United Airlines Holdings, Inc. (UAL) Q2 2015 Earnings Report, Transcript and Summary

Good morning and welcome to United Continental Holdings Earnings Conference Call for the second quarter of 2015. My name is Brandon [ph] and I will be your conference facilitator today. Following the initial remarks from management we will open the lines for questions. [Operator Instructions] This call is being recorded and is copyrighted. Please note that no portion of the call may be recorded, transcribed or rebroadcast without the company's permission. Your participation implies your consent to our recording of this call. If you do not agree with these terms, simply drop off the line. I will now turn the presentation over to your host for today's call, Nene Foxhall and Jonathan Ireland. Please go ahead.

Thank you, Brandon [ph]. Good morning, everyone, and welcome to United's Second Quarter 2015 Earnings Conference Call. Joining us here in Chicago to discuss our results are Chairman, President and CEO, Jeff Smisek; Vice Chairman and Chief Revenue Officer, Jim Compton; Executive Vice President and Chief Operations Officer, Greg Hart; and Executive Vice President and Chief Financial Officer, John Rainey. Jeff will begin with some overview comments, after which Jim will discuss revenue and capacity. Greg will follow with an update on our operations. John will then review our cost, fleet and capital structure after which we will open the call for questions, first from analysts and then from the media. We'd appreciate it if you would limit yourself to one question and one follow-up. With that I'll turn it over to Jonathan Ireland.

Thanks, Nene. This morning we issued our earnings release and separate investor update, both are available on our website at ir.united.com. Information in this morning's earnings release and investor update and remarks made during this conference call may contain forward-looking statements, which represents the company's current expectations or beliefs concerning future events and financial performance. All forward-looking statements are based upon information currently available to the company. A number of factors could cause actual results to differ materially from our current expectations. Please refer to our press release, Form 10-Q and other reports filed with the SEC by United Continental Holdings and United Airlines for more throughout description of these factors. Also, during the course of our call we'll discuss several non-GAAP financial measures. For reconciliation of these non-GAAP measures to GAAP measures please refer to the tables at end of our earnings release and investor update. Copies of which are available on our website. Unless otherwise noted special charges are excluded as we walk through our numbers for the quarter. These items are detailed in our earnings release. And now I'd like to turn the call over to Jeff.

Thanks, Nene and Jonathan, and thank you for joining us on our second quarter 2015 earnings call. Today we reported pre-tax earnings of $1.3 billion, the highest quarterly earnings in United's history. We earned $3.31 per diluted share and produced an 18.2% return on invested capital over the last 12 months. In the quarter, we generated $1.8 billion of operating cash flow and almost $0.5 billion of free cash flow. We put our cash to good use by investing it in our employees and our business, prepaying debt and making significant contributions to our pension plans, buying back stock and investing in strategic partnerships. Over the past few years, we've made good progress strengthening our balance sheet to derisk the business while also making substantial progress completing our initial $1 billion share repurchase program. Accordingly today we announced a new $3 billion share repurchase program to be completed by the end of 2017. In addition we now expect to complete our initial $1 billion authorization in the third quarter, almost two years ahead of schedule. Our new share repurchase program demonstrates confidence in our ability to generate and sustain meaningful free cash flow. Turning to expense, we continue to demonstrate cost discipline, growing second quarter non-fuel unit costs only 0.3%. This excellent cost performance is due in large part to the continuing success of Project Quality, our $2 billion efficiency and quality initiative. Project Quality highlights the dedication and commitment of United's workforce. Our employees continue to discover and implement new ways to improve everything we do and I want to thank them for their efforts to help make our company stronger and more sustainable over the long term. I'd also like to thank our employees for their commitment and effort managing through a challenging operation in June. Our operational performance was below our expectations in June due to tough weather and a spike in maintenance write ups and we took action to address the maintenance related situation. As a result, we've seen a meaningful improvement in our operations over the past few weeks and Greg will provide further detail in a few minutes. We expect the third quarter to be another good quarter for United financially, and we estimate our pre-tax margin will be between 13.5% and 15.5% driven by continuing cost discipline and lower oil prices. Although our expected margin performance is muted by the current weak revenue environment for our industry we're making network and capacity decisions to address this weakness with a focus on structuring our network to expand both margins and return on invested capital. Over the last several years we have demonstrated our commitment to matching United's capacity with demand and we will continue to take the appropriate network and capacity actions to deliver value to our shareholders. In conclusion the second quarter was a very good quarter for United and I am proud of the work our employees have done to deliver record earnings which benefit all our constituencies, including our employees themselves. We have a great deal of confidence in our future as we work to make United the carrier of choice. Now I'll turn the call over to Jim, Greg and John.

Thanks, Jeff. I'd like to thank our customers for flying United. We work hard every day to improve our performance, our product and our network to deliver the choice and experience you desire. In the second quarter our consolidated unit revenue fell 5.6%. The drivers were consistent with our initial expectations, a strong U.S. dollar, the effects of lower oil prices, pressure as a result of margin-accretive initiatives and competitive pricing actions. While the drivers were unchanged, unit revenue deteriorated throughout the quarter. In particular revenue from our energy-related corporate contracts declined more than we anticipated and the effects of competitive pricing worsened throughout the quarter. Corporate revenue for the second quarter decreased by approximately 5% on roughly flat traffic year-over-year, largely due to a 30% reduction in revenue from oil and gas related corporate customers. We believe this decline has roughly leveled out, and we don't anticipate material deterioration for the remainder of the year. Excluding oil and gas related corporate revenue our corporate revenue was down approximately 2% with traffic volumes up approximately 2% year-over-year. Ancillary revenue continued to perform well over the second quarter, growing 7% per passenger versus the second quarter of last year. We are now generating more than $23 per passenger in ancillary revenue and remain on track to achieve $3.2 billion of ancillary revenue this year. In the third quarter, we expect our [indiscernible] to decline 5% to 7% on capacity growth of 1.25% to 2.25%. We anticipate international unit revenue will be down [to 11%] [ph] and domestic unit revenue to decline 1% to 3%. The drivers of our third quarter unit revenue are largely the same as those in the second quarter. We expect the foreign exchange impact to account for 1.5 points of year-over-year PRASM pressure. We anticipate that the impact of lower international surcharges will account for one point of weakness, and that lower oil and gas related corporate revenue will drive nearly one point of PRASM decline. We also expect the current competitive pricing actions will drive another 1.5 points of decline in the quarter. Finally, the margin accretive actions we are taking, such as installing slim line seats and consolidating frequencies through up gauging will drive a half point of unit revenue decline. As we expect this to be our second consecutive quarter of negative year over year unit revenue performance, we have taken the appropriate actions to minimize this decline. We reduced second half capacity by approximately half a point and now expect full year 2015 consolidated capacity to grow between 1% and 1.5% this year. The capacity reduction largely comes from three markets where we've seen meaningful reduction in demand. First we further reduced capacity in our Core Energy markets. We have reduced capacity in those markets by 9% in the third quarter and 8% in the fourth quarter. Second, we pulled down capacity into Brazil by 7% in the fourth quarter to help offset the yield weakness driven by the strong U.S. dollar and the weak Brazilian economy. Finally we further reduced our Trans-Atlantic capacity in the fourth quarter. Our Trans-Atlantic capacity will decline approximately 0.5% year over year. The total impact of these changes will result in fourth quarter consolidated capacity of approximately 0.5% to 1.5%, more than 1.5 points lower than we had initially planned. As we have demonstrated over the last several years United has historically built its capacity to match demand and will continue this practice going forward. We will evaluate further capacity actions based on our expectations for demand as we move into the winter periods. We continue to improve our network with a focus on enhancing our core strengths. In June we announced our decision to move our p.s. service from JFK to our global gateway at Newark Liberty. With this change we will have the most flat lie-flat seats between New York and Los Angeles and San Francisco of any airline and will now offer our premium p.s. product at our premier New York Hub. In conclusion while unit revenue performance is down year over year, I am confident we are taking the appropriate steps to address the current challenging demand environment. At United we have a long history of matching capacity to demand and we intend to continue that. Our decision to move our p.s. product out of JFK and into Newark Liberty is one example of how we are prepared to take significant actions for the long-term benefit of our network, our customers, our employees and our shareholders, and we will continue to evaluate other opportunities going forward. With that, I'll turn it over to Greg.

Thanks, Jim, and thank to everyone for joining the call this morning. I'd like to take this opportunity to thank our employees for the continued hard work and for managing through a difficult operation in June. I'm proud of how you handled the tough conditions by putting our customers first and I appreciate your dedication and professionalism. Despite a challenging June, our operation has improved materially this year. In fact we have cancelled 24,000 fewer flights during the first half of this year than we did during the same period last year. We also improved our system-wide on time performance by over four points during the same period. This improvement could not have been achieved without the commitment of our experienced team. With respect to the second quarter, we performed well in April and May, but a difficult June led to second quarter operational performance that did not meet our expectations. One factor was weather. In June we faced thunderstorm activity at one or more of our hubs during 25 of the 30 days of the month. We also experience an increase in maintenance write-ups in the first three weeks of June. We've taken steps to address the maintenance related issues and over the last four weeks we've seen our performance improve materially including a roughly 50% reduction in maintenance cancellations when compared to the first three weeks of June. Over the past several calls I've talked to you about the investments we've made to better communicate with our customers. During the difficult June period we used these new tools and procedures to more quickly and effectively respond to our customers' needs. For example with these tools we are able to proactively notify customers about disruptions and resolve their issues in a more timely manner than we could have in the past. In addition, by equipping our airport employees with handheld devices and mobile printers, our agents were able to assist thousands of customers throughout the gate area with average transaction times of less than a minute. In closing while our performance in June did not meet our expectations, we have seen meaningful improvement in our operation year-to-date due to the hard work of employees and the use of new technology. We are committed to doing what it takes to run an even more reliable airline and we are making, and we'll continue to make, the investments to ensure we do so. With that I'll turn the call over to John.

Thanks, Greg, and thanks to everyone for joining the call this morning. I also want to take this opportunity to thank our employees. Today we announced record quarterly earnings in large part due to the commitment and professionalism that our employees bring to the job every day. Our second quarter pre-tax profit was $1.3 billion with a pre-tax margin of 12.7% and we increased our earnings per share by 41% year-over-year. We achieved a 12 month return on invested capital of 18.2% and generated $1.8 billion of operating cash flow, net of $620 million of pension contributions. Second quarter consolidated CASM excluding fuel, profit sharing and third-party business expense, was up only 0.3% year-over-year, a result of our continued focus on efficiency and reducing cost. For the third quarter we expect consolidated CASM excluding fuel, profit sharing and third-party business expense to be approximately flat year-over-year. We now expect full year 2015 CASM, again excluding fuel, profit sharing and third-party business expense, to be between flat and up 0.5% despite, again, reducing our expected full year capacity by an additional quarter point. Project Quality, our $2 billion efficiency and quality initiative continues to play a critical role in our excellent cost performance. Year-to-date we have achieved approximately $350 million in non-fuel savings and expect to realize $800 million for the full year. Based on our progress to date we now expect to achieve our goal of $1 billion in annual non-fuel cost savings by the end of next year, a full year in advance of our initial expectations. Productivity improvements continue to be a major driver of our Project Quality success. This quarter productivity improved 2.2% over last year, marking eight consecutive quarters of year-over-year improvement. Turning to fuel expense, we recorded a hedge loss of approximately $200 million in the quarter. For the third quarter we are approximately 20% hedged and based on the July 16 forward curve we expect to incur approximately $230 million in hedge losses while participating in 83% of any future price declines. For the fourth quarter our hedge book is in a loss position of approximately $225 million, and allows us to participate in 77% of any decline in oil prices. Additionally, in the quarter we began building a small hedge position in 2016, marking our first entry into the market since oil prices began to decline late last summer. We will continue to be opportunistic as we consider layering on additional hedge positions. We expect to generate continued margin expansion and free cash flow in the third quarter with a pre-tax margin between 13.5% and 15.5%. We continue to take a balanced approach to deploying our cash. In the second quarter we prepaid $800 million of debt bringing our year-to-date debt payments to $920 million. Additionally we spent $620 million funding our pension plans in the quarter bringing our total pension funding for the year to $800 million and materially reducing our unfunded-pension liability. Given the progress we've made year to date, we don't anticipate significant additional funding this year. We also invested in the business with $1.26 billion in capital expenditures and repurchased $250 million of stock. Finally we spent $130 million on two strategic investments. First we invested $100 million to purchase a stake in approximately 5% of Azul Brazilian airlines, a carrier that, over the long term, will strengthen our Latin network and provide United's customers with exclusive connection opportunities throughout Brazil. Second we invested $30 million for an equity stake in Fulcrum BioEnergy, an alternative fuels company. We are excited about each of these equity investments and look forward to these new partnerships. Along with our second quarter results today we announced a new $3 billion share repurchase program to be completed by the end of 2017. In addition we intend to complete the remained $230 million of our initial $1 billion authorization in the third quarter of this year, almost two years ahead of schedule. Over the last several quarters we have taken a balanced approach to investing in our employees and the business, paying down debt, funding our pension and repurchasing stock. We have now eliminated all prepayable high-interest rate debt from our balance sheet while also significantly reducing our unfunded pension liability. While there is still more that can be done in these areas, we are excited about our new $3 billion share repurchase authorization. We also continued investing in our fleet in the second quarter adding six 737-900ERs, one 787-9, three used 737-700s and 15 additional 76-seat Embraer E175 regional aircraft to our fleet. We now have 60 E175s in our fleet and have removed almost 100 50 seaters since the beginning of last year. In the quarter we announced plans to lease up to 25 used A319s and add 10 to 28 more E175s in 2016 and 2017 bringing the total number of E175s in our fleet to as many as 153 by 2017. In conclusion, I'm pleased with our record-setting second quarter results, marking our fifth consecutive quarter of year-over-year improvement. We will continue to execute on our plan to increase shareholder value as we focus on growing earnings, generating free cash flow, increasing our return on invested capital, and returning cash to shareholders through our new buyback program. I'll now turn it over to Jonathan to open up the call to questions.

Thank you, John. First we will take questions from the analyst community. Then we will take questions from the media. Please limit yourself to one question, and if needed, one follow-up question. Operator, please describe the procedure to ask a question.

Thank you. And the question-and-answer session will be conducted electronically. [Operator Instructions] And from Credit Suisse, we have Julie Yates online. Please go ahead.

Good morning.

Good morning, Julie.

With the incremental capacity reductions, when do you expect United can get back on a flat to positive unit revenue growth trajectory?

Hey, Julie. This is Jim. As you're aware, we don't provide guidance beyond the upcoming quarter. We've guided to third quarter rise and decline of about 5% to 7%. But let me talk about some of the factors that we already know that will positively affect the fourth quarter. First in the fourth quarter we'll begin to lap some of the drivers to our current revenue decline. In particular, the strong dollar and some of the effects of the lower oil prices that began in the fourth quarter of last year. As you just said, we have made adjustments to our capacity. And so as we're responsive to adjusting our network to match demand we expect to realize those benefits. But in the end it's a little bit too early to zero in on where the demand will be, particularly on the business side this far out. But we do, as I mentioned, we do some of the factors that will begin to lap in the fourth quarter will be positive in terms of our unit revenue.

Okay. Understood. Thanks, Jim. And then last week one of your competitors noted 50% of their yield decline was just from three domestic markets. Would you agree or are you seeing more broad based weakness or would you add other cities to those called out that are particularly weak?

Yeah, Jim again. You know we are seeing - our biggest yield pressures are coming in Dallas. You know some of the similar things with Love Field and so for the pressure that's happened in Dallas as well Chicago that we've talked about in the past. And then in Houston, I'll tie back to my energy comments that we're seeing the impact of that. So I think those are probably the three markets that we're seeing the biggest yield decline.

Okay. Thank you very much.

From JPMorgan we have Jamie Baker on line. Please go ahead.

Good morning, everybody. John as it relates to the $3 billion increased authorization, could you just provide some background as to how you arrived at that particular figure, whether you contemplated dividend at any point in your conversation? Just sort of what goalposts you might have established in terms of thinking about the magnitude of the incremental buyback?

Sure, Jamie. Well the magnitude is something we also think about in the timeframe that we expect to accomplish that and we look at both what our expectation about future earnings are and cash flow as well as the other sources of, I guess, draws on that cash. We have been pretty specific about what our intermediate-term debt goal is. We still have a ways to go to accomplish that. Right now we have a gross debt including capitalized leases balance of about $17 billion and the target that we've set out there is $15 billion. So there's still some work to be done there. We also need to continue to invest in our business. We recognize that there's still a lot of things that we can do that are good returns on that cash as we invest improving our operations, providing a better level of customer services and so forth, and giving our employees the tools to do their jobs. So as I talk consistently the allocation of cash flow for us is one about balance and we look – to answer your question, look at sort of what the cash flow that we're going to generate and then look at how we balance that cash flow and returning our cash to shareholders through a share buyback is part of that. With respect to dividend, again, there may be a time and place for a divined in our future, but at this point we still believe that returning cash to shareholders, the best way to do that is buying back our own stock.

Got it. And as a follow-up, it appears that Boeing Capital again has surplus. Embraer 190 down [indiscernible]. You know, from an MTOW perspective I don't believe these are scope compliant at the express level, but you could fly them at the mainline. Would we be remiss in at least contemplating whether these aircraft could wind up at United which in turn would allow you to put down even more 50 seaters?

We always look at every aircraft that's out there. And you could certainly point to that size aircraft and look at our fleet. And there's perhaps a need to fill that gap. But we are taking into account the economics of that aircraft, the availability of them. And there may at some time in our future be a need to place an order for aircraft of that size, but that's not something we've decided yet.

Okay. Fair enough. Thanks very much, John. Take care.

From Bank of America we have Andrew Didora on line. Please go ahead.

Hi. Good morning, everyone. And thank you for taking my question. I guess my first question is for Jim. Outside of the oil industry, how are your corporate volumes trending? And I ask because we've heard a smaller hotel company talk this morning about just being a little more incrementally cautious on the overall demand environment around travel. So just how has your growth been on the corporate side? Has it been decelerating or has it been pretty steady over the last few quarters?

Hey, Andrew. Jim. It really does come down to two separate stories as you mentioned the oil base and all other. And as I mentioned, clearly we're experiencing pressure on the oil base where we're seeing about 30% declines in revenue in our corporate-related contracts in the energy sector. But if you look at the non-oil based companies, we're actually very pleased with our performance. I think you got a segment though, and I think many of them when we talk to them are [feeling] [ph] the pressure of the strong dollar off of. But in general the demand is still solid. The little bit of softening as GDP forecasts have come down as we've moved through the second to the third quarter, the yields have come down. But the demand's pretty solid in the non-oil area.

Okay. Thank you for that. And then I guess my second question is for John. Just in terms of the unit costs continue to come in better than expectations here. And I know you provide a little bit of commentary in your prepared remarks. But I guess going forward from here, what are some of the biggest areas of focus today on the cost side? And where should we be seeing a lot of the cost saves you mentioned be coming through? Thanks.

So with respect to project quality, I would want to emphasize that while we have a specific dollar amount and timeframe associated with this, this is becoming a way of doing business at United. And as we get near completion of this initiative, we will jump right into the next one. We recognize that this is an ongoing improvement process and there's further opportunity. But the main thing I would want to point you to I think in terms of magnitude of opportunity going forward is the cost benefit that we have from restructuring our network. So if you look at the second quarter for example, we increased our average gauge by 7% while reducing our departures by almost 5%. That has a tremendous cost benefit that comes with it as well, and as we've talked about as I said in my prepared remarks, continuing to take planes like the E175 and sitting down more of the 50-seaters there's a continuation of this going forward and you should expect to see that in our cost results.

That's great. Thank you very much.

From Wolfe Research we have Hunter Keay on line. Please go ahead.

Good morning, everybody. John Rainey, a couple questions for you, I think this is the first time you've used the word opportunistic as it related to our hedging program and with all due respect your on to a pretty bad track record of being opportunistic with fuel hedging, so I guess I can interpret that two ways. You're going to try to time the market so you're going to get – you're going to hedge the same but you're going to try to do it at times where you feel there's value there or you're actually going to hedge a little bit less and just stop the systematic stuff where you're hedging every day, hedge less but maybe buy some hedges where you feel like there's a pullback in the market.

So I'm going to answer the question slightly differently, Hunter. We have had historically what you might describe as more of a mechanistic structure to our hedging where it's sort of been on autopilot, but in periods of extreme volatility like what we've seen in the back half of last year as well as the first part of this year, that's not necessarily the most prudent way to hedge. And given all the bearish signals in the market for the first part of this year we've been reluctant to take out any position in 2015. However when we look out to 2016 and beyond and we look at both the revenue environment, capacity environment and our cost structure, having the ability to lock-in or said differently, reduce the volatility of one of our single largest cost inputs enables us to accomplish so many other things that are really important and create value in the business. And as we look at hedging, despite maybe taking a more opportunistic approach, it's really more of risk management and reducing the volatility with our costs and that enables us to play on things much like what we did today with the $3 billion share repurchase program. So those go hand in hand. If we see a more stable environment with less volatility going forward, we might be able to get back to a hedge program more like what you've seen in the past, but we are looking at particular price that are more attractive. If that's characterized as opportunistic, then so be it at this point.

Okay. And then was there a cost benefit, revenues for united are probably going to decline [indiscernible]. Is there a cost benefit to that that maybe goes away next year if revenue stabilizes that should make the CASM performance this year a little bit harder to maintain around the increment assuming roughly some more magnitude to capacity growth?

Is there a cost benefit to, I'm sorry, I didn't follow your question exactly.

Sure. Is there a cost benefit to a decline in revenue?

There are revenue-related costs whether it's credit card discount fees, commissions and so forth. But we generally view those as good costs in a business. We much rather focus on the top line growth.

Right.

Over the years the magnitude of those has diminished quite a bit. It's much different than it was 15 years ago in this business where they made up a much larger portion of our cost structure.

Okay. So the nature of the question was basically is there anything in the CASM this year that should be a little bit harder to maintain next year if revenues don't go down just as much?

Sure. We added, as I mentioned, around distribution perhaps.

Yep. Okay. Thank you.

From Stifel we have Joseph DeNardi online. Please go ahead.

Hey. Thanks. Good morning. On the Trans-Atlantic capacity you guys were talking about coming down a little bit in the fourth quarter, is that thing done collectively with your JV partner so that maybe total industry capacity reductions are more than even what you guys are pulling out?

Hey, Joseph. This is Jim. As we work through our capacity, we're always in dialogue with our joint venture partners so that we can as a group manage through that process in the best way. Our capacity reductions are, as I mentioned, focused on where we think demand is relative to our network. We clearly make that, have those conversations with our partners and share that information as the group works together to manage across the Trans-Atlantic. So the answer is yes. We're tweaking some things. The great thing about our network and our fleet is its flexibility. And so what you're seeing in the Trans-Atlantic is that fleet flexibility going up, allowing us to gauge appropriately to the demand we expect in the fourth quarter.

Okay. And then John or Jim, have you guys looked at all at implementing any sort of a credit card surcharge? And what would be some of the considerations there?

I wouldn't comment on that at all.

Okay. Thank you.

From Deutsche Bank we have Mike Linenberg online. Please go ahead.

Yeah, hey. Good morning, everyone. Two questions here. John, you did a nice rundown on the fleet. But I didn't hear any mention of the 777 300 ERs. When do you take delivery of them? And then I did hear that you are going to early retire some 7-4s? Can you just touch on that?

We take delivery of the first planes at the end of 2016. And with respect to the 7-4s, there are a couple in our fleet that we will take out, but we'll make a decision about whether the 777s or for that matter that A350s replace the 7-4s a little bit later. We are going to hit a period at the late 2019 time period where a lot of those 7-4s that we have in our fleet come due for a more expensive maintenance visit and that might be a good opportunity to sit them down at that point in time.

Are there any that are going to come out in 2016 2017 or it's a more 2019 decision?

There might be a couple that come out in the earlier years, yes.

Okay, good, and then this question may be it's John or Jim. On the p.s. service you started up in October so that's sort of one action. The second action as it just relates to the slots, I guess the slot swap between you and Delta, what sort of – do you need any sort of regulatory approval for that or you can just proceed with that and it's a done deal?

This is Jeff. On the slots at Newark we are in discussions with the – they have trust authorities that relate to that, they have the opportunity to view that and we are in discussions with them but we are highly confident that we will consummate that transaction.

Great. Thanks a lot, Jeff.

From Cowen we have Helane Becker on line. Please go ahead.

Thanks very much, operator. Hi guys, thanks for the time. Just a question on your second quarter salaries and benefits, head count was up just under a half a point and capacity was up 2.3%, but that line item was up over 12% and it was up more than it was up than it was for the year-to-date so was there something special in the second quarter we should know about and then how should we think about that going into the rest of the year?

There's two things I'd point out there, Helane. One is profit sharing and because of our higher pre-tax margin in the second quarter we trigger a higher profit sharing ratio and so that's probably higher than what we have modeled. The other thing, we continue to see pressure both with respect to pensions as well as medical and dental. We saw a lot of pressure last year and we're seeing a lot of cost increase in those areas this year as well.

Is that because you have an older workforce?

There's a lot of reasons that go into that and certainly the tenure of your workforce is one of them.

Okay, and then can you just update us on your unfunded liability? Thanks.

If we were to look at our contributions to date, without making adjustments for any actuarial assumptions or anything like that, which need to be done, we're actually at about $1 billion of an unfunded liability. That's obviously subject to change when we measure that at year-end but it puts us in a very good position over the next several years as we think about that like any other debt obligation. We've said before, we want to get to a point where if we were to get in an interest rate environment where rates are higher than they are today, we can get close to fully funded, and we are effectively in that position right now.

That's great. Thanks so much for your time. I appreciate it.

You're welcome.

From Buckingham Research, we have Dan McKenzie online. Please go ahead.

Hey, good morning, guys. Thanks.

Hey, Dan.

John, regarding the 18% return on invested capital over the past 12 months, how does that break down domestically versus internationally? And I'm guessing international worse, domestic better, but what is that gap? And then as you think, say, the international, is the fix on the international side just as simple as the U.S. dollar stabilizing against other currencies? Or are you thinking that beyond this year perhaps bigger steps might be required?

Well, let me first take the return on invested capital piece. As you can appreciate, we have fungible assets and it's pretty difficult to take a 777 that may fly domestically and also fly internationally and allocate that capital base between the two. So we don't look at return on invested capital on an international versus domestic basis. If you were to look at just NOPAP [ph], the numerator, certainly you've seen a better balance today that what we've seen historically where a lot of the profitability from airlines came – at least from the airlines that I've been associated with – came from the international portion. The domestic environment is a very good one right now and happens to be a very profitable one as well.

Okay. Very good. And then I guess just following up with a second question here. Holding steel prices constant, how are you thinking about the medium-term margin goals? And how far along are we on the trajectory versus the November 2013 Investor Day.

I would say, Dan, we're probably a little bit more than halfway through it, if you could all of the various initiatives that we outlined. Certainly we've had a little quicker pace with respect to our cost achievements but we recognize that we still have a lot of work to do here and we're pleased with the progress. A lot is made of core earnings improvement versus last year and it's certainly very difficult to strip out oil without acknowledging that there's some effect on revenue as well. So we tend to focus on the things that we can measure. The fact that we've improved productivity for eight quarters, the fact that we've cancelled 24,000 fewer flights for the first part of this year. We had one of the highest completion factors of the major carriers coming out of Newark, the fact that our cost performance continues to improve quarter-after-quarter. And all those are good indications of the progress that we were making, and we feel like we've got a good plan that we're executing on. We'll continue to demonstrate that performance.

Fantastic. Thanks, guys.

From Evercore ISI, we have Duane Pfennigwerth online. Please go ahead.

Thanks for taking the questions. Just going back to Mike's question about moving your Transcon flights from JFK to Newark, can you talk about the profit improvement that you expect from that move?

Hey, Duane, this is Jim. We would obviously, not that we won't talk about this profit, I will tell you, we're really excited. I mean if you think about the PS product United had for long history in that product of serving our customers with that premium service and the ability to introduce it to really the premier hub in New York, at Newark Liberty and offer from L.A. and San Francisco every flight flatbed seat, we're very excited about it and what the results will be on that. In addition to, if you're leaving from L.A. or you're leaving from San Francisco and you're going over the Europe, you'll have that flatbed experience across your whole journey and so forth. So I won't disclose profit but I will tell you, we're very excited about the move. We think this is really incremental to our net worth. As I mentioned, we think it's terrific for the long term for our product, our customers, our employees and obviously, our shareholders.

Okay. And then can you comment a little bit about what you're seeing in China right now. Obviously, that's been a competitive market for you, and you focus more on less competitive long-haul service there. But can you comment on any specific demand trend changes that you're seeing to that market?

This is Jim again. We obviously continue to see the significant capacity in this region. But again, as I mentioned, our history there, our position there, we're very happy with and happy with the performance. China runs at a very high level and so forth. China is such an important market to us, given our footprint there. We also take the long view of it. We're really confident where we see demand today even in today's environment. And although that capacity growth is strong, that demand will come in line over the next several years and so forth. Working with our network guys, if you look at areas that capacity is growing and that RASM pressure is on it, the demand side in China today actually puts less pressure to razz them than the other markets that are growing. So it's really that demand catching up to the capacity levels there. And we think over the next five years, and again, given as you mentioned, our ability to fly to secondary cities and so forth with our fleet in the 787, we're really well positioned to do well there.

Okay. So if I could just summarize what you said, the competitive capacity is still an issue. But in terms of end market demand, you haven't really seen an incremental change to the downside?

Yes. Yeah. The demand is still growing. Clearly obviously not at the 20% capacity we've seen. But again, the long-term view on demand for capacity has continued to grow at a pretty good rate.

Thanks. And then just lastly, John, on pensions. Can you just help us think about the implication of your improved funding status? What do you expect cash funding to be going forward? Next year? And how much could this be a cost tailwind into 2016? Thanks for taking the questions.

I would describe it less as a cost tailwind and more of a cash flow tailwind. So year-to-date we've funded $800 million. Going forward, this would probably be a rounding error in your model. You could see us fund somewhere between $50 million to $150 million a year. But there's not a need to have a big catch-up contribution like what we have this year. Again, everything else being equal, given what we know today.

Thank you.

From Barclays, we have David Fintzen online. Please go ahead.

Hey. Good morning, everyone. Just a follow-up on some of the Atlantic comments. Is there any reasons within Atlantic in Europe specifically that are requiring more capacity adjustments? Or is it a broader reduction across the network?

Hey, David. This is Jim. I think the Trans-Atlantic as it relates obviously to foreign exchange makes it a broad breadth impact in terms of demand and so forth. That being said, we are seeing good premium traffic into the U.K. and so forth. But if you think about it, remember that foreign exchange has really affected our offshore point of sale. And in the third quarter period of time, it's seasonally the point of sale out of Europe is one of the better periods of time during the year. At the same time, that stronger dollar, our expectations to drive higher U.S. point of sale because of the stronger dollar, although we've seen an uptick, it's not at the level of expectations that we originally thought. So it's really more broad-based and so forth. And in addition to the capacity reductions that we made over the course of the year out of Scandinavia and so forth, Norway, Sweden and we've adjusted some of our capacity down there. So if there was a reason we probably seen it more there, but generally it's across the board in Europe.

Okay. And presumably it's harder to shift point-of-sale in off-peak 4Q than it would be through the summer?

Yeah. You know, again, I'm a big believer – we chase demand, right? And off-peak periods demand softer and so you could reach that conclusion and so forth. But the U.S. point-of-sale growth from the stronger dollar still hasn't reach the level based on what we anticipated earlier in the year.

Okay. That's helpful. And this is a little bigger picture question. In terms of all the refleeting efforts, which is obviously important cost initiatives, does that add or subtract from flexibility to adjust capacity? And does that give you more levers to pull in the timing of those pieces?

Well I would say one of our main focuses that we've had for a number of years right now is to preserve fleet flexibility to be able to respond to any type of economic environment. And if you look at the composition of our fleet today of roughly 700, 710 mainline planes, 22% of that fleet is free and clear of debt unencumbered. We could sit down in any type of economic environment and we want to continue to preserve that going forward. In fact, as you see us finance less of new aircraft and in some cases buy aircraft entirely for cash, that preserves that flexibility, because what we don't want is to be in an environment where we want to adjust capacity but we're still have to cover the cash cost of those planes.

And David, I would just add – this is Jim. I think actually one of the flexibilities that it does add for us is in the area of range. And so we're able to kind of look at different markets based on the range we're getting through the refleeting we're happening. And on the other side also is the fact that it drives new revenue opportunities within [indiscernible].

Okay. That's very helpful. I appreciate all that.

From Morgan Stanley we have Rashiv Lalani [ph] on the line. Please go ahead.

Hi. Thanks for taking my question. I wanted to come back to the comments you made about the domestic environment and some of the competitive behavior. Do you feel like the aggressiveness, I guess, is leveling out or do you see the potential for that to maybe increase and spread beyond the couple of cities that you touched on?

Yeah, as I mentioned I talked to a couple of the cities, Dallas, Huston, Chicago where we're seeing most the pressure. We're looking at a 1% to 3% decline in consolidated domestic in the third quarter, as I guided to. In the second quarter that was down 3.6% and so I think the team's doing a terrific job of managing what is a softer demand environment that quite frankly creates lower price points and we're meeting that demand. And so I'm thinking the domestic relative basis is more stable and that actually our guidance relative to the second quarter shows that.

Okay, great. And then just another question, John, maybe coming back to some of the comments you made on the cost side. You talked about a lot of the opportunities that are ahead of you, but how does labor come into play just given what we've seen on pilot agreements and what you've got open in front of you on flight attendance, et cetera.

We have in our cost guidance this year, we've provided for 2015, there is an assumption about getting agreements with the last two remaining groups out of the 30 collectively bargain agreements completed, and I think importantly for us, but that goes both ways. So there's also a cost benefit to the company of getting those collective bargaining agreements, but more importantly, we want to get everybody under a joint contract and moving forward. There's a big sort of cultural morale piece to that as well that we're very focused on. So hopefully, we'll complete those agreements in the near future.

Okay. And then just longer term as we think about the pilot side maybe?

Well, we've said consistently that we need to run this business where we can keep our unit cost growth at something less than inflation, and that includes all of the cost inputs including labor. We certainly want to pay our employees competitive wages that are market-based and that goes into that assumption, but to the extent that we've got inflation pressure in certain areas, like that perhaps, we're going to offset it in other ways by becoming more efficient and more productive.

Very helpful. Thank you.

Yep.

And our last question from Goldman Sachs, we have Tom Kim. Please go ahead.

Hi. Jim, I wanted to follow up on your China strategy. Can you talk about like what opportunities you may have to form strategic partnerships with the Asians as you've done in Europe and now recently in Latin America?

In terms of our alliances and so forth, as we think about China, clearly envisioning we have a terrific partner in Air China, and to the level that we're allowed to in terms of how we can expand our net worth by connecting and creating more connections for our customers and expanding our footprint there. And we'll continue to do that and look for opportunities with our Star partners to do that and at the same time, obviously, complement that with what we think is a terrific strategy given our fleet, the 787, the ability to fly secondary cities such as Chengdu from San Francisco and so forth, as well as build on our core markets in both Beijing and Shanghai. So the answer is like Latin America, as John mentioned, expanding our network with Azul, we'll continually look for opportunities that are growth markets, and clearly China is, and ways to expand our presence and our footprint in the market.

This is Jeff, Tom. The one thing I would add to what Jim said is, as you know, China is not open skies. But there will come a day when China is open skies and when that day comes, we would be keenly interested in exploring a joint venture similar to the type of joint venture that we enjoy with A&A today across the Pacific and that we enjoy with Lufthansa and other of our partners, Air Canada and others, across the Atlantic.

Good stuff. We obviously understand that the Chinese are building up their network from the trans-Pac and I'm wondering which inning do you think they're at. Basically, we're trying to size up when we should anticipate trans-Pac capacity slowing?

Yeah. That's a great question. I think to begin, the industry as demand grows, capacity is going to grow. I think expectations for demand growth in China, clearly we believe are strong and long term and so forth. It would be difficult for me to put a level of that but I think where demand grows, you're going to see capacity grow. I think as I mentioned earlier, we're really well positioned.

Okay. If I can just squeeze in one more. Just to follow-on an earlier question about fuel. And this is really for John or Jim. I'm curious about your risk management strategy, particularly around fuel. Quite candidly, if it were not for lower fuel prices, the airline industry profits would be done and obviously for your company as well, not up. And this is in spite of all of your successes in containing non-fuel CASM growth. And obviously pricing is going to be whatever the market is willing to pay but I'm wondering how are you thinking about earnings risk if the consensus viewer of a lower for longer fuel environment doesn't happen? If we go back to last year, I don't think any of us thought fuel was going to drop suddenly the way that it did in the second half. We all know fuel is really volatile and it could obviously go the other way. I'm just wondering given the consensus view is that fuel is lower for longer, how are you thinking about the biggest risk to your earnings expectations? And related to that, how quickly can you respond should fuel suddenly sort of spike unexpectedly?

First of all, I disagree with the way you characterize that slightly because to say that – to just look at the impact of fuel and not understand that fuel also impacts the revenue environment I think only looks at one side of the equation there. A lot of the headwinds that Jim talked about earlier are certainly very related to fuel. Even if we take the foreign exchange headwind that we've seen, that's due to a stronger dollar. A stronger dollar has in part influenced the price of fuel. So we're seeing a lot of pressure year over year. As we move long term though and we look at an environment that potentially could have lower fuel inputs than what we've seen, we're going to update United Airlines. We're going to focus on what we can control and that's balancing the right amount of capacity for the demand in our markets.

Fair enough. Thanks a lot, guys.

Thank you, ladies and gentlemen. This concludes the analyst and investor portion of our call today. We will now take questions from the media. [Operator Instructions] From Reuters we have [Indiscernible] on line. Please go ahead.

Thank you very much for taking the question. What steps has United taken in recent weeks, if any, to ensure that diverse technological issues do not cause more system-wide ground stops which is adding redundancy?

Sure, Jeffrey. This is Jeff. I'm glad we enjoy the same first name. First of all we had an item that was disruptive that lasted about two hours that was a network connectivity issue. We recognize the inconvenience to our customers and the inconvenience to our employees. Our employees responded very well. Our IT people responded very well, got the system back up. In fact a lot of the tools that Greg talked about that we've invested in also the many of which are technology tools, decision-making tools actually permitted us to have a really good operations start-up the next day despite that disruption. I will tell you that the technology is our single largest area of non-aircraft CapEx. A lot of that goes to the operation itself, providing better tools and better decision-making tools as well. We're investing in hardware. We're investing in software. We're investing in the people and the processes to recover from irregular operations, because those are always going to occur because of weather or, for example, some kind of a maintenance issue with an airplane. We're focused very heavily on investing in the reliability of our systems and I can assure our customers that that investment will continue and that we're very focused on not only improving the stability, but actually offering additional technology to our customers to permit them to have better information, better choices better control of their travel, and for our employees that will permit them to do their jobs better. For example we're issuing 2,200 iPhone 6 Pluses to our flight attendants and over time as we add to those iPhones, our flight attendants will have vastly better information than they've had before and better interaction with their customers and can be better opportunity to serve our customers. So we're keenly focused. No one likes to have a technology outage. It can happen at any company. It happened to happen to us on a day that, of course, there was a lot of media excitement around the New York Stock Exchange. But I can tell you we are keenly focused on improving our technology, improving the stability of our technology, and more importantly, as you obviously have to have stability. Stability, to me, is like safety in an airline. You have to have this job, one, but improving the quality of our technology for our customers and the quality of our technology for our employees. And both those things are really important. And we are keenly focused on it, and we are spending a significant amount of both time and money and bandwidth to get that accomplished.

Well, thank you so much. And just to clarify, because it's unclear where a technological issue can occur, is it difficult to really target those investments? Do the investments need to be general?

Well, no. Not necessarily. We know areas, for example, where we can beef up systems or beef up backups. And so we know where to look. We also obviously do invest in significant amount, a significant amount of time and attention to the network itself and all the connectivity of the network, and of course, as all companies do today. We have very sophisticated investments in cyber security as well. So I think we know exactly where we're going and what we need to invest in.

Great. Thank you. And I'm so sorry. Just last follow-up then. So since you have pinpointed those areas, have you started those particular investments? Or do you have at least plans already to start those investments?

Oh, you bet. We've already started. We have regular investments. We have a system-wide program we call Refresh in terms of improving all of the backbone of the system, the connectivity of the system. And again, continuing to improve Wi-Fi bandwidth and coverage because so much of our future and so much of our obviously the customer usage, but our own usage particularly at airports and onboard airplanes is Wi-Fi related. And we have very significant not only investments but processes going on today to continue to upgrade and improve our technology.

Thank you so much.

You bet.

Okay. With that, we're out of time. So we'll conclude. Thanks to all of you on the call for joining us today. Please call media relations if you have any further questions. We look forward to talking to you next quarter. Goodbye.

Ladies and gentlemen, this concludes today's conference. Thank you for joining you may now disconnect.