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UNITED CONTINENTAL HOLDINGS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) Overview United Continental Holdings, Inc. (together with its consolidated subsidiaries, "UAL" or the "Company") is a holding company and its principal, wholly-owned subsidiary is United Airlines, Inc. (together with its consolidated subsidiaries, "United"). This Quarterly Report on Form 10-Q is a combined report of UAL and United including their respective consolidated financial statements. As UAL consolidates United for financial statement purposes, disclosures that relate to activities of United also apply to UAL, unless otherwise noted. United's operating revenues and operating expenses comprise nearly 100% of UAL's revenues and operating expenses. In addition, United comprises approximately the entire balance of UAL's assets, liabilities and operating cash flows. When appropriate, UAL and United are named specifically for their individual contractual obligations and related disclosures and any significant differences between the operations and results of UAL and United are separately disclosed and explained. We sometimes use the words "we," "our," "us," and the "Company" in this report for disclosures that relate to all of UAL and United. The Company transports people and cargo through its mainline operations, which utilize jet aircraft with at least 118 seats, and regional operations, which utilize smaller aircraft that are operated under contract by United Express carriers. The Company serves virtually every major market around the world, either directly or through participation in Star Alliance®, the world's largest airline alliance. The Company operates an average of 5,100 flights a day to 374 airports across six continents. 30-------------------------------------------------------------------------------- Table of Contents Third Quarter Financial Highlights • Third quarter 2014 net income was $1.1 billion, or $2.75 diluted earnings per share, excluding $40 million of special charges and $111 million of Economic Hedge Adjustments, consisting of $95 million of mark-to-market losses recorded in Nonoperating expense from fuel hedges settling in future periods and $16 million of prior period gains recorded in Nonoperating expense on fuel contracts settled in the current period. Unadjusted third quarter 2014 net income was $924 million, or $2.37 diluted earnings per share. • Passenger revenue increased 4.4% to $9.3 billion during the third quarter of 2014 as compared to the third quarter of 2013. • Third quarter 2014 aircraft fuel cost decreased 4.1% year-over-year due mainly to a 3.2% decrease in fuel prices, combined with a 0.9% decrease in fuel consumption. • Unrestricted liquidity was $6.9 billion, including $1.35 billion of undrawn commitments under the revolving credit facility of the Company's Credit and Guaranty Agreement (the "Credit Agreement"). • On July 24, 2014, UAL announced a $1.0 billion share repurchase program, which was authorized by UAL's Board of Directors. UAL may repurchase shares through the open market, privately negotiated transactions, block trades, or accelerated share repurchase transactions from time to time in accordance with applicable securities laws. UAL will repurchase shares of common stock subject to prevailing market conditions, and may discontinue such repurchases at any time. On July 24, 2014, pursuant to the $1.0 billion share repurchase program, UAL entered into two separate agreements to repurchase an aggregate of $200 million of shares of UAL common stock through an accelerated share repurchase program (the "ASR Program"). UAL paid $200 million and received approximately 4.4 million shares. In addition to shares purchased under the ASR Program, UAL spent $20 million on open market repurchases of 0.4 million shares of UAL common stock in September 2014. See Part II, Item 2. "Unregistered Sales of Equity Securities and Use of Proceeds" of this report for additional information. Third Quarter Operational Highlights • For the quarter ended September 30, 2014, United recorded a U.S. Department of Transportation on-time arrival rate of 77.4% and a system completion factor of 98.8%. • Consolidated traffic increased 0.4% and consolidated capacity increased 0.5% during the third quarter of 2014 as compared to the third quarter of 2013. The Company's load factor for the third quarter of 2014 was 85.8%. • The Company took delivery of four Boeing 737-900ER aircraft, one Boeing 787-9 aircraft and four Embraer 175 aircraft during the third quarter of 2014. Outlook The Company expects full-year 2014 consolidated capacity to increase between 0.2% and 0.4% year-over-year. The Company expects full year 2014 cost per available seat mile ("CASM") excluding profit sharing, third-party business expense, fuel and special charges to increase 1.2% to 1.6% year-over-year. We are unable to project CASM on a GAAP basis, as defined below, as the nature and amount of special charges are not determinable at this time. United announced five new international routes including Guam to Seoul, Korea and Shanghai; Houston to Punta Cana, Dominican Republic; and Newark to London, Ontario, Canada. Should fuel prices increase significantly or should the U.S. or global economic growth outlook decline substantially, we would likely adjust our capacity plans to reflect the different operating environment. Effective March 1, 2015, the Company will modify its MileagePlus program for most tickets from the current model in which members earn redeemable miles based on distance traveled to one based on ticket price (including base fare and carrier imposed surcharges). Members will be able to earn between five and eleven miles per dollar spent based on their MileagePlus status. The updated program will enhance the rewards for customers who spend more with United and give them improved mileage-earning opportunities. 31-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following discussion provides an analysis of results of operations and reasons for material changes therein for the three months ended September 30, 2014 as compared to the corresponding period in 2013. Third Quarter 2014 Compared to Third Quarter 2013 The Company recorded net income of $924 million in the third quarter of 2014 as compared to net income of $379 million in the third quarter of 2013. Excluding special charges and with Economic Hedge Adjustments, the Company had net income of $1.1 billion in the third quarter of 2014 as compared to net income of $541 million in the third quarter of 2013. See "Reconciliation of GAAP to Non-GAAP Financial Measures" at the end of this item for additional information related to accounting principles generally accepted in the United States ("GAAP") to Non-GAAP financial measures. We consider a key measure of our performance to be operating income, which was $1.2 billion for the third quarter of 2014, as compared to $508 million for the third quarter of 2013. Significant components of our operating results for the three months ended September 30 are as follows (in millions, except percentage changes): Increase % Increase 2014 2013 (Decrease) (Decrease) Operating revenue $ 10,563 $ 10,228 $ 335 3.3 Operating expense 9,372 9,720 (348 ) (3.6 ) Operating income 1,191 508 683 134.4 Nonoperating expense (271 ) (126 ) 145 115.1 Income tax expense (benefit) (4 ) 3 (7 ) NM Net income $ 924 $ 379 $ 545 143.8 NM - Not meaningful Certain consolidated statistical information for the Company's operations for the three months ended September 30 is as follows: Increase % Increase 2014 2013 (Decrease) (Decrease) Passengers (thousands) (a) 36,735 36,795 (60 ) (0.2 ) Revenue passenger miles ("RPMs") (millions) (b) 56,065 55,863 202 0.4 Available seat miles ("ASMs") (millions) (c) 65,378 65,040 338 0.5 Passenger load factor (d) 85.8 % 85.9 % (0.1) pts. N/A Passenger revenue per available seat mile ("PRASM") (cents) 14.25 13.71 0.54 3.9 Average yield per revenue passenger mile (cents) (e) 16.61 15.96 0.65 4.1 CASM (cents) 14.34 14.94 (0.60 ) (4.0 ) Average price per gallon of fuel, including fuel taxes $ 3.02 $ 3.12 $ (0.10 ) (3.2 ) Fuel gallons consumed (millions) 1,037 1,046 (9 ) (0.9 ) Average full-time equivalent employees 81,900 84,500 (2,600 ) (3.1 ) (a) The number of revenue passengers measured by each flight segment flown. (b) The number of scheduled miles flown by revenue passengers. (c) The number of seats available for passengers multiplied by the number of scheduled miles those seats are flown. (d) Revenue passenger miles divided by available seat miles. (e) The average passenger revenue received for each revenue passenger mile flown. 32 -------------------------------------------------------------------------------- Table of Contents Operating Revenue The table below shows year-over-year comparisons by type of operating revenue for the three months ended September 30 (in millions, except for percentage changes): Increase 2014 2013 (Decrease) % Change Passenger-Mainline $ 7,414 $ 7,025 $ 389 5.5 Passenger-Regional 1,900 1,893 7 0.4 Total passenger revenue 9,314 8,918 396 4.4 Cargo 237 199 38 19.1 Other operating revenue 1,012 1,111 (99 ) (8.9 ) $ 10,563 $ 10,228 $ 335 3.3 The table below presents selected passenger revenue and operating data, broken out by geographic region, expressed as third quarter year-over-year changes: Total Domestic Pacific Atlantic Latin Mainline Regional Consolidated Increase (decrease) from 2013 (a): Passenger revenue (in millions) $ 216 $ 37 $ 87 $ 49 $ 389 $ 7 $ 396 Passenger revenue 6.5 % 2.9 % 4.9 % 7.8 % 5.5 % 0.4 % 4.4 % Average fare per passenger 6.6 % 6.5 % 5.5 % (5.8) % 4.7 % 2.5 % 4.6 % Yield 7.6 % 1.8 % 5.4 % (2.1) % 5.1 % 0.1 % 4.1 % PRASM 7.9 % 0.2 % 3.6 % 0.9 % 4.8 % 1.2 % 3.9 % Average stage length 0.2 % 5.3 % 0.7 % (3.0)% 1.0 % 3.5 % 2.2 % Passengers (0.1)% (3.4)% (0.6)% 14.4 % 0.8 % (2.1)% (0.2)% RPMs (traffic) (1.1)% 1.1 % (0.5)% 10.1 % 0.4 % 0.2 % 0.4 % ASMs (capacity) (1.3)% 2.7 % 1.3 % 6.8 % 0.7 % (0.9)% 0.5 % Passenger load factor (points) 0.2 (1.3) (1.5) 2.5 (0.3) 0.9 % (0.1) (a) See Item 6 of the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for the definition of these statistics. Consolidated passenger revenue in the third quarter of 2014 increased 4.4% as compared to the year-ago period due to an increase in consolidated yield of 4.1% year-over-year and year-over-year increases in traffic and capacity of 0.4% and 0.5%, respectively. Cargo revenue increased $38 million, or 19.1%, in the third quarter of 2014 as compared to the year-ago period due to higher volumes year-over-year, as cargo traffic returned following lower bookings during the implementation of the Company's new cargo system in the third quarter of 2013. Other operating revenue in the third quarter of 2014 decreased $99 million, or 8.9%, as compared to the year-ago period due to the Company's decision to discontinue sales of aircraft fuel to a third party, partially offset by an increase in ancillary revenue. 33-------------------------------------------------------------------------------- Table of Contents Operating Expenses The table below includes data related to the Company's operating expenses for the three months ended September 30 (in millions, except for percentage changes): Increase 2014 2013 (Decrease) % Change Aircraft fuel $ 3,127 $ 3,262 $ (135) (4.1) Salaries and related costs 2,344 2,209 135 6.1 Regional capacity purchase 597 621 (24) (3.9) Landing fees and other rent 567 540 27 5.0 Aircraft maintenance materials and outside repairs 435 472 (37) (7.8) Depreciation and amortization 422 435 (13) (3.0) Distribution expenses 375 377 (2) (0.5) Aircraft rent 222 231 (9) (3.9) Special charges 43 211 (168) NM Other operating expenses 1,240 1,362 (122) (9.0) $ 9,372 $ 9,720 $ (348) (3.6) Aircraft fuel expense decreased $135 million, or 4.1%, year-over-year primarily due to a 3.2% decrease in the average price per gallon of aircraft fuel, combined with a 0.9% decrease in fuel consumption in the third quarter of 2014 compared to the year-ago period. The table below presents the significant changes in aircraft fuel cost per gallon in the three month period ended September 30, 2014 as compared to the year-ago period: (In millions) Average price per gallon % % 2014 2013 Change 2014 2013 Change Total aircraft fuel purchase cost excluding fuel hedge impacts $ 3,127 $ 3,276 (4.5) $ 3.02 $ 3.13 (3.5) Hedge gains reported in fuel expense - 14 NM - 0.01 NM Fuel expense as reported 3,127 3,262 (4.1) 3.02 3.12 (3.2) Cash received on settled hedges that do not qualify for hedge accounting (a) 1 13 NM 0.01 0.01 NM Fuel expense including all gains (losses) from settled hedges $ 3,126 $ 3,249 (3.8) $ 3.01 $ 3.11 (3.2) Total fuel consumption (gallons) 1,037 1,046 (0.9) (a) Includes ineffectiveness gains (losses) on settled hedges and gains (losses) on settled hedges that were not designated for hedge accounting. Ineffectiveness gains (losses) and gains (losses) on hedges that do not qualify for hedge accounting are recorded in Nonoperating income (expense): Miscellaneous, net. Salaries and related costs increased $135 million, or 6.1%, in the third quarter of 2014 as compared to the year-ago period primarily due to higher pay rates driven by new collective bargaining agreements and higher payments under employee incentive plans due to improvements in operational performance and customer satisfaction. Regional capacity purchase expense decreased $24 million, or 3.9%, in the third quarter of 2014 as compared to the year-ago period primarily due to a transition from paying regional carriers for landing fees to paying airports directly. Landing fees paid directly to airports are charged to Landing fees and other rent while payments to regional carriers are recorded to Regional capacity purchase. As a result of this change, there has been a shift of expense out of Regional capacity purchase into Landing fees and other rent in the third quarter of 2014 versus the year-ago period. Landing fees and other rent increased $27 million, or 5.0%, in the third quarter of 2014 as compared to the year-ago period primarily due to a transition from paying regional carriers for landing fees to paying airports directly. Aircraft maintenance materials and outside repairs decreased $37 million, or 7.8%, in the third quarter of 2014 as compared to the year-ago period primarily due to improved terms related to outsourced maintenance, a reduction in the volume of aircraft interior upgrades and improvements in the efficiency of the Company's maintenance programs. 34-------------------------------------------------------------------------------- Table of Contents Details of the Company's special charges include the following for the three months ended September 30 (in millions): 2014 2013 Integration-related costs $ 28 $ 50 Severance and benefits 6 - Labor agreement costs - 127 Losses on sale of assets and other special (gains) losses, net 9 34 Special charges $ 43 $ 211 See Note 10 to the financial statements included in Part I, Item 1 of this report for additional information. Other operating expenses decreased $122 million, or 9.0%, in the third quarter of 2014 as compared to the year-ago period primarily due to the Company's decision to discontinue sales of aircraft fuel to a third party, partially offset by increases in other personnel-related expenses and purchased services. Nonoperating Income (Expense). The following table illustrates the year-over-year dollar and percentage changes in the Company's nonoperating income (expense) for the three months ended September 30 (in millions, except for percentage changes): Increase % 2014 2013 (Decrease) Change Interest expense $ (186) $ (195) $ (9) (4.6) Interest capitalized 13 12 1 8.3 Interest income 8 5 3 60.0 Miscellaneous, net (106) 52 (158) NM Total $ (271) $ (126) $ 145 115.1 During the third quarter of 2014, Miscellaneous, net included unrealized losses of $102 million from derivatives not qualifying for hedge accounting as compared to gains of $61 million in the year-ago period. Income Taxes. Our effective tax rates are lower than the federal statutory rate of 35% primarily because of the impact of changes to existing valuation allowances. We continue to provide a valuation allowance for our deferred tax assets in excess of deferred tax liabilities because management has concluded that it is more likely than not that such deferred tax assets will ultimately not be realized. See Note 4 to the financial statements included in Part I, Item 1 of this report. 35 -------------------------------------------------------------------------------- Table of Contents First Nine Months 2014 Compared to First Nine Months 2013 UAL recorded net income of $1.1 billion in the first nine months of 2014 as compared to net income of $431 million in the first nine months of 2013. Excluding operating and nonoperating special charges and with Economic Hedge Adjustments, UAL had net income of $1.5 billion in the first nine months of 2014 as compared to net income of $791 million in the first nine months of 2013. See "Reconciliation of GAAP to Non-GAAP Financial Measures" at the end of this item for additional information related to GAAP to Non-GAAP financial measures. We consider a key measure of our performance to be operating income, which was $1.7 billion for the first nine months of 2014, as compared to $1.0 billion for the first nine months of 2013. Significant components of our operating results for the first nine months of 2014 are as follows (in millions, except percentage changes): Increase % Increase 2014 2013 (Decrease) (Decrease) Operating Revenue $ 29,588 $ 28,950 $ 638 2.2 Operating Expense 27,840 27,936 (96 ) (0.3 ) Operating Income 1,748 1,014 734 72.4 Nonoperating Expense (643 ) (587 ) 56 9.5 Income Tax Expense (Benefit) 1 (4 ) 5 NM Net Income $ 1,104 $ 431 $ 673 156.1 NM - Not meaningful Certain consolidated statistical information for UAL's operations for the nine months ended September 30 is as follows: Increase % Increase 2014 2013 (Decrease) (Decrease) Passengers (thousands) (a) 104,472 105,102 (630 ) (0.6 ) RPMs (millions) (b) 156,348 155,988 360 0.2 ASMs (millions) (c) 185,808 185,663 145 0.1 Passenger load factor (d) 84.1 % 84.0 % 0.1 pts. N/A PRASM (cents) 13.82 13.54 0.28 2.1 Average yield per revenue passenger mile (cents) (e) 16.42 16.12 0.30 1.9 CASM (cents) 14.98 15.05 (0.07 ) (0.5 ) Average price per gallon of fuel, including fuel taxes $ 3.09 $ 3.14 $ (0.05 ) (1.6 ) Fuel gallons consumed (millions) 2,957 2,986 (29 ) (1.0 ) Average full-time equivalent employees 82,500 84,700 (2,200 ) (2.6 ) (a) The number of revenue passengers measured by each flight segment flown. (b) The number of scheduled miles flown by revenue passengers. (c) The number of seats available for passengers multiplied by the number of scheduled miles those seats are flown. (d) Revenue passenger miles divided by available seat miles. (e) The average passenger revenue received for each revenue passenger mile flown. Operating Revenue The table below shows year-over-year comparisons by type of operating revenue for the nine months ended September 30 (in millions, except for percentage changes): Increase 2014 2013 (Decrease) % Change Passenger-Mainline $ 20,410 $ 19,792 $ 618 3.1 Passenger-Regional 5,269 5,353 (84) (1.6) Total passenger revenue 25,679 25,145 534 2.1 Cargo 678 662 16 2.4 Other operating revenue 3,231 3,143 88 2.8 $ 29,588 $ 28,950 $ 638 2.2 36 -------------------------------------------------------------------------------- Table of Contents The table below presents selected passenger revenue and operating data, broken out by geographic region, expressed as year-over-year changes for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013: Total Domestic Pacific Atlantic Latin Mainline Regional Consolidated Increase (decrease) from 2013 (a): Passenger revenue (in millions) $ 432 $ (24) $ 111 $ 99 $ 618 $ (84) $ 534 Passenger revenue 4.5 % (0.7)% 2.4 % 5.0 % 3.1 % (1.6)% 2.1 % Average fare per passenger 5.1 % 2.3 % 3.2 % (4.8)% 2.8 % 0.8 % 2.7 % Yield 5.1 % (1.0) % 3.0 % (1.4)% 2.8 % (1.6)% 1.9 % PRASM 5.9 % (2.7) % 1.3 % 1.2 % 2.8 % 0.2 % 2.1 % Average stage length 0.9 % 3.9 % 0.5 % (2.9)% 1.3 % 3.3 % 2.4 % Passengers (0.6)% (2.9) % (0.8)% 10.2 % 0.3 % (2.3)% (0.6)% RPMs (traffic) (0.6)% 0.3 % (0.5)% 6.4 % 0.3 % - % 0.2 % ASMs (capacity) (1.3)% 2.2 % 1.0 % 3.7 % 0.4 % (1.8)% 0.1 % Passenger load factor (points) 0.6 (1.5) (1.3) 2.2 (0.1) 1.4 0.1 (a) See Item 6 of the Company's Annual Report on Form 10-K for the year ended December 31, 2013 for the definition of these statistics. Consolidated passenger revenue in the first nine months of 2014 increased 2.1% as compared to the year-ago period due to an increase in consolidated yield of 1.9% year-over-year and year-over-year increases in traffic and capacity of 0.2% and 0.1% respectively. Other operating revenue in the first nine months of 2014 increased $88 million, or 2.8%, as compared to the year-ago period due primarily to increases in ancillary, MileagePlus, and contract services revenues partially offset by a reduction due to the Company's decision to discontinue sales of aircraft fuel to a third party. Operating Expenses The table below includes data related to UAL's operating expenses for the nine months ended September 30 (in millions, except for percentage changes): Increase 2014 2013 (Decrease) % Change Aircraft fuel $ 9,145 $ 9,380 $ (235) (2.5) Salaries and related costs 6,684 6,511 173 2.7 Regional capacity purchase 1,747 1,837 (90) (4.9) Landing fees and other rent 1,706 1,544 162 10.5 Aircraft maintenance materials and outside repairs 1,364 1,390 (26) (1.9) Depreciation and amortization 1,248 1,268 (20) (1.6) Distribution expenses 1,039 1,052 (13) (1.2) Aircraft rent 668 706 (38) (5.4) Special charges 264 355 (91) NM Other operating expenses 3,975 3,893 82 2.1 $ 27,840 $ 27,936 $ (96) (0.3) Aircraft fuel expense decreased $235 million, or 2.5%, year-over-year primarily due to a 1.6% decrease in the average price per gallon of aircraft fuel and a 1.0% decrease in fuel consumption in the first nine months of 2014 compared to the year-ago period. The table below presents the significant changes in aircraft fuel cost per gallon in the nine months ended September 30, 2014 as compared to the year-ago period. 37-------------------------------------------------------------------------------- Table of Contents (In millions) Average price per gallon % % 2014 2013 Change 2014 2013 Change Total aircraft fuel purchase cost excluding fuel hedge impacts $ 9,141 $ 9,376 (2.5) $ 3.09 $ 3.14 (1.6) Hedge losses reported in fuel expense (4) (4) NM - - NM Fuel expense as reported 9,145 9,380 (2.5) 3.09 3.14 (1.6) Cash received on settled hedges that do not qualify for hedge accounting (a) 13 35 NM - 0.01 NM Fuel expense including all gains (losses) from settled hedges $ 9,132 $ 9,345 (2.3) $ 3.09 $ 3.13 (1.3) Total fuel consumption (gallons) 2,957 2,986 (1.0) (a) Includes ineffectiveness gains (losses) on settled hedges and gains (losses) on settled hedges that were not designated for hedge accounting. Ineffectiveness gains (losses) and gains (losses) on hedges that do not qualify for hedge accounting are recorded in Nonoperating income (expense): Miscellaneous, net. Salaries and related costs increased $173 million, or 2.7%, in the first nine months of 2014 as compared to the year-ago period primarily due to higher pay rates driven by new collective bargaining agreements, partially offset by lower pension and post-employment benefit costs. Regional capacity purchase expense decreased $90 million, or 4.9%, in the first nine months of 2014 as compared to the year-ago period primarily due to a transition from paying regional carriers for landing fees to paying airports directly. Landing fees paid directly to airports are charged to Landing fees and other rent while payments to regional carriers are recorded to Regional capacity purchase. As a result of this change, there has been a shift of expense out of Regional capacity purchase into Landing fees and other rent in the first nine months of 2014 versus the year-ago period. Regional capacity expense also decreased due to a significant number of weather-driven flight cancellations in the first quarter of 2014. These benefits were partially offset by higher rates primarily due to annual rate escalations and higher aircraft ownership expenses related to an increase in the number of aircraft flying under capacity purchase agreements versus the year-ago period. Landing fees and other rent increased $162 million, or 10.5%, in the first nine months of 2014 as compared to the year-ago period primarily due to a transition from paying regional carriers for landing fees to paying airports directly. Landing fees have also increased due to airport security services and modernization projects at certain airport locations. Details of UAL's special charges include the following for the nine months ended September 30 (in millions): 2014 2013 Integration-related costs $ 79 $ 165 Severance and benefits 58 14 Labor agreement costs - 127Costs associated with permanently grounding Embraer ERJ 135 aircraft 66 - Impairment of assets held for disposal 33 - Additional costs associated with the temporarily grounded Boeing 787 aircraft - 18 Losses on sale of assets and other special (gains) losses, net 28 31 Special charges $ 264 $ 355 See Note 10 to the financial statements included in Part I, Item 1 of this report for additional information. Other operating expenses increased $82 million, or 2.1%, in the first nine months of 2014 as compared to the year-ago period primarily due to increases in purchased services, other personnel-related expenses, and advertising costs, partially offset by a reduction due to the Company's decision to discontinue sales of aircraft fuel to a third party. 38-------------------------------------------------------------------------------- Table of Contents Nonoperating Income (Expense). The following table illustrates the year-over-year dollar and percentage changes in UAL's nonoperating income (expense) for the nine months ended September 30 (in millions, except for percentage changes): Increase 2014 2013 (Decrease) % Change Interest expense $ (559) $ (590) $ (31) (5.3) Interest capitalized 40 35 5 14.3 Interest income 17 16 1 6.3 Miscellaneous, net (141) (48) 93 193.8 Total $ (643) $ (587) $ 56 9.5 Miscellaneous, net increased by $93 million in the first nine months of 2014 due primarily to fuel derivatives losses of approximately $107 million versus fuel derivatives gains of $30 million in the year-ago period and $21 million of losses due to exchange rate changes implemented in Venezuela applicable to funds held in local currency, partially offset by favorable comparisons versus the year-ago period in foreign currency translation results, debt-related expenses and the results of investments sales. United's nonoperating expense also includes net gains of $19 million and $51 million for the nine months ended September 30, 2014 and 2013, respectively, associated with marking to market the fair value of derivative assets and liabilities related to agreements that provide for United's convertible debt to be settled with UAL common stock. This net gain and related derivatives are reflected only in the United stand-alone financial statements as they are eliminated at the consolidated level. See Note 6 to the financial statements included in Part I, Item 1 of this report for additional information. Income Taxes. Our effective tax rates are lower than the federal statutory rate of 35% primarily because of the impact of changes to existing valuation allowances. We continue to provide a valuation allowance for our deferred tax assets in excess of deferred tax liabilities because management has concluded that it is more likely than not that such deferred tax assets will ultimately not be realized. See Note 4 to the financial statements contained in Part I, Item 1 of this report for additional information. LIQUIDITY AND CAPITAL RESOURCES Current Liquidity As of September 30, 2014, the Company had $5.5 billion in unrestricted cash, cash equivalents and short-term investments, as compared to $5.1 billion at December 31, 2013. At September 30, 2014, the Company also had $316 million of restricted cash and cash equivalents, which is primarily collateral for performance bonds, letters of credit, estimated future workers' compensation claims and credit card processing agreements. As of September 30, 2014, the Company had its entire commitment capacity of $1.35 billion under the revolving credit facility of the Company's Credit Agreement available for letters of credit or borrowings. Approximately $100 million of the Company's unrestricted cash balance was held as Venezuelan bolivars as of September 30, 2014. As is the case with many of our principal competitors, we have a high proportion of debt compared to capital. We have a significant amount of fixed obligations, including debt, aircraft leases and financings, leases of airport property and other facilities, and pension funding obligations. At September 30, 2014, the Company had approximately $12.1 billion of debt and capital lease obligations, including $1.4 billion that will become due in the next 12 months. In addition, we have substantial non-cancelable commitments for capital expenditures, including the acquisition of new aircraft and related spare engines. The Company will continue to evaluate opportunities to repurchase its debt in open market transactions to reduce its indebtedness and the amount of interest paid on its indebtedness. 39 -------------------------------------------------------------------------------- Table of Contents As of September 30, 2014, United had firm commitments and options to purchase aircraft from The Boeing Company ("Boeing"), Embraer S.A. ("Embraer") and Airbus S.A.S. ("Airbus") presented in the table below: Number of Firm Aircraft Type Commitments (a) Airbus A350-1000 35 Boeing 737-900ER 39 Boeing 737 MAX 9 100 Boeing 787-8/-9/-10 53 Embraer 175 22 (a) United also has options and purchase rights for additional aircraft. The aircraft listed in the table above are scheduled for delivery for the remainder of 2014 through 2025. In the remainder of 2014, United expects to take delivery of five Boeing 737-900ER aircraft, one Boeing 787-8 aircraft, one Boeing 787-9 aircraft and 11 Embraer 175 aircraft. As of September 2014, United has arranged for EETC and bank debt financing for all 2014 aircraft deliveries and 20 of our 2015 aircraft deliveries, including 11 Boeing 737-900ER aircraft, four Boeing 787-9 aircraft and five Embraer 175 aircraft. In addition, United has secured backstop financing commitments from certain of its aircraft manufacturers for a limited number of its future aircraft deliveries, subject to certain customary conditions. Financing will be necessary to satisfy the Company's capital commitments for its firm order aircraft and other related capital expenditures. The Company can provide no assurance that any financing not already in place for aircraft and spare engine deliveries will be available to the Company on acceptable terms when necessary or at all. See Note 9 to the financial statements included in Part I, Item 1 of this report for additional information on aircraft financing. As of September 30, 2014, UAL and United have total capital commitments primarily related to the acquisition of aircraft and related spare engines, aircraft improvements and acquisition of information technology services and assets of approximately $22.6 billion, of which approximately $1.1 billion, $3.0 billion, $1.7 billion, $1.2 billion, $2.1 billion and $13.5 billion are due in the last three months of 2014 and for the full year for 2015, 2016, 2017, 2018 and thereafter, respectively. Any incremental firm aircraft orders, including through the exercise of purchase options and purchase rights, will increase the total future capital commitments of the Company. As of September 30, 2014, a substantial portion of the Company's assets, principally aircraft, route authorities and certain other intangible assets, were pledged under various loan and other agreements. We must sustain our profitability and/or access the capital markets to meet our significant long-term debt and capital lease obligations and future commitments for capital expenditures, including the acquisition of aircraft and related spare engines. In September 2014, United entered into an amendment to a contract with Shuttle America Corporation ("Shuttle America"), a wholly-owned subsidiary of Republic Airways Holdings, for Shuttle America to operate 50 new Embraer 175 aircraft under the United Express brand and extend the term of 38 existing Embraer 170 aircraft operating under the United Express brand. Shuttle America will acquire fifty 76-seat Embraer 175 aircraft with deliveries from 2015 through 2017, although United has the right to acquire the aircraft under certain circumstances and lease the aircraft to Shuttle America. These 50 aircraft are in addition to United's other 70 Embraer 175 aircraft that are currently being operated or will in the future be operated by different United Express carriers under capacity purchase agreements. In a separate but related amendment with Republic Airways Holdings Inc. and its subsidiary, Republic Airline Inc. ("Republic"), United and Republic agreed to remove 31 Q400 aircraft from United Express service in 2015 and 2016. See Note 8 to the financial statements included in Part I, Item 1 of this report for additional information. In September 2014, United entered into a 10-year lease extension through 2035 with the City and County of Denver to continue its use of the airport terminal space at Denver International Airport. This extension is expected to result in annual cost savings for the Company through the original lease term end date of 2025. See Note 8 to the financial statements included in Part I, Item 1 of this report for additional information. 40-------------------------------------------------------------------------------- Table of Contents Credit Ratings. As of the filing date of this report, UAL and United had the following corporate credit ratings: S&P Moody's Fitch UAL B B2 B United B * B * The credit agency does not issue corporate credit ratings for subsidiary entities. These credit ratings are below investment grade levels. Downgrades from these rating levels, among other things, could restrict the availability or increase the cost of future financing for the Company. Sources and Uses of Cash Operating Activities. Cash flow provided by operations for the nine months ended September 30, 2014 was $2.7 billion compared to $1.8 billion in the same period in 2013. The increase is primarily attributable to an increase in operating income and advanced ticket sales, partially offset by a decrease in other working capital items. Investing Activities. Capital expenditures were $1.3 billion and $1.4 billion in the nine months ended September 30, 2014 and 2013, respectively. Capital expenditures for the nine months ended September 30, 2014 were primarily attributable to the purchase of aircraft, facility and fleet-related costs. In addition to capital expenditures during the nine months ended September 30, 2014, we acquired 36 aircraft through the issuance of debt. See "Financing Activities" below for additional information. Financing Activities. During the nine months ended September 30, 2014, the Company made debt and capital lease payments of $2.1 billion. During the second quarter of 2014, UAL used cash to purchase and retire $28 million aggregate principal amount of its 4.5% Convertible Notes due 2015 in market transactions. As of September 30, 2014, the outstanding balance was $202 million. During the nine months ended September 30, 2014, UAL issued approximately five million shares of UAL common stock in exchange for, or upon conversion of, $46 million in aggregate principal amount of UAL's outstanding 6% convertible senior notes due 2029 held by the holders of these notes. As of September 30, 2014, the outstanding balance is $58 million. In October 2014, UAL notified holders of these notes of its intention to redeem the remaining notes outstanding with the redemption scheduled to occur in late November 2014. The holders of these notes have the right to convert their notes into shares of UAL common stock prior to redemption at a conversion rate of 115.1013 per $1,000 principal amount of notes. If all of the holders of these notes exercise their conversion right, UAL would issue approximately 6.7 million shares of UAL common stock upon conversion. UAL redeemed in cash at par value all $400 million aggregate principal amount of its 8% Notes due 2024 on January 17, 2014. On January 10, 2014, UAL called the 4.5% Senior Limited-Subordination Convertible Notes due 2021 (the "4.5% Notes") that remained outstanding for redemption on February 10, 2014. In the first quarter of 2014, holders of substantially all of the remaining $156 million outstanding principal amount of the 4.5% Notes exercised their right to convert such notes into approximately five million shares of UAL common stock at a conversion rate of 30.6419 shares of UAL common stock per $1,000 principal amount of 4.5% Notes. In September 2014, United borrowed a $500 million term loan under the Credit Agreement. The loan is due September 2021 and bears interest at LIBOR plus a margin of 3.0% per annum. The $500 million term loan ranks pari passu with the $900 million term loan that United originally borrowed under the Credit Agreement, of which $887 million is outstanding. Also in September 2014, UAL amended its revolving credit facility under the Credit Agreement increasing the capacity from $1.0 billion to $1.35 billion and establishing the maturity date for $1.315 billion in lender commitments as January 2, 2019. As of September 30, 2014, United had its entire capacity of $1.35 billion available under the revolving credit facility of the Company's Credit Agreement. 41 -------------------------------------------------------------------------------- Table of Contents The obligations of United under the Credit Agreement are secured by liens on certain international route authorities between certain specified cities, certain take-off and landing rights and related assets of United. Certain covenants in the Credit Agreement and in the Company's indentures are summarized in Note 11 of the 2013 Annual Report. In September 2014, United retired, at par, the entire $800 million principal balance of the 6.75% Senior Secured Notes. On October 10, 2014, United used cash to retire, at par, the entire $248 million principal balance of the 6% Convertible Junior Subordinated Debentures and the 6% Convertible Preferred Securities, Term Income Deferrable Equity Securities (TIDES). United will account for this debt extinguishment as a component of Special charges in Nonoperating income (expense): Miscellaneous, net for approximately $65 million in the fourth quarter of 2014. Share Repurchase Program. UAL's Board of Directors authorized a share repurchase program to acquire up to $1 billion of UAL's common stock. UAL may repurchase shares through the open market, privately negotiated transactions, block trades, or accelerated share repurchase transactions from time to time in accordance with applicable securities laws. UAL will repurchase shares of common stock subject to prevailing market conditions, and may discontinue such repurchases at any time. On July 24, 2014, pursuant to the $1.0 billion share repurchase program, UAL entered into two separate agreements to repurchase an aggregate of $200 million of shares of UAL common stock through an accelerated share repurchase program (the "ASR Program"). UAL paid $200 million and received approximately 4.4 million shares. In addition to shares purchased under the ASR Program, UAL spent $20 million on open market repurchases of 0.4 million shares of UAL common stock in September 2014. See Part II, Item 2., "Unregistered Sales of Equity Securities and Use of Proceeds" of this report for additional information. EETCs. In August 2014, April 2014 and August 2013, United created separate EETC pass-through trusts, each of which issued pass-through certificates. The proceeds of the issuance of the pass-through certificates are used to purchase equipment notes issued by United and secured by its aircraft. The Company records the debt obligation upon issuance of the equipment notes rather than upon the initial issuance of the pass-through certificates. The pass-through certificates represent fractional undivided interests in the respective pass-through trusts and are not obligations of United. The payment obligations under the equipment notes are those of United. Proceeds received from the sale of pass-through certificates are initially held by a depositary in escrow for the benefit of the certificate holders until United issues equipment notes to the trust, which purchases such notes with a portion of the escrowed funds. These escrowed funds are not guaranteed by United and are not reported as debt on our consolidated balance sheet because the proceeds held by the depositary are not United's assets. United expects to receive all proceeds from these pass-through trusts by the end of 2015. Certain details of the pass-through trusts are as follows (in millions, except stated interest rate): Proceeds received from issuance of Remaining debt in the proceeds from Final Total debt nine months issuance of debt expected Stated recorded ended to be received distribution interest as of September 30, September 30, in future EETC Date Class Principal date rate 2014 2014 periods August 2014 A $ 823 September 2026 3.75% $ - $ - $ 823 August 2014 B 238 September 2022 4.625% - - 238 April 2014 A 736 April 2026 4.0% 427 427 309 April 2014 B 213 April 2022 4.75% 123 123 90 August 2013 A 720 August 2025 4.3% 720 567 - August 2013 B 209 August 2021 5.375% 209 165 - $ 2,939 $ 1,479 $ 1,282 $ 1,460 Commitments, Contingencies and Liquidity Matters As described in the 2013 Annual Report, the Company's liquidity may be adversely impacted by a variety of factors, including, but not limited to, obligations associated with fuel hedge settlements and related collateral requirements, pension funding obligations, reserve requirements associated with credit card processing agreements, guarantees, commitments and contingencies. See the 2013 Annual Report and Notes 5, 7, 8 and 9 to the financial statements contained in Part I, Item 1 of this report for additional information. 42-------------------------------------------------------------------------------- Table of Contents RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES The Company evaluates its financial performance utilizing various GAAP and Non-GAAP financial measures, including net income/loss and net earnings/loss per share. The Non-GAAP financial measures in this report are presented because they provide management and investors the ability to measure and monitor the Company's performance on a consistent basis. The Company believes that adjusting for operating and nonoperating special charges is useful to investors because they are nonrecurring charges not indicative of UAL's ongoing performance. In addition, the Company believes that reflecting Economic Hedge Adjustments is useful because the adjustments allow investors to better understand the cash impact of settled hedges in a given period. Reconciliations of net income and diluted earnings per share to the Non-GAAP financial measures of net income and diluted earnings per share, excluding operating and nonoperating special charges and reflecting Economic Hedge Adjustments, for the three and nine months ended September 30 are as follows in the tables below (in millions, except per share amounts): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Net income - GAAP $ 924 $ 379 $ 1,104 $ 431 Operating and nonoperating special charges, net (a) 40 211 281 355 Mark-to-market (gains) losses from fuel hedges settling in future periods 95 (55) 57 (34) Prior period gains on fuel contracts settled in the current period 16 6 63 39 Net income excluding operating and nonoperating special charges, net and reflecting Economic Hedge Adjustments-Non - GAAP $ 1,075 $ 541 $ 1,505 $ 791 Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Diluted earnings per share - GAAP $ 2.37 $ 0.98 $ 2.84 $ 1.15 Operating and nonoperating special charges, net (a) 0.10 0.53 0.71 0.91 Mark-to-market (gains) losses from fuel hedges settling in future periods 0.24 (0.14) 0.15 (0.09) Prior period gains on fuel contracts settled in the current period 0.04 0.02 0.16 0.10 Diluted earnings per share excluding operating and nonoperating special charges, net and reflecting Economic Hedge Adjustments-Non - GAAP $ 2.75 $ 1.39 $ 3.86 $ 2.07 (a) See Note 10 to the financial statements included in Part I, Item 1 of this report for additional information related to operating and nonoperating special charges, net. CRITICAL ACCOUNTING POLICIES See "Critical Accounting Policies" in Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2013 Annual Report for a discussion of the Company's critical accounting policies. See Note 1 to the financial statements included in Part I, Item 1 of this report for a discussion of changes in accounting for revenue for the Company's loyalty program. 43-------------------------------------------------------------------------------- Table of Contents FORWARD-LOOKING INFORMATION Certain statements throughout Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report are forward-looking and thus reflect our current expectations and beliefs with respect to certain current and future events and financial performance. Such forward-looking statements are and will be subject to many risks and uncertainties relating to our operations and business environment that may cause actual results to differ materially from any future results expressed or implied in such forward-looking statements. Words such as "expects," "will," "plans," "anticipates," "indicates," "believes," "forecast," "guidance," "outlook" and similar expressions are intended to identify forward-looking statements. Additionally, forward-looking statements include statements that do not relate solely to historical facts, such as statements which identify uncertainties or trends, discuss the possible future effects of current known trends or uncertainties, or which indicate that the future effects of known trends or uncertainties cannot be predicted, guaranteed or assured. All forward-looking statements in this report are based upon information available to us on the date of this report. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise, except as required by applicable law. The Company's actual results could differ materially from these forward-looking statements due to numerous factors including, without limitation, the following: its ability to comply with the terms of its various financing arrangements; the costs and availability of financing; its ability to maintain adequate liquidity; its ability to execute its operational plans and revenue-generating initiatives, including optimizing its revenue; its ability to control its costs, including realizing benefits from its resource optimization efforts, cost reduction initiatives and fleet replacement programs; its ability to utilize its net operating losses; its ability to attract and retain customers; demand for transportation in the markets in which it operates; an outbreak of a disease that affects travel demand or travel behavior; demand for travel and the impact that global economic conditions have on customer travel patterns; excessive taxation and the inability to offset future taxable income; general economic conditions (including interest rates, foreign currency exchange rates, investment or credit market conditions, crude oil prices, costs of aircraft fuel and energy refining capacity in relevant markets); economic and political instability and other risks of doing business globally; its ability to cost-effectively hedge against increases in the price of aircraft fuel; any potential realized or unrealized gains or losses related to fuel or currency hedging programs; the effects of any hostilities, act of war or terrorist attack; the ability of other air carriers with whom the Company has alliances or partnerships to provide the services contemplated by the respective arrangements with such carriers; disruptions to its regional network; the costs and availability of aviation and other insurance; industry consolidation or changes in airline alliances; competitive pressures on pricing and on demand; its capacity decisions and the capacity decisions of its competitors; U.S. or foreign governmental legislation, regulation and other actions (including open skies agreements and environmental regulations); labor costs; its ability to maintain satisfactory labor relations and the results of the collective bargaining agreement process with its union groups; any disruptions to operations due to any potential actions by its labor groups; weather conditions; the possibility that expected merger synergies will not be realized or will not be realized within the expected time period; and other risks and uncertainties set forth under Part I, Item 1A., "Risk Factors" of the 2013 Annual Report and Part II, Item 1A., "Risk Factors" of this report, as well as other risks and uncertainties set forth from time to time in the reports the Company files with the U.S. Securities and Exchange Commission (the "SEC"). |