United Airlines Holdings, Inc. quarterly report, Q2 FY2016

Business context and reporting period

United Continental Holdings, Inc. (UAL), the parent of United Airlines, Inc., filed this combined unaudited Form 10-Q for the quarter ended June 30, 2016. United accounts for nearly all of UAL’s revenue, expenses, assets and operating cash flows. Unless stated otherwise, figures below are UAL consolidated amounts; dollar figures are in millions.

Financial performance and position

For the first six months of 2016, revenue was $17,591, operating income $1,709 and net income $901, versus $18,522, $2,186 and $1,701, respectively, in the first half of 2015. Six-month diluted EPS was $2.63 versus $4.45.

In Q2, passenger revenue fell mainly as consolidated yield declined 6.1%; PRASM fell 6.6%. Traffic decreased 0.5%, capacity increased 0.1%, and load factor was 83.5%, down 0.4 points. Other operating revenue rose 7.5%, primarily reflecting the Chase co-branded card agreement. Fuel expense declined with a 31.4% decrease in average fuel price per gallon, while salaries and related costs increased 5.6% and depreciation and amortization rose 10.3%.

For the six months, operating cash flow was $3,746, compared with $3,577 in 2015. Capital expenditures were $1,654; net investing cash outflow was $1,619 and net financing cash outflow was $2,650. Cash and cash equivalents declined $523 to $2,483. At June 30, unrestricted cash, cash equivalents and short-term investments totaled $4.7 billion; including the fully available $1.35 billion revolving facility, unrestricted liquidity was $6.0 billion. Restricted cash and cash equivalents were $167.

At June 30, long-term debt was $9,275 and current maturities of long-term debt were $1,272; total debt and capital lease obligations were approximately $11.4 billion, including $1.4 billion due within 12 months. The company had $1.35 billion available under its revolving credit facility and was in compliance with debt covenants. Current liabilities exceeded current assets by approximately $6.1 billion; management noted that about $7.5 billion of current liabilities was advance ticket sales and frequent-flyer deferred revenue, largely associated with future travel rather than cash payments.

Material changes and unusual items

• Q2 operating income declined $385 million year over year despite fuel expense savings, as lower revenue and $434 million of operating special charges weighed on results.
• The largest special item was a $412 million impairment of Newark Liberty International Airport slot rights ($264 million after tax), following the FAA’s decision to designate Newark a Level 2 schedule-facilitated airport. The company concluded the slots’ intangible asset value was impaired because the slots would no longer govern take-off and landing rights.
• Other first-half special charges included $110 million for labor-agreement costs and $74 million related to restructuring a Cleveland airport lease. Total operating special charges were $624 million for the first half.
• Q2 income tax expense was $343 million, versus $4 million a year earlier; the 2016 effective tax rate was 36.9%. The 2015 comparison reflected a valuation allowance against deferred tax assets, substantially released in Q3 2015.
• UAL repurchased 42 million shares for $2.2 billion in the first half. At June 30, $255 million remained under the 2015 authorization; the board authorized a new $2 billion repurchase program in July 2016.
• In June, United arranged a $1.1 billion EETC offering, but had not received or recorded the proceeds as debt at June 30; receipt was expected by the end of Q1 2017.

Outlook, commentary and risks

• Management expected full-year 2016 consolidated capacity to grow 1.0%–1.5% year over year and targeted $3.1 billion of incremental value by 2018 through operational improvements, premium-customer initiatives, product and MileagePlus enhancements, aircraft upgauging and cost management.
• Labor contract extensions and agreements were expected to add approximately 1.5 percentage points to full-year 2016 non-fuel unit costs and 0.75 points in 2017. Flight-attendant negotiations remained subject to member ratification; technician negotiations continued in mediation. Management warned that higher labor pay and benefits could materially affect results.
• Fuel prices remained volatile: a $1 change in crude oil per barrel was estimated to change annual fuel expense by approximately $93 million. The company had hedged about 12% of projected fuel needs for the remainder of 2016.
• United had approximately $23.7 billion of capital commitments, primarily for aircraft and related items, including $2.3 billion due in the last six months of 2016. A substantial portion of assets was pledged under financing agreements. Credit ratings were below investment grade.
• Risks included demand and fare pressure, economic and currency volatility, fuel costs and hedge performance, competition and capacity, labor costs or disruption, financing and liquidity needs, and legal and regulatory matters. The company entered a two-year Non-Prosecution Agreement with the U.S. Attorney’s Office on July 14, 2016 concerning the Port Authority investigation; a related SEC investigation continued. A UK vote to leave the EU was identified as a potential source of economic, market and currency uncertainty.

Most important facts for investors to verify

• Whether passenger yields and PRASM stabilize, given the reported declines and management’s capacity-growth outlook.
• How recurring labor, maintenance, depreciation and other costs evolve as fuel-price benefits change.
• Execution and cash funding of the $23.7 billion capital commitment schedule, alongside debt maturities, aircraft financing and liquidity.
• The impact of Newark slot impairment and Cleveland lease restructuring, and whether further special charges arise.
• Progress on labor negotiations, the flight-attendant agreement and the effect of contract costs on non-fuel unit costs.
• Use of the new $2 billion share repurchase authorization relative to investment, debt and liquidity requirements.
• Compliance with the Non-Prosecution Agreement and outcomes of the continuing SEC investigation.