – Credit Suisse

Jamie Baker – J. P. Morgan

Gary Chase – Lehman Brothers

Ray Neidl – Calyon Securities

William Green – Morgan Stanley

Kevin Crissey - UBS

Chris Cuomo – Goldman Sachs

Operator

Good morning ladies and gentlemen and welcome to the Delta Air Lines June 2008 quarter financial results conference call. (Operator Instructions) I would now like to turn the presentation over to Shannon Mutschler, General Manager of Investor Relations for Delta Air Lines; please proceed.

Shannon Mutschler

Good morning everyone. Thank you for joining us today to discuss Delta’s June 2008 quarter financial results. Speaking on today’s call are Richard Anderson, Chief Executive Officer and Ed Bastian, President and Chief Financial Officer. Also joining us for Q&A is Glen Hauenstein, Executive Vice President of Network and Revenue Management and Hank Halter, Senior Vice President and Controller.

Before we begin please note this call is being webcast live via the internet and is also 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 the express written permission of Delta Air Lines.

Today’s discussion contains forward-looking statements that represent our beliefs or expectations about future events. All forward-looking statements involve risks and uncertainties that could cause the actual results to differ materially from the forward-looking statements. Some of the factors that may cause such differences are described in Delta’s SEC filings. We will also discuss certain non-GAAP financial measures. You can find the reconciliation of those non-GAAP measures on our Investor Relations website at www.delta.com.

With that, I’ll turn the call over to our Chief Executive Officer, Richard Anderson.

Richard Anderson

Thank you Shannon and good morning everyone. Thanks for joining us on the call today. This morning we announced Delta’s financial results for the June, 2008 quarter. Excluding special items Delta recorded net income for the second quarter of $137 million in spite of record high fuel prices that drove more then $1 billion in additional fuel input costs year-over-year. This compared to net income of $274 million in the June quarter of 2007.

On a GAAP basis we recorded a $1 billion loss driven mainly by a $1.1 billion non-cash impairment charge and you’ll recall last quarter we had the first part of that charge and this is the final true-up and a $96 million severance charge and I’d note on the $96 million severance charge, that was part of our process that we initiated earlier in the year to reduce overall staffing at the airline and that process has gone well and will result in significant payback within the year.

Generating positive earnings for the quarter given the unprecedented rise in the price of jet fuel is something that not many of our competitors will be able to report and it is a testament to the hard work of all the people at Delta Air Lines. They are delivering on our internal financial goals and they’re running a great airline. For the last 12 months Delta ranks number two among our competitive set for on time performance. In addition the latest view of key statistics ranked Delta in the top five for baggage performance in May and we had a 32% decline in the number of mishandled bags year-over-year in the June quarter.

This improvement reflects our ongoing investment in technology and process reengineering so we appreciate and want to thank all the Delta employees for their great work. They received $10 million in shared reward payments during the quarter for achievement of operational performance goals. So really great work by our people and we all want to thank them.

Moving on to the most pressing topic for Delta and the entire industry is the price of jet fuel. It continues to rise. In the second quarter alone the price of a gallon of jet fuel increased $1 to $4. Crude jumped $40 to over $140 per barrel and prices continue to rise from there. While these prices are causing a tremendous amount of pain for almost every industry you can think of, without a doubt they have created a crisis in the airline industry not only because of the magnitude of the change but also because of the pace of the change.

However Delta is taking aggressive actions to position the company to survive this crisis and become the industry leader and we’re doing this in several core areas. First we’re intently focused on preserving liquidity. We are currently projecting that we’ll see about $4 billion of additional fuel costs this year alone, however we expect to mitigate almost $3 billion of that higher cost by aggressively hedging our fuel needs, maintaining strict cost discipline so that we preserve our best-in-class cost structure and continuing to grow top line revenue.

We’re now earning a revenue premium to our peers as a result of our industry leading domestic capacity reductions, international expansion, yield management strategies and overall top line growth of other revenue. In spite of how high fuel prices it’s important to continue to invest in our product and in the markets that are profitable to us. As a result we recently exercised two additional options for B-777-LR aircraft to be delivered in early 2010 which will further support our plans for international growth.

We’re also looking forward to the delivery of the first of 10 B-727-700s next week. With the B-777 and B-737 we’ll have 20 international capable aircraft deliveries this year and through 2010. The B-737-700s are for the longer, thinner, higher airports in South America. Unfortunately fuel prices also demand that we make difficult decisions about areas of the business that aren’t profitable. Smaller regional aircraft are not efficient to operate in current fuel levels and so we are now targeting to remove the equivalent of 100 regional aircraft from the system by the end of the year through a combination of lease returns, decreased utilization and changes in contractual arrangements.

As a result of these actions to mitigate fuel prices, we expect to close the year with unrestricted liquidity of $3.2 billion including our $1 billion undrawn revolver and we are evaluating additional cash raising opportunities post-closing of our merger with Northwest. Second of all we recognize that there are a number of key factors that are driving the recent unprecedented rise in fuel prices, the lack of any real energy policy in this country, the weak dollar as well as supply shortages in the face of increasing global demand. We believe that speculation in the market is also a very real component that must be addressed. As a result Delta has partnered with all of our competitors at the Air Transport Association both inside and outside the airline industry, to insist that necessary changes are made in the regulation of energy markets.

Last and most importantly we’re moving forward with the Northwest merger. We believe this deal makes even more sense at these fuel price levels and given the lack of follow-on consolidation in the industry it gives us a real leg up on the competition in the long-term. It’s a real game-changer in terms of this industry. In fact we’ve already achieved two milestones in the path toward closing the merger and achieving a seamless integration of the two airlines. The first was reaching an unprecedented pre-merger contract with both Delta and Northwest pilots which calls for an integrated seniority list upon closing of the transaction that allows us to capture the synergies much more quickly.

The leadership of both pilot groups approved the combined agreement earlier this month and we expect voting by the general membership to be completed by mid-August. Second earlier this week we announced the post-merger organizational structure and the executive team that will lead the new Delta. The team will combine leadership from both Delta and Northwest and their diverse backgrounds and extensive experience to provide a solid foundation for building America’s premier airline. In addition our integration teams have been working hard to refine earlier synergy estimates and identify new opportunities. We have 26 working teams of executives from the two airlines building the bottoms-up plan for both integration and development of the synergies.

Edward will provide the details later in the call but at a high level we expect the merger to provide approximately $2 billion in annual synergies by 2012. We’ve also taken a hard look at the cost and timeline to integrate the two airlines and now project cash integration costs of approximately $600 million over three years. Our goal is to provide a seamless transition on day one and our guiding principal will be to focus on integrating only those activities that will provide real value to customers, employees and shareholders.

In closing Delta is a very different airline today from others in the industry. We have a very strong and flexible workforce driven by outstanding employees who are working hard to deliver industry leading operating performance across all metrics. We are now earning a revenue premium to the industry due to our focus on network and revenue management and great work from our sales and marketing teams. Our flexible fleet has allowed us to react quickly and decisively to rising fuel costs having a low capital cost; one of the lowest capital cost fleets in the industry and many [paid for] airplanes gives us a lot of flexibility to react to the demands of the marketplace.

We have a significant cost advantage to our peers and a solid balance sheet. We have a strong liquidity position with substantial opportunities available to enhance that position, particularly as we approach the merger with Northwest. Our transatlantic joint venture with Air France, KLM and Northwest will be unrivaled in the industry particularly with the anti-trust immunity and the long-term evolution of both of those alliances.

Our merger with Northwest which will be unmatched by any of our competitors builds on all of these assets driving approximately $2 billion in synergies that will help mitigate the fuel challenge. And lastly we’re very focused not just on passenger revenue but all other revenue; cargo revenue, Affinity Card revenue, and we expect to be able to have the strongest top line growth in the industry. Because in the end that’s what really is the driver of the engine and once again, just like the three previous quarters we have very strong top line growth.

So in summary we believe that Delta holds one of the strongest hands in the industry and because of the strength of our people and our business model I’m confident we can seize opportunities from the current environment and strengthen our leadership position as we move forward with the merger with Northwest. With that, I’ll turn the call over to Edward to discuss the financial details for the quarter and give you a detailed merger update and then we’ll open it up as usual for questions. Thank you, thank you for being on the call this morning.

Edward Bastian

Thanks Richard, good morning everyone and thank you for joining us today. For the June quarter Delta reported a $1 billion loss which includes three special charges; a $1.1 billion non-cash charge net of $119 million tax benefit relating to the impairment of goodwill and other intangibles. This charge represents a true-up to the estimates recorded in March and reflects third party evaluations that were finalized during the June quarter. Next a $96 million severance charge related to the over 4,000 employees who participated in our early retirement program announced last quarter. About one-third of those employees have left the company as of June, 80% in total will have left by the end of September and the remainder will exit by the end of this year. And finally a small $6 million charge related to facilities restructure.

Excluding these special charges net income for the period was $137 million which compares to net income of $274 million in the June, 2007 quarter. On a base of 396 million diluted shares this equates to earnings per share of $0.35 per share and compares to [consensus] of $0.10 per share. Operating margin in the quarter was 4% in spite of the fact that fuel prices were 50% higher on a year-over-year basis. In fact higher fuel prices added over $1 billion in additional fuel input costs this quarter. Delta was able to mitigate almost 80% of this additional fuel cost through the increased revenues of almost $500 million including international expansion as well as the other revenue gains that Richard was referring to, productivity initiatives and importantly fuel hedging gains which totaled $313 million in the quarter.

Delta began taking aggressive actions to combat rising fuel costs last year when we developed our 2008 business plan which included $400 million in revenue and cost initiatives. As fuel continued to ramp we worked to make further changes in our model allowing us to identify additional revenue enhancing opportunities and cost savings and we’ve accelerated the timing of previously identified initiatives. Revenue initiatives include growing our cargo business, our third party MRO, and ancillary revenue stream, new fees for services provided to customers such as the second check bag fee, ticket changes, excess baggage and [accompanying] minor changes, and adding fuel surcharges on

[inaudible] or award tickets.

Some of the cost initiatives that we’ve implemented include the workforce reductions that we’ve already implemented, deferral of certain rebranding activities and technology enhancements such as expanding self-service boarding. All the initiatives combined equate to roughly $650 million in value in 2008 and $1 billion in annual value so we’ll continue to see the benefits from these actions as they annualize next year.

Turning to revenue our June quarter revenue improved 10% or almost $500 million on a year-over-year basis. Our network restructuring and yield management initiatives continued to deliver strong results with a 6% increase in passenger revenue this quarter. Delta’s consolidated unit revenue increased in the June quarter by 5% on a 5% increase in the length of haul. This improvement was driven by 4% higher yield and 2% higher traffic. Delta’s consolidated length of haul adjusted RASM as reported to the ATA was 102% of industry average for the year-to-date period through the end of May; the last month reported.

In fact in every region during this period we were at a revenue premium to industry. Hats off to the network, revenue management sales and marketing team for delivering premium revenue results a full year ahead of planned. Our cargo team is also doing a great job; revenues continue to improve growing $42 million or 36%. These results reflect significantly higher yield from a more aggressive focus on yield management, and a 15% increase in cargo ton miles, mostly in international markets. The team is implementing structural and operational changes to further enhance the business.

Our other net revenue also increased $177 million or 45% driven by higher passenger fees, growth in our third party MRO business and growth in the SkyMiles revenue program. Moving to cost, our mainline CASM ex special items increased 16% for the quarter which reflect the sharp run-up in fuel costs. Excluding fuel and other special charges, mainline CASM increased one point on a year-over-year basis to 7.03 cents. We hedged 49% of our second quarter fuel consumption and averaged in all in fuel price of $3.13 per gallon. As a result our hedges reduced fuel expense in the quarter by $313 million. Non-operating expenses for the quarter also include a $31 million gain from FAS 133 benefits.

Strengthening our balance sheet and liquidity continues to be a top priority. We ended the quarter with a strong unrestricted cash and liquidity of $4.3 billion which includes our undrawn revolver. Key components include operating cash flow of $1 billion. Beginning this quarter we began requiring that our fuel hedged counterparties post cash collateral due to our fuel hedge positions being significantly in the money. Operating cash flow includes $671 million from these deposits.

CapEx for the period was approximately $260 million which includes $220 million in net expenditures for aircraft, parts and mods. During the quarter we issued debt totaling $115 million to finance aircraft pre-delivery payments as well as three CRJ-900 aircraft that were delivered in the quarter. In addition we paid $97 million in debt maturities and capital lease obligations which result in a net debt increase of $18 million. And as I mentioned earlier, our $1 billion revolver remains fully available and undrawn at the end of the quarter. At the end of the June quarter we were well within the required range of all of our financial covenants.

As Richard mentioned we expect to end the year with $3.2 billion in total liquidity which does include our undrawn revolver. Liquidity preservation is right at the top of our priorities as we navigate a highly volatile environment. We have been working on additional cash raising opportunities that we plan to act on following the close of the merger later this year. Looking at advanced revenue trends overall they are ahead of last year however the pace of change has not been enough to keep up with the change in the price of jet fuel.

On the international side, yields are up for both business and coach classes. International business demand exit US is down slightly but yields are more then compensating for lower load factors. We’re also continuing to see strength in demand on the exit international side with additional yield improvement from foreign exchange gains. Domestically business travelers seem to be showing more price sensitivity with a shift of booking further out to take advantage of lower fares. As a result we are recapturing revenue by adding pricing [inaudible] back into the fare structure.

Looking forward to the fall while there is some concern about the domestic demand environment we are optimistic that the actions we and the industry have taken to rationalize capacity will have the desired affect. The amount of capacity that’s coming out of the domestic system is unprecedented. You are seeing reductions along the magnitude of those seen post-9-11. We’ll continue to evaluate our outlook and competitive position and we’ll take additional actions if called for.

We would typically walk you through our guidance at this point of the call; however we included that information in our press release this morning to allow time to provide you an update on Delta’s merger with Northwest. It’s been three months since we announced the merger agreement with Northwest and we wanted to update you on the progress we made including revisions to both the synergy as well as one-time cost targets.

As Richard mentioned we reached a pre-merger contract with both the Delta and Northwest pilots which calls for an integrated seniority list upon the closing of the transaction. This is a first in the industry and it is representative of the value that we place on positive labor relations. We believe that we have one of the best pilot working relationships in the industry and are working hard to establish the same with the Northwest pilots.

The four year contract that we’ve agreed to runs through 2012 and calls for pilot pay to be harmonized day one with pay increases of roughly 4% annually. Note that this includes previously contracted increases so the incremental cost is roughly three points a year. While pay rates will be harmonized the retirement arrangements will not be harmonized until the end of the contract. In addition Delta pilots will receive a 3.5% equity stake and the Northwest pilots will receive a 2.38% equity stake in the new Delta. This agreement provides substantial financial and operational benefits which will far outweigh the cost. It accelerates our ability to realize network synergies by achieving that integrated pilot workforce and fleet; it expands our ability to [coach-share] and importantly gets our pilot group behind the merger during this critical integration period for our two airlines.

As you know our initial synergy estimates were based on a high level analysis. Since that time we have refined earlier estimates through a very detailed bottom-up analysis that included 26 teams across both Delta and Northwest and we’ve identified substantial new opportunities. As a result we’ve increased our synergy target to roughly $2 billion annually which compares to the $1 billion previously estimated. We expect total synergies in 2009 of roughly $500 million, increasing about $500 million each year until you get to the full run rate by 2012.

When fully ramped up our network synergies are expected to be $1.4 billion and our net cost synergies to be roughly $600 million annually. Roughly half of the $1 billion increase in total synergies is from refining earlier estimates. We now have better information about overhead reduction opportunities, technology; facilities overlap, and improved efficiencies possible in the airport operations [and] our selling costs. With a combined pilot deal reached we also now have the full ability to realized network and fleeting synergies which accelerates our revenue capture.

The remainder of the increase comes from identifying structural opportunities which we knew were available but had not yet quantified. These opportunities include the value of aligning the Affinity Card strategy, optimizing the regional jet portfolio and creation of a single powerful frequent flyer program. Additional details on the merger status and synergy update can be found in an 8-K investor update that we filed this morning.

We have refined our estimate of one-time cash integration costs to approximately $600 million over three years. As Richard mentioned our guiding principal in the integration will be to focus on activities that generate a return on their investment thereby conserving cash and providing value to our shareholders. Our initial priorities will be to transition technology systems to a single platform, move to a single operating certificate for the two airlines and deliver a consistent customer experience by standardizing our brand, our employee training, our uniforms, aircraft interiors, and liveries.

We have established 26 integration teams whose mission it is to ensure a smooth integration and meet our new synergy and integration cost targets. They are already hard at work and have made significant progress in a number of key areas. For example, earlier this week we announced the [inaudible] structure of the combined airline which will be in place at the close of the merger. In August we plan to file with the FAA for achieving a single operating certificate. And following the closing of the merger we’ll immediately begin the process of linking our route networks, substantially increasing our level of billion-lateral coach sharing and quickly move to a single powerful frequent flyer program for our customers.

We have continued to work closely with the DOJ to provide all their requested data and we remain comfortable with our target of closing the transaction by the end of this year.

In closing while the economic challenges that the industry faces today are very serious Delta has been a leader in taking aggressive action to position this airline for long-term success. This is demonstrated by our strong focus on liquidity, our plans to merge with Northwest and our swift action to significantly reduce domestic capacity and their related cost. We are confident that the transformation of our business model over the last few years coupled with the strategic actions we’ve taken over the last number of months make Delta a very formidable competitor, well positioned for long-term success.

That ends the prepared remarks section of our call. At this time we’ll be happy to take any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mike Linenberg – Merrill Lynch

Mike Linenberg – Merrill Lynch

As it relates to your cuts in capacity, what does that mean for airport costs and specifically I’m looking at some of the stuff that you’re pulling back in Las Angeles, do we see on a unit basis those numbers move up or do you have a unique opportunity with the merging in the offing to go back to these airport authorities and re-cut deals?

Richard Anderson

One of the integration teams has the facilities groups of the two organizations and you’ll notice in this quarter we’ve already gone down the road of staring to do that with part of the special charge that we have in the GAAP reported earnings of $6 million is related to reduction of those facilities. We have a plan with Northwest that basically every airport in the United States to rationalize our capacity. LA would be a prime example where you can consolidate into one of the two facilities and probably have a gain on the facility that you get rid of at an airport like that. There’s a lot more opportunity and we have one team dedicated to that and our station overlap, to give you some idea, our station overlap synergy number on the cost side is well in excess of $100 million. You’ve hit the nail on the head.

Mike Linenberg – Merrill Lynch

The situation with Mesa, obviously I believe, I don’t know if its formally out on appeal yet, but from what I’ve heard is that at present they’re not flying, or the airplanes aren’t in the schedule, what’s the minimum that you have to pay them, I don’t know if its on a monthly basis, what cash is going out and yet you’re not receiving any services?

Richard Anderson

Since its pending litigation it would be best for us to not comment on what the status of it is. So while I wish I could answer your question, I think that its best advice that given the nature of the litigation with Mesa that we stay off the record on that.

Operator

Your next question comes from the line of Daniel McKenzie – Credit Suisse

Daniel McKenzie – Credit Suisse

Economic conditions appear to be deteriorating pretty rapidly in the euro area and open skies appears to be a counter-punch for Delta going into London Heathrow, so I’m wondering what gives you the comfort that international demand is going to keep pace with the capacity that’s entering the market looking ahead.

Glen Hauenstein

We react to demand and our commitment to our shareholders and our employees is that we will react to demand changes relatively quickly and I think that you would see from the domestic pull-down that we had this summer that we were way out ahead of the industry in seeing what was happening last fall and we reacted quickly. We are paring down some of our international growth and we’re taking the laggards out of the network for the fall anticipating that the robust growth that we’ve seen over the past two years in international and traffic and revenues will start to level out as we move into the fourth quarter. But right now everything is still remaining very strong from all indications including forward bookings and advance yields. So as we see that softening we will react. We have a lot of opportunities to continue to move the asset base around and maximize revenue so I’m relatively confident that we will adjust appropriately but I do share your concern that we may see a softening in some of the international markets moving forward.

Edward Bastian

Remember also that our growth in the transatlantic is largely going across to new territories, into Africa, into The Middle East so it’s not solely in the open skies arena in terms of some of the classical European arrangements so we’ve got a little bit of a different footprint then some of our competitors.

Daniel McKenzie – Credit Suisse

Given the surprise on the integration costs I wonder if you could highlight some of the big buckets where the $600 million spend is going to be and is there potentially some room for improvement there?

Edward Bastian

When we announced the deal back in the April timeframe we said integration costs were not to exceed $1 billion so we were confident at that point but we needed to do some more detailed work to get the number down to where you’re seeing it. Some of the big areas that we’re going to be spending are obviously in the technology space. It’s going to be critical that we had an effective and seamless technology integration of the two airlines. There’s going to be money spent in aircraft modifications in terms of bringing our product standards into a consistent look and feel. We’re going to be moving expeditiously to try to bring from a customer perspective our brand together as rapidly as possible.

You’re going to see some costs on the maintenance programs as well as we bring our maintenance programs into a single standard so that we can receive a single operating certificate and you’re also going to see transaction costs which whether it be advisor fees and they’re not just Delta’s fees, obviously they’re the Northwest fees as well and some costs on the financing side. Those are some of the larger bucketed areas for the integration and we expect the $600 million to be over three year timeframe. Our commitment to our shareholders is that we will get out ahead of the value of the deal. We will not be spending money waiting for value to show up. We’re going to time the cost of the integration to the value received.

Operator

Your next question comes from the line of Jamie Baker – J. P. Morgan

Jamie Baker – J. P. Morgan

I’m wondering if you’ve changed your mind regarding the decision to wait until after the deal closes to secure any additional funding. Obviously there’s some risk that whatever financing pool is out there today could dry up between now and then.

Edward Bastian

We have not changed our mind in a macro sense, we are working on some targeted initiatives that we might be able to close pre the merger transaction closing and I know the Northwest team is working on some specific tactical cash raising opportunities as well. But the bigger cash raising opportunities we continue to believe will be following our close of the merger which will be in the fourth quarter.

Jamie Baker – J. P. Morgan

As you potentially bake off the Affinity card providers off one and another, any thought on the expected proceeds you might be able to generate particularly now that you can frame your optimism against what Continental was able to achieve?

Richard Anderson

There is a very substantial opportunity there. When you think about the size of what this frequent flyer program will be and you just kind of look at what our other revenue line is at Delta and the other revenue line at Northwest and try to glean out sort of what the size is, its substantially more then the numbers that Continental posted in their reported mileage and we’re pretty optimistic about that because the termination periods of the two Affinity cards at each of Northwest and Delta are pretty well aligned. So we’re actually pretty excited about that opportunity.

Jamie Baker – J. P. Morgan

Based on the capacity cuts that you and others have announced so far and based on your view for 2009 do you think the model is working again at $4 jet fuel that you can be profitable next year, has enough capacity come out?

Richard Anderson

I think we’re still in the planning process for 2009 and I think probably what we’d look at doing is in the 3Q call is try to give you a bit more of an update but I think we need to see where the final schedule takes come in in the fall. There’s still, while there have been a number of announcements we still need to see what the final schedules are and I think we’ve got a bit more work to do on our business plan looking out at 2009. I think the model has got to—the whole industry model has got to evolve much more quickly in that kind of a fuel environment and you’ve got to really be thinking through about—you’ve got to really be thinking through what does the network look like? What size aircraft work at what demand levels?

When you think about the amount of leisure traffic, there’s been a lot of capacity built in the United States over the past decade to carry pretty much low end traffic, unlike the Europeans by the way. You think about the European model, the European model is a model that doesn’t have as much sort of excess capacity to carry the lower end traffic and it’s probably the lower end traffic that is not going to want to purchase at the market clearing price that covers the cost of fuel. We’re spending a lot of time rethinking what that model, what the industry model looks like and how you make it work at those levels but a lot of its going to depend upon what the total industry reaction is to these fuel price levels and how that reaction is demonstrated in the capacity changes that are made over the next two quarters.

Operator

Your next question comes from the line of Gary Chase – Lehman Brothers

Gary Chase – Lehman Brothers

You mentioned in the prepared commentary you’re planning to remove 100 regional jets, or affectively remove the equivalent of 100 regional jets by the end of the year is that foreshadowing additional capacity reductions off the mainline, away from the mainline during 2009 or should we consider that pretty consistent with what you talked about in terms of your capacity plan for the fourth quarter and the run rate of that?

Edward Bastian

I think it’s consistent with what we’re looking at for the fourth quarter but certainly you can’t [force] the mainline and the regional portfolios from themselves. When you look at this fuel environment there’s no question the most inefficient and least productive aircraft that we operate are the smaller gauged regional jets and that’s why we’re moving as aggressively as we are to reduce that—we’ve announced some deals here very recently and we’re going to probably have some additional announcements coming over the next few months. I’d expect there to be some potential for some additional mainline reductions going into next year.

Richard Anderson

It’s hard to breakout what portion of the 100 but its really a bit additive if you will. In other words there’s some of that 100 that’s in the domestic pull-down and I don’t have the exact breakout but there’s some of it that’s on top of that because we’re just looking at what 50-seat airplanes look like on some of the longer stage lengths and it just doesn’t make sense on the longer stage lengths for sure. Some of those will be additive and as we finish our capacity planning for the fourth quarter and the first quarter you should expect us to continue to trim on the regional jet fleet.

Gary Chase – Lehman Brothers

If I could ask you to tighten up a little bit, I think the stuff that you’ve disclosed about how the synergies are going to look for next year is important because you’re talking about realizing more operational synergy then you are cash integration costs and in an environment like this where liquidity is at a premium as you’ve acknowledged, that’s really important. Can we talk about the $500 million that you’re expecting to generate in 2009 and just give us a sense of what that is that’s hitting and what you’re confidence level is in that $500 million and the speed with which that will spool versus the $2 billion you expect to get to over time?

Edward Bastian

The bulk of the early savings or the synergy benefits if you recall are going to come initially from the coupling of the networks together. So being able to fully flow the fleet back and forth between the two networks that’s one of the rationale why we wanted to get the unified pilot deal done prior to closing as well as with the integrated seniority list prior to closing so that you’ll see the network synergies are probably the bulk of that $500 million in the first year. Network synergies includes not just S curve and presence but benefits also coming from our frequent flyer program, benefits coming potentially from the Affinity card program as well.

Many of the cost synergies will take a little bit longer to get at because some of those are technology oriented and they also will require us to continue to work with the various labor groups at Delta as well as Northwest and there will be some cost dis-synergies attached to those in the first year. I think you can think about the first year as largely being a revenue play and then by the second year we’re starting to ramp up the cost synergies and the network synergies are taking firmer shape.

Gary Chase – Lehman Brothers

You mentioned, I think you said a $3.2 billion liquidity target by the end of the year and you noted you expect to close the merger before the year end and there might be some liquidity opportunities that follow that, does the $3.2 billion contemplate any additional financing or is that just sort of where you expect to end prior to additional financing options you may pursue?

Edward Bastian

The $3.2 billion is a Delta stand-alone estimate and it has no benefit from any financing or cash raising opportunities that we’re exploring.

Richard Anderson

We would expect on the timeline that we have that between Delta and Northwest there will be fairly significant cash raising done prior to the close but the lion share will come after the close but we’re pretty comfortable with where we are on the liquidity position because we already have contemplated a couple of actions that one of which is the Affinity card we alluded to earlier—a couple of actions that can substantially increase the combined free liquidity of the merged entity.

Operator

Your next question comes from the line of Ray Neidl – Calyon Securities

Ray Neidl – Calyon Securities

With the grounding of 100 regional aircraft I was just wondering if you could go into a little bit more detail on what you think your regional needs will be going forward both as Delta stand-alone and then after the merger, will there be more cutbacks and will you take [inaudible] from Northwest and use your own pilots to fly a lot of the regionals?

Edward Bastian

One of the benefits that we factored into the update synergy analysis is the fact that we’ll be fairly large scale customer if you will of the regional jets, in fact I think we’re going to have roughly 40% of the smaller gauge regional jets under Delta code between us and Northwest by—at the time we close this deal. We do expect there’s going to be rationalization of the portfolio. We do expect that the 100 aircraft reduction that you see, there will be additions to that, not in terms of reductions not additional aircraft, but additional reductions and I think more importantly I think it gives us a chance to sit down with our contract partners across both networks on the regional jet front and talk about how we can do business more effectively together and more efficiently together because there’s a lot of redundancy and a lot of cost to operating as many contracts as both we and Northwest do. We’ll have a nice blend of owned carriers as well as contract carriers and I think there’s going to be a substantial value that we can create over the next couple of years there.

Richard Anderson

The interesting thing on the owned side when you take Comair, Mesaba, and Compass even they will still continue to be operated as separate carriers; there are very significant overhead and fleet commonality opportunities that can come from operating those sort of more collectively. They’d each maintained their separate carrier status but at the same time there are many overhead and SG&A opportunities that can be rationalized because that’s in and of itself a very large airline, those three airlines combined in terms of their fleets.

Ray Neidl – Calyon Securities

Being that Delta is one of the leaders in writing a letter to congress for an investigation on the futures markets and oil, would you like to go into a little bit more detail on why you think that market may be manipulated and more importantly what you think the positive aspects of an investigation will do in possibly lowering oil prices?

Richard Anderson

When you think about what’s happened in the money markets generally, the bond market, the stock market, the mortgage lending market, pretty much all the other places for money to go the last two years have not been very good. And when you look at where the large investment banks are making a lot of their money these days, it’s in the commodities market. And if you look over the last three or four years all investment advisors to endowments and pension and trusts, have now moved into the new category class of “commodities.” So since 2004 you’ve had about $350 billion move into the futures market and when you look at just the pure paper trading on a daily basis versus what the actual consumption is, it’s significantly higher.

And these are very unregulated markets and while the lobby on the other side of this is incredibly powerful, the Nimex and the Chicago Mercantile Exchange, and Goldman Sachs and firms like that, make an enormous amount of money in churning these futures markets. And I think there’s a fundamental public policy that with respect to food and fuel are you going to have that kind of speculation in the market that drives price.

When you have price of a barrel of oil go up $10, $11 as we had it happen one day earlier this summer, when an investment bank issues a report saying oil is going to $150 or $200 and then immediately everybody rolls their futures, there’s something more going on in the market in a relatively unregulated market, there’s more going on there then just hooking supply to demand. We think that—just like yesterday the SEC reacted very quickly to speculation in the stock market. We haven’t seen that kind of reaction in the commodities market and because all of these other markets are doing so poorly and PEs are down so low, all the money is flooding in to the long commodity markets.

So you’re seeing it in wheat, in corn, in oil, and ultimately there have to be some public policy decisions made about whether or not that’s the right public policy.

Ray Neidl – Calyon Securities

And would you be in favor of more transparent SEC investigations of the short player and stocks?

Richard Anderson

I think the work that the SEC is doing right now is the right work. I think that from a policy standpoint what they’re trying to do is make the markets work and when markets don’t work because of aberrant sort of behavior like this, it’s not good for anybody.

Operator

Your next question comes from the line of William Green – Morgan Stanley

William Green – Morgan Stanley

Can we just come back to the synergies here and can I ask you—do you have an impact from Continental leaving SkyTeam and do you have any assumptions of more mergers coming down later on and is the SkyTeam ATI incremental to the synergy or is it within the synergy?

Edward Bastian

Yes when we did the deal we fully were aware that there was a high risk that Continental would be leaving SkyTeam so we factored that into our thinking. I would tell you it’s not a big number in our view.

William Green – Morgan Stanley

I thought Northwest had said it was somewhere around $125 to $200 somewhere around that from the joint venture that they have?

Edward Bastian

There’s clearly some value on the Northwest side, but at the end of the day it’s probably as it relates to SkyTeam in and of itself it’s not a big--

Richard Anderson

It’s not much at all. Over time with yield management mapping and steps that had been taken over time between the two carriers it’s not a very material amount of money.

William Green – Morgan Stanley

In your synergies do you assume there are more mergers or no this is it?

Edward Bastian

Our synergies again, the focus was putting our two networks together against the economic backdrop that we can see today. When we did this work, are we assuming there’s going to be a follow-on deal? You tell me, I think at some point we certainly thought there was going to be; now it appears there may not be for a little bit of time. I’m not certain that it’s shaded plus or minus as the industry consolidates. We do believe long-term there probably will be some additional consolidation but its certainly not going to be in the near-term.

William Green – Morgan Stanley

Is the SkyTeam ATI benefit in the synergy number or no?

Edward Bastian

Yes.

Richard Anderson

Its understated, its in the synergy benefit but I would say that overall we haven’t really leveraged the full impact of what having 30% of the market in an immunized joint venture with KLM, Air France, Northwest and Delta is long-term really going to be able to create because if you look at the margins that Northwest has across the transatlantic they are among the highest margin in any airline business anywhere in the world. When you think about being able to leverage that across a network that’s three times as big it has significant opportunities.

William Green – Morgan Stanley

If I turn to the cost segment how much did the cost synergy change as a result of the pilot deal?

Edward Bastian

The cost synergy number didn’t change in aggregate much, the timing moved a little bit up so we have the cost synergies kicking in on the Northwest side day one whereas when we announced the deal in April we didn’t have a deal so that was viewed as it was going to be a slower ramp. That said also the revenue benefits have kicked in day one on a much enhanced basis so there’s substantial accretion given to the fact that we actually have this deal done.

William Green – Morgan Stanley

If you look at the capacity cuts that you’ve got planned for the fourth quarter how much above that sort of absolute value of that capacity cut should we expect RASM to go up, how much yield managing can you really do above and beyond the cut?

Glen Hauenstein

Well I think that’s the $64,000 question isn’t it. Unprecedented industry capacity reductions, will that translate, what will the actual economic backdrop be? What will be able to be translated into unit revenue increases? And while we’re cautiously optimistic we don’t know if that’s enough yet, if that’s enough capacity from the industry and to add to Richard’s comment earlier, more industry capacity has to come out. The question is where does it have to come from? Does it have to come from those carriers that don’t have business plans that are languishing in bankruptcy court or does it have to come from the legacy carriers?

And I guess the markets will determine that too. So there’s a lot out on the plate waiting to see how this evolves into the fall and our commitment to our shareholders and to our employees is to stay ahead and I think we’ve done a good job to date staying ahead and we plan on continuing to stay ahead as these trends develop. But we don’t have great visibility into October, November for revenue yet and that’s when a lot of the capacity actually hits so cautiously optimistic, would hope that—it needs to be double-digit numbers to cover fuel. Right and so we’re hoping we get there and we’re hoping that the industry environment stays in a rational pricing and that demand holds out.

Operator

Your next question comes from the line of Kevin Crissey - UBS

Kevin Crissey – UBS

Can you talk about the merger review process outside of the US and the status in the EU?

Edward Bastian

That process is moving on quite well. I know there was a recent announcement about a suspension of the review, that’s apparently—my understanding is that’s a fairly small detail that needs to be wrinkled out. We do not expect there to be any delay as a result of that EU review process and our ability to close the deal by the end of this year.

Kevin Crissey – UBS

Could you talk about—AirTrans according to the stock market and on our numbers AirTrans in significant trouble; can you talk about your approach to AirTran markets and capacity cuts as it relates to those markets?

Glen Hauenstein

There are no capacity cuts in AirTran markets, as a matter of fact, despite the fact that we are down in general capacity by about 13% to 14% in the fall domestically, we are actually up in AirTran competitive markets into and out of Atlanta. Some of the point to point flying we have taken reductions in. But into and out of Atlanta of course Atlanta being our core strength market we are continuing to leave that capacity in.

Kevin Crissey – UBS

In terms of the first bag fee, I think Northwest has it and you don’t, where is that heading?

Edward Bastian

We will study it, we will continue to study it but we have no plans to implement it at this point.

Operator

Your final question comes from the line of Chris Cuomo – Goldman Sachs

Chris Cuomo – Goldman Sachs

If you could perhaps just dig a little bit deeper into the pricing activity that you’re seeing in the here and now sort of in the domestic markets as opposed to what you expect looking forward, with respect to competitor action, your own action, you are cutting domestic capacity reasonably significantly, but only generating modest yield gains in Q2, could you just comment on what’s driving that? Why is that the case?

Glen Hauenstein

I think there are a couple of issues that are going on and we’re studying each one of these individually because there have been unprecedented moves in pricing by the legacy carriers in the non-LCC competitive markets and there are a lot of satellite airports and we’re seeing changes in traffic patterns which we’re having to react to by either going back on some of the pricing increases in the fuel surcharges to move the traffic back into the appropriate airports or we’re cutting capacity. So we are in a transition process here. The whole industry is. I think what you’ve seen, and we’ve given our increase in length of haul is that our capacity cuts have put us at the upper end of the range of where the industry is at as far as unit revenues go and we think there’s a lot more opportunity as we fine tune this. We’ve never as an industry seen pricing move as quickly as we have.

Of course in response to the run up in fuel and that creates an entirely different demand set and now we have to go back and analyze individual markets, every individual market. Was that the right move? Is there more upward mobility in pricing? Do we have to move back on some markets or should we take capacity out? And that’s the process we are in right now and that’s I think why we’re not doing more capacity cuts right now. We’re waiting to see essentially where this equilibrium goes and how when we fine tune it what more we can get out and as the industry starts to come to the party in the fall, what the implication of that is. But there are carriers out there pricing for cash.

And that’s really continuing to put a big dampening on the impact so while I’m optimistic that Delta will be in a great relative position I’m also wondering, maybe you can help me answer this is, we hear there’s a global demand for narrow body equipment yet carriers that are in bankruptcy today, those planes are not leaving and so what is the global demand environment and is it softer then we think?

Edward Bastian

One further point, remember also that a significant amount of our capacity reductions really kick in at the end of the summer season so you haven’t seen the yield effects yet of the large scale domestic pull-down. It will be kicking in in the August, September timeframe.

Chris Cuomo – Goldman Sachs

How about just quickly on the other revenue line, obviously you and may other carriers have instituted a number of additional fees and charges, have you put a target out there or sort of all in bucket that you’re seeking to achieve and broadly speaking how are you tracking with respect to your initial goals?

Edward Bastian

We are tracking on to [plus] on the initial goals. We’re seeing on the other revenue line about a 25% to 30% growth rate all in when you factor in not just the fees and the additional charges from decoupling the pricing environment and actually charges for services rendered, but also look at what we have on our SkyMiles program, when you look at what we’re doing in cargo, when you look at what we’re doing in our third party MRO business, we’re expecting non-passenger revenues for Delta this year, full year, to end the year at about $2.8 billion; a substantial business and that’s growing at a 25% growth rate and we continue to see that growth into next year as well. It’s a big part of our strategy with respect to how the business model is changing and the type of revenue we’re needing to generate to cover this higher fuel cost.

Chris Cuomo – Goldman Sachs

The real important question, what’s your second half crude oil assumption, what are you going with, the forward curve?

Edward Bastian

We use the forward curve on our guidance; I think we gave guidance on fuel for the third quarter roughly in the 135 range crude assumption is the assumption.

Operator

That concludes the question-and-answer session for today’s conference call. Thank you very much for your participation.

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Source: Delta Air Lines, Inc. F2Q08 (Qtr End 06/30/08) Earnings Call Transcript
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