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Delta Air Lines, Inc. (NYSE:DAL) Cowen and Company 11th Annual Global Transportation Conference Call September 5, 2018 8:00 AM ET

Executives

Paul Jacobson - EVP and CFO

Analysts

Helane Becker - Cowen and Company

Helane Becker

Okay. Good morning, ladies and gentlemen. It's my pleasure to welcome you to Cowen's 11th Annual Transportation Conference. I'm Helane Becker, Cowen's Senior Airline Analyst. And with me in the audience today are my associates, Conor Cunningham and Tyler Seidman. They work for me and with me. And this is a record year for us. Here at the conference we have presentations from 15 companies between now when Delta begins and 4:31, Azul ends their presentation.

In addition, we have another five airlines Aeroméxico, Allegiant, Atlas Air, Go, and Volaris and Copa, actually six airlines hosting one-on-one phone line. So with that in mind, I'm pleased to welcome Delta Airlines. Making their presentation from Delta today is Paul Jacobson sitting right to my left, Executive Vice President and Chief Financial Officer. With Paul in the audience today are Elizabeth Lippitt, and Julie Stewart from Delta's Investor Relation team. So, Paul the floor is yours.

Paul Jacobson

Great. Thank you for that Helane and good morning, everybody. We are webcast today. So -- and our presentation does contain forward-looking statements. As you know, these statements are subject to various risk factors which can be detailed in our SEC filings in our Form 10-K.

Well, first of all, let me start by saying welcome back. I thank many of you have enjoyed a Labor Day weekend and like most of America traveled. In fact, people traveled in record numbers on Delta over the weekend, and our people delivered a stellar operation over Labor Day weekend, with over almost 2 million passengers in plane over the weekend and over 70% of those on time without a single minute of delay.

That is a testament to what we have created together at Delta. Particularly as it relates to our foundational strength including our culture, which is what the core of the -- our flippers not working here, battery might be lose.

We'll get that fixed, but for those of you following our webcast, the culture is the core of our foundation and where we believe that we can really make a difference within Delta as our Founder, CE Woolman talked about everybody flies the same airplanes, everybody can stake the airplane with the same food, and the same amenities, but people are what makes the difference. And when you look at our culture, the Delta people are continuing to shine each and every day.

In fact, in the month of August alone, we inclined over 18 million customers and this summer we had 9 of our all-time top 10 passenger days in the company's history. And you see that with the level of operational performance and reliability that we've been -- we've become known for, which is driving a revenue premium the likes of which we haven't seen in the industry, particularly domestically.

When you combine that level of service and that operational excellence with the best domestic network in the country, you get the type of results that we've been able to drive. And we've been able to generate consistently over the last several years. And that is fundamentally what is different this time when we talk about that. And I know that phrase has been used often over years and it becomes a little bit cliché. But what we do at Delta every day is really fundamentally different from the way we've done it in the past.

And that's engendering a level of customer loyalty and differentiated revenue streams that are really helping to harvest and harness the benefits of all of these core foundational principles and the strengths that we have. And when you steward that with good capital allocation, you also end up in a position, where you can drive an investment grade balance sheet to really harness that foundation if you will to the point that we can drive sustainability and durability in our earnings stream, and really kind of undue some of the historical volatility and cyclicality that we have seen in the business.

So, we focus on two different things, we’re really focused on durability and sustainability. We know that this business has challenges that popup, whether it be weather, or fuel prices, volatility and such, you end up in a position where we have to drive consistency in the results, get out of the historical cyclicality that we’ve been in and drive consistent returns for our shareholders. And that really starts with that customer oriented reliable airline that we see every day.

But none of that is going to matter if at the end of the day we can’t stabilize margins. We have been in a period of margin declines for the last few years, coming off low oil prices. And while the industry has constantly been in shifting and we have seen some improvement there, we have got to get the business back to producing margin expansion and getting back to the margins that we have seen before.

And we’re positioned to be able to do that as soon as by the end of this year heading into 2019, which really sets the table for what we think is going to be a terrific year, at least based on where we sit today.

And ultimately driving that long-term value for owners, despite the run that the stock has been on over the last several years, we still do feel that we’re pretty consistently undervalued by the market against most metrics, we’ve got to be able to overcome that history and drive consistency in the business model in order to prove that this is foundational.

We have been on a good start for that. If you look over the last several years, we have generated pretty consistent pre-tax profit, consistent operating cash flow and we have been growing our return of capital to shareholders, while at the same time we have also been improving the balance sheet by paying down debt and funding our pension plan ahead of our expectations.

This recipe has been strong for Delta and I think has led to some of the differentiation that investors see in the Delta story going few. And while 2018 has been a challenging year, and will face over $2 billion in year-over-year fuel headwind, we still do expect that this will be our fourth consecutive year with over $5 billion in pre-tax profit.

That’s important, because that’s been in a low fuel environment and it’s been in a challenging RASM environment, now we can deliver it in a much higher fuel environment, where we saw pretty heightened volatility in the early part of the year. That’s why we’re driving towards that goal and why we think that’s important. Because that’s going to drive that steady operating cash flow that gives us an ability to plan, while returning our capital to shareholders and improving the balance sheet simultaneously. So we’re not just with sowing the capital structure of the Company towards these short-term goals and objectives.

We highlighted on our July -- our June quarter call in July, that we see a path towards margin stabilization, as soon as by the end of this year. Strong revenue momentum in the businesses is augmenting our ability to recapture the higher fuel prices and certainly this quarter is shaping up both on the revenue and the cost side much as we expected going into the quarter and that’s a strong statement. When you can recover $2 billion of fuel costs and get back to flat to expanding margins that really is setting the table as I mentioned earlier for a positive start to 2019 and a good foundational year.

So we are reaffirming our earnings per share guidance of $1.65 to $1.85 per share for the September quarter. If you recall, we talked about TRASM being in the up 3.5% to 4.5% range -- 5.5% range, 3.5% to 5.5% on TRASM for the quarter and costs flat and we’ll talk a little bit about how we abate the unit costs growth that we saw in the first half of the year.

So with those trajectories we’re looking at top-line growth of 8% for the year, that’s up from where our initial expectations were, capturing somewhat our ability to go in and offset the higher fuel costs with some of the pricing actions that we have been able to take to pass through those higher fuel costs to the customer.

The cost trajectory is a critical part of this, and we are on track like I said to deliver flat CASM for third quarter. But as that year-over-year fuel pressure updates in fourth quarter, it'll go down to about 25% year-over-year, as well as lapping the profit sharing harmonization that we did in the fourth quarter of 2017. We do believe that there's a path to flat to expanding margins as soon as the fourth quarter of this year. And that's an important goal for us as we set our objectives for the coming week.

That revenue growth doesn't happen just by chance. This is a deliberate strategy that we pursued by trying to differentiate our product over time. Both in terms of the customer service, which is driven by those strong cultural roots that I highlighted at the beginning, which are foundational for us, but also by the operational reliability.

That doesn't happen by chance either and this has been a multi-year exercise really going back to the summer of 2010. If you look at our improvement in our statistics are cancellations for maintenance reasons since 2010 are down 99%. In 2010, we had over 5,000 cancellations due to maintenance. This year we'll have less than 100 for the entire year.

Our maintenance team and our spares team are doing a fantastic job of running the airline consistently, because at the core what customers want is that reliability and that consistency to know that when I buy a ticket on a flight that plane is going to go and it's going to go on time.

And that's another important driver for us. I highlighted that over 70% of our flights over the Labor Day weekend were on time. That's against in A0 [ph] metric, not the DOT, the A14 metric. We believe that we should hold ourselves to a higher standard and when we look at customer satisfaction A0 is one of the highest drivers and highest correlated variables to net promoter score.

So when you hit those types of levels, it's no surprise that you see net promoter scores in the domestic operation at all-time highs for us. And that is what has been the fundamental driver of our revenue premium versus the industry, which domestically in the first half of this year hit almost 120%. Like I said, that level of revenue premium on a unit basis is somewhat unprecedented, let alone driving it as consistently as we have over the last several years. And that’s a testament to all of our people throughout the system and the job that they do every single day.

But importantly, and I know we spent a lot of time talking about this across the industry. But importantly, that drives the customer loyalty that has been monetized in new and creative ways through our relationship with American Express, which this year will drive over $3.5 billion of additional revenue and value into Delta, which is a testament to the brand that we’ve created.

If you go back 15 years, airlines chased credit card companies, because we wanted the loyalty that the card provided to attach to the airline. That’s almost completely reversed in the industry today, and the changing economics of the credit card business and what credit card companies and issuers want is the loyalty that airlines have and the airlines engender attached to those cards. And that has been an incredible value driver for airlines, and one of the ways and which we can utilize our brand to create more durability and sustainability in the business.

We -- costs have been a big story at Delta over the last several years. And while we talked about at Investor Day being below 2% for this year, the first half of the year was quite a bit of a challenge. We knew that going into the year as we lapped investments in the product and our people, as well as year-over-year increases in depreciation driven by the acceleration of the MD-88 retirements, the grounding of other airplanes, et cetera.

And that fuel cost is expected to flip by 3 to 4 points in the back half of the year. So we were 3 to 4 in the first half, we’re looking at flat in 3Q, as we said, on our June quarter call better than that in the fourth quarter as we see.

This is more important than ever, this is going to be the source of the margin accretion, as you see the top-line growth going forward. And we believe we have the right momentum both in terms of lapping overhead, but also driving the efficiency in the business from the upgrading of the larger airplanes that are coming in this year, as well as the beginning of the realization of some of our One Delta transformation efforts.

As we talked about at Investor Day and we’ve updated throughout the year. That One Delta project is transformational. In fact, we don’t even like to think about it as a project because what we really need to do is think about the businesses at an enterprise level the way our customers do. Our customers don't interact with our divisions silos; they interact with the horizontal swap across the company as a whole.

And when we can drive efficiencies horizontally through the company through things like better network optimization, better logistics management, handling company materials, better coordination across the system. We know that we can drive savings. In fact, many of those operational benefits have been implemented post summer as a way to minimize some of the risk of implementation and the impact that we might have on our customers and put those in post-summer.

So we're starting to see those lap and that's a contributing factor to why our second half unit costs are going to be considerably lower than what we saw in the first half. Those initiatives will continue to analyze as we get into 2019 and we continue to drive even more ideas to really kind of kick that cost efficiency into high-gear for us going forward. And that will be a consistent source of what we see as margin expansion over the coming months and years.

But as you know, all of that is move lieu, if at the end of the day we aren't good stewards of the capital that we're generating and the capital that we're raising every year. So we start with investing 50% in the business. This year that number will be a little bit higher as the businesses adjusted to the higher fuel cost. But this is a long-term business and the long-term investments we need to continue to make as long as we can. But we do have flexibility in our capital expenditures and we do see opportunities to use them in the event that we see sustained drop in operating cash flow.

For example, one of the things that we have at our disposal is the ability to differ pension contributions. With the pension contributions that we've made including $3.5 billion in 2017, we have actually exceeded the minimum required contributions under airline relief through 2024. That means that in the event that we see headwinds on cash flow, we could dial back our planned $500 million in annual contributions in 2019 and 2020, creating a very easy switch to pool in the event that we need to preserve that cash flow going forward.

But we're also doing that through aircraft. We've got an ambitious fleet plans where we're replacing about 30% of the mainline fleet through 2020, completely retiring the MD-88 airplanes as I mentioned earlier to drive not only efficiencies in the business, but enhanced customer service and enhanced customer amenities onboard.

It also provides for continued investment in the technology as we completed last year a heavy infrastructure year. This year is tilting more towards digital and how we interact with the consumer and how we arm our people with the best tools in the business to serve our customers at a level that they never seen before. And that technology is moving along very nicely and we'll see the results of that in early 2019.

We've got to continue to strengthen the balance sheet not just in terms of debt pay down, but also continuing to attack that pension liability. And what you’ve seen over the last -- since 2009 is over $11 billion in reduction in both debt and our pension liability going forward. That's important because while return to capital -- return of capital to shareholders is critically important for our business thesis in what we think the industry has been missing for most of its history. That consistent return of capital can't come at the expense of the balance sheet over the long-term. We need to have an investment grade balance sheet and we need to maintain that.

So the ability to return capital at the levels that we have, while also improving our balance sheet and reestablishing our investment grade credit rating is paramount to that balance of how we think about maintaining our cash flows and being strong stewards of that capital flow. But even with that, we have been committed to consistent return of capital to shareholders, and we've been targeting 70% of free cash flow back to our owners.

Again, this year it will a little bit higher based on lower cash flow. But we think there is value and the consistency of what we're driving. So since 2013, we returned more than $11 billion in the form of dividends and buybacks, and this year we had our 5th consecutive increase in our dividend, which is testament to what we think both is the sustainability of what we've created here, but most importantly the commitment to continuously returning capital back to our shareholders. We are making progress against our buyback, we have just over $3.5 billion remaining and we do expect to complete that by mid-2020.

So, as we think about the business going forward, we have the right momentum, we have overcome two big increases in fuel prices in March and May of this year as we start to lap the fuel increases from last year and we start to see that year-over-year fuel pressure come down. We believe that the business is in a strong position heading into 2019 in order to drive those margin stability and ultimately margin expansion off the levels that we have seen and we believe that the momentum is headed in absolutely the right direction, feel good about where we sit.

With that, I will turn it over to Helane to ask any questions or ask any questions from the group.

Question-and-Answer Session

Q - Helane Becker

Okay. And first of all, asking the group, does anybody have any questions, because I always have tons of questions. So I’ll give the group a chance to ask the questions.

Okay, so Paul, thank you for that really great presentation. Just first question that comes to mind is about data mining. So you have a lot of information on your customers and how do you use that to target maybe specific marketing, are there opportunities to use that information to appeal to certain customers or certain times a year in terms of opportunities for travel for them?

Paul Jacobson

Sure Helane, that’s a great question and one that I think, we’re in the infancy of I think the airline industry has always been replete with lots of data across the system and our ability to harness that has been somewhat limited by our technology. And the fact that we have been playing from behind for a lot of times as evidenced by some of the infrastructure investment that you have seen over the last couple of years. But this is exactly what we mean and this is exactly what we’re focused on with the digital transformation of Delta.

So, we have been good in terms of personalizing the experience. So when you logon to delta.com, making sure that the experience matches what your preferences are. But we’ve got to take that on to the service level and one of the tools that we have that’ll be coming out, I alluded to it briefly in the presentation, as the single view of the customer, in which we can connect all of the data sources that we have on customers to enhance that travel experience.

So for example, when you walk on board a flight today and interact with a flight attendant, they may not know the experience that you had last week or last month, when we can unite these systems together operationally and customer service, we can actually come in and acknowledge, I know we failed last week, we apologize for that, here is what we do to make it up, or you know that the flight today is going to be on time, you’re not going to have those problems. That’s a level of personalization that we really haven’t seen before and digital is the key to that.

So, as we link all these systems together, and give our customers a complete view -- or our employees a complete view of the customer then you’ll have a consistent interaction regardless of whether you’re dealing with some of the reservations, or flight attendant, or somebody at the ticket counter, and that we believe is a game changing opportunity for us. When you put those tools in the hands of the best customer service people in the industry.

Helane Becker

Okay. Just for the webcast I have to give you the mic.

Unidentified Analyst

So were to follow-on, Helane’s question. Have another question, so can you talk about upsell, I mean, that’s something that’s been a big opportunity. You pretty much been very positive about that, but also then could you -- what can you do with that? So I know when I go online maybe I have a ticket miss like oh, really, you can upgrade to first class is something like that, but what about all by the way we also know that you have your health [indiscernible] co-policy, your Marriott account or whatever is linked with you, do you have the hotel in whatever city you are going in, we have this deal for you. I mean, are you looking at things beyond just upselling to first class. Could you do things with data, so maybe try another loyalty program?

Paul Jacobson

Sure and I think this is a little bit of what I alluded to, when I said I think that we are in the infancy. I mean, we are in a company now that is truly a world class identifiable, ascending brand. And that is something that I think over the last few years we've gotten better at harvesting that. But we have so much potential in that space, whether it be who we deal with business with, in terms of partnering onboard, all the way up to how we link our mileage and loyalty program, and how we use that to cross-sell across the board.

Right now what we are focused on uniquely is how do we create that different experience for each and every customer that we can within a well-defined set of operational limitations, so that we don't try to be everything to everyone. And I think what the team has done an incredible job of is packaging those individual experiences, 10 years ago it was just simply a matter of did you want to fly first-class or coach.

And now what we've done is we've been able to differentiate those experiences across multiple cabins, multiple boarding experiences, multiple amenities onboard. And that's created an opportunity for us to really differentiate based on what customers’ value.

And we've got to continue down that path, whether it be the onboard experience or also the purchasing experience wherever we can in order to maximize those brand benefits.

Unidentified Analyst

You mentioned in your presentation the strong revenue momentum you're having. Can you just talk about kind of the fare environment, what you're seeing there in terms of closing pricing et cetera? And then just in terms of where you expect fuel recapture as we go into 2019. Do you see momentum there given the higher fuel prices?

Paul Jacobson

Sure, so we measure fuel recapture first based on all revenue has to go to cover the increases in our non-fuel cost and then what's left goes to cover fuel. And that puts us in a position where we're ensuring that we're taking the most of what the market will give us. So when we say that we can get to flat margins or expanding margins by definition that gets to 100% fuel recapture the way we're measuring it.

So we feel like we're on a good trajectory to do that. There is still obviously some risk as we look out into the future, but that's certainly what we're targeting. And the momentum that we've seen in close in bookings as well as the heavy summer loads alluded to all the records that we set for passenger employment has been a strong indicator that the business is trending in the direction that we needed to, particularly as it relates to closed in fares in order to drive that momentum to get us to flat margins and ultimately that 100% recapture by the end of this year to set the table for 2019.

Unidentified Analyst

Paul, Delta has always been known as employing a successful strategy with respect to its use of used aircraft to keep its capital investment low. And I noticed in so like the MD-88s and the 717s, et cetera. With your new sound cash flow, are you abandoning that historical strategy?

Paul Jacobson

Well, I think the cash flow story has been somewhat consistent over the last several years. And by definition as we've talked about that used aircraft strategy it's been opportunistic. So when you look at the MD-90s that we were able to roll up or the 717 transaction that we acquired from Southwest, those are both very opportunistic in nature. What we've been focused on over the last couple of years is how do we create that up-guaging momentum and use our negotiation leverage to the maximum of our ability.

So when you see the forward order book it's largely new airplanes coming. We still do have some dry powder in the event that we see those opportunities, but they haven't been as prevalent over the last few years as what we saw five and six, seven years ago with those transactions. But we are still open to it under the right opportunities.

Unidentified Analyst

Just want to follow on that with a different question, similar but different. Delta takeoffs, that in the past has been talked about is being $1 billion plus business. And can you just talk about your plans for that? Because I know in a $45 billion revenue company a $1 billion in revenue is not a big number, but I suspect the margins on that business are fairly high. So can you just maybe talk a little bit about the plans for that business?

Paul Jacobson

Sure, absolutely. Our takeoffs professionals are the best in the business. And when we see that ability to drive that third-party work we've done it extraordinarily well. We had a dip down a couple of years ago. The margins weren't what we expected them to be and we kind of went in and cleaned up a number of contracts. But since that time, the business has been on a fantastic trajectory.

So as we see going forward, we've done innovative partnerships with both Rolls Royce where we built the -- a large engine test facility, which is going to be a fantastic opportunity for us. And then if you look at the most recent deal we signed with Pratt to be the North American exclusive MRO shop for the gear turbo fan. Those are the types of momentum that are going to drive that business well beyond $1 billion in revenue as we see it going forward. And those margins are strong, but that's a testament to the work of the team that does that over in our maintenance space.

Helane Becker

So I think we have time for maybe one or two more questions. So according to the work we've done, it looks -- in your own pilots so it looks like you have about 14,643 to be exact pilots, maybe that’s different today, staff. And then between now and 2030, 7,925 turned 65, so we know that’s the mandatory retirement date and obviously some pilots retire younger. So that’s more than half of your pilots. So how do you replace them and if you grow to 1% a year, how do you do that and replace the pilots?

Paul Jacobson

Well, thanks for that question Helane, and first of all I remiss, in not having introduced, Joe Pinkelton [ph] had jumped into the slides too quickly and the frustration have been not moving. I didn’t mean to omit Joe, who is with Investor Relations with Delta’s Alpha Group [ph], great. So Joe welcome and apologize for that, oversight earlier.

This is a challenge for the industry, but when you look at the carrier path that the Delta pilot has, it really is among the highest in the business. So it’s incumbent upon us to focus on training, the next generation of pilots and also making sure that the carrier prospects for a Delta pilot are strong and you see that both with the breadth and depth of our international network that gives more opportunities to fly bigger airplanes longer. But also just the package that comes with being a Delta pilot, industry leading profit sharing, et cetera.

But we are partnering with a couple of innovative programs to help augment that, we’ve just recently launched the Propel program, which is a partnership with eight universities, particularly with aviation programs to really help college students get a leg up on the training needs, as well as knowing that they have got the Delta job, assuming they meet all their requirements and do what they need to do at the end of a short period just after college.

So, focusing on innovative strategies like that, as well as combining it with the best carrier preposition in the industry is what ultimately is going to keep Delta well insulated for many pilot shortages in the future.

Helane Becker

Perfect, thanks very much. Okay, thanks everybody. That’s Delta’s presentation. Thank you so much, Paul for all the years supporting our conference. We really appreciate it.

Paul Jacobson

Thank you for having us, Helane and thanks everybody for joining.

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