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Executives

Eric Briggle - MD, IR

Gerard Arpey - Chairman and CEO

Tom Horton - EVP and CFO

Analysts

Jamie Baker - JPMorgan

Gary Chase - Barclays Capital

Mike Linenberg - Merrill Lynch

William Greene - Morgan Stanley

Ray Neidl - Calyon Securities

Hunter Keay - Stifel Nicolaus

Helane Becker - Jesup & Lamont

Bob McAdoo - Avondale Partners

Bill Mastoris - Broadpoint Capital

Kevin Crissey - UBS

AMR Corporation (AMR) Q4 2008 Earnings Call January 21, 2009 2:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the AMR fourth quarter 2008 Earnings Conference Call.

At this point, we do have all of your phone lines in a muted or in listen-only mode. After the executive team's presentation today, there will be opportunities for your questions. As a note, we'll be taking questions first from the members of the analyst community, and then after a short break, move into our immediate Q&A session. As a reminder, today's call is being recorded.

We are very pleased to have on the call with us today, AMR's Chairman and Chief Executive Officer, Gerard Arpey; and Executive Vice President of Finance and Planning, and Chief Financial Officer, Tom Horton. And here with our opening remarks is AMR's Managing Director of Investor Relations, Eric Briggle. Please go ahead Sir.

Eric Briggle

Good afternoon everyone. Thank you for joining us on today's earning call. During call Gerard Arpey will provide an overview of our performance and outlook, and then Tom Horton will provide the details regarding our earnings for the fourth quarter, along with some perspective on 2009.

After that, we'll be happy to take your questions. In the interest of time, please limit your questions to one with a follow-up.

Our earnings release earlier today contained highlights of our financial results for the quarter. This release continues to provide additional information regarding entity performance and cost guidance, which should assist you in having accurate information about our performance and outlook.

In addition, the earnings release contains reconciliations of any non-GAAP financial measurement that we may discuss. This release along with the webcast of today's call is available on the Investor Relations section of aa.com.

Finally, let me note that many of our comments today regarding our outlook for revenue and cost, as well as forecast of capacity, traffic, load factor, fuel costs, re-plans and other matters will constitute forward-looking statements. These matters are subject to a number of factors that could cause actual results to differ from our expectations.

These factors include changes in the economic, business and financial conditions, high fuel prices and other factors referred to in our SEC filings including our 2007 Annual Report on Form 10-K, and our Quarterly Report for the third quarter of 2008 on Form 10-Q.

And, with that I'll turn the call over to Gerard.

Gerard Arpey

Thank you, Eric. Good afternoon everyone. As you have seen in our press release, we reported a net loss of $2.1 billion for the full-year 2008 compared to a net profit of $504 million in 2007 including several special charges in both years.

As all of you know too well, the biggest challenge of 2008 was the price of fuel. While the cheaper oil prices have dominated the headlines for the past few months, in 2008 we paid about $2.7 billion more for fuel than we would have paid at 2007's prices. To put that in some perspective, our largest net profit in our company's history was $1.3 billion in 1998.

The run-up in fuel during the first half of the year was extraordinary, and the fall of oil prices since then has been nearly as remarkable. We took action by cutting capacity levels and by stepping up our efforts to unbundle our product, both of which were critical to our ability to weather 2008 severe storm.

As it turns out, the capacity reductions that we and our competitors put in place during the run-up in oil prices has left us, and arguably the industry in better shape as we face another significant hurdle presented by the global economic downturn. Nevertheless, one only need to look at our fourth quarter and our full-year results to see that high fuel prices left a lot of damage in their wake.

And of course now the downturn in the global economy is top of mind for everyone, it's certainly no secret that demand for air travel has declined. But while the airline industry is certainly affected by this downturn, as I mentioned, the industry's capacity reductions last year turned out to be very well timed.

I think it is fair to say that this is the first time the industry has acted proactively in front of a recession to [peer back] capacity. So the prospects for American in 2009, I think, are much better than they would have been without the capacity reductions put in place late last year.

We intend to continue our capacity discipline in the year ahead and based on the tougher economic climate that we're seeing today, we announced a modest downward revision to our capacity outlook. And as we've done in the past, we'll continue to monitor conditions and take action as necessary.

On the operations front, we had a very challenging year for a variety of reasons, some within our control and some outside of our control. We are pleased that the steps we took in the fall to address reliability issues within our control have begun to pay off. In the fourth quarter, we had very good operating performance which we expect to carry forward into this year.

Last year on this call, I pointed out how much work we had done during two profitable years in 2006 and 2007 to repair our balance sheet. Indeed those efforts proved fruitful in 2008 as many airlines scrambled to shore up their liquidity. In the fourth quarter, the credit markets tightened very significantly as everyone knows.

Fortunately, we had taken advantage of opportunities to raise cash earlier in the year. We completed the Beacon divestiture shortly before the market's melt-down. We opportunistically issued equity when we felt like we had a good opportunity. And we closed several financing transactions to bolster our liquidity.

We raised $200 million in the fourth quarter and in total, we raised nearly $2 billion during the full year 2008. Our efforts toward balance sheet repair in profitable years provided us, I think, this flexibility. And as we look forward, we will redouble our efforts towards undoing the damage to our balance sheet that we had to incur in 2008. And I think by doing this, we'll better position American to face adversity in the future and prepare for the investments, needed investments in our airline and prepare to protect all of our stakeholders.

So, we have and we will continue to take on the challenges that we see and plan for ones we don't, all the while trying to build our airline for long-term success. And as most of you know, I have been in this industry a long time. And the one thing that is certain in the airline industry is uncertainty. But I am guardedly optimistic about our prospect for 2009 against a backdrop of a very difficult economic climate.

While we'll be a smaller airline in 2009, we will be ramping up our fleet renewal with 29 new 737-800 aircraft that will be coming this year with another 39 coming in 2010 and eight more coming in early 2011. And we are very much looking forward to getting approvals from the various regulatory authorities for our application for with antitrust immunity with British Airways, Iberia, Royal Jordanian and Finnair. And once we've got those approvals, we'll be on a level playing field to be able to compete with the other alliances across the transatlantic. So we are optimistic we're going to get that done this year.

So as all I said, I'll turn it over to Tom.

Tom Horton

Thanks, Gerard, and good afternoon, everyone. As you can see, detailed in the press release, we recognized a few special items during the quarter. The most significant of these was the $103 million pension charge associated with the early retirement of pilots and a $23 million charge associated with our capacity reduction.

In the fourth quarter of 2007, we had a one-time gain of $39 million related to the expiration policy for advantage miles, a charge of $63 million for the write-down of retired MD-80s, and $138 million gain on the sale of ARINC. For the remainder of the call, I will exclude the impact of special items more accurately reflect our performance on an ongoing basis.

So excluding these special items, we lost $214 million versus a loss of $184 million in the fourth quarter of 2007, a change of $30 million. Clearly, fuel prices continued to impact our results. We started the quarter with oil spot prices near $100, and thus the average fourth quarter fuel prices remained relatively high. As a result, we paid $133 million more for fuel than we would have paid at fourth quarter '07 fuel prices.

The fall in the price of oil has been nothing short of remarkable. And while fuel may have abated for the time being, fuel prices remain volatile and we will continue to do our best to dampen that volatility through our systematic hedging program that continues to serve its purpose. That seems too often in the case in this industry, a new challenge has been posed to American Airlines and to our industry, and that is the impact of the global economic downturn and its resulting impact on demand.

Through other efforts over the past several years, we have better positioned ourselves to face troubling times and we continue to take action in light of these challenges. We've been steadfast in our view that a big part of the solution is to affect a more stable supply/demand balance. And for several years, we've taken a very disciplined approach to our capacity plans and much of the industry is now doing the same. These actions have dampened the impact of what would have been and even more challenging fourth quarter and put us on sounder footing to face the uncertainty in the year ahead.

As you may recall, in May of last year we announced capacity reductions that had first dried in the fourth quarter, with consolidated capacity down about 8.5% versus the fourth quarter of '07.

In October, we announced the discipline 2009 capacity plan, and we said that we'd be quick to act if more should be done. Given the economic uncertainty, the delay to our aircraft deliveries by a couple of month due to the Boeing strike has provided us an opportunity to further reduce capacity, albeit modestly. We have decided not to backfill expected flying from our delayed 737 deliveries with MD-80 flight.

And we are announcing a revision downward to our 2009 mainline capacity as over a point versus our previous guidance. But the revenue environment isn't the only challenge facing us this year.

As Gerard mentioned from an operational perspective, we had a challenging 2008. But, we're taking action to address those challenges in 2009 and we're excited that we'll begin executing on our fleet renewal plans with the 29 737 deliveries schedule for this year.

But with these initiatives and other cost headwinds that I'll talk about later welcome challenges from a unit cost perspective. In short, there is lot on top for 2009 but let me first recap our fourth quarter performance starting with revenues.

Our fourth quarter mainline unit revenue increased by 5.5% year-over-year on yield improvements of over 8% while unit revenue for our consolidated system was up 5.1%. While we currently face a challenging revenue environment moving forward, yield and unit revenue improvements of these levels during a tough quarter demonstrate the pricing traction possible under rational capacity levels.

In our domestic markets, fourth quarter mainline unit revenue increased by 4.8% compared to last year on over 12% less capacity as yield improvements more than offset lower load factors.

I'd like to point out that we've taken several steps over the past year to improve the customer experience. We continue to enhance our on-board food and wine offerings. We've introduced PriorityAAccess to provide a more differentiated product for our premium passengers. And we're testing a mobile phone and PDA boarding pass initiative at certain airports.

On the international front, we saw positive unit revenue growth in the fourth quarter versus '07 across all entities with yield increasing more than offsetting load factor declines.

In the aggregate, international unit revenue was up over 6% year-over- year. Latin America continued its positive performance in the fourth quarter posting a unit revenue improvement of over 7%, despite a very competitive environment in some markets. For our Pacific operations, we also saw unit revenues rise by 11%, driven by higher yields.

And finally, even as competition continues to evolve under open skies, Atlantic fourth quarter unit revenues were up about 3% versus last year on 3% less capacity.

While our fourth quarter unit revenue performance was reasonably strong, the weakening global economy was evident in the second half of the quarter, and this weakness has continued into the first quarter.

In addition, the Easter shift from the first quarter into the second quarter this year will make for a tougher comparison in the first quarter. Currently, mainline book load factors are down significantly at about 4.5 point lower versus last year with domestic down about 2.5 points, and international down nearly eight points.

Given the weakening economy, it is fortunate and a bit uncharacteristic that the airline industry appears to be the first industry to have taken actions on capacity. These actions have significantly improved the outlook for 2009 relative to what it would have been at 2008 capacity levels.

On the regional front, quarterly revenue declined by 8.5% versus last year, but much like our mainline capacity, we've been disciplined on the regional side as well. Our regional capacity was down over 12% for the quarter, resulting in unit revenue improvement of about 4% versus last year.

As many of you know, in addition to passenger travel we have other lines of business that are impacted by the economic downturn to varying degrees. We also experienced effects of the recession in our cargo business, as well as revenues associated with mileage sales.

Our cargo revenues declined significantly versus the fourth quarter of '07, declining nearly 14% on traffic deterioration that accelerated during the quarter. And in other revenue, we've seen substantial year-over-year increases from the service charges we did put in place in June, including the first [add] charge.

However, these increases were partially offset by year-over-year declines driven by our divestiture of American Beacon Advisors in the third quarter of 2008, and reduced mileage sales to our AAdvantage co-branded credit card and other AAdvantage partners, which is consistent with the broader decline in consumer and retail spending as being seen throughout the economy.

The net impact of these effects was an increase in other revenue of almost $48 million, or about 9.5% versus last year.

On the alliance front, our application for antitrust immunity with BA, Iberia, Finnair and Royal Jordanian, rest with the regulators and we have been on schedule with the customary request for follow-up information.

And as Gerard said, while we can't make promises about the outcome of that process, we believe we've made a very strong case and we continue to expect that approval will occur in the second half 2009.

Shifting to costs, while spot fuel price declines during the latter part of the fourth quarter were remarkable, the average cost over the quarter was still high by historical standards.

Our fuel price came in at $2.60 per gallon consolidated, representing an increase of almost 8% versus last year. And as mentioned earlier, this raised our consolidated fuel costs in the quarter by over $130 million.

Excluding fuel, our unit costs rose by 6.8% mainline, and 6.6% consolidated, driven by reduced capacity and headwinds from higher materials and repairs cost and increased foreign exchange charges.

Now turning to the balance sheet, we ended the quarter with $3.6 billion in cash, including $459 million in restricted cash. Hedged collateral held by counterparties totaled about $575 million at the end of the quarter.

Although down from recent levels, $3.6 billion is a sizeable amount of cash by historical standards. Nevertheless, with the damage done in 2008 by high fuel prices and given the uncertainties facing us in 2009, we continue to look for opportunities to build our financial flexibility.

Even in a challenging credit market, during the quarter we raised $200 million through a sale-leaseback transaction involving our fleet of ATR aircraft. It bears mentioning that our efforts to repair the balance sheet during profitable years provided us additional financial flexibility such that even after the financing we secured in 2008, we still have unencumbered assets and other sources of liquidity that we valued at over $3.5 billion.

In the fourth quarter, our scheduled principal payments on long-term debt and capital leases totaled over $180 million, and our capital expenditures totaled about $190 million.

Our total debt as defined in the earnings release is now $15.1 billion, down from $15.6 billion last year. Our net debt defined as total debt plus unrestricted cash and short-term investments is now $12 billion.

This is the first year-over-year increase in net debt since 2002, and while we've made a lot of progress in whittling it down from a high of almost $19 billion at the end of '02, it highlights the need for us to regain the momentum on the balance sheet that we lost during 2008 when fuel prices eroded much of what we'd accomplice.

Looking forward to this year, I want to first touch on capacity. Obviously, the direction of the economy remains a big uncertainty as we enter the New Year.

As I mentioned at the beginning of my remarks, due to the delay of our 737, 800 deliveries caused by the Boeing strike, and given the uncertainty around the economy, we think it's sensible to revise our capacity downward for 2009.

We now expect mainline system capacity to be down over 6.5% versus 2008, more than a point lower versus our last guidance.

On a year-over-year basis, we expect mainline domestic capacity for the year to decrease by about 9% and mainline international to be down over 2.5%.

Within 2009, we expect the first quarter to see the steepest year-over-year capacity decline with mainline and consolidated capacity expected to be down over 8.5%. With a decline of this magnitude comes significant unit cost pressure.

We've done a lot over the past years to extract cost from our systems, and in terms of ex-fuel, ex-labor unit cost, on an absolute basis, we've consistently been at or near the best of the big five for years.

We continue to be diligent towards finding additional cost savings, and this year we're targeting another $130 million. That said, our operational performance last year was at par, and so we're making some investments in our operation to improve dependability and the customer experience. We've put some of these initiatives in place in the fourth quarter and we've already seen some improvement in our dependability metrics both on an absolute and on a relative basis.

In addition to our dependability initiatives, we're fighting several cost headwinds with some specific to us and other airlines, and others the type of cost pressures that many companies are facing. As you know, unlike most of our peers who have terminated or frozen their defined benefit pension plans, we have preserved our plans and continue to meet this important commitment to employees.

And while we believe through responsible stewardship of our pension asset, our pension asset performance compared well relative to that of other companies amid the severe market downturn. Pension expense is increasing dramatically due to the asset value declines. This alone represents three points of our forecasted ex-fuel unit cost increase.

Other cost pressures come from rising employee and retiree medical expense and other inflation factors. Increased facility costs and landing fees, additional aircraft rent associated with the sale-leaseback transaction on our 737 deliveries and other cost headwinds from our capacity reduction.

That said, in the first quarter, we expect our ex-fuel mainline unit cost to increase about 10% year-over-year, and consolidated unit cost to increase 9%. And we anticipate 2009 full year mainline ex-fuel unit cost to increase by about 9% and consolidated to increase by about 7.5%.

Our fuel expectations are a different story. On a consolidated basis, we forecast our first quarter fuel price of $2.04 per gallon and a full year price of $2.06 per gallon.

With regards to hedging, we have 42% of first quarter consumption hedged with floors at $68 a barrel on a crude equivalent basis, and cap on 45% of consumption at $93 per barrel. And a full year hedge of about 32% of consumption with floors at an average price of $67 per barrel and 35% of consumption capped at $94 per barrel.

As of January 16th, the average 2009 market forward price for crude was $51 per barrel. In total for 2009, we expect to pay about $2.7 billion less than we would pay at 2008 prices. This decrease in fuel expense will result in full year total unit cost improvement of about 6.5% for mainline and about 7% consolidated versus 2008.

With the fuel price volatility we've seen over the past year, fuel hedging has certainly dominated the headlines. And I would like to take a minute to say a few words about our program. From early this decade, when we couldn't afford to hedge very much until today, we have steadily built up a systematic hedging program that is designed to dampen the impact of fuel price volatility, and it is not designed to take risky speculative bets on what we believe the price will be at a specific point in the future.

In periods the fuel prices rise, hedges can buffer expense increase, while the periods where fuel prices are falling, hedges will offset some of that favorable impact. We believe this approach has served us well and for the full year 2008, our hedging program lowered our fuel expense by over $380 million.

Moving to cash forecast. Our principal payments on long-term debt are expected to equal about $1.8 billion with the principal portion of our capital lease payments accounting for an additional $110 million. These are sizable outflows, but with these payments include maturities of two EETCs and our revolver that we expect will unencumber about $1.2 billion worth of assets.

In terms of the pension, as I mentioned earlier, it's no secret that the broader market have seen a significant decline in most asset classes. Accordingly, the asset value of our pension plan has declined significantly. Due to our high pension funding levels last year, we had no minimum obligation for this year. And given the uncertainty in the economy, we have not yet decided our expected funding for 2009.

This year we expect capital expenditures to total about $1.6 billion. We expect our non-aircraft CapEx for 2009 to be about $500 million, which includes investments in our Boston and Heathrow Admirals Club, interior modifications to our 767-200 aircraft, and we're converting 18 of our 757's to support international flying that will include coach and business class cabin upgrades. It bears noting that we have committed financing for all of our 2009 aircraft deliveries, totaling approximately $1 billion from mortgages and sale-leasebacks associated with these deliveries.

So we continue to take a measured approach to our capital with the aim being to make sound investments in our business that will help keep American Airlines strong and competitive for the long-term.

So to conclude, there's a lot of uncertainty around where 2009 will take us. The near term revenue environment will present a significant challenge, but we've taken meaningful steps to reduce capacity in front of this weakness while fuel has declined substantially.

So with that, Gerard and I would be happy to take your questions regarding our quarterly results.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question today will come from the line of Jamie Baker with JPMorgan, and your line is open.

Jamie Baker - JPMorgan

Good afternoon. A question for Gerard or Tom. You moved last year to strengthen and enhance the value of the Infinity agreement with Citi. But you didn't do a forward mileage sales I recall, which is something that at least we've been assuming you may still have in your back pocket should you seek additional liquidity.

First question is, if there is any allowance for this in the $3.5 billion unencumbered asset level that you identify? Second, do you care to share any thoughts or comments given the situation at Citi and whether a mileage sale is still something that externally we should be considering?

Gerard Arpey

Yes, Jamie, it's a very good question. You are correct. We have not capped a forward mileage sale as many of our competitors have. So, we do contribute do that a potential source of liquidity moving forward and it is reflected in the $3.5 billion, I mentioned earlier.

Jamie Baker - JPMorgan

Okay. That's helpful. That'll be good.

Gerard Arpey

Thank you, Jamie.

Operator

Thank you. Our next question in the queue that will come from the line of Gary Chase with Barclays Capital and your line is open.

Gary Chase - Barclays Capital

Good afternoon.

Gerard Arpey

Hi, Gary.

Gary Chase - Barclays Capital

Two questions for you. First on the dependability initiatives that you described, sounds like the pension headwind year-on-year is about $400 million; do you have a dollar amount in the caseum that comes from trying to run a better operation the way you described in the release?

Gerard Arpey

Gary, I think you're pretty accurate on the pension number, its north of $400 million and dependability, initiatives plus or minus about a $100 million.

Gary Chase - Barclays Capital

And then when you give the book load factors, its been a little confusing over the last couple of years because it feels like those have been all over the place to a much a greater extent in the revenue trend. Can you help us think about what it might mean to be running at down eight book load factor internationally and down two domestic? Maybe could you give us some perspective on where we started the fourth quarter with an overall load factor that was only down two?

Tom Horton

Well, Gary, it's Tom. I wish I knew the answer to that question. I mean I think its going be dependent partly on -- how the economy starts off the year and how progressive it is during the first half of the year. And I don't think any of us have totally good visibility on that. At this point, as I mentioned our first quarter system book load factor is down 4.5 points. One point I would make to you though is that the Easter shift historically accounts for about one to two points of load factor from March into April.

So that's going to be driving a portion of the decline, but clearly, we're in an environment where demand is weak. You just to have look at our fourth quarter results and even though our RASM was respectable, we had 10% less traffic. And I think sometimes that gets lost in the -- when we all look at RASM and load factors and things like that, but we had 10% less traffic on our airline.

Gary Chase - Barclays Capital

Is there a way to think go about this on a trend line, like you've been running down one or two, and now it's down 4.5?

Tom Horton

I think it's too early to say. I really do. I just don't know. It depends. It is conceivable that we would have some stronger build later in the quarter. But as we look at the quarter right now, it's down and March, in particular looks weak.

Gerard Arpey

I think, Gary, it's somewhat indicative of other markets, not that it's a perfect analogy, but I think there is a lot of volatility generally and I think we have a lot of volatility in advanced bookings. So, I wouldn't be surprised to see advanced bookings build closer into the actual travel date in light of the economic climate we're in. So I agree with Tom, I think it's too early to tell.

Gary Chase - Barclays Capital

Okay. Thanks.

Gerard Arpey

Thank you, Gary.

Operator

Our next question in queue that will come from the line of Mike Linenberg with Merrill Lynch. Please go ahead.

Mike Linenberg - Merrill Lynch

Yes, just two questions on that pension, Tom. I just want to make sure I heard correctly for 2009, there you are not required to make any cash contributions, is that right?

Tom Horton

That's correct, Mike.

Mike Linenberg - Merrill Lynch

Okay, good. And then just my second, in the press release you gave us the ABO funded status, 69%. Is that a GAAP calculation or is that an ERISA calculation?

Tom Horton

That's a GAAP calculation.

Mike Linenberg - Merrill Lynch

Okay, that's it. Thanks.

Tom Horton

You bet.

Operator

Thank you. And the next question in queue that will come from the line of William Greene with Morgan Stanley. Please go ahead.

William Greene - Morgan Stanley

Hi. Can I follow-up a little bit on Gary's question? Gerard, you'd mentioned that the industry and American in particular had benefited so much from cutting in advance, the changes, particularly in the domestic market on the demand side.

Gerard Arpey

Right.

William Greene - Morgan Stanley

And yet we're not really cutting that much in the way of international capacity at this point yet, load factors are down 8 points. So why wouldn't you be cutting a lot more at this point just to address that before it happens, because I think it's inevitable that we'll see a slowdown in international more sooner than we are already seeing.

Gerard Arpey

Bill we were not aggressively adding international capacity last year like many of our competitors. And as I indicated in my remarks, we're going to be looking at capacity very carefully this year and looking at economic trends just as we did last year at this time. And if it would be prudent to make a cut in our international capacity or our domestic capacity, we'll be prepared to do that.

It's difficult as that is to do but I think, as we sit here today we're not prepared to take that step based on what we're looking at but we're certainly watching the trends very carefully and we'll be prepared to act in a manner similar to what we did last year if we think that's prudent.

Tom Horton

Well, I think we said last year, as maybe others in the industry were adding international capacity faster than we were that this industry has a tendency to overshoot and try to chase profitability, and with kind of a bad ultimate effect, and we did not add a lot of international capacity when it looked like perhaps that was the tractionable thing to do. So as a consequence, I think we probably have less to pull down today but as Gerard said, we're going to keep a close eye on it throughout the year, and if that makes sense that's right, there is something we'll do.

William Greene - Morgan Stanley

Okay. And then on your CASM ex-fuel guidance, does that include a profit sharing assumption for 2009?

Tom Horton

It does not.

William Greene - Morgan Stanley

Okay. Thanks for your help.

Operator

Thank you. And the next question in queue that will come from the line of Ray Neidl with Calyon Securities. And your line is open.

Ray Neidl - Calyon Securities

Yeah, just some general things. Regarding the FAA with some of the investigations they're doing, is there potential of a large cash liability for any fines that they may put to American?

Gerard Arpey

Not that I'm aware of, Ray.

Ray Neidl - Calyon Securities

Okay. And as far as the unencumbered assets that you talked about, the $3.5 billion, you commented on one item that might be in there. What are some of the other items? Is it pretty much unencumbered value on aircraft and ground facilities, as well as maybe your loyalty program or things like that, is that what you're are calculating in there?

Tom Horton

You hit the nail on the head; it's all of those things. We've also got a big portfolio of Heathrow slots. We've never encumbered that, aircraft and the frequent flyer program, and then some other corporate real state type assets. So it's a collection of things.

Ray Neidl - Calyon Securities

Okay. And then finally, British Airways; if they don't get antitrust they have been talking about dropping out of the alliance. Is there any danger there?

Tom Horton

Ray, I certainly read those comments from BA's Chairman with interest, and having not been there during that discussion, I'm not sure exactly in what contacts those comments were made but I think I would just come back to the fact that global alliance is a very strong alliance. It represents, we believe the best global brands in the world.

Oneworld is designed to emphasize quality over quantity, and it's no secret that we have felt to some degree handicapped by the fact that we don't have immunity across the North Atlantic, and we very much want to level that playing field so we can compete effectively with Star and SkyTeam. And based on the facts, if the facts guide the regulators, we will get that playing field leveled this year, and that will be a good thing for American, it will be a good thing for Oneworld.

If we don't get it approved this year, which I think would be unlikely; I do not think that that spells the end of Oneworld.

Ray Neidl - Calyon Securities

Okay.

Tom Horton

I think it would be a big setback, it would be a disappointment. But it would not be in my view, the end of oneworld by any means.

Ray Neidl - Calyon Securities

Okay, great. Thanks.

Tom Horton

Thank you.

Operator

Thank you. And the next question in the queue that will come from the line of Hunter Keay with Stifel Nicolaus. Please go ahead.

Hunter Keay - Stifel Nicolaus

Hey guys, thank you very much. Question, can you just enlighten us to sort of, without getting to specifics, just sort of procedurally how the change in presidential administration is going to impact things, your labor relations with NMB. I assume media (inaudible) will remain in place.

But I am just wondering if there is going to be any kind of impact that we may not be aware of in terms of shift the people that are involved or any kind of major change in say philosophy from NMB given the new appointments or any kind of reversal of groundwork that may have already been put in place which regarding the negotiations you've already done so far.

Gerard Arpey

Well, Hunter, I really don't know how to respond to that because I just think it's hard to say. You've got a change in administration and party, and you're going to have lots of players change in all kinds of organizations in Washington. So, I think to predict the implications of that for our company or labour negotiations, I think it's very difficult at this point to say.

I don't think it changes at although our approach to our labour negotiation, I think we are going to continue to try to strike the right balance towards trying to get ratified agreements with all of our unions that on the one hand protect the long-term interest of our employees and on the other hand allow our company to be competitive.

Because, if the company doesn't have a competitive cost structure over the long run, then it will be bad for the employees, so we're trying to strike that balance have reached to common ground with organized labour remains our objective. So, I don't think that changes irrespective of what happens in Washington.

Hunter Keay - Stifel Nicolaus

Sure. Again, of course, I actually understand that, but just in terms of the media that's going to be involved, I mean there is not going to be anything, I don't know if it's going to be disrupted in terms of sort of who you are dealing with in that regard. I mean there should be no potential change there right in terms of media that's involved in dealing with the unions, just because of the presidential confession change.

Gerard Arpey

No, I don't think that that is the seminal, there will be seminal, any seminal changes there.

Hunter Keay - Stifel Nicolaus

Okay, great. And, just one quick follow-up. With regard to the impact of the delays from the craft deliveries because of the Boeing strike, is there going to be any kind of incremental cash flow tail end here or maybe expense you have budget for that might be helping a little than the cash flow line in '09, in terms of deposits and what not.

Gerard Arpey

Yes, a little bit, Hunter. It's reflected in the CapEx and financing numbers that I quoted.

Hunter Keay - Stifel Nicolaus

Okay, very good. Thank you.

Operator

Thank you, and our next question in queue that will come from the line of Helane Becker with Jesup & Lamont. Please go ahead.

Helane Becker - Jesup & Lamont

Thank you very much, operator. Hi, gentlemen.

Gerard Arpey

Hi, Helane.

Tom Horton

Hi.

Helane Becker - Jesup & Lamont

So I just have two questions. One is with respect to the salary line in the fourth quarter. I would think that with capacity coming down that number should not be increasing so much. So, could you talk about third quarter or fourth quarter, could you talk about what was in those numbers that would cause it to the do that? And how we should think about it in the first quarter?

Tom Horton

Yes, Helane, I think most of what's going on that you are seeing is the special charges. We called out the $100 million pension charges in there, and then much of the severance charges in there as well.

Helane Becker - Jesup & Lamont

Okay. And then in terms of as we think about the pricing and the demand, normally we would see capacity or rather traffic down something on the order of 5% or 7% or 10%, and we would see airlines quick to cut prices. But you don't seem so much to be doing that in the first quarter of '09. Can you just talk a little bit about how you think about that and whether or not you can hold the line on prices going forward?

Tom Horton

Well, I think that remains to be seen. Obviously, our view is that air travel remains incredible bargain and thus is underpriced. And you'll have to keep an eye on the demand environment where every day our revenue management guys are out there trying to make the right trade-off between fares and availability and demand to maximize our revenue. They do that on a market-by-market, flight-by-flight basis and we'll continue to do that.

So I think as we've seen in the latter part of the last quarter and rolling into this quarter, while fare levels have remained relatively tame, we have seen some shift in the fare mix and that's reflected in the yield numbers. So, we're just going to keep managing that on a day-by-day basis, try to maximize our revenue.

Gerard Arpey

So, Helane, the only thing I would add to that is I think if you look historically at our company, I think you'll see that we have been consistent capacity either reducers or constrainer, consistent price leaders in terms of increasing prices and we certainly have advocated or initiated a number of service charges that we believe are appropriate and serve the industry well.

So, going forward, I think that those principles will continue to guide us, but certainly we have to be mindful of elasticity. We got to be mindful of what our competitors are doing. but those kind of the philosophy of being disciplined about capacity, raising prices, because I agree with Tom, airfares have been an extraordinary bargain since 9/11, and unbundling in charging modest service charges are all appropriate and needed ways to raise revenue in an industry that needs more revenue, so that it can produce the profits that it needs to continue to reinvest in itself. And, of course there has been a lot of dislocation in the industry because of desperate hedging positions that have led to different views on pricing and capacity. And that just is what it is. It hasn't been helpful.

Helane Becker - Jesup & Lamont

Got you. Thank you very much.

Gerard Arpey

Thank you, Helane.

Operator

Thank you and our next question in queue that will come from the line of Bob McAdoo with Avondale Partners and your line is open.

Bob McAdoo - Avondale Partners

Thank you, just another round on the pension question. If you could talk to me about what the accounting rules are, what the process is. Give us a couple of kind of points here on $400 million and three points in your CASM. When there is a shortfall, because of pension asset performance in the year, how do they calculate what needs to be made up and how quick it needs to be made up? How much has to be piled in to '09 versus future years of a short fall that occurred because of losses in '08 how does that work?

Tom Horton

Bob, this is Tom. It gets amortized in over a period of time, and in our case, that's approximately 12 years. So that's given rise to this year's increase in pension expense. Tom, when we get to this time next year we will have had a meaningful rise in the pension assets owing to stronger returns in '09. I don't know whether that will happen or not, but if it does, it may mean that we have the converse effect next year. So we'll just to have wait and see. This is obviously an extraordinary year from a return standpoint across all asset classes.

I will say that Bill Clinton and American Beacon Advisors who manage our pension money have done a terrific job even in a very difficult market and as a consequence our asset return on average was roughly a negative 19%, which while it's a very unhappy story, I think that will compare pretty well to…

Bob McAdoo - Avondale Partners

It beats negative 35 and 40.

Tom Horton

Exactly.

Bob McAdoo - Avondale Partners

One other quick thing. Gerard, I think earlier a couple of quarters ago or so had said when he was looking at all the kinds of things that might happen that we might be able to do, go out and get money. One of the kind of the single biggest item was this whole issue of bag -- charging to check bags. And as I recall, there were some number upwards of 300 million it seems likely the number that you guys quoted and I am curious is that number turning out to be anywhere near the right number and on what line do you find those kind of dollars or is it varied in terms of what line in the revenue stream?

Gerard Arpey

It's in the other revenue line, and it's pretty much tracking with the run rate we had expected.

Bob McAdoo - Avondale Partners

Okay. One last quick one. When Obama put out this regulation, this thing it stopped all changes in regulations that were being considered or in process or whatever. Does that have any effect on this issue of trying to force people to give up slots at LaGuardia? Does that put a hold on that?

Gerard Arpey

I think that's a good question, Bob, that I don't know the answer too.

Bob McAdoo - Avondale Partners

Okay. Thank you.

Operator

Thank you. And our next question in queue that will come from the line of Bill Mastoris with Broadpoint Capital. And your line is open.

Bill Mastoris - Broadpoint Capital

Thank you. Tom, recognizing that we're in the most difficult credit market environment certainly in either one of our careers, but also giving account to the fact you got a lot of collateral as you previously indicated that's free enough. I'm wondering do you have financing lined out for anyone of the following transaction due to the spare parts deal, which matures obviously in February and the EETC transaction which I think matures right around mid October. I know you have back stuff financing but are there any other transactions for which at least there is at least a letter of intent or there is a reasonable certainty that at least a portion is going to be refinanced?

Tom Horton

We do not have anything lined up for either of those Bill. Though, as I mentioned earlier we got pretty good tool on encumbered assets, which will increase as we pay down some of the debt that has collateral associated with it. So, I think we're going to have to wait and see how the capital markets evolve, but when they do begin to thaw I think we have got a pretty good story to tell and pretty good pool of assets to finance against.

And as you pointed out it was pretty good that we last year were very aggressive in financing and got a little bit ahead of this situation particularly with respect to our new deliveries coming in 2009. Those all being financed, but I think we're going to have wait and see how the capital markets behave this year.

Bill Mastoris - Broadpoint Capital

And, Tom, I assume the same is also true, I skipped over the bank debt agreement. I assume the same comments are also true for the collateral which would be free for the bank debt, is that correct?

Thomas Horton

That is correct.

Bill Mastoris - Broadpoint Capital

Okay. Historically, you have indicated in the past you'd like to maintain a much higher liquidity position then what is now I think it is about a 15% liquidity position as a percent of LTM revenues, I think historically in the past you preferred anywhere between 20-25 which is where you've been in the past. Where would you anticipate you might be at year end?

Tom Horton

Well, we're not ready to comment on that just yet. We don't typically forecast our cash. But I will say that I think holding higher cash balances has served our company well as we've gone into this period of incredible market turmoil.

And one of the reasons we've carried higher cash balances in the last year or so has been that, given the state of the industry, it's very difficult to have a sensible standby credit facility as you might in another sensible industry, if you can find a sensible industry right now. And so, we think it's made a lot of sense to keep ourselves more liquid and financially flexible. And we'll continue to do so.

Bill Mastoris - Broadpoint Capital

Okay. Thank you.

Operator

Thank you, and ladies and gentlemen, this will be our last question for this session of the analyst Q&A. Next question will come from the line of Kevin Crissey of UBS. Please go ahead.

Kevin Crissey - UBS

Hey, good afternoon, everybody.

Gerard Arpey

Hi, Kevin.

Kevin Crissey - UBS

When I look at your CASM ex-fuel guidance, I think it's reasonably high. Does it include any accrual for labor increases?

Gerard Arpey

It does not, Kevin. We don't have any insight on that. And so, we're not going to guess at it.

But it certainly appreciates your perspective on that, Kevin. But if you take out oil from our cost guidance for the year, our expenses are up $125 million, but if you take out, what Tom talked about, the [pension bad guy] is over $400 million. So if you neutralize for that or set that aside, our expenses are down on a budget basis about 2% on 6.5%, 7% reduction in capacity.

If you take out fuel and the [pension bad guy], I think we haven't lost sight of managing our cost in this tough environment, but it is more difficult when you are reducing capacity to control your unit cost obviously then when you are increasing your capacity. So, we worked hard on our budgets for this year with an eye towards continued vigilance on the cost front, but also some reinvestment in the quality of our product which we think will pay dividends on the revenue side of the equation.

And so we'll continue to work the cost side along with the revenue side throughout the years and if we can do better, we will, on both fronts.

Kevin Crissey - UBS

Thanks. And the last follow-up would be on foreign exchange, and you may have touched on there. I may have missed it, just there's been a lot of detail here. If the foreign exchange stays where it is today, which seems at this point headwinds, what does that create from a RASM perspective?

Tom Horton

Well, it is a headwind. I don't know if I can give you a number right at hand, but you are quite right that the strength of the dollar has impacted our business in the various markets we operated around the world, not just on the Atlantic and Pacific, but also in Latin America where if you just look at the fourth quarter results, we saw an impact from the stronger dollar on particularly the premium, Kevin.

Kevin Crissey - UBS

And that's the translation effect, Tom? Because there should be some booking benefit right from point of sale going to the U.S., or am I wrong on that?

Tom Horton

Well, the net effect we find is negative.

Kevin Crissey - UBS

Okay. Thank you very much.

Tom Horton

You bet.

Operator

Thank you. And ladies and gentlemen, members of the analyst and financial community, that does conclude your question-and-answer session for today. After a brief break, we will begin the media Q&A session.

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