Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

AMR Corporation (AMR)

Q3 2007 Earnings Call

October 17, 2007 2:00 pm ET

Executives

Gerard Arpey - Chairman, President and CEO

Kenji Hashimoto - MD of IR

Tom Horton - CFO, EVP Finance

Analysts

Frank Boroch - Bear Stearns

Gary Chase - Lehman Brothers

Robert Barry - Goldman Sachs

Michael Linenberg - Merrill Lynch

Jamie Baker – JP Morgan

Dan McKenzie - CSFB

Bob McAdoo - Avondale Partners

Ray Neidl - Calyon Securities

Kevin Crissey - UBS

William Greene - Morgan Stanley

Presentation

Operator

Ladies and gentleman, thank you for standing by.We do appreciate your patience today, while the conference assembled; and goodafternoon.

Welcome to AMR’s third quarter 2007 earningsconference call.

Now, at this point and during the presentation,we do have all your phone lines muted, or in a listen-only mode. However, afterthe executive teams’ prepared remarks, there will be opportunities for yourquestions.

Now, just to note, we’ll be taking questionsfirst from the members of the analyst community that has joined us; and thenimmediately after their session, we’ll be moving into the media portion of thecall.

As a reminder, today’s call is being recordedfor replay purposes. So, with that being said, let’s get right into this thirdquarter agenda.

Here’s Kenji Hashimoto, Managing Director ofInvestor Relations.

Kenji Hashimoto

Good afternoon, everyone. Thank you for joiningus on today’s earnings call.

Similar to last quarter, Gerard Arpey willprovide an overview of our performance, and then Tom Horton will provide thedetails regarding our earnings for the third quarter, along with some guidanceof the remainder of 2007 and a few perspectives on 2008.

After that, we will be happy to take yourquestions. In the interests of time, please limit your questions to one, withone follow-up.

Our earnings releaser earlier today containshighlights of our financial results for the quarter. This release continues toprovide additional information regarding SEC performance and cost guidance,which should assist you in having accurate information about our performanceand outlook.

In addition, the earnings release containsreconciliations of any non-GAAP financial measurement we may discuss.

This release, along with a web cast of today’scall, is available on the investor relations section of 8A.com.

Finally, let me note that many of our commentstoday on our outlook for revenue and earnings, cost estimates and forecast ofcapacity, traffic, load factor, fuel costs and other matters constitute forward-lookingstatements. These matters are subject to a number of factors that could causeactual results to differ from our expectations.

These factors include changes in economics,business and financial conditions, high fuel prices and other factors referredto in our SEC filing, including our 2006 annual report on form 10-K(a).

With that, I’ll turn the call over to Gerard.

Gerard Arpey

Thank you Kenji. Good afternoon everyone. As yousaw this morning in our press release, we earned a third quarter net profit of$175 million, which includes a $40 million out-of-period charge. This comparesfavorably to the third quarter of 2006’s net profit of $15 million, whichincluded a $99 million special item.

This is the highest third quarter profit sincethe year 2000, when oil was only $28 per barrel, versus today’s nearly $90 perbarrel.

Obviously, oil prices are a very big concern forus in the industry right now. Tom will talk to you more about that in a momentbut suffice it to say that, just like any other cost in our company, we’ve gotto find a way to pass it on to our customers. We have led several priceincreases with the run-up in oil costs lately, and we will have to see where allthat shuttles out in the market; but I figured it’s fair to say we are alarmedat the level of oil prices as we see them today.

Our traffic levels were strong in the thirdquarter, setting another record load factor of 83.9%. Our Pacific and LatinAmerican results were particularly strong and we were pleased that theDepartment of Transportation awarded us the right to serve the Chicago Bejingmarket effective in 2009.

We are also excited about our planned servicefrom Chicago to Moscow, beginning next summer.

We are continuing our cautious approach tocapacity, while making prudent investments in our product. At this point, themajority of our 767’s have completed their interior refurbishment, whichincludes our next generation business class heat, and our customer feedback hasbeen outstanding on the new seats and the new interiors. Our triple 7’s will bestandardized around our flagship suite 1st class product and thatwill also include, in the business class cabin, our next generationbusiness-class seat. That project will be completed by next summer.

We have several Admiral’s club renovations underway right now, giving many of our clubs a needed facelift, and we recentlycompleted and opened the final phase of our new JFK facility. I was very gratefulthat Mayor Bloomberg came out helped us inaugurate the final phase of thatproject.

I am also pleased with the progress we havecontinued to make on the balance sheet front. We paid down another $560 milliondollars in long term date and capital leases in the third quarter of this year.Our net interest expense for the first 9 months of this year was down $133million. I think Tom Horton and his team have done an outstanding job,particularly in the first half of this year when the capital markets were alittle more friendly than they are now, to get ahead of some of this stuff, andso I’m pleased with the progress that we have made there. As you all saw in therelease, we ended the quarter with $5.8 billion dollars in cash.

It’s also good to see that we were able tocontribute another $200 million to our various defined benefit pension plans inthe quarter, bringing our year-to-date total to $380 million.

I think our financial performance can bemeasured in many ways; profitability, balance sheet strength, pension funding,and reinvestment in our products and services. On all these measures, we havebeen continuing our positive momentum, and we’re pleased by that.

We are also continuing to give carefulconsideration to the best use of our strategic assets and the impact thesedecisions might have in the long run for our shareholders; and Tom willelaborate on some of our thinking in just a moment. So, let me turn things overto Tom and he’ll take you through the details regarding our third quarter performancein the outlook for the balance of the year. Tom.

Tom Horton

Thanks, Gerard, and good afternoon, everyone.

As Gerard said, in the third quarter we earned$175 million versus $15 million in the third quarter of last year. Both yearsinclude special items, which I’d like to briefly touch on.

As indicated in our release four weeks ago, thisyear’s third quarter includes an out-of-period charge of $40 million, relatedto an adjustment for additional salary and benefit expense from prior periods.$40 million of this charge is attributable to the years 2003 through 2006, and$10 million of the charge relates to the first half of ’07.

And some of you may recall that last year’sthird quarter had a special item related to marking to market our fuel hedges.In the third quarter of last year we experienced a fuel price decline thatreduced the book value of certain outstanding fuel hedge contracts and resultedin a $99 million non-cash charge in the other income and expense line.

So, for the remainder of the call, I’ll excludethe impact of special items and out-of-period charges, to more accuratelyreflect our performance on an ongoing basis.

This quarter demonstrated our continue momentum,despite high fuel prices. We have had six consecutive profitable quarters; andwhile we still have a long way to go, we believe we are moving down the righttrack by continuing our capacity discipline while we strengthen our balancesheet and reinvest in key products, services, and in our fleet.

So, moving to our numbers. Let’s start with ourthird quarter revenue performance.

For the quarter, mainline unit revenue increasedby 5% year over year, on record load factors. Our unit revenue for ourconsolidated system was up 4.7%.

Before we get started on the entity-specificrevenue results, I want to remind you that, since the beginning of this year,we have included this data in the earnings release, for your convenience.

In our domestic markets, third quarter unitrevenue increased versus last year. And this year-over-year improvement wassequentially better than first and second quarter of this year.

As we have noted in the past, our revenueresults are not yet impacted by changes to our advantage frequent flyerprograms mileage expiration period. The reason we announced from 36 months to18 months expiration period for miles, will be effective December 15 of thisyear. At that time we expect to recognize the affect of expired miles through aone-time benefit.

Before leaving the domestic discussion, one itemI’d like to note is that our ongoing focus on enhancing AA.com is paying off.Recently, the Forester Group ranged AA.com as the best web site in the airlineindustry.

Moving on to international. While moderating,our international continued to be strong, as third quarter unit revenueincreased versus 2006, on both yield and load factor improvement. We hadpositive performance across all entities, with all having unit revenueimprovement.

While Pacific’s strong performance was influencedby our cancellations of Dallas-Osaka and San Hose-Tokyo, at the end of Octoberlast year, this entity has been performing very strongly on an absolute basis.

We have been trying to bolster our network tothe Pacific and are happy to say that we have been awarded Chicago-Bejingservice, effective 2009, which will compliment our Chicago-Shanghai flying,along with all of our Tokyo flying, and robust alliance relationships in the Pacific.

Atlantic third quarter unit revenue performanceversus last year also improved. And there is a lot going on to upgrade ourproduct. As Gerard mentioned, we continue to make progress on upgrading ourbusiness class seats on our 777 and 767, 300 aircraft.

At this point, over 80% of our 767 300’s havethe new product, and we expect that project to be complete by early January.

In addition, on the triple 7, the first classproduct will be standardized around our flagship suite by the end of next year.And the next generation business class fee will be on the entire triple 7 fleetby mid-2008.

We have also been busy refining our schedule.Recently, we have announced JFK to Barcelona and Milan, alongwith Chicago to Moscow; and we are very excited about these additional opportunities tobroaden our already deep network.

Finally, Latin America continuedits positive performances, as unit revenue increased year-over-year, despitelast year’s very strong third quarter 13% increase, in an increasinglycompetitive environment in some markets.

In addition to the added flights to San Jose, Cost Ricaand Santo Domingo from south Florida, that I mentioned last quarter, we have recently announced newservice from Chicago to Buenos Aires, DFW to Panama City, and Miami toBarancia Colombia.

Rounding out the international discussion, Iwould like to touch on a couple of pieces of positive alliance news. OnNovember 1, Dragonair will be joining Oneworld. Dragonair serves 19destinations in China and has regularly been named in customer surveys as the bestairline serving China.

Earlier in the quarter, we filed with the DOTfor anti-trust immunity with Iberia, Finnair, Malev and Royal Jordanian. It follows to allow the fiveairlines to cooperate in a wide variety of areas that will provide a bettertravel experience for our customers.

Turning to other revenue items, third quarterrevenue for our regional affiliate operation increased by 0.6% compared to lastyear, and showed a positive unit revenue improvement versus last year.

Total cargo revenue decreased by 8% year overyear. Freight revenue, including fuel surcharge, was down 4%.

As we discussed last quarter, this expectedperformance was driven by lower freight and mail traffic year over year.

Finally, in the third quarter, our other revenueline was up 5.7% year over year, at $352 million.

Moving on to expenses. We continue to face headwinds in our costs, as we had accelerated depreciation from previously plannedaircraft cabin refurbishment projects; certain salary and benefit investments,to improve the customer experience; higher revenue-related expenses; and watercancellations in July.

Excluding fuel and the out-of-period charge, ourunit costs rose by 4% mainline and 4.2% consolidated.

Our fuel price came in about even with lastyear’s third quarter, at $2.18 consolidated. Despite the somewhat flat fuelprice versus last year, fuel price still remains historically high andvolatile; and I will get into our fourth quarter thoughts in a moment.

So, if fuel goes high, conservation continues tobe one of our top priorities, as we continue to explore opportunities for moresavings.

We just completed a wing light installation onall the 737’s, and anticipate completion on the entire 757 fleet by fourthquarter of next year.

We also continue to do many smaller things, suchas converting all MBA tail comps to be more aerodynamic; and replacing beveragecarts with lighter weight versions, which would save 20 lbs. per cart.

Moving to non-operating costs, these were betteryear-over-year by $26 million in the quarter, driven by improvements in bothinterest income and interest expense, as we had both higher cash balances andlower debt balances.

Now, turning to the balance sheet, we enteredthe quarter with $5.8 billion dollars in cash, including $447 million dollarsin restricted cash.

In the third quarter, our scheduled principlepayments on long term debt and capital leases totaled $560 million, whichleaves a remaining $294 million in scheduled payments for the fourth quarter.

In addition, we prepaid $32 million of EagleAircraft debt and announced our intention to prepay $545 million in aircraftdebt later in the fourth quarter.

As a result of scheduled principle payments, aswell as incremental efforts to strengthen our balance sheet, we lowered our netinterest expense for the first nine months of year by $133 million.

Our capital expenditures totaled $146 million inthe third quarter.

On the pension front, we contributed $200million to our defined benefit pension plans in the third quarter, for a totalof $380 million so far this year.

As a reminder, we’ve signed an agreement to sellour stake in ARINC, the air-to-ground communications company. We expect toclose this deal later this quarter; and when the transaction closes, we expectto receive proceeds of approximately $194 million, and record a one-time gainof $140 million, assuming the closing conditions are satisfied.

So, in sum, it’s fair to say that, while thereis still much work ahead, we have made some solid progress on the balancesheet. Our total debt, as defined in the earnings release, is now $16.6billion. Our net debt, defined as total debt, less unrestricted cash and shortterm investments, is now $11.2 billion. That represents a 2.8 billion dollar or20% reduction in net debt versus the same time last year.

Moving to guidance, our full year 2007 mainlinecapacity is now expected to decrease about 2%, compared to 2006.

Both load factor for the fourth quarter iscurrently about half a point higher than at this point last year.

On the fuel side, fuel prices continue to behigh and volatile. As we stated in our earnings release, the fourth quarterprice is anticipated to be $2.27, with a full year consolidated price forecastof $2.10 per gallon. I would like to note that the fourth quarter estimated priceis 20% higher than last year’s actual fourth quarter price.

In regards to hedging, we continue to follow astrategy of systematically laying in hedges, using primarily collars, to dampenvolatility. We have 40% of our fourth quarter consumption capped at $69 abarrel, and our mainline consumption is anticipated to be approximately 700million gallons in the fourth quarter.

As discussed previously, we continue to worktowards our goal of achieving $300 million in cost savings for 2007. This isdriven by our cost initiative such as distribution cost savings, schedule andfleet simplification, and ongoing fuel conservation initiatives.

As the data in the earnings release indicates,the weather impact on first-half unit costs puts more pressure on our goal tocontain full year unit costs.

Our original goal was to keep mainline unitcosts, excluding fuel and profit sharing, flat with last year. When we excludedthe weather impact from our mainline unit costs, we are, unfortunately, stillfalling a bit short.

We are taking steps to enhance our focus oncontaining costs for the company; and everyone is dedicated to contributing tothis effort. One recent example is that we are consolidating our reservationsoffices, which will result in the Cincinnatireservations office closing later next year.

Moving to our cash forecast, we expect capitalexpenditures of more than $600 million in 2007; which excludes the possibleimpact of future pre-delivery deposits, associated with future aircraftcommitments, as we execute on our fleet renewal strategy.

Our schedule principle repayments are stillexpected to equal $1.3 billion for a full year.

Adding in debt retirement, early debtretirement, full year debt pay-down is expected to be $2.3 billion; and we’vemade total expected pension contributions for 2007, of $380 million.

Finally, a quick update on our fleet renewalstrategy that we announced in March.

At that time, we stated our intention to pullforward all 47 Boeing 737 commitments into the 2009/2012 time frame, ahead oftheir previous 2013/2016 delivery schedules; and we have been executing on thatplan throughout the year.

In the first half of 2007, as you already know,we accelerated the delivery of nine 737 800s into early 2009. And, as we notein our press release today, in the third quarter, we pulled forward three 737’sfor delivery in the second half of 2009.

In addition, on October 1, we notified Boeing ofour intent to take delivery of an additional 737 in early 2009, representingour first 737 commitment beyond the initial 47 aircraft.

All told, we now have a scheduled delivery of 13737’s through 2009. Any decisions to accelerate additional 737 aircraftdeliveries will depend on factors such as economic and industry conditions, andthe financial condition of the company.

We believe this is a very prudent and flexibleapproach that allows us to match our fleet to the market conditions, whileleading us down a path of improved fuel efficiency and lower emissions.

Looking forward to next year, we are stillfinalizing our budget, so we’ll have more information to share with you on ournext call.

Right now, our 2008 plan calls for a mainlinecapacity increase of a little of over 1% compared to 2007.

By entity, we are currently planning for about a0.5% increase in 2008 domestic capacity, while international capacity isplanned to increase by about 3%.

However, keep in mind that we are expecting tounder-fly our 2007 schedule by a significant portion, approximately 1.2%,primarily driven by weather. So, on a schedule-to-schedule basis, our systemcapacity is roughly flat.

So, to summarize our outlook, high fuel pricesare a big concern for the fourth quarter, which is our seasonally weakerquarter. We continue to work to improve the balance sheet; and, of course, wewill continue to make a very measured approach toward capacity and continue todig deep to find more improvement in our cost structure.

While plenty of challenges remain ahead, we areworking hard to build on the progress achieved thus far.

And finally, we thought it would be appropriateto briefly discuss a matter that’s top-of-mind for many of you, as it is forus; mainly, how we are approaching value creation related to certain businessesunder the A&R umbrella.

It goes without saying that we are committed todeploying our resources, to enhance shareholder value. This naturally includesinvestments, to support and grow our core business, as well as opportunities todeleverage our balance sheet, and other strategic options, such as asset divestituresthat we might consider, to improve shareholder returns.

With regard to the latter point, we are proud ofour long track record of building businesses over the years. When it made sensefor our shareholders, we would take appropriate steps to unlock the value wehave created.

Examples include the IPO of Sabre Group, and thesubsequent full spin-off in 2000; and the sale of AMR Services, AMR coms, andTSR in the late 1990’s.

Characteristics of these businesses includedmarket leading positions in their respective industries, separate support andmanagement structures, and the prospect of benefiting from clear marketcomparisons with their peers, to more appropriately reflect their full valueand potential.

Additionally, we looked at whether the divestitureof these businesses made sense for, and did not aversely affect, AMR.

Today, we are continuing this process ofbuilding businesses; and we are fortunate to have a master range of strategicassets that contributes significant value to AMR.

At the same time, we are always looking todetermine the best structure and strategy for each of these businesses, inorder to enhance shareholder value.

Included in this category are such diversegroups as American Eagle, our regional airlines; American Beacon Advisors, ourinvestment advisory subsidiary; our maintenance repair and overhaul operation,or MRO; and Advantage, the word’s most popular frequent flyer program.

For each of these businesses, there arearguments for some type of value-enhancing activity; but there are alsostrategic and practical challenges.

We need to consider the strategic in therelationships of the businesses. In particular, the potential impact on thesynergies of the businesses versus the potential value creation fromseparation.

As with all companies, we need to evaluatewhether there are any implications down the line that might cause what appearsto be a smart decision on its face, to be questionable in retrospect.

Therefore, we are carefully considering the prosand cons as we make our decisions. Let me discuss a few of these in moredetail.

American Eagle is a fully developed operatingunit with an industry leadership position, a strong management team, and annualrevenues of approximately $2.4 billion.

The potential benefits of pursuing some type of divestitureinclude: proving Eagle with the structure, incentives and opportunities to growits business, while also enabling American to focus on its mainline businessand ensure continued access to cost-competitive regional feed over time.

However, we must make certain that anytransaction does not merely become an extensive financing but, rather, one thatliberates value and takes into account the impact on American.

Similarly, American Beacon Advisors is asuccessful money management business, with a strong management team and annualrevenues that have grown steadily to nearly $100 million. Assets undermanagement have more then doubled, to $65 billion, with the majority of theseassets being unrelated to American since 2003, when we put it up for sale andentertained offers to buy it.

We chose not to pursue the sale becausewe thought that the offers undervalued the business, relative to keeping andbuilding it, in part, because of the then-weaker financial condition of AMR.Since that time, AMR's financial condition has improved significantly and wehave aggressively grown Beacon and diversified its business base to become lessdependent on AMR. We continue to study the appropriate path that makes the mostsense for this business and for our shareholders.

Our MRO has a lot of potential to grow its base of thirdparty maintenance business, but it is still early on in its development and Iwould note that the vast majority of its business is AMR-derived. We believethat it would be premature to make a judgment on its long-term potentialwithout the benefit of more time.

With regard to the potential separation of the AdvantageProgram, let me share with you some of our thinking to date. It is aninteresting idea; one that has received a lot of attention at our company andof late, in our industry as well, and one that we continue to think about.

The structure most often cited would involve dividing AMRinto two parts: a cash-flow driven business with potential to generate ongoingdividends, and the remaining business without the Advantage cash flow. Thisraises fundamental questions that must be addressed regarding cash usage, riskprofile, and the current environment and capital structure.

In addition, it goes without saying that our frequent flyerprogram is deeply intertwined with AMR, and has been strategically integral tothe long-term success of American Airlines and American Eagle. It is thecornerstone for how we interact with our best customers. Any value-enhancingaction must be carefully analyzed within that context.

For example, beyond all the marketing and licensingcomplexities, if the loyalty program were separated from AMR, the question ofwho would own and control those customers, by definition, American Airlines'best and most frequent travelers, must be carefully considered. These are someof the factors that make separation more complicated than it might firstappear, but I want to underscore that we are evaluating the Advantage businessin the context of building shareholder value.

Finally, I also want to mention that we'll be looking at howto best provide financial disclosure and metrics for these businesses that willimprove transparency, and we expect to provide more on that during our nextearnings call.

With that, Gerard and I would be happy to take yourquestions regarding our quarterly results.

Question-and-AnswerSession

Operator

Your first question comes from Frank Boroch - Bear Stearns.

Frank Boroch - BearStearns

Tom, if you could maybe give us a sense of how unit revenueperformed across the hubs in the quarter, that would be helpful.

Tom Horton

Our domestic unit revenue in the quarter was up 4.8%. As youbreak that down, it was up about 5.5% to TransCON, Dallaswas up about 2.8%, Chicago was up3.8%, Miami was up a little over 3%, and St. Louis was up almost 8%.

Frank Boroch - BearStearns

You alluded to the policy change, the expiration policychange coming in December. Can you give us a sense of the magnitude, therevenue impact you're expecting from the 18-month expiration period?

Tom Horton

We're still working on it. It will depend on the results ofthat work, but it will be measured in the tens of millions of dollars inrevenue.

Frank Boroch - BearStearns

Is there anything happening in the Atlantic division, interms of, your revenue seems to be underperforming a little bit the broaderindustry?

Tom Horton

I think that's a fair question. Our Trans-Atlanticperformance continues to be impacted by the weak market environment in London.As you know, about half of our Trans-Atlantic capacity is Londoncompared to the rest of the U.S.industry, which is around the 20% range for their Trans-Atlantic capacity.

London hasstruggled for a number of reasons. It's struggled with higher taxes, ongoingsecurity concerns, and I think it's fair to say increased competition. If youlook at the pricing environment in London,it continues to be extremely competitive, and you've seen aggressive pricingled by BA and Virgin. The Londonpoint of sale yields are down year over year, despite the beneficial impact ofthe exchange rate fluctuations on our UKpoint of sale yields. Pricing has been a bit weak and the premium trafficresults have also been impacted by some of the factors I just mentioned, butalso by increased capacity by other airlines in the New York and Chicagomarkets. So London's really been abit weaker than the rest of Europe.

Operator

Your next question comes from Gary Chase - Lehman Brothers.

Gary Chase - Lehman Brothers

Tom, could youelaborate a little bit? You said that despite the weather-related issues, youdo have a couple of things that are running a little bit over on the cost side.Could you just elaborate a little bit on what you're doing to stem that?

For both of you guys, as you look into 2008, what do youthink the opportunities are on non-labor costs, something that you've done areally exceptional job of controlling over the last couple of years? Can you gothrough another year where you offset inflation in the business with some ofthese initiatives that you've been rolling out?

Tom Horton

I'll start off, let Gerard chime in if he likes. Our costswere a little bit higher than we had hoped for in the quarter and I'll give youa couple of the reasons why. We had additional labor expense for investments inimproved dependability. No secret that it has been a very difficult year forthe whole industry, very difficult summer from a dependability standpoint, sowe've made some investments there.

We've also made some investments on improving our aircraftinteriors. This sort of thing I think is likely to occur in the short run, butit's really too soon to call it a long-term trend, but we're going to keep workingon our dependability metrics.

We did accelerate some depreciation expense associated withsome of the aircraft cabin improvement projects we have going on, so the waythat works is if you replace interior components, you have to write off theassets that you have on the books. So there's some of that in the numbers.

Third, a little bit of a good news/bad news story, and thatis we do have higher unit revenues and some of our costs are revenue-related asyou know, so we have higher revenue-related expenses.

To your question, we are very focused on costs, as we havebeen, I think everybody on the call knows we've been grinding costs out of herefor a long time and we continue to do so. A few things that we have in theworks right now, as I mentioned, consolidating our reservation centers whichresulted in the closing of the Cincinnatires office. We're working at grinding more costs out at JFK, now that we'reback down to a single terminal. We keep our focus on distribution costopportunities and there may be a few things there that we're working on butwill be incremental to what we've done thus far.

We have a very aggressive fuel conservation initiativeongoing. I mentioned a couple of the things in my opening remarks, but I cantell you that every month we sit down and we go through a long list ofopportunities to improve our fuel burn. We're very focused, and you're going tosee us keep the pressure on costs.

Rolling into next year, we haven't yet completed our budget,so I can't tell you what our cost reduction target is going to be, but the morecosts you take out the harder it gets to find the next dollar of savings.

Gary Chase - Lehman Brothers

A bigger question behind it, embedded in the fuel forecastfor the fourth quarter, if you use even yesterday’s, they are now out of date.Two days ago, they are really out of date. What's the spot assumption behindthe 227 you've got out there, just so we know?

Tom Horton

Let me round that uphere, it's probably just a couple of days ago.

Gary Chase - Lehman Brothers

While you're thinking about that, Tom, the important one is,obviously with fuel changing as much as it has even this week, that's asignificant number for you if you look over the span of say 2008. I'm curiousfor the capacity plan that you articulated earlier, which is flattish on ascheduled basis, up a touch. Is that contemplating $80 oil and at what pointmight you revisit that just given what we've seen here over the last few weeks?

Tom Horton

Let me just come back to your first question. The spot pricein the forward curve that was embedded in the fourth quarter guidance was as ofOctober 1st. So you can go back and look at what the spot was on October 1st.It was considerably lower than where oil is today.

I mean, you're right on point, because oil has just beenextraordinary for this industry. If you go back to January and look at theaverage price of oil at the beginning of this year, so the month of January,the average price was around $54 a barrel; it's $88 today. That's $34 a barrel.That equates to over $2.5 billion a year in costs on an annualized run rate. Soit is extraordinary. You're absolutely right. I think the whole industry willhave to look at that and consider that in making capacity plans for 2008.

Our capacity plans at this point, we think, are prettyconservative, as they have been for the past several years, on aschedule-to-schedule basis, we're basically holding our capacity flat, whilethe rest of the industry looks like it's going to be up around 3.5%.

Gerard Arpey

The only thing I would add to Tom's comments would be tounderscore the sentiment in your question which is what I alluded to in myprepared remarks, which was the fact that not just American but the industry'sis going to have to find way to recover these costs, and I think if we're notable to do that, it does very much call into question our operating plan fornext year and the levels of flying that we want to anticipate. So I thinkthat's clearly something we're going to be paying close attention to as wefinalize the plan for next year.

Operator

Your next question comes from Robert Barry - Goldman Sachs.

Robert Barry - Goldman Sachs

Maybe just a follow-up on that, I was wondering if you couldgive us any color on just how you're thinking about maybe even what you'reseeing in the market vis-a-vis recovering some of those costs? Because eventhough the market doesn't seem to be acting like it, the economists tell mewe're moving into a cyclical slowdown here. How are you thinking about that?What are you actually seeing, looking out the next couple months?

Tom Horton

Well as I mentioned aminute ago, our advanced bookings are up a little bit year-over-year in thefourth quarter, not a lot but off of some pretty high load factors last year sothat, I think, is a modest positive. There have been, over the course of thelast few days, some price increases; one that we led, and one that was led byour competitor across town. Those are modest price increases, but I think much-needed,given what's going on with oil.

If you look at the third quarter of '07, even setting thosetwo price increases aside, there have been something like nine price increasesout of 11 attempts, and so the industry, as Gerard said in his remarks, theindustry is going to have to recover its costs of inputs, or it's not going tobe profitable.

Robert Barry - Goldman Sachs

When you said earlier also that you thought the rest of theindustry would be up 3.5%, was that domestic capacity?

Tom Horton

That was system-wide.

Robert Barry - Goldman Sachs

Could you tell us how much the FX did impact RASM in the Atlanticand then Latin America?

Tom Horton

It looks to us likeif you just held point of sale mix constant and you use last year's exchangerate, that would lower our Europe RASM by a couple of points. That's if youassume that a weaker dollar doesn't impact U.S.demand and point of sale mix. So that would say FX drove a 2 point improvementin our year-over-year RASM.

However, as we dig into that a little bit deeper, we sawmuch lower U.S. point of sale demand and stronger Europe point of sale demand,and as you probably know, our Europe point of sale traffic is generally loweryielding, and we saw a lot of aggressive price discounting for both U.S. andEurope point of sale, which I pointed out a minute ago.

Given the overall demand picture we saw, the lower year overyear sale levels and the point of sale shift to lower yielding Europepoint of sale suggests that the net benefit of a weaker dollar was really quitemodest.

Robert Barry - Goldman Sachs

As we look into '08, how should we think about modeling thedepreciation, given the dynamic of the accelerated depreciation?

Tom Horton

Depreciation will be relatively flat to down a little bit,that's the way you should think about it.

Operator

Your next question comes from Michael Linenberg - MerrillLynch.

Michael Linenberg - Merrill Lynch

Tom, I appreciate all the detail here on all the variousentities. Are you prepared to give us the revenue number for Advantage?

Tom Horton

Mike, we're still thinking about what actually will bedisclosed. I think with respect to the businesses that are most developed, likeEagle and Beacon, it would be revenues and perhaps profitability. Advantage isobviously not the same stage as those two businesses. So we'll have to think alittle bit more about that. One of the things we're going to think about is,what of this data is competitively sensitive to us? So we have to balance transparencywith, with competitively sensitive data.

Michael Linenberg - Merrill Lynch

My second question, with the announcement of the Delta AirFrance JV this morning, obviously markets like Heathrow to Atlantaand New York, I think most peoplewere expecting that, the fact that they are looking beyond that to markets likeLA-Heathrow, a market that you serve. Thoughts on the announcement? Does itcreate a sense of urgency within your organization that you maybe have topursue something a bit more comprehensive with one of your partners? Should westay tuned/ Should we anticipate something as we approach the March 30th startdate of open skies?

Gerard Arpey

Michael, I'll startand maybe Tom can add some color. I think much of what we've read, including someof the specific markets that you commented on, I think were anticipated by us.I would go back to some of Tom's comments about the Londonmarket in general. I think anyone who thinks that is going to be an easy marketor a panaceas for terrific profits is really not mindful of what's beenoccurring in the London market formany months now.

We regret the fact that we have not been able to get to thepoint where we have immunity with British Airways, but I continue to beoptimistic that we will get to the point where we can be successful in animmunity application with British Airways, because I think the regulators aregoing to have to start looking at these markets. Not in terms of individualairlines and individual city pairs, but they are going to have to look at theworld and look at the way airlines are now competing across alliances.

If they begin to look at the way the airlines actuallycompete as opposed to the historic ways that they have looked at this industry,they will see that what we're trying to do with British Airways is reallypro-competitive to be able to compete with what the other alliances are doing.

I remain optimistic that we're going to get there somedayand I think when we do, we'll be able to hold our own in Londonwith everybody.

Tom Horton

In the meantime, we're very focused on our own product in London.I mentioned some of the product upgrades we're making earlier, but also some ofthe schedule changes, so as of this next summer, we're going to operate up to20 daily round trips from the U.S.to London airport, so I think we'llbe a formidable competitor for anybody who enters that market.

Michael Linenberg - Merrill Lynch

Tom, just one last one. , you gave us some '08 debt, etcetera. I think the pension legislation, I think you start seeing the benefitof that in '08. I could be wrong then, but do you have an early read of whatthat cash contribution looks like for '08 or is that for the next call?

Tom Horton

I think we're goingto put that actually in our 10-Q. You know how the pension legislation works,it doesn't change the company's total future contributions, but it does give usmore flexibility in the near term. So our '08 required minimum contribution isreally quite modest after the new legislation. But our practice has been, allelse equal, to fund something like our ongoing normal service costs.

That number for '08 is on the order of $350 million. That'snot required, but that's sort of what right now sitting here today, what wethink we would contribute for '08.

Operator

Your next question comes from Jamie Baker – JP Morgan.

Jamie Baker - JP Morgan

Good afternoon,gentlemen. Gerard, I appreciate all of Tom's commentary today, but oil's almost$90 here. You've told us again today that you're evaluating consolidation andasset spend. The situation with the pilots actually seems to be deteriorating,at least from our vantage point. Londoncompetition, you concede it is only going to get worse from here, and last timeyour stock was down at this level, I think you were expected to be losingmoney.

So I have to ask the same question that I asked of Deltayesterday. How much more time do you need before you reach some of theseimportant conclusions, decisions in terms of M&A and asset spends?

Gerard Arpey

Jamie, I think we worked hard to outline our thinking on thepotential strategic assets we have in our thought process. In terms of atimeframe, this is an issue that is a matter that we are giving carefulconsideration as we speak. When we reach the appropriate conclusions, you'llhear about that, but I think we're giving it the appropriate consideration, andall of the issues that Tom discussed, I think, need to be thoughtfullyconsidered before we draw any conclusions.

With respect to consolidation, the biggest question I thinkwe've acknowledged is that we understand the fragmentation in this industry andthe challenges that that fragmentation has caused the industry. Historically,there have been a lot of obstacles to airline industry consolidation. That'sbecause this industry is unique compared to other industries that have found iteasier to find their way to a more stable industry environment, and I've talkedabout that with you and others in the past, Jamie. That the obstacles have beenthe government, organized labor and the amount of liquidity you need to makethese complex mergers a success.

Now, whether or not those will remain obstacles for us orother carriers I'm not prepared to elaborate on, but those are historicconsiderations that have contributed to the airline industry being in thecondition it is today. Just like the other things we've talked about. We'regiving careful consideration to options that we have ahead of us, but we'vealso got to be practical about a lot of this stuff, which we're trying to be.

Jamie Baker - JP Morgan

Gerard, maybe it's just me, but there just doesn't seem tobe much of a sense of urgency. Perhaps that's just my own flawedinterpretation, but I'm sure some of your stakeholders would agree with me. Asa follow-up, Tom as it relates to Eagle, do you consider your current cost ofregional fee to be above market, above competing market rates? If so anyapproximation as to how much?

Tom Horton

Well, we've recently restructured our deal with Eagle to getit to a rate that we think approximates market. Then the question becomes doesEagle has competitive costs to go out and grow its business? I think that's avery legitimate question, one the whole team is working on. But as to ourcosts, that deal has been structured where we think the market is.

Gerard Arpey

Jamie, that's one of the things that we've been working onthis year, is putting in place a market rate, market-based relationship betweenAmerican and Eagle, so we would have the possibility of considering alternativeownership structures, but you have to do that before you get to that point.

Tom Horton

Jamie, I would just add to what Gerard said. These are allcomplicated things, but I want to assure you that this review process I describedearlier is a, is a real priority for the company and our shareholders, but it'sobviously in all of our interests to deliver that so that we get the rightanswer.

Operator

Your next question comes from Dan McKenzie - CSFB.

Dan McKenzie - CSFB

I just wanted to circle back on the capacity plans. Higherfuel prices, higher fares suggest less people traveling next year, yet AMR'scapacity plan appear really moderately bullish on demand, given flat capacity.So really how high can fares go without causing demand destruction? Where isthe demand coming from, business/leisure, stimulated with lower fares? Anyperspective would be helpful.

Gerard Arpey

I think you raise an important question. There is elasticityin this business. One of the things that we are concerned about and are keepinga watchful eye on is demand. At this point, as I mentioned, our advancedbookings are up a little bit for the fourth quarter, but as prices go higher inthe industry and the economic situation looks increasingly uncertain, I thinkthe question is at what point we see demand growth abate? So we're just goingto have to watch that on a day by day basis. We've been very measured about ourcapacity. We think that's an absolutely essential part of this company's recoveryand essential to the industry's recovery. I think flat capacity for right nowfeels about right on a schedule to schedule basis, feels about right for '08,but we're going keep an eye on that.

Dan McKenzie - CSFB

Any initial read on corporate travel spending for next year?Up, down?

Gerard Arpey

I haven't heard. We haven't picked up an appreciabledirection one way or the other. There has been a little bit of rumbling aroundless travel in the financial services sector. We haven't seen a lot of thatjust yet.

Dan McKenzie - CSFB

Should investors rule out share buybacks or dividends, givenAMR's debt and fleet obligations, if AMR does decide to monetize the non-coreholdings?

Tom Horton

It would be premature to talk about what we would do with cashgenerated from a transaction we haven't even done yet, so I wouldn't speculateon that. I would tell you that our recent focus has been putting our cash touse to improve balance sheet, buy back and retire debt, funding the pension isa priority for us, and funding CapEx but doing it in a prudent and sensibleway, as I described earlier on.

So that's been the priority near term. Our focus has been onreally building the company's financial flexibility, and building itsfoundation for the future. As to what we would do in the future with respect toanything generated from monetization.

Operator

Your next question comes from Bob McAdoo - AvondalePartners.

Bob McAdoo - Avondale Partners

A couple of questions. You talk about adjusting the cost of thefee from Eagle. I assume that has to come by adjusting the pro raterelationship between Eagle and American? Has that been done very recently, orhas that been far enough back that there's some way we can get a sense of howthat's moved and where that might be? Obviously the costs of Eagle probablyhaven't changed any.

Gerard Arpey

Bob, what we've beenworking on is structuring the relationship between Eagle and American, muchlike the market structures. So in many of these agreements, the major airlinekeeps all of the revenue and then pays the commuter partner for services on abunch of different measures; some of it per departure, some per flight hour,and so that's what we've been working on this year. We've put in place thisyear what we believe to be a market-based relationship between American andAmerican Eagle, so that American Airlines is receiving feed on a market basis,and that has been our objective and a consideration for thinking about atransaction long term, is making sure that over the long run, American hasaccess to cost-effective feed.

We think we've put in place that kind of agreement. So it'snot a pro rate agreement. It's a big airline keeps all the revenue and pays thepartner for its feed services.

Tom Horton

The standard industrycapacity.

Bob McAdoo - Avondale Partners

The real question I'm trying to figure out, is there a wayfrom the kind of public data that we get in terms of the individual statementsfor American Airlines versus the parent and all of that, and anything thatmight be filed in DOT schedules, that would give us any real way to get a senseof how much that's changed or where the current rate is versus some of theother guys?

Gerard Arpey

We made that change as of midyear. As mentioned earlier, we'reworking on some additional disclosures, which we will be able to get you moreinsight into that, Bob.

Bob McAdoo - Avondale Partners

One other real quick one. You got the 13 737s that arecoming in. First, are they just like the existing 800s, are there differencesthere? Are they replacing airplanes that are being sent to the desert, or arethey adds to the fleet? How do we think about that?

Gerard Arpey

It's all replacementaircraft. We have no plans for growth in aircraft at this point. The 737 800sthere are some modest differences, but they are basically the same airplane.

Operator

Your next question comes from Ray Neidl - Calyon Securities.

Ray Neidl - Calyon Securities

I just wanted toverify what you were talking about before. Looks to me like internationalcapacity growth, you're kind of leveling off going forward. Delta andContinental appear to be aggressively growing the Atlanticout of New York and other places,and Northwest and United probably aggressively growing the Pacific, which isrestricted, especially into China.

Is that synopsis pretty accurate? Are you giving up, for thetime being anyway, on the international capacity growth that you were doing? Inregard to the Delta/Air France situation, if they bring in Northwest withantitrust, which you don't have with British Airways, what does that do to yourinternational operation, leaving your domestic operation if Delta and Northwestget together on an antitrust basis?

Tom Horton

I will start with a baseline on the facts. We said oursystem capacity was going to be up a little over 1% in '08; domestic, about0.05%; international, up around 3% and if you adjust for the weather effect,international is going to be up a little bit year over year.

We do have some international growth, some important changesto our international network for '08. We've got the Stanstead flying, we've gotDFW Buenos Aries and I mentioned some of the Latin adds, Chicago-Moscow. Sowe're making some changes where we think it makes sense. Obviously we wouldlike to do more flying to China,but we won't be able to do that until our new Beijingaward takes effect in '09.

I think it's fair to say that we already have a prettyrobust international network, both Trans-Atlantic and into Latin America and into the Pacific, particularly when you consider ouralliance relationships, which we think are the best in the industry.

So, we have maybe a little less sense of urgency aboutgrowing our network to fill gaps. Again, I think it's important for us all toremember this is a cyclical business and the international parts of ourbusiness tend to be even more cyclical, so we try to be measured in the way wemanage our capacity so that we don't overshoot demand.

Ray Neidl - Calyon Securities

With antitrust, as Delta has with Air France,if they manage to bring in Northwest-KLM how does that effect you not onlyinternationally, but domestically?

Tom Horton

It gives us renewed focus on our relationship with BritishAirways. As you know, we've tried to get antitrust immunity in the past andwith the increased service at Heathrow, we're going to have to see if thatrepresents an opportunity for us to achieve antitrust immunity in the future.Those are the sorts of things we talk to BA about all the time.

Ray Neidl - Calyon Securities

The government is talking about doing something with thecongestion by next summer in the U.S.;either pricing by movement, in other words, raising the prices of smalleraircraft landings, or even restricting, major hub restrictions in the Northeastand New York and that could evenspread to Dallas and so forth.

Would that be a positive, do you think, for the industry andfor American? Would it bring some discipline to them, as far as capacity goes,and if there's restrictions on capacity, does that mean that the airlines wouldhave the latitude to increase prices?

Gerard Arpey

Ray, I think that the congestion problem in the Northeast inparticular is a very serious problem, and of course today it manifests itselfin poor customer service, because you're just trying to put ten pounds of sugarin a five pound sack, and that results in a tremendous number of delays and inreally adverse weather, a lot of cancellations.

From our standpoint, I think that the model that wasfollowed in Chicago was a prettygood model in terms of solving the same problem that existed at O'Hare. Thegovernment allowed us to work in concert with the government and ourcompetitor, our principal competitor in Chicagoto draw down capacity to levels that we could operate reliably. We did thatunder some duress from the government, but recognizing it was a good outcome interms of the operation.

If you look at Kennedy in particular, and look at the growthin the number of flights over the past few years, I think the same model wouldbe appropriate there and I think it would be good for the industry to followit. I think it would have a much bigger effect than trying to change how muchyou charge to land at 4:00 versus a different time, because I don't thinkthat's going to have much impact on the way airlines schedule, because theairlines are simply trying to schedule when people want to fly. There's notenough leverage in changing your landing fees across the day to really havethat big an impact on the daily schedule.

Ray Neidl - Calyon Securities

Finally, are you going to start accruing for pilot expenseswith the contract becoming amendable going forward? Are you still shooting fora neutral contract? Any salary increases would have to be compensated for byproductivity improvements?

Tom Horton

Ray, the way the accounting rules work on such things, isyou accrue when something is probable and reasonably estimable and I don'tthink we're to that point yet and when we are, we would do the accountingaccordingly.

Operator

Your next question comes from Kevin Crissey - UBS.

Kevin Crissey - UBS

Hi, guys. I just waswondering what the positive sales pitch on say an American Eagle spin? I mean,you listed it first among the businesses that could potentially be monetizedand expressed as a proxy, it doesn't strike me as a particularly goodinvestment for the investment community.

What's the positive sales pitch? I see it from the American,AMR's perspective, but what's some of the investors prospective, why would theywant to buy an above market American Eagle?

Gerard Arpey

I don't think we're quite ready to be making a sales pitchon it, because we haven't made any decision just yet. What I would say aboutthe, the way we're thinking about it is if Eagle were to be separated, I thinkit would create a structure and we try to create incentives and opportunitiesto grow that business, while letting American focus on what it does best andmake sure that we have access to cost competitive regional feed over time. Sothat's the way we're thinking about it, and whether we ever get around tomaking that sales pitch, I think that's the subject for another day.

Operator

Your final question comes from William Greene - MorganStanley.

William Greene - Morgan Stanley

Gerard, can I just ask you a little bit about the laborstuff? As Jamie sort of mentioned earlier in his question, it is sort ofdeteriorating, and it seems like rhetoric is escalating. So how do you stopthat cycle? Can you? How do you make sure you get a deal that works for you andthe union?

Gerard Arpey

Bill, I think the rhetoric across the industry is prettyhigh right now and I continue to believe as a matter of principle that the bestoutcome for our employees -- all of our employees, our pilots -- can beachieved through involvement in collaboration. I think this is a complicatedbusiness with lots of challenges, and including the employee stakeholders in acollaborative, constructive dialogue I think will, and in fact I think we havea demonstrated track record of that leading to a better outcome for employees.

I'm just going to continue with the principles that I'veused since I became CEO in 2003, and try to have a constructive dialogue at thenegotiating table, and try to use the facts to educate our workforce andeducate our unions about our competitive position. I think what we have to dois balance the interest of everyone's desire to have a better personal outcomewith the reality that we have to be a competitive company. If we're not acompetitive company, that's not going to lead to a good outcome for employees.

I just will continue to be guided by the facts and thetruths, and, and hopefully that will lead to a constructive outcome for all thestakeholders.

William Greene - Morgan Stanley

Have you seen any impact from Virgin America on theTransCON?

Gerard Arpey

Yes, of course. Any time you get a new competitor in amarket when you've got enough capacity in the market to begin with, you have anegative impact. So, yes.

William Greene - Morgan Stanley

How much?

Gerard Arpey

I don't know that I could quantify that. I don't know if anyof my colleagues can. Bill, we face a lot of low cost carrier pressure acrossour system, and Virgin America is pressuring the TransCON market. We got a lowcost carrier trying to build a hub in Fort Lauderdale,and we are very aggressive in terms of our pricing structure. Everybody cancompete on the basis of product and service and schedule, and we think we do apretty good job on all those fronts and we're going to be very pricecompetitive, but that means in a lot of these markets it's having an impact.

Operator

That does conclude the analyst portion of our Q&Asession.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

This Transcript
All Transcripts