Delta Air Lines (Atlanta) today reported financial results for the March 2015 quarter kicking off the airlines earnings reporting period. Key points include according to the airline:

Delta’s adjusted pre-tax income1 for the March 2015 quarter was $594 million, an increase of $150 million over the March 2014 quarter on a similar basis. Delta’s adjusted net income for the March 2015 quarter was $372 million, or $0.45 per diluted share, and its adjusted operating margin was 8.8 percent.

On a GAAP basis, Delta’s March quarter pre-tax income was $1.2 billion, operating margin was 14.9 percent and net income was $746 million, or $0.90 per share.

Results include $136 million in profit sharing expense, recognizing Delta employees’ contributions toward meeting the company’s financial goals.

The company used its strong cash generation in the quarter to return $500 million to shareholders through dividends and share repurchases and to make $904 million in pension contributions.

“Delta’s business is performing well, producing the best March quarter, both operationally and financially, in Delta’s history,” said Richard Anderson, Delta’s chief executive officer. “While the strong dollar is creating headwinds with international revenues, it also contributes to the lower fuel prices which will offset those headwinds with over $2 billion in fuel savings this year. We are looking at June quarter operating margins of 16-18 percent with over $1.5 billion of free cash flow—these record results and cash flows show that the strong dollar is a net positive for Delta.”

Capacity Actions in Light of Strong Dollar and Lower Energy Prices

To address currency headwinds, Delta plans to reduce its international capacity by 3 percent year over year for the winter schedule. These international reductions, combined with 2 percent domestic growth, will result in flat system capacity for the December quarter. Capacity adjustments will be focused on markets that have been most affected by the strong dollar and markets where demand has been negatively impacted by the decline in oil prices. Key actions for the December quarter will include a 15-20 percent reduction in service from Japan, a 15 percent reduction to Brazil, a 15-20 percent reduction to Africa, India and the Middle East, and suspension of service to Moscow for the winter season.

Revenue Environment

Delta’s operating revenue improved 5 percent, or $472 million, in the March 2015 quarter compared to the March 2014 quarter. Traffic increased 3.6 percent on a 5.0 percent increase in capacity, which includes 2 points due to capacity removed in the first quarter of 2014 as a result of winter storms. Foreign exchange pressured revenue by $105 million for the quarter.

Passenger revenue increased 3 percent, or $246 million, compared to the prior year period.

Passenger unit revenue (PRASM) decreased 1.7 percent year over year primarily driven by 1.5 points of negative foreign exchange impact.

Cargo revenue was unchanged from the prior year period as higher volumes offset lower yields.
Other revenue increased 22 percent, or $226 million, driven by SkyMiles revenues and third-party refinery sales.

“For the March quarter, Delta delivered solid 5 percent top line growth and a 17.8 percent operating margin at market fuel prices,” said Ed Bastian, Delta’s president. “The substantial benefit from lower fuel prices will again more than offset the unit revenue decline of 2 to 4 percent for the June quarter to produce operating margins north of 20 percent at market fuel prices.”

Fuel

Adjusted fuel expense2 increased $23 million as lower market fuel prices were offset by $1.1 billion of settled hedge losses, including $300 million of early settlements of contracts originally settling in the second half of 2015 as the company restructured its hedge book. Delta’s average fuel price was $2.93 per gallon for the March quarter. Operations at the refinery produced an $86 million profit for the March quarter, a $127 million improvement year-over-year.

Cost Performance

Consolidated unit cost adjusted for fuel expense, profit sharing and special items (CASM-Ex3), was down 1.4 percent in the March 2015 quarter on a year-over-year basis, with higher capacity, foreign exchange and the benefits of Delta’s domestic refleeting and other cost initiatives offsetting the company’s investments in its employees, products and operations.

“With nearly 10 percent of our expenses non-dollar denominated, we are seeing cost tailwinds from the strong dollar which should benefit our non-fuel unit costs by 1 point in the June quarter,” said Paul Jacobson, Delta’s chief financial officer. “With this currency benefit and the strong cost control that is a hallmark of the Delta culture, we are on track to deliver our eighth consecutive quarter of non-fuel unit cost growth below 2 percent in the June quarter.”

Adjusted for special items, non-fuel operating expense in the quarter increased $333 million year-over-year driven by wage increases, profit sharing, and higher volume-related expenses. These cost increases were partially offset by foreign exchange and savings from Delta’s cost initiatives.

Non-operating expense, adjusted for special items, declined by $34 million as a result of $55 million in lower interest expense, partially offset by an $11 million higher foreign exchange loss on foreign-denominated assets and liabilities compared to the first quarter of 2014.

Cash Flow

Cash from operations during the March 2015 quarter was $1.1 billion and free cash flow was $511 million, driven by the company’s March quarter profit and the normal seasonal increase in advance ticket sales. Cash flow from operations and free cash flow exclude the return of fuel hedge margin posted. Capital expenditures during the March 2015 quarter were $586 million, including $411 million in fleet investments. During the quarter, Delta’s net debt and capital lease maturities were $260 million.

With its strong cash generation in the March 2015 quarter, the company returned $500 million to shareholders. The company paid $75 million in cash dividends and repurchased 9.3 million shares for $425 million. Delta also made over $900 million in pension contributions during the quarter.

Delta ended the quarter with adjusted net debt4 of $7.4 billion, including cash held by counterparties as hedge margin. The company has achieved nearly $10 billion in net debt reduction since 2009, resulting in a roughly 50% reduction in annual interest expense.

GAAP Metrics Related to Cost Performance and Cash Flow

On a GAAP basis compared to the March 2014 quarter, consolidated CASM declined 8 percent, total operating expense was down $306 million, and fuel expense declined $600 million. GAAP fuel cost per gallon for the quarter was $2.29. Non-operating expenses for the quarter decreased by $73 million. Cash from operations for the March 2015 quarter was $1.6 billion and the company ended the quarter with debt and capital lease obligations of $9.6 billion on a GAAP basis.

June 2015 Second Quarter Guidance

Following are Delta’s projections for the June 2015 quarter:

2Q15 Forecast

Operating margin

16% – 18%
Fuel price, including taxes, settled hedges and refinery impact

$2.35 – $2.40
CASM – Ex (compared to 2Q14)

Up 0 – 1%
System capacity (compared to 2Q14)

Up ~3%

Special Items

Special items, net of taxes, in the March 2015 quarter totaled $374 million, including:

$372 million for mark-to-market adjustments and settlements on fuel hedges;
$8 million for mark-to-market adjustments on hedges owned by Virgin Atlantic; and
a $6 million charge for fleet and other items, primarily associated with Delta’s domestic fleet restructuring initiative.
Special items, net of taxes, in the March 2014 quarter totaled $68 million, including:

a $31 million charge associated with Delta’s domestic fleet restructuring;
a $21 million mark-to-market adjustment on fuel hedges;
an $11 million charge for debt extinguishment; and
a $5 million charge for mark-to-market adjustments on hedges owned by Virgin Atlantic.

End Notes

(1) Note A to the attached Consolidated Statements of Operations provides a reconciliation of non-GAAP financial measures used in this release to the comparable GAAP metric and provides the reasons management uses those measures.

(2) Adjusted fuel expense reflects, among other things, the impact of mark-to-market (“MTM”) adjustments and settlements. MTM adjustments are defined as fair value changes recorded in periods other than the settlement period. Such fair value changes are not necessarily indicative of the actual settlement value of the underlying hedge in the contract settlement period. Settlements represent cash received or paid on hedge contracts settling during the period. These items adjust fuel expense to show the economic impact of hedging, including cash received or paid on hedge contracts during the period. During the March 2015 quarter, we paid $302 million to early settle contracts that were originally scheduled to expire in the second half of 2015. See Note A for a reconciliation of adjusted fuel expense and average fuel price per gallon to the comparable GAAP metric.

(3) CASM – Ex: In addition to fuel expense, profit sharing and special items, Delta believes adjusting for certain other expenses is helpful to investors because other expenses are not related to the generation of a seat mile. These expenses include aircraft maintenance and staffing services Delta provides to third parties, Delta’s vacation wholesale operations, and refinery cost of sales to third parties. The amounts excluded were $293 million and $184 million for the March 2015 and March 2014 quarters, respectively. Management believes this methodology provides a more consistent and comparable reflection of Delta’s airline operations.

(4) Adjusted net debt includes $383 million of hedge margin receivable, which is cash that we have posted with counterparties as hedge margin. See Note A for additional information about our calculation of adjusted net debt.

Fiona Cincotta, senior market analyst at www.finspreads.com commented on the financial results:

“Delta reported the best first quarter, from a financial perspective, in the company’s history. The airline announced profits, which more than tripled to $746 million from $213 million a year ago and an increase in revenue of 5% to $9.4 billion. The strong dollar has dented Delta’s international revenue to the tune of about $105 million, however it has also been a factor in the decline of the price of oil which has meant cheaper fuel for the company so the strong dollar is actually net positive for Delta. Furthermore Delta expects to save more than $2 billion on fuel this year and also expects record profit margins and free cash flow for the second quarter.

Despite these encouraging results, which beat analyst’s expectations, Delta has also announced that it will be reducing international flights by a further 3% during the last 3 months of the year. This seems to be quite a prudent move by a company who has reported the best first quarter in its history. However, as big price cuts are no longer a significant part for large US airline’s strategy, pulling back on flights seems like a sensible option given the expected strength of the dollar going forward.”

Copyright Photo: TMK Photography/AirlinersGallery.com. Delta is now leasing the former AirTran Airways Boeing 717 fleet from Southwest Airlines. Boeing 717-231 N921AT (msn 55082) taxies at Toronto (Pearson).

Delta Air Lines aircraft slide show (current livery):