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United Continental Holdings, Inc. 10-Q 2012 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2012 OR
For the transition period from to
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
The number of shares outstanding of each of the issuer’s classes of common stock as of April 15, 2012 is shown below:
OMISSION OF CERTAIN INFORMATION This combined Form 10-Q is separately filed by United Continental Holdings, Inc., United Air Lines, Inc. and Continental Airlines, Inc. United Air Lines, Inc. and Continental Airlines, Inc. meet the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and are therefore filing this form with the reduced disclosure format allowed under that General Instruction.
Table of ContentsUnited Continental Holdings, Inc. United Air Lines, Inc. Continental Airlines, Inc. Report on Form 10-Q For the Quarter Ended March 31, 2012
Table of ContentsITEM 1. FINANCIAL STATEMENTS UNITED CONTINENTAL HOLDINGS, INC. STATEMENTS OF CONSOLIDATED OPERATIONS (UNAUDITED) (In millions, except per share amounts)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED CONTINENTAL HOLDINGS, INC. STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED CONTINENTAL HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS (In millions, except shares)
(continued on next page)
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Table of ContentsUNITED CONTINENTAL HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS (In millions, except shares)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED CONTINENTAL HOLDINGS, INC. CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED AIR LINES, INC. STATEMENTS OF CONSOLIDATED OPERATIONS (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED AIR LINES, INC. STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED AIR LINES, INC. CONSOLIDATED BALANCE SHEETS (In millions, except shares)
(continued on next page)
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Table of ContentsUNITED AIR LINES, INC. CONSOLIDATED BALANCE SHEETS (In millions, except shares)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED AIR LINES, INC. CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsCONTINENTAL AIRLINES, INC. STATEMENTS OF CONSOLIDATED OPERATIONS (UNAUDITED) (In millions, except per share amounts)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsCONTINENTAL AIRLINES, INC. STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsCONTINENTAL AIRLINES, INC. CONSOLIDATED BALANCE SHEETS (In millions, except shares)
(continued on next page)
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Table of ContentsCONTINENTAL AIRLINES, INC. CONSOLIDATED BALANCE SHEETS (In millions, except shares)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsCONTINENTAL AIRLINES, INC. CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED) (In millions)
The accompanying Combined Notes to Consolidated Financial Statements are an integral part of these statements.
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Table of ContentsUNITED CONTINENTAL HOLDINGS, INC., UNITED AIR LINES, INC. AND CONTINENTAL AIRLINES, INC. COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) United Continental Holdings, Inc. (together with its consolidated subsidiaries, “UAL”) is a holding company and its principal, wholly-owned subsidiaries are United Air Lines, Inc. (together with its consolidated subsidiaries, “United”) and Continental Airlines, Inc. (together with its consolidated subsidiaries, “Continental”). All significant intercompany transactions are eliminated. This Quarterly Report on Form 10-Q is a combined report of UAL, United and Continental. We sometimes use the words “we,” “our,” “us,” and the “Company” for disclosures that relate to all of UAL, United and Continental. As UAL consolidates United and Continental for financial statement purposes, disclosures that relate to United and Continental activities also apply to UAL. When appropriate, UAL, United and Continental are named specifically for their related activities and disclosures. Interim Financial Statements. The UAL, United and Continental unaudited condensed consolidated financial statements shown here have been prepared as required by the U.S. Securities and Exchange Commission (the “SEC”). Some information and footnote disclosures normally included in financial statements that comply with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted as permitted by the SEC. The financial statements include all adjustments, including normal recurring adjustments and other adjustments, which are considered necessary for a fair presentation of the Company’s financial position and results of operations. Certain prior year amounts have been reclassified to conform to the current year’s presentation. These reclassifications were made to conform the financial statement presentation of UAL, United and Continental. The UAL, United and Continental financial statements should be read together with the information included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Annual Report”). UAL’s quarterly financial data is subject to seasonal fluctuations and historically its second and third quarter financial results, which reflect higher travel demand, are better than its first and fourth quarter financial results. NOTE 1—FREQUENT FLYER AND PASSENGER REVENUE ACCOUNTING Frequent Flyer Awards. Effective January 1, 2012, the Company updated its estimated selling price for miles to the contractual rate at which we sell miles to our Star Alliance partners participating in reciprocal frequent flyer programs. This change in estimate has been applied prospectively effective January 1, 2012. United and Continental account for miles sold and awarded that will never be redeemed by program members, which the Company refers to as “breakage,” using the redemption method. UAL reviews its breakage estimates annually based upon the latest available information regarding redemption and expiration patterns. The Company re-evaluated its population breakage estimates for OnePass miles, which were previously not subject to an expiration policy, and increased the estimate of miles in the population expected to ultimately expire. The Company’s estimate of the expected expiration of miles requires significant management judgment. Current and future changes to expiration assumptions, the expiration policy, program rules or program redemption opportunities may result in material changes to the deferred revenue balance as well as recognized revenues from the programs. For the three months ended March 31, 2012, the combined net impact of these changes to UAL, United and Continental were not material. NOTE 2—NEW ACCOUNTING PRONOUNCEMENTS In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-04 (“ASU 2011-04”), Fair Value Measurement: Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRS. Some of the key amendments to the fair value measurement guidance include the highest and best use and valuation premise for nonfinancial assets, application to financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk, premiums or discounts in fair value measurement and fair value of an instrument
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Table of Contentsclassified in a reporting entity’s shareholders’ equity. Additional disclosures for fair value measurements categorized in Level 3 of the fair value hierarchy include a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation processes in place, a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs and the level in the fair value hierarchy of items that are not measured at fair value in the consolidated balance sheet but whose fair value must be disclosed. ASU 2011-04 became effective for the Company’s annual and interim periods beginning January 1, 2012, and the required disclosures are disclosed in Note 6 of this report. NOTE 3—LOSS PER SHARE The table below represents the computation of UAL basic and diluted earnings per share amounts and the number of securities that have been excluded from the computation of diluted earnings per share amounts because they were antidilutive (in millions, except per share amounts):
UAL’s 6% Senior Notes due 2031 (the “6% Senior Notes”), with a principal amount of $652 million as of March 31, 2012, can be redeemed, and the $125 million of UAL’s 8% Contingent Senior Notes (the “8% Notes”), which UAL issued in January 2012, are redeemable with either cash or shares of UAL common stock, or in the case of mandatory redemption, a combination thereof, at UAL’s option. These notes are not included in the diluted earnings per share calculation because it is UAL’s intent to redeem these notes with cash if UAL were to decide to redeem these notes. NOTE 4—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 we have concluded that it is more likely than not that such deferred tax assets will ultimately not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income (including the reversals of deferred tax liabilities) during the periods in which those deferred tax assets will become deductible. The Company’s management assesses available positive and negative evidence regarding the realizability of its deferred tax assets, and records a valuation allowance when it is more likely than not that all or a portion of the deferred tax assets will not be realized. To form a conclusion, management considers positive evidence in the form of reversing temporary differences, projections of future taxable income and tax planning strategies, and negative evidence such as recent history of losses. Although the Company was no longer in a three-year cumulative loss position at the end of 2011, management determined that the size and frequency of financial losses in recent years and the uncertainty associated with projecting future taxable income supported the conclusion that the valuation allowance was still needed on net deferred assets. If UAL achieves significant profitability in 2012, then management will evaluate whether its recent history of profitability constitutes sufficient positive evidence to support a reversal of a portion, or all, of the remaining valuation allowance.
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Table of ContentsNOTE 5—EMPLOYEE BENEFIT PLANS Defined Benefit Pension and Other Postretirement Benefit Plans. The Company’s net periodic benefit cost includes the following components (in millions):
During the three months ended March 31, 2012, Continental contributed $33 million to its tax-qualified defined benefit pension plans. Continental contributed an additional $42 million to its tax-qualified defined benefit pension plans in April 2012. Share-Based Compensation. In February 2012, UAL granted share-based compensation awards pursuant to the United Continental Holdings, Inc. 2008 Incentive Compensation Plan. These share-based compensation awards include approximately 0.5 million shares of restricted stock and 0.6 million restricted stock units (“RSUs”) that vest pro-rata over three years on the anniversary of the grant date. In addition, UAL granted 1.3 million performance-based RSUs which will vest based on UAL’s return on invested capital for the three years ending December 31, 2014. If this performance condition is achieved, cash payments will be made after the end of the performance period based on the 20-day average closing price of UAL common stock immediately prior to the vesting date. The Company accounts for the RSUs as liability awards. The table below presents information related to share-based compensation (in millions):
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Table of ContentsProfit Sharing Plans. In 2012, substantially all employees participate in profit sharing, which pays 15% of total pre-tax earnings, excluding special items and share-based compensation expense, to eligible employees when pre-tax profit, excluding special items, profit sharing expense and share-based compensation program expense, exceeds $10 million. Eligible U.S. co-workers in each participating work group receive a profit sharing payout using a formula based on the ratio of each qualified co-worker’s annual eligible earnings to the eligible earnings of all qualified co-workers in all domestic workgroups. The international profit sharing plan pays eligible non-U.S. co-workers the same percentage of eligible pay that is calculated under the U.S. profit sharing plan. UAL recorded no profit sharing and related payroll tax expense in the three months ended March 31, 2012 and 2011, respectively. Profit sharing expense is recorded as a component of salaries and related costs in the consolidated statements of operations. NOTE 6—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS The table below presents disclosures about the financial assets and financial liabilities measured at fair value on a recurring basis in the Company’s financial statements as of March 31, 2012 and December 31, 2011 (in millions):
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The tables below present disclosures about the activity for “Level 3” financial assets and financial liabilities for the three months ended March 31 (in millions):
As of March 31, 2012, Continental’s auction rate securities, which had a par value of $135 million and an amortized cost basis of $111 million, were variable-rate debt instruments with contractual maturities generally greater than ten years and with interest rates that reset every 7, 28 or 35 days, depending on the terms of the particular instrument. These securities are backed by pools of student loans guaranteed by state-designated guaranty agencies and reinsured by the U.S. government. All of the auction rate securities that Continental holds are senior obligations under the applicable indentures authorizing the issuance of the securities.
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Table of ContentsAs of March 31, 2012, United’s EETC securities, which were repurchased in open market transactions in 2007, have an amortized cost basis of $63 million and unrealized losses of $1 million. All changes in the fair value of these investments have been classified within accumulated other comprehensive income. Continental’s debt-related derivatives presented in the table above relate to (a) supplemental indenture agreements that provide that Continental’s convertible debt, which was previously convertible into shares of Continental common stock, is convertible into shares of UAL common stock upon the terms and conditions specified in the indentures, and (b) the embedded conversion options in Continental’s convertible debt that are required to be separated and accounted for as though they are free-standing derivatives as a result of the Continental debt becoming convertible into the common stock of a different reporting entity. These derivatives are reported in Continental’s separate financial statements and eliminated in consolidation for UAL. See the Company’s 2011 Annual Report for additional information. The table below presents the carrying values and estimated fair values of financial instruments not presented in the tables above as of March 31, 2012 and December 31, 2011 (in millions):
Quantitative Information About Level 3 Fair Value Measurements as of March 31, 2012 ($ in millions)
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Valuation Processes—Level 3 Measurements—The Company’s internal valuation group is responsible for determining the fair value of financial instruments. Depending on the instrument, the valuation group utilizes discounted cash flow methods or option pricing methods as indicated above. Valuations using discounted cash flow methods are generally conducted by the valuation group. Valuations using option pricing models are generally provided to the Company by third-party valuation experts. Each reporting period, the valuation group reviews the unobservable inputs used by third-party valuation experts for reasonableness utilizing relevant information available to the Company from other published sources. The Company has a formal process to review changes in fair value for satisfactory explanation. Sensitivity Analysis—Level 3 Measurements—Changes in the unobservable input values would be unlikely to cause material changes in the fair value of the auction rate securities and EETCs. The significant unobservable inputs used in the fair value measurement of the Continental convertible debt derivative assets and liabilities are the UAL stock expected volatility and the Company’s own credit risk. Significant increases (decreases) in expected volatility would result in a higher (lower) fair value measurement. Significant increases (decreases) in the Company’s own credit risk would result in a lower (higher) fair value measurement. A change in one of the inputs would not necessarily result in a directionally similar change in the other. Fair value of the financial instruments included in the tables above was determined as follows:
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Table of ContentsNOTE 7—HEDGING ACTIVITIES Aircraft Fuel Hedges. The Company has a risk management strategy to hedge a portion of its price risk related to projected aircraft fuel requirements. The Company periodically enters into derivative contracts to mitigate the adverse financial impact of potential increases in the price of fuel. The Company does not enter into derivative instruments for speculative, non-risk management purposes. Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges. All derivatives designated as hedges that meet certain requirements are granted special hedge accounting treatment. Generally, utilizing the special hedge accounting, all periodic changes in fair value of the derivatives designated as hedges that are considered to be effective are recorded in accumulated other comprehensive income (loss) (“AOCI”) until the underlying fuel is consumed and recorded in fuel expense. The Company is exposed to the risk that its hedges may not be effective in offsetting changes in the cost of fuel and that its hedges may not continue to qualify for special hedge accounting. Hedge ineffectiveness results when the change in the fair value of the derivative instrument exceeds the change in the value of the Company’s expected future cash outlay to purchase and consume fuel. To the extent that the periodic changes in the fair value of the derivatives are not effective, that ineffectiveness is classified as other nonoperating income (expense). The Company records each derivative instrument as a derivative asset or liability on a gross basis in its consolidated balance sheets and, accordingly, records any related collateral on a gross basis. As of March 31, 2012, our projected fuel requirements for the remainder of 2012 were hedged as follows:
The following tables present information about the financial statement classification of the Company’s derivatives and related gains (losses) (in millions):
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Derivative Credit Risk and Fair Value The Company is exposed to credit losses in the event of nonperformance by counterparties to its derivative instruments. While the Company records derivative instruments on a gross basis, the Company monitors its net derivative position with each counterparty to monitor credit risk. Based on the fair value of our fuel derivative instruments, our counterparties may require us to post collateral when the price of the underlying commodity decreases, and we may require our counterparties to provide us with collateral when the price of the underlying commodity increases. The following table presents information related to the Company’s derivative credit risk as of March 31, 2012 (in millions):
NOTE 8—COMMITMENTS AND CONTINGENCIES General Guarantees and Indemnifications. In the normal course of business, the Company enters into numerous real estate leasing and aircraft financing arrangements that have various guarantees included in the contracts. These guarantees are primarily in the form of indemnities under which the Company typically indemnifies the lessors and any tax/financing parties against tort liabilities that arise out of the use, occupancy, operation or maintenance of the leased premises or financed aircraft. Currently, the Company believes that any future payments required under these guarantees or indemnities would be immaterial, as most tort liabilities and related indemnities are covered by insurance (subject to deductibles). Additionally, certain leased premises such as fueling stations or storage facilities include indemnities of such parties for any environmental liability that may arise out of or relate to the use of the leased premises. Legal and Environmental Contingencies. The Company has certain contingencies resulting from litigation and claims incident to the ordinary course of business. Management believes, after considering a number of factors, including (but not limited to) the information currently available, the views of legal counsel, the nature of contingencies to which the Company is subject and prior experience, that the ultimate disposition of these contingencies will not materially affect the Company’s consolidated financial position or results of operations. The Company records liabilities for legal and environmental claims when a loss is probable and reasonably estimable. These amounts are recorded based on the Company’s assessments of the likelihood of their eventual disposition. Commitments. The table below summarizes the Company’s commitments as of March 31, 2012, which primarily relate to the acquisition of aircraft and related spare engines, aircraft improvements and include other commitments primarily to acquire information technology services and assets (in millions):
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Table of ContentsUnited Aircraft Commitments. As of March 31, 2012, United had firm commitments to purchase 50 new aircraft (25 Boeing 787 aircraft and 25 Airbus A350XWB aircraft) scheduled for delivery from 2016 through 2019. United also has options to purchase 42 Airbus A319 and A320 aircraft, and purchase rights for 50 Boeing 787 aircraft and 50 Airbus A350XWB aircraft. United has secured considerable backstop financing commitments from its aircraft and engine manufacturers, subject to certain customary conditions. However, United can provide no assurance that backstop financing, or any other financing not already in place, for aircraft and engine deliveries will be available to United on acceptable terms when necessary or at all. Continental Aircraft Commitments. As of March 31, 2012, Continental had firm commitments to purchase 78 new aircraft (53 Boeing 737 aircraft and 25 Boeing 787 aircraft) scheduled for delivery from 2012 through 2016. From April 1, 2012 through December 31, 2012, Continental expects to take delivery of 15 Boeing 737-900ER aircraft and five Boeing 787-8 aircraft. Continental has arranged for financing of eleven Boeing 737-900ER aircraft and four Boeing 787-8 aircraft scheduled for delivery from April 2012 through December 2012. See “Note 9—Debt—Continental EETCs” of this report for additional information. However, Continental does not have backstop financing or any other financing currently in place for the other Boeing aircraft on order. Financing will be necessary to satisfy Continental’s capital commitments for its firm order aircraft and other related capital expenditures. Continental can provide no assurance that backstop financing, or any other financing not already in place, for aircraft and engine deliveries will be available to Continental on acceptable terms when necessary or at all. The Company is currently in discussions with Boeing over potential compensation related to delays in the 787 aircraft deliveries. The Company is not able to estimate the ultimate success, amount of, nature or timing of any potential recoveries from Boeing over such delays. Credit Card Processing Agreements. United and Continental have agreements with financial institutions that process customer credit card transactions for the sale of air travel and other services. Under certain of United’s and Continental’s credit card processing agreements, the financial institutions either require, or under certain circumstances have the right to require, that United and Continental maintain a reserve equal to a portion of advance ticket sales that have been processed by that financial institution, but for which United and Continental have not yet provided the air transportation. As of March 31, 2012, United and Continental provided a reserve of $25 million, as required under their combined credit card processing agreement with JPMorgan Chase Bank, N.A. and Paymentech, LLC. Additional reserves may be required under this or other credit card processing agreements of United or Continental if the amount of unrestricted cash, cash equivalents, short-term investments and undrawn amounts under any revolving credit facilities held by United and Continental is less than $3.5 billion as of any calendar month-end measurement date. In addition, in certain circumstances, an increase in the future reserve requirements and the posting of a significant amount of cash collateral as provided by the terms of any or all of United’s and Continental’s material credit card processing agreements could materially reduce the Company’s liquidity. Guarantees and Off-Balance Sheet Financing. Guarantees. United and Continental are the guarantors of approximately $270 million and $1.7 billion, respectively, in aggregate principal amount of tax-exempt special facilities revenue bonds and interest thereon. These bonds, issued by various airport municipalities, are payable solely from rentals paid under long-term agreements with the respective governing bodies. The leasing arrangements associated with $1.8 billion ($270 million for United and $1.5 billion for Continental) of these obligations are accounted for as operating leases with the associated expense recorded on a straight-line basis resulting in ratable accrual of the lease obligation over the expected lease term. The leasing arrangements associated with $190 million (for Continental only) of these obligations are accounted for as capital leases. These bonds are due between 2015 and 2033. In the Company’s financing transactions that include loans, the Company typically agrees to reimburse lenders for any reduced returns with respect to the loans due to any change in capital requirements and, in the case of loans in which the interest rate is based on the London Interbank Offered Rate (“LIBOR”), for certain other increased costs that the lenders incur in carrying these loans as a result of any change in law, subject in most cases to obligations of the lenders to take certain limited steps to mitigate the requirement for, or the amount of, such increased costs. At March 31, 2012, UAL had $2.7 billion of floating rate debt (consisting of United’s $2.0 billion and Continental’s $742 million of debt) and $385 million of fixed rate debt (consisting of United’s $200 million and Continental’s $185 million of debt), with remaining terms of up to ten years, that are subject to these increased cost provisions. In several financing transactions involving loans or leases from non-U.S. entities, with remaining terms of up to ten years and an aggregate balance of $3.0 billion (consisting of United’s $2.2 billion and Continental’s $840 million balance), the Company bears the risk of any change in tax laws that would subject loan or lease payments thereunder to non-U.S. entities to withholding taxes, subject to customary exclusions.
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Table of ContentsHouston Bush Terminal B Redevelopment Project. In May 2011, UAL, in partnership with the Houston Airport System, announced that it would begin construction of the first phase of a three-phase $1 billion terminal improvement project for Terminal B at George Bush Intercontinental Airport (“Houston Bush”) by the end of 2011. In November 2011, the City of Houston issued approximately $113 million of special facilities revenue bonds to finance the construction of a new south concourse at Houston Bush dedicated to the Company’s regional jet operations. The bonds are guaranteed by Continental and are payable from certain rentals paid by Continental under a special facilities lease agreement with the City of Houston. Continental’s initial commitment is to construct the first phase of the currently anticipated three-phase project. Continental’s cost of construction of phase one of the project is currently estimated to be approximately $100 million and is funded by special facilities revenue bonds. Construction of the remaining phases of the project will be based on demand over the next seven to 10 years, with phase one currently expected to be completed in late 2013. Based on a qualitative assessment of the Houston Bush Terminal B Redevelopment Project, due to the fact that Continental is guaranteeing the special facilities revenue bonds and the requirement that Continental fund cost overruns with no stated limits, Continental is considered the owner of the property during the construction period for accounting purposes. As a result, the construction project is being treated as a financing transaction such that the property and related financing will be included on UAL’s consolidated balance sheet as an asset under operating property and equipment and as a construction obligation under other long-term liabilities. Credit Facilities. As of March 31, 2012 the Company had its entire commitment capacity of $500 million available under the Credit and Guaranty Agreement, dated as of December 22, 2011 (the “Revolving Credit Facility”) with a syndicate of banks led by Citibank N.A., as administrative agent. The Revolving Credit Facility has an expiration date of January 30, 2015. Labor Negotiations. As of March 31, 2012, UAL and its subsidiaries had approximately 87,000 active employees, of whom approximately 80% are represented by various U.S. labor organizations. On February 27, 2012, the pilots at both United and Continental agreed to an extension of their protocol for joint negotiations and continue to engage in joint bargaining with the Company. On February 28, 2012, the flight attendants at United ratified a new collective bargaining agreement and joint negotiations will begin shortly for a joint collective bargaining agreement covering both United’s and Continental’s flight attendant work groups. On March 7, 2012, the passenger service employees at both United and Continental voted to be represented by the International Association of Machinists and Aerospace Workers, AFL-CIO and negotiations are underway for a joint collective bargaining agreement for this employee group. We are continuing our negotiations for joint collective bargaining agreements with other work groups, including technicians, dispatchers, fleet service employees, storekeepers and various smaller groups. As part of the recently amended collective bargaining agreement with the Association of Flight Attendants, the Company agreed to offer a voluntary program for flight attendants at United to retire early in exchange for a cash severance payment. The payments are dependent on the number of years of service each employee has accumulated. The Company is not currently able to estimate the amount of the total expense associated with the program as the deadline for volunteering is May 31, 2012. NOTE 9—DEBT As of March 31, 2012, a substantial portion of our assets are pledged as collateral for our debt. These assets principally consist of aircraft and the related spare parts and engines, route authorities and loyalty program intangible assets. As of March 31, 2012, UAL, United and Continental were in compliance with their respective debt covenants. Continental EETCs. In March 2012, Continental created two pass-through trusts, one of which issued $753 million aggregate principal amount of Class A pass-through certificates with a stated interest rate of 4.15% and the other of which issued $139 million aggregate principal amount of Class B pass-through certificates with a stated interest rate of 6.25%. The proceeds of the issuance of the Class A and Class B pass-through certificates, which amounted to $892 million, have been and will be used to purchase equipment notes issued by Continental. Of the $892 million in proceeds raised by the pass-through trusts, Continental received $188 million as of March 31, 2012, in exchange for Continental’s issuance of an equivalent principal amount of equipment notes, which has been recorded as debt. The remaining amount is expected to be received during the last nine months of this year as aircraft are delivered to Continental and Continental issues equipment notes to the trusts. Continental records the debt obligation upon issuance of the equipment notes rather than upon the initial issuance of the pass-through certificates. The proceeds have been and are expected to be used to fund the acquisition of new aircraft, and in the case of currently owned aircraft, for general corporate purposes. The Company evaluated whether the pass-through trusts formed are variable interest entities (“VIEs”) required to be consolidated by the Company under applicable accounting guidance, and determined that the pass-through trusts are VIEs. The Company determined that it does not have a variable interest in the pass-through trusts. The Company does not invest in or
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Table of Contentsobtain a financial interest in the pass-through trusts. Rather, Continental has an obligation to make interest and principal payments on its equipment notes held by the pass-through trusts. The Company was not intended to have any voting or non-voting equity interest in the pass-through trusts or to absorb variability from the pass-through trusts. Based on this analysis, the Company determined that it is not required to consolidate the pass-through trusts. 8% Contingent Senior Notes. UAL is obligated under an indenture to issue to the Pension Benefit Guaranty Corporation (“PBGC”) up to $500 million aggregate principal amount of 8% Notes in up to eight equal tranches of $62.5 million if certain financial triggering events occur (with each tranche issued no later than 45 days following the end of any applicable fiscal year). During 2011, a financial triggering event under the 8% Notes indenture occurred at both June 30, 2011 and December 31, 2011 and, as a result, UAL issued two tranches of $62.5 million each of the 8% Notes in January 2012, which were recorded during 2011 at their fair value of $88 million as a component of integration costs. If a triggering event occurs as of June 30, 2012, UAL would be obligated to issue $62.5 million of the 8% Notes by February 14, 2013 and would record such obligation in the second quarter of 2012. NOTE 10—SPECIAL CHARGES Special Charges. For the three months ended March 31, special charges consisted of the following (in millions):
Integration-related costs include compensation costs related to systems integration and training, costs to repaint aircraft and other branding activities, costs to write-off or accelerate depreciation on systems and facilities that are no longer used or planned to be used for significantly shorter periods, relocation costs for employees and severance primarily associated with administrative headcount reductions. During the three months ended March 31, 2012, the Company recorded $49 million of severance and benefits associated with two voluntary employee programs. In one program, approximately 400 mechanics offered to retire early in exchange for a cash severance payment that was based on the number of years of service each employee had accumulated. The other program is a voluntary company-offered leave of absence that approximately 1,800 flight attendants accepted, which allows for continued medical coverage during the leave of absence period. In addition, the Company sold six aircraft and its interest in a crew hotel in Hawaii during the first quarter of 2012. The Company also recorded an impairment charge on an intangible asset related to take-off and landing slots to reflect the discontinuance of one of the frequencies on an international route. The Company also made adjustments to certain legal reserves. Accruals The accrual for severance and medical costs was $90 million, $69 million and $21 million related to UAL, United and Continental, respectively, as of March 31, 2012. In addition, the accrual balance of future lease payments on permanently grounded aircraft was $23 million for both UAL and United as of March 31, 2012.
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Table of ContentsThe severance-related accrual as of March 31, 2012, which primarily relates to the integration of United and Continental, is expected to be paid during 2012. Lease payments for grounded aircraft are expected to continue through 2013. At March 31, 2011, the accrual balance for severance and medical costs was $81 million, $45 million and $36 million, related to UAL, United and Continental, respectively. In addition, the accrual balance of future lease payments on permanently grounded aircraft was $38 million for both UAL and United as of March 31, 2011. NOTE 11—RELATED PARTY TRANSACTIONS Intercompany transactions—United and Continental United and Continental perform services for one another including various aircraft maintenance services and aircraft ground handling at certain airports, and they utilize one management team to oversee the sales and administrative functions of both airlines. For services provided, Continental paid United $120 million and United paid Continental $86 million during the quarter ended March 31, 2012. These payments do not include interline billings, which are common among airlines for transportation-related services. Most of these transactions are routinely settled through the clearing house, which is customarily used in the monthly settlement of such items. Transactions not settled through the clearing house are typically settled in cash on a quarterly basis. As of March 31, 2012, Continental had a net current payable of $1.5 billion to United primarily related to the transfer of the current portion of the frequent flyer liability and the cash transfer from United in conjunction with the conversion to the new passenger service system, as described below. In addition, Continental had a $1.3 billion noncurrent payable to United associated with the transfer of the long-term portion of the frequent flyer liability. Frequent flyer program transition In the first quarter of 2012, the Company moved to a single loyalty program. Continental’s loyalty program formally ended in the first quarter of 2012, at which point United automatically enrolled OnePass members in MileagePlus and deposited into those MileagePlus accounts award miles equal to these members’ OnePass award miles balance. In March 2012, the related frequent flyer deferred revenue and advance purchase of miles liabilities for Continental’s OnePass program was transferred to United with a corresponding liability recorded by Continental payable to United for assuming the frequent flyer obligations. No gain or loss was incurred from the transaction as the liabilities were transferred at their respective net book value. The obligation associated with this transfer will be settled by Continental through future redemptions by MileagePlus members on Continental operated flights. The Company currently does not expect a material impact in redemptions from moving to a single loyalty program. Passenger service system and ticket stock integration In March 2012, Continental and United converted to a single passenger service system, allowing the Company to operate using a single reservations system, carrier code, flight schedule, website and departure control system. In conjunction with the conversion to a single passenger service system, all tickets are now sold by United. As a result, the air traffic liability of Continental will diminish as tickets previously sold by Continental are used or refunded and United’s advanced ticket sales liability and associated cash receipts from the ticket sales will increase accordingly. Given the system conversion, United transferred $1 billion in cash to Continental in March 2012 as an advance against future settlements when passengers travel. Revenue will continue to be recorded by the carrier that is operating the flight. Revenue and expense allocation In November 2011, the Company received a single operating certificate from the Federal Aviation Administration. The Company plans to merge Continental and United into one legal entity. Once this legal merger occurs, the financial statements of United and Continental will be combined for all periods presented from the date of the merger at their historical cost, and there will no longer be a requirement to separately report the historical financial statements of Continental. Until Continental and United are merged into one legal entity, revenue and expenses will continue to be recorded by each entity based on either specific identification of the related transaction, where applicable, or appropriate allocations based on metrics that are systematic and rational. Certain revenues and expenses that were previously recorded based on a specific identification were allocated in March 2012 in connection with the conversion to a single passenger service system. We believe the allocated amounts will generally be comparable to historical amounts. Each airline will continue to record actual expenses for aircraft that are owned or leased and passenger revenue will be determined on an actual basis for the carrier operating the flight. The table below illustrates a summary of the primary allocation metrics to be used:
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Table of ContentsITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Overview United Continental Holdings, Inc. (together with its consolidated subsidiaries, “UAL”) is a holding company and its principal, wholly-owned subsidiaries are United Air Lines, Inc. (together with its consolidated subsidiaries, “United”) and Continental Airlines, Inc. (together with its consolidated subsidiaries, “Continental”). All significant intercompany transactions are eliminated. This Quarterly Report on Form 10-Q is a combined report of UAL, United and Continental. We sometimes use the words “we,” “our,” “us,” and the “Company” for disclosures that relate to all of UAL, United and Continental. As UAL consolidates United and Continental for financial statement purposes, disclosures that relate to United and Continental activities also apply to UAL. When appropriate, UAL, United and Continental are named specifically for their related activities and disclosures. The Company transports people and cargo through its mainline operations, which utilize jet aircraft with at least 100 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. Based on annual flight schedules as of April 1, 2012, the Company offers approximately 5,700 daily departures to 376 destinations. First Quarter Financial Highlights
First Quarter Operational Highlights
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