United Continental Holdings, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2011. This combined filing covers United Continental Holdings, Inc. (UAL), United Air Lines, Inc. and Continental Airlines, Inc. UAL completed its acquisition of Continental on October 1, 2010; consequently, consolidated 2011 results include Continental while 2010 comparisons generally do not. Continental’s standalone 2011 and 2010 results also use successor and predecessor accounting, respectively, and are not directly comparable.
Financial results and liquidity
| UAL consolidated metric | Q2 2011 | Six months 2011 |
|---|---|---|
| Operating revenue | $9.809 billion | $18.011 billion |
| Operating income / margin | $808 million / 8.2% | $842 million / 4.7% |
| Net income | $538 million | $325 million |
| Diluted EPS | $1.39 | $0.88 |
| Operating cash flow | Not separately stated | $1.758 billion |
- Q2 revenue increased 7.1% and operating expenses 7.9% versus 2010, excluding the effect of adding Continental. On that basis operating income was down $7 million. Passenger revenue rose 6.6%; yield rose 7.7% and PRASM 7.5%.
- Management reported Q2 net income of $577 million, or $1.49 diluted EPS, excluding special items, compared with GAAP net income of $538 million and diluted EPS of $1.39. A $107 million one-time special revenue gain was partly offset by $146 million of special charges, primarily integration costs. The MD&A highlights contain an apparent “diluted loss” wording error; the financial statements report diluted earnings of $1.39.
- For the first half, operating revenue increased 8.2% and operating expenses 9.5% excluding merger effects; operating income declined $78 million on that basis. Passenger revenue increased 8.2% excluding merger effects. Management’s non-GAAP first-half net income was $441 million, versus GAAP net income of $325 million.
- Fuel was the principal cost pressure: excluding merger effects, Q2 fuel expense rose 23.4% and first-half expense rose 24.2%. UAL’s average fuel cost per gallon increased 24.2% in Q2 and 23.6% for the first half.
- First-half operating cash flow was $1.758 billion, investing cash outflow $829 million, and financing cash outflow $1.479 billion. Cash and cash equivalents declined $550 million to $7.519 billion; unrestricted cash, cash equivalents and short-term investments totaled $8.579 billion at June 30.
- At June 30, UAL reported $12.490 billion of debt and $1.108 billion of capital-lease obligations, approximately $13.6 billion combined; $1.5 billion was due within 12 months. Total debt and lease obligations declined from year-end, following debt repayments including $570 million to repurchase convertible notes.
- Current assets were $12.391 billion and current liabilities $12.762 billion. Restricted cash and equivalents totaled $404 million. UAL said it remained in compliance with debt covenants; a substantial portion of assets was pledged as collateral.
Material developments, outlook and risks
- Accounting and loyalty program: A new revenue standard increased first-half passenger revenue by $161 million compared with the former accounting method. The modified Chase co-brand agreement generated a separate one-time $107 million non-cash revenue adjustment. UAL expected the agreement to increase other revenue by about $70 million per quarter and reduce passenger revenue by about $20 million per quarter for the remainder of 2011, subject to transaction volumes.
- Capacity and demand: Due to higher fuel prices, UAL planned to reduce flight frequencies, defer certain market launches and exit less profitable routes. It projected full-year 2011 consolidated capacity roughly flat versus 2010 pro forma, international capacity up 2%–3%, and domestic capacity down 2%–3%. The March 2011 Japan earthquake and tsunami reduced passenger revenue by an estimated $100 million in Q2 and $130 million in the first half.
- Fuel exposure: At quarter-end, UAL had hedged 51% of expected fuel consumption for the remainder of 2011 on maximum-price terms and 30% on minimum-price terms; it had hedged 13% of projected first-half 2012 consumption. Fuel-hedge ineffectiveness produced $31 million of nonoperating expense in the first half. Hedge values, fuel prices and counterparty performance remain variable.
- Contingent notes: A financial trigger required UAL to issue a $62.5 million tranche of 8% notes to the PBGC by February 14, 2012, maturing in 2026. UAL recorded a $49 million fair-value liability/charge. Further issuances of up to $500 million in aggregate could occur if future indenture triggers are met.
- Integration and labor: The companies were still operating as separate airlines while integrating. Integration-related special charges were $224 million in the first half. Labor negotiations and representation matters were ongoing; the filing says their eventual financial impact could be material but was not yet estimable. Management cited progress in co-locating facilities and selecting MileagePlus as the combined loyalty program beginning in 2012.
- Financing and liquidity risks: Aircraft commitments totaled $13.018 billion, including significant deliveries after 2015. Continental lacked financing in place for most aircraft on order and said additional financing would be needed, with no assurance of availability on acceptable terms. Credit-card reserve requirements could rise if combined unrestricted cash falls below $3.5 billion and could materially reduce liquidity. Ratings were below investment grade.
- Other identified risks include fuel-price volatility, labor disruption, economic and travel-demand changes, merger synergy execution, regulation, operating disruptions and contingencies. Management considered pending legal and environmental matters not expected to materially affect consolidated results, while noting estimates could change. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Reconcile the reported $538 million Q2 GAAP profit and $1.39 diluted EPS with the MD&A’s apparent “diluted loss” typo, and distinguish GAAP from management’s adjusted figures.
- Assess underlying trends using merger-adjusted comparisons, while accounting for the one-time loyalty-program revenue adjustment and the new revenue-recognition method.
- Track fuel prices, hedge settlements and hedge coverage, and test the capacity outlook against realized fuel costs and passenger demand.
- Review debt maturities, aircraft financing availability, capital commitments, PBGC contingent-note triggers and credit-card collateral thresholds against liquidity.
- Monitor integration costs, labor negotiations and progress toward a combined operating platform and realization of expected synergies.