Business context and reporting period
Delta Air Lines, Inc. reported unaudited results for the three and nine months ended September 30, 2016, compared with the same 2015 periods. The independent accountant performed an interim review, not an audit. Delta operates airline and refinery segments; seasonal travel demand and fuel-price volatility mean interim results may not indicate full-year performance.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $10.483B | $11.107B | $30.181B | $31.202B |
| Operating income | $1.969B | $2.213B | $5.932B | $6.085B |
| Income before taxes | $1.900B | $2.072B | $5.684B | $5.624B |
| Net income | $1.259B | $1.315B | $3.751B | $3.546B |
| Diluted EPS | $1.69 | $1.65 | $4.92 | $4.37 |
| Operating margin | 18.8% | 19.9% | 19.7% | 19.5% |
- Revenue and unit metrics: Q3 revenue fell 5.6%; passenger revenue declined 5.5% and PRASM fell 6.8% with capacity up 1.5%. Nine-month revenue declined 3.3%; passenger revenue fell 3.2% and PRASM declined 5.5% with capacity up 2.4%.
- Costs: Q3 operating expense decreased 4.3%, including a 21.8% reduction in aircraft fuel and related taxes; salaries and related costs rose 8.2%. Consolidated CASM was 12.33 cents, down 5.7%; CASM-Ex including profit sharing was 9.58 cents, up 0.1%.
- Cash flow: Nine-month operating cash flow was $6.080B, versus $6.448B. Capital expenditures were approximately $2.6B. Cash and cash equivalents ended at $1.638B, down from $1.972B at year-end 2015.
- Liquidity and debt: Delta reported $5.6B of unrestricted liquidity: $3.2B cash and short-term investments and $2.4B in undrawn revolving facilities. Debt and capital lease principal was $7.7B, compared with $8.9B a year earlier. Delta said it was in compliance with financing covenants.
- Shareholder returns: Delta repurchased $2.3B of shares and paid $360M in dividends during the first nine months. The quarterly dividend was raised 50% to $0.2025 per share beginning in Q3.
Material changes versus prior periods
- Q3 pretax income decreased $172M year over year, despite lower fuel expense; operating income fell 11.0%, while net income declined 4.3%. For the first nine months, net income rose 5.8% despite lower revenue and operating income.
- Management attributed Q3 revenue pressure to U.S. dollar strength, supply-demand imbalances—especially in the Atlantic and China—and weakness in domestic close-in yields. The August technology outage also reduced PRASM by about one percentage point.
- The outage followed a loss of power at Delta’s data center on August 8; about 2,300 flights were canceled over three days. Delta estimated a $150M pretax impact, including recovery costs.
- Fuel hedge losses were $11M for Q3 and $326M for the nine-month period, versus $250M and $563M, respectively, in 2015. The refinery recorded Q3 and nine-month losses of $45M and $83M, versus profits of $106M and $282M in 2015.
Outlook, risks, contingencies and unusual items
- Delta expected to meet cash needs for the next 12 months with operating cash flows, available cash and investments, and financing arrangements; it also expected positive operating cash flow for the remainder of 2016. Management projected an approximately 34% effective tax rate for 2016.
- Delta planned to reduce U.S.-U.K. capacity in Q4 2016 and optimize Pacific routes, including planned Tokyo Haneda service from Los Angeles and Minneapolis. Management cited continued exposure to weak yields, foreign exchange movements, economic conditions and fuel-price volatility. Absent new derivatives, a one-cent-per-gallon fuel-price increase would add about $40M to annual fuel expense.
- Delta had approximately $15.4B of future aircraft purchase commitments. Its LAX terminal project included an initial $350M investment and a possible additional $1.5B expansion, subject to approvals; Delta expected most project costs to be funded through loans repaid from airport-authority purchases of completed assets.
- A proposed pilot agreement remained subject to finalization, union approval and pilot ratification. If ratified, it would provide an 18% pay increase retroactive to January 1, 2016. Delta also disclosed $922M of accrued profit-sharing expense for the first nine months.
- Delta expected its Aeroméxico tender offer, subject to regulatory approvals, to be completed within six months; the potential payment was estimated at approximately $710M. Delta had guaranteed a $300M GOL loan facility; no liability was recorded because GOL remained compliant with its loan terms.
- Legal matters include a first-bag-fee antitrust class action: class certification was granted, appellate review was pending, and summary-judgment motions remained pending. Management said resolution of its legal proceedings was not expected to materially affect the financial statements. The Republic Airways bankruptcy-related $75M debtor-in-possession facility remained undrawn.
- Adoption of the new lease accounting standard was expected to significantly affect the balance sheet, though Delta did not expect changes to lease expense presentation in the income statement or cash flow statement. Adoption of the new revenue standard was still under evaluation.
Important facts for investors to verify
- Whether the pilot agreement was ratified and the effect of any retroactive pay increase on labor costs.
- Actual financial, operational and customer effects of the August outage compared with the $150M estimate.
- Passenger-yield and PRASM trends, capacity discipline, and the pace of recovery in the Atlantic, China and domestic close-in markets.
- Fuel costs, hedge settlements and refinery performance, including the effect of fuel-price changes on margins and cash flow.
- Progress and funding for aircraft commitments and LAX redevelopment, as well as approvals and cash needs for the Aeroméxico tender offer.
- Developments in the antitrust litigation and any change to Delta’s stated assessment of legal contingencies.