United Continental Holdings, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. This combined filing covers United Continental Holdings, Inc. (UAL), United Air Lines, Inc. and Continental Airlines, Inc. Continental was consolidated following the October 1, 2010 merger; therefore, reported year-over-year UAL comparisons include a substantial merger effect. UAL’s 2010 and 2011 consolidated totals are not directly comparable without adjusting for that effect.
Financial performance and liquidity
| UAL consolidated metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Operating revenue | $8.202 billion | $4.241 billion |
| Operating income | $34 million | $76 million |
| Net loss | $213 million | $82 million |
| Basic and diluted loss per share | $0.65 | $0.49 |
| Cash from operating activities | $1.005 billion | $482 million |
- UAL’s reported operating margin was approximately 0.4%, compared with 1.8% in Q1 2010; reported net margin was approximately negative 2.6%. These reported comparisons are affected by the merger.
- Excluding Continental’s post-merger contribution, revenue increased 10.2%, while operating expenses increased 12.1%; operating income declined $69 million. Management attributed the revenue improvement mainly to higher fares and stronger demand, while higher fuel costs weighed on results.
- Fuel expense was $2.672 billion for UAL, including Continental. On a merger-excluded basis, fuel expense rose 25.3%, primarily as fuel prices increased; United’s average fuel cost per gallon rose 23.6% to $2.72.
- Operating cash flow benefited from a $1.326 billion increase in advance ticket sales and fuel-hedge collateral movements. Investing cash use was $320 million, including $205 million of capital expenditures; financing cash use was $589 million.
- At March 31, unrestricted cash, cash equivalents and short-term investments totaled $8.887 billion, versus $8.680 billion at year-end 2010. Restricted cash and equivalents totaled $425 million.
- UAL reported $13.434 billion of debt and $1.150 billion of capital lease obligations on its balance sheet; management described approximately $14.6 billion of debt and capital lease obligations, including about $2.5 billion due within 12 months. Substantially all assets were pledged as collateral. The companies reported compliance with debt covenants.
Material changes and operating context
- Excluding the merger effect, passenger revenue grew 10.2% and cargo revenue 7.0%. Average fare per passenger increased 14.6%, yield 10.9%, and passenger revenue per available seat mile 8.9%. Traffic declined 0.7% while capacity rose 1.1%; load factor fell 1.4 percentage points to 79.0%.
- Fuel costs increased sharply: merger-excluded fuel expense rose 25.3%, despite higher hedge gains. UAL recorded $610 million of unrealized fuel-hedge gains in accumulated other comprehensive income at quarter-end.
- UAL incurred $77 million of special charges, primarily merger integration costs, versus $18 million in Q1 2010. Excluding special charges, UAL reported a $136 million net loss, or $0.41 per share, compared with a $93 million adjusted net loss in Q1 2010.
- Effective January 1, 2011, UAL adopted new accounting for ticket sales that include frequent-flyer miles. The change increased Q1 revenue by approximately $55 million; the filing says the effect for the rest of 2011 cannot be reliably estimated. Potential changes to co-branded credit-card mile-sale contracts could cause a material revenue adjustment, whose amount was not clear.
Outlook, risks and unusual items
- In response to higher fuel prices, UAL planned to reduce flights, postpone some market launches and exit less profitable routes. It expected 2011 consolidated capacity to be roughly flat year over year, international capacity up 3%–4%, and domestic capacity down 2%–3%, compared with 2010 pro forma capacity. It was also evaluating removal of less fuel-efficient aircraft and other cost savings.
- Management cited stronger economic conditions and improved fares, but reported that the March 2011 Japan earthquake and tsunami reduced first-quarter consolidated passenger revenue by approximately $30 million.
- Fuel remains a key exposure. At March 31, 2011, UAL’s fuel derivatives were a net asset of $695 million; the filing reports hedges covering 44% of projected remaining-2011 consumption at maximum-price levels and 28% at minimum-price levels. Derivative counterparty failure could expose UAL to an estimated $425 million loss, based on quarter-end values and collateral.
- Liquidity risks include significant debt and aircraft commitments, limited undrawn credit, pledged assets, and possible additional credit-card processing reserves following rating or liquidity deterioration. Credit ratings were below investment grade: S&P B, Moody’s B2 and Fitch B- (positive outlook).
- UAL had $12.690 billion of commitments, primarily aircraft and related items. Continental stated that financing was not in place for most of its aircraft orders and that future financing might not be available on acceptable terms.
- A dispute with the PBGC concerned whether the merger triggered an offer to redeem $615 million of UAL notes. UAL disputed the PBGC’s position; if the PBGC prevailed, related debt agreements could require prepayment of approximately $2.1 billion of principal. The filing says the outcome could not be predicted.
- Other uncertainties include ongoing labor negotiations and possible operational disruption, a technology-services contract dispute with unquantified potential damages, and the possibility that integration synergies may not be achieved. Management said the ultimate disposition of ordinary-course legal and environmental matters was not expected to materially affect results, while noting estimates may change.
- Integration was ongoing; United and Continental continued to operate as separate airlines. Management reported progress on co-located facilities, fleet repainting and product integration. Disclosure controls were assessed as effective, with internal controls continuing to be evaluated during integration.
Important facts for investors to verify
- How much of the reported revenue, expense, cash flow and debt picture reflects merger consolidation, and how comparable are management’s merger-excluded metrics?
- Whether higher fares and demand can offset fuel-price inflation, and how hedge positions, collateral and fuel prices change after quarter-end.
- Cash availability after near-term maturities, capital commitments, credit-card reserve requirements and aircraft financing needs.
- Developments in the PBGC note dispute, labor negotiations and the technology-services contract matter, including any quantified financial exposure.
- The realized costs, timing and benefits of merger integration, including any changes to frequent-flyer accounting or co-branded-mile contracts.