American posts substantial improvement despite loss, new aircraft order and management realignment

"We are far from satisfied, but we believe the improvement indicates we are headed in right direction and determined to build on the process," he said. In an action-packed news day for the carrier, it also reported that the volcanic disruptions across the Atlantic reduced operating earnings by USD17 million, a management reshuffle and a new B737 order.

Interestingly, its second quarter press release seemed designed to bolster Chair and CEO Gerald Arpey's credentials given the amount of coverage in it of the progress the company has made since he assumed his post in 2003. It also seemed designed to counter the impatience Wall Street has expressed with both him and the company in the last several months. Indeed, the management shuffling - promoting Horton, formerly Executive VP of Finance and Planning and CFO - could be seen as part of its plans to bolster the confidence lost during the recession and as American's fortunes faltered in relation to its peers.

Arpey came out swinging against analyst impatience last month during the Bank of America Merrill Lynch Global Transportation conference. See related report: American Airlines strikes back at doubters: Bullish on future

"The execution of the joint businesses we are creating with our oneworld partners will be watershed events for American Airlines," said Arpey of the management shifts. "We have an opportunity to create great benefits…and are realigning and consolidating our internal resources to make sure we do so."

Continuing to report to Arpey, Horton will oversee finance, planning, sales and marketing, customer service, and information technology organisations. As part of these changes, Bella Goren will assume the role of Senior VP - CFO. Goren, formerly Senior Vice President - Customer Relationship Marketing, will report to Horton. (See below for details of the rest of the management shifts at the company).

The company said the management changes would position it to take full advantage of the coming changes now that the oneworld joint business agreement (JBA) in the USD7.5 billion Atlantic market has been approved in both Washington and Brussels which is expected to bring a USD500 million boost when it rolls out beginning in October. Horton reported that 98% of total capacity is now focused on its cornerstone markets, which is expected to boost the carrier's fortunes further.

Alliances

Both Horton and Arpey also pointed to the joint venture with Japan Airlines now pending a decision by the Department of Transportation and indicated that the benefits coming from the Atlantic JV would be repeated over the Pacific, especially as JAL and American take advantage of the upside potential at Haneda.

"The future depends on the power of the network," said Horton. "We are now at a point where we are starting to see the benefits of our network realignment that we started in April with our corner-post strategy. We've added a fair bit of flying to Chicago and have a lot more connecting opportunities. We've seen some of what we expected to see with the realignment and with the joint business agreement with British Airways and Iberia, I think you'll see more and more of that take effect. And we are taking steps to build on the double-digit revenue growth we've seen and the synergies brought by the network realignment as the alliance takes shape. We'll see most of the USD500 million in 2011 with the full run rate coming in 2012. The oneworld team will be coordinating activities that will result in a combined entity that will be much more than the sum of its parts. We plan to do the same with JAL once the Pacific joint business agreement is approved."

"We've been talking about all this for a long time and now we are going to prove to you how powerful we can make these joint ventures across the Atlantic and Pacific," Arpey told analysts yesterday. "This is not just about us being able to compete more effectively with Star and SkyTeam. One of the things no one has focused on is the fact that while we may be teamed with British Airways we have also been competing against them. This is very impactful since we have been fighting to get passengers to choose American over BA. One of the first thing that changes is we stop caring whether they get on American or BA. We are now focused on taking customers from Star and SkyTeam and putting them on either American or BA."

He indicated that since they have had such a long time to prepare, they will start in October with frequent flier reciprocity, joint selling activities, code sharing, joint pricing, scheduling, and co-location. "There are a lot of pieces to this that are worth a lot of money," he said. "If anything our estimates are conservative."

Arpey also indicated the JVs would also make its moves on Charlotte, Atlanta and Minneapolis, which American has tried and failed before, more successful since it could now leverage the power of its global partners. "We've got a better mix of aircraft to use," he added. "A lot of markets we've tried in the past will be much sharper in terms of connecting to our international flights which will bring more fire power to the markets."

Aircraft and JBLU

The company also announced yesterday that it is ordering an additional 35 B737-800s as part of its fleet renewals plan to replace its MD-80s with an ultimate goal of replacing them all in the next several years. The 35 aircraft are in addition to the 84 B737s that began entering the fleet in April 2009 and American expects the 35% greater fuel efficiency of the new jets will save 800,000 gallons per aircraft per year. In 2010, its Fuel Smart program - from employee suggestions on fuel consumption reduction - aims to reach an annual fuel savings of 120 million gallons and reduce carbon dioxide emissions by 2.5 billion pounds. At AMR's projected average system price of USD2.29 for 2010, that would represent savings of USD275 million.

The airline has already obtained "backstop" financing commitments covering the new order. American expects to have a total of 195 B737-800s in its narrow-body fleet by the end of 2012.

Finally, the company announced the expansion of its JetBlue partnership to include the ability for passengers to build frequent flyer credits on each their interline routes.

AA vs peers

Arpey made a point that in addition to the fact that American labour costs are 30% higher than its peers and the fact that it has been at a competitive advantage on the alliance front, different carriers have different strengths in given regions which will be leveled once American's joint ventures get underway. He reported that the company saw particularly high unit revenue growth during the second quarter in Europe and China at 28% and 38%, respectively. "The markets are rebounding, but our relative share is less than that of our competitors," he said. "On the flip side we are uniquely large in Latin American and Caribbean."

During a discussion on American labour cost disadvantage, Arpey, who has been reporting on the growing convergence between American's costs and those of its peers for months, said that the message he takes to employees is that American has to be competitive in everything it does because that is the only way to guarantee secure jobs.

"We've got to make the case that on some issues - scope and productivity - we have got to close the gap and it is in our employees' interest to do that," he said. "The scope flexibility at our peers is being used against our employees and us. I think we've made progress in our current agreement with the Transport Workers Union. We have been talking constructively about the competition and how they have outsourced maintenance. We do the vast majority of our maintenance in house. Part of our dialogue is we have to be mindful of the need for flexibility to improve our competitiveness and it is in the mechanics best interest to do that. It would do them and us a lot of good if we could get changes in the contract that could help us become more competitive. This is not just about the rates, but what we are trying to do at the negotiating table across all these groups is to get them to understand what these companies did through bankruptcy." A new contract with TWU is pending ratification.

In response to a question on what will happen to the revenues side once the labour and work rule gaps are closed, Arpey said that the biggest problem has been that the industry has been unable to enough for the product. "Their input costs are less," he said of his peers. "Whether it is fuel hedging or labor, the biggest input to airline costs structure, they can charge less for the product. Is that sustainable? I don't think so. If the input costs become more level across the industry they have an incentive across the board to recover costs and that will be healthy for the entire industry. I don't think it will lead to dragging anybody down. It will just get them thinking differently on how they price their product. It will also require further constraints on capacity and may mean more reduction in capacity depending on what happens with the GDP around the world. Our philosophy is that capacity should grow no faster than the GDP."

The question then becomes whether or not the discount carrier advantage will grow as legacy costs converge.

And Arpey was ready with an answer. "If you look at the margin of the network guys versus the low cost guys, that margin gap has closed considerably over the past 10 years as one of us has restructured consensually and the rest went bankrupt," he said. "If you look at the gap that is narrowed considerably and there's a lot of cost pressure going on at the so-called low cost carriers. So, I think they're being pushed in a similar direction. If you look at what happened with Spirit this summer, that's convergence in action."

2Q2010 results

Arpey reported that domestic unit revenues improved 14.5%, along with improvements in all cornerstone markets, while the Atlantic and Pacific performed particularly well. Its corporate travel growth outpaced the first quarter improvements giving the company strong corporate yield which is continuing to improve.

"We also see fewer fare sales and the industry had been successful in raising fares," said Arpey. "Some 70% of the more than 20 fare increases this quarter were successful. Advance bookings are up 1% versus last year, flat domestically and up 2.5 points internationally."

Mainline unit revenue rose 16.8% to 11.14 cents driven by improving economic conditions coupled with tight capacity and higher load factors. Indeed, American reported record load factors in the quarter at 83.9%, up two points from the year-ago period. International load factor rose 3.8 points across all three regions to 81% with the Pacific region rising the most at six points to 86.3%.

Second quarter international unit revenue rose a whopping 20.9% to 11.05 cents with double-digit increases in each region. Atlantic RASM led the regions seeing a 21.9% rise in yield to 11.36 cents. Consolidated unit revenue increased 16.7% on a 16% increase (USD785 million) in consolidated revenue to USD5.7 billion. Yield rose 14% to 13.28 cents on a 0.4% reduction in mainline available seat miles compared to 2Q2009.

American Airlines operating statistic by region: 2Q2010

Region	RASM (cents)	Y-O-Y change	ASMs* (bill)	Y-O-Y change	Load Factor (pts)	Y-O-Y change (pts)	Yield (cents)	Y-O-Y change
DOT Domestic	11.20	14.4%	23.4	0.0%	85.7	0.8	13.06	13.3%
International	11.05	20.9	15.0	(1.0)	81.0	3.8	13.64	15.1
DOT Latin America	10.90	13.8	7.2	2.7	76.3	3.3	14.27	8.9
DOT Atlantic	11.36	28.3	6.0	(6.2)	85.0	4.3	13.37	21.9
DOT Pacific	10.57	25.3	1.8	3.6	86.3	6.0	12.25	16.6

Source: Company reports

Regional affiliate revenue grew 16.9% to USD600 million while expenses increase substantially from USD608 million in the 2009 period to 662 million during 2Q-2010. It continues as a money losing proposition as the company and newly installed American Eagle President Dan Garton works to sell the entity off. Both Horton and Arpey agreed that spinning out the company would be in the best interest of stakeholders. Revenue passenger miles rose 2.2% to 2.2 billion while ASM's rose 2.5% to 2.9 billion. Passenger load factor dropped 0.2 points to 74.5%

AMR reported continued improvement in ancillary revenue. Revenue from confirmed flight changes, purchased upgrades, Buy-on-Board food services and baggage service charges jumped 10.2% in the second quarter to USD625 million. During the second quarter new products were offered including being in the first group of general boarding, discounts on flight changes and stand by for earlier flights. "We are pleased with the early returns and we also have a mile multiplier that triples the miles earned with mileage purchase on selected flights," said Horton.

The company finished the quarter with USD5.5 billion in cash and short-term investments having built its liquidity up from USD3.3 billion in the year-ago period. This included a restricted balance of USD461 million. Net debt, which AMR defines as Total Debt less unrestricted cash and short-term investments, was USD11 billion at the end of the second quarter, compared to USD11.4 billion in 2Q2009.

On the expense side, American reported mainline fuel price per gallon for the quarter rose 25% year on year and the second quarter price of USD2.37 approaches three times the 83 cents per gallon paid when Arpey first assumed his post. In the second quarter of 2003, fuel expense represented 19.8% of total operating expenses compared to the current percentage of 30.2%. Fuel expense this quarter was just USD60 million shy of eclipsing wages, salaries and benefits as the company's largest cost.

CASM rose 7.3% to 12.62 cents. American predicted that full-year unit costs will be up 1% compared to 2009, slightly better than previous guidance and does not include the labor agreements. If ratified, those agreements will mean a slight increase of unit costs of about 1.5% ex fuel. But, they also include productivity gains to offset the increases.

"We've got a lot of cost initiatives under way that you'll see bearing fruit later this year," said Horton, cited productivity and technology initiatives that are coming on line.

Arpey and Horton were asked about a statement made at the Farnborough air show that airlines were starting to take planes out of the desert to add capacity.

"That would be a foolish thing to do," said Arpey as Horton jumped it to say, "I wouldn't recommend it." Interestingly, this discussion came after a similar discussion during the US Airways conference call in which Chair Doug Parker was asked whether, now that cash coffers were healthy, airlines would go back to their old ways of piling on capacity. Similar to Arpey and Horton, Parker indicated it would not be a smart thing to do then added, "you won't see us doing it."

AMR's total debt, defined as the aggregate of its long-term debt, capital lease obligations, the principal amount of airport facility tax-exempt bonds, and the present value of aircraft operating lease obligations, was $16.1 billion at the end of the second quarter of 2010, compared to USD14.2 billion a year earlier.

AMR's net debt, defined as total debt less unrestricted cash and short-term investments, was USD11.0 billion at the end of the second quarter, compared to USD11.4 billion in the second quarter of 2009.

Guidance

AMR expects its full-year mainline capacity to increase by 0.9% in 2010 compared to 2009, with domestic capacity down 0.1% and an increase of international capacity of 2.4% compared to 2009 levels. On a consolidated basis, AMR expects full-year capacity to increase by 1.2% in 2010 compared to 2009.

The company's 2010 capacity levels include the reinstatement of flying that was canceled in 2009 due to the H1N1 virus and the launch of Chicago-Beijing service, which was deferred from 2009.

AMR expects mainline capacity in the third quarter of 2010 to increase by 3% compared to the third quarter of 2009, with domestic capacity expected to be up 0.3% and international capacity expected to be up 7.3% compared to third quarter 2009 levels. AMR expects consolidated capacity in the third quarter of 2010 to increase by 3.4%compared to the third quarter of 2009.

Mainline CASM for the third quarter will be up 1.7% and 4.0% in the fourth quarter ex fuel versus the year ago period. Consolidated CASM will be up 2% and 4.1% in the third and fourth quarters, respectively.

The company cited the higher revenue-related expenses (such as credit card fees, commissions, and booking fees), airport-related expenses (such as landing fees and facilities costs), and financing costs related to new aircraft deliveries for the estimated 1.2% increase in consolidated cost per seat mile, excluding fuel and special items. However, it does not account for any change resulting from labor agreements which are expected to increase full-year unit costs by 0.4%, matching the company's guidance. The increased costs are largely the result of the signing bonus and wage increases included in the agreements. If the agreements are ratified, the Company anticipates implementing productivity improvements consistent with the agreements that will help to offset the ongoing cost of salary increases.