United Airlines Holdings, Inc. quarterly report, Q2 FY2015

Business context and reporting period

United Continental Holdings, Inc. (UAL), the parent of wholly owned United Airlines, Inc., filed this combined Form 10-Q for the quarter ended June 30, 2015. United’s operations comprise nearly all of UAL’s revenue, expenses, assets, liabilities and operating cash flows. Unless noted, financial amounts below are UAL consolidated figures in millions of dollars; the filing reports both the three and six months ended June 30.

Financial performance and position

Metric	Q2 2015	Q2 2014	Six months 2015	Six months 2014
Operating revenue	$9,914	$10,329	$18,522	$19,025
Operating income	$1,445	$906	$2,186	$557
Operating margin	14.6%	8.8%	11.8%	2.9%
Net income	$1,193	$789	$1,701	$180
Diluted EPS	$3.14	$2.01	$4.45	$0.47
Operating cash flow	Not separately presented	Not separately presented	$3,577	$2,158

Q2 operating expenses were $8,469, down 10.1% year over year; fuel expense fell 32.1% to $2,106, while salaries and related costs rose 12.2% to $2,454. Q2 net margin was 12.0%, versus 7.6% a year earlier.
For the first half, operating expenses were $16,336, down 11.5%. Aircraft fuel expense fell 34.0% to $3,970. The company reported first-half cash from operations of $3,577, capital expenditures of $1,311, and net cash used in financing of $1,610.
At June 30, cash and cash equivalents were $2,796 and short-term investments were $2,189, totaling about $5.0 billion of unrestricted cash and investments. An additional $1.35 billion revolving credit facility was undrawn; reported unrestricted liquidity including that facility was $6.3 billion.
Long-term debt was $9,938 and current debt maturities were $1,047; capital lease obligations totaled $674. Management cited approximately $11.7 billion in debt and capital lease obligations, including $1.2 billion due within 12 months. Total assets were $39,367 and current liabilities exceeded current assets by approximately $5.0 billion. Management noted that about $7.3 billion of current liabilities were advance ticket sales and frequent-flyer deferred revenue, largely expected to be recognized as travel rather than paid out in cash.
Debt and capital lease obligations are supported by pledged assets; the company reported compliance with debt covenants. The full $1.35 billion revolving facility was available at quarter-end.

Material changes versus the prior comparable period

Q2 revenue declined 4.0% and passenger revenue fell 3.4%, while operating income increased 59.5% and net income rose 51.2%. Lower fuel costs and reduced special charges more than offset the revenue decline.
Q2 traffic increased 0.7%, but capacity grew 2.3%; load factor decreased 1.4 percentage points to 83.9%. Passenger revenue per available seat mile fell 5.6%, and yield declined 4.1%.
Management attributed passenger yield pressure to domestic fare competition, adverse foreign-currency effects from a stronger U.S. dollar, and lower international surcharges. Other operating revenue fell 9.6%, primarily due to reduced third-party fuel sales.
First-half revenue decreased 2.6%, while operating income rose to $2,186 from $557 and net income rose to $1,701 from $180. First-half non-GAAP net income, excluding special charges and reflecting hedge program adjustments, was $1,842 versus $430.
Q2 GAAP net income was $1,193; the company’s non-GAAP figure was $1,260, or $3.31 diluted EPS. That measure excludes $183 of special charges and adjusts for fuel-hedge timing items. First-half non-GAAP diluted EPS was $4.82 versus $1.11.
Cash and short-term investments increased to about $5.0 billion from $4.4 billion at December 31, 2014. First-half operating cash flow increased by $1.4 billion year over year, primarily reflecting higher net income.

Outlook, risks, contingencies and unusual items

Management expected full-year 2015 consolidated capacity to grow 1%–1.5% year over year. It forecast full-year CASM excluding profit sharing, third-party business expense, fuel and special charges to be flat to up 0.5%; it said a GAAP CASM forecast was not available because future special charges could not be determined.
Fuel prices remained volatile. Management estimated that a $1 per barrel change in crude oil would change annual 2015 fuel expense by approximately $93 million. At June 30, the company had hedged about 22% of projected fuel needs for the remainder of 2015 and 5% for 2016; fuel derivatives were in a net liability position of $361 million. Hedge effectiveness, collateral needs and counterparty performance are risks.
First-half operating and nonoperating special charges totaled $253, including $134 of nonoperating loss related primarily to writing off unamortized discounts on the early redemption of 2026 and 2028 notes. Q2 included $128 of that debt-extinguishment charge. First-half operating special charges included $75 of severance and benefits, primarily related to a flight-attendant voluntary early-out program.
Capital commitments were approximately $21.9 billion, primarily for aircraft, engines, aircraft improvements and technology; $1.6 billion was scheduled for the second half of 2015. The company also had substantial aircraft orders extending through 2024 and stated that financing would be needed to meet capital commitments.
Approximately 80% of about 84,000 active employees were represented by labor organizations. Negotiations for joint collective bargaining agreements with technicians and flight attendants were ongoing.
UAL’s and United’s credit ratings were below investment grade. Management identified financing access and cost, liquidity, fixed obligations, pension funding, fuel-price volatility, competition, labor relations, foreign exchange and operational disruptions among relevant risks. About $80 million of unrestricted cash was held in Venezuelan bolivars, with repatriation limited by local law.
On June 30, 2015, UAL received a Department of Justice Civil Investigative Demand concerning airline capacity statements and decisions. After quarter-end, UAL and United were named in multiple class actions alleging airline capacity collusion and seeking treble damages; the company said it intended to defend the claims. The filing says the outcome of the government investigation could not be predicted.
The company reported a $4.1 billion deferred-tax-asset valuation allowance, citing its history of operating losses and uncertainty about future taxable income. It also noted seasonal fluctuations, with second- and third-quarter results historically stronger than first- and fourth-quarter results.
After quarter-end, on July 21, 2015, the board authorized a new $3 billion share repurchase program, expected to be completed by December 31, 2017. The prior $1 billion program had $230 million remaining at June 30.

Most important facts for investors to verify

Whether passenger yields, PRASM and load factor stabilize as capacity expands, particularly amid fare competition and currency pressures.
How much of reported earnings improvement is sustainable after accounting for lower fuel prices, hedge timing adjustments and special charges; assess GAAP and non-GAAP results together.
Whether operating cash generation and available liquidity can support approximately $11.7 billion of debt and lease obligations, aircraft commitments and planned shareholder returns.
The company’s fuel-hedge exposure, collateral requirements and sensitivity to fuel-price movements, including the effect of hedge losses recognized in fuel expense.
Developments in the DOJ inquiry and related class-action litigation, including potential financial, operational or reputational consequences.
Progress in labor negotiations, aircraft financing and delivery commitments, and any changes in below-investment-grade credit ratings or financing access.
Whether sustained taxable income supports any future reduction in the valuation allowance; the filing provides no assurance of realization.