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United Continental Holdings (NYSE:UAL)

Q1 2014 Earnings Call

April 24, 2014 10:30 am ET

Executives

Irene E. Foxhall - Executive Vice President of Communications & Government Affairs

Jonathan Ireland

Jeffery A. Smisek - Chairman, Chief Executive Officer, President, Member of Executive Committee and Member of Finance Committee

James E. Compton - Vice Chairman and Chief Revenue Officer

John D. Rainey - Chief Financial Officer and Executive Vice President

Gregory L. Hart - Senior Vice President of Operations

Analysts

Michael Linenberg - Deutsche Bank AG, Research Division

Hunter K. Keay - Wolfe Research, LLC

Jamie N. Baker - JP Morgan Chase & Co, Research Division

John D. Godyn - Morgan Stanley, Research Division

Helane R. Becker - Cowen and Company, LLC, Research Division

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Operator

Good morning, and welcome to United Continental Holdings earnings conference call for the first quarter 2014. My name is Brendan, 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.

Irene E. Foxhall

Thank you, Brendan. Good morning, everyone, and welcome to United's First Quarter 2014 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 Financial Officer, John Rainey; and Executive Vice President and Chief Operations Officer, Greg Hart. Jeff will begin with some overview comments, after which, Jim will review operational performance, revenue and capacity. John will follow with a discussion of our cost, fleet and capital structure. After which, we will open the call for questions, first from the analysts and then from the media. [Operator Instructions] With that, I'll turn it over to our new Head of Investor Relations, Jonathan Ireland.

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 release and investor update and 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-Q and other reports filed with the SEC by United Continental Holdings and United Airlines for a more thorough description of these factors. Also, during the course of our call, we will discuss 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 and investor update. Copies of which are available on our website. Unless otherwise noted, special charges are excluded as we walk you 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 Smisek, Chairman, President and CEO of United.

Jeffery A. Smisek

Thanks, Nene and Jonathan, and thank you, all, for joining us on our first quarter 2014 earnings call. Our financial performance in the first quarter was disappointing. I want to start by saying that this management team understands the importance of improving our financial results. Although the historic winter weather adversely affected our results this quarter, we know we can do better and are taking actions to do just that.

I'm confident that our strong assets, combined with the strategies we have in place, will begin to yield improving revenue results as we progress through 2014 and beyond. We're seeing encouraging progress, particularly in the domestic entity, from changes we're making to our revenue management and scheduling practices. We continue to face significant pressure in the Pacific entity given the increasing competitive capacity to China and the depreciation of the yen. But we are taking appropriate actions to maintain and capitalize on our leadership position in the region. We will make the appropriate adjustments to our network, schedule and fleet to grow our positions of strength and eliminate our weaknesses. This could require tough choices such as our recent decision to substantially reduce our flying in Cleveland, but we can't make progress without being willing to make changes that are necessary for our long-term success. Jim will discuss in further detail the actions we're taking to improve our revenue throughout the network.

I am pleased with our cost performance in the first quarter, particularly given the challenging weather. I attribute this good performance to the dedication of our employees and their active engagement in the launch of Project Quality. The Project Quality program, designed to remove to $2 billion of annual cost by 2017, is off to a strong start. It is very early in the process, but I can assure you that we are intensely focused on and committed to its success. We're engaging in a rigorous process as we work to achieve our goal of delivering durable efficiencies and high quality, all while offering excellent customer service and building a great place to work. We will continue to invest in our employees, providing them better tools and training to do their jobs more effectively and improved facilities like renovated break rooms and in-house health clinics to make their work experience better.

Our operations are running well now that the brutal winter is over. Our customer satisfaction scores from the first quarter of 2014 exceeded those of the first quarter last year. It's clear that our investment in customer service training last year is having a positive effect on our passenger's experience on United. This year, we'll be training all of our customer-facing frontline employees to detailed customer service standards and will be objectively measuring our performance against those standards. This will give us better visibility in how we're doing and where we need to target improvements.

We continue to invest in products and services our customers value from new airplanes, to onboard Wi-Fi, to power outlets, to enhanced digital tools, to functional, comfortable facilities on the ground. In the first quarter, we introduced 11 new aircraft into our fleet, including 2 787 Dreamliners. By the end of this year, we will have installed next-generation slimmer economy seats on all of our Airbus and CRJ-700 aircraft, providing a good product with superior operating economics. And next week, we'll be opening our brand new Terminal B at Boston Logan Airport. It will provide a state-of-the-art experience for our passengers, with self-bag-tagging in the lobby, 8 gates equipped with self-boarding technology, 100% in-seat power at the gates, and a brand new United Club.

I feel good about our direction. We are committed to expanding our profits this year and to improving our profitability each year after that. We have established the building blocks it will take to get us where we want to be and where you want us to be.

Now I'll turn the call over to Jim and John.

James E. Compton

Thanks, Jeff. First, I'd like to thank our employees for their tremendous efforts in the quarter. Through extremely challenging winter weather, in the midst of grueling storms and bitter cold, we worked together and improved our customer satisfaction scores year-over-year. I'd also like to thank our customers for choosing United. We worked hard to deliver a flyer-friendly experience through these difficult months and we appreciate your business.

The winter storms severely impacted the operation in the first quarter. In total, we canceled 35,000 flights in the first quarter, including 30,000 flights from our regional operations. This represents 2.5x the cancellations we had in the first quarter of last year. Put another way, this is the equivalent of not flying for 7 of the 90 days this past quarter. Running a reliable airline and providing good customer service are critical to our business, driving both higher revenue and lower cost. We need to earn our customers' business and we will continue to make prudent investments in our operations and our customer service to provide a product our customers value and will pay for.

Turning to revenue. Our first quarter consolidated PRASM decreased by 2.0%. The severe weather drove PRASM down by 1.5 percentage points in the quarter, given the disproportionate number of cancelations on our regional partners, flights, which typically have nearly doubled the PRASM of mainline flying, but also impact the fewest customers for cancellations. Additionally, our first quarter year-over-year PRASM was negatively impacted by approximately 1.25 percentage points due to the shift of Easter and spring break demand out of March and into April. Our revenue performance in the first quarter was by no means an acceptable result. While some of the events affecting our revenue were outside of our control, we expect to perform better. We are committed to expanding year-over-year revenue each and every quarter, and this quarter, we fell short.

For the second quarter, we expect our consolidated PRASM to increase between 1% and 3% year-over-year. We see substantial opportunity to improve our top line performance in quarters and years to come. And we are beginning to see encouraging signs from actions we've already taken, most readily apparent in our domestic entity.

I want to highlight 4 actions in particular that we believe will improve our revenue performance going forward. First, we've made changes to our revenue management processes, taking fewer early bookings and reserving seats for later higher-yielding bookings. In the second quarter, we believe these changes alone will drive 0.5 percentage point of PRASM improvement year-over-year. Second, we have begun redesigning the flight bank structures at our Denver and Houston hubs. This will allow us to build more efficient, directional flows and shortened connection times at these hubs. We plan to implement the majority of these changes by the end of this year. Third, we have recently launched the program to more actively sell premium cabin seats on some of our domestic and short-haul international flights at the time of booking. By more dynamically pricing these seats, we have increased our percentage of paid premium traffic by more than 20% while improving the PRASM on these select flights by 0.5 percentage point. Fourth, we are better matching aircraft size to demand closer to departure. On routes where we are seeing high demand, we are increasingly swapping out smaller aircraft and substituting larger aircraft to better meet overall demand. These actions represent a sample of the initiatives we are instituting to improve our revenue performance going forward. Given these improvements, we expect second quarter consolidated domestic PRASM to increase between 4% and 6% year-over-year, outpacing our expected consolidated PRASM increase.

The Pacific entity continues to put pressure on our year-over-year consolidated PRASM performance due largely to competitive capacity increases and the weakening yen. Despite this pressure, the Pacific continues to drive solid absolute results. And United is firmly committed to the Pacific region. We are the leading U.S. airline to Asia and expect to strengthen that position as travel demand in Asia continues to grow. We have, however, experienced substantial pressure in the region over the last several quarters. Capacity between the U.S. and China in the second quarter is increasing approximately 20% year-over-year and has increased more than 30% since 2012. Additionally, the depreciation of the Japanese yen and weakening Japanese economy continue to be a drag on our Japan results. In total, we expect the Pacific entity to reduce our consolidated year-over-year PRASM by 1 to 2 percentage points in the second quarter.

To counter these challenge in the Pacific market, we are reinforcing our areas of strength and are expanding into new areas of opportunity. For example, this quarter, we will launch nonstop service between our San Francisco hub and Chengdu, China. This routing addition represents the start of the second phase of our Pacific strategy, which focuses on secondary Asian cities. It's also a perfect example of the power of the 787 Dreamliner. Its long range and appropriate gauge make it an ideal aircraft for routes such as this. We are the only carrier to connect the United States to this rapidly growing Chinese market, and we are pleased with the early bookings.

Additionally, we are in the process of restructuring our Narita flying. We have dropped noncore trans-Pacific flights like Seattle to Tokyo and are continuing to reduce our flying between Tokyo and Asian destinations. This permits us to free up aircraft that were sub-optimally used to carry traffic beyond Tokyo and reallocate those aircraft to more profitable flying. For example, our recent network changes, which included eliminating service between Tokyo and Bangkok, Taipei and Hong Kong, and down gauging service between Tokyo and Seoul, have allowed us to more efficiently use those aircraft on long-haul routes, such as our new services between our San Francisco hub and Taipei, and between our Houston hub and Munich, which we launched just today. Our joint venture with ANA has made this possible. As we eliminated Tokyo to Bangkok service, for example, ANA retimed and up-gauged their Tokyo to Bangkok flight to maintain connectivity for our passengers, and also, retime their Tokyo to Jakarta flight to connect to our late afternoon trans-Pacific bank in Tokyo. As we continue to coordinate on schedule via our joint venture, we have been able to significantly increase the amount of traffic connecting on ANA. For example, in the second quarter, we expect 30% more passengers to connect on ANA year-over-year. We are excited about the opportunities we have to further develop this relationship.

Corporate revenue continued to grow in the first quarter. In spite of the difficult weather, our corporate revenue increased 2% during the quarter and grew 5% in March. We are actively working to increase the value we offer to and generate from our corporate partners with both existing and new accounts. Given changing industry dynamics, we're well positioned to compete and are very focused on account retention and expanding our overt position with key corporate accounts. Additionally, we have considerably improved our corporate customers compliance with their contracts and are at our highest level of compliance since 2012. Our corporate partners recognize the value United provides, robust schedule facility, a competitive product offering, a reliable operation and improving customer service. And we expect to continue our progress in the corporate state in quarters to come.

Our consolidated capacity for the first quarter was down 0.3%, mostly driven by regional client, which was down 1.8%. For the second quarter, we expect capacity to be between flat and up 1%. For the full year, we now expect capacity to grow between 0.5% and 1.5%. Our lower capacity guidance is largely due to weather-related cancellations in the first quarter and reduced regional flying throughout the year. The confluence of the 865 retirements, the new flight and duty time and the new 1,500-hour rule for new pilots have particularly affected regional carriers, making it difficult for many regional carriers to fulfill their schedules. As a result, we have modestly reduced our schedule and that is reflected in the capacity guidance I just provided. If this issue should worsen, we will be prepared to make the appropriate adjustments to our schedule and fleet.

Ancillary revenue continued to grow in the first quarter, growing 6% year-over-year and 8% per passenger. We continue to see solid Economy Plus growth from enhanced pricing capabilities and favorable booking performance on united.com. Additionally, in the first quarter, we reached an agreement to begin altering Economy Plus through Travelport, and just recently, reached a similar agreement with Amadeus. This will improve access to ancillary products for some of our most valuable customers by distributing these products through the channels most corporate customers use. We expect to generate $3 billion of ancillary revenue in 2014, which represents 8% growth year-over-year. We are beginning to use our real-time positioning tool which allows us to tailor ancillary offers to specific customers based on their travel pattern, prior purchases and destination among other criteria. Initial results show more than 15% increase in year-over-year ancillary revenue where we use the real-time positioning tool. We will be expanding the use of this powerful tool to more customers, through more channel in the near future.

This summer, we will roll out the first phase of our new website, which will provide improved ancillary revenue opportunities and a better customer experience and result in lower distribution cost as more of our customers use united.com.

Earlier this month, we launched an all-new United app for the Android platform, which offers the customers innovative new features, smoother functionality and an improved touch-friendly design. In total, we have had more than 10 billion app downloads to date. We are now generating on average over $1 million in revenue per day through our mobile applications. And in the first quarter, we nearly doubled our revenue through our mobile app year-over-year.

We're also continuing to install satellite-based Wi-Fi on our aircraft. We have more than 230 Wi-Fi equipped aircraft today and expect to have more than 450 aircraft enabled with this technology by the end of 2014. In addition, this quarter, we will start to roll out our personal device entertainment product, which wirelessly delivers streaming video from the aircraft's on-board server to our customers' own electronic devices.

In conclusion, United had a challenging first quarter and I am not pleased with our results. But we are already making progress in the second quarter, and we are taking prompt action to improve results going forward. We are on track to achieve our ancillary revenue goals and continue to improve our operations, customer service, digital tools and products. We know we're capable of much more at United and we have the right plans in place to achieve our full potential and profitably grow our top and bottom lines in the quarters and years to come.

With that, I'll turn the call over to John.

John D. Rainey

Thanks, Jim, and thank you to all of you for joining us this morning. I also want to thank our employees for their efforts in the first quarter in what were very difficult operating conditions.

Today, we reported a $489 million loss for the first quarter, which includes an approximately $200 million negative impact from the severe winter weather. Despite our unsatisfactory earnings performance, I am pleased with the progress we are making on some of our key company goals of reducing costs and strengthening our balance sheet. Our first quarter consolidated CASM, excluding fuel, third-party business expense and profit sharing, increased 3.1% year-over-year, nearly 1 full point lower than the midpoint of our original cost guidance despite the weather driving decreased capacity and incremental costs throughout the system. These headwinds were offset by solid progress we're making with Project Quality initiatives. Project Quality is designed to make fundamental, permanent changes to the way we do business. And we've seen promising early progress toward our $2 billion annual cost savings goal.

One area in which we've made good progress to date is on procurement where we've achieved approximately $20 million in savings in the first quarter. Another area in which we've laid the groundwork to drive significant savings is in our airports. I have spent time at multiple hubs recently observing the progress we're making in this area. And I'm encouraged by the engagement of our employees in finding better and more efficient ways to serve our customers. We're beginning to transform the way we operate in our airport lobby, on the ramp, in the bag room and at the gate, much of it through better use of technology. And it's precisely the steps of changes that Project Quality is designed to deliver, changes that redesign processes and improve efficiency without sacrificing the quality of service that we provide. We are pleased with the Project Quality progress to date and expect to generate between $250 million and $300 million of nonfuel savings from this effort in 2014.

Our overall productivity improved 1.6% in the first quarter, lower than we expected due primarily to the extreme winter weather. We currently expect to improve productivity by approximately 3% in 2014, and our long-term goal is to improve productivity, 15% to 20%, by 2017, generating approximately $500 million in annual savings.

We expect CASM, excluding fuel, third party business expense and profit sharing to increase between 1.25% and 2.25% for the second quarter. We plan to improve our year-over-year non-fuel cost performance in each successive quarter in 2014 and expect nonfuel CASM to be up approximately 1% in the second half of 2014. Much of this sequential improvement is related to our Project Quality savings accelerating as we move throughout the year.

In the second quarter, we expect to incur approximately $800 million of gross capital expenditures. We plan to take delivery of 9 737-900ERs, each of which provides a greater than $2 million annual benefit versus the 757-200 aircraft they're replacing. We're also excited to introduce our first 6 highly efficient Embraer 175 aircraft this quarter. And we plan to introduce 70 of these E175s in total by the end of 2015, which will replace less efficient 50-seat regional aircraft.

The E175, featuring first class, Economy Plus and Economy also provides a better product than the 50-seaters. During the first quarter, we retrofitted our first 737-800 aircraft with new Split Scimitar Winglets, which reduce fuel consumption by up to an additional 2%. We expect to have this Winglets installed in over 80 aircraft by the end of 2014. We improved our fuel efficiency in the first quarter by 0.6%. This metric came in slightly lower than our initial expectations because the severe weather during the quarter led to higher taxi times, aircraft rerouting and longer APU usage. But we still expect to improve our full year fuel efficiency by approximately 1.5%, in-line with the guidance I've provided on the call last quarter. At today's prices, that represents nearly $200 million in the annual cost savings.

We continue to improve the quality of our balance sheet in the first quarter and made $637 million of debt and capital lease payments. We made further progress to our goal of reducing nonaircraft-related debt by redeeming, at par, $400 million of 8% unsecured notes due in 2024 and by reducing convertible debt by $202 million. We have reduced our total convertible debt by nearly 50% since the end of 2012.

In addition to paying down debt, we're also making good progress reducing our pension liability. Our unfunded pension liability was approximately $1.6 billion at the end of the first quarter. We've made $118 million of cash contributions toward our pension year-to-date and expect to contribute approximately $290 million for the full year. This is approximately double our minimum funding requirement. Continuing to fund our pension in excess of our minimum requirement, will meaningfully reduce our risk over the long term. We also completed 2 significant financings during the quarter, including pricing our first EETC of the year. We raised $949 million through this transaction to finance 25 new aircraft, including 787, 737-900ER and Embraer 175 aircraft scheduled for delivery this year. The blended rate of 4.13% is the lowest among any recent EETC deals. During the quarter, we also repriced our $900 million term loan due in 2019, reducing the LIBOR margin and LIBOR floor each by 25 basis points. The success of these transactions is indicative of the progress we've made in derisking our business over the past few years.

In conclusion, we are far from satisfied with our first quarter results. And we need to, and will, substantially improve our financial performance in the coming quarters with the plans we have in place and the actions we are taking. Through our initiatives to grow our revenue, embed efficiency throughout the business and further improve our balance sheet, we will expand earnings in each of the remaining quarters this year. We had a clear goal and a solid commitment to generate the level of returns our investors and management team expect.

I'll now turn it over to Jonathan to open up the call for questions.

Jonathan Ireland

Thank you, John. First, we will take questions from the analyst community, and then we will take questions from the media. [Operator Instructions] Operator, please describe the procedure to ask a question.

Question-and-Answer Session

Operator

[Operator Instructions] From Deutsche Bank, we have Michael Linenberg on line.

Michael Linenberg - Deutsche Bank AG, Research Division

Two questions here. Jim, you went through some of the revenue initiatives like rebanking Denver, Houston. You talked about revenue management. Do you have like a rough number on what the revenue enhancement would be on an annual basis in aggregate for all 4 of these initiatives? How do we think about that?

James E. Compton

Mike, it's Jim. The number that -- one of the areas of revenue management we gave some insights and it's adding about 0.5 through the second quarter, and that's the only one that we're talking about in terms of the incremental impact to our RASM. I've put that in a context of what we've talked about in the third quarter call when we acknowledged the inputs to the revenue management system and made the quick changes to recalibration that we found it affected our September number by about a percentage of RASM. So you can think of the run rate of being about 1.0% in terms of RASM performance due to the changes that we're making on the revenue management side.

Michael Linenberg - Deutsche Bank AG, Research Division

Okay, good. And then just one other question here. And I guess maybe this would be for you, Jim, as well. You look at how Delta is sort of rethinking their frequent flyer plan and then basically now sort of changing, tying the miles there on -- basically tied to revenue paid. And it's not unique. I mean, I think, JetBlue, Virgin America, Southwest, they're also along those lines. Is that something that you may be looking at or studying? Is that something that makes sense given your network, your customer base? Any thoughts on that would be great.

Jeffery A. Smisek

This is Jeff. Clearly, frequent flyer -- or our frequent flyer program is evolving and as are others. And what we're trying to do is better align the benefits that we deliver to our customers through the frequent flyer program with the benefits that the customers deliver to us from their flying, including the profitability of their flying. And I believe that you will see evolution of our program over time. We can't talk about specifics at this point in time, but clearly, this is an evolving process. And frequent flyer -- our frequent flyer program is becoming much more sophisticated and is better aligning the benefits bidirectionally.

Operator

From Wolfe Research, we have Hunter Keay on the line.

Hunter K. Keay - Wolfe Research, LLC

John, you talked about at Analyst Day, a commitment to cash deployment next year. But given the loss this quarter and what I believe to be a really lack of any free cash flow this year about substance, is there a chance that you find that you're really not in a position to do that? I mean, if you have, say, like a 1% dividend yield next year, but your margins are 500 basis points below Delta and American, I'm not really sure if that's going to really change the minds of people that are on the fence about buying your stock. So is there a point where if your operational performance is not good enough relative to others that you say, "Hey, maybe we should focus inwards to take some dramatic steps to fix what's wrong before we start deploying cash next year."

John D. Rainey

Good question, Hunter. And I'll tell you that we've been consistent and we have -- the 2 things we need to accomplish prior to returning cash to shareholders. One being having a level of earnings performance which supports that, and we also have goals to take care of some debt that we can pay off at the back half of the year. And so to your point about earnings improvement, I'll tell you that we're extremely disappointed in first quarter results. There's no doubt about it. We have the same feeling about this as the analyst community and investors. But we have absolutely not lost any conviction at all on the plan we've laid out last fall. We are encouraged by a lot of progress that we're making right now. And it's more difficult to see that in some of our financial results but we've got an extreme focus on improving revenue with Jim's team. And the entire company is bought in to be more efficient and improving our cost along the lines of Project Quality. I'll give you the example of that. Honestly, for the first quarter, this was one of the most difficult operational quarters we had since 9/11. Despite that, our over time improved year-over-year for both our airport groups, which is by over 1 point, and as well as our technical operations group. So despite having a more difficult operating environment, the progress that we're making and becoming more efficient is being seen throughout the business. Now admittedly, that's not reflected in our first quarter results, but again, we have not lost any of the conviction about the back half of this year, and we are fully committed to accomplishing the goal of being able to return cash to shareholders next year.

Hunter K. Keay - Wolfe Research, LLC

And would you care to share maybe what that earnings threshold would be?

John D. Rainey

Well, the way that -- when we look at returning cash to shareholders, I think it's important to be able to do that in good years and bad years. And we look at a lot of the volatility of earnings. And we haven't come out and said, "We've got to earn x million -- x billion to achieve that, but it's really a level of earnings that we're comfortable with in the business. And we're making progress. We feel good about the back half of the year. And as I said in my prepared remarks, we expect to have earnings improvement in each of the remaining quarters this year.

Hunter K. Keay - Wolfe Research, LLC

Okay, thanks. Maybe one for Jim and Jeff, if you [indiscernible] would be great. Well, I look at Los Angeles as a hub, and I see what the Asian Airlines is doing there. Makes me ask some hard questions. I mean, Asian Airlines, you talked about the competitive capacity at 20%. Asian Airlines right now have over 500 widebodies on order, already, right now, the top 11 Asian Airlines. All these guys are Chinese guys with whom you're not going to have a JV for the foreseeable future. They're going to run their business for returns. Los Angeles, not a great corporate market, domestic stuff very fragmented, because of multiple airports, when do you ask yourself -- is Los Angeles is a great place to actually run a hub, not serve, but run a hub when you got such a great hub just a few hundred miles north in San Francisco.

James E. Compton

Hunter, this is Jim. A couple of thoughts. One is our Pacific, as I mentioned, is running at extremely high levels of performance in terms of the economics of this. And there are some near-term challenges that you're alluding to in terms of the capacity, particularly to China where we're seeing 20% growth. And for us, that growth is primarily into the U.S. to our hubs. And so yes, it does affect San Francisco, Los Angeles and so forth. I'll tell you we performed very well out in Los Angeles to China. And the unique -- we have adapted, we actually, the 787 is the terrific aircraft for us to kind of manage some of the competitiveness given its fuel efficiency and its gauge and so forth. I think for us what we'll always do is continue to kind of watch demand and make sure that capacity is in line with demand. And at the same time, we're going to continue to build on our strengths and where our assets are at their strongest point. But you're right, it's a competitive environment, and it's an area that we'll continually watch and make the right moves depending on where the necessary moves that we need to make.

Operator

From JPMorgan, we have Jamie Baker on line.

Jamie N. Baker - JP Morgan Chase & Co, Research Division

Quick question for Jim, a follow-up to Mike's question on the revenue initiative kind of spilling out by year end. Does that mean, you believe United can close your RASM gap to the industry by year end or should we not be that ambitious?

James E. Compton

Jamie, it's Jim. First, let me tell you this. We obviously -- we run the highest length of haul RASM in the industry and we're going to continue to do that. We're disappointed in the rate of growth off of that. And those initiatives that I talked about are specifically -- work to put us on the path that will get us to the point that we're growing at the rate that we feel that we need to do. To put us -- what I will say is that, yes, we expect to close the gap on RASM performance. And I'd like to leave it at that. Because we will close it. We have a great plan. We have our strong commitment of the team here, and we will close that gap over the next -- over the quarters and years to come.

John D. Rainey

Jamie, I would just add to that, that we recognize that we're underperforming in the industry. And we have an expectation among ourselves that we should be an industry leader. But the first step is to have industry competitive markets. And so when we talk about closing the RASM gap, we're actually much more focused on closing the margin gap. And some of the decisions that we make maybe RASM dilutive, but profit maximizing. And so you could see some of that in our numbers, but I think, at the end of the day, we need to be held accountable for our margin performance versus our competitors.

Jamie N. Baker - JP Morgan Chase & Co, Research Division

Okay, and that actually leads me to the second part, and perhaps, the tougher part of that question for Jeff. Have you considered at any point that perhaps, not just perhaps, there is a more structural explanation as to why results are being held back? For example, we cited, and others have as well, that you face more competition in your hubs than American and Delta do? If I jump in a taxi in San Fran or Denver and say, "Take me to the airport." the guy asks, "Who are you flying?" And that just doesn't happen in Charlotte. You've pursued a 4-cabin strategy that should be generating a RASM premium, but currently isn't. And I appreciate all the talk about winglets and Wi-Fi and the like, but I'm just not convinced that even if properly executed, even if properly mined, United has the same profit potential as your primary competitors. Any thought on that?

Jeffery A. Smisek

Well, I don't think, Jamie, that there's a fundamental structural problem. I mean, all things being equal, high concentration to hub is a good thing, there's no question about it. But it's also important to have hubs in the key business markets. It's important to have a good mix of local inflow traffic. We do that. So no, I don't think there's a fundamental structural problem. Now there are issues with geographic locations for winter storms, I will grant you that. We've got west to east, Denver, Chicago and Cleveland, New York and Dulles all in a row. And some of our friends in the south did not have that difficulty. But I don't think there's a fundamental structure there. I think from us, it's a lot of basic blocking and tackling, getting our operational integrity humming and we're clearly making progress there. And certainly, Greg Hart is here, if he wants to comment on that. But we clearly are focusing on tuning all of our revenue initiatives. And Jim and his team are working very hard on that. Making -- we operate really inefficiently today, Jamie. And that's what Project Quality is all about, bringing quality and efficiency, elimination of defects all across the system. We also candidly are still operating with a number of parallel systems, processes, leftovers from the merger that we need to conclude and those drive inefficiencies and they drive costs. And our customers service, historically, since the merger, has not been as good as it should be. And we're spending a lot of time and money and effort training our folks. And this year, importantly, we're bringing in a third party which will objectively measure us against those customer service standards . We're going to establish a baseline to would help us improve customer service. But if you've got -- if you have some -- the lack of operational reliability which is historically, which we're improving a great deal, that drives a lot of cost and a lot of dissatisfaction which drives away revenue and improves costs. So in answer, no, I don't think we have structural problems. I think we are -- I think we've identified all the areas where we need to improve. We have very good, very disciplined, very rigorous plans to attack each of those areas and I am very confident that we will.

Operator

From Morgan Stanley, we have John Godyn on line.

John D. Godyn - Morgan Stanley, Research Division

Obviously, investors are losing faith a little bit based on the second quarter performance that the revenue side of the turnaround is going according to plan. On the other hand, Jeff, Jim, John, what we hear from you guys is that you're taking the appropriate actions, you're seeing encouraging signs, you have a lot of confidence that things are going to work. I was just hoping that you could elaborate on that disconnect. What exactly are you seeing that gives you more confidence than, I guess, what investors are seeing and when might investors start to see the same things?

John D. Rainey

Well, John, I'll start from a cost perspective. Obviously, our costs have been too high. And if you look at our cost guidance for the year, being 1% to 2%, excluding fuel, that's a much more appropriate level to how we need to run the business. And candidly, an expectation of what we have going forward to the next few years, and it's something less than inflation. And we're seeing a tremendous amount of focus and improvement and a lot of the initiatives that we've undertaken. I gave the example to an earlier question of the improvement in overtime. But we're seeing deployment of technology that is enabling us to better staff airports, to do it in a more customer-friendly way as well. There's every aspect of our business that we're able to test where we're seeing good improvements and overall engagement by the employees. And that's reflected in our cost results. I think, speaking for both cost and revenue, the issue is often the pace of change and it's never as fast as what we'd like. Look, no one wanted it to occur faster than we do as a management team, but the things that we're seeing, whether the booking information that we see or the cost expectations, the early indications we're pretty excited about.

James E. Compton

And John, this is Jim. Again, on the revenue side, obviously, we have the advantage of seeing things at a much more granular level on the revenue side, which is quite frankly why, in the second quarter, we wanted to break out the PRASM guidance from the -- to highlight some of the pressure areas that we're in, in the Pacific, but also highlight the consolidated domestic growing 4% to 6%. Even if I adjust for weather in the first quarter, what the team is seeing is the beginning of the actions they've taken grabbing hold at the granular level. And so those are the things that here drives so much optimism on our side, it's because we can separate the pressure areas such as China and so forth and understand that market and how well we perform in that market. And at the other hand, the initiatives that we're doing, we can see some of the early results, for instance, from the revenue management recalibration. We have all the confidence, whether it's the upselling initiatives, whether it's the rebanking based on the initiatives that we've driven so far today, that we're going to have success in that. And that's where the enthusiasm on the revenue side comes from as we kind of look forward over the next several quarters and next several years.

John D. Godyn - Morgan Stanley, Research Division

And when we think back to the fall, the first half of the year was when we were supposed to see a lot of this inflection. You sort of get a pass from the first quarter because of weather. We're not seeing it in the second quarter. Looking out today, at what quarter can we all agree that it's not working?

James E. Compton

Well, John, I think, in terms of revenue, if anything, I highlighted that we're seeing those benefits in the second quarter, 0.5% PRASM in terms of contributing to the 4% to 6% consolidated domestic guidance. So we are seeing the benefits as we move through the year and we're we'll -- kind of the full effect as we kind of get over the month of September in the third quarter. The other initiatives are building. Some of the ones I've talked about, swapping of aircraft, we can actually measure those real-time how we're doing. We're going to start expand those. So again, at the granular level, we're early in initiatives and we're actually seeing the benefits, and those are the things that we were highlighting today on the call.

Operator

From Cowen and Company, we have Helane Becker on the line.

Helane R. Becker - Cowen and Company, LLC, Research Division

I think one of last year's many excuses was regarding maintenance and having aircraft parts out of place when things went wrong. So as part of the improvement process, have you -- can you speak to that and whether that's actually showing signs of improvement?

Gregory L. Hart

This is Greg. As it relates to the maintenance investment in the infrastructure, we've actually spent quite a bit of time actually last year putting the infrastructure in place that provided us the opportunity to perform at a much higher level. And the data that we can point to that says that the success is, then, that calendar year 2013 we canceled fewer flights at United Airlines and the airline -- as it relates to the maintenance cancels, that the airline had done in the last decade. So we've seen a lot of progress as it relates to that. And we continue to build on that progress and have a lot of momentum moving forward in terms of improved performance as it relates to not only maintenance, but all of our operations.

Helane R. Becker - Cowen and Company, LLC, Research Division

Okay. And then, one of the questions that I get, and maybe this is for Jeff, is that for a while your revenues were about equal to your peer group and you earned half as much. And actually, now your revenues are less than your peer group, right? Delta and American both out -- out reported -- out earned you this quarter. And I'm just kind of wondering how much of the revenue gap gets narrowed by some of these initiatives that you're putting in place in an environment where your 2 biggest airports are undergoing runway construction this summer and are undergoing -- and especially at Newark where the AirTrain isn't going to work from May 1 through, I think, it's July 15. It's like peak season. How does that happen?

Jeffery A. Smisek

Well, Helane, first of all, let's focus kind of bigger picture here, and I'll ask Jim to talk about San Fran and Newark. But -- the EMAS in San Fran and runaway work in Newark. But our goal here isn't really focused on peer revenue comparisons, but rather, as John talked about, making sure we are earning industry competitive margins. We have a lot of assets that generate a lot of revenue for us and we could do a better job and we'll be doing a job, generate even more revenue from that set of assets. But our goal really is focused on margin. We're focused at pulling, obviously, the 2 levers of revenue and cost, but also making sure, as Greg talked about, making sure that we're operating reliably because you've got to have a reliable core to generate revenue and to run that -- run your operations efficiently since you're doing it so at lower cost. The issues, which are quite temporary at Newark, which is flight constrained, and so that's actually a much easier than San Francisco. Those are temporary. I'll ask Jim or Greg to talk to you about those.

Gregory L. Hart

This is Greg. In Newark, just a point of clarification, we actually have runway construction in April and May, so we're halfway through that. We're hopeful that it actually might end a little earlier than planned. And as it relates to the connecting train that runs from the train station to the terminal area, we've worked with the Port Authority to put in a very, very vigorous plan to recover with buses, and I think that while a little inconvenience for the passengers, will be a very good product. And of course, the terminals on the air side we have a bus and service that runs between our 2 terminals in Newark. In San Francisco, we also spent a lot of time working to make measure that we mitigate as much as possible, the runway construction that is taking place there. It starts in May and ends in September, and we're obviously hopeful again that, that ends a little bit sooner given some of the incentives in the construction contract that the airport has put out there. But we have worked to isolate the impact to San Francisco. The construction is happening this summer because there's less weather disruptions in the summer in San Francisco, so it's the right time to do it from a weather perspective. And we've also, again, isolated schedules as much as we can adding ground time in San Francisco, block time, as well as isolated the flows of the aircraft in San Francisco as much as we could.

Helane R. Becker - Cowen and Company, LLC, Research Division

Okay, and then, just with respect to the 50-seat issue, I guess, the performance of the regional airline where you seem to cancel -- or your regional partners seem to cancel a huge number of flights. As you move up the food chain to the 76-seaters and larger, is that going to be done more mainline flying, is that how we should think about that?

James E. Compton

Helane, this is Jim. The -- I also want to remind that the completion factor that we saw on the regional in the first quarter is driven by far primarily by the weather event to severe weather event. As I mentioned in my comments of the 35,000 cancellations, you're right, 30,000 were regional. And the severe weather and our trying to affect the least number of customers as possible drove disproportionate to regional. As that weather moves out, we're already seeing the regional completion factor improve relative for the first quarter significantly. And that's the 70-seaters that operates under our regional partners and not on the mainline.

Jeffery A. Smisek

But Helane, to your point, it is important that -- take weather events aside, it is important that we deliver the same degree of focus to the operational reliability and on-time performance of our regional partners as we do to the mainline. We have a lot of time and attention to that. We have a number of regional partners, obviously, as well. But from a customer's perspective, it's important that those -- we have those aircraft as reliable as they can be, and with as much on-time performance as they can be. It is true, however, that during severe weather, those get canceled more. They affect the fewest passengers comparing or canceling a 50-seater versus canceling a 777.

Operator

We have time for one final question. From Evercore, we have Duane Pfennigwerth on line.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

I think I heard you talk about closing refleeting. I wondered if you'd expand on that a little bit. How many aircraft swaps per day would you expect? And how do you manage that complexity?

James E. Compton

Duane, this is Jim. On a daily basis, we're probably doing approximately 50 swaps where we're swapping, where we have a good sense of the demand, and demand is stronger for instance and we'll swap in a larger gauge and move that flight to obviously a market where the demand is less and so we're marching capacity and gauge very much in line. We actually look at that 30 to 45 days out and start watching it. So some of those swaps will start out as far out as 45 days. And as we get closer into 30 day, it's clearly working very closely -- the team works very closely with Greg's team in Ops to make sure that we're providing a consistent reliable product. And we're seeing great and early results from that, great results from it.

Duane Pfennigwerth - Evercore Partners Inc., Research Division

Okay, I appreciate that. And then, just on the regionals, on your 50-seat regionals, can you -- I wondered if you'd be willing to talk about kind of the number of 50-seaters that are -- where you have leases expiring in 2014 and 2015, and how that number compares with those same aircraft that come off contract with your regional service provider. In other words, is there a chance that you have to sort of find a new service provider for some of those for a period of time?

John D. Rainey

Duane, this is John. Over the next 18 months, we've got 175 aircraft that come out from underneath the capacity purchase agreement. Of those, 125 -- actually, the head lease expires. So a certain number of those, we could place with another provider or extend the capacity purchase arrangement with that current provider. But even of those remaining aircraft that'll come of lease, the lease expiration is in the very near future as well. One of the things that we've talked to you about in the past is it's important for us to have a lot of flexibility in our fleet plan. And you see that both in our mainline fleet, as well as our regional fleet. And we've laddered a lot of these capacity purchase agreements so that it allows us to have that flexibility to remove aircraft from our schedule when we need to.

Operator

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 The Street, we have Ted Reed online.

Ted Reed

I was thinking about Jamie's question. And is it possible to say that what's really hurting United is that your best asset is the San Francisco hub to Asia, and that the capacity issues in Asia and the yen devaluation are what is really contributing to the underperformance just as much or more than anything else?

Jeffery A. Smisek

Well, Ted, let me just talk about the hub for a moment, and I'll turn over to Jim. Look, we have a number of -- San Francisco is a terrific gateway to Asia. It is clearly the best hub on the West Coast for Asia. We also have terrific hubs throughout the United States. So I wouldn't say San Francisco is the best hub. It is a great hub. But there's no doubt that competitive capacity pressures from the U.S. to Asia, particularly to China, where we are the largest U.S. airline, by far, have contributed to our -- pressured our unit revenue. And that said, we make good money in Asia today even with that pressure. We expect to continue to make good money to Asia. We expect to not only maintain our lead there, but we would have opportunities to grow in the new markets. A lot of capacity has gone in for China, for example, in Beijing or Shanghai, and our new route to Chengdu, nonstop, is an exciting opportunity and we think we have future opportunities for that. But I'll ask Jim if he'd like to comment anymore.

James E. Compton

Ted, this is Jim. I'll take you over to the other side of the coast because Newark's a terrific asset also. We have a terrific presence in New York, and we have the unique presence, right. And that presence is because we have the true connecting hub. So from a network perspective, not only all the things that go with that hub, great facility, great products and so forth, but we have that opportunity to offset weak demand in the local market, whether it be absolute demand or demand that's driven by lower pricing with higher-yielding demand that wants to connect to Europe over Newark. Nobody else can do that in the New York area. So I think I would to add to Jeff's point is that, we have a number of great assets in the hub, where each of them are unique, whether it's Houston into Latin America, Jeff's comment on San Francisco, New York, all of our hubs have unique strengths to them. And as we go forward, we're going to build on those strengths.

Irene E. Foxhall

Okay. With that, we're out of time, so we're going to conclude. Thanks, everybody, for joining this call today. Please call media relations if you have any further questions. Goodbye.

Operator

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

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