United Airlines Holdings, Inc. quarterly report, Q3 FY2011

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Business context and reporting period

United Continental Holdings, Inc. (UAL), the parent of United Air Lines and Continental Airlines, filed this combined unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. United and Continental operated as separate airlines while integration continued. Continental’s acquisition accounting began October 1, 2010, so its 2011 Successor results are not directly comparable with its 2010 Predecessor results. UAL’s year-over-year comparisons also include Continental only after the merger; the filing separately identifies merger effects where available. Unless noted, amounts below are in millions of dollars.

Financial results and position

  • Third-quarter UAL results: Revenue was $10,171; operating income was $935 (9.2% operating margin); net income was $653; diluted EPS was $1.69. Excluding special items, management reported net income of $773 and diluted EPS of $2.00.
  • Nine-month UAL results: Revenue was $28,182; operating income was $1,777; net income was $978; diluted EPS was $2.59. Excluding special items, management reported net income of $1,214 and diluted EPS of $3.18.
  • Revenue and operating performance: Excluding merger effects, third-quarter revenue increased 7.1% year over year and operating income increased $34, or 6.3%. Passenger revenue rose 7.7%; passenger yield and PRASM each increased 9.8%. Traffic and capacity each declined 2.0%. The reported consolidated totals are substantially affected by the inclusion of Continental.
  • Fuel and costs: UAL third-quarter aircraft fuel expense was $3,371, up 27.1% excluding merger effects; the average fuel price was $3.13 per gallon, up 31.0%. Nine-month fuel expense was $9,270. Third-quarter operating expenses were $9,236; nine-month expenses were $26,405.
  • Cash flow: In the first nine months, UAL generated $2,143 of operating cash flow, used $1,282 in investing activities and used $1,946 in financing activities. Cash and cash equivalents declined from $8,069 at year-end 2010 to $6,984 at September 30, 2011.
  • Liquidity and debt: Unrestricted cash, cash equivalents and short-term investments totaled $8,357, down from $8,680 at December 31, 2010. UAL reported approximately $13.2 billion of debt and capital-lease obligations, including $1.3 billion due within 12 months. Total debt carrying value was $12,074; capital-lease obligations were approximately $1,083. The companies reported compliance with their debt covenants. Credit ratings were below investment grade: B/B2/B across S&P, Moody’s and Fitch.

Material changes versus the prior comparable period

  • Excluding merger effects, higher pricing and capacity discipline supported passenger revenue growth, while reduced business-traveler demand and lower traffic were noted. Fuel-price increases were a major offset: UAL’s third-quarter fuel price rose 31% and nine-month fuel price rose 26.4% on the filing’s comparable basis.
  • For the first nine months, UAL operating income increased to $1,777 from $1,058, but excluding merger effects it declined 4.2%, as comparable operating expenses grew 8.3% against revenue growth of 7.4%. Fuel and aircraft maintenance were significant cost pressures.
  • UAL’s third-quarter GAAP net income rose from $387 to $653, but per-share results are affected by the merger-related change in share count. United alone reported third-quarter net income of $415 versus $399; Continental reported $236 versus $354, with acquisition accounting limiting comparability.
  • Operating cash flow increased to $2,143 from $1,801 for the nine-month period, while investing and financing outflows rose. UAL spent $510 on capital expenditures and made $2.1 billion of debt and capital-lease payments, including repurchases of convertible notes.
  • Adoption of new frequent-flyer revenue accounting increased 2011 revenue; UAL recorded $254 of additional passenger revenue for the nine months. A separate $107 one-time, non-cash special revenue adjustment arose from modifying the Chase co-brand agreements.

Outlook, management commentary, risks and unusual items

  • Capacity outlook: Citing significant fuel-price increases, management expected combined fourth-quarter 2011 capacity to decline 2.6%–3.6% year over year, with domestic capacity down 4.6%–5.6% and international capacity approximately flat. Planned actions included reducing frequencies, postponing some market launches, exiting less profitable routes and considering removal of less fuel-efficient aircraft. No earnings or full-year financial guidance is provided in the supplied filing text.
  • Integration and investment: Management targeted a single operating certificate in fourth-quarter 2011 and a single passenger-service system by the end of first-quarter 2012. It announced a $550 investment in onboard product upgrades. Integration costs contributed to $343 of nine-month special charges, mostly related to integration; third-quarter special charges were $120.
  • Frequent-flyer accounting and Chase agreement: Revenue effects depend on credit-card sales and redemption patterns. The filing estimated approximately $50 of additional fourth-quarter revenue from the modified co-brand agreement, subject to variability. The one-time $107 special revenue item increased reported nine-month earnings but was non-cash.
  • Fuel hedging: UAL had hedged 56% of expected fuel consumption for the remainder of 2011 at maximum prices and 37% at minimum prices under its disclosed instruments, and 34% of projected first-half 2012 consumption. Fuel-hedge ineffectiveness contributed $87 of nine-month nonoperating expense; unrealized hedge losses could affect earnings if not reversed before contract expiration.
  • Funding and liquidity risks: Aircraft commitments totaled $12,875, primarily for aircraft and related equipment. Continental had no backstop financing in place for its aircraft orders; the filing cautioned that future financing might not be available on acceptable terms. Much of UAL’s assets were pledged, undrawn credit was limited, and additional credit-card reserve requirements could materially reduce liquidity. A $62.5 tranche of 8% notes was triggered and was due to be issued to the PBGC by February 14, 2012; UAL recorded a $49 fair-value charge.
  • Other risks and contingencies: Labor negotiations and potential operational disruption, fuel and financing costs, demand and economic conditions, merger execution, and legal and environmental matters were identified as risks. The filing describes ongoing merger-related antitrust litigation and an EU emissions-trading challenge. Management stated it believed ordinary-course legal and environmental contingencies would not materially affect consolidated results, while acknowledging estimates may change. A significant number of employees were union-represented and the outcome of negotiations could materially affect future results.

Most important facts for investors to verify

  1. Separate underlying operating trends from merger effects and Continental’s acquisition-accounting comparability limitations.
  2. Reconcile GAAP results to management’s non-GAAP figures, particularly the $107 non-cash revenue adjustment and $343 of year-to-date special charges.
  3. Track fuel prices, hedge performance and cash collateral needs, including possible recognition of unrealized hedge losses.
  4. Assess liquidity against $1.3 billion of near-term debt and lease maturities, aircraft commitments, credit-card reserve terms and financing availability.
  5. Monitor capacity reductions, labor negotiations and integration milestones, and their effects on revenue, costs and operations.