Debt Load

[Connected1]

BOW - "Bill of Work" - The level of cleaning assigned for the aircraft, which varies depending upon aircraft type and outbound destination.

 

[Bob Owens]

FWAAA
No, Mr Owens, you just don't understand it. Your post is not unlike me asking "Why does AA perform all that heavy maintenance on its airplanes? Wouldn't it be cheaper to fly them until they fall apart? Seems to me that all that heavy maintenance is just wasted money."

You'd call me a dumbass if that were my view, wouldn't you? And rightly so, because if I subscribed to such an uninformed viewpoint, I'd have earned that label.

No,because that is exactly what they do to a certain extent. They extend check intervals, defer maintenance and order less parts.

AA didn't spend anywhere near $240 million for interest on that $3.8 billion of cash. AA earned $157 million in interest income last year, and that is likely almost as much as the interest paid on the $3.8 billion of cash. That's what effective cash management can do for you.

But as you admit, you really dont know.

Ever received an offer from your credit card company for something like 1.9% for the life of the balance? I've got a couple of those right now. Wanna know what I did with the money? Invested it. I've done a little better than 1.9%.

Sure, but most often there is a 3 % fee attached to it so for the first month you effectively pay 36%APR.

I doubt AA did has achieved the same results on its cash balance, but to assert that AA would likely have been profitable last year if only it reduced its cash balance to near zero is just so far out of touch with reality that I feel compelled to point it out for you.

It's not like your (or mine) "free" checking account where you earn zero interest in exchange for free checking; AA actively invests its cash to minimize the net cost of carrying that cash. $157 million of interest income is impressive, especially since AA's cash balance grew during the year (it didn't start 2005 with $3.8 billion of unrestricted cash).

Its very unlikely that AMR was able to earn enough on their investing of that money than it cost them to hold it.

You obsess over the minimum unrestricted cash requirement of $1 billion; do you really think AA's management finds that requirement burdensome?

No. Thats the point. The $1 billion created the crisis and AMR exploited it.

The fact that management has worked hard to increase the cash balance by $2.8 billion over that minimum amount should tell you something.

Maybe it serves other purposes as well but from where I'm sitting its just more debt, part of the scare tactics that the company is using to get more concessions from the workforce.

Sure, AA told you repeatedly that it was in danger of falling below that minimum in early 2003; had it done so, it would have been in default on most (if not all) of its debt and would have had to file for Ch 11.

Or it would have had to approach the bank and renegotiate the deal.I dont believe that they would have had to file BK.

 

[Bob Owens]

FWAAA
Notice the "air traffic liability" figure of $3.8 billion? That represents tickets puchased for flights not yet flown and AAdvantage miles sold to Citibank and other partners. Might be a good idea to keep cash on hand with which to satisfy that liability. Maybe you know better.

Why? AAdvantage miles are like Green Stamps, a lot of them will never be cashed in.

$7.8 billion of current liabilities (those are debts due within a year - or by 9/30/06, since this is from the 9/30/05 balance sheet) plus $12.3 billion of long-term debt (bank loan plus bonds and notes) plus $4.8 billion of pension and post-retirement benefits plus $900 million of capital lease obligations (principal equivalent of those lease obligations) plus almost $4.3 billion of other liabilities. Totals $30.165 billion of total liabilities. Long term debt plus current liabilities alone equal $20.161 billion.

Ok so they owe $7.8 this year, and they expect $20 billion in revenue.

The $12.3 is long term, much of that is probably for all the new terminals and airplanes.

$4.8 billion of pension and post retirement benifits. Well we pay for the post retirement benifits and the pension would be part of that long term liability.

$900 million for Capital Leases, well lets go back to the $20 bilion in revenue.

 

[eolesen]

Bob, the traffic liability is not like green stamps -- it's a matter of sales made to customers without the product being delivered yet. If we didn't carry that on the balance sheet and have cash to back it up, the credit card companies would simply do what they did to ATA before they filed for bankruptcy -- withhold all of the funds they collect on our behalf, so that they have something with which to issue refunds to customers. We lose the cash up front, and we lose the interest float that provides us, which add up much faster than the three pennies per gallon I like to save on gas by driving a mile extra down the road.

Would you cash in your savings account or 401K to pay off a credit card in full? Or would you risk running less than a $100 checking account balance just to pay down an extra $100 on a credit card bill?

Sometimes you have to keep money in the bank even though you own a balance somewhere else. You still need to have free cash onhand to pay for things which come up unexpectedly. If we had another air traffic shutdown like we did on 9/11, it would be necessary to pay for salaries and other things due to no cash coming in the door.

 

[Bob Owens]

Bob, the traffic liability is not like green stamps -- it's a matter of sales made to customers without the product being delivered yet. If we didn't carry that on the balance sheet and have cash to back it up, the credit card companies would simply do what they did to ATA before they filed for bankruptcy -- withhold all of the funds they collect on our behalf, so that they have something with which to issue refunds to customers. We lose the cash up front, and we lose the interest float that provides us, which add up much faster than the three pennies per gallon I like to save on gas by driving a mile extra down the road.

Would you cash in your savings account or 401K to pay off a credit card in full? Or would you risk running less than a $100 checking account balance just to pay down an extra $100 on a credit card bill?

Sometimes you have to keep money in the bank even though you own a balance somewhere else. You still need to have free cash onhand to pay for things which come up unexpectedly. If we had another air traffic shutdown like we did on 9/11, it would be necessary to pay for salaries and other things due to no cash coming in the door.

The AAdvantage miles end up in the accounts of people who used their credit card to make a purchase, many of those miles will never be cashed in, just like green stamps, but in the meantime AA already collected cash for them up front.

The miles are not converted into cash, they are converted into a ticket to ride on the plane so its not as if $5 billion worth of miles requires the company to lay out $5 billion worth of cash, instead those miles are given a value based on a regular fare. So even if $5 billion worth of AAdvantage miles are exercised it might only cost the company $900 million to deliver.

 

[Connected1]

I would recommend that everyone take a look at the cash flow statement rather than get wrapped around the axle looking at the balance sheet. Our operation is modestly cash-positive - not cash-positive enough to fully cover the $1.2B in debt repayments, $XXX million in pension contributions, and $XXX million in capital expenditures in 2006 that are over and above the normal cash requirements of the business. That, in addition to the uncertainty of oil, is the reason why we are carrying a high cash balance into the year.

 

[jimntx]

The AAdvantage miles end up in the accounts of people who used their credit card to make a purchase, many of those miles will never be cashed in, just like green stamps, but in the meantime AA already collected cash for them up front.

The miles are not converted into cash, they are converted into a ticket to ride on the plane so its not as if $5 billion worth of miles requires the company to lay out $5 billion worth of cash, instead those miles are given a value based on a regular fare. So even if $5 billion worth of AAdvantage miles are exercised it might only cost the company $900 million to deliver.

Bob, I don't think anyone disputes your point that a lot of FF miles are never cashed in--hell, I lived in Houston for over 30 years and am a OnePass member. Right now, I have over 100,000 miles in my OnePass account that I keep "meaning to cash in." However it hasn't happened yet.

The point is though, that neither the FASB--Federal Accounting Standards Board--nor the SEC allows companies to "guess" or estimate how much of an apparent liability is ever going to be exercised. A company must list every dollar of a liability. Such as, Total Accrued Frequent Flyer Miles: 46 Billion. The company is allowed, however, to put a footnote in the annual report--which I don't think they do--that says something like "Historical experience with this item indicates that no more that 65% of this liability will ever be cashed in by AAdvantage members."

That is permissible. Listing the liability as 29.9 Billion frequent flyer miles (65% of 46 Billion) is not permissible.

The balance sheet must be balanced to the total liability, not to what one "thinks" the liability will eventually cost.

Another reason why the total has to be recorded. If AMR should start making noises about BK, or the "Talking Heads" start saying that AMR is in serious financial trouble, I can guarantee you that there will be a run on those AAdvantage miles. It happened at UAL, and US Airways, and at every other airline that has filed for bankruptcy and had a FF program. And, every seat allotted to FF rewards is a seat that can not be counted on for current revenue.

 

[FWAAA]

The AAdvantage miles end up in the accounts of people who used their credit card to make a purchase, many of those miles will never be cashed in, just like green stamps, but in the meantime AA already collected cash for them up front.

The miles are not converted into cash, they are converted into a ticket to ride on the plane so its not as if $5 billion worth of miles requires the company to lay out $5 billion worth of cash, instead those miles are given a value based on a regular fare. So even if $5 billion worth of AAdvantage miles are exercised it might only cost the company $900 million to deliver.

Of the $3.8 billion of Air Traffic Liability I mentioned, approximately $250 million relates to the actual cost of fulfilling AAdvantage awards. The deferred revenue from the sale of AAdvantage miles to Citi and other partners is about $1.25 billion; that deferred revenue is recognized over a 28 month period. The rest, or about $2.3 billion, represents the money from actual tickets sold for future flights.

You are certainly correct that fulfilling AAdvantage mile award obligations is very cheap; of the airlines still disclosing their estimates of that liability, most record a typical 25k mile coach award seat at about $25 each. That's the average marginal fuel and catering expense attributable to the additional body and their bags. I don't know the price paid by Citi per mile, but I'd bet it's a little north of one cent each. AA's ask for smaller businesses is north of two cents each. So AA takes in at least $250 (and likely a little more) for each of those basic award seats.

I agree with Connected1, who knows a lot more about this than I do.

Cash flow has been the most important metric for the companies wanting to avoid Ch 11. Those who can keep their cash balance strong have avoided it (notably, AA and CO as the only legacies on the list) and those who failed to maintain a strong cash position have filed for Ch 11 protection. And despite glowing, gushing press releases from UA and US/HP, it remains to be seen whether their expensive odysseys thru bankruptcy will actually result in profits. So far, neither has demonstrated profits.

AA operations have been cash flow positive since the concession agreements became effective. And since those concessions, AA has borrowed more money - lots of it.

 

[Bob Owens]

jimntx

Bob, I don't think anyone disputes your point that a lot of FF miles are never cashed in--hell, I lived in Houston for over 30 years and am a OnePass member. Right now, I have over 100,000 miles in my OnePass account that I keep "meaning to cash in." However it hasn't happened yet.

Exactly! But its all still claimed as a debt.

The point is though, that neither the FASB--Federal Accounting Standards Board--nor the SEC allows companies to "guess" or estimate how much of an apparent liability is ever going to be exercised. A company must list every dollar of a liability. Such as, Total Accrued Frequent Flyer Miles: 46 Billion.

There are things that must be estimated, however if thats the case FASB rules urge want them to err on the side of caution, in other words go on the high side of liabilities. These rules work well with what I,m claiming management is doing, overstating the crisis.

The company is allowed, however, to put a footnote in the annual report--which I don't think they do--that says something like "Historical experience with this item indicates that no more that 65% of this liability will ever be cashed in by AAdvantage members."

And why would they leave that out? Once again it serves their objective to make things seem as bad as they can.

That is permissible.Listing the liability as 29.9 Billion frequent flyer miles (65% of 46 Billion) is not permissible.

No arguement there. Remember the SEC is trying to protect shareholders rights, not workers rights. Since shareholders are usually harmed by companies that overstate the positive thats what the rules of the FASB are geared for, they dont contemplate the opposite.

Thebalance sheet must be balanced to the total liability, not to what one "thinks" the liability will eventually cost.

From what I've read thats not entirely true. Sometimes liabilities can only be estimated to where they expect that they will fall within a certain range. However they are supposed to go with the high side according to FASB.

 

[jimntx]

From what I've read thats not entirely true. Sometimes liabilities can only be estimated to where they expect that they will fall within a certain range. However they are supposed to go with the high side according to FASB.

This does not apply to the FF miles liability. Yes, if there is an accident, for instance, that is still in litigation or negotiation, the company must estimate what they think the eventual liability will be. However, they know exactly how many FF miles they have awarded. Therefore, the liability must be stated in full.

The fact that "everybody knows that a lot of those miles will never be cashed in" is not an accounting principle. Just because "everybody knows" that the Republican Party is pro-business and anti-labor does not mean that you can count on working people not voting Republican.

 

[Connected1]

It is my understanding that our FF liability contains a breakage assumption, as Bob states. It is based upon historical redemption rates and may be tweaked up or down as we get new information.

The underlying accounting concept is similar to bad debt. When you make a sale on credit, you don't recognize the full value of the sale. Instead, you hold a bit back for expected bad debt. Since the calculation is based upon historical data and can be reliably estimated, accounting rules require that you make the adjustment to better reflect your future cash collections.

Granted, bad debt is an account receivable and the FF liability is an account payable, but it's the same idea.