DELTA AIR LINES, INC. quarterly report, Q2 FY2016

Delta Air Lines, Inc. — Q2 2016 Form 10-Q

Business context and reporting period. Delta reported results for the quarter and six months ended June 30, 2016. The unaudited interim financial statements were reviewed by Ernst & Young, not audited. Airline results are seasonal and affected by fuel-price volatility.

Financial results and position

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Operating revenue	$10.447B	$10.707B	$19.698B	$20.095B
Operating income	$2.423B	$2.474B	$3.963B	$3.872B
Income before taxes	$2.350B	$2.366B	$3.784B	$3.552B
Net income	$1.546B	$1.485B	$2.492B	$2.231B
Diluted EPS	$2.03	$1.83	$3.23	$2.72

Revenue and operating performance: Q2 passenger revenue fell 1.8%, while total operating revenue declined 2.4%. Passenger revenue per available seat mile (PRASM) fell 4.9% on 3.2% higher capacity; load factor was 85.5%, down 0.1 percentage point. Consolidated cost per available seat mile (CASM) was 12.16 cents, down 5.6%; CASM-Ex including profit sharing, a non-GAAP measure, was 9.54 cents versus 9.55 cents.
Profit and fuel: Q2 operating income declined $51 million, while net income rose $61 million. Lower fuel expense benefited results, partly offset by higher wages and weaker revenue. Management reported adjusted Q2 pre-tax income of $1.682B versus $1.640B, excluding specified items, principally fuel-hedge mark-to-market adjustments and settlements.
Cash flow and investment: First-half operating cash flow was $4.226B, compared with $4.381B. Investing activities used $1.713B, including $1.917B of capital expenditures; financing activities used $2.823B. Cash and equivalents ended the period at $1.662B.
Liquidity and debt: Delta reported $5.4B of unrestricted liquidity: $3.0B in cash, cash equivalents and short-term investments, plus $2.4B in undrawn revolving credit facilities. Debt and capital leases were $7.9B principal amount ($7.492B net carrying amount). The company was in compliance with financing covenants.
Balance sheet: Total assets were $51.634B and stockholders’ equity was $11.810B at June 30, 2016. Pension, postretirement and related benefit liabilities were $12.576B. Current assets were $7.638B and current liabilities were $16.250B.
Shareholder returns: Delta repurchased $1.801B of stock and paid $210M in dividends in the first half. The board approved a 50% increase in the quarterly dividend to $0.2025 per share beginning in the September 2016 quarter.

Material changes versus comparable periods

Q2 revenue fell $260M (2.4%); first-half revenue fell $397M (2.0%). Passenger yield and PRASM weakened despite capacity growth, and cargo revenue dropped 20.3% in Q2 and 22.9% in the first half.
Q2 operating expense decreased $209M, mainly due to lower fuel costs; salaries and related costs increased 8.9% in Q2 and 9.7% for the first half, primarily following 2015 pay increases.
First-half fuel expense, including regional carriers, declined $1.010B, primarily reflecting a 33% lower market price per gallon, partly offset by increased consumption and weaker refinery results. The refinery recorded a $38M first-half loss versus $176M profit in the prior-year period.
Principal debt and capital leases declined to $7.9B from $9.3B at June 30, 2015. First-half debt and lease payments were $1.149B.
First-half pension contributions totaled $1.3B, including $350M of treasury shares; Delta said these contributions satisfied 2016 required contributions on an accelerated basis.

Outlook, commentary, risks and unusual items

Management expected positive operating cash flow for the remainder of 2016 and said expected cash needs for the next 12 months could be met through operating cash flow, existing liquidity and financing arrangements. It projected a 2016 effective tax rate of approximately 34%.
Delta expected 2016 investment of more than $3B, primarily for aircraft and fleet modifications. Aircraft purchase commitments totaled approximately $15.98B, including an agreement for 75 Bombardier CS100 aircraft and commitments for 37 additional A321 aircraft. A potential Aeroméxico tender offer was expected in the second half of 2016 and could require approximately $700M.
To address weak yields and supply-demand imbalances, Delta planned to reduce U.S.-U.K. capacity in the second half of 2016 and continue capacity reductions in underperforming Pacific markets; it was also reducing capacity in Brazil. Management cited domestic close-in yield weakness, U.S. dollar strength, excess capacity in some international markets, and economic challenges in certain regions.
Delta reduced and effectively neutralized its airline fuel-hedge positions, locking in net hedge settlements for the remainder of 2016 and 2017; it early settled $455M of 2016 positions during Q2. Fuel prices remain a significant exposure: the filing estimated a $3.58B change in fuel cost for a hypothetical 40% price change over July 2016–December 2017, before demand or mitigation effects.
Other notable exposures include approximately $16.0B of aircraft purchase commitments; a $300M guarantee of GOL’s loan facility, secured by GOL’s interest in Smiles, with no liability recorded while GOL remained compliant; and up to $75M of debtor-in-possession liquidity for bankrupt regional carrier Republic Airways. Delta said it did not expect Republic’s bankruptcy to materially affect its operations or financial statements.
The refinery recorded $54M of renewable-fuel credit (RIN) expense in Q2 2016 versus $22M a year earlier. Delta also disclosed that a court granted class certification in the first-bag-fee antitrust litigation on July 12, 2016; defendants’ summary-judgment motions remained pending. Delta said it believed the claims were without merit.
Delta identified uncertainty following the U.K. referendum to leave the EU, including potential adverse economic, currency, regulatory or air-travel agreement changes. Adoption of the new lease accounting standard was expected to significantly affect the balance sheet, though Delta did not expect changes to lease expense recognition or cash-flow presentation.
Delta early adopted share-based compensation guidance in Q2, recognizing $95M of previously unrecognized excess tax benefits in deferred taxes and opening retained earnings, and $24M of excess tax benefits in the income tax provision.

Important facts for investors to verify

How passenger yields, PRASM and international capacity reductions develop, particularly in the Atlantic, Pacific and Latin America regions.
Fuel-price exposure and the cash, earnings and settlement effects of Delta’s revised hedge positions.
Execution, financing and cash requirements for aircraft commitments, fleet investment and any Aeroméxico tender offer.
Progress in reducing debt and funding pension obligations, alongside planned repurchases and the higher dividend.
Developments in the checked-bag antitrust case, Republic Airways bankruptcy arrangements, and GOL’s financial condition and loan compliance.
Potential effects of Brexit, RIN requirements and lease-accounting adoption; the filing does not provide a clear quantified estimate for these impacts.