Business context and reporting period
United Continental Holdings, Inc. (UAL) and wholly owned United Airlines, Inc. filed this combined unaudited Form 10-Q for the quarter ended September 30, 2014. United accounts for nearly all of UAL’s operating revenue, expenses, assets, liabilities, and operating cash flow. Unless noted, amounts below are UAL consolidated and in U.S. dollars.
The company operates mainline and regional passenger and cargo services. Results are seasonal; historically, the second and third quarters benefit from higher travel demand.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Operating revenue | $10.563 billion | $10.228 billion | $29.588 billion | $28.950 billion |
| Operating income | $1.191 billion | $508 million | $1.748 billion | $1.014 billion |
| Net income | $924 million | $379 million | $1.104 billion | $431 million |
| Diluted EPS | $2.37 | $0.98 | $2.84 | $1.15 |
| Operating margin | 11.3% | 5.0% | 5.9% | 3.5% |
Reported net margin was approximately 8.7% in Q3 2014 versus 3.7% in Q3 2013, and 3.7% for the first nine months versus 1.5% a year earlier. Management’s non-GAAP net income, excluding special charges and reflecting Economic Hedge Adjustments, was $1.075 billion for Q3 and $1.505 billion for the nine months, compared with $541 million and $791 million, respectively. Corresponding adjusted diluted EPS was $2.75 and $3.86, versus $1.39 and $2.07. These are non-GAAP measures, not reported GAAP results.
- Passenger revenue rose 4.4% in Q3 to $9.314 billion; mainline passenger revenue increased 5.5%. Consolidated yield rose 4.1%, while traffic and capacity grew 0.4% and 0.5%, respectively. Q3 load factor was 85.8%, down 0.1 percentage point.
- Q3 fuel expense fell 4.1% year over year to $3.127 billion, reflecting a 3.2% lower average fuel price and 0.9% lower consumption. Salaries and related costs rose 6.1%, chiefly due to higher pay rates and incentive-plan payments.
- For the first nine months, operating cash flow was $2.732 billion, up from $1.778 billion. Capital expenditures were $1.345 billion. Cash and cash equivalents declined to $3.117 billion from $3.220 billion at year-end 2013, while short-term investments rose to $2.397 billion.
- At September 30, unrestricted cash, cash equivalents, and short-term investments totaled $5.514 billion; the company also had $1.35 billion of undrawn revolving-credit capacity. Management cited total unrestricted liquidity of $6.9 billion.
- UAL reported $9.988 billion of long-term debt and $1.340 billion of current debt maturities, plus $766 million of capital-lease obligations. Management described approximately $12.1 billion of debt and capital-lease obligations, with about $1.4 billion due within 12 months. Debt covenants were in compliance.
Material changes versus prior comparable periods
- Q3 revenue increased 3.3%, operating expenses decreased 3.6%, and operating income rose 134.4% year over year. Lower fuel, special charges, and other operating expenses more than offset higher labor costs.
- Q3 special charges were $43 million, versus $211 million in Q3 2013. First-nine-month special charges were $264 million, versus $355 million.
- Q3 nonoperating expense increased to $271 million from $126 million, principally reflecting $102 million of unrealized losses on derivatives that did not qualify for hedge accounting, compared with $61 million of gains in Q3 2013.
- For the first nine months, revenue grew 2.2% and operating expenses declined 0.3%. Lower fuel expense was partly offset by higher salaries and landing fees.
- UAL repurchased approximately $220 million of shares during the first nine months under a newly authorized $1 billion program: $200 million through accelerated repurchases and $20 million in open-market purchases.
Outlook, commentary, risks, and unusual items
- Management expected full-year 2014 consolidated capacity growth of 0.2%–0.4% and CASM growth of 1.2%–1.6%, excluding profit sharing, third-party business expense, fuel, and special charges. It said it could not project GAAP CASM because future special charges were not determinable.
- Management said significantly higher fuel prices or a substantial decline in U.S. or global economic growth could prompt changes to capacity plans. Fuel hedges covered approximately 39% of projected requirements for the remainder of 2014, 24% for 2015, and less than 1% for 2016. Fuel derivatives were in a net liability position of $114 million at September 30.
- Future capital commitments totaled approximately $22.6 billion, primarily for aircraft, spare engines, improvements, and technology. Financing was arranged for all 2014 aircraft deliveries and 20 aircraft deliveries in 2015; the filing cautions that additional financing may not be available on acceptable terms or at all.
- Other significant obligations include future capacity-purchase payments of $11.605 billion, aircraft operating-lease payments of $8.347 billion, and facility and other operating-lease payments of $10.987 billion, as scheduled in the filing.
- Special items included $79 million of integration costs, $58 million of severance and benefits, $66 million related to permanently grounding 21 Embraer ERJ 135 aircraft, and $33 million of asset impairment for the first nine months. Management noted that Cleveland capacity reductions could lead to further potentially significant charges tied to contractual commitments.
- Approximately $100 million of unrestricted cash was held in Venezuelan bolivars; the company recorded $21 million of related exchange-rate losses for the first nine months and described ongoing negotiations concerning those funds.
- United had approximately 85,000 active employees, about 80% represented by labor organizations, and was negotiating amended agreements with some employee groups. It announced an enhanced voluntary early-out offer for flight attendants, targeting approximately 2,100 participants; actual participation was unknown.
- UAL and United had below-investment-grade credit ratings. The filing identifies liquidity, refinancing, fuel prices and hedging, demand, competition, labor relations, weather, operations, and execution of cost and merger-integration plans among risks.
- After quarter-end, United retired $248 million of convertible debentures and related securities for cash; management expected an approximately $65 million fourth-quarter nonoperating special charge. UAL also planned to redeem $58 million of remaining convertible senior notes, subject to holders’ conversion rights.
Important facts for investors to verify
- Whether reported GAAP earnings and margins, rather than management’s adjusted figures, best represent sustainable results; review the fuel-hedge adjustments and special-charge reconciliation.
- Whether the stated $6.9 billion liquidity measure, including undrawn credit capacity, remains available after near-term debt service, lease obligations, and capital spending.
- How the $22.6 billion of capital commitments will be financed and whether aircraft deliveries, lease obligations, and debt maturities can be met on acceptable terms.
- Potential effects of fuel-price movements and hedge accounting: hedge coverage is limited beyond 2015 and derivatives were a net liability at quarter-end.
- Whether labor negotiations, Cleveland contractual commitments, Venezuelan currency exposure, and the flight-attendant early-out program create additional costs or charges.
- Whether the 2014 capacity and CASM outlook is achieved; the filing’s outlook excludes specified costs and is subject to demand, fuel, and economic conditions.