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(Mark One)

                  For the quarterly period ended September 30, 2002

                   For the transition period from __________ to __________

                   Commission file number 33-21220*
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 

*  Registrant is the wholly owned subsidiary of UAL Corporation (File 1-6033).  Registrant became subject to filing periodic reports under the Securities Exchange Act of 1934 as a result of a public offering of securities which became effective June 3, 1988 (Registration Nos. 33-21220 and 22-18246).

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
 

Item 1.  Financial Statements
 
 

The Company

         United Air Lines, Inc. ("United" or the "Company") is a wholly owned subsidiary of UAL Corporation ("UAL").

Basis of Presentation

         The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  As more fully discussed in "Liquidity and Capital Resources," the Company may file for bankruptcy if it is unable to raise sufficient liquidity to support its ongoing operations and capital and debt requirements.  The financial statements do not include any adjustments that might result from a potential bankruptcy filing.

         The consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to or as permitted by such rules and regulations, although United believes that the disclosures are adequate to make the information presented not misleading.  In management's opinion, all adjustments (which include normal recurring adjustments, the special charges described below and a deferred tax valuation allowance described below) necessary for a fair presentation of the results of operations for the three- and nine-month periods have been made.  Certain prior-year financial statement items have been reclassified to conform to the current year's presentation.  These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in United's Annual Report on Form 10-K for the year 2001.

Accounting Changes

         Effective January 1, 2001, United adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), as amended.  The adoption of SFAS No. 133 resulted in a cumulative credit of $3 million, net of tax, to first quarter 2001 earnings.

         Effective January 1, 2002, United adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142").  In connection with the adoption, United has discontinued $12 million in annual amortization expense on route acquisition costs, which are indefinite-lived intangible assets.  SFAS No. 142 also requires companies to test intangibles for impairment on an annual basis or on an interim basis when a triggering event occurs.  During the first quarter, the Company performed an initial evaluation of its intangibles and determined that the fair value of its intangibles was in excess of the book value.  In the third quarter, the Company reviewed the evaluation of its intangibles and determined that the fair value continued to be in excess of the book value.

         The following information relates to United's intangibles at September 30, 2002:
 

         Slots and gates are being amortized on a straight-line basis over the life of the related leases.  Other intangibles are being amortized over periods of 3 to 10 years.  Total amortization expense recognized in the first nine months of 2002 was $9 million.  The Company expects to record amortization expense of $11 million for the full year 2002, $8 million in 2003, $7 million in 2004 and 2005 and $6 million in 2006.

         Route authorities are rights granted by governments to operate flights to and from a particular country.  These authorities are very specific and limited, fixed in nature and are rarely available in the marketplace.  Accordingly, route authorities are highly valued and sought after assets by all airlines.  During 2002, United obtained a third-party appraisal of its route authorities which concluded that the market value of these assets continues to be considerably in excess of the book value.

         Gates, like routes, are highly valued assets that do not frequently come into the marketplace.  The Company has no intent to sell these gates and believes that the market value is in excess of the recorded book value.

          During the third quarter of 2002, United, through a wholly owned subsidiary, purchased an additional 6% interest in the Galileo Japan Partnership ("GJP"), bringing its ownership interest to 56% and requiring the Company to consolidate the entity.  In connection with the acquisition, United recorded $2 million in goodwill representing the excess of the purchase price over the book value of the assets acquired, based on the preliminary purchase price allocation.

         Pro forma results for the three and nine months ended September 30, 2001, assuming the discontinuation of amortization are shown below:
 

         Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which addresses the accounting and reporting for the impairment or disposal of long-lived assets.  SFAS No. 144 did not have an effect on the Company's results of operations.  In the third quarter of 2002, the Company evaluated its fleet for impairment in accordance with SFAS No. 144.  Utilizing the Company's current cash flow projections based on the updated business plan submitted in October to the Air Transportation Stabilization Board, as described in "ATSB Loan Application" and appraisals of aircraft as necessary, management determined that no impairment is required.

Restricted Cash

         At September 30, 2002, the Company had $333 million in restricted cash, which primarily consists of deposits posted for various states where United is self-insured for workers' compensation claims.

Income Taxes

         The Company's provision for income taxes is based on the estimated annual effective tax rate, which generally differs from the federal statutory rate of 35% principally due to state income taxes and certain nondeductible items.  In the third quarter of 2002, the Company recorded a valuation allowance of $418 million against its deferred tax assets.  In recording the valuation allowance, management considered whether it was more likely than not that some or all of the deferred tax assets would be realized.  This analysis includes considering scheduled reversal of deferred tax liabilities, projected future taxable income, carryback potential and tax planning strategies.

Long-Term Debt

         During the first quarter of 2002, the Company refinanced approximately $525 million in interim financing through a $775 million private debt financing which refinanced certain aircraft.  During the second quarter of 2002, the Company refinanced approximately $314 million in interim financing to long-term.  In the third quarter of 2002, the Company refinanced approximately $238 million in long-term debt through a sale-leaseback transaction.

Segment Information

         United has a global route network designed to transport passengers and cargo between destinations in North America, the Pacific, the Atlantic and Latin America.  These regions constitute United's four reportable segments.

         In accordance with Department of Transportation guidelines, the Company allocates passenger and cargo revenues for the North America segment based on the actual flown revenue for flights with an origin and destination in the U.S.  Passenger and cargo revenue for international segments is based on the actual flown revenue for flights with an origin or destination in that segment.  Other revenues that are not directly associated with a flight (such as Red Carpet Club membership fees) are allocated based on available seat miles flown in that segment.

         A reconciliation of the total amounts reported by reportable segments to the applicable amounts in the financial statements follows:
 

Other Comprehensive Income

         Total comprehensive income (loss) is made up of the following:
 

United Express

         United has marketing agreements under which independent regional carriers, flying under the United Express name, feed passengers to United owned and operated flights.  United pays these carriers on a fee-per-departure basis and includes the revenues derived from the carriers in passenger revenue, net of these expenses.  Amounts included in passenger revenues for the three and nine month periods are as follows:
 

         While the effect on United's results, taking into account only the United Express flights, is negative, the Company realizes a significant benefit (not included in the results shown above) from the traffic provided to United's operations as a result of these agreements.

         In addition, United has call options on 64 regional jets owned or leased by these carriers.  The call option is a standard part of the United Express agreement and is intended to allow United to secure control over regional jets used for United Express flying in the event one of the United Express agreements is terminated.  The call option reduces this risk if the Company determines that a change of United Express carrier is necessary, particularly due to the significant time lag between order and delivery of aircraft (such as regional jets made to United's specifications).

         The call options are only exercisable if United maintains a specified credit rating and the United Express carrier fails to meet required operating and/or financial performance levels for a specified period of time.  Due to United's current credit rating, none of the call options would be exercisable at this time.

ULS Transaction

            UAL Loyalty Services ("ULS"), a wholly owned subsidiary of UAL, had been United's agent to market and sell Mileage Plus miles to non-airline business partners.  In the first quarter of 2002, UAL made changes to its corporate structure which resulted in substantially all of UAL's customer loyalty and marketing programs (which were previously the responsibility of United) becoming owned and operated by ULS.  These changes were designed to increase the overall value of UAL's loyalty businesses by focusing management attention on these activities and enhancing the range of products and services offered to Mileage Plus members and business partners.

            First, Mileage Plus, Inc. ("MPI") dividended certain assets related to the Mileage Plus business to its parent company, Mileage Plus Holdings, Inc. ("MPH"), which was then a wholly owned subsidiary of United.  Immediately thereafter, MPH dividended to United all of the stock of MPI.  United then sold all of the stock of MPH to ULS in consideration for a $900 million unsecured promissory note (payable over 12 years and bearing interest at a rate of 7% per annum), plus the assumption of the outstanding liability for miles previously sold to non-airline third parties (approximately $500 million).  The purchase price was based on the estimated fair value of MPH, as determined by the present value of the net future cash flows of the entity.

            Simultaneously with the above transactions, United also dividended certain assets associated with direct-to-consumer marketing and service businesses.  These included certain united.com related assets, certain United Vacations and Mileage Plus related assets, and the assets relating to Silver Wings, Cruise4Miles and Sky Mall services.  UAL then made a capital contribution of these same assets to ULS.

            Mileage Plus participation agreements with other airlines and the customer service call centers supporting Mileage Plus members were not included in these transactions.  These assets will remain part of MPI and therefore, of United.

            Due to the related party nature of these transactions, no gain or loss was recorded at United, UAL or ULS.  Any differences between the purchase price and the book value of the assets was adjusted through equity.  As a result of these transactions, United's equity increased approximately $1.4 billion.

            Also as a result of these transactions, ULS became responsible for the sale of non-airline miles and retains the gross proceeds (and associated liability) for the sale of those miles.  United, through MPI, retains the right to sell and the associated liability of the miles awarded for travel on United or any of its airline partners.  As Mileage Plus members use miles earned through means other than air travel to redeem a travel award on United, ULS will be obligated to compensate United for the value of this award travel.  Likewise, United will be obligated to pay ULS for miles earned through air travel as they are redeemed for any non-air travel award.  The price of a mile sold between the two entities as a result of these arrangements is expected to be contractually mandated and fixed.  The initial allocation of the total mileage liability and the percentage of miles deemed to be earned through other than air travel are also expected to be contractually fixed and will be based on specified market factors.  Terms of these contracts may change based upon market conditions.

            It is the intention of both United and ULS that these transactions and the allocation of miles be transparent to Mileage Plus members and partners.  While United's passenger and other revenue will be significantly impacted from these transactions, the interest and principal repayments on the promissory note, as well as the anticipated growth in the number and value of United's customers and business partners as a result of these relationships, are intended to compensate United for this reduction in revenue.

         In the third quarter of 2002, United recognized $77 million in revenues and $16 million in interest income from ULS and $10 million in commission expense and purchased services paid to ULS.  In the first nine months of 2002, United recognized $242 million in revenues and $47 million in interest income from ULS and $26 million in commission expense and purchased services paid to ULS.

Special Charges Related to September 11

        During the third quarter of 2001, United recorded a special charge of $1.3 billion in operating expense and $49 million in non-operating expense for amounts relating to the September 11 terrorist attacks and the resulting impact on the Company's schedule and operations.

         The special charge in operating expense was made up of the following (in millions):
 

         After the September 11 terrorist attacks, the Company grounded the B727-200 and B737-200 fleets and recorded a charge of $271 million, reflecting the write down of the fleets to fair value.

         Due to the changes implemented to United's operations, the Company reviewed its fleet for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No. 121").  Under SFAS No. 121, United's policy is to recognize an impairment charge when an asset's carrying value exceeds its net undiscounted future cash flows and its fair market value.  The amount of the charge is the difference between the asset's carrying value and fair market value.  Management determined that the estimated net undiscounted future cash flows generated by its B737-500 and B747-400 fleets would be less than their carrying value.  Management estimated the undiscounted future cash flows with models used by the Company in making fleet and scheduling decisions.  These models utilized the Company's projections of passenger yield, fuel costs, labor costs and other relevant factors for the markets where these aircraft will operate.  The aircraft in each of these fleets were written down to their fair market values, as estimated by management using published sources, third-party appraisals and bids received from third parties.  Accordingly, the special charge includes an impairment charge of $517 million for these aircraft fleets resulting from the anticipated decrease in future cash flows.

          Also as a result of the terrorist attacks, the Company furloughed approximately 20,000 employees across all work groups (pilots, flight attendants, mechanics, ramp service, customer service and management and salaried employees).  In connection with the furloughs, United accrued severance costs of approximately $217 million, including a one-time curtailment charge relating to the accelerated recognition of unrecognized prior service costs for certain of the Company's pension plans.

         Also included in the special charge is $107 million relating to the write-off of capital projects no longer being pursued.  As a direct result of September 11, management made the decision to terminate all funding and labor resources for numerous capitalized projects that were in-process prior to September 11 and which did not provide any immediate economic or long-term safety benefits to customers or the airline.  The projects and related amounts capitalized that were discontinued following September 11 included computer system development costs ($48 million), aircraft improvements ($33 million), airport facility improvements ($21 million) and other miscellaneous projects ($5 million).

         After management announced the furlough and the freeze on all capital expenditures, United determined that the Company was unlikely to meet certain commitments or provisions of certain executory contracts with third parties.  The executory contracts are related to agreements with state and local governments ($157 million), aircraft improvements ($11 million) and facilities and other ($13 million)

          Additionally, the Company recorded a non-operating special charge of $49 million related to certain non-operating aircraft that were leased to others.  The fair value of these aircraft was significantly impacted by the events of September 11.

         As part of the Air Transportation Safety and System Stabilization Act of 2001 (the "Act") enacted in response to the events of September 11, 2001, the federal government made $5.0 billion in federal grants available to the airline industry.  Through September 30, 2002, the Company has received a total of $782 million in grants under the Act, of which $391 million was received in the third quarter of 2001, $261 million in the fourth quarter of 2001, $80 million in the second quarter of 2002 and $50 million in the third quarter 2002.  These amounts represent the Company's total allocation of grant money under the Act.

         At December 31, 2001, United had accruals of $87 million related to the reduction in force and $171 million related to early termination fees resulting from the September 11 terrorist attacks.  During the first, second and third quarters of 2002, the Company made payments of $34 million, $5 million and $2 million, respectively, for severance and related fringe benefits to displaced employees.  As passenger demand rebounded faster than anticipated in the first quarter of 2002, the Company increased its scheduled flying beyond planned levels in April 2002 and again in June 2002.  As a result, the Company determined that fewer front-line employees would be permanently displaced, and reversed $25 million of accrued severance and related costs in the first quarter 2002 and $19 million in the second quarter.  In addition, the Company paid $11 million, $34 million and $2 million, respectively, in early termination fees during the first, second and third quarters, respectively.  During the third quarter, the Company recorded an additional $15 million in early termination fees related to commitments to state and local governments.  Accordingly, accruals remaining at September 30, 2002 were $139 million for early termination fees and $2 million for the reduction in force.

         Through September 30, 2002, the Company had received approximately $58 million related to insurance recoveries on aircraft destroyed by the September 11 attacks and approximately $12 million related to other covered expenses.  The Company anticipates that its liability from claims arising from the events of September 11, 2001 will be significant, after considering the liability protections provided for by the Act; however, the Company expects that any amounts paid on such claims will be borne by its insurance carriers as claims are resolved and, in any event, the Company believes that, under the Act, its liability will be limited to its insurance coverage.

         The Company has not incurred any material environmental obligations relating to September 11.

Contingencies and Commitments

         United has certain contingencies resulting from litigation and claims (including environmental issues) incident to the ordinary course of business.  Management believes, after considering a number of factors, including (but not limited to) the views of legal counsel, the nature of contingencies to which United is subject and its prior experience, that the ultimate disposition of these contingencies is not expected to materially affect United's consolidated financial position or results of operations.

         At September 30, 2002, commitments for the purchase of property and equipment, principally aircraft, approximated $1.6 billion, after deducting advance payments of $179 million.  An estimated $0.2 billion will be spent during the remainder of 2002, $0.5 billion in 2004 and $0.9 billion in 2005 and thereafter.  The major commitments, which include price escalations, are for the purchase of A319, A320 and B777 aircraft, which are scheduled to be delivered through 2007.  As part of its Financial Recovery Plan described below, the Company is exploring opportunities to reduce and/or defer capital spending.