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Holly Hegeman : “Glad I had my boots on” – 4.20.07

Ah, nothing like the smell of tulips in the air. Or the sight of dogwoods blooming. Or the vision of airline employees marching against management.

This week, American Airlines was the first airline to trot out its first quarter earnings, even as thousands of employees joined picket lines across the country and marched in Dallas, in protest of the airline's anticipated PUP incentive bonus payments.

The airline reported earnings of $81 million, or $0.30 a share, compared to a loss of $92 million, or $0.49 for the same quarter in 2006. This was the airline's fourth consecutive quarterly profit, though it was the first time the airline has reported a first quarter profit in seven years.

While operating revenue was up 1.6%, operating expenses were down 1%, with operating income up 115% to $248 million.

Revenue passenger miles were down 1.3% while available seat miles were down 2.5%, resulting in a load factor increase of 0.9 points to 78.1%.

With fuel costs lower in the first quarter, American saw CASM excluding fuel (and affiliate expense) up 2.2% to 7.86 cents/mile for the mainline. (On a consolidated basis, CASM was up 2.7%.)

CASM excluding affiliate expense, but including fuel, was up only 0.9% to 10.91 cents/mile.

On the revenue side, American posted PRASM of 10.38 cents/mile, up 4.5% over the first quarter of 2006, while yield was up 3.3% to 13.28 cents/mile.

So, enough of the numbers. Was this performance what Wall Street had expected, and what guidance did we get from the airline's earnings call?

First, the earnings call was a full house, including: Jamie Baker with JP Morgan, Kevin Crissey with UBS; Dan McKenzie with Credit Suisse; Bill Greene with Morgan Stanley; Ray Neidl with Calyon Securities; Gary Chase with Lehman Brothers; Frank Boroch with Bear Stearns; Robert Barry with Goldman Sachs; and Mike Linenberg with Merrill Lynch.

After an intro by CEO Gerard Arpey, CFO Tom Horton took over the bulk of the call.

Early in his comments, he brought up the subject of bad weather, as he estimates the airline saw its consolidated revenue decline by some $60 million as a result of the weather issues during the quarter. 3% of the mainline flights and 4% of the regional flights were canceled as as result of bad weather.

In what I think is going to be a familiar refrain this quarter, Tom said the main driver of the revenue improvement for the quarter came from international flying. Revenue per available seat mile was up 19% on the airline's Pacific routes, compared with a 10.3% gain on Latin American routes and a 9.7% increase on Atlantic flights. But domestically, RASM increased only 1% over last year.

On the other hand, he also noted that the airline's regional affilitates saw revenues decline by 4.5%. Reason? Horton cited weather and "increased low-cost carrier overlap on some of our northeast routes."

In terms of the balance sheet, the airline ended the quarter with $5.9 billion in cash.This total included $471million in restricted cash.

In the first quarter, the airline's scheduled principal payments on long-term debt and capital leases totalled $282 million. In addition, the airline paid down its $285 million revolving credit facility and prepaid $79 million of aircraft debt.

Shortly after the quarter ended, American refinanced $350 million of tax-exempt bonds for its Alliance maintenance and engineering base in Fort Worth.

In addition, during the quarter, the airline did an equity offering of 13 million shares which brought in $500 million.

The airline had capital expenditures of $126 million in the first quarter.

On the pension front, the airline contributed $62 million to its defined-benefit pension plans during the first quarter and made an additional $118 million contribution on April 13th, for a total of $180 million for the year.

The airline's total debt now stands at $17.5 billion.

"Net debt," defined as total debt, less unrestricted cash and short-term investments, is now $12.2 billion. That represents a $3.3 billion or 19% reduction versus the same time last year.

In the guidance area, Horton's comments were not overly positive, as he told analysts on the call that the airline expects that second quarter load factor will be about flat year over year. In addition, the airline is modeling for fuel to come in at an average of $2.09 a gallon, with a full-year consolidated fuel price forecast of $2.09 per gallon as well.

On the cost side, Horton said that while the airline expects to come up with an additional $300 million in cost savings in 2007, the outlook for unit costs was not too rosy.

Horton told analysts "we expect overall unit cost to increase for both the second quarter and the full year versus last year." He said the airline expects capital expenditures of more than $600 million in 2007 and he told analysts the airline would update them as the airline made "further commitment regarding our fleet renewal strategy."

The airline expects to make total pension contributions of around $364 million in 2007. This total would include the amounts already contributed this year.

Bill Greene with Morgan Stanley opened up questioning asking about the airline's guidance. He noted that "it seems like you need to have flat CASM to get your guidance since the first half will grow at about 3%. What are the line items that are going to drive that improvement?"

Tom responded , "Okay. As you'll recall, our goal at the beginning of the year was to have $300 million in cost savings to offset inflation largely. And we also said that we were aiming for flat ex-fuel and profit sharing unit cost in the mainline business for full year. So as I said, in the remarks, I think we're on track to get the $300 million in cost savings for the year."

"And barring any serious operational disruptions like we had in the first quarter, we'd expect to continue on the pace we set for ourselves in the second through the
fourth quarters. However, you know, the first quarter with all the operational and unit cost challenges, is going to make it more difficult for us to meet the original full-year goals."

He concluded, "So that said, we are going to try to continue to make up lost ground."

"Now, as you look into the second quarter, you know again, we'll have a little bit of a unit cost challenge because of capacity. And you probably saw our guidance that our capacity is going to be down a bit, again, in the second quarter and that is really
a result of the schedule simplification which resulted in a flattening of our schedule throughout the year. So where we normally see an increase of 4% to 5% in capacity from the first quarter to the second, this year it's going to look more like 2%.
So a much flatter schedule. So that will put a little pressure on second quarter unit cost but conversely, will give us a little help later on."

Got that? I think the easy way to digest all of that is to say the airline is probably not going to make its former goals in 2007.

Kevin Crissey from UBS questioned Horton about the large divergence between revenue performance domestically and that internationally.

Horton responded, "Well, we've seen much stronger international business across all of the entities and if you look at unit revenue in each of our entities, Pacific, Latin, and Atlantic, see double-digit or near double-digit improvement. So it has been very strong and I think it's, it's a result of our fairly attractive supply-demand balance. Demand has been strong. Capacity has been relatively restrained. It's a different story by region as I mentioned in the Pacific. We pulled some capacity down specific to us. So, but it's been strong just about everywhere."

Everywhere but in the U.S.

Crissey followed up, "I mean, I guess what I'm not fully appreciating is, it's not just you guys that are seeing this obviously. But what the driver is and what we would look for, other than additional capacity coming in that might change the scenario because its been ongoing for quite a while now, more than four quarters. So effectively we've already lapped, question is what might change the demand environment and basically what is the underlying driver?"

Horton responded, "I wouldn't necessarily ascribe it more to business or leisure. It's strong across the portfolio, depending on the region you're talking about. I think the things to look out for and thing that is we always pay attention to are the balance between demand growth and capacity growth. And in general, the international economies that we serve have been pretty strong. And capacity growth hasn't been crazy. So, you know, watch capacity growth and watch the state of economic growth of the big industrial centers."

Meanwhile, Jamie Baker came in at that point with a follow-up on the guidance question, "Your fuel bill is admittedly going to be much higher this year relative to your prior guidance for a full year estimate of a $1.98 to the $2.09, given what is left in the year, that's about $330 million, $340 million."

He continued, "But your ex-fuel CASM numbers are unchanged and those incorporate profit sharing as you just indicated in the prior question. So, doesn't that mean that you've also made offsetting and improving assumptions to your revenue forecast?"

Seems like a logical question to me.

Horton responded, "(Pause) Um. You know, I'm not sure — let us come back to you later in the call. I'm not sure I completely follow you but I'll try to get you an
answer to that."

Jamie responded that he would take it up with Tom offline.

"You bet, Jamie," Tom responded.

As for more opportunities to China, Dan McKenzie asked what the airline thought were the chances of a potential relaxing of the current bilateral agreements with China.

Gerard responded, "Well, Dan, I guess what I would say at this point is, at this stage, this kind of dialogue, you get a lot of mixed signals. But I think there's a degree of optimism that there will be more opportunity to China and we'll certainly be first in line for that. We need to get our long-haul agreement worked out with our pilots. But I'm optimistic that there will be more opportunities for us in China."

Frank Boroch asked if, because Easter came early this year, the airline expected a bit of a drop in revenues for the second quarter.

Horton responded, "… very modest effect. So I think you're right, there is an effect there but it's pretty small. So I wouldn't expect for that to be particularly noticeable."

Robert Barry then asked a good question, "Did the weather actually help the RASM growth in the quarter?"

Tom responded, "Sure. Yes, it does. You obviously hang onto some of the revenue — when you lose the ASM. So there is some natural lift to RASM and some offsetting negative impact to CASM."

Barry followed up, "On my rough estimate it looks like maybe consolidated RASM was more like 2.5 instead of of 3.9. And if that's kind of in the ballpark given the strength you're seeing internationally, it does imply a pretty lackluster domestic RASM growth, maybe even flatish to slightly negative. I guess I was curious to have you dissect what you're seeing in the domestic environment. Clearly, we've got a slowing macro environment. But how is that manifesting itself in the business, more advanced bookings, how is the impact coming at you?"

Tom responded, "Yes, you see the numbers for the quarter and domestic RASM year-over-year is up only a percent relative to the system. And I think to take the 30,000-foot level, it's back to supply and demand. There's more capacity growth domestically than GDP growth would suggest there should be. So I think that's really what's driving a more modest growth in domestic RASM. And that's, you know, that's to be expected."

Barry pushed further, asking, "I guess my question was, how was the slowing demand manifesting itself? Manifesting it more on the business side, or the
leisure side?"

To which Horton said, "I'm not sure I would characterize it as slowing demand so much as a lot of capacity. When you think about the supply and demand balance, which really is a result of more capacity than we ought to be seeing, given the economic growth in the U.S."

Interesting way to look at it. Is it the chicken or the egg? Too much capacity or slowing demand? Take your pick.

Mike Linenberg asked, "I think on peak days this summer, we're going to see EOS with three flights in the New York-London market. Maxjet is there and Silver Jet will add another flight out of Newark. Are you seeing any sort of share shift? Now with call it half a year competing against these carriers, what if anything you are seeing in that market?"

Horton responded, "Well, since the security concerns in London last August, we saw some of the London routes underperforming core unit business. And that has abated somewhat but we're still, we're still performing a little bit less positively than some of the other trans-atlantic business. So there may be some of that effect there mixed in with the additional competition."

He then added, "But in general, more capacity of these markets is not going to be helpful for the universe and performance. Jump back maybe for a minute to Jamie's question earlier and I apologize if I was obtuse, Jamie. But I think the gist of your question was about profit sharing and the impact on unit costs and guidance. And as you probably know, profit sharing is 15% of American's pretax profit above $500 million. While that amount that we book is a material dollar amount the unit cost impact is relatively modest and not that noticeable in the guidance as of yet. Of course, if our profits grow from our current expectations, that could become a big factor going forward."

Actually that wasn't Jamie's point — and I don't think it had anything to do with Mike's question either.

But Jamie was back for more. In a follow-up question, he asked, "Just a quick follow-up because I'm generally getting a bunch of questions from some of your shareholders here. In response to one of my competitor's questions, you didn't seem to want to get pinned down…[unclear]. I just want to make sure that this is the message you're trying to get out, just seeing if that [comment] was an inadvertent endorsement of a RASM decline. I interpreted that statement as AMR just being kind of cautious on the demand front. But if you're in fact endorsing a scenario where both loads and yields are flat, then that would in fact be a, very negative piece of guidance. Could you just revisit what you were trying to say?"

Horton's response was, "No, that's just something we don't comment on. It's not something that we're offering further guidance on, so your interpretation
is right, Jamie."

Meaningless suspicious set-up softball question of the call — followed by one of the more meaningless responses? This one from Ray Neidl at Calyon, who also worked in the finance department at American for a number of years, who asked, "I know the contracts don't come up for another year or couple of years in the case of some labor unions there seems to be a lot of concern on the part of many of the employees, now that the airlines are starting to make money again, that they want their so-called fair share. How are you communicating with the employees to demonstrate to them that one or two quarters of profitability does not solve all your problems?"

Gerard responded, "Well, Ray, I guess you're communicating best right now. I think that's obvious given the years and years of losses that the company incurred that we've got a lot of work to do to recover from the $8 billion that we lost between '01 and '05. So we have had a very open dialogue with organized labor for many years now — a partnership to work together to make our company stronger and we're just going to stay the course with that and do our best to continue to work together, to strengthen the company and we will go through the Section 6 process with all of our unions with the same spirit that's gotten us to this point — the spirit of collaboration and cooperation and try to get the best outcome for everyone, recognizing that there's a lot of stakeholders at this company. So we'll do the very best we can."

I don't know what I can possibly say to follow that comment up adequately. Where would one start?

I'm just glad I had my boots on.

Overall, an okay performance by the airline, but nothing outstanding. The American Eagle network continues to be an expensive operation, and as Jamie Baker said in his note after the call, "the airline's future guidance is 'discouraging.'" He said that the airline's revised cost forecasts "call into question the achievability of its full-year plans."

In addition, it just seemed to me that Tom Horton was not very forthcoming with much information on the call, nor was Gerard. They gave out what information they had to, not much else. A little too constrained, a little too uptight. Tense might even be appropriate. Then again, not one analyst had the balls to directly ask them about the increasing level of employee dissatisfaction, or the reason behind it.

Unfortunately, we all know why. Because if someone were to directly ask them on the call about the issue — that analyst would no doubt be put on ice — in terms of future communications between the airline and the analyst.

As Louis Armstrong said, "What a wonderful world."

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APFA Headquarters
1004 West Euless Boulevard
Euless, Texas 76040

M-F: 9:00AM - 5:00PM (CT)
Phone: (817) 540-0108

Call APFA

Contract & Scheduling Desk
M-F: 7:00AM - 7:00PM (CT)
Phone: (817) 540-0108

Chat APFA

After-Hours Live Chat
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