Delta Air Lines' Management Presents at Deutsche Bank Global Industrials and Basic Materials Conference (Transcript)

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Delta Air Lines Inc. (NYSE:DAL) Deutsche Bank Global Industrials and Basic Materials Conference Transcript June 4, 2014 2:40 PM ET


Paul Jacobson - Executive Vice President and CFO

Gary Chase - Senior Vice President, Financial Planning and Analysis and IR

Jill Greer - Managing Director-Investor Relations

Doug Ralph - MEC Government Affairs Committee


Mike Linenberg - Deutsche Bank

Mike Linenberg - Deutsche Bank

Okay. If you guys -- everyone can just come in and take a seat. Okay. Great. I’m pleased to introduce Paul Jacobson, Executive Vice President and CFO of Delta Air Lines. Paul started as a financial analyst at Delta in 1997 and over the years took on roles of increasing responsibility before being named Treasurer in 2005.

In March 2012 he became Chief Financial Officer. Now, Paul, has been a key contributor to Delta’s financial strategies over the years and some of his more high profile initiatives include the company's capital allocation strategy first announced in May 2013 and recently augmented about a month ago, the purchase of the Trainer refinery from ConocoPhillips and the balance sheet initiatives to reduce debt by more than $7 billion among other things.

And so, now, to give us his latest thoughts on Delta, Paul Jacobson.

Paul Jacobson

Thanks Mike. Good afternoon, everybody. And it’s pleasure to be here and we’d be representing a number of airlines here at this conference, which five years ago we were beating, Mike, on the door, trying to say, please let us in to your industrial conference. But now here we are and things are going quite well. So thanks to Jeff for delivering the keynote address at lunch, sorry to miss it, but it’s glad to see industry representation at these conferences.

With me today, I have got Gary Chase and Jill Greer from our Finance Department and Investor Relations Department, as well as Doug Ralph, who is our partner with [Delta] (ph) that attend these events to help deliver some of the pilot perspective that we have.

So, glad that they are here. We have had a great day explaining some of the story of Delta, which might be new to some of you guys, but we couldn’t be proud of what’s happening right now among the team as a whole.

Turning to the presentation, regulatory Safe Harbor statement, we will talk about some forward-looking statements in here, any questions that you might have you can refer to our SEC filed statements going forward.

But the story for Delta is really one that that has gained a lot of traction, a lot of theme over the last five years in particular as we came out of the integration with the Northwest merger.

We continue to see improving financial metrics as we've been derisking the business and driving incremental profitability out of the business. And while 2013 was by all accounts a record year which is actually exceeded by far the best year combined that you could have ever put forward for Delta on regardless of year, on the best quarters.

We are really trying to sustain that momentum going forward. We have got a solid start to 2014 with our first quarter performance, as well as our second quarter guidance both in terms of margin expansion and free cash flow generation. But really the story and the focus for Delta for the management team today is creating that sustainability going forward.

The business model is clearly different than it was historically for the airline industry as a result of consolidation, but its one that result in more stability and more sort of regular systematic investment in the infrastructure, which ultimately leads to better customer satisfaction, better operational performance and better financial profitability for our shareholders as well.

In other words, everything that real business is tend to have that airline over the history have lack with their cyclicality overtime. And we have done a lot of, taken a lot of steps over the last several years setting the foundation to sustain this type of performance over the long-term.

And most recently, as Mike mentioned, with our capital deployment plans that really began in 2009 with the delevering project that we started has now branched into direct shareholder returns through the payment of a dividend, which was candidly the first real dividend that the industry had paid of any significance declared last year and increased a month ago. But also some pretty sizable share buyback which we will get into the details on that over the coming presentation.

Clearly, we have been outpacing the airline industry as a whole, I think for a couple of reasons. Number one, we were first to go from the standpoint of creating as truly U.S. global airline and we've enjoyed a lot of benefit from the head start that we've achieved through that.

But, clearly, there is also a lot of things going on that are different at Delta than what we've seen in the industry in terms of the implementation of the integration, as well as the post-integration work that we've done from the standpoint of the technology and product investments that are delivering across the system on the strength and the capabilities of the 80,000 Delta people worldwide driving operational outperformance at record levels.

We've never seen Delta in its history and certainly, no airline of this size delivering the type of completion factor on time performance, baggage handling and customer satisfaction scores that has ever been seen in the industry.

And that's a testament to the people of Delta and a strong testament to this financial outperformance that you see. Because at the end of the day when you see the consolidated airline industry, the -- among the global carriers, the networks that all going to be relatively equal, are going to be pockets of relative strength and weakness, but way that differentiate your product is through the operational performance and customer service that the Delta people is provided and that’s contributed greatly to we believe our outperformance and think it’s sustainable going forward.

We started off this year with a record first quarter, if you look back a year ago we completed in the March quarter of ’13. Our first profitable March quarter in over 10 years, which was a big goal of the airline, but it was really a sign of things to come because as we went through 2013 and culminating as we lap that in the first quarter of 2014, we’ve seen a serial margin expansion that is really, really given outperformance and free cash flow and cash from operations with 400 basis points of pre-tax margin expansion in the first quarter alone and looking to do 400 basis points of margin expansion in the second quarter as well.

The free cash flow which helped to contribute to the consistent debt reduction which you have seen overtime, as well as returning cash to shareholders and we will talk about that in a few slides.

So as you look at that performance, the question is what does that means for the second quarter? So this is our updated guidance in some respects for the second quarter of 2014. But we do expect a record June quarter with about 10% topline revenue growth, 400 basis points of margin expansion and nearly $1.5 billion of free cash flow over that time period.

That free cash flow is by far an impressive number. It used to be an impressive number for a year and now we’re doing this in the June quarter specifically and that represents a little bit of an increase in our guidance -- our prior guidance of $1.25 billion.

Our operating margins still fall in that range of 14% to 16% for the quarter. Although, we've been able to tighten down our guidance a little bit and improvement on both fuel price and non-fuel CASM.

Fuel price is down about $0.04 at the range is from the original guidance that we had previously and CASM is nearly in zero to 1 versus our prior guidance of zero to 2. This is strong performance for us and we’re looking forward to a solid June quarter.

All of that is driven by the revenue outperformance that we have experienced and you look back to 2009, 2010 timeframe as this evolution has began, we've moved from having an industry revenue discount -- discount to the industry in terms of our unit revenues to a 7 point premium.

This roughly translates to 7.7 percentage of extra revenue on every seat in throughout the system on a unit revenue basis, driven primarily by those initiatives that we talked about earlier with the operational performance, which has led the gains in our corporate travel market, which is even the companies that come to us to try to sign contracts for large-scale corporate travel relationships and we continue to see solid outperformance in that area.

The investments that we've been making in New York and Seattle, as well as the investments across the alliance base would be the long time relationship with Air France-KLM, as well as relatively new relationship with Virgin Atlantic, which last year we purchased 49% stake in that entity and became the first real viable meaningful competitor to AAB Alliance on the U.S. to Heathrow route with the portfolio that again with that.

As well as the number merchandising initiatives and ancillary revenue is a key part of the equation for everybody in terms of trying to uncrack or try to crack the code if you will of how do you transfer revenue strength into an enhanced customer experience by segmenting passengers according to what their needs and what their desires are in every piece of travel and balancing that against the operational complexity of implementing that across every dimension.

So the airlines are going to be successful going forward is really the ones that can -- are able to really differentiate the passenger experience based upon desires and make sure you are maximizing the revenue opportunities of every passenger the boards in airplane.

The other piece of our story that is contributed to our margin expansion is our cost performance and as finance executive and with Gary in the room as well, all credit to the finance side, as well as the operators within the business for really embracing this goal and candidly exceeding ever opportunity that we found.

The cost story at Delta going back to 2011, 2012 really stems from the product that we put in place in the summer of 2010, fresh out of the merger. We struggled with operational performance. We struggled with reliability. We struggled with bags. So, candidly, when you look at the weighted probability, roughly better than a coin flip that you are going to have something go wrong during that process to do with the bag delay or miss a connection.

We knew that wasn't acceptable and we focused on investing in that. And as a result over the subsequent couple of years, our unit cost grew at a rate that was about double the rate of the industry as a whole. And many claim whether or not Delta was going to be able to maintain its unit cost advantage that it is historically known.

What we were able to do going back to 2012 was really embrace through, at the beginning a $1 billion structural cost initiative to really bend that cost curve and flatten out that unit cost growth without sacrificing the product gains and the operational gains that we had made over the prior couple of years.

So what we've done since then has really been nothing short of remarkable in terms of really flattening out our unit cost, such that our long-standing goal right now, as we've articulated on various Investor Days is to grow the airline at slightly less than the rate of GDP and keep our cost below the rate of inflation on a unit basis. It's a strong way to leverage the operational power of the business and put us on a trajectory to continue to expand margins.

The way we are able to do that is through a number of initiatives throughout the business. But formally through, we are disciplined in the planning process. So when we plan the airline, we are not planning based on where the forward curve is where you see oil prices a year out $2, $3 cheaper than what the current prices are. We actually project and forecast the business at a much higher rate of fuel because it's easier for us to adapt to the business to a lower fuel price environment than to build the business based on a fuel assumption that may not come to fruition.

Because once those costs go into the business, it's difficult to take them back out and what that does is it leads to a lot of operational leverage being able to squeeze a little bit of extra capacity on the existing fixed cost infrastructure. So maintaining discipline around headcount, maintaining discipline around facility, supply chain, et cetera.

And then combining that with a number of operational initiatives through the business and anybody who’s studied this business for a long time and I've been in it since 1997. Several people in the room have been in it longer than that. You'll know that the history of this business has been one where everything that touched the airline made healthy consistent, stable returns.

And it was the airline that was left to capture whatever was left. Sometimes those times were good and there was a lot less. Sometimes those times were bad and the airline lost a lot of money, while at the same time manufacturers, parts suppliers, government, labor, a lot of folks made that money and got those stable returns anyway over time.

So what we needed to do is make sure that we are able to leverage our scale and relationship with some of those suppliers and vendors across the system. And one of those examples that we talk about is the part of initiative where we disclose on our call that we will actually buy an airplane that is headed for the desert to run out and harvest it for its spare parts value.

This industry is popped up decades ago. And you know, they made healthy margins and sizeable returns on that, where we can buy an airplane fairly cheaply. And because of the complexity and scale of our fleet, consume every usable power within a period of about 18 months and get a very quick cash-on-cash return for that.

That’s part of the way that we can lead into very significant maintenance efficiency to leading the industry on a maintenance unit cost basis, while still having an older fleet and a lower capital investment in our fleet going forward. It helps us drive additional return on invested capital outperformance.

Combining that with the productivity and probably the single biggest initiative we have on the cash front, on the CASM front is the 50-seat reduction or the upgauging in the airline. And if you look at all the stats and all the performance and numbers that we quoted in the first quarter, the one that stands out to me the most, to be the most significant driver of value in Delta is the fact that we were in the first quarter able to maintain flat capacity on 5% fewer departures.

That's an operational leverage to drive significant cost efficiencies out of the business by being able to drive the same level of product, if you will or capacity on a much lower capital investment that’s sized for significant capital ROIC outperformance, as well as a significant source of our unit cost discipline that we've got going forward. So we are still in the relative early innings of that.

We began that process with deliveries in the second half of last year of our 76-seaters and 717s that we are acquiring from southwest. But we are still in the early stages of that. We don't expect to be at a run rate benefit of optimal 50-seaters in the system until the end of 2015. So this is going to be a sizeable benefit for us and help lend to the confidence that we have in our ability to hit these types of cost goals for the foreseeable future and contribute to additional margin expansion going forward.

But really everything that we've been doing in this process has been about reducing risk across the business. I know there are a number of you in the room and perhaps some of you listening on the webcast as well. We talk to people everyday. Let us say, they would -- thought they would never talk to an airline again after the history of this business. And many are going to come back into the stock. We’ve talked to a lot of them and they are very impressed with what's going on, not only at delta but within the industry dynamic as well.

But there is still some uncertainty out there. A lot of the questions that we get around, tell me why it’s different, tell me what you're doing to take the risk out of the equation. And what this slide demonstrates is a number of the inflection point that we talked about that is really tried to emphasize the de-risking of the business, so that we don’t experience the type of P&L volatility that we have in years past, where one year we might have record profits and two years later, we might have record losses. We’ve got to contribute to the stability, and these are a number of ways that we are doing that.

We would be creation of a global carrier. We’ve really diversified globally the footprint, both with the network, but also the sources of revenue that we have in terms of a non-ticketed revenues or the ancillary businesses, whether it’d be Cargo, the Maintenance, Repair and Overhaul business, Delta Private Jets, Vacations, etcetera. Nearly 20% of our total revenues come from ancillary sources beyond just ticket prices that you see going forward.

And then when you combine that with the immunized joint ventures which effectively become very similar to mergers in terms of how we can cooperate without any trust community on capacity, you get to a much more disciplined global framework similar to the some of the consolidation that you’ve seen in the U.S. which has really, really helped to derisk some of that revenue volatility that we’ve seen over time and better able to position the airline to respond to demand shots like we saw in 2009, 2001 etcetera.

Labor risk, we have a very, very strong partnership with all of our employee groups and we believe it would be a key to this is the fact that we pay our profit sharing to the program -- to our employees. So every non-management employee participates in a profit sharing pool, where they directly participate in every incremental dollar of profitability across the system. That’s aligning our employees interest with shareholder value and shareholder creation as well and keeps them motivated along that frontline, and plus the profit sharing creates some variability in terms of the overall salary component.

So you are able to flex wages a little bit in the aggregate with profit sharing in the event that we see a downturn and that flexibility gives us a little bit more of a cushion versus what we’ve seen in historical models going forward. But probably the biggest area of where we change the business has been around financial risk. So ultimately, what we are able to do through our fleet strategy is we are able to drive a similar level of industry capacity on a much, much lower capital base because of our fleet strategy.

By purchasing previously owned airplanes, we are able to significantly lower the capital base and the cost base to deliver the capacity that we need to which gives us the opportunity to flex capacity should we needed. So if we see a demand shock like we saw in 2009, the capacity that can be put down comes at a much lower expense ratio than it otherwise would if we’re re-fleeting the airline with brand new airplanes left and right and having to pay those lease expenses or those ownership costs associated with it.

We’ve also significantly reduced fuel risk since 2009 through the investment, through the Trainer refinery, as well as the investment that we made in our hedging activities. We have really emerged as an industry leader in terms of fuel price. In the first quarter, we beat the industry average by about $0.10 a gallon. We expect based on current public guidance that we will pose similar results in 2Q as well, and that’s important because every $0.01 a gallon for Delta is $40 million a year. So if we’re able to outperform by $0.10 a gallon, that’s about $400 million a year of extra margin outperformance than you would otherwise expect from Delta and that comes from our investment in the infrastructure, predominantly through the Trainer refinery.

The Trainer has been a challenging story through the first year of operation. While we didn’t derive the benefits specifically out of the Trainer profitability, we did see a noticeable impact in the price of jet fuel relative to the other products and the barrel partly because of the extra supply that we put into the marketplace. Through the changes we put into the refinery in the first quarter of this year, we are now producing over 40,000 barrels a day of jet fuel, which puts us in about 50% of the total PADD I or northeastern production among all the northeastern refineries.

We are now producing half of that jet fuel and we believe that over the coming years we can increase that number even more. That puts significant pricing pressure on the margins per jet fuel, which is good for the airline. Every day that we fly we are short 260,000 barrels of jet fuel across the system globally, that’s where we get to a $0.01 a gallon is worth about $40 million a year.

So the improvement that we’ve seen in the jet price market has been a meaningful contributor to the overall outperformance for Delta, but we are not done yet. In the second quarter, we expect to produce a small profit at the Trainer refinery, which will represent about a $50 million year-over-year turnaround, primarily driven by the increase in domestic crude supply through the refinery. This has been a big initiative for us for 2014 and is what makes one of the things that make Delta unique. No other airline in the world is poised to take advantage of the domestic crude oil boom like Delta because of our ownership of the Trainer refinery.

We projected in 2014 we will get to about 70,000 barrels a day on average of domestic crude, which will be approximately 40% of the total crude died in the refinery. And by reducing our dependence on West African crude, we will able to lower the expense by about $2 to $3 a barrel for every barrel that run through that refinery as a whole, and that can contribute to potentially up to a $150 million of savings over 2013, as we progress this and ramp this up over time to produce a consistent stable profit within the refinery and give Delta an extra edge on fuel.

Probably the piece that I am most proud of from the Delta, the Delta team is the unity around the strong balance sheet. This is something that high quality industrial transportation companies have and something that the airline industry has historically lacked, particularly among the network carriers. But if you look at the power of the P&L advantage or the strong balance sheet, let’s take 2009 as an example. We used that for the recession on the prior discussion.

In 2009, Delta lost $1.1 billion in that year where unit revenues were down 20%, capacity was down 10%, but that year we had $1.3 billion of interest expense and over $17 billion of net adjusted debt when you take into account leases. The goal that we articulated last month as part of our capital deployment strategy will have that number go down to $5 billion and the run rate on interest expense to about $350 million a year, which puts us in a level where it would be comparable to other high quality investment grade type companies.

Now I don’t know whether we will get an investment grade rating or not, but we don’t care about that. We care about a balance sheet that has the metrics there comparable to the companies that many of you at an industrial conference are used to see in terms of balance sheet stability.

But additionally that billion dollars of less interest expense on a run rate basis puts us in a position where we’re going to be much more able to weather the storm should they come again as well as proactively addressing our pension obligations through additional contributions. This gave us the ability last month to update our five-year plan targets.

So the column on the left that you see were the operating margin, EPS growth, ROIC and other measures represented what we outlined at Investor Day last year. And through the performance that we’ve seen and what we've been able to do in terms of the confidence in our five-year plan, we've been able to raise those goals such that we’re now shooting for an operating margin 11% to 14%, EPS growth of 10% to 15%, that's consistent with what we see out of high quality industrial companies, and ROIC is 15% to 18% return on invested capital.

That bar continues to go up and is a real driver of lot of the value that we've seen. $6 billion of operating cash flow and $3 billion of free cash flow, which even in the $35 billion market capital we are today represents approximately 9% free cash flow yield which would be among the highest -- really all high-quality industrial company in terms of our ability to generate free cash.

But we got to demonstrate that we can do that consistently. So we’re going to continue to de-lever and focus on getting the $5 billion of adjusted net debt and getting our pension plan, which is a hard frozen plan to an 80% funded status by 2020. Why we do that is we continue our momentum through revenue growth, capacity discipline, driving the continued cost efficiencies and ultimately through conservative CapEx yielding stronger free cash flow over time.

And this is probably one of my favorite charts as the finance person marketing might disagree because they are like charts that are passenger related. But when it comes to finance, we think about cash flow and free cash flow. And this shows you a strong demonstration of what's different about this industry today especially among Delta versus where we were last time we were generating cash flow at this level.

In the late 90s, we're generating approximately $4 billion of free cash flow. But our overinvestment in aircraft and other assets at that time actually led to an increase in leverage at the time when the industry was making the most amount of money that they have ever made before. What's changed is the level of capacity discipline through our strategies. And our capital strategies have driven significant free cash flow even as our cash from operations [is solid] (ph) over last couple of years as result of our initiatives.

We've been able to keep that capital discipline down and driving that free cash flow performance. That’s driven the net adjusted debt down. We finished 2013 under our $10 billion net adjusted debt goal. And we believe it will be a $5 billion by the end of 2016. And that will get us to that run rate benefit of about $350 million on interest expense total.

The pension obligations we've been funding at about $1 billion a year over the last couple of years that we've outlined in our last capital deployment in May of ‘13. By continuing that trajectory, making slightly more than the minimum required contributions of about $1 billion a year, even with no change in interest rates, we believe we can get to an 80% funded status by 2020 with no change in interest rates.

That gives us both the flexibility to significantly reduce our pension expense which hovers at around $275 million a year right now but also gives us the flexibility to address it through annuitization buyout, et cetera depending on the interest rate environment that we might be in and for hard frozen plan that really is just administrative piece today because nobody is earning any new benefits under this plan and haven't been since 2006.

We want to get to a point where we can really just immunize this and let it runoff from that perspective. So it’s not a source of volatility for us in the P&L. And this funding strategy will get us there by the end of the decade. And of course, we announced in May that that we’re augmenting our capital return. We’re announcing today that last week we did complete the initial $500 million authorization more than two years ahead of schedule from when we originally announced that program back in May of 2013.

Through that program, we were able to retire approximately 18 million shares and contribute greatly to our EPS accretion going forward. And we expect more of the same with the new authorization. So we increased our dividend by 50% year-over-year beginning in the second half of this year. We’ll now pay $0.09 a share, which will represent approximately $300 million a year of cash flow through dividends and then $2 billion repurchase authorization through 2016.

That gives us the flexibility and we demonstrated the willingness to be able to accelerate those plans with the completion of the $500 million program in a year that if we exceed our cash flow projections in our operations, we have the ability to increase the velocity of that buyback and complete that ahead of schedule. But this plan will put us on track to return almost $3 billion to shareholders by the end of 2016.

And ultimately we think that leads to a path of improved valuation. I have been counseled that standing up here and complaining about valuation is not the way to get a higher valuation and I agree with that. And as somebody who has been in this industry for almost 20 years, I can tell you that history doesn’t deserve that type of valuation.

But it is what we have our sights on. And when you look at our ROIC metrics and the goal that we've outlined, in addition, to the current performance that we have in the amount of free cash flow that the airline is spinning off, it's really a strong testament to what we've created and the ability to really transform that. And as we drive towards more sustainability and consistent performance along the lines of this industrial transport comparatives that we would expect it over time to see our multiples run.

So in closing, we feel confident that this is sustainable. We feel like we've got still more room to go on our cost efficiency, as well as our revenue initiative than what we're doing and look forward to continued margin expansion over time.

With that, I'll conclude my comments and open it up to some questions. I want to thank you for your attention and for those listening in on the webcast, I appreciate your interest in Delta. Thank you.

Question-and-Answer Session

Mike Linenberg - Deutsche Bank

Paul, let me kick it up with the first question. We’ll go out to the audience. Thank you very much. Very comprehensive, that was great. When you look at your June quarter, you’ve indicated that it’s going to be record profit. You look at the margins 14%, 16% of the range. I mean, we’re almost that record margin as well. You have to go back to late 1990s, I mean, Delta did hit 15%, 16% maybe even 17% type operating margins that you’re able to do with fuel at $0.60 a gallon. But that’s answering part of the question.

The response that we do get from investors is it looks like the stocks up several 100% over the last three years, margins on your peak margins. How could we be investing in the stock, given the fact that we are at peak margin, how much better can it get. And I think that you sort of started to answer it. The macro context was significantly far more favorable back in the late 1990s and now. And so are we seeing here a step function improvement in just longer term profitability of this industry. I mean that’s really what manifests in itself here.

Paul Jacobson

Well, certainly I think Mike, its great question, a great observation based on the historical context to the industry, which like I said in my prepared remarks, you can't discount that. We have to own the history of this industry, if we’re going to change it. But there’s a lot of industry dynamics that are very, very different.

Number one is that fuel cost piece of it which the last time the margin were like this fuel is $0.60 a gallon, which didn't really present a barrier-to-entry or any barrier to new capacity additions and going back to that slide which we highlight in the interest of time, I won’t pull it up. But the capital that was going into the industry at that time was massive, even to the point of increasing leverage on the entity which over the long term wasn’t sustainable and we saw that in the post 9/11 industry as a whole.

That’s different today because that marginal capacity at $3 a gallon is a very different metric. And I think when you look at Delta included in this, the industry is more and more focused on return on invested capital, both in terms of its investor presentation but also in terms of the accountability to compensation building it into exactly a comp models.

ROIC doesn’t allow for that level of overinvestment in a fuel price environment that we expect to continue for a long time. We manage the business to high fuel prices because that’s the responsible thing to do for our shareholders and for the company as a whole.

So that dynamic has changed. And I think for the Delta position in that, I think a lot of people asked the question of Delta, you had so much success. You got so much higher valuation than the other airlines, convince us that there's still room to improve. And I think many of the initiatives that we talked about whether it's the revenue diversification or the re-fleeting and up gauging of the airline, we’re still in relative early stages of that.

Delta still has over 150 regional, 50-seat regional jet to retire and we only really began delivering the replacement for those in the back half of 2013. So we still have room to go. We won’t be at our goal till the end of 2015. And you’ll still continue to see aggregate annualization benefit through 2016. So I think there is still a lot of room to go on both the Delta story and consolidation within the industry is still relatively in its infancy.

Unidentified Analyst

Great. Thanks Paul. From the audience, any question?

Unidentified Analyst

So you talked about your ability to maintain an older fleet through your cannibalization harvesting and use your capital market. And obviously you’ve taken your refinery that allows you to do that as well. But curious that it seems like a differentiator that could create a risk, 17-year-old average age of the fleet in the closest majors are 13. At what level does that become more of a risk than an asset, if those benefit that you used to offset the age go away or are they strong as they appear?

Paul Jacobson

Well, that’s a great question. I’m actually of the belief that this is a sustainable benefit for Delta, because if you look at the manifestation of that strategy, the reason it works for Delta is because we have above average industry productivity around our workforce and our ability to turn engines and airframes cheaper than our competitors can, as well as the operational reliability and customer satisfaction scores that go along with a strong operation. If you're not able to maintain those, the idea that you're flying a fleet that’s older than your competitor starts to become more visible and more accretive in terms of inconvenience in passengers from that standpoint, and that will ultimately lead to revenue destruction.

The way if you got that advantage from an operational reliability and from a maintenance cost productivity standpoint, the way to really leverage that advantage is not by flying the same airlines on a lower cost, the way to really leverage that advantage is to deploy the same amount of capacity on a significantly lower capital base. That still gives you those advantages from an operational reliability and a cost perspective.

So it really amplifies the sustainability based on the capital deployment. So it’s not that we’re flying airplanes that require significantly greater maintenance, they require different maintenance. And at times during periods of checks, they can require more maintenance, but you're able to do that through a whole pool of inventory of assets that the market doesn’t value anymore. So when you're able to take that advantage and do it in a seamless way that you're still driving an advantaged operation that really is a managed risk associated with it.

Now over time you've seen us announced a number of tactical purchases of airplanes, the most recent one on Monday for 15 Narrowbody airplanes. Those will replace some of the older airplanes that have to come out of the fleet over time. But what we have to do in this industry is we have to realize full value for what you pay for, because at the end of the day you’re delivering capacity on a depreciating asset. You’ve got to try to drive that as much as you can if you’re going to be capital efficient through that process.

Mike Linenberg - Deutsche Bank

We have time for one more.

Unidentified Analyst

Sorry I was in the meeting today. So (indiscernible) around some of these points, but you made announcement today that free cash flow is coming about $250 million higher. Can you tell me exactly where that’s from operations, depreciation, CapEx, where does that drive?

Paul Jacobson

Sure. Well, I think if you look at both the traffic release yesterday as well as the updated guidance that we’ve scene on cost and fuel, you’re seeing a little bit of P&L uptick through that. So I think as you look at that build, if you look at ticket receipts going forward and building, that leads naturally to additional cash. We feel really good about where we are and this is going to be a quarter to remember for Delta. We’re excited about it with that type of guidance.

Mike Linenberg - Deutsche Bank

Great. Well, thank you, Paul.

Paul Jacobson

Thank you all for your time and for your interest in the industry and Delta. Thank you.

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