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AMR Corporation (AMR)

Q2 2007 Earnings Call

July 18, 2007 2:00 pm ET

Executives

Gerard Arpey - Chairman, President and CEO

Kenji Hashimoto - MD of IR

Tom Horton - CFO, EVP Finance

Analysts

Mike Linenberg - Merrill Lynch

Robert Barry - Goldman Sachs

Frank Boroch - Bear Stearns

Kevin Crissey - UBS

Jamie Baker - J.P. Morgan

Gary Chase - Lehman Brothers

Dan McKenzie - Credit Suisse

Ray Neidl - Calyon Securities

Andrew Light - Citigroup

William Greene - Morgan Stanley

Presentation

Operator

Ladies and gentlemen, thank you very much for standing by. We do appreciate your patience today while the conference assembled and good afternoon. Welcome to American Airlines Second Quarter 2007 Earnings Conference Call. Now, at this point and during the presentation we do have all of your muted or in a listen-only mode. However, after the executive team's prepared remarks, there will be opportunities for your questions.

Now just as a note, we will be taking questions first from the members of the analyst community that have joined us and then immediately after their session, moving into the media portion of the call (Operator Instructions).

And as a reminder, today's call is being recorded for replay purposes. So with that being said, let's get right to the second-quarter agenda. Here is our host, Chairman and Chief Executive Officer, Mr. Gerard Arpey. Good afternoon, sir. The floor is yours.

Gerard Arpey

Okay. Good afternoon. We're actually going to start with Kenji, so over to you, Kenji.

Kenji Hashimoto

Thank you. Good afternoon, everyone. Thank you for joining us on today's earnings call. Similar to last quarter, Gerard will provide an overview of our performance and then Tom will provide the details regarding our earnings for the second quarter along with some perspective on the remainder of 2007. After that, we will be happy to take your questions. In the interest of time, please limit your questions to one with one follow-up.

Our earnings release earlier today contains 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.

The earnings release along with the webcast of today's call and reconciliations wise is posted on the investor relations section of AA.com. Slide deck in conjunction with the earnings release contains a reconciliation of any non-GAAP financial measurement we may discuss and we encourage you to view the press release as well as the slide deck during the course of this call.

Finally, let me note that many of our comments today and our outlook for revenue and earnings, cost estimates, and forecasts of capacity, traffic, load factor, fuel costs, 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 economic, business and financial condition, high fuel prices, and other factors referred to in our SEC filings including our 2006 annual report on Form 10-K/A.

With that, I will turn the call over to Gerard.

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Gerard Arpey

Okay. Good afternoon, everyone. Thank you, Kenji. As you’d have all seen in our press release and despite our many difficulties with Mother Nature and near record fuel prices, we earned a second quarter net profit of $317 million, which was $26 million better than the second quarter of 2006's net profit of $291 million.

This is the largest quarterly profit since we launched the turnaround plan more than four years ago. Our performance is a testament to the hard work and perseverance of the thousands of employees who tirelessly work to keep our customers safe during a truly unique and trying quarter of weather challenges. I want to thank take this opportunity to thank all of my co-workers along with our patient customers who experienced the inevitable challenges bad weather can throw at us.

Our financial performance can be measured in many ways; profitability, balance sheet strength, pension funding, and reinvestment in our products and services and on all these measures, we have been continuing our positive momentum. This progress has been achieved despite the intense competition and high fuel prices that continue to afflict our industry. And while we have a lot of work left to do to increase profitability further, which will help us build a stronger financial foundation, our pattern of results gives us a great deal of confidence in our belief that we are on the right track.

There is a lot more behind these positive results, so let me turn the call over to Tom Horton to take you through some details regarding our second quarter performance and our outlook for the remainder of the year and then Tom and I will be happy to answer your questions. Over to you, Tom.

Tom Horton

Thanks, Gerard and good afternoon, everyone. Before we recap the highlights of the quarter's results, I don't think enough can be said about the tremendous efforts everyone in this company put in this past quarter. I'm sure everybody on the call has heard about the extraordinary weather we have experienced in North Texas. Let me just put it in some perspective.

DFW Airport received over 11 inches of rain during the month of June, which compares to an average of three inches in a normal June. And the last time we got more than 11 inches of rain was in June of 1928. DFW had 19 days of rain in June and 21 days of rain in May. As a result, six counties surrounding the Dallas-Fort Worth area have been declared federal disaster areas.

Of course, this rain came in the form of thunderstorms, which causes delays, diversions, and ramp closures at the airports. This caused us to cancel an exceptional number of flights and incur many flight delays to keep our customers and our employees safe. Due to the weather impact and as previously disclosed on June 22nd, during the period from April 1st through June 20th, we canceled 1.8% of our second quarter mainline departures.

Thereafter, we had more than 1,000 weather related cancellations during the last ten days of June, increasing total weather related cancellations during the quarter to 2.1% of second quarter scheduled mainline departures. These weather events had a negative impact on our profitability as we incurred overtime and burned additional fuel due to reroutings, diversions and additional time on the taxiways. However, the largest impact to our profitability was in the revenue line.

In many cases, when we have a cancellation, we are able to reaccommodate many of the customers on other flights. This is part of our network and schedule strength. However, as all of you know, we had very high load factors in the entire quarter. These loads, especially in late June when we had many days with load factors over 90%, made it difficult to retain as much revenue as originally booked. So these exceptionally high load factors, combined with exceptional weather, negatively impacted our revenue and profitability.

We will get into a few details as we go through the numbers, but our analysis shows that the adverse earnings impact caused by bad weather in the second quarter was approximately $36 million or $0.12 per diluted share. Now, we should definitely keep the weather impact in perspective.

By all other measures, this was a very strong quarter for AMR and a demonstration of our continued momentum despite weather and high fuel prices. We've had five consecutive profitable quarters and this is our largest net profit since launching the turnaround plan back in 2003.

We still have a long way to go, but we believe we're moving down the right track by continuing our capacity discipline while we strengthen our balance sheet and reinvest in key products, services, and in our fleet. Our goal of building American Airlines for long-term success is most definitely a balancing act. And as we walk through the details in a moment, I think you will see how we are striking that balance in the interest of customers, employees, and shareholders.

So, moving to the numbers, let's start with our second quarter revenue performance. For the quarter, mainline unit revenue increased by 3.6% year-over-year on record load factors while unit revenue for our consolidated system was up 2.6%. As we discussed last quarter, our comps are clearly tougher with the first and second quarter of 2006 having double-digit unit revenue improvements versus 2005. And as you just heard, weather also had a significant impact on our revenue results and we estimate that this drove our consolidated revenue and down nearly $50 million.

Before we get started on the entity specific results, I want to remind you that similar to last quarter, we have placed this data in the earnings release for your convenience. In our domestic markets, second-quarter unit revenue increased versus last year. Similar to last quarter, unit revenue improvements were particularly strong in transcon.

As noted in the Eagle Eye, we issued on June 22nd, our revenue results are not yet impacted by changes in our AAdvantage Frequent Flyer Program. The recently announced change to 18 months expiration of miles will be effective December 15th of this year. At that time, we will recognize the effect of expiring miles.

One item I would like to note is our new booking tool on AA.com that allows you to look at price and schedule simultaneously, which allows customers to best balance their price and schedule needs. This has been a very popular feature for our 1.2 million daily website visitors.

International continued to be strong and second quarter unit revenue increased versus 2006, primarily on yield improvement. We had positive performance across all entities with all having RASM improvement. Specific strong performance was influenced by our cancellations of Dallas-Osaka and San Jose-Tokyo at the end of October, 2006 as we have retained some of that traffic over our other Japan routes. Atlantic's second-quarter unit revenue performance versus last year also improved. And there’s a lot going on to upgrade our product.

As a follow-up to discussions we had several months ago, we continue to make progress on upgrading our business class seats on our 777 and 767-300 aircraft. At this point, we have 35 of 58 767-300s with the new product and we expect that project to be complete by the end of this year.

I’d like to note that our maintenance and engineering folks have done an outstanding job in turning around these planes. In addition, on the 777, the first-class product will be standardized around our Flagship Suite by the end of this year. And the next generation business class seat will be on the entire 777 fleet by mid 2008.

As we announced two weeks ago, we are moving one of our daily Dallas/Fort Worth and the Raleigh/Durham services from London Gatwick to London Heathrow as we take advantage of the open skies agreements between the EU and the U.S. These frequencies will be served with 777 aircraft.

In addition, we are ramping up to two daily JFK to London-Stansted services using 767-300s. That will give us a total of 20 daily frequencies to London, the most of any U.S. carrier.

The Stansted service will complement our other European services out of our new JFK terminal. Many of you have already experienced the new terminal as we have brought portions of it on line. However, it’s expected to be fully complete by August of this year.

The terminal will have 84 ticketing positions, security checkpoints capable of handling 1800 customers per hour, a new U.S. Customs and Immigration facility which can handle 1600 customers per hour, two new Admirals Club lounges, as well as a new Flagship Lounge for international first-class customers with total lounge seating for 460 people.

And finally, in Latin America, we continue to see positive performance as unit revenue increased despite last year's second quarter increase of 18%, which made comparisons especially difficult. Some recent news in this region is that we've bolstered our South Florida service to important Latin American markets. Specifically, we have larger aircraft on service from Fort Lauderdale to San Juan and Port of Prince along with new service to San Jose, Costa Rica, and Santo Domingo.

Second quarter revenue for our regional affiliate operation decreased by 6.3% compared to last year as weather had a negative impact. In addition, we continue to be negatively impacted by increased low-cost carrier overlap on some of our Northeast routes.

Turning now to our cargo operation, for the second quarter, total cargo revenue decreased by 2.9% year-over-year. Freight revenue, including fuel surcharge, was down 5%. While mail revenue did increase 13% this quarter versus last year, we expect mail and cargo revenue to be down in the third quarter on lower freight and mail traffic year-over-year.

Finally, in the second quarter, our other revenue line was basically flat at $348 million. This was a tougher comparison as the line increased 20% year-over-year in the second quarter of last year. We continue to search for sensible business opportunities in our third-party maintenance area and we are hopeful we can build off our current portfolio of business as the year progresses.

In addition, you may have seen that we launched a new redesigned website for our AA Vacations division at AAVacations.com. This site gives customers the ability to view and compare individual trip components, such as air, hotel, car, and activities and then see how their choices affect the pricing.

Moving on to expenses, similar to the top line, we had significant impact on our unit costs driven by the weather. We estimate the impact to have increased mainline unit costs by about 1.2 points. Our unit costs, excluding fuel, rose by 3.5% mainline and 3.8% consolidated.

Our fuel price did come in better than we anticipated as we recorded a gain of $15 million related to our hedging program. The gain as a result of the value of our hedging instrument, in this case, heating oil prices, increasing more than jet fuel prices. Excluding this accounting impact, we would have had a fuel price of $2.10 per gallon consolidated.

Despite the somewhat improved fuel price versus last year, fuel prices still remain historically high and volatile. So, fuel conservation continues to be one of our top priorities as we continue to explore opportunities for more savings.

One of the highlights of this focus is installation of winglets on our 737 and 757 fleet. We currently have completed about three quarters of the 737 fleet and about one quarter of the 757 fleet. We expect to be complete on all the 737s by the fourth quarter of this year, and on the entire 757 fleet by the fourth quarter of next year.

Moving to non-operating costs, they were better year-over-year by $35 million in the quarter, driven by improvements in both interest income and interest expense as we had both higher cash balances and lower debt balances.

Now, turning to the balance sheet, we ended the quarter with $6.4 billion in cash, including $470 million in restricted cash. In the second quarter, our scheduled principal repayments on long-term debt and capital leases totaled $168 million, which leaves a remaining $900 million in payments for the second half.

In addition, we amended the $442 million floating rate term loan portion of our credit facility. We prepaid $48 million of Eagle aircraft debt, we refinanced $128 million of DFW tax-exempt bonds, and refinanced $109 million of Chicago O'Hare tax-exempt bonds. In each refinancing we reduced the interest rate by 1.25 to 3.25 percentage points. These efforts follow similar actions in the first quarter of 2007, and taken together, result in the elimination of $27 million in annual net interest expense.

As we've stated last quarter, although conditions can always change, at this point, we continue to feel more confident in our ability to achieve the necessary balance sheet improvement through internally generated cash flow. And as we have said before, going forward, depending on market conditions, our cash position, and other considerations, we may, from time to time, redeem repurchase our debt or take other steps to reduce our debt or lease obligations.

Our capital expenditures totaled $154 million in the second quarter. On the pension front, we contributed $118 million to our defined benefit pension plan in the second quarter and we made an additional $86 million contribution on July 13 for a total of $266 million so far this year.

These contributions are representative of our efforts to continue to deliver on this important commitment to our employees. As a result of the Pension Protection Act of 2006 and other pension reform legislation, the timing of the company's minimum required contributions to its defined benefit pension plans has changed significantly.

The legislation did not change the company's total future contributions, and also did not change the expected contribution in 2007. But it did enhance our ability to continue meeting this important obligation. Similar to last year, we may elect at our discretion to contribute amounts in excess of the minimum required. To the extent we do that, it would reduce the expected minimum required contributions in subsequent periods.

In addition, as most of you probably saw, the announcement that we recently signed an agreement to sell our stake in ARINC., the air to ground communications company, we expect to close this deal prior to October 31st and when the transaction closes, we expect to receive proceeds of approximately $194 million and record a onetime gain of $140 million, assuming the closing conditions are satisfied.

So in sum, it's fair to say that while there's still much work ahead, we have made some solid progress on the balance sheet. Our total debt, which we define as the aggregate of long-term debt, capital lease obligations, the principal amount of airport facility tax-exempt bonds, and the present value of aircraft operating lease obligation, now stands at $17.3 billion. Our net debt, which we define as total debt less unrestricted cash and short-term investments, is now $11.4 billion. That represents a $2.9 billion or 20% reduction versus the same time last year.

Moving to guidance, when factoring in first-half results, our full-year 2000 mainline capacity is now expected to decrease about 2% compared to 2006, with a 2.6% reduction in the domestic system while international capacity is expected to decrease by more than 1%.

Book load factor for the third quarter is currently several tenths of a point higher than at this point last year. On the fuel angle, fuel prices continue to be high and volatile. Of course, this volatility adds a challenge to planning. As we stated in our earnings release, the third-quarter price is anticipated to be $2.24 per gallon with a full-year consolidated fuel price forecast of $2.11 per gallon.

In regard to hedging, we continue to follow a strategy of systematically layering in hedges using primarily collars to dampen volatility. Our mainline consumption is anticipated to be 723 million gallons in the third quarter. As discussed previously and at our analyst conference, we continue to target and we believe that we are currently on track for $300 million of cost savings for 2007. This is driven by our cost initiatives such as distribution cost savings, schedule and fleet simplification, and ongoing fuel conservation initiatives.

As the data in the earnings release indicates, the weather impact on first-half unit cost put more pressure on our goal to contain full-year unit costs. And the current fuel curve means we expect overall unit costs to increase for both the third quarter and the full year versus last year.

Moving to cash forecasts, we expect capital expenditures of more than $600 million in 2007, and we will update you as we make any further commitments regarding our fleet renewal strategy. Our scheduled principal payments are still expected to equal $1.3 billion for the full-year. And our total expected pension contribution for 2007 is $364 million including the amounts already contributed that I mentioned earlier.

Before we wrap up, a quick update on our fleet renewal that we announced in March. We are starting by pulling forward deliveries of 737-800s, beginning with three in early 2009. And we just announced an additional six for the first half of 2009. We intend to continue pulling forward deliveries for the remainder of the 47 737 aircraft from their current 2013 to 2016 delivery schedules into the 2009, 2012 timeframe.

Any decisions to accelerate 737 aircraft deliveries will depend on factors such as the economy and industry conditions and on the financial condition of the company. We believe this is a very prudent and flexible approach that allows us to match our fleet to the market conditions while leading us down a path of improved fuel efficiency and lower emissions.

So to wrap it up, we continue to be cautiously optimistic about this year, though rising fuel prices are a real concern in the second half. Profitability and the balance sheet continue to improve, and of course, we will continue to take a very measured approach toward capacity and continue to dig deep to find more improvements in our cost structure. While challenges remain, we are working hard to build on the progress we have achieved thus far. So with that, Gerard and I’ll be happy to try and answer some questions.

Question-and-Answer Session

Operator

Indeed. Well, thank you very much Mr. Arpey and Mr. Horton for that update. We do appreciate that. And ladies and gentlemen, as you just heard then, at this point, we do invite any questions or comments that you may have. In case you've joined late, we are asking everyone in the interest of time to limit themselves to one initial question with one follow-up. Members of the media will be taking your questions directly after the analyst portion, so please feel free to queue up at this point as well.

(Operator Instructions) Our first question we go to line of Mike Linenberg with Merrill Lynch. Please go ahead sir.

Mike Linenberg - Merrill Lynch

Yeah, good afternoon, guys. Just, I guess two questions. I guess if I could start off, Tom, RASM, how it trended through the quarter and as you look out into July, I know it's still maybe an early read on August, how that trend looks, any color on that would be great.

Tom Horton

Sure. As you know, we don't give a lot of forward-looking guidance on RASM, but I guess what I can tell you is our book load factors for the third quarter are up a little bit and that's in contrast to where we were at this time last quarter. So that's encouraging. That doesn't mean that we've abandon our strategy of foregoing lower yielding and early booking traffic. It just means that we like some of the bookings that we were able to get at this point. So that strategy, we felt pretty good about as we looked back on the results for this past quarter, particularly as you see load factors in the 90% range.

Mike Linenberg - Merrill Lynch

Okay. And then my second question and this is probably for both Tom and Gerard. Obviously, deleveraging has been the theme and you have a sizable amount of cash and I think, Tom, you indicated that there's still more work to be done.

When you look at some of your I don't know if it's core or non-core assets, and you look at your frequent flyer program and you sort of compare where Air Canada's Arrow Plan is trading. And I realize it's a different investment vehicle, but I think today its market cap is about $4 billion U.S. when you do the conversion, and I think it's maybe one-fifth the size of AAdvantage. At what point does it become compelling to you to seriously consider monetizing that asset?

And maybe I don't appreciate the complexity because I realize when you actually go down those steps, it's a multi-year process. So I'm just, any thoughts on that just kind of based on where Arrow plan is trading.

Gerard Arpey

All right, well Mike, maybe I'll start and this is a subject that I think we've discussed with the financial community before. We certainly recognize that we've come through this very difficult period in the airline industry with a number of our strategic assets in place.

You highlighted one of them. We also continue to own American Eagle, which is the majority of our commuter fee today. American Beacon, our company that manages both American Airlines internal pension assets as well as cash balances, is now managing the majority of its money is actually money that is given to us by folks on the outside.

And that gives us size and profitability has continued to grow. So we’re very pleased with the results of Beacon and Eagle, and of course the AAdvantage program, which you referenced. And we are very mindful of the fact that we have those strategic assets. But we are also a management team focused on running the company for the long run for our shareholders, and we recognize that we, if we decide that a different ownership structure for any of those assets is sensible, we would do that in the context of the long-term interest of our shareholders.

And given the balance sheet strength that we've been able to build and the liquidity that we've been able to build the past several years, we no longer, not that we ever did, but I think other airlines, perhaps, use some of their strategic assets as financings during their dark days before they file for bankruptcy and we don't really look at these as vehicles for financing.

We look at them as strategic assets and if we ever got to the point where we thought it was not in our shareholder’s long-term interest to hold these assets, then we would move in a different direction, but we haven't reached that conclusion at this point, but it is something we're mindful of.

Mike Linenberg - Merrill Lynch

Okay. Thanks and good quarter.

Gerard Arpey

Thank you, Mike.

Operator

And thank you very much Mr. Linenberg. And next in queue we’ll go to line of Robert Barry representing Goldman Sachs. Please go ahead Mr. Barry.

Robert Barry - Goldman Sachs

Hi, guys good afternoon.

Gerard Arpey

Hey, Robert, how you’re doing?

Robert Barry - Goldman Sachs

Good. How are you?

Gerard Arpey

Good.

Robert Barry - Goldman Sachs

Actually I just wanted to follow-up on that question or your answer to that question. Does that mean that either theoretically or practically you just don't feel that spinning off all or part of an asset like AAdvantage creates value for shareholders? I understand the potential financing raising implications, but separate from that, that's part of the argument that there is some unlocking of value or shedding light on value that’s hidden. And Beacon, in your case, is probably the most obvious example of potential for that.

Gerard Arpey

Yes, well, Robert, I guess the way I would come at that is we had the same discussion back in 2003 and 2004 about whether we should unlock value by spinning off or selling Beacon. And we concluded then that overall based on the long-term interests of our shareholders, we concluded then, three or four years ago, that that wasn't the prudent thing to do.

And since that point in time, that company has grown, I would guess. I mean It's not a public company, so you don't really know its market value, but I would conservatively estimate that it's probably worth three times what it was worth back in 2003. And I think that we are mindful of the fact that we are running the company for the shareholders and we want to produce the best results for the shareholders over the long run.

And if we can continue to grow this business successfully internally and have the kind of results that we've had for the past three, four years, that may very well be in the long-term interest of our shareholders, but that's something that we routinely think about. And if we ever got to the point where we felt like we could produce a better result for shareholders with a different ownership structure, we would certainly, we are not religious about it. We would move in that direction.

Robert Barry - Goldman Sachs

Okay. And then just a second question on the operations actually. The international operations, Latin America and the Atlanta in particular, it looks like both of those float up quite a bit in terms of RASM growth. And I was just wondering what you were seeing there.

I know I think a lot of supply has been coming into the Latin market in particular from some of your competitors and maybe over the Atlantic too. And when you're answering, too, I was curious if there was any dramatic difference in what you are seeing in those markets in the front of the plane versus the back. Thank you.

Gerard Arpey

Robert, I think it is, its two things. It's what you first mentioned, that there has been some increase in capacity, but it's also that the comps year-over-year are very difficult given the increases we saw this time last year, so the comps went to those two things has resulted in a deceleration of growth.

And in terms of the cabin mix, I don't think we've seen anything significant in terms of change one way or the other.

Robert Barry - Goldman Sachs

Okay. Thank you.

Operator

And representing Bear Stearns, we next go to the line of Frank Boroch. Please go ahead sir.

Frank Boroch - Bear Stearns

I wanted to follow up on that question about the Atlantic unit revenue growth in the second quarter. It looks like comparing American's numbers up against what we know from the ETA that that was a region that came in a little bit below where we would have expected.

Is there anything that you could speak to, I mean other than comps that might explain the difference between the other carriers in American and Atlantic?

Tom Horton

Yes, well, you've got, as we mentioned, you've got more supply. You've got a handful of new entrants, particularly into the London market, which is having some impact, modest, but some impact on the premium business in that market in particular.

Frank Boroch - Bear Stearns

Okay. And on the Latin America, I think TAM has moved to end your partnership for Brazil. What do you look to do to replace that last mile distribution?

Tom Horton

Well, as you know, our most important relationship in Latin America now is with Lon and we think the combination of our flying into Latin America with Lon with whom we have antitrust immunity, is a pretty unmatched combination. Regarding Brazil, we will look around for other opportunities there. But we feel pretty good about what we have in Latin America right now.

Frank Boroch - Bear Stearns

Great. Thanks.

Operator

And thank you very much sir. And next in queue is Kevin Crissey with UBS. Please go ahead sir.

Kevin Crissey - UBS

Good afternoon everyone.

Tom Horton

Hi, Kevin.

Kevin Crissey - UBS

How about an idea of capacity for '08? Have you put out anything on that?

Tom Horton

We haven't, Kevin, but I don't see anything on the horizon that would indicate that we would materially shift from what has been our strategy for many years, which is to be very conservative from a capacity standpoint for all of the reasons we've been articulating for many years.

We, as I said at the Merrill conference this summer, we don't see at all a demand problem in the airline industry. We see a supply problem. And, in fact, our advance book for the third quarter I think despite conservative yield management approach, would underscore that.

So I think the only thing we would be prepared to say at this point for next year is that we will continue the conservative approach that we have taken.

Kevin Crissey - UBS

Okay. And when you mentioned weather I think and some LCC competition on the regional side. Is there anything else there in terms of color that you can provide on a go forward basis?

Do you see any change in and obviously, well, weather, but other than the weather, do you see change in that to think that the comps get a bit easier on the regional side. What should we be looking for there in terms of RASM growth?

Gerard Arpey

We're just praying for better weather. In terms of the competition landscape, I don't think it's going to get any better. So, setting aside the weather impact, I would expect more of the same.

Kevin Crissey - UBS

Okay. And one final one if I could. If you’re looking at a company to make an acquisition, and I'm not saying that you are, but if you were, would you find if they had outsourced their, say their frequent-flier program, they had spun that off, would that have any implications for your desire to acquire that company?

Tom Horton

We generally don't comment on things such as that for obvious reasons.

Kevin Crissey - UBS

Okay. Thank you.

Tom Horton

Thanks.

Operator

Thank you very much Mr. Crissey. Jamie Baker with J.P. Morgan, has our next question. Please go ahead.

Jamie Baker - J.P. Morgan

Hi Gerard, good afternoon gentlemen.

Gerard Arpey

Hi Jamie, how are you doing?

Jamie Baker - J.P. Morgan

I’m doing okay. Thanks. Gerard, you know your employees want to get paid more, quite a bit more in the case of the pilot group. It seems to me that you would have to earn more first if this were to actually occur.

And one way that you might be able to accomplish that is through consolidation. I am curious if laborers demand, or aspirations have changed your views on consolidation at all and whether this topic has come up in some of your conversations with your working groups.

Gerard Arpey

Well, Jamie, I don't believe that I've taken a position publicly regarding consolidation other than to reflect on the fact that the industry does remain highly fragmented and the fact that other industries that have chronic profit problems like the airline business do have a tendency to consolidate as one of the means to try to improve their performance.

But for reasons that we’ve discussed over the years, it’s been difficult for the airline industry primarily because of the government and the way the government has viewed airline mergers. The unions have historically not viewed airline mergers positively, I think in part because in the short run, integrating a seniority list is a…

Jamie Baker - J.P. Morgan

Yes.

Gerard Arpey

Very difficult process to go through. But, I think you are highlighting an interesting point, which is if you, you’re making a hypothesis that if you didn't have as fragmented an industry perhaps the airlines would be doing better financially. If they were doing better financially, maybe some of that benefit would extend to employees. And I would not argue with that hypothesis. Because fundamentally, for any stakeholders in any company to keep what they've got or do better, they have to rely on the financial results of the institution that they had their wag and hook to, whether they are a shareholder or a creditor or an employee, no matter who you are.

So I think there's an obvious link between the strengths of the company that an employee works for and how well that employee can do. And so I wouldn't dispute your hypothesis, but I would remind you that I've really not taken a public position on this subject and we've obviously done that because we don't comment on our views on consolidation publicly.

Jamie Baker - J.P. Morgan

Has this been something that, the views you've just expressed to me, is this something that you have shared with labor leaders in more recent negotiation or recent discussions?

Gerard Arpey

Well, let me come at it this way, Jamie, and say that we have, over the past many years, spent a tremendous amount of time with organized labor and our independent employees for that matter, giving them a seat at the table and an opportunity to weigh in on all matters that affect the future of the company. That's not an abdication of management's responsibility to run the company and ultimately decide what we should do. But we have felt like having laborer’s voice at the table is in a non confrontational collaborative process, is very helpful, because one, if you involve the folks who do the work in the unions who represent the people before you make decisions, you probably make a better decision and then you'll execute better on that decision by having them involved.

So that's been a principle of what we have been doing. It hasn't been perfect and certainly we don't always agree. But we have on many occasions on important issues, yeah, I wouldn't say we were headed 360 and ended up going 180. But we definitely changed course in terms of some of the things that we were contemplating or doing based on input from organized labor or our independent employees. So I think those forums are critically important to us. They're certainly voluntary, and subjects that are important to the company get raised there.

I won't comment further because those dialogs are confidential. And that allows us to be able to have a very robust dialogue on matters that confront the company. So I can't comment directly on what we may or may not talk about.

Jamie Baker - J.P. Morgan

Got you. Well, I appreciate the inside, Gerard. Just as a very quick follow-up, could you remind us, I probably have this in my notes somewhere, but the revenue impact that you ascribe to last year's liquid bomb I guess event is the right term. How it impacted last year's third quarter? If you don't have that at your fingertips, I assume it's in your release from last year. I was, just for modeling purposes today, trying to normalize for that?

Tom Horton

It was $50 million as I recall.

Jamie Baker - J.P. Morgan

Okay. And was that a net number or was that solely a top-line revenue figure?

Tom Horton

That was a revenue number.

Jamie Baker - J.P. Morgan

Okay, perfect. That's what I needed. Thanks a lot, gentlemen. I appreciate it.

Gerard Arpey

And Jamie, that was third quarter, not second quarter.

Jamie Baker - J.P. Morgan

Yes, understood. Thanks, Gerard.

Gerard Arpey

Okay. Thank you.

Operator

And thank you Mr. Baker. Next representing Lehman Brothers, a question from Gary Chase. Please go ahead sir.

Gary Chase - Lehman Brothers

Good afternoon guys.

Gerard Arpey

Hey, Gary.

Gary Chase - Lehman Brothers

Gerard, I wondered if you could just sort of elaborate a little bit on this concept, Tom might have touched on the prepared remarks, on balancing the needs of stakeholders. And, in particular, I'm thinking that two of them was labor and shareholders. I know you've kind of held out there that you’re not earning the kind of returns you need for growth.

Is there a set of financial metrics that we should be thinking or managing to as you kind of undertake this process with labor? Last time you negotiated with labor, you had a pretty clear set of objectives as to what you needed as a company to kind of implement the Turnaround Plan. Now that we’re in better times, what should we be thinking as kind of the go-forward benchmark you’re using to manage the business towards?

Gerard Arpey

Well, Gary, you got kind of started by talking about returns necessary for growth and that, I think the implication was, and I don't want to put words in your mouth, but you were referring to American. But I would look at the whole industry and the return on capital for the industry and I would daresay I don't really see anyone producing returns that would warrant the kind of capital that is being allocated by the capital markets to this industry by some company. So I don't think we are unique in our returns and our view that we obviously represent the shareholder’s interests and in order to invest capital, we should be getting a return on that capital.

And yes, we have come a long way and we’re pleased with this quarter. We’re pleased with the balance sheet improvements that we've made. We’re pleased with the pension funding that we've been able to accomplish. But I think it's important to recognize that relative to a lot of industries, or just industry in general, our company and the airline industry is still performing poorly. We have a year-to-date pre-tax margin of about 3.5% and the S&P 500 is about 15%.

So our goal has been, since we launched the Turnaround Plan, is to drive our sales to a 5% to 10% pre-tax margin and companies that are able to achieve satisfactory returns, the capital markets and shareholders like that, they give them more money and they get to grow. And we think we are on the right path to getting there, but not there yet and I would argue the industry is not there yet either.

Gary Chase - Lehman Brothers

And is that the bogey that you have in mind as you approach really all aspects of the business, which include labor negotiations looking forward? Is it five to 10 where you think you need to be to generate an adequate return?

Gerard Arpey

Yeah, that has been, not unlike any company, that's the kind of pre-tax margin we think we have to have to be successful. And by extension, how every stakeholder, the kind of return that we need so that every stakeholder can be successful, our shareholders, our employees, our creditors, and our retirees. So what we’re trying to do and have been trying to do for many years now is drive our company out of the destructive capital cycle into the so-called virtuous cycle of earning a satisfactory return so people can get paid more, we can invest more capital, and we can sensibly grow the business.

And by that, by sensible, I mean that we start American Airlines as the largest airline in the world. Historically, traffic and revenue in our industry has been highly correlated to GDP and if we can get to the point where we’re earning satisfactory returns, we should be able to grow with GDP. As the revenue pie expands for the industry, we ought to be able to keep pace with that. And that is ultimately where we would like to be.

Gary Chase - Lehman Brothers

Okay, guys. Thanks.

Gerard Arpey

Thank you, Gary.

Operator

And representing Credit Suisse our next question Dan McKenzie. Please go ahead sir.

Dan McKenzie - Credit Suisse

Yeah, hi, I guess, just a question it’s sort of the reverse of that. You guys have shrunk for essentially shrinking capacity for two years in a row. How much further can you continue to shrink, even as GDP continues to grow? Is there some point where you just say, we have to stop shrinking and we have to protect our network at all costs or how should we think about that?

Tom Horton

Well, technically we haven’t given any guidance on 2008, as Gerard mentioned, but if you look out into '08, our fleet is relatively stable. So you can think about our capacity situation in that context, and so I think for the near term, we see relatively stable capacity.

Gerard Arpey

But, Dan, the only thing I would add to that is that a byproduct of the fact that we are now recalling quite a number of pilots, I think this month we recall 40 or 45 pilots through American Airlines. The way our bidding system works and training, when you bring, when you recall pilots, at the bottom of the seniority list, everybody kind of moves up the food chain as people retire and that creates a domino cascading effect of training all across the airline. And a byproduct of that is in order to stay where you are when you begin recalling you have to deep down in order to accommodate all the training. If that made any sense.

Tom Horton

So you will see relative stability year on year, but it will vary by quarter based on what Gerard just described.

Dan McKenzie - Credit Suisse

I see. Okay. Just a separate question here pertaining to the reauthorization bill. Can you provide any perspective on your sense for whether that gets postponed for a year, whether that gets passed? What are you hearing from your Washington contacts? And then just as a follow-up to that, I think RNP has been rolled out at Dallas; I'm just wondering if you can provide any metrics with respect to cost savings and where you are at with that with respect to the future.

Gerard Arpey

Dan, there are two bills moving in Congress as we speak, one through the Senate and one through the House. And I tell you, depending on which day you take a read, you get a different indication about whether we're going to get that done this year or not. Of course, we are huge advocates for getting FAA reauthorization done this year. And doing so in a way that more fairly allocates the cost of today's air traffic control system between the airlines and the business jet community and more importantly, beginning to raise the money necessary to build the Next Generation navigation systems for the industry.

And you only have to look at this year's events, the near gridlock we have in the Northeast with only the slightest bit of weather because we are continuing to operate with a system that was put in place 30, 40, 50 years ago. So it's a critical infrastructure issue for the country. And it is one that we are working very hard both at American and through the ATA to advance the cause of. But whether we will get it done this year or not and whether we will get it done in any sensible way, I would have to say your guess is as good as mine.

We have gotten RNP arrivals and departures at DFW airport that has been a very much a success, but I would call it kind of a first phase of what we could do if we truly move to a GPS-based navigation system. And the way I often end up talking to folks about it is that today at DFW, like many airports, we have four cornerposts around the airport and all of our departing and arrival traffic have to go over those four cornerposts. And in May and June, we had many days where the weather at DFW airport was VFR. But we had weather over the cornerposts, either in Southwest, Southeast, Northeast, Northwest, and as a result, we ended up diverting flights when the airport, itself, was VFR.

And you can imagine a world where you could move your cornerposts through a satellite based systems if you weren't fixed on the ground and you could keep moving traffic in that kind of situation, which would reduce delays, reduce cancellations, be environmentally friendly, and all of the good stuff that you know about. So we are working that issue very hard. Whether we get it done this year or not and done sensibly, I don't know.

Dan McKenzie - Credit Suisse

Great. Potential savings from that?

Tom Horton

It looks like right now, it's saving us around a minute on average taxi time. So, there are some savings there. We're doing 100% at DFW now, RNP now.

Dan McKenzie - Credit Suisse

Okay. Great. Thanks a lot.

Tom Horton

Thank you.

Operator

And next representing Calyon Securities we go to the line of Ray Neidl. Good afternoon sir and please go ahead.

Ray Neidl - Calyon Securities

Yes. Why did you decide at this time to enter London Stansted airport?

Gerard Arpey

Well, Ray, a lot of our customers told us they want to go to Stansted and a lot of our corporate customers want that as an option for London. And London is a very important market for American. As you know, we've got a very big presence at Heathrow and got flights into Gatwick converting some of those flights to Heathrow. And so London is very important to us and Stansted is a natural addition to our network.

Tom Horton

With the network to express train service there, Ray, we've seen some of our attractive city business flowing out over Stansted. So we want to capture that.

Ray Neidl - Calyon Securities

Would you do anything with Ryan Jet, which flies to 55 destinations out of Stansted?

Tom Horton

No plans at this time.

Ray Neidl - Calyon Securities

Okay. The other thing is, it looks like you are entering more routes out of JFK into some of your competitors market, something that you kind of pulled back from a few years ago. I'm just wondering, why are you doing that? Are you just trying to fill up the terminal at JFK or are you trying to build a complex there the way that Delta is doing at JFK and that Continental has at New York airport?

Tom Horton

New York is important to us. It's a natural point of strength for us given that we operate out of all three airports there and we are big at LaGuardia and we've got this terrific new terminal at JFK. So we're going to look for every opportunity to grow profitably there and that's what these new opportunities represent.

Ray Neidl - Calyon Securities

By the way, it's a beautiful terminal. I went through it the other day and you are to be congratulated on that.

Gerard Arpey

Thank you. I hope you’ve bought a ticket and were flying and not just looking at it.

Ray Neidl - Calyon Securities

No. I've used it a couple of times with a ticket. Thanks a lot.

Gerard Arpey

Thanks, Ray.

Operator

Thank you, Mr. Neidle. Andrew Light now with Citigroup, please go ahead.

Andrew Light - Citigroup

Hi. Good afternoon. I've got a question for Mr. Rose actually. How you’ll view on the ability to obtain antitrust immunity with BA changed given the open skies at Europe, and especially given the antitrust immunity application from Delta Northwest and Air France and KLM?

Gerard Arpey

Well, Andrew, we are, of course, BA is our partner, our long-standing partner. We have wanted to get antitrust immunity with British Airways and for many, many years. Certainly our view would be that this immunity is granted to our competitors, that the antitrust body should begin to look at the competition between alliances rather than on the city pair basis that they have brought historically.

And that whether or not we apply together with British Airways. In the near term for immunity is a subject that under discussion between us and British Airways. But as to whether we think that that is something that we should be granted? The answer would be absolutely. But we've got to make some judgment about the approach we take with the competition authorities and that's something we're in a dialogue with BA on right now.

Andrew Light - Citigroup

Okay. Thanks. The coming out -- in your transfer services from Gatwick to Heathrow, did you actually purchase lots at Heathrow or you just shuffled around your existing flights?

Gerard Arpey

We did acquire of more Heathrow slots.

Andrew Light - Citigroup

And will you be touching BA on the Stansted, the Heathrow to Kennedy route?

Gerard Arpey

Not decided to at this point.

Tom Horton

I don't think we've made a decision on that.

Andrew Light - Citigroup

Okay. All right, thank you very much for that.

Tom Horton

Thank you, Andrew.

Operator

And thank you Mr. Light. We are presenting Morgan Stanley, Mr. William Greene, please go ahead.

William Greene - Morgan Stanley

Yeah. Hi. Tom, can I ask you to give a little bit more color on some of the CASM guidance. If I did the math right, it seems like the fourth-quarter number has to be down pretty substantially and I'm not sure how you intend to achieve that.

Tom Horton

Yeah. We expect to hit our $300 million cost savings and we also said at the beginning of the year, I think you might remember that we were aiming for flat X fuel and X profit-sharing unit costs for the mainline business for all of '07. As I said, earlier, I think we are on track since 300 million. We would expect to continue on the pace.

We've set for ourselves in the third and fourth quarter. It's really the first and second quarter with all the operational plus unit cost challenges that make it tough to meet our original unit cost goals, but having said that we would be looking to makeup as much ground as we can. And in the fourth quarter, we would expect to see better unit cost performance, absent any extraordinary event that than that we've seen in the first three quarters.

William Greene - Morgan Stanley

Okay. And then, can I ask just on the balance sheet, so how should we think about your leverage and when you sort of have enough cash? Should we think about it in coverage ratio terms? Should we look at sort of a net debt to EBITDAR including the off balance sheet items or what do you recommend? How do we think about when you've built enough cash?

Tom Horton

Yes. It's a good question. Gerard's answer to that it's just a little bit more. But I think, the way we think about it is net debt to EBITDAR coverage ratios. And we tend to look back to the late '90s when the industry was a lot healthier and think that ratios and the zone of that period is not too far off the mark over a full cycle.

And if you look at debt to EBITDA for S&P 500 companies, it tends to look like 2 to 3 turns and that doesn't seem like an unreasonable place to be. Again, over the course of a full cycle, sometimes it will be little higher, sometimes lower. But we are still a bit north of where we think the company ought to be for the long-term.

William Greene - Morgan Stanley

Okay.

Gerard Arpey

And I think, Bill, the only thing I would add is that I think we all become somewhat jaded or just conditioned looking at airline industry balance sheets and kind of forget what normal companies look like and the amount of leverage that normal companies would have. And as Tom and I and our finance team here look at our balance sheet, it certainly doesn’t look like anything you would have created by design. It came out of multiple years of turmoil and many, many months of looking at the cliff.

So the building of liquidity, the paying down of debt, carrying the high cash balance is all about reducing risk in the company in the event of another external shock and we think that is in the interest of our shareholders, as we have built back the strength of the company to be sure that we continue down the path of being sure that we can withstand external shocks. And that's why we have proceeded cautiously.

Tom Horton

We're trying to build a balance sheet that looks like it was designed on purpose rather than one that's an accident.

William Greene - Morgan Stanley

Understood. And when you think about these net debt numbers, do you also include pension or is it just the off balance sheet?

Tom Horton

We look at it both ways.

William Greene - Morgan Stanley

Okay. Thanks for your help.

Tom Horton

You bet.

Operator

Thank you very much, Mr. Greene. And with that, ladies and gentlemen, we will conclude the analyst portion of our Q&A session. So at this point, we do invite our members of the media that have joined us today (Operator Instructions).

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