United Bankruptcy Court Update -- November 21, 2003
Your Honor, as we informed your clerk, we want to open this month's Hearing with a comprehensive status report, which we thought appropriate as these cases near the twelve-month mark.
Since filing on December 9, United has made major strides in substantially lowering its labor and non-labor cost structure; improving its revenue performance; addressing its governance issues; and in delivering top operational performance for its customers.
Let me start with the company's restructuring. Through consensual negotiations, United entered into landmark, six-year contracts with each of its six unions, with average annual labor cost savings of $2.5 billion as compared to original "contractual path" and also achieved significant outsourcing and work rule flexibility. This new flexibility optimizes the company's ability to react to rapid changes in the marketplace and to compete more vigorously.
United is driving substantial additional savings through maintenance productivity, airport productivity and strategic sourcing. Disciplined project management and best practice programs in purchasing, operations, maintenance and all other functions are ahead of plan to realize cost reductions of over $450 million in 2003 as part of a net benefit of $1.1 billion in expense and revenue improvements for the year.
And the groundwork has been laid for 2004 projects, which are expected to result in $650 million in cost reductions, part of the planned $1.5 billion in profit improvement next year.
United is also using the Section 1110 process in the Bankruptcy Code to ensure our aircraft financing arrangements reflect current market rates and align our fleet better with customer demand. Our target for the post-restructuring and ownership cost of our fleet is $900 million, down from approximately $2 billion. We have brought over 225 restructured transactions to Your Honor for approval, subject only to confirmation of a plan. I'll discuss shortly the work still to be done in 1110.
All together, United is now on track to realize approximately $5 billion in total savings annually by 2005. That translates to reducing United's cost per available seat mile from a near-industry high in the third quarter of 2002 to a best-in-class position by end of 2004.
Additionally, United's key governance issues have been addressed. During the Chapter 11 process, United's ESOP was sunset, eliminating the complex governance structure that sometimes impeded board deliberations and much-needed strong and swift responses to market challenges. All substantive board committees are now independent and the board's complex voting and governance structures have reverted to a conventional corporate structure. Oversight of the company is now focused on financial return with traditional stakeholder balance among shareholders, employees, and other stakeholders.
The company has also moved quickly to address management accountability, introducing a realigned organizational structure, putting numerous new senior officers in place and appointing new directors with experience in marketing, corporate restructuring and global finance.
Management's accountability for the direction and success of the company is formalized with well-defined expectations throughout the organization.
United's restructuring of its business model logically builds on the company's existing strengths -- among the best assets in the industry -- and its lower cost structure and flexibility. A complete portfolio of products is offered across a diverse marketplace:
· We start with a competitive mainline that retains its global network and industry-leading frequent flyer program. Importantly, United has recaptured its share among these core customers.
· United Express, which feeds passengers to United's mainline hubs, is expanding into more destinations where flying the mainline is unprofitable or to build greater frequency to select destinations. New long-term contracts negotiated during the last year with most of the United Express carriers have dramatically lowered costs and built in substantial performance metrics, while helping the company buttress its express fleet with more regional jets. We will discuss the open issue of ACA and United Express shortly.
· The company continues to nurture and expand its premier Star Alliance and international codeshares. In the last six months, United has announced the addition of US Airways and LOT as new Star members, as well as a new codeshare agreement with Air China that will expand United customers' access to major destinations in China. Importantly, United is implementing a codeshare agreement with US Airways that opens more flights and destinations domestically to United customers and has proven successful financially. Recently, Mexicana announced it is leaving the Star Alliance. We don't anticipate that their decision will have a major impact on our operations.
· United's new low fare operation, which it recently announced will be called Ted - is designed to allow the company to compete with low-cost carriers for price-sensitive customers on defined leisure routes. The first-year plan for Ted calls for a fleet of approximately 40 aircraft from United's mainline fleet. Operations will begin in February from the Denver hub with flights to numerous destinations. It will be expanded to other hubs next year. And, by offering seamless connectivity to the entire United network, Ted represents a compelling alternative to other low fare airlines.
In the first half of 2003, we were confronted with the challenging environment of bankruptcy and new CBAs, new security concerns and record load factors - all on top of the Iraqi War and SARS. Some of the aforementioned challenges placed great strain on United's business operations earlier in 2003. At that time, it appeared possible that our financial performance would not recover sufficiently to avoid a violation of our DIP covenants by around mid-year, and possible liquidity constraints in early 2004. Given those exigent circumstances, we were prepared for the necessity of emergence by year-end 2003 with exit financing in place. We so informed the Court and our stakeholders of this possibility. But due to the company initiatives outlined above, and favorable external developments, our situation greatly improved. We once again had the ability to be deliberate and thorough in rationalizing our business and our costs. This time resulted in, for example, the Denver lease amendment deal, which I will speak about in a moment; additional savings through our executory contract process, some of the fruits of which we expect to put before the Court at the next omnibus; additional opportunities to improve upon other real property leases; and the opportunity to fully explore a legislative solution to pension issues. We have been using this time to the significant benefit of the Company and its stakeholders.
Despite the extraordinary challenges of the first half of 2003, United employees are leading the industry in operational performance. For the most recent quarter ended September 30th, on-time zero departure performance was 73%, the best third-quarter performance in United's history. The Company's other operational metrics continue to set records.
For year-to-date 2003, United remains number one in arrivals within 14 minutes of schedule among the six major network carriers, according to the U.S. Department of Transportation. United was number one for all of 2002 as well.
This level of operational excellence by employees underscores their extraordinary loyalty and their commitment to the customers of United, ensuring that United emerges to compete for the long-term.
What all this work means is that United's restructuring has established a foundation for success -- United is back in the game, competing effectively. So an innovative marketing and sales campaign has been launched, supported by strong advertising, enhanced corporate sales and channel development efforts.
This includes the introduction in July of United's "Fly the World for Free" promotion with advertising in 22 countries in 11 languages; the launch of the "Go. Go. Stay." promotion in August to attract leisure customers; significant enhancement of elite frequent flyer programs, including a new, exclusive community website for 1K frequent flyers; and the implementation of national and international sales blitzes targeting corporate clients and travel agencies in Denver, Los Angeles, Hong Kong and cities in Australia, Mexico, Argentina and Thailand.
United is continuing to invest in customer-focused initiatives that make travel easier for our customers. United's recently released financial results for the third quarter make it clear that the company's restructuring is on track. United delivered a third quarter operating profit of $90 million, excluding special charges - a dramatic $665 million improvement over last year. Its margin was on par with Northwest and ahead of American, Delta and US Airways.
United's mainline passenger unit revenue increased 12% year-over-year, well ahead of the company's peers in the industry. Unit costs improved 9% year-over year. Excluding special charges and fuel, unit costs improved 14% over last year, again ahead of most network carriers.
The company's Monthly Operating Report for October showed continued improvement. United's cash balance remained strong at $2.5 billion with $600 million in restricted cash, and the company achieved a positive cash flow for the month of approximately $7 million per day, compared to a cash burn of about $7 million per day one year ago. And United has met its DIP covenants for each of the nine months since filing for Chapter 11 protection and in fact has delivered positive cumulative EBITDAR.
Looking ahead to 2004, United projects very modest pre-tax earnings, excluding restructuring and special charges, with significant profits after that.
So what is left to be done? There is, of course, substantial, complex and interrelated work still to be done in order to exit as anticipated in the first half of 2004. The company has five major issues to resolve: one, the remainder of the 1110 fleet restructuring; two, the ACA situation; three, municipal bonds; four, our claims pool; and, five, pension liabilities. I will take each briefly in turn.
First, as we discussed, our Section 1110 fleet restructuring is far along, but we need to resolve negotiations with our public aircraft debt holders because of our operational need for a significant portion of that part of the fleet. This open issue is closely related to the ACA issue, the resolution of which will help determine precisely how many aircraft we need going forward.
We remain in a constructive, but exceedingly complex negotiation with our public aircraft debt. That group represents 174 aircraft in both our four enhanced equipment trust certificate transactions as well as a significant number of other public and older private transactions. The number of financial institutions with significant stakes in the debt represented by that group exceeds 100. There are issues regarding cross holdings of institutions among various transactions, between senior and subordinate tranches in public deals, different mixes of wide-bodied and narrow-bodied aircraft, as well as recent and older vintage aircraft among all these transactions. There are securities law concerns that have to be attended to.
All of these negotiations are being conducted against the backdrop of Section 1110 and the current economic environment. Thus, you have one of the most multi-faceted negotiations I've ever been involved in. The parties have had literally dozens of in-person meetings and telephone conferences. The parties continue to work in good faith toward a rational and constructive solution and we are confident that a mutually beneficial agreement covering this component of the fleet can be achieved. That is an important hurdle yet to be cleared in these cases.
Second, the ACA situation itself is highly uncertain. United Airlines' senior-most executives negotiated extensively and in good faith with Atlantic Coast Airlines (ACA) to try to reach a competitive United Express agreement similar to those we reached with other carriers. However, ACA's management rejected our offers, deciding instead to try to become an independent low fare carrier to compete with United with Dulles as its hub.
Subsequently, Mesa Airlines, a United Express carrier in other regions of the country, has announced its intent to launch a solicitation to acquire the stock of ACA. As we have said previously, United was not a participant in Mesa's offer to acquire ACA.
To date, ACA's board of management has rebuffed Mesa's advances. Whether Mesa will succeed in acquiring ACA is something that will be decided by ACA's shareholders and, it appears, courts in Delaware and/or the District of Columbia, where various litigation, to which United is not a party, initiated by the parties is pending. United expresses no opinion on the legal or business merits, or lack thereof, of Mesa's effort to acquire ACA.
Separately, United last week established a conditional memorandum of understanding with Mesa Airlines that would govern a relationship between United and Mesa should Mesa succeed in its takeover efforts.
United has also developed a transition plan should Mesa fail to acquire control of ACA, and should the ACA contract ultimately be rejected by United. The plan is designed to ensure that United has sufficient aircraft capacity and infrastructure to continue to serve our Dulles customers with the same high level of service should the contract with ACA ultimately be rejected upon exit from Chapter 11.
As part of this effort, United has been working diligently to come up with a facility solution at Dulles involving existing United-controlled gates and other remote passenger processing facilities. Just so the Court understands the scope of the ACA issue, ACA operates United Express flights in and out of approximately 66 airports. ACA leases many of its facilities necessary to support United Express operations at various stations. Accordingly, not only does the ACA situation impact the Section 1110 restructurings, it also is a significant factor in United's determination whether to assume or reject certain leases as set forth in our 365(d)(4) motion which we'll discuss later in the agenda.
The third open issue is our municipal bond obligations, whose potential material impact on United's balance sheet and cash flow represents a major factor in our ability to exit. Further, this is also an instance where remaining uncertainty in one aspect of the Chapter 11 case spills over to another. The potential negative implications of an assumption of municipal bond "leases" under Section 365(d)(4) before they are even determined to be leases at all, and, in certain cases, before it is determined whether they can be severed from the true leases in which certain bond obligations are embedded, is apparent. We also have the O'Hare litigation, which is in an earlier stage, but which will also determine how United treats $601 million of prepetition obligations.
Fourth, the claims process. United is faced with an enormous amount of claims, both in terms of dollar value and number. We are working to reduce these claims by expunging duplicate, redundant, superceded claims and those with insufficient documentation, as well as through straightforward objections. At the same time, we will work to reclassify and recharacterize claims into appropriate categories while seeking to reduce claims through negotiation and additional objections. The outstanding major categories of claims we will be addressing in the coming months include employees, Federal and state tax agencies, federal government agencies, aircraft financing-related, trade and other unsecured claims, bond and other debenture holders and litigation-related. As part of our claims review process, we are preparing an estimation procedures motion to be heard at the December omnibus. That motion is intended to put the estate in a position where it is not unduly delayed by significant, contingent, unliquidated claims and will permit plan distributions to be made at the earliest possible date.
Lastly, on pensions, United has several means of resolving its pension obligations and is aggressively pursuing several tracks. First, United has submitted applications to the IRS for nine funding waivers related to pension plan contributions from 2003-2006. If granted, a total of approximately $2.4 billion in plan year contributions would be spread over a period of five years versus the normally required twenty-month funding schedule. This application is a complex situation, involving many federal agencies including the IRS, the PBGC, and the Department of Labor.
Second, United continues to work with its unions and industry groups in support of legislation currently before Congress that would smooth out pension contributions over the near-term. These include provisions related to current liability interest rate calculation and the unintended, harmful impact of Deficit Reduction Contributions required under law. Without these so-called DRCs, United would be able to fulfill all of its pension obligations, so we are supporting legislation that would permit many companies, including United, to waive them temporarily.
There is cautious optimism that some measure of relief will be passed and, with the current Congressional session likely to end in the next few days, we should have much greater clarity soon. I'll note that yesterday the U.S. House of Representatives passed provisions that would grant temporary DRC relief. United is also looking at other options as complements to, or in lieu of, waivers and legislation. Some of these options may involve United coming back to this Court.
One more point on pensions. In response to a New York Times article published yesterday regarding the pension issue, United issued the following clarifying statement, and I quote: "Some people are trying to confuse our situation. The facts are that we can fund our pension obligations on the standard, non-accelerated timetable; we intend to continue to fund our pension obligations; and we do not want to shift this burden to the Pension Benefit Guaranty Corporation and the American taxpayer.
"The only issue we have is the significantly accelerated pension funding schedule currently mandated. United, along with many other companies, supports the efforts in Congress to modify this accelerated timeline and smooth out pension contributions in the short term. This would enable companies to protect the pension benefits of millions of American workers and retirees for the future. We are emphatically not seeking government aid or asking the government to take over our obligations." End quote.
Those are the five key issues to resolve ahead of exit. And it's important to know that the philosophy of senior management, with respect to this Chapter 11, is to ensure that the Company is fully rehabilitated before emergence. Thus, rather than letting artificial timing constraints limit its accomplishments inside of Chapter 11, United's accomplishments and the flexibility provided by the Company's improved financial performance, are driving its timing in Chapter 11. That being said, we are ardently desirous of expediting our exit from Chapter 11 to the greatest extent possible, consistent with those goals.
The length of our stay in Chapter 11 has permitted us to accomplish things that may not have otherwise been possible had United been looking at a quicker exit. The pending motion before your Honor to assume an amended lease at Denver is just one example. Our agreement saves millions of dollars for United and for the City of Denver. Finally, let me cover the process that United is pursuing to procure exit financing to support a plan of reorganization.
United has met with and presented its business plan to its primary DIP lenders, JPM Chase and CitiBank, to discuss the possibilities of those institutions taking the lead in procuring exit financing. We were pleased with how our initial meetings with the banks have gone and expect to hear back from them in the next several weeks. Our business plan was also presented to the Official Committee of Unsecured Creditors last week. We intend to continue to work hard to achieve consensus with the committee and to do so in the constructive manner that has marked our interaction with the committee and its professionals from the start of the case.
Assuming for the moment that we are able to procure commitment letters from our potential exit financiers, those letters and an updated business plan will be submitted to the Airline Transportation Stabilization Board (ATSB) for its formal consideration.
In the meantime, we've been meeting regularly with ATSB staff and staff of the relevant federal agencies that are represented on the ATSB board working groups to keep them apprised of our progress. We have also been meeting with and presenting our business plan to the IRS and the PBGC regarding our various approaches to pension funding issues and waiver requests.
Beginning with the submission of our updated ATSB application, we envision the following sequence of steps toward exit: We would expect to hear back from the ATSB within approximately 60 days of our application. Next, if our application was granted, United would file with the court a plan of reorganization and a disclosure statement. Following these filings, we would then have the statutory periods for approval of the Disclosure Statement and thereafter for solicitation of votes and the holding of a confirmation hearing.
All told, we remain on track for an exit before the end of the first half of 2004 - which is in keeping with our initial estimate of an 18 month process. Again, this sequence assumes clarity around the five outstanding matters I discussed earlier - the ACA situation, municipal bonds, pension obligations, 1110 restructuring and claims reduction. Because these issues are so interrelated on many levels, as I indicated, challenges in any one area could have an impact on our ability to meet our initial estimate, and could affect the timing of our exit. However, the Company continues to have a compelling desire to exit as soon as possible, and is working diligently to resolve the five issues I've outlined.
That's our best thinking at this point in time, and that concludes the United update, your Honor. We appreciate the Court's indulgence and I'd be happy to address any particular questions the Court might have now or any time during the Hearing.
Of course, I believe it's always better to be conservative in these matters and then be pleasantly surprised on the upside.
