10-Q 1 dal930201410q.htm 10-Q DAL 9.30.2014 10Q


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-5424
DELTA AIR LINES, INC.
(Exact name of registrant as specified in its charter)

State of Incorporation: Delaware

I.R.S. Employer Identification No.: 58-0218548

Post Office Box 20706, Atlanta, Georgia 30320-6001

Telephone: (404) 715-2600
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer 
þ
Accelerated filer 
o
Non-accelerated filer 
o
Smaller reporting company
o
 
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
Number of shares outstanding by each class of common stock, as of September 30, 2014:
Common Stock, $0.0001 par value - 836,941,362 shares outstanding
This document is also available through our website at http://www.delta.com/about_delta/investor_relations.
 









Unless otherwise indicated, the terms “Delta,” “we,” “us,” and “our” refer to Delta Air Lines, Inc. and its subsidiaries.

FORWARD-LOOKING STATEMENTS

Statements in this Form 10-Q (or otherwise made by us or on our behalf) that are not historical facts, including statements about our estimates, expectations, beliefs, intentions, projections or strategies for the future, may be “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from historical experience or our present expectations. Known material risk factors applicable to Delta are described in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (“Form 10-K”), other than risks that could apply to any issuer or offering. All forward-looking statements speak only as of the date made, and we undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this report.


1




DELTA AIR LINES, INC.
Consolidated Balance Sheets
(Unaudited)
(in millions, except share data)
September 30,
2014
 
December 31,
2013
ASSETS
Current Assets:
 
 
 
Cash and cash equivalents
$
2,510

 
$
2,844

Short-term investments
1,852

 
959

Restricted cash, cash equivalents and short-term investments
149

 
122

Accounts receivable, net of an allowance for uncollectible accounts of $20 and $23 at September 30, 2014 and
December 31, 2013, respectively
2,135

 
1,609

Fuel inventory
602

 
706

Expendable parts and supplies inventories, net of an allowance for obsolescence of $113 and $118
at September 30, 2014 and December 31, 2013, respectively
340

 
357

Deferred income taxes, net
2,187

 
1,736

Prepaid expenses and other
1,220

 
1,318

Total current assets
10,995

 
9,651

Property and Equipment, Net:
 
 
 
Property and equipment, net of accumulated depreciation and amortization of $8,959 and $7,792
at September 30, 2014 and December 31, 2013, respectively
21,722

 
21,854

Other Assets:
 
 
 
Goodwill
9,794

 
9,794

Identifiable intangibles, net of accumulated amortization of $782 and $738
at September 30, 2014 and December 31, 2013, respectively
4,614

 
4,658

Deferred income taxes, net
3,696

 
4,992

Other noncurrent assets
1,119

 
1,303

Total other assets
19,223

 
20,747

Total assets
$
51,940

 
$
52,252

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
 
 
 
Current maturities of long-term debt and capital leases
$
1,169

 
$
1,547

Air traffic liability
4,992

 
4,122

Accounts payable
2,577

 
2,300

Accrued salaries and related benefits
2,299

 
1,926

Frequent flyer deferred revenue
1,584

 
1,861

Taxes payable
687

 
673

Fuel card obligation
603

 
602

Other accrued liabilities
902

 
1,121

Total current liabilities
14,813

 
14,152

Noncurrent Liabilities:
 
 
 
Long-term debt and capital leases
8,970

 
9,795

Pension, postretirement and related benefits
11,529

 
12,392

Frequent flyer deferred revenue
2,386

 
2,559

Other noncurrent liabilities
1,946

 
1,711

Total noncurrent liabilities
24,831


26,457

Commitments and Contingencies
 
 
 
Stockholders' Equity:
 
 
 
Common stock at $0.0001 par value; 1,500,000,000 shares authorized, 856,710,375 and 869,484,981
shares issued at September 30, 2014 and December 31, 2013, respectively

 

Additional paid-in capital
13,464

 
13,982

Retained earnings
4,244

 
3,049

Accumulated other comprehensive loss
(5,100
)
 
(5,130
)
Treasury stock, at cost, 19,769,013 and 18,041,848 shares at September 30, 2014 and
December 31, 2013, respectively
(312
)
 
(258
)
Total stockholders' equity
12,296

 
11,643

Total liabilities and stockholders' equity
$
51,940

 
$
52,252

 
 
 
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

2



DELTA AIR LINES, INC.
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions, except per share data)
2014
 
2013
 
2014
 
2013
Operating Revenue:
 
 
 
 
 
 
 
Passenger:
 
 
 
 
 
 
 
Mainline
$
8,144

 
$
7,566

 
$
21,950

 
$
20,222

Regional carriers
1,632

 
1,688

 
4,769

 
4,846

  Total passenger revenue
9,776

 
9,254

 
26,719

 
25,068

Cargo
244

 
229

 
691

 
699

Other
1,158

 
1,007

 
3,305

 
2,930

  Total operating revenue
11,178

 
10,490

 
30,715

 
28,697

 
 
 
 
 
 
 
 
Operating Expense:
 
 
 
 
 
 
 
Aircraft fuel and related taxes
2,952

 
2,291

 
7,612

 
7,175

Salaries and related costs
2,069

 
1,976

 
6,084

 
5,809

Regional carrier expense
1,353

 
1,459

 
4,033

 
4,302

Aircraft maintenance materials and outside repairs
440

 
474

 
1,354

 
1,437

Depreciation and amortization
440

 
418

 
1,333

 
1,238

Contracted services
459

 
429

 
1,326

 
1,239

Passenger commissions and other selling expenses
476

 
447

 
1,289

 
1,212

Landing fees and other rents
393

 
378

 
1,089

 
1,060

Profit sharing
384

 
249

 
823

 
387

Passenger service
227

 
214

 
615

 
575

Aircraft rent
65

 
47

 
172

 
162

Restructuring and other items
570

 
106

 
649

 
242

Other
515

 
439

 
1,302

 
1,160

Total operating expense
10,343

 
8,927

 
27,681

 
25,998

 
 
 
 
 
 
 
 
Operating Income
835

 
1,563

 
3,034

 
2,699

 
 
 
 
 
 
 
 
Other (Expense) Income:

 

 
 
 
 
Interest expense, net
(140
)
 
(176
)
 
(460
)
 
(526
)
Amortization of debt discount, net
(14
)
 
(37
)
 
(53
)
 
(120
)
Loss on extinguishment of debt
(134
)
 

 
(263
)
 

Miscellaneous, net
32

 
13

 
(46
)
 
(1
)
Total other expense, net
(256
)
 
(200
)
 
(822
)
 
(647
)
 
 
 
 
 
 
 
 
Income Before Income Taxes
579

 
1,363

 
2,212

 
2,052

 
 
 
 
 
 
 
 
Income Tax (Provision) Benefit
(222
)
 
6

 
(841
)
 
9

 
 
 
 
 
 
 
 
Net Income
$
357

 
$
1,369

 
$
1,371

 
$
2,061

 
 
 
 
 
 
 
 
Basic Earnings Per Share
$
0.43

 
$
1.61

 
$
1.63

 
$
2.42

Diluted Earnings Per Share
$
0.42

 
$
1.59

 
$
1.61

 
$
2.40

Cash Dividends Declared Per Share
$
0.09

 
$
0.06

 
$
0.21

 
$
0.06

 
 
 
 
 
 
 
 
Comprehensive Income
$
394

 
$
1,376

 
$
1,401

 
$
2,314

 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

3



DELTA AIR LINES, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Nine Months Ended September 30,
(in millions)
2014
 
2013
Net Cash Provided by Operating Activities
$
4,365

 
$
3,373

 
 
 
 
Cash Flows From Investing Activities:
 
 
 
Property and equipment additions:
 
 
 
Flight equipment, including advance payments
(1,179
)
 
(1,276
)
Ground property and equipment, including technology
(410
)
 
(340
)
Purchase of Virgin Atlantic shares

 
(360
)
Purchase of short-term investments
(1,642
)
 
(719
)
Redemption of short-term investments
748

 
869

Other, net
58

 
18

Net cash used in investing activities
(2,425
)

(1,808
)
 
 
 
 
Cash Flows From Financing Activities:
 
 
 
Payments on long-term debt and capital lease obligations
(2,485
)
 
(968
)
Repurchase of common stock
(600
)
 
(93
)
Cash dividends
(176
)
 
(51
)
Proceeds from long-term obligations
980

 
68

Fuel card obligation
1

 
90

Other, net
6

 
(9
)
Net cash used in financing activities
(2,274
)
 
(963
)
 
 
 
 
Net (Decrease) Increase in Cash and Cash Equivalents
(334
)
 
602

Cash and cash equivalents at beginning of period
2,844

 
2,416

Cash and cash equivalents at end of period
$
2,510

 
$
3,018

 
 
 
 
Non-Cash Transactions:
 
 
 
Flight equipment under capital leases
$
28

 
$

SkyMiles used pursuant to advance purchase under American Express Agreements

 
250

Build-to-suit leased facilities
6

 
103

 
 
 
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.



4



DELTA AIR LINES, INC.
Notes to the Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Delta Air Lines, Inc. and our wholly-owned subsidiaries. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Consistent with these requirements, this Form 10-Q does not include all the information required by GAAP for complete financial statements. As a result, this Form 10-Q should be read in conjunction with the Consolidated Financial Statements and accompanying Notes in our Form 10-K. Unless otherwise noted, all amounts disclosed are stated before consideration of income taxes.

Management believes the accompanying unaudited Condensed Consolidated Financial Statements reflect all adjustments, including normal recurring items and restructuring and other items, considered necessary for a fair statement of results for the interim periods presented.

Due to seasonal variations in the demand for air travel, the volatility of aircraft fuel prices, changes in global economic conditions and other factors, operating results for the three and nine months ended September 30, 2014 and September 30, 2013 are not necessarily indicative of operating results for the entire year.

Recent Accounting Standards

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers." While the standard supersedes existing revenue recognition guidance, it closely aligns with current GAAP. Under the new standard, revenue is recognized at the time a good or service is transferred to a customer for the amount of consideration received for that specific good or service. It is effective for annual reporting periods beginning after December 15, 2016, including interim reporting periods, and early adoption is not permitted. Entities may use a full retrospective approach or report the cumulative effect as of the date of adoption. We are currently evaluating the impact, if any, the adoption of this standard will have on our Consolidated Financial Statements.

NOTE 2. OIL REFINERY

Fuel expense is our single largest expense. In recent years, global demand for jet fuel and related products has increased while jet fuel refining capacity has decreased in the United States (particularly in the Northeast), resulting in increases in the refining margin reflected in the prices we paid for jet fuel. In June 2012, we purchased an oil refinery as part of our strategy to mitigate the increasing cost of the refining margin we pay.

Refinery Operations and Strategic Agreements

The refinery's production consists of jet fuel, as well as gasoline, diesel and other refined products ("non-jet fuel products"). We use several counterparties to exchange gas and diesel the refinery produces for jet fuel consumed in our airline operations. The gross fair value of the products exchanged under these agreements during the three and nine months ended September 30, 2014 was $1.4 billion and $3.9 billion, respectively, compared to $1.5 billion and $4.2 billion during the three and nine months ended September 30, 2013, respectively. A multi-year product exchange agreement with a significant counterparty, BP Products North America, Inc., was terminated early effective July 1, 2014, and replaced with another counterparty.


5



Segment Reporting

Segment results are prepared based on our internal accounting methods described below, with reconciliations to consolidated amounts in accordance with GAAP. Our segments are not designed to measure operating income or loss directly related to the products and services included in each segment on a stand-alone basis.
(in millions)
Airline
Refinery
 
Intersegment Sales/Other
 
Consolidated
Three Months Ended September 30, 2014
 
 
 
 
 
 
Operating revenue:
$
11,114

$
1,836

 
 
 
$
11,178

Sales to airline segment
 
 
 
$
(345
)
(1) 
 
Exchanged products
 
 
 
(1,393
)
(2) 
 
Sales of refined products to third parties
 
 
 
(34
)
(3) 
 
Operating income(4)
816

19

 

 
835

Interest expense, net
140


 

 
140

Depreciation and amortization
433

7

 

 
440

Total assets, end of period
50,648

1,292

 

 
51,940

Capital expenditures
449

8

 

 
457

Three Months Ended September 30, 2013
 
 
 
 
 
 
Operating revenue:
$
10,490

$
1,892

 
 
 
$
10,490

Sales to airline segment
 
 
 
$
(320
)
(1) 
 
Exchanged products
 
 
 
(1,504
)
(2) 
 
Sales of refined products to third parties
 
 
 
(68
)
(3) 
 
Operating income(4)
1,560

3

 

 
1,563

Interest expense, net
176


 

 
176

Depreciation and amortization
413

5

 

 
418

Total assets, end of period
44,823

1,174

 

 
45,997

Capital expenditures
618

13

 

 
631

(1) 
Represents transfers, valued on a market price basis, from the refinery to the airline segment for use in airline operations. We determine market price by reference to the market index for the primary delivery location, which is New York Harbor, for jet fuel from the refinery.
(2) 
Represents value of products delivered under our strategic agreements, as discussed above, determined on a market price basis.
(3) 
Represents sales of refined products to third parties. These sales were at or near cost; accordingly, the margin on these sales is de minimis.
(4) 
Includes the impact of pricing arrangements between the airline segment and refinery segment with respect to the refinery's inventory price risk.

6



(in millions)
Airline
Refinery
 
Intersegment Sales/Other
 
Consolidated
Nine Months Ended September 30, 2014
 
 
 
 
 
 
Operating revenue:
$
30,651

$
5,317

 
 
 
$
30,715

Sales to airline segment
 
 
 
$
(981
)
(1) 
 
Exchanged products
 
 
 
(3,920
)
(2) 
 
Sales of refined products to third parties
 
 
 
(352
)
(3) 
 
Operating income (loss)(4)
3,043

(9
)
 

 
3,034

Interest expense, net
460


 

 
460

Depreciation and amortization
1,315

18

 

 
1,333

Capital expenditures
1,552

37

 

 
1,589

Nine Months Ended September 30, 2013
 
 
 
 
 
 
Operating revenue:
$
28,697

$
5,487

 
 
 
$
28,697

Sales to airline segment
 
 
 
$
(927
)
(1) 
 
Exchanged products
 
 
 
(4,172
)
(2) 
 
Sales of refined products to third parties
 
 
 
(388
)
(3) 
 
Operating income (loss)(4)
2,769

(70
)
 

 
2,699

Interest expense, net
526


 

 
526

Depreciation and amortization
1,225

13

 

 
1,238

Capital expenditures
1,591

25

 

 
1,616


(1) 
Represents transfers, valued on a market price basis, from the refinery to the airline segment for use in airline operations. We determine market price by reference to the market index for the primary delivery location, which is New York Harbor, for jet fuel from the refinery.
(2) 
Represents value of products delivered under our strategic agreements, as discussed above, determined on a market price basis.
(3) 
Represents sales of refined products to third parties. These sales were at or near cost; accordingly, the margin on these sales is de minimis.
(4) 
Includes the impact of pricing arrangements between the airline segment and refinery segment with respect to the refinery's inventory price risk.


7



NOTE 3. FAIR VALUE MEASUREMENTS

Assets (Liabilities) Measured at Fair Value on a Recurring Basis
(in millions)
September 30,
2014
Level 1
Level 2
Cash equivalents
$
1,700

$
1,700

$

Short-term investments
 
 

U.S. government and agency securities
619

503

116

Asset- and mortgage-backed securities
368


368

Corporate obligations
841


841

Other fixed income securities
24


24

Restricted cash equivalents and investments
128

128


Long-term investments
115

86

29

Hedge derivatives, net
 
 
 
Fuel hedge contracts
(63
)
67

(130
)
Interest rate contracts
(14
)

(14
)
Foreign currency exchange contracts
184


184


(in millions)
December 31,
2013
Level 1
Level 2
Cash equivalents
$
2,487

$
2,487

$

Short-term investments
 
 


U.S. government securities
959

959


Restricted cash equivalents and investments
118

118


Long-term investments
109

80

29

Hedge derivatives, net
 
 
 
Fuel hedge contracts
314

16

298

Interest rate contracts
(67
)

(67
)
Foreign currency exchange contracts
257


257


Cash equivalents and restricted cash equivalents and investments. Cash equivalents generally consist of money market funds. Restricted cash equivalents and investments primarily support letters of credit that relate to certain projected self-insurance obligations and airport commitments and generally consist of money market funds and time deposits. These investments are recorded at cost, which approximates fair value. Fair value is based on a market approach using prices and other relevant information generated by market transactions involving identical or comparable assets.

Short-term investments. Short-term investments generally consist of U.S. Treasury securities, U.S. government agency securities, asset and mortgage-backed securities, corporate obligations and other fixed income securities. The Treasury securities designated as held-to-maturity are recorded at cost, which approximates fair value, while those that are designated as available-for-sale are valued based on quoted market prices. The fair values of our U.S. government agency securities, asset- and mortgage-backed securities, corporate obligations, and other fixed term securities are based on a market approach using industry standard valuation techniques that incorporate observable inputs such as quoted interest rates, benchmark curves, credit ratings of the security and other observable information.

Long-term investments. Our long-term investments that are measured at fair value primarily consist of equity investments in Grupo Aeroméxico, S.A.B. de C.V., the parent company of Aeroméxico, and GOL Linhas Aéreas Inteligentes, S.A, the parent company of GOL. Shares of the parent companies of Aeroméxico and GOL are traded on public exchanges and we have valued our investments based on quoted market prices. The investments are classified in other noncurrent assets.

8




Hedge derivatives. Our derivative contracts are generally negotiated with counterparties without going through a public exchange. Accordingly, our fair value assessments give consideration to the risk of counterparty default (as well as our own credit risk).

Fuel contracts. Our fuel hedge portfolio consists of call options, put options, swaps and futures. The products underlying the hedge contracts include crude oil, diesel fuel and jet fuel as these commodities are highly correlated with the price of jet fuel that we consume. Option contracts are valued under an income approach using option pricing models based on data either readily observable in public markets, derived from public markets or provided by counterparties who regularly trade in public markets. Volatilities used in these valuations ranged from 11% to 24% depending on the maturity dates, underlying commodities and strike prices of the option contracts. Swap contracts are valued under an income approach using a discounted cash flow model based on data either readily observable or derived from public markets. Discount rates used in these valuations vary with the maturity dates of the respective contracts and are based on LIBOR. Futures contracts and options on futures contracts are traded on a public exchange and valued based on quoted market prices.

Interest rate contracts. Our interest rate derivatives consist of swap contracts and are valued primarily based on data readily observable in public markets.

Foreign currency exchange contracts. Our foreign currency derivatives consist of Japanese yen and Canadian dollar forward contracts and are valued based on data readily observable in public markets.

NOTE 4. SHORT-TERM INVESTMENTS

During the September quarter, we modified our approach to managing short-term investments by investing $1.5 billion of cash reserves in externally managed investment accounts. These new investments are comprised of U.S. government and agency securities, asset- and mortgage-backed securities, corporate obligations and other fixed term securities. The new approach is expected to generate a greater return on our liquidity with a low level of risk due to diversification.

Investments with maturities of greater than three months, but not in excess of one year, when purchased are classified as short-term investments. Investments with maturities beyond one year when purchased may be classified as short-term investments if they are expected to be used to support our short-term liquidity needs. All short-term investments are classified as either available-for-sale or held-to-maturity and realized gains and losses are recorded using the specific identification method.

Maturities for short-term investments

The estimated fair values of short-term investments, which approximate cost at September 30, 2014, are shown below by contractual maturity. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

(in millions)
Available-For-Sale
Held-To-Maturity
September 30, 2014
 
 
Due in one year or less
$
198

$
479

Due after one year through three years
900


Due after three years through five years
199


Due after five years
76


Total
$
1,373

$
479



9



NOTE 5. DERIVATIVES

Changes in aircraft fuel prices, interest rates and foreign currency exchange rates impact our results of operations. In an effort to manage our exposure to these risks, we enter into derivative contracts and adjust our derivative portfolio as market conditions change.

Aircraft Fuel Price Risk

Changes in aircraft fuel prices materially impact our results of operations. We actively manage our fuel price risk through a hedging program intended to reduce the financial impact from changes in the price of jet fuel. We utilize several different contract and commodity types in this program and frequently test their economic effectiveness against our financial targets. We rebalance the hedge portfolio from time to time according to market conditions, which may result in locking in gains or losses on hedge contracts prior to their settlement dates.

We do not designate our fuel derivative contracts as accounting hedges. We record changes in the fair value of our fuel hedges in aircraft fuel and related taxes. These changes in fair value include settled gains and losses as well as mark-to-market adjustments ("MTM adjustments"). MTM adjustments are based on market prices as of the end of the reporting period for contracts settling in future periods. During the three months ended September 30, 2014 and 2013, we recorded a $238 million fuel hedge loss and a $337 million fuel hedge gain, respectively. During the nine months ended September 30, 2014 and 2013, we recorded a $63 million fuel hedge loss and a $336 million fuel hedge gain, respectively.

Hedge Position as of September 30, 2014
(in millions)
Notional Balance
Final Maturity Date
Prepaid Expenses and Other
Other Noncurrent Assets
Other Accrued Liabilities
Other Noncurrent Liabilities
Hedge Derivatives, Net
Designated as hedges
 
 
 
 
 
 
 
 
Interest rate contract (fair value hedge)
$
416

U.S. dollars
August 2022
4



(18
)
(14
)
Foreign currency exchange contracts
88,163

Japanese yen
April 2017
142

42



184

426

Canadian dollars
 
 
 
 
 
Not designated as hedges
 
 
 
 
 
 
 
 
Fuel hedge contracts
5,500

gallons - crude oil, diesel and jet fuel
January 2016
378

9

(426
)
(24
)
(63
)
Total derivative contracts
 
 
$
524

$
51

$
(426
)
$
(42
)
$
107


Hedge Position as of December 31, 2013
(in millions)
Notional Balance
Final Maturity Date
Prepaid Expenses and Other
Other Noncurrent Assets
Other Accrued Liabilities
Other Noncurrent Liabilities
Hedge Derivatives, Net
Designated as hedges
 
 
 
 
 
 
 
 
Interest rate contracts (cash flow hedges)
$
477

U.S. dollars
May 2019
$

$

$
(17
)
$
(26
)
$
(43
)
Interest rate contract (fair value hedge)
$
445

U.S. dollars
August 2022


(2
)
(22
)
(24
)
Foreign currency exchange contracts
120,915

Japanese yen
August 2016
157

100



257

438

Canadian dollars
 
 
 
 
 
Not designated as hedges
 
 
 
 
 
 
 
 
Fuel hedge contracts
5,318

gallons - crude oil, diesel and jet fuel
March 2015
428

29

(127
)
(16
)
314

Total derivative contracts
 
 
$
585

$
129

$
(146
)
$
(64
)
$
504



10



Interest Rate Risk

During the three months ended September 30, 2014, we terminated our remaining interest rate swap agreements designated as cash flow hedges in connection with the extinguishment of the underlying debt. These interest rate swap agreements had an aggregate notional amount of $231 million at the date of termination.

Offsetting Assets and Liabilities

We have master netting arrangements with all of our counterparties giving us the right of setoff. We have elected not to offset the fair value positions recorded on our Consolidated Balance Sheets. The following table shows the potential net fair value positions had we elected to offset.
(in millions)
Prepaid Expenses and Other
Other Noncurrent Assets
Other Accrued Liabilities
Other Noncurrent Liabilities
Hedge Derivatives, Net
September 30, 2014
 
 
 
 
 
Net derivative contracts
$
215

$
46

$
(117
)
$
(37
)
$
107

December 31, 2013
 
 
 
 
 
Net derivative contracts
$
456

$
116

$
(19
)
$
(49
)
$
504


Designated Hedge Gains (Losses)

Gains (losses) related to our designated hedge contracts are as follows:
 
Effective Portion Reclassified from AOCI to Earnings
 
Effective Portion Recognized in Other Comprehensive Income
(in millions)
2014
2013
 
2014
2013
Three Months Ended September 30,
 
 
 
 
 
Interest rates contracts
$
(12
)
$

 
$
15

$
3

Foreign currency exchange contracts
47

55

 
38

(71
)
Total designated
$
35

$
55


$
53

$
(68
)
Nine Months Ended September 30,
 
 
 
 
 
Interest rates contracts
$
(31
)
$

 
$
38

$
24

Foreign currency exchange contracts
118

100

 
(73
)
70

Total designated
$
87

$
100


$
(35
)
$
94


As of September 30, 2014, we have recorded $142 million of gains on cash flow hedge contracts in AOCI, which are scheduled to settle and be reclassified into earnings within the next 12 months.

Credit Risk

To manage credit risk associated with our aircraft fuel price, interest rate and foreign currency hedging programs, we evaluate counterparties based on several criteria including their credit ratings and limit our exposure to any one counterparty.

Our hedge contracts contain margin funding requirements. The margin funding requirements may cause us to post margin to counterparties or may cause counterparties to post margin to us as market prices in the underlying hedged items change. Due to the fair value position of our hedge contracts, we posted net margin of $2 million as of September 30, 2014 and received net margin of $65 million as of December 31, 2013, respectively. Margin received is recorded in accounts payable and margin posted is recorded in prepaid expenses and other.


11



NOTE 6. LONG-TERM DEBT

Fair Value of Debt

Market risk associated with our fixed and variable rate long-term debt relates to the potential reduction in fair value and negative impact to future earnings, respectively, from an increase in interest rates. In the table below, the aggregate fair value of debt is based primarily on reported market values, recently completed market transactions and estimates based on interest rates, maturities, credit risk and underlying collateral and is classified primarily as Level 2 within the fair value hierarchy.
(in millions)
September 30,
2014
December 31,
2013
Total debt at par value
$
9,804

$
11,228

Unamortized discount, net
(101
)
(383
)
Net carrying amount
$
9,703

$
10,845

Fair value
$
10,200

$
11,600


Debt Extinguishment

During the three and nine months ended September 30, 2014, we extinguished $725 million and $1.6 billion, respectively, of existing debt under our secured financing arrangements prior to scheduled maturity. We recorded losses on extinguishment of debt for the difference between the principal paid and the carrying value of the debt, which included unamortized discounts or premiums and unamortized issuance costs. The losses also included premiums paid to retire the debt. During the three and nine months ended September 30, 2014, we recorded losses of $134 million and $263 million, respectively, in connection with the early extinguishment of debt obligations. The losses primarily relate to unamortized debt discounts resulting from fair value adjustments recorded in the 2008 purchase accounting of Northwest Airlines.

Aircraft Financings

During the three months ended September 30, 2014, we entered into financing arrangements to borrow $707 million, which are secured by 20 aircraft. These loans bear interest at a variable rate equal to LIBOR plus a specified margin and mature between 2018 and 2026.

Covenants

We were in compliance with the covenants in our financing agreements at September 30, 2014.
 
NOTE 7. COMMITMENTS AND CONTINGENCIES

Aircraft Purchase and Lease Commitments

At September 30, 2014, future aircraft purchase commitments totaled approximately $8.5 billion and included 73 B-737-900ER, 45 A321-200, 18 B-787-8, 6 CRJ-900, and 10 A330-300 aircraft. We have obtained long-term financing commitments for a substantial portion of the purchase price of these aircraft, except for the 18 B-787-8 aircraft. Our purchase commitment for the 18 B-787-8 aircraft provides for certain aircraft substitution rights.
(in millions)
Total
Three months ending December 31, 2014
$
200

2015
1,355

2016
1,730

2017
1,500

2018
1,035

Thereafter
2,700

Total
$
8,520


We also have agreements with Southwest Airlines and The Boeing Company to lease an additional 43 B-717-200 aircraft, and deliveries will continue through 2015.

12




Venezuelan Currency Devaluation

As of September 30, 2014, we had $108 million of unrestricted cash on our Consolidated Balance Sheets related to our 2013 and 2014 Venezuelan ticket sales for which repatriation has been requested, but not yet authorized. While the cash is available for use in Venezuela, our ability to repatriate these funds has been severely limited due to Venezuelan government controls. We have, however, been able to repatriate $74 million related to certain 2013 and 2014 sales during the nine months ended September 30, 2014. Cash related to 2013 sales of $106 million is stated at the official exchange rate of 6.3 bolivars per US dollar. The remaining $2 million is related to our 2014 sales and stated at the SICAD I reference rate of 11.7 bolivars per US dollar. The SICAD I reference rate is a complementary currency auction system that was created by the Venezuelan government in 2013 for purposes of exchanging currency. Until these funds can be repatriated, they are at risk of future devaluations.

In January 2014, the Venezuelan government affirmed the official exchange rate for 2013 sales and announced that some sectors of the economy, including airlines, will use the SICAD I reference rate for 2014 sales and repatriation requests. At the time of the announcement, we recorded a $23 million charge in miscellaneous, net within other (expense) income to reflect the devaluation of currency related to January 2014 sales that were denominated in bolivars. We are recording all sales subsequent to January 2014 at the then current SICAD I reference rate.

Part of the unrestricted cash balance is for advance ticket sales for which we have yet to provide services. Due to our repatriation concerns, we reduced service to Venezuela on August 1, 2014 from daily to weekly service. We have refunded 83%, or $22 million, of tickets previously sold for flights to and from Venezuela originally scheduled on or after August 1, 2014 that we did not or will not operate. These refunds are being made in local currency and result in a reduction to our cash balances in Venezuela.

Legal Contingencies

We are involved in various legal proceedings related to employment practices, environmental issues, antitrust matters and other matters concerning our business. We record liabilities for losses from legal proceedings when we determine that it is probable that the outcome in a legal proceeding will be unfavorable and the amount of loss can be reasonably estimated. We cannot reasonably estimate the potential loss for certain legal proceedings because, for example, the litigation is in its early stages or the plaintiff does not specify the damages being sought. Although the outcome of the legal proceedings in which we are involved cannot be predicted with certainty, management believes that the resolution of these matters will not have a material adverse effect on our Condensed Consolidated Financial Statements.

Other Contingencies

General Indemnifications

We are the lessee under many commercial real estate leases. It is common in these transactions for us, as the lessee, to agree to indemnify the lessor and the lessor's related parties for tort, environmental and other liabilities that arise out of or relate to our use or occupancy of the leased premises. This type of indemnity would typically make us responsible to indemnified parties for liabilities arising out of the conduct of, among others, contractors, licensees and invitees at, or in connection with, the use or occupancy of the leased premises. This indemnity often extends to related liabilities arising from the negligence of the indemnified parties, but usually excludes any liabilities caused by either their sole or gross negligence or their willful misconduct.

Our aircraft and other equipment lease and financing agreements typically contain provisions requiring us, as the lessee or obligor, to indemnify the other parties to those agreements, including certain of those parties' related persons, against virtually any liabilities that might arise from the use or operation of the aircraft or other equipment.

We believe that our insurance would cover most of our exposure to liabilities and related indemnities associated with the commercial real estate leases and aircraft and other equipment lease and financing agreements described above. While our insurance does not typically cover environmental liabilities, we have certain insurance policies in place as required by applicable environmental laws.


13



Certain of our aircraft and other financing transactions include provisions that require us to make payments to preserve an expected economic return to the lenders if that economic return is diminished due to certain changes in laws or regulations. In certain of these financing transactions, we also bear the risk of certain changes in tax laws that would subject payments to non-U.S. lenders to withholding taxes.

We cannot reasonably estimate our potential future payments under the indemnities and related provisions described above because we cannot predict (1) when and under what circumstances these provisions may be triggered and (2) the amount that would be payable if the provisions were triggered because the amounts would be based on facts and circumstances existing at such time.

Employees Under Collective Bargaining Agreements

At September 30, 2014, we had approximately 79,710 full-time equivalent employees. Approximately 18% of these employees were represented by unions.

Other

We have certain contracts for goods and services that require us to pay a penalty, acquire inventory specific to us or purchase contract-specific equipment, as defined by each respective contract, if we terminate the contract without cause prior to its expiration date. Because these obligations are contingent on our termination of the contract without cause prior to its expiration date, no obligation would exist unless such a termination occurs.

NOTE 8. RESTRUCTURING AND OTHER ITEMS

The following table shows amounts recorded in restructuring and other items on the Condensed Consolidated Statements of Operations and Comprehensive Income:
 
Three Months Ended September 30,
Nine Months Ended September 30,
(in millions)
2014
2013
2014
2013
Fleet and other
$
574

$
106

$
653

$
242

Severance and related costs
63


63


Litigation settlement
(67
)

(67
)

Total restructuring and other items
$
570

$
106

$
649

$
242


Fleet and other. The fleet and other charges for the September 2014 quarter primarily relate to the retirement of the B-747-400 aircraft fleet. During the quarter, we decided to retire the fleet of 16 aircraft over the next four years. As part of the accelerated retirement, we recorded an impairment charge for the owned and capital leased aircraft. This impairment charge was calculated using Level 3 fair value inputs based primarily upon recent market transactions and existing market conditions. Also, we recorded a lease restructuring charge for the three B-747-400 aircraft under operating leases that were retired during the quarter. As part of our ongoing initiative to reduce 50-seat CRJ aircraft, we retired certain CRJ aircraft under operating leases during the quarter and recognized a related lease restructuring charge.

As we restructure our fleet and assess our fleet plans, we will continue to evaluate older, retiring aircraft and related equipment for changes in depreciable life, impairment and lease termination costs. The retirement of aircraft, when permanently removed from our fleet, will likely result in lease termination and other charges. The timing and amount of these charges will depend on a number of factors, including final negotiations with lessors, the timing of removing aircraft from service and ultimate disposition of aircraft included in the fleet restructuring program. We expect to benefit from reduced future maintenance cost and improved operational and fuel efficiency over the life of the new aircraft.

Severance and related costs. In June 2014, we announced a voluntary retirement program for eligible U.S. employees. During the September 2014 quarter, voluntary commitments were finalized and we recorded a $63 million charge in connection with this program and other programs related to our restructuring of the Pacific network.

Litigation settlement. In July 2014, we settled outstanding litigation resulting in a favorable settlement of $67 million, which was received in September.


14



The following table shows the balances and activity for restructuring charges:
(in millions)
Severance and Related Costs
Lease Restructuring
Liability as of December 31, 2013
$

$
168

Additional costs and expenses
63

272

Payments

(33
)
Liability as of September 30, 2014
$
63

$
407


NOTE 9. EMPLOYEE BENEFIT PLANS

The following table shows the components of net periodic cost:
 
Pension Benefits
Other Postretirement and
Postemployment Benefits
(in millions)
2014
2013
2014
2013
Three Months Ended September 30,
 
 
 
 
Service cost
$

$

$
13

$
12

Interest cost
232

215

39

36

Expected return on plan assets
(207
)
(184
)
(21
)
(21
)
Amortization of prior service credit


(6
)
(7
)
Recognized net actuarial loss
33

56

1

6

Net periodic cost
$
58

$
87

$
26

$
26

Nine Months Ended September 30,
 
 
 
 
Service cost
$

$

$
39

$
36

Interest cost
696

645

117

108

Expected return on plan assets
(621
)
(552
)
(63
)
(63
)
Amortization of prior service credit


(20
)
(21
)
Recognized net actuarial loss
100

167

3

18

Settlements

6



Net periodic cost
$
175

$
266

$
76

$
78


NOTE 10. ACCUMULATED OTHER COMPREHENSIVE LOSS

The following tables show the components of accumulated other comprehensive loss:
(in millions)
Pension and Other Benefits Liabilities
Derivative Contracts
Investments
Total(1)
Balance at December 31, 2013
$
(5,323
)
$
219

$
(26
)
$
(5,130
)
Changes in value (net of tax effect of $20)

33

4

37

Reclassifications into earnings (net of tax effect of $4)(2)
48

(55
)

(7
)
Balance at September 30, 2014
$
(5,275
)
$
197

$
(22
)
$
(5,100
)
  

15



(in millions)
Pension and Other Benefits Liabilities
Derivative Contracts(3)
Investments
Total
Balance at December 31, 2012
$
(8,304
)
$
(263
)
$
(10
)
$
(8,577
)
Changes in value (net of tax effect of $0)

194

(9
)
185

Reclassifications into earnings (net of tax effect of $0)(2)
168

(100
)

68

Balance at September 30, 2013
$
(8,136
)
$
(169
)
$
(19
)
(8,324
)

(1) 
Includes $1.9 billion of deferred income tax expense, primarily related to pension obligations, that will not be recognized in net income until the pension obligations are fully extinguished, which is not expected to occur for at least 25 years.
(2) 
Amounts reclassified from AOCI for pension and other benefits liabilities are recorded in salaries and related costs in the Condensed Consolidated Statements of Operations and Comprehensive Income. Amounts reclassified from AOCI for derivative contracts designated as foreign currency cash flow hedges and interest rate cash flow hedges are recorded in passenger revenue and interest expense, net, respectively, in the Condensed Consolidated Statements of Operations and Comprehensive Income. Amounts reclassified from AOCI for investments are recorded in interest income in the Condensed Consolidated Statements of Operations and Comprehensive Income.
(3) 
Includes $321 million of deferred income tax expense that remained in AOCI until December 2013 when all amounts in AOCI that related to derivative contracts designated as fuel cash flow hedges were recognized in the Consolidated Statement of Operations and Comprehensive Income.


NOTE 11. EARNINGS PER SHARE

We calculate basic earnings per share by dividing net income by the weighted average number of common shares outstanding, excluding restricted shares. Antidilutive common stock equivalents excluded from the diluted earnings per share calculation are not material. The following table shows the computation of basic and diluted earnings per share:
 
Three Months Ended September 30,
Nine Months Ended September 30,
(in millions, except per share data)
2014
2013
2014
2013
Net income
$
357

$
1,369

$
1,371

$
2,061

 
 
 
 
 
Basic weighted average shares outstanding
834

851

840

850

Dilutive effect of share-based awards
9

10

9

8

Diluted weighted average shares outstanding
843

861

849

858

 
 
 
 
 
Basic earnings per share
$
0.43

$
1.61

$
1.63

$
2.42

Diluted earnings per share
$
0.42

$
1.59

$
1.61

$
2.40


NOTE 12. DIVIDEND AND SHARE REPURCHASE

In May 2013, we announced a plan to return more than $1 billion to shareholders over the next three years. As part of this plan, our Board of Directors initiated a quarterly dividend program and a $500 million share repurchase program, which was to be completed no later than June 30, 2016. During the June 2014 quarter, we completed this share repurchase authorization.

In May 2014, we announced the next phase of capital returns to shareholders. As part of this phase, the Board of Directors approved a program to increase the quarterly dividend by 50% to $0.09 per share beginning in the September 2014 quarter. Additionally, the Board authorized a new $2 billion share repurchase program to be completed no later than December 31, 2016. Together, the increased dividend program and the new repurchase program are expected to return $2.75 billion to shareholders through 2016. During the three months ended September 30, 2014, we repurchased and retired 6.6 million shares at a cost of $250 million, bringing our total repurchases and retirements under the new program to 9.1 million shares at a cost of $350 million. Including the shares repurchased under the May 2013 share repurchase authorization, we have repurchased and retired 16.4 million shares at a cost of $600 million for the nine months ended September 30, 2014.

On July 25, 2014, the Board of Directors declared a $0.09 per share dividend for shareholders of record as of August 8, 2014. This dividend was paid in August 2014 and totaled $75 million. Including dividend payments in the March 2014 and June 2014 quarters, we have paid $176 million of dividends for the nine months ended September 30, 2014. On October 24, 2014, the Board of Directors declared a $0.09 per share dividend for shareholders of record as of November 7, 2014.

16



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

September 2014 Quarter Financial Highlights

Our pre-tax income for the September 2014 quarter was $579 million, representing a $784 million decrease compared to the corresponding prior year period as a result of $1.1 billion of special items charges recorded during the quarter. Excluding these charges, pre-tax income increased $431 million, or 36%, to $1.6 billion primarily driven by higher passenger revenue, lower fuel prices and flat non-fuel unit cost growth.

Revenue. Our passenger revenue increased $522 million, or 6%, compared to the September 2013 quarter due to a 2% increase in passenger mile yield on 4% higher traffic. Passenger revenue per available seat mile ("PRASM") increased 2% on 3% higher capacity. Our ability to maintain revenue momentum was driven by a strong domestic demand environment, higher corporate sales and merchandising initiatives.

Operating Expense. Total operating expense increased $1.4 billion from the September 2013 quarter driven by the special items charges noted above and discussed below. Our consolidated operating cost per available seat mile ("CASM") for the September 2014 quarter increased 12% to 15.69 cents from 13.97 cents in the September 2013 quarter, on a 3% increase in capacity. Non-fuel unit costs ("CASM-Ex," a non-GAAP financial measure) increased 0.3% to 8.66 cents compared to the September 2013 quarter.

The increase in total operating expense is primarily due to special items charges recorded during the quarter, including $570 million of restructuring and other items, primarily related to the early retirement of B-747-400 aircraft associated with our ongoing restructuring of the Pacific network, and $347 million related to unfavorable mark-to-market adjustments on hedges recorded in periods other than the settlement period ("MTM adjustments"). These MTM adjustments primarily offset hedge gains recorded in prior periods.

The increase in our total operating expense also reflects higher profit sharing, higher salaries and related costs and volume-based cost increases driven by the increase in capacity. The increase in profit sharing results from our current expectations for 2014 pre-tax profit. Salaries and related costs are higher primarily due to employee investments.

The non-GAAP financial measures for pre-tax income and CASM-Ex used in this section are defined and reconciled in "Supplemental Information" below.

Company Initiatives

Network Strategy

We are implementing several strategies that are designed to strengthen and expand our global network and presence. These include our investment in and joint venture with Virgin Atlantic, facility improvements at our hubs at LaGuardia and JFK in New York and the restructuring of the Pacific network. As part of the Pacific restructuring initiative, we are realigning our Pacific fleet by removing less efficient B-747-400 aircraft and replacing them with smaller gauge widebody aircraft that we are redeploying from the transatlantic. The smaller gauge aircraft will help better match capacity with demand in the Pacific and improve margin. We have also made a significant investment in developing Seattle as a hub and international gateway, which will provide for convenient access to and from the Pacific. 

Maintaining Cost Performance

As part of our ongoing efforts to maintain cost performance, we are focused on keeping the rate of CASM-Ex growth at less than 2% annually. Fleet restructuring is an important component of our cost initiatives and is focused on lowering unit costs while investing in our fleet to enhance the customer experience. We are restructuring our domestic fleet by replacing a significant portion of our 50-seat regional flying with more efficient and customer preferred CRJ-900 and B-717-200 aircraft and replacing older, less cost effective B-757-200 aircraft with B-737-900ER aircraft. During the September 2014 quarter, we took delivery of eight CRJ-900, nine B-717-200 and five B-737-900ER aircraft. We are retiring a significant portion of the 50-seat regional fleet that we lease as part of the fleet restructuring activities. We expect to continue to recognize restructuring charges, representing the remaining obligations under the leases, as we retire the leased aircraft. Although many factors could change over the 50-seat regional fleet restructuring period, we currently estimate that future charges will be between $50 million and $150 million.


17



For more in-depth discussion regarding our network strategy and maintenance of cost performance, refer to Management's Discussion and Analysis in our Form 10-K.

Increasing Shareholder Value

We continue to focus on cash flow generation with the goal of further strengthening our balance sheet. We finished the September 2014 quarter with $6.4 billion in unrestricted liquidity (consisting of cash, cash equivalents, short-term investments and undrawn revolving credit facilities). During the nine months ended September 30, 2014, we generated $4.4 billion in cash from operating activities, which we used to reduce debt and capital lease obligations by $1.5 billion, fund capital expenditures of $1.6 billion and return $776 million to shareholders, while maintaining a solid liquidity position.

We contributed $905 million to our qualified defined benefit pension plans during the first four months of 2014, including $250 million above the minimum funding requirements. These contributions satisfied the required contributions for our defined benefit plans for 2014 on an accelerated basis.

In May 2013, we announced a plan to return more than $1 billion to shareholders over the next three years. As part of this plan, our Board of Directors initiated a quarterly dividend program and a $500 million share repurchase program, which was to be completed no later than June 30, 2016. During the June 2014 quarter, we completed this share repurchase authorization.

In May 2014, we announced the next phase of capital returns to shareholders. As part of this phase, the Board of Directors approved a program to increase the quarterly dividend by 50% to $0.09 per share beginning in the September 2014 quarter. Additionally, the Board authorized a new $2 billion share repurchase program to be completed no later than December 31, 2016. Together, the increased dividend program and the new repurchase program are expected to return $2.75 billion to shareholders through 2016. During the three months ended September 30, 2014, we repurchased and retired 6.6 million shares at a cost of $250 million bringing our total repurchases and retirements under the new program to 9.1 million shares at a cost of $350 million. Including the shares repurchased under the May 2013 share repurchase authorization, we have repurchased and retired 16.4 million shares at a cost of $600 million for the nine months ended September 30, 2014.

On July 25, 2014, the Board of Directors declared a $0.09 per share dividend for shareholders of record as of August 8, 2014. This dividend was paid in August 2014 and totaled $75 million. Including dividend payments in the March 2014 and June 2014 quarters, we have paid $176 million of dividends for the nine months ended September 30, 2014. On October 24, 2014, the Board of Directors declared a $0.09 per share dividend for shareholders of record as of November 7, 2014.
 
SkyMiles Program

During the March 2014 quarter, we announced that we would be making changes to the SkyMiles program. Effective January 1, 2015, the SkyMiles program will be modified from the current model in which customers earn redeemable mileage points based on distance traveled to one based on ticket price. Customers will be able to earn between five and 11 miles per dollar spent based on their SkyMiles status, and will continue to earn up to an additional two miles per dollar when using their Delta SkyMiles Credit Card, for a total of up to 13 miles per dollar. The updated program will better reward customers who spend more with Delta and give them improved mileage-earning opportunities.

The SkyMiles program will also include a new award redemption structure that will improve award seat availability at the lowest point redemption levels, offer one-way awards at half the price of round-trip, provide new miles plus cash award options, as well as make significant improvements to delta.com and Delta reservations award shopping tools.


18



Fuel Expense, Including Refinery Results

Fuel Expense. Fuel expense is our largest expense, representing 33% of total operating expense in the September 2014 quarter. For the quarter, total fuel expense (including our regional carriers) increased $609 million compared to the same period in 2013. This increase is primarily due to unfavorable changes in MTM adjustments as compared to the prior year quarter and an increase in consumption, partially offset by lower market jet fuel prices and increased profitability at Monroe. Excluding MTM adjustments, our fuel price per gallon, adjusted (a non-GAAP financial measure) for the September 2014 quarter was $2.90 per gallon, compared to $2.97 per gallon in the September 2013 quarter.
Fuel Purchase Cost. The market price per gallon of jet fuel decreased 5% compared to the September 2013 quarter.
Fuel Hedging Program Impact. We actively manage our fuel price risk through a hedging program intended to reduce the financial impact from changes in the price of jet fuel. During the September 2014 quarter, our airline segment fuel hedge loss was $284 million. This hedge loss included $347 million of unfavorable MTM adjustments. These MTM adjustments are based on market prices as of the end of the reporting period for contracts settling in future periods. Such market prices are not necessarily indicative of the actual future value of the underlying hedge in the contract settlement period. Excluding these MTM adjustments, we recognized settled hedge gains of $63 million.

Refinery Segment Impact. The refinery primarily produces gasoline, diesel and jet fuel. Under multi-year agreements, we are effectively exchanging the non-jet fuel products the refinery produces with third parties for jet fuel consumed in our airline operations. The jet fuel produced and procured through exchanging gasoline and diesel fuel produced by the refinery provided approximately 148,000 barrels (approximately six million gallons) per day for use in airline operations during the September 2014 quarter. A multi-year product exchange agreement with a significant counterparty, BP Products North America, Inc., was terminated early effective July 1, 2014, and replaced with another counterparty.
A refinery is subject to U.S. Environmental Protection Agency ("EPA") requirements that are established each year to blend renewable fuels into the gasoline and on-road diesel fuel it produces. Alternatively, a refinery may purchase renewable energy credits, called RINs, from third parties in the secondary market.
Because the refinery operated by Monroe does not blend renewable fuels, it must purchase its entire RINs requirement in the secondary market or obtain a waiver from the EPA. The refinery is exposed to the market price of RINs. The price at September 30, 2014 was $0.46 per RIN, which exceeds historical averages. We recognized $18 million of expense related to the RINs requirement in the September 2014 quarter, which is included in the refinery's results. Additionally, we have accrued $79 million related to our unsettled 2013 and 2014 RINs obligation as of September 30, 2014. We believe that holders of RINs have been withholding them from the secondary market. This reduction of available RINs significantly impairs the secondary market as a means of compliance with the RINs requirement. Therefore, we are pursuing legal, regulatory and legislative solutions to this problem.
The refinery recorded a profit of $19 million in the September 2014 quarter, a $16 million increase over the prior year period. We believe that the increase in jet fuel supply due to the refinery's operation has decreased the overall market price of jet fuel, and lowered our cost of jet fuel.


19



Results of Operations - Three Months Ended September 30, 2014 and 2013

Operating Revenue
 
Three Months Ended September 30,
 
 
(in millions)
2014
2013
Increase (Decrease)
% Increase
 (Decrease)
Passenger:
 
 
 
 
Mainline
$
8,144

$
7,566

$
578

8
 %
Regional carriers
1,632

1,688

(56
)
(3
)%
Total passenger revenue
9,776

9,254

522

6
 %
Cargo
244

229

15

7
 %
Other
1,158

1,007

151

15
 %
Total operating revenue
$
11,178

$
10,490

$
688

7
 %

Passenger Revenue
 
 
Increase (Decrease)
vs. Three Months Ended September 30, 2013
(in millions)
Three Months Ended September 30, 2014
Passenger
Revenue
RPMs(1)
(Traffic)
ASMs(2)
(Capacity)
Passenger Mile
Yield
PRASM(3)
Load
Factor
Domestic
$
4,599

12
 %
7
 %
4
 %
5
 %
7
 %
2.1
 pts
Atlantic
1,924

4
 %
1
 %
4
 %
3
 %
 %
(2.8
) pts
Pacific
1,016

(3
)%
(1
)%
(1
)%
(1
)%
(2
)%
(0.8
) pts
Latin America
605

10
 %
14
 %
16
 %
(3
)%
(5
)%
(1.7
) pts
Total Mainline
8,144

8
 %
4
 %
4
 %
3
 %
3
 %
0.1
 pts
Regional carriers
1,632

(3
)%
(3
)%
(5
)%
 %
2
 %
1.9
 pts
Total Consolidated
$
9,776

6
 %
4
 %
3
 %
2
 %
2
 %
0.4
 pts

(1) 
Revenue passenger miles (“RPMs”)
(2) 
Available seat miles (“ASMs”)
(3) 
Passenger revenue per ASM (“PRASM”)

Passenger revenue increased $522 million, or 6%, over the September 2013 quarter. PRASM increased 2% and passenger mile yield increased 2% on 3% higher capacity. Load factor was 0.4 points higher than the prior year quarter at 86.4%.

Our geographic regions generally performed well compared to the same period in the prior year, with the domestic region leading unit revenue improvement. Unit revenues of the domestic region rose 7% led by strong performances from our hubs in Atlanta and New York-LaGuardia, with Seattle also producing solid results.

Revenues related to our international regions increased 3% year-over-year primarily due to 16% capacity growth in the Latin America region as a result of our efforts to improve connections with GOL and Aeroméxico. GOL contributed nearly 30% of the traffic from the U.S. to Brazil while Aeroméxico provided over 20% into key Mexico markets. Despite these contributions, Latin America unit revenues declined 5% as a result of the capacity increase, residual business demand weakness associated with the FIFA World Cup in Brazil and economic concerns in both Venezuela and Argentina. Atlantic unit revenue was flat with a 4% increase in capacity. While our joint venture with Virgin Atlantic is showing solid revenue growth, especially in London-Heathrow, Atlantic yields are showing pressure from geopolitical unrest and its impact on our service to Moscow and Tel Aviv. Our Pacific region experienced a 2% decline in unit revenues driven by lower yield, primarily due to the effects of the weakening of the Japanese yen.

Other Revenue. Other revenue increased $151 million, or 15%, primarily due to an increase in sales of SkyMiles, settlements associated with our transatlantic joint venture agreements and sales of gasoline, diesel and other refined products ("non-jet fuel products") to third parties by our oil refinery.

20



Operating Expense
 
Three Months Ended September 30,
Increase
(Decrease)
% Increase
(Decrease)
(in millions)
2014
2013
Aircraft fuel and related taxes
$
2,952

$
2,291

$
661

29
 %
Salaries and related costs
2,069

1,976

93

5
 %
Regional carrier expense
1,353

1,459

(106
)
(7
)%
Aircraft maintenance materials and outside repairs
440

474

(34
)
(7
)%
Depreciation and amortization
440

418

22

5
 %
Contracted services
459

429

30

7
 %
Passenger commissions and other selling expenses
476

447

29

6
 %
Landing fees and other rents
393

378

15

4
 %
Profit sharing
384

249

135

54
 %
Passenger service
227

214

13

6
 %
Aircraft rent
65

47

18

38
 %
Restructuring and other items
570

106

464

NM(1)

Other
515

439

76

17
 %
Total operating expense
$
10,343

$
8,927

$
1,416

16
 %
 
(1)
NM - Not meaningful

Fuel Expense. Including our regional carriers, fuel expense increased $609 million due to unfavorable changes in MTM adjustments as compared to the prior year quarter and a 2% increase in consumption, partially offset by a 5% decrease in fuel market price per gallon and increased profitability at Monroe. The table below presents fuel expense, gallons consumed and average price per gallon, including the impact of hedging and the refinery:
 
Three Months Ended September 30,
Increase
(Decrease)
% Increase
(Decrease)
(in millions, except per gallon data)
2014
2013
Aircraft fuel and related taxes(1)
$
2,952

$
2,291

$
661

 
Aircraft fuel and related taxes included within regional carrier expense
492

544

(52
)
 
Total fuel expense
$
3,444

$
2,835

$
609

21
%
 
 
 
 
 
Total fuel consumption (gallons)
1,067

1,050

17

2
%
Average price per gallon
$
3.23

$
2.70

$
0.53

20
%

(1) 
Includes the impact of fuel hedging and refinery results described further in the table below.

The table below shows the impact of hedging and the refinery on fuel expense and average price per gallon, adjusted:
 
 
Average Price Per Gallon
 
Three Months Ended September 30,
Change
Three Months Ended September 30,
Change
(in millions, except per gallon data)
2014
2013
2014
2013
Fuel purchase cost
$
3,179

$
3,190

$
(11
)
$
2.98

$
3.03

$
(0.05
)
Airline segment fuel hedge losses (gains)(1)
284

(352
)
636

0.27

(0.33
)
0.60

Refinery segment impact(1)
(19
)
(3
)
(16
)
(0.02
)

(0.02
)
Total fuel expense
$
3,444

$
2,835

$
609

$
3.23

$
2.70

$
0.53

MTM adjustments
(347
)
285

(632
)
(0.33
)
0.27

(0.60
)
Total fuel expense, adjusted
$
3,097

$
3,120

$
(23
)
$
2.90

$
2.97

$
(0.07
)

(1) 
Includes the impact of pricing arrangements between the airline segment and refinery segment with respect to the refinery's inventory price risk.


21




Fuel Purchase Cost. Fuel purchase cost is based on the market price for jet fuel at airport locations.

Airline Segment Fuel Hedge Impact and MTM Adjustments. During the three months ended September 30, 2014, our airline segment fuel hedge loss of $284 million included $347 million of unfavorable MTM adjustments. These MTM adjustments are based on market prices as of the end of the reporting period for contracts settling in future periods. Such market prices are not necessarily indicative of the actual future value of the underlying hedge in the contract settlement period. The MTM adjustments are reflected in the table above to calculate an effective fuel cost for the period.

Refinery Segment Impact. The refinery results include the impact on fuel expense of self-supply from the production of the refinery and from refined products exchanged with certain counterparties. As described in Note 2 of the Notes to the Condensed Consolidated Financial Statements, to the extent that we account for exchanges of refined products as nonmonetary transactions, we include the results of those transactions within fuel expense.

We adjust fuel expense for the items noted above to arrive at a more meaningful measure of fuel cost. Our average price per gallon, adjusted (a non-GAAP financial measure) was $2.90 for the three months ended September 30, 2014.

Salaries and Related Costs. The increase in salaries and related costs is primarily due to investments in our employees and an increase in pilot and flight attendant block hours, partially offset by lower pension expense. We contributed $905 million to our qualified defined benefit pension plans during the first four months of 2014, including $250 million above the minimum funding requirements. These contributions satisfied the required contributions for our defined benefit plans for 2014 on an accelerated basis.

Regional Carrier Expense. The reduction in regional carrier expense is primarily due to lower fuel cost from a 5% decrease in capacity and fewer required maintenance events. During the September 2014 quarter, we removed thirteen 50-seat regional aircraft from our fleet as part of our strategy to restructure our domestic fleet.

Aircraft Maintenance Materials and Outside Repairs. Aircraft maintenance materials and outside repairs consists of costs associated with maintenance of aircraft used in our operations and costs associated with maintenance sales to third parties by our MRO services business. The reduction in aircraft maintenance materials and outside repairs is due primarily to lower cost of sales from our MRO business and a one-time contract settlement charge in 2013, partially offset by the timing of airframe and engine maintenance volume.

Depreciation and Amortization. Depreciation and amortization expense increased year-over-year primarily due to investments in new B-737-900ER and CRJ-900 aircraft, the purchase of aircraft off-lease, and aircraft modifications that upgraded aircraft interiors and enhanced our product offering.

Contracted Services. Contracted services expense increased year-over-year due primarily to costs associated with the 3% increase in capacity.

Passenger Commissions and Other Selling Expenses. Passenger commissions and other selling expenses increased on higher passenger revenue.

Profit Sharing. The increase in profit sharing is driven by an increase in the projected full year pre-tax income compared to the prior year. Our broad-based employee profit sharing program provides that, for each year in which we have an annual pre-tax profit, as defined by the terms of the program, we will pay a specified portion of that profit to employees. In determining the amount of profit sharing, the program defines profit as pre-tax profit excluding profit sharing and special items, such as MTM adjustments and restructuring and other items. Our profit sharing program pays 10% to employees for the first $2.5 billion of annual profits and 20% of annual profits above $2.5 billion.

Aircraft Rent. Aircraft rent increased year-over-year due primarily to the addition of leased B-717-200 and B-737-900ER aircraft delivered during the period, partially offset by the purchase of various aircraft off-lease in 2013.

Restructuring and Other Items. Due to the nature of amounts recorded within restructuring and other items, a year-over-year comparison is not meaningful. For a discussion of charges recorded in restructuring and other items, see Note 8 of the Notes to the Condensed Consolidated Financial Statements.

Other. Other operating expense increased primarily due to costs associated with sales of non-jet fuel products to third parties by the oil refinery.

22




Non-Operating Results
 
Three Months Ended September 30, 2014
 
 
(in millions)
2014
2013
 
Favorable (Unfavorable)
Interest expense, net
$
(140
)
$
(176
)
 
$
36

Amortization of debt discount, net
(14
)
(37
)
 
23

Loss on extinguishment of debt
(134
)

 
(134
)
Miscellaneous, net
32

13

 
19

Total other expense, net
$
(256
)
$
(200
)
 
$
(56
)

The declines in interest expense, net and amortization of debt discount, net are driven by reduced levels of debt and the refinancing of debt obligations at lower interest rates. Our principal amount of debt and capital leases has declined from $12.3 billion at September 30, 2013 to $10.2 billion at September 30, 2014.

During the three months ended September 30, 2014, we extinguished $725 million of existing debt under our secured financing arrangements prior to scheduled maturity. We recorded losses on extinguishment of debt for the difference between the principal paid and the carrying value of the debt, which included unamortized discounts or premiums and unamortized issuance costs. The losses also included premiums paid to retire the debt. During the three months ended September 30, 2014, we recorded a loss of $134 million in connection with the early extinguishment of debt obligations. The loss primarily relates to unamortized debt discounts resulting from fair value adjustments recorded in the 2008 purchase accounting of Northwest Airlines.

Miscellaneous, net is favorable primarily due to our proportionate share of earnings from our equity investment in Virgin Atlantic. We made a 49% ownership investment in Virgin Atlantic during the June 2013 quarter.

Income Taxes

We released substantially all of our valuation allowance against our net deferred tax assets on December 31, 2013. We project that our annual effective tax rate for 2014 will be approximately 38%. In certain interim periods, we may have adjustments to our net deferred tax assets as a result of changes in prior year estimates and tax laws enacted during the period, which will impact the effective tax rate for that interim period. At September 30, 2014, we had over $13 billion of U.S. federal pre-tax net operating loss carryforwards, which do not begin to expire until 2023. Accordingly, we believe we will not pay any cash federal income taxes during the next several years.


23



Results of Operations - Nine Months Ended September 30, 2014 and 2013

Operating Revenue
 
Nine Months Ended September 30,
 
 
(in millions)
2014
2013
Increase (Decrease)
% Increase
 (Decrease)
Passenger:
 
 
 
 
Mainline
$
21,950

$
20,222

$
1,728

9
 %
Regional carriers
4,769

4,846

(77
)
(2
)%
Total passenger revenue
26,719

25,068

1,651

7
 %
Cargo
691

699

(8
)
(1
)%
Other
3,305

2,930

375

13
 %
Total operating revenue
$
30,715

$
28,697

$
2,018

7
 %

Passenger Revenue
 
 
Increase (Decrease)
vs. Nine Months Ended September 30, 2013
(in millions)
Nine Months Ended September 30, 2014
Passenger
Revenue
RPMs(1)
(Traffic)
ASMs(2)
(Capacity)
Passenger Mile
Yield
PRASM(3)
Load
Factor
Domestic
$
12,827

12
 %
6
 %
4
 %
6
 %
8
 %
2.0
 pts
Atlantic
4,597

3
 %
 %
 %
3
 %
3
 %
(0.4
) pts
Pacific
2,662

(3
)%
(1
)%
 %
(3
)%
(3
)%
(0.5
) pts
Latin America
1,864

17
 %
19
 %
19
 %
(2
)%
(2
)%
(0.2
) pts
Total Mainline
21,950

9
 %
5
 %
4
 %
4
 %
5
 %
0.9
 pts
Regional carriers
4,769

(2
)%
(2
)%
(4
)%
 %
3
 %
2.4
 pts
Total Consolidated
$
26,719

7
 %
4
 %
3
 %
2
 %
4
 %
1.1
 pts

(1) 
Revenue passenger miles (“RPMs”)
(2) 
Available seat miles (“ASMs”)
(3) 
Passenger revenue per ASM (“PRASM”)

Passenger revenue increased $1.7 billion, or 7%, over the corresponding prior year period. PRASM increased 4% and passenger mile yield increased 2% on 3% higher capacity. Load factor was 1.1 points higher than the prior year period at 85.3%.

Our geographic regions generally performed well compared to the same period in the prior year, with the domestic region leading unit revenue improvement. Unit revenues of the domestic region rose 8% led by strong performances from our hubs in Atlanta and New York-LaGuardia, with Seattle also producing solid results.

Revenues related to our international regions increased 4% year-over-year primarily due to 19% capacity growth in the Latin America region as a result of our efforts to improve connections with GOL and Aeroméxico. GOL contributed over 25% of the traffic from the U.S. to Brazil while Aeroméxico provided approximately 20% into key Mexico markets. Despite these contributions, Latin America unit revenues declined 2% as a result of the capacity increase, some business demand weakness associated with the FIFA World Cup in Brazil and economic concerns in Venezuela. Atlantic unit revenue increased 3% driven by yield improvements. While our joint venture with Virgin Atlantic is showing solid revenue growth, especially in London-Heathrow, Atlantic yields are showing pressure from geopolitical unrest and its impact on our service to Moscow and Tel Aviv. Our Pacific region experienced a 3% decline in unit revenues driven by lower yield, primarily due to the effects of the weakening of the Japanese yen.

Other Revenue. Other revenue increased $375 million, or 13%, primarily due to an increase in sales of SkyMiles, settlements associated with our transatlantic joint venture agreements and sales of non-jet fuel products to third parties by our oil refinery.


24



Operating Expense
 
Nine Months Ended September 30,
Increase
(Decrease)
% Increase
(Decrease)
(in millions)
2014
2013
Aircraft fuel and related taxes
$
7,612

$
7,175

$
437

6
 %
Salaries and related costs
6,084

5,809

275

5
 %
Regional carrier expense
4,033

4,302

(269
)
(6
)%
Aircraft maintenance materials and outside repairs
1,354

1,437

(83
)
(6
)%
Depreciation and amortization
1,333

1,238

95

8
 %
Contracted services
1,326

1,239

87

7
 %
Passenger commissions and other selling expenses
1,289

1,212

77

6
 %
Landing fees and other rents
1,089

1,060

29

3
 %
Profit sharing
823

387

436

NM

Passenger service
615

575

40

7
 %
Aircraft rent
172

162

10

6
 %
Restructuring and other items
649

242

407

NM

Other
1,302

1,160

142

12
 %
Total operating expense
$
27,681

$
25,998

$
1,683

6
 %

Fuel Expense. Including our regional carriers, fuel expense increased $332 million due to unfavorable changes in MTM adjustments as compared to the prior year period and a 1% increase in consumption, partially offset by a 2% decrease in fuel market price per gallon. The table below presents fuel expense, gallons consumed and average price per gallon, including the impact of hedging and the refinery:
 
Nine Months Ended September 30,
Increase
(Decrease)
% Increase
(Decrease)
(in millions, except per gallon data)
2014
2013
Aircraft fuel and related taxes(1)
$
7,612

$
7,175

$
437

 
Aircraft fuel and related taxes included within regional carrier expense
1,465

1,570

(105
)
 
Total fuel expense
$
9,077

$
8,745

$
332

4
%
 
 
 
 
 
Total fuel consumption (gallons)
2,949

2,906

43

1
%
Average price per gallon
$
3.08

$
3.01

$
0.07

2
%

(1) 
Includes the impact of fuel hedging and refinery results described further in the table below.

The table below shows the impact of hedging and the refinery on fuel expense and average price per gallon, adjusted:
 
 
Average Price Per Gallon
 
Nine Months Ended September 30,
Change
Nine Months Ended September 30,
Change
(in millions, except per gallon data)
2014
2013
2014
2013
Fuel purchase cost
$
8,956

$
8,969

$
(13
)
$
3.04

$
3.09

$
(0.05
)
Airline segment fuel hedge losses (gains)(1)
112

(294
)
406

0.04

(0.10
)
0.14

Refinery segment impact(1)
9

70

(61
)

0.02

(0.02
)
Total fuel expense
$
9,077

$
8,745

$
332

$
3.08

$
3.01

$
0.07

MTM adjustments
(380
)
184

(564
)
(0.13
)
0.06

(0.19
)
Total fuel expense, adjusted
$
8,697

$
8,929

$
(232
)
$
2.95

$
3.07

$
(0.12
)

(1) 
Includes the impact of pricing arrangements between the airline segment and refinery segment with respect to the refinery's inventory price risk.



25



Fuel Purchase Cost. Fuel purchase cost is based on the market price for jet fuel at airport locations.

Airline Segment Fuel Hedge Impact and MTM Adjustments. During the nine months ended September 30, 2014, our airline segment fuel hedge loss of $112 million included $380 million of unfavorable MTM adjustments. These MTM adjustments are based on market prices as of the end of the reporting period for contracts settling in future periods. Such market prices are not necessarily indicative of the actual future value of the underlying hedge in the contract settlement period. The MTM adjustments are reflected in the table above to calculate an effective fuel cost for the period.

Refinery Segment Impact. The refinery results include the impact on fuel expense of self-supply from the production of the refinery and from refined products exchanged with certain counterparties. As described in Note 2 of the Notes to the Condensed Consolidated Financial Statements, to the extent that we account for exchanges of refined products as nonmonetary transactions, we include the results of those transactions within fuel expense.

We adjust fuel expense for the items noted above to arrive at a more meaningful measure of fuel cost. Our average price per gallon, adjusted (a non-GAAP financial measure) was $2.95 for the nine months ended September 30, 2014.

Salaries and Related Costs. The increase in salaries and related costs is primarily due to investments in our employees and an increase in pilot and flight attendant block hours, partially offset by lower pension expense. We contributed $905 million to our qualified defined benefit pension plans during the first four months of 2014, including $250 million above the minimum funding requirements. These contributions satisfied the required contributions for our defined benefit plans for 2014 on an accelerated basis.

Regional Carrier Expense. The reduction in regional carrier expense is primarily due to lower fuel cost from a 4% decrease in capacity and fewer required maintenance events. During the nine months ended September 30, 2014, we removed twenty-six 50-seat regional aircraft from our fleet as part of our strategy to restructure our domestic fleet.

Aircraft Maintenance Materials and Outside Repairs. Aircraft maintenance materials and outside repairs consists of costs associated with maintenance of aircraft used in our operations and costs associated with maintenance sales to third parties by our MRO services business. The reduction in aircraft maintenance materials and outside repairs is due primarily to the timing of airframe and engine maintenance volume and a one-time contract settlement charge in 2013.

Depreciation and Amortization. Depreciation and amortization expense increased year-over-year primarily due to investments in new B-737-900ER and CRJ-900 aircraft, the purchase of aircraft off-lease, and aircraft modifications that upgraded aircraft interiors and enhanced our product offering.

Contracted Services. Contracted services expense increased year-over-year due primarily to costs associated with the 3% increase in capacity.

Passenger Commissions and Other Selling Expenses. Passenger commissions and other selling expenses increased on higher passenger revenue.

Profit Sharing. The increase in profit sharing is driven by an increase in the projected full year pre-tax income compared to the prior year. Our broad-based employee profit sharing program provides that, for each year in which we have an annual pre-tax profit, as defined by the terms of the program, we will pay a specified portion of that profit to employees. In determining the amount of profit sharing, the program defines profit as pre-tax profit excluding profit sharing and special items, such as MTM adjustments and restructuring and other items. Our profit sharing program pays 10% to employees for the first $2.5 billion of annual profits and 20% of annual profits above $2.5 billion.

Aircraft Rent. Aircraft rent increased year-over-year due primarily to the addition of leased B-717-200 and B-737-900ER aircraft delivered during the period, partially offset by the purchase of various aircraft off-lease in 2013.

Restructuring and Other Items. Due to the nature of amounts recorded within restructuring and other items, a year-over-year comparison is not meaningful. For a discussion of charges recorded in restructuring and other items, see Note 8 of the Notes to the Condensed Consolidated Financial Statements.

Other. Other operating expense increased primarily due to costs associated with sales of non-jet fuel products to third parties by our oil refinery.

26



Non-Operating Results
 
Nine Months Ended September 30, 2014
 
 
(in millions)
2014
2013
 
Favorable (Unfavorable)
Interest expense, net
$
(460
)
$
(526
)
 
$
66

Amortization of debt discount, net
(53
)
(120
)
 
67