United Continental Holdings (UAL) Oscar Munoz on Q2 2016 Results - Earnings Call Transcript

| About: United Continental (UAL)

United Continental Holdings, Inc. (NYSE:UAL)

Q2 2016 Earnings Call

July 20, 2016 10:30 am ET

Executives

Jonathan Ireland - Managing Director-Investor Relations

Oscar Munoz - President, Chief Executive Officer & Director

James E. Compton - Vice Chairman & Chief Revenue Officer

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

Analysts

Darryl Genovesi - UBS Securities LLC

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Hunter K. Keay - Wolfe Research LLC

Andrew George Didora - Bank of America Merrill Lynch

Savanthi N. Syth - Raymond James & Associates, Inc.

Jamie N. Baker - JPMorgan Securities LLC

Rajeev Lalwani - Morgan Stanley & Co. LLC

J. Yates - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Mike J. Linenberg - Deutsche Bank Securities, Inc.

Helane Becker - Cowen & Co. LLC

Dan J. McKenzie - The Buckingham Research Group, Inc.

Duane Pfennigwerth - Evercore ISI

Jack Atkins - Stephens, Inc.

Operator

Good morning and welcome to United Continental Holdings Earnings Conference Call for the Second Quarter 2016. My name is Brendan and I'll be your conference facilitator today. Following the initial remarks from management, we will open the lines for questions.

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, Jonathan Ireland, Managing Director of Investor Relations. Please go ahead, sir.

Jonathan Ireland - Managing Director-Investor Relations

Thank you, Brendan. Good morning, everyone, and welcome to United's second quarter 2016 earnings conference call. Yesterday, we issued our earnings release and separate investor update. Additionally, this morning, we issued a presentation to accompany this call. All three of these documents are available on our website at ir.united.com.

Information on yesterday'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-K, 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 reconciliation of these non-GAAP measures to GAAP measures, please refer to the tables at the end of our earnings release and investor updates, 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.

Joining us here in Chicago to discuss our results are President and CEO, Oscar Munoz; Vice Chairman and Chief Revenue Officer, Jim Compton; and Senior Vice President of Finance and Acting Chief Financial Officer, Gerry Laderman. We also have Chief Operations Officer and Executive Vice President, Greg Hart, in the room to assist with Q&A.

And now, I'd like to turn the call over to Oscar.

Oscar Munoz - President, Chief Executive Officer & Director

Thank you, Jonathan, and thank you all for joining us today. As we look at the second quarter, we certainly made significant progress and as we continue to execute against our global operations better than our company has actually ever seen and at the same time delivering solid financial performance.

As you can see on the chart, for the second quarter, we recorded a pre-tax profit of $1.4 billion and achieved pre-tax margins of 14.5%. Those are both excluding special items. For the quarter, we earned $2.61 of diluted earnings per share, which once adjusted for taxes, represents a 25% increase year-over-year, and we delivered this result while improving on our initial expectations.

So, clearly, we accomplished a lot and I'm proud of the hard work of the United team. So, let me give you – give me a minute to thank all of our employees for their continued dedication to providing a positive and reliable experience for our customers. This can be seen as our operation continued to perform at a high level last quarter with our on-time performance improving over 11 points year-over-year, and on the heels of our best ever six month run on on-time arrivals and bag handling, we are now consistently performing at the level that we and our customers expect of us. Our focus has now shifted to maintaining this level of reliability while doing so more efficiently.

We also completed an important milestone in our labor negotiations by reaching a joint tentative agreement with our flight attendants. If that applies, this agreement will bring our 20,000-plus flight attendants on to a single contract, relieving inefficiencies we have experienced over the last several years. And, most importantly, this will be an important step in unifying our airline to one shared purpose: to be the airline we know we can be.

I want to extend a special thank you to the AFA for their dedication and effort in reaching this agreement. As we speak, our flight attendants are participating in road shows and submitting their votes and we look forward to seeing the results in mid-August.

Speaking about flight attendants, training is already underway with them, and many of our other employees in preparation for the December launch of our new United Polaris business class. Discussion Construction has already started on the first Polaris launch in Chicago, production has also started on our new suite-like seats and the first wave of our chef-inspired menus are being finalized. The experience we're creating, as you know, is exactly, what our customers have asked for and we can't wait for you to enjoy yourself starting on the 1st of December.

Now, back to the quarter. We also continued repurchasing our stock, spending approximately $700 million, representing just a little bit over 4% of our shares outstanding and as we announced yesterday, our board has approved an additional authorization for $2 billion.

Many of you have heard me say, I believe in proof not promise. As you can see this quarter, we had many proof points that we're continuing to build a great airline. However, as we mentioned on our June Investor call, this is not enough and we fully acknowledge we aren't yet performing, from a financial perspective, to the level of our and your expectations and we're not standing still. This can be seen on slide five. On our June call, we laid out a description of the initiatives we are currently implementing and are expected to drive over $3 billion in benefit by 2018. If you've not seen our June presentation, I encourage you to go to our website and download.

We expect these initiatives to contribute to driving incremental value and shrinking our margin gap to peers. We'll keep you updated on the progress of these initiatives.

And we're not stopping there. We are currently in the middle of a thorough self-evaluation of all aspects of our business. In particular, as shown on slide six, we are working to identify ways to operate our airline more efficiently now as it's reached top tier reliability. We are also refining the mission of each geographic region, hub and spoke. Additionally, we are implementing a profit-maximizing product and segmentation strategy that best aligns with our customers.

And finally, we have a cost gap to our peers that we're identifying and addressing those costs that are controllable. I am looking forward to presenting this next chapter of United at our fourth quarter Investor Day.

But before I turn the call over to Jim, I'd like to speak to our future capacity plans. Let me start by saying we acknowledge, truly acknowledge the importance of returning to positive unit revenue, and, of course, we recognize that our future capacity plans directly impact the future PRASM performance. However, we must evaluate what our network is today, and the evolution to ensure that long-term optimization and sustainability of earnings is maintained. At times, this may include adding capacity to strengthen our best performing markets and ensuring we remain competitive. However, we determine that certain clients will not generate sustained profitability; we will then carefully consider modifying that capacity.

Proof of our result is seen in us again reducing full year capacity 0.25 point. We have now reduced our 2016 capacity growth plans by 0.75 point. This is a meaningful demonstration of our responsiveness to the present demand environment, particularly given that our initial guidance have always been responsibly and conservatively disruptive. Our review and analysis won't stop here as we continue to closely evaluate future changes. Going forward, as we adjust our capacity we tend to update shareholders on these modifications.

So, to wrap up, again, I want to thank our employees for another great quarter and a continued focus on our customers and continue to spend a lot of time visiting stations and I can't be more proud of the work they are all doing.

So, with that, I'll turn the call over to Jim.

James E. Compton - Vice Chairman & Chief Revenue Officer

Thanks, Oscar. As you can see on slide eight, our second quarter revenue declined 6.6%, nearly a full point better than our initial expectations primarily due to international yields, 4th of July holiday timing and other initiatives.

With respect to the third quarter, we expect our passenger unit revenue to decline approximately 5.5% to 7.5% year-over-year with domestic and international PRASM to be in those same ranges.

On slide eight, we defined each of the major headwinds we anticipate for the third quarter summing to approximately 3.5 points of drag on PRASM.

I'd now like to explain what we are seeing in the current demand environment. Leisure bookings have been strong as travelers are taking advantage of attractive fare levels and a strong U.S. dollar. Corporate travel bookings in the second quarter were essentially flat with revenue down approximately 3% as corporate yields continue to be pressured.

Looking towards the rest of the year, we expect to see further softening of corporate yields as summer leisure travel subsides. We will closely monitor these effects as they impact our closing yield, high-yield revenue.

On our April earnings call, we provided an outlook for fourth quarter PRASM and I'd like to update you on that today. Due to downward revisions for fourth quarter GDP as well as a growing concern in the pace of corporate yield recovery, our fourth quarter estimates have been revised downward. In response, as you have seen from our announcement yesterday, we are reducing second half capacity to better align with demand.

On slide nine, we show specific actions we have taken in each geographic entity. I'll let you read through the details on your own but rest assured, we are actively managing our network to optimize results in a challenging revenue environment and are seeing the results. For instance, as a result of our capacity reallocation, Houston had the best year-over-year PRASM of any hub in June, followed closely by San Francisco and Denver.

Taking all these regional dynamics into account, with respect to capacity, as can be seen on slide 10, we now anticipate full year capacity to grow between 1% and 1.5%. As Oscar mentioned, we are currently in the process of closely evaluating our capacity for the fourth quarter and 2017.

As I wrap up, I want to reiterate our focus on maximizing profitability throughout our entire network. We are constantly evaluating the revenue and profitability landscape to ensure we have the proper plan in place. We continue to be committed to growing our capacity in line with demand but remain willing and prepared to adjust when necessary.

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

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

Thanks, Jim. A summary of our financial performance can be seen on slide 12 for GAAP financials and slide 13 for non-GAAP financials. Excluding special items, pre-tax earnings were $1.4 billion with a pre-tax margin of 14.5%. Importantly, our earnings per share were $2.61, a 25% improvement year-over-year when adjusted for taxes as we continue to repurchase shares.

Moving to slide 14, non-fuel unit costs for the quarter grew 2.5%, when excluding special charges, profit sharing and third-party expenses. For the third quarter, we expect non-fuel unit costs to grow 2.5% to 3.5% and for the full year, we continue to expect unit costs to grow to 2% to 3%, despite reducing capacity by almost 1 point versus initial expectations. This guidance includes the benefits of our annual efficiency savings initiatives from our 2013 cost savings program as well as our recently announced 2016 program. In total, we expect these two programs to drive $400 million of cost benefit when compared to 2015.

This CASM guidance also includes the impact from the three ratified labor agreements reached this year, but does not include any assumptions associated with the tentative agreement we recently reached with our flight attendants. Once ratified, we will provide more specifics on the impact to our cost.

Based on the guidance we have provided for revenue and costs, we expect our pre-tax margin to be between 13.5% and 15.5% for the third quarter. With respect to cash, in the second quarter, we generated approximately $2.5 billion of operating cash flow and $1.8 billion of free cash flow.

As you can see on slide 15, during the quarter we invested approximately $770 million in the business and took delivery of two Boeing 787-9 aircraft and two Boeing 737-800 aircraft. As Oscar mentioned, we repurchased approximately $700 million of our shares in the quarter. As of the end of the second quarter, we still have approximately $255 million remaining on our prior $3 billion authorization. Additionally, as announced yesterday, our board has approved a new $2 billion share repurchase authorization.

Returning cash to our shareholders is a core element of our capital allocation strategy. However, this will not be done at the expense of the health of our balance sheet, as maintaining manageable debt levels is critical to running the airline through a variety of economic cycles.

In conclusion, throughout the quarter, we have continued to demonstrate strong cost discipline, a commitment to invest in our business and a desire to reward our shareholders. We believe the plan we have in place positions us well to continue these actions going forward, while allowing us to be nimble and responsive to a changing economic environment.

I'll now turn it back over to Oscar.

Oscar Munoz - President, Chief Executive Officer & Director

Thank you, Gerry. As you've heard, we've made substantial progress in the second quarter but we know there is more work to do. It has already been quite a busy summer and will continue to be up, for us here at United, as we work to set up our next chapter. I look forward to sharing more of this with you later in the year.

I'd like to close by thanking our customers for flying United. Our operation is running well, our schedules are adapting to meet your needs and our airport and onboard products continue to elevate your flying experience.

Thank you for choosing United and look forward to seeing you on a flight soon. With that, I'll turn it over to Jonathan for Q&A.

Jonathan Ireland - Managing Director-Investor Relations

Thank you, Oscar. We'll now take questions from the analyst community. Please limit yourself to one question. If you'd like to ask another question, please reenter the queue after your question has been addressed. Brendan, please describe the procedure to ask a question.

Question-and-Answer Session

Operator

Thank you, Jonathan. And from UBS, we have Darryl Genovesi. Please go ahead.

Darryl Genovesi - UBS Securities LLC

Hi, guys. Thanks for the time. I mean, can you just give us a sense of how you are thinking about – I know it's early but could you give us a sense of how you're thinking about 2017 capacity levels, at least to start the year?

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey, Darryl. This is Jim. Hey, we're not – we're actually working on our 2017 plans, as I speak right now, and a lot of focus on that. So, it's too early for us to comment specifically on that.

I will say, as we talked about this year and we talked about in the past years, we're focused on keeping capacity in line with demand. So, we're working through that process now and we plan to update you later in the year on what we're going to do in 2017.

Darryl Genovesi - UBS Securities LLC

Thank you.

Operator

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

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Hey, thank you. I'll surprise you with a non-RASM question. Gerry, if you assume that the current field curve and the RASM environment continues into next year, and you plug in some new labor contracts and the step up and CapEx that looks like you guys will have next year, that is the potential that consume most, if not all of your free cash flow next year. So, first of all, can you say whether you agree with that assessment and could you put a finer point on what CapEx looks like next year and how much flexibility you have to manage that down if the RASM environment remains challenging?

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

Sure. Joe, one thing I talked before about looking at free cash flow net of aircraft financing, we've had this discussion that rather we choose to lease aircraft or buy aircraft that can make material difference in free cash flow. So, when I am looking at cash and cash allocation, I do take that into account. And we had to finalize our plan to aircraft financing closer to the start of the year, but just kind of looking at where our aircraft CapEx next year is and kind of what we did this year, I think it's reasonable to assume have a range of about half to two-thirds of our aircraft CapEx being financed next year. So you could probably plug that into your number. It could be a little bit less, it could be a little bit more depending on interest rates but in the current interest rate environment, as you've seen us and others do, the capital markets are quite attractive. So, that's one lever we have sort of depending on the environment how much of our aircraft CapEx is financed.

In terms of other levers, we can always dial down non-aircraft CapEx. We've had reasonable experience doing that. Aircraft CapEx, the only comment I would make is that it tends to be the case that when a manufacturer is building an aircraft, they expect you to take it, and they tend to start cutting metal, call it 18 months, 15 months ahead of schedule. So, you pretty much lock in most of the year's aircraft sort of if not now, within the next few months but you can do a lot with aircraft beyond that and we've done that in the past when necessary.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Okay. Thank you.

Operator

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

Hunter K. Keay - Wolfe Research LLC

Hi. Good morning. Thank you. So, Oscar, you mentioned that you're undertaking a self evaluation of all aspects of the business and there is some headlines, I think Bloomberg that says you guys are reviewing management hubs and operations. So, this is good, and this is, I think, a lot of people have been waiting to see. So, can you give us some color on this? Is this like a full scale what you would refer to sort of like a top to bottom strategic review? And can you give us maybe a sense of how to think about a timeline when you'll have something to say about these things? What is the potential set of outcomes or is this more not like a finite thing that's going to last six months or something, but more of just like an ongoing new approach to how you're thinking about writing the business? So, any color around this would be great. Thanks a lot.

Oscar Munoz - President, Chief Executive Officer & Director

I think with regards to duration, I think companies make the mistake of doing these near-term things and then stopping. It's a dynamic world and you have to adjust accordingly but you have to start with a full blown thrust, and it's amazing how quick news travels. I just issued that note this morning to our employees. It is a top to bottom full-scale view on everything that we do. It's something that we have to do and acknowledge and that involves the management structure and who is aligned. I've always said that structure follows strategy and so developing in the near-term what our North Star is, has, I think, been the critical plan.

So we do have a finite time period that we'll work through over the summer. We have a board meeting in September where we'll sort of talk a lot about this, and you'll hear about it in our fourth quarter Investor Day. And then, again, it will change as the dynamics of the competitive marketplace do. But we're excited. It is spanning the globe, if you will, with regards to the conversations we're having. We have more than a few work streams working around every little thing to product offerings, to the broader issues around capacity and network planning. And so, I think it's exciting. So, thank you for asking that.

Hunter K. Keay - Wolfe Research LLC

Yeah, great. Thanks.

Operator

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

Andrew George Didora - Bank of America Merrill Lynch

Hey, good morning, everyone. So, Oscar, United's operating performance from both in on-time and delay perspective has been steadily improving since last fall, but there has obviously been a lot of industry headwinds that have not allowed your PRASM to really show any benefit from this. I guess, one, what are some of the initiatives you believe have helped you get where you are operationally? And then, second, do you have an estimate of what kind of the PRASM benefit that you have gotten this year from this improved performance?

Oscar Munoz - President, Chief Executive Officer & Director

No. I was looking at Greg. I don't know that I have a number specifically for the PRASM impact. But with regards to your question about what's generating this, first and foremost is the incredible passion of the professionals that run our business. They have re-engaged in a way that we haven't seen in a long time. And that's just not me talking; you can ask a lot of folks that are seeing that benefit. They are just working hard and they're engaged and I think that's a big critical factor.

In addition, over time, between project quality, a lot of the process and procedures and investments that we've made in the business, which are substantial, are all assisting those folks, giving them the tools to properly do their job. And the benefits, again, it's a good question that we should come up with a more quantitative answer. It is a significant value. I'd say running better is running cheaper and we are seeing that and we'll get you a better number here in the course of time.

James E. Compton - Vice Chairman & Chief Revenue Officer

Andrew, if I could add just from a customer perspective on what we're hearing in the marketplace, as Oscar said, the level of operations is really, really strong and the operations team has proven it's sustainable and durable. We're hearing that back from our customers. Our corporate sales force on a routine basis is very excited about, for instance, going in and bringing in the scorecard of our corporate guarantee. And year-to-date, six plus months into it, we're not paying on it, which means we're meeting our commitment on terms of our operations.

So, that – as Oscar said, it's hard to put a PRASM on it. Those are the things that will lead to PRASM. We're seeing our local share in our hubs rebounding back to levels that we saw before some of our integration issues. And so, we're really, really excited about it.

And lastly, on our call in June, we talked about $300 million of operational efficiency, as well as some of the what I call choice as we get back in terms of being a carrier of choice among our corporate partners. That's a line item in there that does relate to PRASM.

So, as Oscar said, a little bit too early to put a specific number on it but we're getting the right momentum.

Oscar Munoz - President, Chief Executive Officer & Director

As we said to the sales force, Jim and I, the notion that we can't sell anymore because we don't a particularly good product, that excuse is no longer on the table.

James E. Compton - Vice Chairman & Chief Revenue Officer

Yeah.

Oscar Munoz - President, Chief Executive Officer & Director

It fell away. Thank you..

Andrew George Didora - Bank of America Merrill Lynch

Great. Thanks, guys.

Operator

From Raymond James, we have Savi Syth on line. Please go ahead.

Savanthi N. Syth - Raymond James & Associates, Inc.

Hey, good morning. Thanks for the update on your thinking on the fourth quarter. I was wondering if you could provide a little bit more granularity as to which areas or maybe segments, international segments where you're feeling a little bit more concerned about what your thinking is on the kind of the progression here as you head into the end of the year.

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey, Savi, this is Jim. I think as we look out, and as I mentioned, fourth quarter, our expectations, given expectations of demand is measured by GDP declining, we expect obviously that to continue.

The corporate business, although we see the demand flat, the revenue is down on lower yield. We expect that to continue. That's correlated to that expectations of GDP coming down, so that's part of what was driving it. So that's that domestic piece of our ability – of putting pressure on our ability that I talked about on our April call.

Internationally, we did see weakness in trans-Atlantic PRASM in the second quarter. We're adjusting to that on our slide. We talked about the fourth quarter being down 1% to 2% capacity. So we're reacting to that, Our capacity was up about 2% in the second quarter. We're guiding to 0.6% to 1.6% in the third quarter and we're guiding to down 1% to 2%. So we're addressing some of that demand on the trans-Atlantic side aligning with that capacity with demand.

Latin, we actually – that's the one where we actually see the quarter-over-quarter improvement on a RASM basis stronger than some of the other entities. And so, we feel good about where the Latin entity is heading as we head into the fourth quarter.

On the Pacific side, it's really from a demand perspective, a lot of the things we talked about in the past with OA capacity. I will say our launches of our new markets are meeting or exceeding our expectations. We are particularly proud that we jumped back in the trans-Atlantic on this, but our San Fran/Tel Aviv flight is doing exceptionally well and our Asia flights are all meeting and exceeding our expectations. But the demand – there is still OA capacity demand. We are starting – we have an opportunity to start San Fran/Shanghai number two in October. So we're seeing a little bit of capacity from that but we think that over the long run that's the right investment for us to make.

Savanthi N. Syth - Raymond James & Associates, Inc.

All right. Thank you.

Operator

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

Jamie N. Baker - JPMorgan Securities LLC

Hey. Good morning, everybody. Jim, you've cited that GDP expectations are coming down but GDP is still growing, yet it's revenue that's declining. So, in other words, that long-term relationship between GDP and revenue appears to be decoupling, Ken (28:00).

Now, I understand why this happened when the Internet came along. I understand why it happened briefly during the financial crisis, but I can't point to a secular cause over the last 18 months. So, this leaves us with the obvious conclusion that revenue weakness has to be self-inflicted. Do you share this view or can you identify something secular that's causing this decoupling? Because if you're a rental car agency, and we're talking about Uber, okay, I can kind of figure it out. I can't cite what that secular change might be.

James E. Compton - Vice Chairman & Chief Revenue Officer

Yeah. Hey, Jamie, I think there is that one correlation with fuel price that has that impact on revenue. We talked about surcharges over time and so forth being down and that correlation in terms of how fuel has affected revenue. So, some of that – because I do agree in 2015, you're right: industry revenue as a percent of GDP was down and was an inflection point from previous years and I expect that will continue again today.

And so, other than that correlation to fuel, I'll go back to the other thing we've talked about right? We have seen capacity grow faster than demand and that's putting pressure on yields and corporate demand is not growing at the pace. The corp yields, the corporate demand is not growing at that pace of capacity.

We are pretty consistent. I mean, we're back to our initial year guidance on capacity and we're down from that initial year guidance on capacity, and that capacity even where we're guiding today will be less than what expectations of GDP today that we are talking to. So we're managing our plan in this environment and we feel pretty good about it.

The last thing I would say is that on the June call we talked about our slimline and upgauge program. We have some modest growth in the third quarter. That capacity becomes really margin accretive. And so where leisure bookings are strong that's the capacity to absorb that leisure bookings. Lower RASM but at extremely lower cost CASM. So we really feel good about the plan we're rolling out.

Oscar Munoz - President, Chief Executive Officer & Director

Jamie, this is Oscar. Jamie?

Jamie N. Baker - JPMorgan Securities LLC

Yeah. Great go ahead, please.

Oscar Munoz - President, Chief Executive Officer & Director

No, no. You get one question. You got to get back in line but I just (30:40) by the way, it's a very thoughtful question as all of them are but the concept of the self-inflicted portion I think is a very interesting one, and somebody had asked me earlier about the work that we're doing here over the summer. We have to explore that a little bit to make sure that we're not just following historical conventional wisdom all the time because again, as I said, it's a dynamic marketplace and we have to find either the secular impacts or things that we can generate or do better. So, thanks. We'll go to the next call.

Operator

From Morgan Stanley, we have Rajeev Lalwani. Please go ahead.

Rajeev Lalwani - Morgan Stanley & Co. LLC

Hi, thanks for the time. Jim, a question for you. On slide eight, you did a good job of providing just color on PRASM and some of the drivers there. But it seems to only explain about half of the weakness in your unit revenues, right? I mean, just a simple math, you've got 3.5 points out of that 6.5 points. What are some of the other drivers? What are we missing out there?

James E. Compton - Vice Chairman & Chief Revenue Officer

I think the other drivers are little bit of – I just mentioned, capacity is growing faster than demand across the industry and that's putting pressure on yields in an environment where corporate demand is not keeping up with that pace of capacity. And that higher yielding demand that's not there at that greater capacity puts pressure on PRASM.

And the other piece is that modest capacity, in that modest capacity growth we have, if you look at our domestic, we will actually be slightly down in departures in the third quarter to drive that modest capacity growth. That's that margin accretive initiatives that we talked about in June giving a little bit more hold as we roll though the year.

So, that's slimline growth and the upgauge strategy becoming less dependent on the regional and more dependent on to the main line. Again, it offers us ancillary product both first class and Economy Plus. But it does come in at RASM that's lower than the average but an even lower CASM which makes the margin accretive. Those are really the elements that are putting pressure on RASM.

Operator

From Credit Suisse we have Julie Yates on line. Please go ahead.

J. Yates - Credit Suisse Securities (USA) LLC (Broker)

Good morning. Thanks for taking my question. Jim, another one for you. Just when put out the flat RASM targets in April, what level of sequential improvement were you expecting at the time for the third quarter? I'm just trying to reconcile Q2 coming in at the better end of your range but the outlook for H2 has worsened. So, just trying to calibrate expectations on what the sequential improvement looks like from here?

James E. Compton - Vice Chairman & Chief Revenue Officer

If I got the question correct, what we kind of thought third quarter sequential improvement would have been when we made that?

J. Yates - Credit Suisse Securities (USA) LLC (Broker)

Correct. Like how much did the outlook for the third quarter deteriorate since the April call?

James E. Compton - Vice Chairman & Chief Revenue Officer

It has come down. And so – and due to that kind of revision down in GDP, the specific number, I don't have that in front of me where we were at from a forecast point of view. But given those GDP revisions, as that related to fourth quarter it's also impacting third quarter. So that weakness is rolling to the third quarter also.

J. Yates - Credit Suisse Securities (USA) LLC (Broker)

Okay, understood. Is there an updated timeframe in which you are expecting the different entities to get back to flat deposit of RASM?

James E. Compton - Vice Chairman & Chief Revenue Officer

Again, we're not – I'm not – I don't have...

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

We're really focused on profitability, as Oscar mentioned in his comment. And so our initiatives out there are focused on doing that. As we lay out that game plan, we're focused on optimizing RASM every day and then put some RASM. And so, as we move through the rest of this quarter into the fourth quarter, we'll be able to get a little more insight and kind of continue to update you guys where we think PRASM is and ultimately where that lands relatively to positive PRASM growth.

J. Yates - Credit Suisse Securities (USA) LLC (Broker)

Thanks for taking the question.

Operator

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

Mike J. Linenberg - Deutsche Bank Securities, Inc.

Hey, good morning, everyone. Jim, I want to go back to – you talked about further softening of corporate yields. I couldn't tell if that was just a continuation of what we were seeing or is it just noticeable deterioration from where we were a few months back. And the fact that you – I mean, you mentioned that demand seems to be fine and yet yields are under pressure, how much of that is a function of some of the changes to the fare structures with respect to advanced purchase restrictions maybe going away or Saturday night stays, some of the expenses getting lifted off, sort of lifted away. I mean, maybe that speaks to the point that Jamie brought up about the fact that we're sort of seeing a breakdown here between revenue and GDP. Some of it is related to just the structure out there and maybe the prevalence of a much more liberal fare regime in place. Thoughts on that?

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey, Mike. Thanks for the question. I think pricing actions always affect PRASM, but I think it's more a continuation of what the demand that we're seeing where demand is relatively flat on lower yields.

So, one thing, as you move into a summer peak period and you have that leisure demand strength, it actually, with lack of better words props up your inventory. And so, your lower inventory buckets are not as open as much.

One of the things we're watching as we move past that peak period of summer season is strong leisure demand. And to your point, kind of the corporate demand being relatively flat, that can put relatively more pressure on yields relative to the third quarter where you have peak demand, strong from the June, July, August months.

But to answer your question, we're kind of seeing demand where it was at. I would note that as energy sector continues to be down year-over-year, it's decelerating at a slower rate. So, that's also putting pressure on us on a year-over-year basis as we go forward.

Mike J. Linenberg - Deutsche Bank Securities, Inc.

Okay. Thank you.

Operator

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

Helane Becker - Cowen & Co. LLC

Thanks very much, operator. Hi, guys. Thank you for the time. And, Oscar, as we look ahead to your business over the next say two years to five years and during this time period of the revenue improvement that you outlined last month, is there an earnings per share target we should be thinking about that you are thinking about managing to or should we not be looking at it as an EPS target, should we be looking at it as an operating margin target?

Oscar Munoz - President, Chief Executive Officer & Director

It's a great question and one that we are in the process of developing with that specific public measure that we're going to be driving to and obviously keeping you updated on. They all have merit. We're going to pursue all of them and certainly, it's more profitable; it's margin improvement; it's closing the margin gap to others or whatever the big drivers are. It's a great question but we will certainly definitely tell you at our fourth quarter Investor Day. It will be the culminating part of our conversation I suspect.

Helane Becker - Cowen & Co. LLC

Okay. We'll look forward to it. Thanks.

Operator

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

Dan J. McKenzie - The Buckingham Research Group, Inc.

Hey. Good morning. Thanks for the time here. Jim, I am wondering where are we at with respect to, I'll call it enhanced revenue management technology getting rolled out. So, the entry-level fares product, I believe United in the past had been targeting the fourth quarter. I am just wondering is that still the case and what does it mean for United exactly here?

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey, Dan. Entry-level fares, yeah we are still targeting second half of this year, a lot of work going on in that area to roll that product out into the marketplace. We're very excited and when you asked what it means for United, it's going to allow us to have a price point that allows us to compete for sure against ultra-low cost carriers and allow us to move some of the dilution that we've placed on ourselves today with our current fare structure. So we're very excited about that. We see that rolling out in the second half of the year.

And so, we look forward to updating you on that. And it will be significant, in our earnings call. We talked about revenue initiatives, of strong customer choice revenue initiatives of $2.5 billion by 2018. That entry-level fare is a piece of that but also pieces of that as we update and become much reliable on the regional carriers and introduce more first class and the Economy Plus will drive other components of ancillary revenue that we have out there today.

And then, finally, on revenue management, as I mentioned on the call in June, we're in the process of moving to a new forecasting model. We call it Gemini. We're in the market. About 2% or 3% of our overall domestic revenue is affected by it and we're getting good results. And so, that is also part of our 2018 initiatives that we talked about that rolling out and we'll update you as we ago but we're still in the very early testing phases of it but getting good results from it.

Dan J. McKenzie - The Buckingham Research Group, Inc.

Yeah. Thanks. Appreciate the color.

Operator

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

Duane Pfennigwerth - Evercore ISI

Hey, thanks good morning. So, going back to Mike's question, our checks suggest that you've actually tried to show some leadership with respect to restoring advanced purchase requirements. Would you comment on your experience in this regard and if the more reluctant party was willing to restore these fences as well, what is that worth to United or the industry?

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey. This is Jim. Yeah. I'm not going comment on pricing initiatives in the marketplace both ours and other carriers. I'm just not going to comment on that.

Duane Pfennigwerth - Evercore ISI

Okay. Could I get a second, since I didn't get a byte on that? Jim, do you feel better about year-over-year unit revenue improvement during the peak leisure demand period or during a pure corporate demand period like September?

James E. Compton - Vice Chairman & Chief Revenue Officer

Well, as I mentioned, it's – you know, the leisure period drives relatively better unit revenue in the peak summer months relative to other periods of the year. It's a little early for us to get a good handle on corporate demand as we move past the Labor Day weekends; we're very much focused on it. There are things we're lapping across our system that we've talked about in terms of how it affects unit revenue.

On the corporate side, we're seeing flattish demand on lower yields and we're seeing GDP revisions step down and so we're keeping a close eye on that. Again, that's why we've adjusted capacity. Our capacity adjustments that we made to the rest of the year are across the system both international and domestic, and we'll continue to do that as we watch demand going forward.

Duane Pfennigwerth - Evercore ISI

Thanks, guys.

Operator

From Stephens, we have Jack Atkins. Please go ahead.

Jack Atkins - Stephens, Inc.

Hey. Good morning. Thanks for the time. As it relates to the slimline seats, could you give us an update on how much of your domestic network has already been outfitted with these slimline seats and is there a way to sort of summarize the impact that could have in terms of profitability on a seat mile basis?

James E. Compton - Vice Chairman & Chief Revenue Officer

Slimline, our program is little bit over 50% rolled out right now. In our June call, we talked about it being 50%, so we're beyond that as we're into July now. So it's little bit 50%-plus on the whole network. And so that program is past the halfway point on the slimline side.

In terms of profitability, it comes at a lower RASM but a lower CASM and we haven't put numbers around what that's worth yet. As we walk through the rest of the year, we'll update you folks on our initiatives and we can put some more color on that going forward. We did talk about that program, slimline and upgauge program, driving $800 million of contribution by 2018. So, we'll be able to update you where we are at as we go forward.

Operator

Okay. And from UBS, we have Darryl Genovesi. Please go ahead.

Darryl Genovesi - UBS Securities LLC

Hi, guys. Thanks for the follow-up. I'm just wondering the cost reduction targets that you guys provided on June 21 and then today's presentation again. Is there a portion of that that's specifically related to achieving a joint collective bargaining agreement with flight attendants?

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

No. That's...

Darryl Genovesi - UBS Securities LLC

That's the incremental (44:50)

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

It's Gerry. Those cost target is unrelated to the collective bargaining agreements.

Darryl Genovesi - UBS Securities LLC

But, I guess, presumably, getting a deal done with the flight attendants would allow you to realize some of the merger synergies that were originally intended. Are you saying that that would be incremental to your $1.3 billion cost reduction target?

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

Yeah. We look at that separately, that can depend.

Darryl Genovesi - UBS Securities LLC

Any – sorry, Oscar.

Oscar Munoz - President, Chief Executive Officer & Director

Go ahead with your third question.

Darryl Genovesi - UBS Securities LLC

I was just going to ask if there was – if you could provide an updated view on what that -if you could help quantify that synergy from the integration effort and I'll leave it at that? Thanks

Oscar Munoz - President, Chief Executive Officer & Director

We have not done that for a host of different reasons but there are incredible inefficiencies by the way its structured today and we are so anxious to put this behind us for so many different reasons. One of them being the efficiency, mostly the level of service we could provide across our system. So, thank you.

Darryl Genovesi - UBS Securities LLC

Thanks.

Operator

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

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Yeah, thanks. Gerry, just on the CASM outlook for the year. You took 50 bps or 25 bps, I guess, out of the full year capacity guidance. How much pressure did that put on CASM? Is the FX environment helping the CASM outlook now? If you could just help us understand the relationship between kind of capacity reductions and how much pressure that puts on CASM.

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

It puts some pressure on CASM. We've dealt with this in the past. Last year, in a situation of declining capacity versus our original guidance, we managed CASM down actually. So, this is all part of the process we have of always looking at opportunities to run the business more efficiently and to drive the cost savings through the various initiatives we have. It's not one thing. It's just all those little things that add up to our ability to manage CASM even in a declining capacity environment.

Joseph DeNardi - Stifel, Nicolaus & Co., Inc.

Okay, thank you.

Operator

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

Hunter K. Keay - Wolfe Research LLC

Hi, again thanks. So, Jim, you said that corporate bookings are about flat with revenues down about 3%. Is it fair to assume that that entire gap is driven by the concept that you've referred to in the past as dilution and is it fair to assume that the main thrust or one of the main thrusts of Gemini is to minimize dilution and in that regard as it relate to the small market that you roll it out, you said you're seeing good results. Is that effectively minimizing dilution or is it good results from other stuff that maybe we're not appreciating that we know about? Thanks.

James E. Compton - Vice Chairman & Chief Revenue Officer

Hi, this is Jim. You're absolutely right. It's minimizing dilution and that's the result that we're seeing. That's what we're targeting and in our test market that's also what we're seeing. So, it's consistent with what our expectations were.

Hunter K. Keay - Wolfe Research LLC

Okay. Thank you.

Operator

From Raymond James, we have Savi Syth on line. Please go ahead.

Savanthi N. Syth - Raymond James & Associates, Inc.

Hey, thanks for taking the extra question. Just wondering if you could give a little bit more color on the – and what we're seeing on the energy demand in terms of kind of the decline. I just want to make sure I understand. It seems like it's still declining but the comps are getting easier. And then also just from a newer perspective, I don't think we have seen much kind of in the way of volumes in additions of new capacity coming in and then wanted your latest thoughts on what's happening in Newark? Thanks.

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey, Savi, this is Jim. As it relates – you broke up a little bit on the question – in terms of Newark and the removal of slots, yeah, I think, we've seen – we work really, really closely with the FAA, and other carriers. The FAA would say they're oversubscribed in the peak slot period. And on their Level 2, they've worked with the carriers to make sure that we don't deteriorate the operations at Newark. And so we're hopeful and in very close contact with the FAA on that, working with them to do that.

Outside of that, we're not seeing that much in terms of OA growing capacity. And so as it relates to – that's what we're seeing that's happening in Newark right now.

Savanthi N. Syth - Raymond James & Associates, Inc.

Okay. And just the clarification on the energy decline?

James E. Compton - Vice Chairman & Chief Revenue Officer

Oh, on the energy, I am sorry. In terms of energy, we're still seeing the decline in energy demand. It is coming at a decelerated pace than what we've seen in the past but it's cumulative so it is impacting our RASM as we move through the rest of the year. The energy sector continues to weaken but at a slower rate.

Savanthi N. Syth - Raymond James & Associates, Inc.

Got it. All right. Thank you.

Operator

From Morgan Stanley we have Rajeev Lalwani. Please go ahead.

Rajeev Lalwani - Morgan Stanley & Co. LLC

Thanks for the follow up. Just on the capacity side internationally, is there anything that you're seeing today that would lead you to believe that industry growth is going to slow materially from that sort of mid-to-high single digit range? I'm just trying to figure out if it's reasonable to assume that international PRASM just remains materially negative as we look into next year.

James E. Compton - Vice Chairman & Chief Revenue Officer

Yeah. This is Jim. Again, we'll focus on United's capacity. The one piece I'll point out is in Asia and the China capacity. There is limits to capacity growth based on the bilateral that's agreed between China and the U.S. government. And those bilaterals are almost to the point where they've been met. So that will have a natural kind of slowdown in capacity growth from the main U.S. to China. But I wouldn't to comment on other industry capacity around other regions of the world.

Rajeev Lalwani - Morgan Stanley & Co. LLC

But on that 10 points that you noted capacity growth for the industry in 2Q in Asia, how much of that would actually come down with what you are describing in China?

James E. Compton - Vice Chairman & Chief Revenue Officer

We saw capacity growth in China grow over 20% in Q2. And so, obviously, there is run rates that affect as you think about going forward. But pretty much all of it, the – we're close the route authorities being granted between the two countries work (52:00) out but we did see capacity growing at a little bit over 20% in the second quarter.

Rajeev Lalwani - Morgan Stanley & Co. LLC

Got it. Thanks.

Operator

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

Mike J. Linenberg - Deutsche Bank Securities, Inc.

Yeah. Hey, thanks for the follow-up question. Hey just – and this is for Gerry, just with respect to strengthening the balance sheet. When I sort of look at later this year, it looks like there is some additional cash contributions to the pension. When I think about the amount of stock that you want to buy back and your CapEx even after the piece that's been financed, how should we think about your debt levels going forward? Are they going to stay sort of relatively constant or should we anticipate meaningful debt pay down as we sort of move into 2017 and 2018? How should we think about that? Thanks Gerry.

Gerald Laderman - Senior VP-Finance & acting Chief Financial Officer

Sure. So, Mike, the important point is that we need to maintain a healthy balance sheet. We're there, particularly when you talk – when you add our pension obligation, and when I talk about healthy balance sheet, it's really about managing through a cycle. And we're very comfortable that we would continue to have access to capital through a cycle. We have about $8 billion of unencumbered assets. So I'm comfortable with where our leverage is today, given our business and given what we're trying to do. So, we don't need to significantly reduce leverage at all.

And with the additional CapEx I expect over the next few years, I said when we raised our CapEx guidance back in March with the additional aircrafts our 50 (53:44) seat issue, as well as the early retirement of 747. All of those aircrafts, I would expect to finance and with sort of the range I put out earlier on the call and what I expect to do next year, I think if you run the arithmetic, you would not see a decline in our gross debt number over the next year or two.

Mike J. Linenberg - Deutsche Bank Securities, Inc.

Very good. Thanks, Gerry.

Operator

And from Buckingham Research, we have Dan McKenzie. Please go ahead.

Dan J. McKenzie - The Buckingham Research Group, Inc.

Hey, thanks for the follow-up here. Jim, another question on the $3.1 billion in initiatives underway, I think a big part of the story is improving efficiency via upgauging. And I think, the domestic upgauging is pretty well understood but if I'm not mistaken, there is also a wide body upgauging that is just beginning, which should aid margins on the international part of the network. And I'm just wondering if you can elaborate a little bit further on that?

James E. Compton - Vice Chairman & Chief Revenue Officer

Hey, Dan, it's Jim. The international upgaugings are really, really small piece, and it's driven mainly by the 767-300 conversions to two class. So that's driving a little bit of that upgauging. It's a really, really small piece of the upgauging that we talked about on our $3.1 billion initiative.

Dan J. McKenzie - The Buckingham Research Group, Inc.

Okay. Thank you.

James E. Compton - Vice Chairman & Chief Revenue Officer

And, in addition, as you think about 2018, when the A-350s come, that fleet will all be part of international upgauging but again in total very small piece.

Dan J. McKenzie - The Buckingham Research Group, Inc.

Okay, very good. Thank you.

Jonathan Ireland - Managing Director-Investor Relations

Thank you, Dan, and thank you to all for joining the call today. Please contact Investor Relations if you have any further questions, and we look forward to talking to you next quarter. Take care.

Operator

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

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