Jul 14, 2016
Executives
Jill Sullivan Greer - Vice President, Investor Relations Ed Bastian - Chief Executive Officer Glen Hauenstein - President Paul Jacobson - Chief Financial Officer Steve Sear - President, International and Executive Vice President, Global Sales Peter Carter - Executive Vice President and Chief Legal Officer Kevin Shinkle - Chief Communications Officer
Analysts
Michael Linenberg - Deutsche Bank Andrew Didora - Bank of America Duane Pfennigwerth - Evercore ISI Julie Yates - Credit Suisse Helane Becker - Cowen and Company Hunter Keay - Wolfe Research Jamie Baker - JPMorgan Jack Atkins - Stephens Darryl Genovesi - UBS Joseph DeNardi - Stifel Savi Syth - Raymond James Dan McKinsey - Buckingham Research Jeffrey Dastin - Reuters Michael Sasso - Bloomberg News David Koenig - The Associated Press Kelly Yamanouchi - Atlanta Journal Constitution Ted Reed - The Street Edward Russell - Flight Global Linda Loyd - Philadelphia Inquirer Elliott Blackburn - Argus Media
Operator
Good morning and welcome to the Delta Airlines June Financial Quarter Results Conference Call. My name is Kyle and I will be your coordinator.
[Operator Instructions] As a reminder, today’s call is being recorded. I would now like to turn the call over to Jill Sullivan Greer, Vice President of Investor Relations.
Please go ahead.
Jill Sullivan Greer
Good morning, everyone and thanks for joining us for our June quarter call. Joining us in Atlanta today are Ed Bastian, our CEO; our President, Glen Hauenstein and our CFO, Paul Jacobson.
Ed will open the call. Glen will then address our financial and revenue performance and Paul will conclude with a review of cost performance and cash flow.
To get in as many questions as possible during the Q&A, please limit yourself to one question and a brief follow-up. Today’s discussion contains forward-looking statements that represent our beliefs or expectations about 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 non-GAAP financial measures. All results exclude special items, unless otherwise noted.
And you can find the reconciliation of our non-GAAP measures on the Investor Relations page at ir.delta.com. And with that, I will turn the call over to our Chief Executive Officer, Ed Bastian.
Ed Bastian
Thanks, Jill. Good morning.
Thanks to everyone for joining us. For the June quarter, we reported a $1.7 billion pre-tax profit and we generated $1.6 billion in free cash flow.
We grew our earnings per share 16% to $1.47 beating consensus by $0.05. Strong cost execution and lower fuel prices allowed us to offset a decline in revenues as we continue to face persistent unit revenue headwinds.
In this challenging revenue environment, it’s more important than ever that we differentiate ourselves on service. And in this area, the Delta people have truly risen to the top.
We continue to run the industry’s best operation. We delivered a 99.95% completion factor for the June quarter, including 71 of the 90 days with zero mainline cancellations.
More importantly, we had 23 days of zero system cancellations on any Delta carrier, nearly 6,000 flights a day or 1 out of every 4 days for the entire quarter. Our mainline on-time rate improved 1.5 points year-over-year to 86.9%.
This operational result is contributing to continued solid increases in customer satisfaction. We have achieved all-time highs in our net promoter scores and our customer complaint rate has decreased by 14% so far this year.
These high levels of customer satisfaction are widening our revenue lead relative to the industry with our system RASM index reaching 110% as of the March quarter. Congratulations to the entire Delta team and thank you.
We recognize your outstanding efforts with another $324 million of crude towards our profit sharing program bringing us to $596 million accrued already this year. Despite our strong results, we continue to face persistent headwinds on our unit revenues on a number of fronts that we are working hard to combat.
Capacity is one of the biggest levers we have to move the needle on our unit revenue performance. In May, we announced that we plan to take one point of capacity out of the fourth quarter.
That brought our second half capacity growth plan to below 2%. Now, with the foreign currency pressure from the steep drop in the pound, the economic uncertainty from Brexit and continuing yield pressures in the North Atlantic, we have decided to take an additional 6 points of capacity out of the UK for the winter IATA season.
We have also been working closely with our partner Virgin Atlantic who will be making their own capacity changes. Combined, our overall UK capacity this winter will be down 2% to 4% compared to the prior year.
For Delta, these changes along with other network actions will take roughly 1 point of capacity out of the system and we now expect our fourth quarter capacity to grow by only 1% year-over-year. Glen will take you through the details.
But I want to stress to you that the company is very focused on getting back to positive RASM growth. While admittedly, we have done a poor job forecasting when unit revenues will turn positive, we are working hard to achieve our goal hopefully by the end of the year.
And even if ultimately it takes a little bit longer than year end, we are confident we are on the right path. We expect July and August monthly RASM results to be weak.
However, we are anticipating a market improvement in our September monthly numbers as we implement our capacity changes and see benefits from our domestic revenue management initiatives and easing of foreign exchange headwinds and an improvement in the overall pricing environment as we hit the traditional 9-month period that it takes for revenues to catch up to higher fuel prices that we began experiencing earlier this year. And if we are not seeing the right progress in our results as we moved through the fall, we are prepared to take additional actions as you saw us announced this morning.
Because the reality is that the large year-on-year savings driven by lower fuel are now behind us, market prices are essentially flat for the third quarter and look to be higher year-over-year in the fourth quarter for the first time since 2012. All that said, our results for the third quarter should be a record as we expect to generate a pre-tax margin of 20%, consistent with what we posted a year ago.
Demonstrating the sustainability of our performance is key to delivering the margin, cash flow and return targets that we outlined for you in May. And as we look to drive that performance longer term for the business, we will continue to execute on the strategy that has already delivered tremendous value for all of our stakeholders.
First, we will continue to strengthen our brand around the world. The strong brand improves customer loyalty while driving a sustainable revenue premium and higher margins.
Second, we will maintain a rigorous discipline around cost and capital. This provides the solid foundation for the business, day in and day out.
With our sustainable revenue premium, a solid cost foundation and modest capacity growth, we have the engine for consistent 15% plus long-term earnings growth. Finally, we will use our strong cash flows to reinvest in the business for the long-term, fortify our balance sheet through debt and pension reductions while also returning at least 70% of our free cash flow to our owners.
So to conclude, our second quarter results were strong. However, we need to get unit revenues back on a positive track and Glen and the commercial team are executing on our plan.
Longer term, our revenue premium, solid cost base, balance sheet and cash flows provide the foundation for the earnings growth and substantial capital returns for our owners that we believe will drive value long into the future. And with that, I am happy to turn the call now over to Glen.
Glen Hauenstein
Thanks, Ed and good morning, everyone. While the overall revenue environment continues to present challenges, we expect to outperform our network peers on unit revenues once again in the second quarter.
This is truly a testament to our entire team who continue to provide industry leading revenues by delivering an unparalleled level of reliability and great customer service every day. Turning to our June quarter performance, revenues declined 2% compared to last year, including roughly $65 million of pressure from currency.
We continue to see closing domestic yield deterioration on stable corporate ticket volumes producing domestic corporate unit revenue trends that are down in the high single-digits. This pressure, combined with continued foreign currency impacts and supply demand imbalances primarily in the Trans-Atlantic and China regions, drove a 4.9% decline in system passenger revenues.
While we faced a number of headwinds in the quarter, the expansions of our ancillary revenue initiative remains a significant positive for us. Our branded fare initiative continues to see strong momentum.
Total merchandising revenues for the quarter increased more than $40 million or 13% year-over-year. Comfort+ paid load factory increased by 15 points to 46% as we began selling this product in the purchase path in mid-May.
We now expect Comfort+ to generate nearly $300 million of up-sell revenues in the second half of 2016 with further upside in 2017 as we begin the international rollout scheduled to be complete by the end of ‘17. We now have rolled out our basic economy product to over 7,000 domestic markets or about 50% of our domestic revenue base.
We anticipate that we will have full domestic coverage sometime in 2017. Our international rollout of this product has begun and we are now testing the product in over 50 international markets.
Our intent is to have this in all international markets during the year ‘18. Our partnership with American Express produced $90 million of incremental value in this quarter and we expect over $300 million for the year.
New current acquisitions are on a pace for another record year and have increased 30% year-to-date over our record 2015. A special thanks to the SkyMiles and American Express teams for the great success we have had in enrolling new members this year.
We have a great partner in American Express and look forward to our continued efforts to provide the leading co-brand offering to our mutual customers. While there are areas of the business that have great momentum, there are others that require additional work.
Our entire commercial team has focused on changing the revenue trajectory and getting back to positive RASM by year end. Let me outline for you some of the major initiatives we have underway by region to ensure that we can achieve our goal.
Domestically our unit revenues declined 6% on 5% capacity growth for the June quarter and while absolute volumes for business traffic remained solid, quite simply they didn’t keep pace with sales growth. Yields were further pressured as traditional AP and minimum stay requirements were absent in many major U.S.
markets. On the other hand, leisure yields are strengthening and demand remained strong, so going forward, our path to improving domestic RASM starts by moderating our domestic capacity growth.
This will begin in our post-summer schedule that begins late August. With continued strength and leisure demand and yields reduced capacity growth should allow us to position our inventory towards higher yielding, long AP leisure fares.
This should provide a cushion for unit revenues that will more than offset stubbornly low business fares that are largely sold within the month. July and August will post strong domestic margins and cash flow as we run out the remainder of our summer schedule.
We are confident that we will then see substantial RASM improvement in the September timeframe and may even achieve positive domestic revenue as early as September. In Latin America, unit revenues were down 5% in the quarter.
But June achieved our first positive unit revenue results in 26 months. This result was achieved as Brazil unit revenue declines moderated to just 4% on strengthening currency and capacity reductions.
Delta has removed 25% of capacity in Brazil to deal with the economic crisis. Mexico continued to be strong for us on both leisure and business demand and RASM during the quarter was up 4 points.
Caribbean demand remained solid and we expect favorable unit revenues beginning in 3Q as we lap our own and industry capacity increases. For the remainder of the year, our Latin capacity will decline 2 points to 3 points and we expect this entity to inflect in RASM, consistently as early as the September quarter on reduced currency pressures, strengthening demand and reduced capacity offering.
Moving to the Pacific, the 5% unit revenue decline in the June quarter was the result of a 4-point headwind from lower year-on-year hedge gains. Additionally, there were 2 points of negative impact from – negative fuel searches – surcharges, partly offset by the appreciation of the end spot rate.
As the business practice, we hedge at least 50% of our net yen exposure in any given quarter. However in 2015, we have more significant positions in place at more favorable rates than we do currently.
In fact, we expect to recognize a $5 million hedge loss in the back half of this year compared to a $90 million gain last year. $70 million of that headwind will occur in the September quarter alone, accounting for nearly 1 point of negative system PRASM and more than 7 points of impact on the Pacific unit revenues.
Excluding hedges, we achieved flat RASM in Japan in the June quarter held by our capacity adjustments, our focus on higher you yielding U.S. point of sales traffic and recovery in the Japan point of sale resort markets, driven by a stronger yen.
The strength in Japan was firmly offset by yield pressures in China. Passenger growth in China was up 7% in the quarter and we continue to see increasing demand for connecting traffic with our partners China Eastern and China Southern.
However, industry capacity to and from the U.S. increased nearly 25% in the second quarter, which pressured yields.
This capacity is expected to continue in the second half. For the remainder of the year in the Pacific, we are accelerating our capacity reductions and expect to be down roughly 7.5% in the third quarter and 5% for the winter season.
We expect the combination of our planned capacity reductions, along with the stronger yen to achieve positive RASM growth later this year, excluding the hedge impact. Finally, in the Trans-Atlantic entity, Delta’s second quarter capacity grew in line with traffic trends at 2%, while the industry increased capacity by 10% pressuring yields.
Although this drove our unit revenues down 4.5% for the quarter, the Trans-Atlantic is still on track to produce one of the most profitable summers in history. That said, this area continues to be where we face the greatest challenge in our efforts to get back to positive RASM and we are now facing even additional pressures from Brexit.
In our Continental European markets, customer growth nearly matched capacity growth of five, but double digit low cost carrier growth pressured yields. In the second quarter, Delta and Air France KLM began a code-share agreement with Jet Airways.
We are very optimistic about this opportunity to feed Paris, Amsterdam and London going forward. And given the contra-seasonal nature of the India market, we expect to have a positive impact on fourth quarter Trans-Atlantic revenues.
In the UK, Delta’s British pound denominated revenue is roughly 350 million on an annual basis. So when the pound devalued 12% versus the pre-Brexit levels, our revenues were reduced by 40 million from currency alone.
Since the leave decision, we haven’t seen a material impact on volumes, but as Ed mentioned along with our partner, Virgin Atlantic, we are taking additional capacity out of the UK for winter to address the headwinds of the region. The reduction is focused on UK origin leisure markets.
These changes combined with other actions we are taking will result in our winter IATA scheduled capacity in the Trans-Atlantic being down for the second consecutive year. Even with these capacity actions, we do not expect RASM in the Trans-Atlantic to inflect until sometime in ‘17.
At a system level, with these plans in place across all of our entities and the trends that we see today for the September quarter, we are forecasting system unit revenues to be down between 4% and 6% on a 1% to 2% year-over-year capacity increase. We expect July and August to be at or slightly below the bottom end of that range with September markedly better than both of those months.
Calendar placement creates noise between the months and will be a 2-point headwind in August and a 2-point benefit to September. Additionally, September should see benefit and as currency and fuel surcharge headwinds ease and the fall capacity changes begin to be implemented.
So to wrap everything up, while the current environment remains challenging, we continue to outperform our peer set. We have plans in place to address the challenges we face and are executing against those plans.
Where we haven’t seen the desire traction in our unit revenues, we are taking actions with revenue management strategies and capacity levels. And if necessary, we will take further actions to make sure that we maintain the momentum to achieve our goal of getting to positive unit revenue by year end and ahead of our network peers.
And with that, I would like to turn it over to my good friend, Paul Jacobson.
Paul Jacobson
Thanks Glen and thanks here to entire team. We all appreciate the efforts and the hard work that they are undergoing.
Good morning everyone and appreciate you joining us this morning. Consistent cost execution again this quarter was a key contributor to Delta, delivering an operating margin that was within our initial guidance range before the 4-point headwind from the early fuels hedge settlements.
While we continue to benefit from lower fuel costs, prices remain volatile as does the global environment and we must remain vigilant of those costs that we can control. At the same time, it is critical that we continue to invest in our product and enhance our performance and service to our customers.
Total operating expenses declined by roughly $300 million in the quarter, driven by lower fuel expense. Non-fuel CASM was essentially flat despite pressure from higher wages and product and service investments.
Our strong operational performance, our up-gauging initiatives and the commitment across the organization to delivering productivity savings, drove our solid cost performance again this quarter. I would like to thank the entire Delta team for driving another outstanding result this quarter.
We have the best employees in the industry and this strong performance was made possible by their contributions. We expect our non-fuel unit costs including profit sharing to be roughly flat again in the September quarter and increase less than 2% for the full year.
Turning to fuel, our total fuel expense declined by over $400 million as lower market fuel prices offset higher consumption and hedge losses. We made the decision in the quarter to early settle all of our remaining 2016 hedges, which brought in an additional $450 million of losses to the quarter.
Our all-in fuel price was $1.97 per gallon, including $0.43 from those early settlements. The refinery lost a modest $10 million for the quarter and we expect a lower crack spread environment, which is a positive for Delta overall, will likely result in a modest loss for the refinery for the full year.
Looking ahead, we expect an all-in September quarter fuel price of $1.52 to $1.57 per gallon, which is down 15% from the prior year. With the early hedge settlements complete, we don’t expect to report any additional hedge losses in 2016.
Now, let me address our margin outlook. With another quarter of solid cost performance despite persistent RASM headwinds and a moderating fuel environment, we are forecasting a September operating margin in the 19% to 21% range, which is roughly flat to last year.
Moving on to cash flow, we generated $2.6 billion of operating cash flow in the quarter. We reinvested over $1 billion back into the business during the quarter, with spending primarily related to aircraft deliveries in modification projects.
We expect capital spending will approximate $750 million in the third quarter as we now expect our Aeromexico tender offer to close in the fourth quarter. We will continue to take a balanced approach to the deployment of our cash as we remain focused on long-term durability and sustainability for the business model.
This is what we are driving for with each dollar we spend whether it is going back into the business, the balance sheet or return to our owners. We ended the June quarter with net debt of $6.8 billion, down from $7.1 billion a year ago.
That debt reduction saved another $34 million in interest expense this quarter. With the additional $135 million we contributed to the pension plan this quarter, we have completed our funding commitment for the year.
The progress we have made on de-risking the balance sheet and paying down our debt was recognized by Fitch in the quarter with an upgrade to BBB-. We are now proud that two of the three rating agencies have provided us with this strong endorsement of our commitment to the long-term stability and viability of our business model.
With the $1.6 billion of free cash flow we generated during the quarter, we continued on the path of also increasing shareholder returns with $103 million of dividends and just over $1 billion of share repurchases. As we announced at our May Analyst Meeting, our dividend will increase to $0.81 per share annually beginning in the September quarter.
At current stock prices, this is just over a 2% dividend yield. In addition, we expect to complete our current $5 billion share repurchase authorization by next May, over 6 months ahead of schedule, which will represent our third consecutive authorization completed ahead of time.
We expect to return nearly $3.5 billion to shareholders this year consistent with our goal of returning at least 70% of free cash flow through dividends and share repurchases. In closing, I want to express my excitement about the opportunities ahead for our business.
We are going to continue to stretch ourselves. We are going to continue to follow through on our near-term and long-term plans.
Our performance is simply remarkable against any measure and we are focused on remaining a leading S&P 500 company. Jill?
Jill Sullivan Greer
And we are now ready for the analyst Q&A, if you could give them their instructions?
Operator
Thank you. [Operator Instructions] And we will take our first question from Michael Linenberg with Deutsche Bank.
Michael Linenberg
Yes, hey. Just two quick ones.
Can you just give us the breakout between domestic and international capacity growth for the third and fourth quarters?
Glen Hauenstein
For the fourth quarter which is the endpoint – so I will start there. We will be up about 2 to 2.5 domestic and about down 2 to 2.5 internationally.
Michael Linenberg
Okay. And then do you have that for the third quarter, Glen?
Glen Hauenstein
For the third quarter, I do not have that. I am going to estimate it’s about plus 3.5 for domestic and minus 1 for international.
Michael Linenberg
Okay, that’s perfect. And then just quick question on the Virgin Atlantic, the 49% stake, I know that runs to the non-op.
In your June quarter, does that reflect their June quarter or is that a lag? I know sometimes with private companies, there is a quarter lag.
I just want to clarify that.
Glen Hauenstein
Yes, that’s current, Mike.
Michael Linenberg
So, it is the June quarter Virgin’s numbers in your June quarter?
Glen Hauenstein
Yes, they can count just like we can.
Michael Linenberg
Okay, perfect. Thank you.
Operator
And we will take our next question from Andrew Didora with Bank of America.
Andrew Didora
To the questions, Paul, just on the – given the 2Q CASM results and the 3Q guide, is there anything from a timing or maintenance perspective in 4Q that would prevent you from coming in significantly below your sub 2% long-term CASM goal this year?
Paul Jacobson
Good morning, Andrew. We are still – we haven’t given any guidance on the fourth quarter.
I would say that there isn’t anything on the horizon in terms of maintenance that would cause us to deviate from that. I think we continue to run a great operation and manage through that.
So, our goal is still to keep it below 2%. We are not going to give any forward guidance on 4Q.
Andrew Didora
Okay. And then I guess secondly, Paul, obviously, there has been a lot of movement in the bond market since the Brexit vote and the 10-year treasuries in your record lows.
Are there any significant pension implications that could end up creating a bit of the CASM headwind over the next year or so or is it too small?
Paul Jacobson
Well, I think it’s a little bit too soon to tell. Obviously, our balance sheet liability is impacted by rates.
We have talked about that in the past. So, assuming rates don’t revert back higher, we could see a higher balance sheet liability, but keep in mind that, that has little impact on expense and little impact – no impact at all on our minimum funding requirements for our strategy going forward, which is much longer term based.
Andrew Didora
Great. Thanks a lot.
Operator
And we will take our next question from Duane Pfennigwerth of Evercore ISI.
Duane Pfennigwerth
Hey, thanks. Good morning.
Glen, I wonder if you could playback for us what you were expecting to see with respect to the June quarter monthly. How that was different than what you expected to see and how that maybe is impacting your forecast here into the third quarter, because I thought the idea was peak demand July, August would sort of soak up those excess seats and fix the close-in yield problem, but now it sounds like we are dependent much more on September and maybe a return to corporate.
Glen Hauenstein
Yes. I think what we didn’t expect in the beginning of the year was the continuation and acceleration of the declines in the business traffic sector.
So, what we had anticipated is the strong demand leisure and that has borne out. The demand set for leisure is quite good and in line with our capacity offering, but it has not offset the close-in yield weakness that we have seen.
And so that’s how it played out and that leaves us with really no other choice, but to decrease the capacity levels moving forward, because we can’t count on it to be as we have said in the earnings call, the stubbornly low close-in yields to go away. So, what we need to do now is not go into a month flat, because if we go into a month with flat RASM, we come out with a RASM that’s in the minus 4, 5 range.
So, we have to hit that up 3 to 4 to 5 as we come into the month knowing we are going to give away some of that yield within the month. So, that’s kind of how it played out.
And that’s how we are looking toward September. Of course, when we planned the summer capacity that was back in the February/March time period and while we are looking in a rearview mirror, it will be an incredibly profitable record summer for us.
So, it’s not as disastrous as some people are characterizing it, but it’s really robust and we are going to take the necessary actions to fix it moving forward.
Duane Pfennigwerth
Thanks. And then just as a follow-up, could you give us maybe capacity growth by month?
It looks like it’s fairly similar right now in July, August, September. And then is there any implication for 2017 from that 1% year-to-year growth in the fourth quarter?
Thanks for taking the questions.
Ed Bastian
Duane, we didn’t give the monthly capacity. So we are not going to lay it out.
But I think you can roughly estimate where we are at today as the July, August and then once capacity starts to take down as we get out this summer season, late August into September, the number start to inflect with the greater reductions. We haven’t given 2017 guidance out.
But again if you look at our Q4, up 1%, I would expect our Q1 probably to be in that same range. And certainly by the time we get through this planning for the spring, if conditions are the same, we are going to continue to take the same fact on capacity.
Duane Pfennigwerth
That’s very helpful. Thank you.
Operator
We will take our next question from Julie Yates from Credit Suisse.
Julie Yates
Good morning. Thanks for taking my question.
Glen, I just want to clarify on the PRASM cadence for the third quarter, you mentioned that July and August were looking weak and just to help calibrate expectations, should we expect to see July RASM worsen from June’s down 5% and then improve steadily with September being the best month of the quarter?
Glen Hauenstein
I think that’s probably exactly how you would read it.
Julie Yates
Okay, understood. And then just to reconcile, I mean domestic is now the worst performing entity and that’s where capacity growth is still the highest, how do we get confidence on the level of sequential improvement we – that you need to see in order to write the PRASM trajectory to get to positive by year end?
Glen Hauenstein
Right. Well, I think that is also where on an absolute basis, we are decreasing our rate of growth the most.
And so we are going to be coming down about 300 basis points to 350 basis points from where we are in peak summer versus international, which is going down about 100 basis points. So I think if we have to go further, we will, but this is the next step and seeing if we can get the numbers to where we need them to be to continue to expand our margin into next year.
Ed Bastian
And Julie, this is Ed. Just domestic is incredibly strong in aggregate.
I realize the RASM numbers have been weak, but the bottom line results have been phenomenal. And the premium that we continue to generate versus the competition for domestic is about 1.20.
So the team is doing a great job domestically. But we realize in order to get the RASM improvement to match the increasing fuel prices, we are going to be paying we need to be making the adjustments that Glen talked about.
Julie Yates
Got it. Thanks so much.
Operator
And we will take our next question from Helane Becker with Cowen and Company.
Helane Becker
Hi, I just took some water, [indiscernible] I am okay. I just was wondering, could you update us on where you are with respect to aircraft retirements in the Pacific and how that affects capacity growth in that market for the back half of the year?
Ed Bastian
We still have six 747-400s that are flying in the Pacific that are off schedule to be retired by the year end of ‘17. We are trying to accelerate that closer to September.
But that would likely in and of itself would have a negative bias on Pacific capacity and through the year and next year. It will also be a significant improvement to our P&L as we replace the aging airplanes with much more efficient equipment.
Helane Becker
Okay. And is that included in that system capacity guidance of down 1% that you are referring to in the comments today?
Ed Bastian
Well, I may have missed – you may have misinterpreted what I said. The last six don’t come out until the fourth quarter of next year, not this year.
Helane Becker
Okay, got it, fourth quarter ‘17. And then on an unrelated topic, I am just wondering the tax rate was down, I think it was maybe guidance was 34% or somehow I thought it was going to be 34% and the actual was 33%, so is that – is there something special in there?
Paul Jacobson
Good morning, Helane. It’s Paul.
I hope you got your breath back there. We – during the quarter, we early adopted the set new FASB policy on stock compensation with a benefit to our tax rate for the quarter.
But we still expect our full year tax rate to be 34%.
Helane Becker
Got it, okay. Thank you very much for your help.
Ed Bastian
Thank you, Helane.
Operator
And we will take our next question from Hunter Keay the Wolfe Research.
Hunter Keay
Thank you very much. Good morning.
Ed Bastian
Good morning Hunter.
Hunter Keay
So Ed, I think the last year has proven out that investors probably care more about fundamental behavior from airlines rather than traditional business metrics like profit, for example, so as you think about – you have the long-term financial goals that you guys have laid out relating to ROIC, cash flow, debt and earnings growth, I am kind of curious why you still think earnings growth is a fact, you actually highlighted that and specifically in your prepared remarks, do your – the question is, do your investors tell you that that is something they still want, because it’s certainly not something that other transport or industrial companies achieve or even strive for that’s rated multiples that are much higher than airlines right now, so I guess the question is why is that one metric still included in the bunch?
Ed Bastian
I am not sure I follow entirely your question. Why are we focused on growing our earnings, is that your question?
Hunter Keay
Yes. I guess, well, let me put it in this way, 15% is a lot and inherent in that implies some degree of probable capacity growth to get there, so you think you talk about ROIC and debt and cash flow and people I think all appreciate that, but just like you guys will probably always be a value stock, so why focus on earnings growth, is that something you hear from your investors, is that something that’s important?
Ed Bastian
Yes. We hear from our long-term investors that are continuing to improve all of our financial metrics whether it’s our ROIC or our earnings potential, our top line growth are all important.
We realize we sit in a volatile industry in a volatile space. But we are – our goal is to prove the sustainability and durability of the model.
And we think earnings growth is important, yes.
Hunter Keay
Okay, alright. That’s fine.
And then Glen, you talked about corporate a little bit, we figured airlines talk about this issue of dilution as it relates to some of the closing price pressure I mean it’s obviously, you said volumes are pretty good, so would you categorize dilution as sort of the biggest source of controllable factors contributing to some of the domestic PRASM weakness and if it’s not that, what would you say it is?
Glen Hauenstein
I think we have talked about this before. It’s more of the same.
It’s the way you are approaching the time value for time sensitive customers. And are you getting what people will be willing to pay for their time versus what the market was charging for the time.
And if you look business barriers, as these quarters rollout with government, we can all look at it. But what I think you will see is that the business fares are well below where they have been historically.
And in a lot of markets where there have been little capacity, even no capacity, even negative capacity changes over the medium term. So I hear your question.
And I wish I had the best answer for why that is there. But I think like everything, it’s a part of the cycle.
I think it has to do with lower fuel. And I think as our fuel rolls through, everybody’s P&Ls that there will be a lot more focus on that.
But that’s not – we are a small percentage in the industry. We represent less than 20% of the total industry.
So we don’t have that kind of power or predictions to be able to go out and say those things.
Hunter Keay
Okay, thank you.
Ed Bastian
Thank you.
Operator
And we will take our next question from Jamie Baker with JPMorgan.
Jamie Baker
Hi, good morning everybody.
Ed Bastian
Hi, Jamie.
Jamie Baker
Glen, other revenue declined slightly from the first quarter, which seems a bit inconsistent with seasonality, I know there’s stuff in that category other than ancillary revenue, I am just wondering what the moving pieces were that drove the decline especially since as you noted, Comfort+ turned on in the month of May?
Paul Jacobson
Hi, good morning, Jamie. It’s Paul.
One of the big items in that was lower year-over-year third-party sales from the refinery, so there is a piece of that, that has to flow through gross up revenues and net it out of expense. So with the lower crude oil prices, the product values are substantially down.
So that was about $65 million of that number.
Jamie Baker
Okay, that makes perfectly good sense. Second, if we exclude the hedge impact in the second quarter, you essentially achieved 21% operating margin and you are guiding 19% to 21% for the fourth quarter, I would have to go back, I think it’s 8 years now to find a time when third quarter margins were softer, potentially softer than in the second quarter.
And look, I am not asking you to rehash the components of the guide, the currency disclosures were certainly helpful, but it seems puzzling to me that against an industry backdrop that is so much better today than in 2008, you aren’t even able to achieve normal seasonality, is this just a blip or potentially a new normal in how we think about sort of the seasonal marginal – margin peaks?
Glen Hauenstein
Jamie, you asked a lot in that question and I have not gone back to check to 2008. 2008 to me is a blur going back in time.
Listen, our guide is our best estimate to where we sit now. We do not think that we are at a – trying to forecast any type of inflection on the cycle or the margins if that’s your question.
It’s really where we are. Fuel prices have bounced around a fair bit and fuel prices are up a bit in Q3 versus Q2, hedge aside.
And we realized that we do have unit revenue weakness, particularly in the first half of Q3 that we are recognizing. So, I think that if you look at Q3 year-on-year, I think we are about flat, 20% pre-tax margin and I think that’s a – that’s about all I can draw from that.
Jamie Baker
So nothing structural to suggest that in the long run you would not continue to be a third quarter airline so to speak, third quarter representing the absolute peak of the year?
Ed Bastian
Yes, I think the third quarter is the peak of the year. Candidly, it’s this June, July and August, right?
So, that continues to be our – that’s our sweet spot.
Jamie Baker
Yes, okay. I appreciate the disclosures.
Thanks, everybody.
Ed Bastian
Sure.
Operator
We will take our next question from Jack Atkins with Stephens.
Jack Atkins
Hey, good morning. Thanks for the time.
When we speak specifically about the capacity actions that you are taking both those announced in May and those announced this morning, can you quantify specifically how those actions will impact PRASM? Can you sort of bracket that in terms of impacts?
Ed Bastian
It will improve RASM. How is that?
Jack Atkins
Okay. So, I guess when you think about your desire to get to positive RASM by year end, will you be willing to go to negative capacity growth year-over-year to get to that level?
Ed Bastian
No, that’s not our plan.
Jack Atkins
Okay, thank you.
Operator
We will take our next question from Darryl Genovesi with UBS.
Darryl Genovesi
Hi, guys. Thanks for the time.
Ed, Glen, you both mentioned that you think fuel is the biggest driver of higher RASM on a perspective basis. And I guess I was just wondering how you come to that conclusion?
Do you mean to imply that this move from the kind of $27 or so rent that we saw for a short period in January up to 46, 47 today is likely to have driven a negative profit contribution from some flying in the network, Delta or your peers and that’s likely to drive a capacity reduction? I mean, is that kind of the thought process?
Glen Hauenstein
Well, if you look historically the trends that follow and we started with fuel around 100. We get all the way down to about 25 to 27.
And then now we have been moving back up into the mid to high 40s. It’s very, very high R-squared to go back and look at airline revenues with fuel over time and the lag time that produces the highest R-squared is about 9 months.
So, that’s over a very, very long period of time within the industry. And I think that’s what we are counting on as that on the margin when fuel was $25 there were players who were pricing their products at the incremental marginal cost of $25 fuel.
That marginal cost of production has gone up substantially since the low point. And normally, it would take about 9 months for that to flow through to airline revenues.
Darryl Genovesi
Okay and thanks for that. And then I guess just maybe to follow-up just on Hunter’s question a little bit.
With regards to the close-in yield weakness that we have seen, I guess I would have thought that by this point, assuming that problem isn’t actually getting worse and maybe it is. But I guess I would have thought that at this point, the RM systems would be sort of calibrated and thus holding on – sorry that’s not holding on to as much inventory for sort of late in the booking curve bookings.
Is that not the case?
Glen Hauenstein
Well, late in the booking curve bookings even though their depressed are significantly higher than early in the booking curve bookings. So, you never want to turn out late in the booking curve booking away even though they are depressed on a relative basis.
Darryl Genovesi
Okay. I mean I guess, I just it seems like – at least it seems like in some cases, some of these fares that are being offered very closed in are actually lower than what you can buy in it – for an advance, I mean obviously I have seen some of that myself and heard about it anecdotally and just wonder if there was any progress being made towards cleaning some of that up?
Glen Hauenstein
Yes, we can’t comment on forward pricing. But generally close-in yields are significantly higher than long AP yields.
And so that hasn’t changed.
Darryl Genovesi
Okay, thank you.
Glen Hauenstein
Thank you.
Operator
And we will take our next question from Joseph DeNardi with Stifel.
Joseph DeNardi
Hey, thank you. Glen, the flat PRASM or positive PRASM, is that being for fourth or the month of December?
And then secondly, it sounds like the capacity actions you are taking today are entirely or exclusively focused on the UK and Brexit. If you are seeing weaker close-in yields domestically and softer corporate traffic domestically, why isn’t domestic capacity coming down?
Ed Bastian
No, I think you misread that. Domestic capacity is coming down significantly.
We are decreasing our domestic offering in the fourth quarter versus the current quarter by about 300 basis points, so a very significant decrease in domestic capacity coming from us.
Joseph DeNardi
Okay. And then the RASM goal is that flat for the month of December or positive for December or is it for the full quarter?
Paul Jacobson
Yes, that’s our goal, Joe. Our goal has been to try to get there by the end of the year.
And when we get there, we will let you know.
Joseph DeNardi
Okay. Does that year mean December or the fourth quarter?
Paul Jacobson
We will take either.
Joseph DeNardi
Okay. And then Paul, next year, a year when we should expect maybe a bigger step up in the FX agreement.
Is there some sort of contractual amendment that’s coming next year, any color there?
Paul Jacobson
Good morning, Joe. There is no amendment.
As we announced in the Investor Day, we talked about it a couple year period from the overlap with the prior year agreement and then the new agreement beginning in 2017. So, we have talked about having some additional benefits occurring in 2017 going forward.
We will have more of that probably at Investor Day.
Joseph DeNardi
Okay, thank you.
Operator
We will take our next question from Savi Syth with Raymond James.
Savi Syth
Hey, good morning. Paul, if I may ask.
Your – the core cost performance, I think if you adjust for kind of the labor increased pressures. It’s been quite impressive and I am guessing FX is going to benefit about maybe 0.5 point.
But could you talk a little bit more about what’s driving the kind of – and I am curious, I mean this is the kind of basis that kind of the declines that we are seeing in contract carrier maintenance, I think landing pack services. I am just trying to get an understanding of – does that continue in the second half in 2017 or how should we think about these offsets that you have been driving?
Paul Jacobson
Sure. Good morning, Savy and thanks for those comments.
The biggest driver of our cost performance has obviously been the continued upgauging and efficiency being created in the business through that. As we have talked about in the past, our upgauging has been accruing at about a rate of about 5% a year from 2012 through 2015.
And we have, with our current fleet plans about a 7% upgrade – upgauge between 2016 and 2020. So clearly, that has had a material benefit on our ability to drive cost efficiencies in the business.
That combined with the innovation of Gill’s team and others across the operational sphere have been a huge, huge benefit for us going forward. And we’ have got to continue to find ways to drive productivity in the business without impacting and in fact, enhancing the customer and employee experience, which I think the team has done a great job of.
Savi Syth
Alright, thanks for that. And then a follow-up question.
And Glen, I hate to beat a dead horse on this, but I was just I am trying to understand on the close-in yields. If it deteriorated as you went through the quarter and the reason I ask that is, with the comment on leisure yields transcend.
I thought it was kind of those lower fares that are putting pressure then on close-in yields and it’s kind of the lowest fares and leisure fares strength and I am kind of surprised that we are not seeing at least no further deterioration in those close-in yields and so I am wondering is this maybe sort of actual weakness in corporate that we are seeing?
Glen Hauenstein
So, I think there are a couple of things that we just did a poll survey and maybe I will let Steve talk to that. Steve, you want to pipe in on.
Steve Sear
Yes. Our June corporate survey actually had an uptick year-over-year, but basically stable outlook on all of our top corporate accounts.
So we see it really relatively flat demand throughout the entire year so far. So again, we see a little bit on that yield pressure.
Glen Hauenstein
And so that would say that the real component is that we have flattish corporate demand. We have corporate yields down on the five to seven category.
And we have capacity that’s growing in excess at the rate of growth of the corporate demand set, which is also putting downward pressure on the total RASM. And those are kind of the three components we see.
Savi Syth
That’s very helpful. Thanks.
And just one clarification on the earnings growth over time, you are talking about EPS growth right and not necessarily just earnings?
Glen Hauenstein
We are telling EPS growth, that’s right Savi.
Savi Syth
Alright. Thank you.
Glen Hauenstein
Thank you.
Jill Sullivan Greer
And we are going to have time for one more question from the analysts.
Operator
And we will take our final question from Dan McKinsey from Buckingham Research.
Dan McKinsey
Okay. Good morning guys.
Thanks for squeezing me in here. Glen, how is Delta getting to less capacity exactly from the reduced Atlantic flying, is it less capacity with the same number of planes, is it flying being redeployed to other markets as an optimization move or are some planes potentially being early retired here?
Glen Hauenstein
It’s a little bit of all of the above. If you look at our fleet counts for summer of this year versus summer of last year, it is almost flat.
I think based on about 1,500 flying airplanes, we were up about eight. So the increased capacity has been coming on the marginal utilization because of lower fuel and what we are seeing is we are not getting paid for that, so that’s coming out.
And we will be doing a lot of – more cancellations in the off-peak, more cancellations in the ad-hoc world, as well as gauge reductions. And may be we haven’t committed to it yet but some markets will not make it through.
Dan McKinsey
Understood. Okay.
And then Glen, in May, you talked about seeing some green shoots in the Latin America region and since then we have had a huge move in FX particularly to Brazil and just given what’s happening with capacity and foreign exchange to the country and to the region, I am wondering if you can collaborate a little bit more in the revenue roadmap from here in this entity. And then tied to that, is there a revenue benefit potentially from Aeromexico that could be incremental in the back half of the year?
Glen Hauenstein
Well, I think we have mentioned in the prepared remarks that the Latin unit revenues were up in the month of June for the first time in 26 months. So those green shoots that we saw last quarter are actually coming in and again being driven by strength in Mexico and a lot of that strength may be related to the presence of Delta and Aeromexico together because it seems that we are getting a much higher share of some of the corporate travel to and from Mexico.
And we have had historically even before our ATI enabled joint venture goes into place. And Peter Carter is sitting next to me, may be Peter can talk about the timing of when we believe Aeromexico will be approved.
Peter Carter
Yes. Good morning, Dan.
We expect it to be approved in the fourth quarter.
Dan McKinsey
Understood. Thanks.
And then just one final housecleaning Paul, has Delta been active in buying back stocks since June 30?
Paul Jacobson
Dan, good morning, we – as we talked about before, we are in the market every day, buying back stock. And this quarter is no different.
Dan McKinsey
Thanks for the time guys.
Glen Hauenstein
Thanks, Dan.
Jill Sullivan Greer
Let’s now wrap up the analyst portion of the call. And I will now turn it over to Kevin.
Kevin Shinkle
Good morning. This is Kevin Shinkle.
Welcome to the media portion of the call. We will have about 10 minutes for questions.
So please limit yourself to one question and one brief follow-up. Kyle, will you please provide the instructions on how to register and ask the question.
Operator
[Operator Instructions] We will take our next question from Jeffrey Dastin with Reuters.
Jeffrey Dastin
Thank you for taking the question. Might you breakdown why Trans-Atlantic flights will have one of their most profitable summers in history, is it countries and with which countries and which point of origin, leisure was corporate bookings, that sort of thing?
Ed Bastian
We don’t provide that level of detail, Jeffrey. Trans-Atlantic for us historically has been a strong source of profit.
And as we have expanded to the UK with our Virgin relationship, we have just built on that.
Jeffrey Dastin
Great. Thank you.
And then the follow-up will be, how do forward bookings to the United Kingdom for the fourth quarter compare to how they were last year as in were bookings are faster in the capacity tweaks not just the currency?
Ed Bastian
The currency certainly has impacted the booking point of sale. And we have seen some strength in the U.S.
point of sale to the UK as the talent has deteriorated. Likewise, we have seen some reduction in our UK point of sale coming to the U.S.
And that’s why we are making certain of the capacity adjustments combined with overall high levels of capacity in the North Atlantic, which is putting pressure on yields even before Brexit.
Jeffrey Dastin
Great. Thank you.
Operator
And we will take our next question from Michael Sasso with Bloomberg News.
Michael Sasso
Hey, good morning. I am just a little confused about the issue with close-in bookings, it sounds like demand is still okay, but that maybe some of the problem is too much capacity, is that what I am hearing, can you just explain what specifically is causing those close-in yields to be lower?
Ed Bastian
Well, industry pricing is lower year-over-year and that’s probably the main driver of it. But when you have capacity growth and you have stable demand, that’s also a negative impact to the total composition of your unit revenues, because corporate travel is of course the highest yielding piece of our yield curve.
So it’s a combination of too much capacity and too low fares.
Glen Hauenstein
Next question.
Operator
And we will take our next question from David Koenig with The Associated Press.
David Koenig
Hi, I thought you might touch on this in the last answer in the analyst session, but should we expect you to drop any routes or markets entirely as part of your reduced planned capacity – hello?
Ed Bastian
Hello, we don’t comment on future scheduled changes or future pricing initiatives as a general...
David Koenig
Okay. Yes.
I am not asking you to name the routes or markets, I am just wondering if that’s something we should expect as a possibility?
Ed Bastian
We evaluate them all the time and we add routes and delete routes from our network on a regular basis. So the answer is that we will adjust to market conditions as we see them evolve.
David Koenig
Okay, thanks.
Operator
We will take our next question from Kelly Yamanouchi with Atlanta Journal Constitution.
Kelly Yamanouchi
Hi there. I am wondering about the UK origin leisure markets that you mentioned the capacity cuts will be targeted at, I was just wondering what kinds of markets are UK origin leisure markets?
Glen Hauenstein
Well, clearly London has – is the biggest market in the UK. But London has a very, very high business component.
As a matter of fact, London represents about 35% of the total business to and from the U.S. between U.S.
and Europe. So what we are doing is we are taking potentially down frequencies in off peak days.
We are down-gauging equipment into the regional cities. Manchester tends to be a perfect example of much higher UK point of origin market and that one because there is a lot of leisure travel coming out of Manchester.
And those would be the types of markets that we would look at to reduce.
Ed Bastian
Kelly, this is Ed. We have grown substantially in the UK in the last several years, both we and our partner Virgin Atlantic.
So I wouldn’t be focused on it. This is more trimming from the overall growth.
You have to look at this over a longer time horizon. And our capacity is up substantially to the UK over any period of time.
So I think this is a normal part of the ebb and flow of supply and demand.
Kelly Yamanouchi
Alright, great. Thank you very much.
Operator
We will take our next question from Ted Reed from The Street.
Ted Reed
A Brexit question, my impression from what you said was that more Americans are going to UK in the summer. And so there is good – very good summer travel, but in the winter, the UK travel to the U.S., the U.S.
leisure destinations is what’s declining. Is that fair?
Ed Bastian
That’s our best estimate, Ted, yes.
Ted Reed
When you say leisure destination, does that mean Florida for the UK people coming in the winter, is that Florida?
Ed Bastian
Florida, Vegas, just broadly New York.
Ted Reed
Okay, alright. Thank you.
Operator
We will take our next question from Edward Russell with Flight Global.
Edward Russell
Hi, yes. On the UK cuts, I was wondering are those going to be seasonal just during the winter and the off-peak periods or are they intended to be permanent cuts?
Ed Bastian
They are just seasonal.
Edward Russell
Okay. And then second question, what does this mean for the new routes that you have announced for 2017 into the UK, Portland, additional frequencies from Detroit and Atlanta?
Paul Jacobson
There is no changes.
Edward Russell
Thank you very much.
Operator
And we will take our next question from Linda Loyd with the Philadelphia Inquirer.
Linda Loyd
Thank you. Thank you for taking my question.
With the Trainer refinery posting a loss for the second quarter, $10 million loss in the latest quarter and a $28 million loss in the first quarter, is the refinery still a benefit to Delta, are you still glad you bought it?
Paul Jacobson
Good morning, Linda. This is Paul Jacobson.
Yes, the answer is absolutely. The Trainer refinery for us has been a huge success.
And as we talked about the lower crack spread environment that exists for the entire refining complex is a tremendous benefit to the airline. So, as part of the integrated fuel management strategy, we are absolutely still very pleased with that purchase and that investment.
Linda Loyd
Is there a time you envisioned the refinery becoming profitable again as you look out in future quarters or this year?
Paul Jacobson
Well, I mean, certainly we have had profitable years with the refinery and that business is very cyclical. We certainly hope it doesn’t come at the expense of significantly higher fuel for the airline.
But you have got to remember that its part of that integrated strategy and we know we will have good times and bad times with that refinery, but we are absolutely committed to it despite – or irrespective of its profits.
Ed Bastian
Yes, Linda, this is Ed. Let me be very clear.
We are very happy with the refinery. They are doing a great job.
And yes, we expect they will continue to generate profits as they have historically for Delta over time.
Linda Loyd
Okay, thank you very much.
Kevin Shinkle
Kyle, we have time for one last question.
Operator
And we will take our final question from Elliott Blackburn with Argus Media.
Elliott Blackburn
Good morning. Thanks for taking the question.
Just building off that last question. Can you kind of go through, I mean, considering the fact that the refinery will be adding to your fuel costs it sounds like for the rest of the year.
What does success look like more broadly for that refinery? How do you guys valuate that refinery as a contributor?
Paul Jacobson
Well, Elliott, the main purpose of buying that refinery as articulated in our – all of our commentary has been to still supply jet fuel and increase the supply of jet fuel, which we have done very successfully. We measured the success of that refinery based on how well it operates and the team that we have there has been performing extraordinarily well.
From a cost basis, from an operational reliability cost basis, the refinery leads all comparable indices both in size and geography for its efficiency and its productivity. The absolute crack spreads and the economics of that, you have got to take into account the airline.
And when crack spreads are down that puts pressure on refinery profits, but it’s a huge windfall for the airline as well. So, we feel very good about that.
And as long as it continues to operate the way it is, we view it as strongly successful.
Elliott Blackburn
But it seems like your peers that are also buying jet fuel benefit from that without actually having the risk of operating a refinery. So, I guess can you help me understand why the refinery itself is a unique benefit to Delta in light of that?
Paul Jacobson
Well, the fact that it may or may not be a benefit to our customers doesn’t have any – or our competitors, doesn’t have any bearing as to whether or not we view it as a success for Delta and we do things that are good for us and the refinery is a great example of that.
Ed Bastian
Don’t forget, this was a refinery that was closed. And when we reopened it, we added 40% more supply, the jet fuel into the New York harbor.
That alone was a substantial benefit for Delta. And to the extent it benefits our colleagues and industry all the better.
Elliott Blackburn
Thank you very much.
Operator
And that does conclude our Q&A session. I would now like to turn it back over to management for any additional or closing remarks.
Ed Bastian
With that said, that concludes everything. Thank you for joining us.
Operator
And this does conclude today’s conference call. Thank you all for your participation.
You may now disconnect.