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Executives

[John Geebo]

Glenn Tilton – Chairman, President and Chief Executive Officer

Kathryn Mikells – Chief Financial Officer

John Tague – Chief Operating Officer

Analysts

Kevin Crissey – UBS

Hunter Keay - Stifel Nicolaus

Mike Linenberg – Bank of America

William Greene - Morgan Stanley

Gary Chase – Barclays Capital

Helane Becker – Jesup & Lamont Securities Corporation

Jamie Baker – JP Morgan

Bill Mastoris - Broadpoint Capital

Mary Schlangenstein – Bloomberg News

Harry Weber – The Associated Press

Ted Reed – TheStreet.com

John Pletz - Crain's Chicago Business

UAL Corp. (UAUA) Q2 2009 Earnings Call July 21, 2009 2:00 PM ET

Operator

Welcome to the UAL Corporation's earning conference call for the second quarter of 2009. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, [John Geebo].

[John Geebo]

Welcome to UAL's second quarter earnings conference call. Our earnings release and separate investor update were issued this morning and are available on our Web site at www.united.com/ir. Let me point out that information in the press release under remarks made during this conference call may contain forward-looking statements, which represent 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-K and other reports filed with the SEC for a more thorough description of these factors. Also, during the course of our call, we will be discussing several non-GAAP financial measures. For a reconciliation of these non-GAAP measures to GAAP measures, please refer to the tables at the end of our earnings release.

Unless otherwise noted, as we walk you through our numbers for the quarter, we will be excluding impairment charges and certain other accounting charges of $89 million for the second quarter of 2009 and $2.6 billion for the second quarter of 2008. We will also be excluding fuel hedged, non-cash net mark-to-market gains of $440 million for the second quarter of 2009 and $208 million for the second quarter of 2008. These items are detailed in the table in note six on page 13 at the end of our earnings release.

And now, I'd like to turn the call over to Glenn Tilton, UAL's Chairman, President, and CEO.

Glenn Tilton

Joining me today, in addition to [John], and participating on the call are Kathryn Mikells our Chief Financial Officer, and John Tague our Chief Operating Officer. Pete McDonald our Chief Administrative Officer is also with us and available for questions.

This morning, we reported a second quarter pre-tax loss of $323 million. As I'm sure everyone listening to this call well knows and as you have heard from some of our competitors today, the global airline industry continues to be challenged by the effects of an unprecedented drop in travel demand, particularly among business and premium customers.

At the same time, fuel prices, while down a bit from the highs we saw during the second quarter, continue to be extremely volatile. As an industry, it's clear we are significantly impacted by factors largely outside our control, such as the state of the global economy and the price of oil. As a company, however, it's how we manage against these challenges and how we capitalize on the opportunities challenging times can present that makes the difference for our customers, our investors, and our people.

As you also know, this is a resilient industry and United is a very resilient company. Against the backdrop of difficult economic times, United's people are doing some of the best work this company has done in a very long time. We've consistently outperformed our peers in non-fuel unit cost control and we are on a solid path to realize our goal of delivering top tier non-fuel unit costs. We are continuing to expand our successfully ancillary revenue program to create value.

We're running a better operation with industry leading on-time performance. We're earning significantly improved satisfaction scores from our best customers as we work to improve the quality of their travel experience. We have demonstrated a clear track record of successfully accessing the capital markets raising hundreds of millions of dollars to secure our liquidity, and we are not slowing down. We have plans in place to build on this momentum over the months and years to come.

The proof points of our progress are apparent across our performance metrics in the second quarter. We have once again delivered excellent results on the cost front with non-fuel unit costs down more than 1% despite our significant capacity reductions and we have again reduced our outlook for full year costs. We have maintained our number one position among network carriers for on-time performance year-to-date through May, and were pleased to have been able to reward our employees for their hard work delivering on that goal with $18 million in performance bonuses so far this year.

We delivered a third consecutive quarter of improved customer satisfaction with a significant increase in our scores by our most valued customers. We improved our unrestricted cash during the quarter to $2.6 billion and we once again successfully accessed the capital markets with our recent spare parts financing early in the third quarter.

We have also made significant progress over the last few months on other important work to position United for success as the global economy recovers, as it will. Many of our competitors have recently announced additional capacity reductions, yet industry capacity is still not aligned with demand, particularly internationally. Our previously announced capacity reductions were significantly larger than those of our competition and their recent announcements are bringing their reductions in line with ours.

That said we believe additional international capacity rationalization is necessary in this environment and today we announced a further 7% reduction in international capacity post-Labor Day. Earlier this month, we were very pleased to see Continental receive final approval on our application with the DOT to enable them to join our global immunized alliance with Lufthansa, Air Canada, and six other Star Alliance member carriers.

Although the Department of Justice raised some objections to the application, the Department of Transportation reviewed those and the record created by the response of the joint applicants and determined only minor adjustments to our very thorough application were in fact required. The Department of Transportation outlined a few limitations or carve-outs on the immunity that affect a handful of routes. The DOT also provided a clear process to reverse these carve-outs under certain circumstances, such as the entry of a new competitor.

This is a very good result for United, our employees, our customers, and the communities that we serve. And it reflects exceptional work by our partner, Continental, and many of our United colleagues to get this application over the finish line.

In particular, I'm personally grateful to Continental's outgoing CEO, Larry Kellner, for his commitment to our partnership and to the work that made this process a success. I'd also like to take the opportunity to congratulate and welcome Jeff Smisek, as we look forward to working with him in Continental as they join our alliance.

John Tague and I met with Air Canada's new CEO, Calin Rovinescu, in Montreal last week as a part of our ongoing work together to strengthen our alliance. We're all looking forward to Continental joining us in Star immediately upon their exit from SkyTeam at the end of October, great news for our company and will enable us to better compete and provide our customers with new travel options.

As we also announced earlier in the second quarter, we have issued RFPs to aircraft and engine manufacturers to explore the potential for launching a fleet modernization program that could establish our long-term replacement strategy for both our international and narrow body fleets for many years to come. Some found this announcement a bit surprising given the challenges of the current environment, but the prospect makes very good sense to us. We believe the difficult economic environment may create a unique opportunity for our company to consider a fleet modernization program with the right economics that will lower our operating costs, widen our market opportunities, and improve the customer travel experience.

As we are still early in the process, it's premature to draw conclusions about the outcome. The team is engaged and will be working with the manufacturers over the coming months to determine if we can capitalize on this opportunity. We continue to make progress in our discussions with our labor groups following the commencement of our discussions in April. Our labor negotiations team recently provided an update to the three members of the National Mediation Board on the background and status of United's labor negotiations.

As the team advised the NMB several years ago during our restructuring process, we agreed to begin negotiations well in advance of the amendable dates and to jointly seek mediation services of the NMB with our major labor groups by August 1 in the event that we had not reached agreements by that date. Based on the current status of negotiations, it's likely that we'll file joint request for mediation and we're looking forward to working with our unions and the NMB as we continue our negotiation process.

Our goal, as we have said before, is to reach agreements with our unions that are good for our employees and good for United Airlines. These are, as I've said, challenging times to be sure but all across United our people are doing work required to improve our business and run a great airline. Our actions are having the desired effect. We are delivering improved results with an eye to our competitiveness in the years to come.

With that, I'll hand the call over to Kathryn who will take us through the numbers in further detail.

Kathryn Mikells

The impact of the recession on our industry has clearly been severe with overall traffic down on par with what we experienced in the period following 9/11. Our teams are accustomed to meeting the challenges that we face in this business. We do so through good work. Work that addresses the issues that our industry faces today puts us on a clear path to profitability and positions United for long-term success.

Our second quarter results were significantly impacted by ongoing pressure on global business and premium demand. While we're disappointed with our loss and what is generally one of our and the industries seasonally stronger quarters, we continue to be very pleased by the progress that United people are making on the things that we can and must control.

Total revenues for the quarter declined by 25% or a bit less than $1.4 billion, at the same time operating expense declined by 27% or a bit more than $1.5 billion as we continue to reduce capacity and drive down our cost. The decline in fuel prices was a significant contributor saving us about $1.2 billion year-over-year. With our expense reduction outpacing the decline in revenue year-over-year, our operating income improved by $177 million and our pretax income improved by $46 million.

We reported a pretax loss of $323 million or $2.23 a share a bit better than the streets consensus of $2.61 per share as our revenues came in slightly above the top end of our guidance and cost came in significantly better. The revenue environment is clearly very challenging, especially internationally, with IOTA estimating an industry drop of as much as 30% in May our consolidated passenger unit revenue declined by 17.2% this quarter versus last year about 1% point better than the midpoint of our June guidance.

Gross and ancillary revenues, such as bag and ticket change fees, improved consolidated passenger unit revenue by about 1.5 percentage points. Cargo and other revenue was $328 million down about 31% from last year driven by a 49% decline in cargo revenue. A combination of factors continues to put pressure on cargo revenues. Global economic weakness has reduced freight and mail volumes from anywhere from 20% to 50% depending on the route with the Japan market being amongst the hardest hit.

Specific entity cargo revenues were down more than 50% due to a combination of lower demand, lower yields and reduced capacity. Also contributing to the year-over-year decline in cargo revenue was lower fuel surcharges driven by the year-over-year decline in fuel prices.

Moving to the cost side, as I mentioned previously, total operating expense was down more than $1.5 billion year-over-year for the quarter with $1.2 billion of the reduction coming from lower fuel cost and $288 million reduction coming from lower non-fuel cost. Lower stock prices and reduced volumes brought consolidated fuel expense down $1.4 billion offset by fuel hedged losses on contracts that settled in the quarter totaling $157 million for a net fuel cost reduction of $1.2 billion or more than 50%.

Including the impact of settled hedges, average mainline jet fuel expense for the quarter was $1.94 per gallon down from $3.56 per gallon last year, a reduction of 46%. Our unhedged fuel price for the quarter was $1.63 per gallon. We recorded an additional $95 million in settled hedged losses and non-operating expense. As we've talked about previously, our settled hedged losses from contracts that we put in place last year are completely covered by the return of cash collateral that we posted with counterparties in the second half of 2008.

We benefited from $385 million in cash collateral that was returned this quarter roughly $290 million of which was associated with hedges that settled in the quarter allowing us to participate in about $1.5 billion in consolidated fuel savings on a cash basis.

Once again United's employees have turned an industry leading non-fuel unit cost control. Our team has built real momentum around cost control and we're demonstrating our commitment to achieving top tier unit cost performance, while at the same time delivering industry leading liability and improved customer satisfaction.

Consolidated non-fuel expense was found $288 million this quarter or about 9% as we once again reduced cost at the same pace as capacity despite the headwinds that we faced from fix cost and rate increases. Our second quarter mainline non-fuel unit cost was down 1.2% year-over-year a 10.8% lower capacity, while our consolidated non-fuel unit cost was about flat to last year.

This performance was in line with our first quarter results and represents an improvement on the year-over-year performance of about 3 percentage points compared to the early second quarter guidance that we provided in April. Over the past several quarters we've been discussing with the work we've been doing to reduce our cost, and this quarter serves as yet another proof point.

We're benefiting from the retirements of our 737 fleet and continuing our progress improving maintenance efficiency driving our maintenance related cost down by about 19%. We've been persistent in our focus on reducing distribution costs, which are once again down more than passenger revenue. We continue to work down overhead cost and improve productivity with overall salary and labor cost down over 10%. Purchase services and other operating expense are both down by more than our capacity reduction, which reflects the work we're doing across the country to reduce our costs.

Moving to the balance sheet, we closed the quarter with a solid unrestricted cash balance of $2.6 billion about $100 million higher than last quarter and what we guided in our June outlook. It's important to note that our $2.6 billion unrestricted cash balance at quarter end does not include the $155 million in net proceeds from the recent spare parts financing we completed. Those proceeds were deposited in early July.

Our solid cash balance also means we have no incremental credit card reserve requirements with either of our two major credit card processors. Importantly, we've already posted non-cash collateral with our largest credit card processor that would cover any reserve requirements through early next year. In the case of our other major processor, we have the flexibility to use non-cash collateral in the event a reserve may be required in the future.

We generated positive operating cash flow of $396 million in the quarter and positive free cash flow of $305 million. We made scheduled debt and net capital lease payments of $212 million during the quarter and spent $91 million in non-aircraft capital investment continuing our focus on customer facing projects, like our new international premium seat product. We closed the quarter with $10.9 billion in total debt including off balance sheet obligations, a reduction of nearly $300 million from the end of the second quarter of last year. Our net debt was $8.3 billion.

We're pleased with our continued progress building liquidity with $2.6 billion in unrestricted cash, an additional $1.1 billion in unencumbered hard assets that we can continue to leverage to raise more, and the proceeds from our recent financing transaction, United's liquidity is clearly adequate as well as competitive with peers adjusting for carrier size. We've continually demonstrated our ability to raise cash in a tough credit market and we have the right plans in place to ensure that we continue to have the liquidity that we need to manage the business going forward.

And with that, I'll turn it over to John.

John Tague

During the course of the last 12 months, we've achieved levels of reliability, service, quality and cost performance that represents significant improvements from where we were and clearly lay the foundation for where we are going. This foundation is based on our focus on five goals. These goals allow us to focus our efforts and resources on the things that matter most to our customers, employees and shareholders. We continue to deliver results against these goals in the second quarter, as we again had improvements in key areas across the company.

On the revenue front, for the second quarter our unit revenue results were somewhat better than our recent guidance driven by an improvement in close-in leisure bookings for June. But as with the rest of the industry, our revenue results were severely impacted by the depth and breadth of the global recession. Our consolidated passenger unit revenue declined 17.2% year-over-year driven by a 16.8% decline in yield and a slight decrease in load factor.

Growth in ancillary and fee revenues continues to be a very important aspect of our revenue strategy. We generated over $275 million in revenue in this area in the second quarter, an average of about $13 per passenger, which is a significant premium over the industry. We continue to look for ways to enhance our ancillary revenue opportunities. This month we announced that we are expanding our Premier Line offering to an additional 50 airports across the United States. Premier Line provides our customers with the convenience and choice by offering them, for a fee, priority access to specifically reserved lines at check-in, security and boarding.

We expect full year ancillary revenue, including fees of about $1.1 billion in 2009. That's about $200 million higher than 2008, despite the significant cuts we have made to capacity. For the quarter, we saw strong domestic load factors driven by our aggressive capacity reductions from the elimination of the 737s and right-sizing our service with United Express Flying. Domestic yields remain under pressure as lower business traffic is having a very negative effect on the mix.

Consolidated domestic PRASM for the quarter was down 12.5% year-over-year on a 13.5% drop in yield. International PRASM was down 26% for the quarter, significantly more than domestic, reflecting industry over capacity and the effects of reduced premium cabin traffic. For the second quarter, international premium traffic was down over 24% with revenues off 37%.

The H1N1 flu epidemic had an impact on demand in Latin America and the Pacific. While it is difficult to isolate the magnitude of the overall revenue declines of this one factor, our estimate is the epidemic had a negative impact in the quarter of about $50 million.

Helping to offset the decline in premium traffic, we continue to rollout our new international premium cabins, which reduce the total number premium seats per aircraft by over 20%. We were pleased to complete the conversion of all of our international 767s this quarter and we remain on track to complete our 747 fleet by October. As a part of our reduced capital spending plan, we are delaying until next February the start of the conversion on our 777s, which were previously scheduled to begin late this year.

Turning to entity results, in the Atlantic second quarter PRASM declined 23 % year-over-year, just slightly better than the industry average. We saw significant PRASM declines in all areas of the region. In the Pacific, PRASM declined 29% year-over-year, as we saw weakness in all areas driven by the sharp decline in local economies, including Japan which in previous quarters had sustained less of a negative impact. The Pacific in particular was significantly impacted by the drop in premium traffic. Premium traffic in the Pacific was down over 30% versus last year, while revenues were down 46%.

The Latin American entity, which is significantly smaller than other entities, saw a PRASM decline of 34% year-over-year. Weakness in Brazil and Argentina where United has over half of its Latin American capacity was the main driver. Large capacity reductions in the region reflect the pull-down in capacity to Mexico that we implemented after H1N1. We've begun to add the capacity back to Mexico and we will be back at our full schedule by the end of the third quarter.

While our passenger revenue performance was better than our guidance, demand continues to be significantly affected by the state of the economy. As a result, for our post-Labor Day schedule, we have further reduced our international flying by 7%. We are reducing capacity in Pacific by about 8% and the Atlantic by about 7%.

United has lead the industry in capacity discipline over the last 18 months, with capacity reductions implemented both earlier and deeper than peers. For the second half of 2009, our consolidated capacity will be down about 12% when compared to the second half of 2007, with significant reductions in both the domestic and the international entities. We continue to monitor our capacity levels and will be prepared to make additional reductions if we feel they are necessary.

On the cost front, we are delivering on our commitment to lead the industry in cost discipline. In both the first and the second quarters, we were able to actually reduce our non-fuel unit costs despite double-digit capacity reductions. We also continue to outperform our peers in year-over-year cost control despite these deep capacity cuts.

We continue to aggressively attack structural costs across the company, be it supply chain or overhead. We have improved productivity by 4% in the second quarter despite an 11% decline in mainline capacity, as overhead reductions and efficiencies on the frontline resulted in improved manpower utilization.

We have led the industry in reducing distribution costs by having a willingness to take calculated risks. For the first half of 2009, our distribution costs were 4.6% of revenue down from 6% of revenue in 2005. This amounts to a savings of almost $100 million just for the first half of this year.

We continue to be aggressive in other areas as well. Recently, we have taken advantage of the weakness in the hotel market by renegotiating our crew hotel contracts saving almost $20 million in just this one area. We also put out to bid our ground equipment maintenance work, which was previously done in-house in an effort to reduce costs and improve reliability.

During the bid process, we invited our union to bid to retain the work. Through collaborative work between the project team and our union leadership, we ultimately retained seven of the eight locations in-house, while fully achieving our target cost savings of 30%, along with improved performance and reliability.

Our cost control efforts are active and ongoing and, even with the significant progress we have already made, we have not yet reached our full potential. We are constantly looking for new and innovative ways to reduce costs across the organization, not only responding to the challenges of today's environment, but creating competitive differentiation in the future.

Our United team is working hard to deliver strong operational performance as we continue our efforts to be number one amongst major U.S. carriers in A14 on-time performance for 2009. Our customers are taking note of the work underway at United, as we continue to drive a significant improvement in customer satisfaction scores for the third consecutive quarter.

Customer satisfaction scores are improving across the travel experience, from industry leading operational results to the reliability of our onboard product offering, through cleanliness and the condition of our cabins. Our industry leading products, such as our international first and business class and economy plus, also continue to drive improvements in customer satisfaction.

In closing, our agenda and our focus are clear, from the airports to the office, deliver industry leading performance that we are proud of and that our customers value. The United of the future will be a very different competitor, one that is committed to both cost and quality leadership across the industry.

Now back to you, Kathy.

Kathryn Mikells

Moving now to guidance, for the third quarter we expect mainline capacity to be down 8% to 9% year-over-year and consolidated capacity to be down 5.6% to 6.6%. For the full year, we expect mainline capacity to be down 9.6% to 10.6% year-over-year and consolidated capacity to be down 7.5% to 8.5%. This reflects the post-Labor Day reduction in international flying that John discussed a few minutes ago.

We have once again lowered our full year 2009 cost outlook. We are now expecting our mainline unit costs, excluding fuel and profit sharing, to be down half a percent to up half a percent against the mainline capacity reduction of about 10%. This represents a savings of about $300 million from the full year guidance we provided at the beginning of the year, and about $150 million reduction from the guidance that we gave you last quarter.

Full year 2009 consolidated unit costs, excluding fuel and profit sharing, is expected to be about flat to up 1% year-over-year despite a consolidated capacity reduction of about 8%. For the third quarter, we expect both mainline and consolidated unit costs, excluding fuel and profit sharing, to be about flat to up 1% year-over- year. Based on July 16th closing forward prices, mainline jet fuel prices are expected to be $2.20 per gallon for the third quarter. This price includes taxes, as well as the impact of hedges that settle in the quarter and are recorded in fuel expense.

We've increased our hedged coverage for the second half of the year to about 64% of expected consolidated consumption with 48% of our expected consumption hedged at an average crude equivalent cap of $65 a barrel. You can find a detailed description of our hedged positions, our detailed fuel price outlook, and additional guidance information in the investor update that we issued this morning.

We started the third quarter with a solid cash balance, benefiting from the proceeds of our recent financing transaction. We've taken additional steps to reduce our 2009 capital spending to conserve cash. We now plan to spend $300 million in non-aircraft capital in 2009, down an additional $50 million from what we announced last quarter and down about $150 million from our original plan for 2009.

We continue to enjoy relatively modest debt obligations with only about $460 million in debt and net capital lease payments due in the last two quarters of this year, and we further benefit from some of the lowest fixed obligations among network carriers over the next six quarters.

Unlike some of our peers, we have no large bullet payment debt maturities coming due, no aircraft capital expenditures that may not be fully financeable, and no material defined pension plans to fund. While the environment continues to be a very challenging one, we're taking the right steps to not only see our way through the current environment, but to set us up to be a leaner tougher competitor when the recovery comes.

And with that, [Misty], we're ready to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kevin Crissey – UBS.

Kevin Crissey – UBS

Can you talk about your thoughts on kind of why now for the move with the agencies and the credit card basically moving them to be the merchant of record? I know you have probably gotten too much press for the number of agencies that applies to you, but I just wanted to get your thought as to why now. It seems like a tough time to be moving in this direction.

John Tague

Yes, Kevin, John here. Yes, we have thousands of agency relationships and I would say we have thousands of different terms amongst those agencies. In fact, we currently do have a number of agencies who have been merchants of record for some time. This merely represented an expansion of the definition as to how we were going to apply that initially.

So we're going to reserve the right on a continuing basis to optimize the way we approach each of these distribution agreements based upon the commercial relationship we have with those particular parties. I can't really speak to what we will do on a going forward basis, but I think you can continue to expect us to take calculated risks, such as these, as we move to improve the economics and performance of our distribution relationships.

Kevin Crissey – UBS

Can you talk about what you see as the, I think you noted that June saw a nice close end booking at the end data we have suggests that as well. Do you expect that for the go-forward period and what do the comparisons look like for July, August, and September? When was the falloff? Was that more an October event, kind of trying to think about what the comparisons look like for you on revenue and anything you can give to give us a little color on the third quarter revenue relative to Q2 or however you want to look at it.

John Tague

Well, I wouldn't disagree with the term stabilization, but how far I would carry it into the future may be a little bit different. Clearly, the first half of the summer, which is very heavily leisure driven, is in line with the results we've been experiencing recently.

The second half, frustratingly, we don't have a lot of visibility to as we move into periods of the year that are typically more driven by business traffic contribution and we won't know where that is until we are very close to the outcome. Actually, we peaked in about October of last year. I believe in October we had an 8% increase in unit revenue year-over-year, so it was a very strong October for us. After that the comps get easier.

Operator

Your next question comes from Hunter Keay - Stifel Nicolaus.

Hunter Keay - Stifel Nicolaus

Kathy, on the AMEX covenants can you maybe clarify as much as you possibly can, what you mean by near term when you use that term in the Q when referring to the minimum cash requirement being $2 billion before it goes to $2.4 billion. And also can you maybe describe the ability to substitute aircraft collateral, again, there's the caveat of under certain circumstances is how you phrased it in the SEC filings. Can you maybe shed some light on that?

Kathryn Mikells

Yes, I'm happy to talk about both of those things. So if you look at where our cash balance ended for the quarter at about $2.6 billion, we give pretty deep details disclosures in our Q with respect to all of these agreements that we are talking about. On American Express, we don't have reserve requirements unless our cash balance is below $2.4 billion, and at that point we have to have the ability to post non-cash collateral if we were to be in that position.

That ability to post non-cash collateral, actually, we have a whole lot of flexibility around that. So you mentioned aircraft collateral as one potential, I would simply state that we have very broad flexibility with respect to our contract arrangement and potentially posting on non-cash collateral. So we feel very good about where we ended the quarter in terms of our cash balance and, again, where we ended the quarter did not reflect the proceeds from our transaction. We also feel very good going forward about our arrangements with our credit card processors.

Hunter Keay - Stifel Nicolaus

Sort of also to follow up on this distribution cost discussion, how much of these, the reduced year-over-year changes are from actual sort of structural contractual changes that you alluded to earlier, rather than maybe just depressed volumes as corporations are not using GDS's to book their tickets because of the overall depressed travel. I mean how much of this maybe comes back and how much of it can be thought of as sustainable cost savings?

John Tague

Well, we think it's pretty reflective as a percentage of revenue. We've been making progress quarter after quarter with distribution costs. We developed a very long-term strategy relative to our cost of sales about three to four years ago with five year aspirations, and the work that we believe would allow us to realize that, and we're knocking that work off quarter-after-quarter.

I mean we fundamentally believe that with an industry as challenged as we are, we're going to have to get more efficient about the way in which we distribute the product, be that improved economics or improved performance from our distributors. So, this is a sticky cost reduction that's really been in the works for a number of quarters.

Glenn Tilton

I think back to the question that was posed once removed on why now, given the state of the industry economics and general state of the global economy, I take everybody back to John's comment in his opening remarks that he and the team across the board, Peter and the team, and the staff functions are really examining every imaginable cost component of our overall unit cost to pursue improvement. And when we say there are no sacred cows, given the economics of this industry, I don't think anybody on the other end of the line should be surprised by our aggressive pursuit of those savings.

Operator

Your next question comes from Mike Linenberg – Bank of America.

Mike Linenberg – Bank of America

Two questions here, the 7% cut to the International Peace this fall, how are you getting there? Is that frequency, is that gauged, are there any city pairs that are being dropped? Any color on that, John, would be great.

John Tague

Well it's a combination of both. We are suspending for the winter season at this point in time, we'll reassess in the spring, Washington, D.C. to China, Denver to Heathrow. And we're reducing capacity in San Francisco, Inchon, Osaka and Narita. We are, as a matter of fact, eliminating the second daily trip from San Francisco to Narita, as well as San Francisco to Heathrow.

We're also eliminating one of four trips from Dulles to Heathrow and down-gauging a number of our other operations. So no real headlines in terms of market exits, just responsible trimming around the edges to get the capacity reductions, and I think we acknowledge particularly internationally more may be necessary and we have time to still consider that.

Mike Linenberg – Bank of America

My second question this goes back to, Glenn, I think after you had the shareholder meeting or the annual meeting back in June, I think you're out on record saying that the company was just taking a closer look at the seating in the economy section.

There wasn't much detail on it but when I think about your Star partners, I think [Sing Air] just came out a week ago and said that they were going to reduce the number of seats in their economy class. And then you have Lufthansa who I believe is actually adding more seats back into their economy class, at least on their 747s. Which way are you leaning toward? Any color on that would be great.

Glenn Tilton

One of the things that we had said is that the partnership with Continental and the creation of A++ and initial Atlantic joint venture gives us the opportunity to effect some reconsideration along the lines of which on the team have done post [test]. So we continue to stare hard as we reconfigure the fleet to ask ourselves what the optimal solution would be. But to be perfectly candid with you, it is difficult for us to imagine that there is a solution in this environment that includes taking seats off of aircraft.

Kathryn Mikells

And the one other thing that I would just to that, John mentioned the reconfiguration project that we have underway and that is actually is shrinking our upper class cabins by roughly 20% on average. What we actually end up with about 3% increase in seats because we're going to actually add seats into the coach cabin.

Now all that's already been taken into consideration in terms of the capacity guidance that we gave, but that's clearly a change that we're making and is largely at this point complete with the two fleets, and then we've got the 777 fleets to still complete here.

John Tague

We're going to have to see where corporate travel settles out between the Economy Plus cabin, for example, internationally and business class. Any changes or adjustments we would make are obviously very long-term in nature. We do have opportunities to, for example enhance what comes along with Economy Plus if we see a sustained appetite for long haul corporate interest there. So we'll maintain the flexibility and we'll see where this market settles out. But as Kathy said, we feel that we're directionally very correct with the reconfiguration.

Operator

Your next question comes from William Greene – Morgan Stanley.

William Greene – Morgan Stanley

You noted, Kathy that liquidity is adequate and is competitive relative to peers, but the recent debt issuance was at a very much higher rate than the peers. So what was the driver to that differential do you think?

Kathryn Mikells

Bill, I think the big drivers to the differential are basically the kind of collateral that we used for the transaction and the structure of the transaction. So that transaction had more than 50% "non-eligible" 1110spare parts used in it, which is a collateral type that financiers are not necessarily as fond of, and certainly not as fond of as brand new aircrafts.

If you actually look at the best comp that's out in the market, which is a transaction that [CAL] did a spare parts transaction that they did a couple of years ago, you'd actually see that we're trading much closer to that transaction. And the differential between us and that transaction largely driven by theirs all being 1110 eligible spare parts and being credit enhanced with those liquidity facilities.

So we understand that we're going to end up having to pay a different rate for different transactions with different structures and different collateral. The markets I think have improved in that, while still erratic we're seeing the markets open up a little bit.

This was an opportunity where the market for this kind of transaction was open and we capitalized on the opportunity and as a result we have $155 million in our bank account we didn't have previously and we're very satisfied with that outcome.

William Greene – Morgan Stanley

So when we think about what is still unencumbered, what's the kind of assets that are in there? Can they be placed into a EETC transaction or should we assume more like a loan to value like we saw in this transaction?

Kathryn Mikells

That's a terrific question. I mentioned we've got about $1.1 billion in remaining on unencumbered collateral. A little more than half of that is aircraft and engines, so I think that gives you a good flavor. Beyond aircraft and engines we have all of our simulators that are unencumbered. We own a fair amount of property, ground equipment, domestic slots and things of that nature, but I think that gives you a pretty good feel for the composition.

William Greene – Morgan Stanley

Sorry just to be clear, but the planes and engines are they eligible for the usual EETC structure or will it be similar to the structure that you just issued?

Kathryn Mikells

Honestly, it really depends on market conditions at the time.

William Greene – Morgan Stanley

Just one quick question on CapEx, you cut it a bit again. And I guess I'm assuming that you were pretty much at about the level it can't really go much lower, and yet in the second quarter now you've cut it a little bit from where you were in the first. So I'm trying to figure out kind of where the normal level goes back to? My assumption is going to be materially higher than where we are now, even excluding any fleet renewal.

Kathryn Mikells

So that's a terrific question, I tend to get this question with a fair amount of frequency. I start by saying I think part of what you see is we do bring a lot of creativity to the table and seek to actually retain a lot of flexibility to just help us manage through times like this. It's an industry that's very hard to call just in terms of its cyclicality and some of the external things that we're exposed to.

I have mentioned that I think it's a bad assumption to assume that CapEx sort of immediately springs back and I'm going to differentiate, right. Glenn talked about the fact that we are entertaining discussions with manufacturers about the long-term direction for our fleet, right. And right now what you're seeing is only non-aircraft capital spending.

Clearly, at some point in the future, right, although not in the near-term, we would expect to see some level of capital expenditure in terms of the long-term fleet replacement plan at some point. Too early on in our discussions to suggest that we're going to successfully get to where we want to be with the manufacturers, but I'm just differentiating aircraft versus non-aircraft capital spending.

It's really important to consider just how much smaller we are when you think about ultimately what's a good run rate, where do you think capital spending is going to be? And the other thing I would tell you is we're going to continue to manage conservatively and to really manage around cash flow to ensure that we continue to have the liquidity that we need to manage the business. And that's absolutely what you should expect we're going to do.

John Tague

The only thing that I would add to that is, is currently the international premium cabin reconfiguration is consuming a very large amount of our capital budget. So simply finishing that would free up capacity even within the context of the existing 300 million number.

Operator

Your next question comes from Gary Chase – Barclays Capital.

Gary Chase – Barclays Capital

There were a couple of things, Kathryn, that you said during your prepared remarks that I just wanted to see if you would be willing to shed a little bit more light on. One of the things that you said was that you're doing work that you think puts you on, I think the way you expressed it, was a clear path to profitability.

And I just wanted to get a little bit of a sense of what your thought process is there? What kind of timeframe we might be thinking about and what the assumptions are that underlie that? I mean have you, does United believe that there's a substantial amount of revenue recovery out there in the near future? I mean how do you get there?

And then I wanted to see if you could sort of tie that together with you also said you had a plan in place to sustain appropriate liquidity, and I wanted to see if you could tie that thought, your profit expectations whatever they may be, together with the liquidity plan for us?

Kathryn Mikells

Sure, both very good questions, so taking the first one, we don't give forward-looking guidance at this point in the quarter with respect to revenue for the quarter or profitability for the current quarter. So I'm going to table it from that perspective, but I'm going to come at it from a little different angle.

Clearly, what you're seeing on behalf of our performance is extraordinary good cost control. We are targeting to get down to not just the "competitor level" in terms of our unit cost, but actually to get the industry leader among net work carriers for our unit cost.

And I think you're seeing us make extraordinarily good progress in that regard that clearly better positions the company on a forward-looking basis as the economy starts to turn around and getting back to profitability, and that's clearly one big plank that we're executing on and executing very well on.

I'm not going to give you forward-looking guidance at this point in respect to revenue because we don't give that until later in the quarter. I think John has already commented with respect to seeing a level of stability in terms of current trend.

If we move then to liquidity, I think we have an extraordinarily good track record of continuing to execute transaction and what has clearly been a tough credit environment, a tough capital market environment, and a somewhat erratic capital market environment.

But I think we have a very good history in terms of our ability to raise capital and, as you would expect that we would do, we are continuing to look at all the opportunities we have to raise incremental capital, as well as the opportunities that we have to refinance debts currently outstanding.

Gary Chase – Barclays Capital

And just a couple quick follow ups on both sides of that. In terms of the cost we've estimated I think we've got a view on what the potential is for United, but I wouldn't think that absent revenue improvement you could get close to profitability. And I know that you don't want to give sort of forward guidance on revenue, but does the forward outlook thinking that you could get back to profitability that must require some significant degree of revenue improvement yes or no?

Kathryn Mikells

I'm just not going to give you forward-looking guidance with respect to earnings at this point in the quarter. We certainly have an expectation that the larger macroeconomic environment at some point is going to improve no different than the economic indicators that I'm sure that you look at.

Glenn Tilton

So maybe coming at this a different way. We actually do the work that we have described to you this afternoon with an eye to modest systems from the macro market, so without violating Kathryn's comment that we're not going to be specific in our expectations and forward-looking expectations relevant to revenue recovery.

Stabilization speaks, not only to the stabilization of the revenue environment within the industry it also speaks to stabilization with respect to the global economy itself and all of the economies that affect this business. I think the one thing that maybe we didn't say in the beginning as we work very, very hard to optimize whatever margin is available to us, whatever operating margin, whatever cash margin, whatever pretax margin is available to us.

We also scour all of the businesses within the overall enterprise to make certain that we are optimizing whatever opportunity they may pose to us. And to be candid with you in the course of the conversation in an environment like this it really doesn't get the kind of discussion it might warrant. So we have a full cupboard of opportunities with respect to the full portfolio business and we have business leaders focused on optimizing all of those embedded business within the embedded business.

Kathryn Mikells

And all of the work is focused on building momentum behind the things that we can control in this environment. Clearly, we can't control exactly what the timing and case of economic recovery is going to look like. What we can control is our overall performance, both on cost and running a good airline. And I think it's very clear from what we talked about in our prepared remarks that we're making great headway across all of those metrics.

John Tague

Another thing I'd add is its self evident that without some level of economic recovery more capacity is going to have to come out of the industry. And I think for the most part the industry has been very responsible in that regard. That involves taking out cost too and, as Kathy mentioned, we've got a lot of confidence about our ability to reduce capacity and take cost out with it. But it's not optional I don't believe for the industry to respond to this economic environment should it continue with anything other than additional capacity cut.

Gary Chase – Barclays Capital

And then apologies Kathryn just one very quick clean up, the $2.6 billion in unrestricted cash be your sort of late quarter guidance by a touch is there anything we should be expecting with quickly reverse out of that?

Kathryn Mikells:

No, relative to our guidance obviously fuel hedged collateral moves around every day. Relative to our guidance, our fuel hedged collateral was about $10 million better that is less collateral out the door than what we expected. So really the improvement relative to our guidance was just fundamental performance.

Operator

Your next question comes from Helane Becker - Jesup and Lamount

Helane Becker - Jessup & Lamont Securities Corporation

So I truly have one question and one follow up. My question is this, are layoffs going to be necessary to accommodate the 7% capacity decline that you've announced today? And if so, have you taken that in the guidance that you've given us? And will you have to make additional goodwill adjustments that we should be aware of?

John Tague

Let me talk to the layoffs first of all, Helane. We recently announced an increase in our flight attendant furlough. We're working very, very hard to get that to be all volunteered, if we miss it, it won't be by much. But yes a continued adjustment of the size of the workforce for the capacity plan is incorporated within our guidance.

Kathryn Mikells

And then, Helane, this is Kathryn with respect to your question about kind of goodwill. Generally what we've seen overtime are more modest adjustments, part of those are being driven by our fleet retirement plan. And so every quarter we have to look at those aircraft and reassess them and so you've seen some charges associated with those. You've also seen some charges associated with just having booked it when we exited from Chapter 11 certain intangible assets like what our customer list was worth and so we've made some adjustments to those.

We took a very, very large charge last year. We're not anticipating any kind of impairment charges like that at the moment, but it's obviously something we're looking at every quarter. So you saw sort of the rough order of magnitude both in this quarter and in the first quarter was relatively kind of equal in size but it's something that we'll continue to stare at every quarter.

Operator

Your next question comes from Jamie Baker - JP Morgan

Jamie Baker - JP Morgan

Before I get started just a quick shout out for [John Geebo], I think he's doing a really strong job and your guidance standards are very much improved. Kathryn, on the holdback you stated that you had the flexibility to post non-cash collateral. What is the process for determining the value of those assets and does either processor have the flexibility to turn that down and demand cash instead?

Kathryn Mikells

So we already went through that processes with our largest credit card processor because, as I mentioned early on in the call, we already have collateral posted with them so that's a process that we already went through. We have to go through a process of having assets appraised if in the future we would post any non-cash collateral with our second largest processors. So that would simply be a part of the processes and something that I think is relatively straight-forward.

Jamie Baker - JP Morgan

But in terms of Chase payment [inaudible] they don't reserve the right to unilaterally change their mind that's really what I was after.

Kathryn Mikells

That's correct.

Jamie Baker - JP Morgan

Okay and my follow up is really the same question that I asked on the Southwest call earlier today, I simply can't reconcile why business demand is as bad as it is. The predictive model that I tried to build hasn't helped me out a bit. In order to estimate when business demand might come back, I'd love to hear what United feels is the answer to the very basic question, how did it get this bad in the first place?

Glenn Tilton

Well we don't claim any superior [press].

Jamie Baker - JP Morgan

Oh, no of course not, I would just value your opinion.

John Tague

Don't have to of course not, Jamie, I wanted you to moderately consider it for a moment. I think as we talked on earlier calls, we were really throughout most of the fourth quarter when the economy had clearly been in a recession for a number of months, we were still generating reasonable results on the revenue side. When we hit the middle of January the spigot turned off. Now I can hypothesize that certainly budget calendar years have an impact. And what we saw in January was in effect a managed outcome as corporations sought to reduce their expenses.

I think that that is true. We are a variable expense. It's very easy for some period of time to reduce it substantially. I think that we would argue that, as the economy improves and people seek to build their business back up again, they'll see our product as an essential component of doing that.

We've been relatively cautious as I think we've not talked about in the last few quarters of an imminent improvement, and we don't have any basis to do that now. So I think that always when you're in the depth of an environment like this, everyone is convinced that it won't get better and it won't get better fast enough because it's hard to have the courage. And courage doesn't pay right now in terms of making your business decisions on optimistic assumptions.

Glenn Tilton

I think Jamie, I think that we've lost a little bit of sight of the effect, especially to United that H1N1 had when it was tossed right into the middle of the mix. The commentator rhetoric relative to the crisis isn't as bad today as it was a few months ago, but you remember we had government officials and others describing the economic circumstances in very, very dire terms.

And now that's abated a good bit and we had incremental challenges, such as H1N1 that clearly, if you're a big Asian carrier as we are, added to the mix. I think that all of us have the opportunity, whether it be in the business roundtable, whether it's the business counsel, or in our respective independent boards to speak to other CEOs, to acknowledge that this is a lever that they pull and they pull it quickly when the future is very uncertain for them and calls such as these.

Jamie, we just happen to be collaboratively affected by those decisions. I don't think that those decisions have ever been permanent having been on the other side of this experience as Texaco and Chevron, and others, Jamie. I know exactly what we do and how we do it with respect to our version of the cost management that we've been discussing with you this morning. And, unfortunately, that cost management ripples through this industry if you happen to be on the client side.

That having been said, at some point, those client companies have to go out and generate business and there is no other means by which they turn the corner. So when that happens and to the extent that it happens and how robust it is, we'll all see. What I like very much about what we've described to you this morning, Jamie, is when that happens the work that we've described to you is really going to pay dividends.

Jamie Baker – JP Morgan

Yes, I agree with that. I guess I'm just struggling. The longer the downturn continues for, I think the more accustomed to not traveling certain business travelers will become, and I realize I'm not the best example of that, but we've been flying a lot less at JP Morgan and quite frankly, I kind of like it. And I'm just worried that others are going to kind of get used to that and it will be a much more gradual recovery than I think what people are hoping for. But I'm certainly willing to be wrong on that one, so thank you for your thoughts.

Operator

Your next question comes from Bill Mastoris – Broadpoint Capital.

Bill Mastoris – Broadpoint Capital

I'd like to follow up on an earlier question and this has to do with the unencumbered assets, particularly on the aircraft side. Kathy, I didn't catch it. What was the unencumbered Section 1110 remaining aircraft?

Kathryn Mikells

I didn't actually give you the split between Section 1110 assets and Non-Section 1110 assets. We have a $1.1 billion in total unencumbered and a little bit more than half of that is aircraft and engines. Within that aircraft mix, some are 1110 eligible and some are not. It just depends on the fleet type and vintage of the aircraft.

Bill Mastoris – Broadpoint Capital

And roughly what would that percentage be? Would it be a 60/40 split, 50/50?

Kathryn Mikells

I don't have that split in front of me.

Bill Mastoris – Broadpoint Capital

And then Kathy, how do you think about maybe how much collateral you might need to holdback should conditions worsen and that you might actually have to post some type of non-cash collateral?

Kathryn Mikells

I'm actually going to take them from a little different perspective, Bill. I think as the market, the capital markets have been challenged and have been a little bit erratic, creativity continues to be at a premium and you should expect as we move forward to insure that we have continues to be at a premium and you should expect as we move forward to ensure that we have adequate liquidity. We understand that we're going to have to get more creative with our transactions and that's exactly what we're going to do.

I think you saw some of that in the first quarter with some of the transactions that we did and we certainly understand that we're going to have to continue to be creative. It is a challenging environment. But we're very confident that we have in the past shown ourselves to be very capable of continuing to execute transactions and enhance our liquidity and we're just going to continue that good work.

Bill Mastoris – Broadpoint Capital

And Kathy, finally, do you have the choice of what collateral if it's non-cash collateral that you can actually put to the credit card processors if necessary?

Kathryn Mikells

Yes, we do.

Operator

This concludes the analyst and investor portion of our call today. Before we take questions from media, I would now like to turn the call back to Mr. Tilton for closing comments.

Glenn Tilton

Thanks to everybody on the call for joining us. I think we've established on the call these are very challenging times but the people of United are experienced at doing this work that's necessary to ensure that we compete and eventually return, as Kathy has said, on the path of profitability.

Before we open the call to the media, I'd really like to thank the leadership team of United and all of the employees across the airline for the work that they are doing to run a great airline and position the company for success. With that, operator, we'll open the call to questions from the media.

Operator

(Operator Instructions) Your first question comes from Mary Schlangenstein – Bloomberg News.

Mary Schlangenstein – Bloomberg News

I just wanted to clarify, Mr. Tague, when you were asked about the potential for additional furloughs with the 7% international capacity cut, you referred to the flight attendant decision that you had made recently but then you returned to continuing adjustments to the size of the workforce. So is the answer that you do contemplate additional layoffs in addition to the ones that have already been announced for the flight attendants?

John Tague

We will always adjust the size of our workforce to meet the production plans of the company. I'm not suggesting to you that that will necessarily result in additional furlough announcements. We have attrition and things of that nature to work. If that becomes the case and it's of significance, we'll of course announce that, but I did not mean to do so today.

Mary Schlangenstein – Bloomberg News

So at this point, there are no plans for any further furloughs on a widespread basis in relation to that capacity adjustment?

John Tague

At this point, that is correct.

Operator

Your next question comes from Harry Weber – The Associated Press

Harry Weber – The Associated Press

I have one question and a follow-up for Mr. Tilton perhaps first. What is United's current view on the viability of further industry consolidation given the economic environment and how might United figure into that? And then for Mr. Tague, I have a follow-up related to the headcount issue.

Glenn Tilton

Harry, we've been really dispositive for a long time. We think industry consolidation and actually on a global basis regardless of what form it may take would be beneficial to the challenge of success capacity in the market. John spoke to it a moment ago and [inaudible] take costs out individual companies can't takeout on their own. So any synergy captured opportunity is created by consolidation in the marketplace is simply a transactional extension of everything that we feel we do today we think is important to our company independent [government].

John spoke to the benefits of the alliance structure that the DOT has approved. That's going to give us another opportunity that we wouldn't otherwise have had. And that's a form of some consolidation. We think that consolidation beyond that would also be beneficial. So we really have not changed our view for a number of years on that important issue.

Harry Weber – The Associated Press

On the headcount issue, I'm a little confused. Given the capacity reductions announced today, will United invariably have to reduce headcount further and if so, by how much?

John Tague

As I said, there are a lot of factors that go into that and at this point in time, we have no plans to reduce headcount further. That will ultimately depend upon what attrition is between now and the fourth quarter, what schedules we elect to fly as we're entering into 2010, a number of other factors. So, no, I would not suggest nor would I suggest that you should come to the conclusion that we will inevitably downsize the workforce.

Operator

Your next question comes from Ted Reed – TheStreet.com

Ted Reed – TheStreet.com

My question is about the timing of the pending potential aircraft order. I mean, I must assume that you could not order aircraft in this environment at this moment, maybe I'm wrong. So what needs to happen in the environment in the traffic environment or the financial environment to enable you to potentially make an aircraft order?

Glenn Tilton

I'll say two things before we turn it over to Kathryn. I think she was very dispositive in your remarks, Ted, and said that this is really a strategic consideration with a very forward-looking agenda with the manufacturers. They've been very responsive to that. They know that this is a long lead time business and they know we are talking about more than two or three years out and really modernizing the fleet for the future. And I think we've been very pleased with their responsiveness, but your point's well taken. And I think Kathryn said it about ten minutes ago, this isn't something we're considering within the next year or two. Kathryn, over to you.

Kathryn Mikells

I think that is a very good and fulsome response to the question. This is really about our long-term fleet strategy and the potential good timing to make decisions with respect to our long-term fleet strategy now. So one of the things that Glenn mentioned in his prepared remarks were challenging times like we're operating in today, both present issues that we need to overcome, but also opportunities, right.

And we've got to play both offense and defense and this is an offensive play and we think it's a good time and an appropriate time and we're very, I think, hopeful that we're going to get to a good answer here that's going to be a fiscally responsible one for the company and is going to determine the long-term fleet strategy for us for many years to come.

Ted Reed – TheStreet.com

So are you saying that there couldn't even be an announcement for a couple of years or there could be an announcement with deliveries in a couple of years, starting in a couple of years?

Kathryn Mikells

We are, from a timing perspective, we are looking to make this decision before the end of the year. That would be committing the company to a long-term fleet replacement strategy. Those aircraft, which is what Glenn was trying to get at, would not come for some number of years into the future.

Operator

Your next question comes from John Pletz - Crain's Chicago Business.

John Pletz - Crain's Chicago Business

Can you walk me back through the numbers of what the total reduction in capacity that we get after the international announcement today? Year-on-year, where does 2009 end up?

Kathryn Mikells

So year-on-year 2009 ends up down about 8%. We guided to a range of 7.5% down 7.5% to 8.5% on a consolidated basis, so that's where we end up for the year.

John Pletz - Crain's Chicago Business

When will you know what the new schedule or flight and how that's going to impact either what aircraft are flown or the number of jobs?

John Tague

As I mentioned earlier, I think with some of the specific adjustments we're making, a lot of these are simply a reduction in frequency between the city fair and some of them are going from seven trips a week to five trips a week. So I don't expect that there's going to be any significant impact to either our fleet or the attractiveness and stability of our schedules.

Operator

This concludes our call today. You may disconnect your lines at this time.

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