S&P Airlines

Industry Surveys
Airlines
November 22, 2007
CURRENT ENVIRONMENT..................................................................1 Chronic delays prompt increased government scrutiny
Jim Corridore Airlines Analyst
Delays unlikely to ground profitability Profitability seen for 2007 and 2008 Fares, yields have risen Open skies ahead? Where are the mergers? Labor costs down sharply, but still too high Pressure to go green
INDUSTRY PROFILE...............................................................................9 Airlines still face extreme challenges INDUSTRY TRENDS ...............................................................................10
The impact of five years of multibillion-dollar losses Airlines struggle to survive Security costs rise Start-ups: many fail, a few thrive Small jets create opportunities in regional markets Embracing the Internet... International markets provide growth
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HOW
THE INDUSTRY
OPERATES .............................................................17
Providing transportation Industry structure Competitors on all sides Airline costs Operations overview Distribution changing with technology Regulation under deregulation Feds take jurisdiction over airport security
KEY INDUSTRY RATIOS AND STATISTICS ...................................................25 HOW TO ANALYZE AN AIRLINE .............................................................27
Revenue-related factors Costs Profitability and load factor Balance sheet stability and cash burn Service and safety record Equity valuation
GLOSSARY .............................................................................................32 INDUSTRY REFERENCES.....................................................................33 COMPARATIVE COMPANY ANALYSIS .............................................36

THIS ISSUE REPLACES THE ONE DATED MAY 24, 2007. THE NEXT UPDATE OF THIS SURVEY IS SCHEDULED FOR MAY 2008.
Standard & Poors Industry Surveys

Executive Editor: Eileen M. Bossong-Martines Associate Editor: Joseph M. Coda Copy Editor: Brandon Wilkerson Statistician: Sally Kathryn Nuttall Production: GraphMedia
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VOLUME 175, NO. 47, SECTION 1 THIS ISSUE OF INDUSTRY SURVEYS INCLUDES 2 SECTIONS.
C URRENT E NVIRONMENT
Chronic delays prompt increased government scrutiny

If 2006 was known as the year the industry recovered from five years of billion-dollar losses, 2007 will surely be known as a year of frustrating delays, cancellations, and poor customer service. The year started out with poor winter weather, which led to numerous flight delays and cancellations, as well as several highly publicized incidents of passengers stranded on planes for hours. Summer travel brought severe airport congestion, the return of long security lines, flight delays and cancellations even during good weather, and terrible on-time performance industrywide. Standard & Poors does not believe there is an easy short-term solution to the complex gridlock and congestion problems plaguing the industry. Nevertheless, there are several fixes that we think could alleviate the pressure on the system in the short term until a new air traffic control system can be deployed, which would go a long way toward easing airport delays and congestion. If the carriers themselves are unable or unwilling to take some steps, we think the US government, particularly heading into an election year, could step in and force some corrective action. In fact, on September 20, 2007, the US House of Representatives passed an FAA funding bill (H.R. 2881), which, along with
DOMESTIC AIRLINE YIELDS
(Year-to-year % change)
15 10 5 0 -5 -10 -15 -20 1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Source: Air Transport Association of America.
funding for the Federal Aviation Administration (FAA), included demands that airlines and airports come up with plans to provide passengers stranded by long delays with food, water, and other basic amenities, and to allow passengers to deplane following excessive delays. The White House was threatening a veto under the belief that this measure does not go far enough and wants a bill that includes solutions to improve delays as well. This bill could be the start of some re-regulation of the airline industry in order to ease customer service problems. The issue of overcrowded skies eased with the airline industry downturn that started in 2001. By 2006, however, industry traffic reached pre-2001 levels and delays again reared their ugly head, primarily during peak travel periods. In the summer of 2007, the level of delays ratcheted up further. Year to date through August, the US airline industrys on-time arrival rate was 72%, versus 76% for the first eight months of 2006, according to the Bureau of Transportation Statistics. For the month of August alone, the on-time arrival rate was 71.7%, versus 75.8% a year earlier. Though sharply worse than a year earlier, this was an improvement over July 2007s on-time rate of 69.8%. Also in August 2007, complaints about airline service nearly doubled to 1,634, versus 864 in August 2006. Standard & Poors believes that possible short-term solutions could include the FAA imposing restrictions on US carriers to fly fewer flights during peak periods, which would force airlines to spread more flights out to off-peak periods. In addition, we think that smaller regional and corporate jets could be given less priority for take-off than bigger legacy planes carrying more passengers. The FAA is already implementing changes to flight paths in some major markets including the New York metropolitan area, which is partly intended to allow air
NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY
traffic controllers to spread flights out over a greater geographic area to increase air traffic density. Restrictions on the number of regional jets flown in congested markets could also be a partial solution, since regional jets carry far fewer passengers than large jets, yet take up just as much time taxiing, taking off, and landing as other planes. If airlines were forced to upgauge their fleets (flying bigger jets rather than smaller planes that necessitate more take-offs), we think this could also help cut delays. In the long term, the replacement of the outdated air traffic control (ATC) system will be necessary to ease congestion. This antiquated system uses radar rather than the more sophisticated satellite-based GPS (global positioning system) technology largely available in passenger vehicles. In other words, the plane in which you are flying doesnt have the same level of tracking sophistication that you have available in your car. Though better technology is available, it will take many years and billions of dollars in spending to implement a new system, so Standard & Poors feels that flight delays will be here for some time to come.
Standard & Poors believes that the industry is now in the midst of a recovery, but one that is somewhat fragile. The risks are numerous: a potential spike in oil prices, the effects of a resurgence of concern over terrorism and increased security impositions, and a slowing of the US economy. In addition, any sharp rise in capacity plans at one or more of the carriers could put the industry recovery at risk by sparking a fare war. We believe that it is still too soon to say that the industry is out of the woods, especially given the still-shaky state of many airline balance sheets.
Profitability seen for 2007 and 2008

The 10 largest airlines in the US reported a net profit in 2006 of $1.6 billion excluding reorganization items at bankrupt carriers Delta Air Lines (a loss of $7.2 billion) and Northwest Airlines (a loss of $3.2 billion), and also excluding reorganization items at UAL Corp. (gain of $22.9 billion upon emerging from bankruptcy). This net profit came on total revenues of $112.4 billion, an increase of 11% over revenues of $101.4 billion in 2005. Excluding these reorganization items, the industry returned to profitability for the first time since 2000. Also excluding reorganization items, seven of the 10 largest US airlines were profitable in 2006, with only UAL Corp., Alaska Air Group Inc., and JetBlue Airways Corp. unprofitable for the year. Standard & Poors expects improving industry fundamentals to lead to increased profitability in 2007. Standard & Poors currently forecasts profits at all of the 10 largest US carriers, with their aggregate profit hitting $3.1 billion in 2007. For 2008, we currently forecast a profit of $4.1 billion for the top ten US carriers. Excluding reorganization items, the top 10 US carriers lost about $4.0 billion in 2005, on revenues of $101.4 billion. According to our calculations, the net loss incurred by the top 10 carriers totaled $8.2 billion in 2004 (on revenues of $85.8 billion), following losses of $4.5 billion ($81.6 billion) in 2003, $11.1 billion ($80.9 billion) in 2002, and $7.6 billion ($87.2 billion) in 2001. Airline equities have been a difficult place for investors to make money. In 2006, the S&P Airlines subindex fell 7.7%, significantly underperforming the S&P 500 Composite Stock index, which rose 13.6% over the
Delays unlikely to ground profitability

Standard & Poors believes that 2007 will be looked back on as a year of sharp financial improvement and profitability for the US airline industry, following an improved year in 2006. We also think that 2008 is likely to remain profitable, though we are worried about the impact of a slowing US economy and high oil prices. This follows 2006, when the US airline industry saw sharp improvement in revenues, earnings, and passenger traffic, taking a large step in the right direction after five years of multibillion-dollar losses. Part of the reason for the industrys recovery is reflected in the large number of airline bankruptcies that took place in 2005. At some point between September 14, 2005, and September 27, 2006, five of the 11 major US airlines were operating under Chapter 11 bankruptcy protection. All five of these airlines US Airways Group Inc., UAL Corp. (parent of United Airlines), Global Aero Logistics Inc. (formerly ATA Holdings, parent of ATA Airlines), Delta Air Lines Inc., and Northwest Airlines have emerged from bankruptcy.
FUEL COSTS & CONSUMPTION

(Major US airlines, domestic operations)
1,400 240
Consumption (millions of gallons; left scale)

1,300 1,200 1,100 1,000 900 800 1994 200 160 120 80
Price per gallon (in cents; right scale)

1996 1998 2000 2002 2004 2006
40 0
same period. In 2005, the S&P Airlines subindex rose a meager 1.4%, compared with a 3.0% rise in the S&P 500. Through 2006, the five-year compound annual growth rate in the S&P Airlines subindex was 13.4%, compared with a 4.4% increase in the S&P 500 over the same period. We believe that the poor performance of the S&P Airlines subindex for the past few years reflects high oil prices, airline bankruptcies, and serious questions as to when the industry will return to sustained profitability. Year to date through October 19, 2007, the S&P Airlines subindex declined a further 15.0%, versus a 5.8% rise in the S&P 500.
Fuel costs near historic highs

On October 25, 2007, oil prices hit a record $92.22. As they have risen over the past few years, oil prices have become increasingly volatile, reacting to geopolitical uncertainties such as the war in Iraq; worries about the nuclear ambitions of Iran and North Korea, and about how the United States and the rest of the world will address those ambitions; high oil consumption in the United States, India, and China; worries about supply disruptions in Russia, Nigeria, Venezuela, and the Middle East; and a relatively weak US dollar versus other currencies. Spikes in oil prices caused jet fuel prices to have a more dramatic impact on airline profits. We estimate that fuel costs absorbed about 26% of total airline revenues in 2006, up from 24% in 2005, 19% in 2004, and 15% in 2003. We expect fuel costs to burn about 30% of total revenues in 2007, and about 29% of total revenues in 2008. According to the Air Transport Association
(ATA), an industry trade group that includes most of the major US carriers as members, each penny rise in the price of a gallon of jet fuel costs the industry $190 million to $200 million, assuming industry consumption of between 19 billion and 20 billion gallons a year. Domestic jet fuel reached a record high monthly average of $2.15 per gallon in October 2005, spiking after the hurricanes struck the Gulf Coast. In 2006, domestic jet fuel averaged $1.93 per gallon for the year, up 18% from the average of $1.64 for fullyear 2005. Year-to-date through July 2007 (latest available) domestic jet fuel averaged $1.95 a gallon. For full-year 2007, we expect average jet fuel costs for the major US airlines will be about 5% higher than the levels in 2006. While there is little certainty in predicting the direction of future oil prices, Standard & Poors thinks it highly unlikely that oil will recede to its historic trading range (near $30 per barrel) over the next several years, if ever. For US airlines to be successful, they must find ways to offset higher fuel costs with either revenue increases, the addition of new revenue sources, or cost cuts in other areas. The latter may be difficult, however, after several years of industrywide cost cutting. Much of the low-hanging fruit has already been plucked, and further meaningful cost cuts will be more difficult to attain, in our view. We currently expect that airlines average jet fuel costs will be moderately lower in 2008 than in 2007. However, entering 2007, we thought the same thing; that oil prices would moderate from 2006 highs, but the opposite has occurred. Our current thinking reflects the view that the United States currently has ample supplies of oil, and that prices have already factored in much of the geopolitical turmoil around the world. It is easy to make an argument to the contrary, though, considering growing demand in Asia and the ongoing risk of supply disruptions in the Middle East and elsewhere. For these reasons, we expect oil prices to remain extremely volatile. Crude oil inventories in the United States are another factor in the fuel equation. At 320.1 million barrels on October 5, 2007, inventories were 4.0% below year-earlier levels, but were above the upper end of the average historical range for the time of year. In addition, higher oil prices should be partly
US AIRLINE OVERVIEW
(For the 10 largest US passsenger carriers, in billions of dollars except as noted)
2005
2006
E2007
Passenger revenues Cargo revenues Other revenues Total revenues % change Operating income Revenue passenger-miles (bil.) % change Available seat-miles (bil.) % change Passenger load factor (%)
91.2 3.8 6.4 101.4 12.5 (2.7) 674.7 6.0 859.6 2.5 78.5
101.8 3.9 6.8 112.5 10.9 4.6 713.7 5.8 896.2 4.3 79.6
109.0 4.2 7.2 120.4 7.0 7.0 730.0 2.3 900.0 0.4 81.1
E-Estimated by Standard & Poor's. Sources: US Department of Transportation; Air Transport Association of America.
offset by the use of more efficient fleets, as carriers have retired their oldest, most fuelguzzling planes. Some of the financially stronger airlines are also at least partly protected from price escalations by hedging contracts put in place when prices were lower. Even this, however, will not be nearly enough to fully protect them from high jet fuel costs.
Crack spread exacerbates the pain of high oil prices

Even as crude oil prices hover around record levels, something else is hurting the US airline industry: the crack spread. This measure the cost difference between a barrel of oil and a barrel of refined jet fuel has traditionally hovered somewhere between $5 and $10 a barrel; that is, jet fuel could cost anywhere between $5 and $10 a barrel more than crude oil. In the initial aftermath of Hurricanes Katrina and Rita, however, that spread widened to about $60 a barrel, exacerbating the difficulties the industry was already facing. For full-year 2006, the crack spread averaged $16.64 a barrel, up 5% from the average of $15.84 for 2005 and well above historical levels.
Fares, yields have risen

Starting in April 2005 and continuing since then, US airlines have successfully implemented numerous fare increases, many of which have stuck. As a result, passengers are paying sharply higher fares on some routes
than they have in several years, although the price increases have been lower in markets where the major carriers face significant competition from discount airlines. Though this trend has been in place for two years, Standard & Poors believes that future airfare hikes will depend on the level of industry capacity and passenger travel demand in the wake of a slowing US economy. We think that passengers are likely to continue to see high fares during peak periods such as holidays and traditional vacation months, but that discounting is likely to reemerge at other, less seasonally strong times. Still, with load factors at or near record levels, airlines may opt to continue to try raising fares rather than attracting additional passengers. Higher fares are a prerequisite for higher yields, which, in turn, are essential for industry profitability. Yield, a measure of fare levels, is defined as revenue per revenue passenger-mile (RPM). RPMs are a measure of traffic volume: one RPM indicates that one passenger has flown one mile. In 2006, yields strengthened, continuing a rebound that began in 2005. According to the ATA, the average domestic yield increased 8.9% in 2006 to 12.78 cents per RPM, up from 11.74 cents per RPM in 2005. Total system (domestic and international) yields increased 9.0% to 13.62 cents per RPM, from 12.5 cents per RPM. This came on the heels of a 4.1% dip in domestic yield and a 1.5% drop in system yield in 2004. By comparison, in 2000 prior to the last industry downturn domestic yields averaged 14.49 cents per RPM. Year to date through July 2007, domestic yields averaged 12.9 cents per RPM, down fractionally from 12.91% for the same period in 2006, and total system yields averaged 13.95 cents per RPM, up 1.8% year over year. Standard & Poors does not believe that the industry needs to get back to the 2000 yield level to return to profitability, since cost levels have dropped sharply at all of the major carriers, albeit to varying extents. Certainly, however, with oil prices still at high levels, the industry needs to see continued yield improvement from current levels before it can achieve sustained profitability.
Higher fares limit travel demand somewhat

Travel demand weakened in 2006, due in part to rising airfares, yield management ef-
forts at the carriers (they successfully restricted the number of seats offered at sale prices), and lower industry capacity that made fewer seats available. According to the Air Transport Association, total domestic airline traffic fell 2.2% in 2006 to 379.4 billion RPMs. Still, with airfares rising and flights relatively full, domestic passenger revenues increased 6.5% in 2006 after rising 3.2% in 2005. Standard & Poors currently expects flat domestic airline traffic for 2007. Domestic capacity, as measured by available seat-miles (ASMs, the total number of seats multiplied by the total number of miles flown), declined 4.6% in 2006 to 468.3 billion, after falling 2.8% in 2005. Standard & Poors is forecasting a 1.0% drop in capacity for 2007. Domestic passenger load factor improved by 2.0 percentage points in 2006, hitting a record average of 81.0% for the year, after improving by 3.2 percentage points in 2005, when it averaged 79.06%.
now be able to fly within Europe without giving up similar domestic rights to international carriers. The deal is likely to open up the London market to more competition, as more carriers are likely to be awarded landing slots at Heathrow airport. We think the deal could be beneficial for consumers, as increased competition in some European markets is likely to lead to lower airfares. US carriers that do not currently enjoy landing slots at Heathrow, including Continental Airlines Inc. and Delta, are likely to benefit as well. Carriers such as United, American, and British Airways PLC, though, are likely to see increased competition and could lose some coveted Heathrow landing slots. In addition, the deal could ultimately force international airline industry consolidation, as the increased competition forces industry consolidation. All of this is likely to play out over several years: landing slots have to be awarded, and the deal goes into effect a year from now.
Terror fears to remain with us

On August 10, 2006, numerous individuals were arrested in relation to an alleged terrorist plot to mix liquids on board airliners bound for the United States from Europe, in order to create and then detonate explosive devices while these planes were in flight. In the immediate aftermath of these arrests, airports instituted new security rules. While the reemergence of worries about airline-related terrorist acts and the increased hassle factor at airports have the potential to derail the nascent industry recovery, Standard & Poors currently expects the overall effect to be relatively minimal. We believe that these problems likely shaved about two percentage points from unit revenue growth in the third quarter of 2006, but that the short-term financial penalty was probably more than offset by the positive impact of the recent drop in fuel prices.
Where are the mergers?

On November 15, 2006, US Airways proposed a merger with Delta Air Lines in a deal that set the industry ablaze with merger speculation. The proposed DeltaUS Airways combination would have created the worlds largest airline. Delta successfully fought off the merger, arguing to regulators, creditors and employees that the airline was worth more than the $8.0 billion original offer price and the subsequently increased offer price of $10.2 billion. On January 31, 2007, US Airways rescinded its merger proposal. Standard & Poors believes that the merger would have created a strong global competitor, stronger than either of the carriers on a standalone basis. In addition, we think that the merger could have set up a series of competing mergers as remaining carriers could have potentially combined to increase their ability to combat a combined DeltaUS Airways. We think Delta ultimately was worried that one of these potential mergers could have created a stronger competitor. Despite rampant industry speculation, no major deals have occurred as of October 2007. In fact, the only other deal of recent note the proposed merger of small regional player Midwest Air Group Inc. by AirTran was
Open skies ahead?

The European Union voted on and approved an open skies aviation deal in March 2007. This two-year deal, which becomes effective on March 28, 2008, will essentially open up restricted trans-Atlantic routes and allow US airlines to fly anywhere in the 27-nation European Union to any point in the United States. US carriers will
fought off by MidWest by agreeing to be acquired in a private leveraged buyout. Standard & Poors feels that it will take another industry downturn, with the return of billion-dollar losses, before any major industry consolidation is to take place. We do think that other leveraged private equity deals could occur, but the tightening of the US credit market in the aftermath of the subprime mortgage crisis and housing slowdown should make it more difficult to raise the necessary debt to finance any prospective deal.
Airline industry restructures

In general, Standard & Poors feels that several factors restrained industry capacity levels, a record percentage of seats filled on average, strong passenger demand, and rising prices should drive improved revenue growth in 2007 and 2008. Oil prices remain a significant worry, but any stabilization or moderation could drive strong profit levels for the first time in many years for much of the industry. Nevertheless, the industry remains in flux. In the midst of bankruptcies, restructurings, recoveries, mergers, and growth among discounters, the changing shape of the airline industry is another dynamic variable that could sway results. Delta and Northwest. After struggling for some time, Delta and Northwest filed for Chapter 11 bankruptcy protection on the same day, September 14, 2005. Both carriers emerged from bankruptcy in the first half of 2007 with sharply lower operating costs, lower debt levels, and streamlined operations. So far the emergence of these carriers has not instigated another painful round of capacity hikes, airfare price cuts, and destructive competition; they have so far been more restrained in how they have chosen to compete, which could bode well for future industry prospects. In bankruptcy, Delta has forced pay cuts on its employees, eliminated its pilots pension plan, and shrunk domestic capacity while increasing international capacity. The airline also restructured aircraft operating leases and debt obligations. We believe that Northwests decision to file for bankruptcy was influenced by the changes in US bankruptcy laws that went into effect on October 17, 2005. Among other changes, the revised law gave companies in
bankruptcy only 18 months to file a plan of reorganization with the court; the previous law, in contrast, gave companies an almost unlimited amount of time (as highlighted by United spending more than three years under Chapter 11 protection). Before its bankruptcy filing, Northwest was battling a strike by its mechanics union, as well as experiencing difficult negotiations with flight attendants and pilots. In our view, once Northwest decided that it needed to file before October 17, 2005, the company probably decided to file even sooner to protect as much of its cash as possible. In our view, Northwest was even more aggressive than Delta in pursuing cost cuts from labor groups, and the company underwent brutal negotiations with its mechanics and flight attendants. In October 2006, after a 14-month strike, mechanics agreed to terms with the company. Flight attendants had a pay cut of 21% forced on them by the bankruptcy court. UAL out of bankruptcy. UAL parent of United Airlines, the second largest airline in the United States in terms of both revenues and RPMs filed for Chapter 11 bankruptcy protection on December 9, 2002. This was a monumental event in the industry, given that United accounted for about 25% of all RPMs flown by US scheduled airlines in 2002 and about 24% of the US airline industrys capacity, as measured in ASMs. On February 1, 2006, the bankruptcy court confirmed UALs plan of reorganization, and the company emerged from Chapter 11 after operating for more than three years under bankruptcy protection. UAL emerged with sharply lower operating costs and lower debt levels, and without the burden of a hugely underfunded pension plan, which was passed on to the US Pension Benefit Guarantee Corp. (PBGC), a government agency that insures the pensions of US corporations. In bankruptcy, United cut annual costs by $7.0 billion, cut capacity by about 20%, and sharply reduced debt and other obligations. The company emerged from bankruptcy with about $3.0 billion in cash. The companys restructuring plan was created without long-term oil prices of over $60 a barrel in mind, and may not have fully taken into account the extent to which discount carriers have been driving pricing in the US
airline industry. Still, the company has a fresh chance with lower debt, new capitalization, and no large underfunded pension make-up payments due. Standard & Poors believes that United substantially improved its competitive position while in bankruptcy, but we also believe that the company still has higher operating costs than most of its competitors. Uniteds strong business travel market share and strong international network could allow it to get a yield premium to peers in an industry upcycle, which is what we believe we currently are seeing. If the companys unit costs remain above those of its peers, though, we think that United will remain susceptible to large losses during a future industry downturn. AMR: looking to cut debt. AMR Corp., parent of American Airlines, posted net income of $231 million in 2006, following losses of $861 million in 2005, $761 million in 2004, $1.3 billion in 2003, and $3.5 billion in 2002. In 2003, the airline was successful in coaxing $1.8 billion in annual cost reductions from its unions. Labor concessions and other cost-cutting initiatives, including about $200 million in givebacks by vendors and suppliers, were targeted to reduce AMRs annual costs by about $4 billion. Cost cuts, revenue increases, and sharp reductions in capital expenditures over the past few years have led to a large increase in the companys cash balances, which totaled $5.2 billion at the end of 2006. These high cash levels, along with improving industry prospects, lead us to believe that AMR is not likely to file for bankruptcy at least through the end of 2008. If AMR is to survive in the longer term, it will need to expand its cost-cutting and see a sustained improvement in the industry environment. As of December 31, 2006, the company was saddled with $18.4 billion in long-term debt and capital lease obligations, including current maturities and the present value of operating leases. This was down from $20.1 billion a year earlier. Stockholders equity was a negative $606 million, but that had risen from a negative $1.4 billion a year earlier. The companys ability to stave off bankruptcy has had a strong effect on AMRs stock price since 2003. Since closing on December 31, 2002, at $6.60 a share, the shares increased more than six fold and
reached a high of $41.00 on January 17, 2007, before the price settled to $23.76 on October 11. Continental: focus on Newark and international growth. Continental Airlines, the fourth largest US carrier, has been focused on using its hub in Newark, New Jersey, as an international gateway. To this end, the company has sharply increased international capacity over the past year and a half, adding frequencies and entering new European and Asian markets. Continental hopes to leverage its leading position in Newark to attract more business travelers, an area in which it already leads most of its peers. While many carriers have been cutting capacity, Continental has been adding domestic capacity, which has helped the carrier during the recent period of increasing fares. Standard & Poors expects strong earnings for Continental in 2007 and 2008, following a $389 million net profit in 2006, which were the carriers first profits from operations since before September 11, 2001.
Low-cost carriers feel the heat

Although the airline industry operating environment was brutal from 2001 to 2005, carriers that operated with low costs and low fares were generally able to cope better than their higher-cost counterparts. Notably, Southwest posted its 34th consecutive year of net income in 2006 an amazing feat, given the cyclical nature of the business. Two other low-cost carriers, JetBlue and AirTran, both performed better in 2006 than in 2005, but both these carriers results are disappointing when compared with prior years. JetBlue posted a net loss of $1.0 million, which equates to $0.00 per share, on revenues of $2.3 billion better than the $20.2 million ($0.13 per share) loss that the carrier experienced in 2005 on revenues of $1.7 billion, but sharply worse than net income of $0.29 per share and $0.65 per share in 2004 and 2003, respectively. AirTran posted a $15.5 million net profit in 2006 ($0.17 a share), on revenues of $1.9 billion better than the $1.7 million net profit in 2005 ($0.02) on revenues of $1.5 billion. AirTrans net profit in 2006 equates to a net margin of just 0.8%, sharply lower than the net profit of 10.9% that the carrier reported in 2003. The sharp rise in fuel costs over the past two
years has hurt both JetBlue and AirTran, while a successful fuel-hedging program has protected Southwest. Southwest earned $499 million in 2006 ($0.61 a share), down from $548 million ($0.67) in 2005. Although profits have remained below the levels of 2000, Southwest has maintained its balance sheet health without cutting staff or capacity. In our opinion, Southwest is extremely well positioned relative to its peers. We believe that Southwest will remain profitable in 2007 and 2008 and will outperform the industry financially over the next few years. Standard & Poors believes that the lowcost carriers are likely to continue to grow revenues at a much faster rate than the legacy carriers. Eventually, such carriers could take the lions share of the US air travel market, though such a shift would likely play out over many years.
enues. Finally, we expect continued pressure by most carriers on labor costs, both in terms of absolute pay levels and through attempts to increase employee productivity. For 2008, Standard & Poors thinks the industry will need to see higher average fares and strong passenger travel to help labor costs fall as a percentage of total revenues. We believe much of the benefit of airline bankruptcies to be in place and see some pressure on rates as unions attempt to regain some of what they lost in wages and benefits over the past five years.
Pressure to go green
Recently, some environmental activists have voiced displeasure over the carbon dioxide emissions (carbon footprint) of airlines. This issue, in the face of the ongoing debate on how to fight global warming, could become a public relations problem for an industry that scarcely needs another issue. Airlines are currently fighting the perception that they are a major cause of greenhouse gasses by listing all the ways they have reduced jet fuel usage over the past 10 years: modernizing their fleets to more fuel efficient planes, efforts to control fuel use, and modifications to existing planes to increase fuel efficiency, to name a few. Though the airlines may have undertaken these initiatives to cut costs in the wake of high oil prices, they are using their accomplishments as a way to ease concerns. However, Standard & Poors feels that this issue is only starting to gain attention in the industry, and we expect airlines to face increasing pressure on this front over the next few years.
Labor costs down sharply, but still too high

Standard & Poors estimated that labor costs absorbed 24.5% of revenues at the 10 largest US airlines in 2006, down from 28.2% in 2005. While many of the major airlines have succeeded in getting their work forces to give back a substantial portion of their wages, this percentage must come down further for the industry to return to sustainable financial health. Pension and healthcare costs, which have increased sharply in recent years, are major contributors to the high percentage of revenues absorbed by labor costs, and have partly offset increases in productivity and pay cuts at many of the carriers. We estimate that labor costs will experience healthy declines in 2007, both on an absolute basis and as a percentage of revenues. We base this prediction largely on our expectation of wage and benefit cuts at Northwest and Delta, as well as likely lower pension costs on average, as a rise in the stock market could help underfunded pension plans. Higher interest rates, which we also expect, could allow airlines to raise their pension return assumptions, thus decreasing the amount of pension underfunding (though this will of course be partly offset by higher interest expense at many airlines). In addition, an increase in industry revenues should help lower labor costs as a percentage of rev-
I NDUSTRY P ROFILE
Airlines still face extreme challenges

As of January 2007, the US commercial aviation industry consisted of 20 major air carriers (annual revenues of more than $1 billion), 33 national airlines (revenues between $100 million and $999 million), 31 large and medium regionals (annual operating revenues less than $100 million), and 55 small commuter and other air carriers, according to the Air Transport Association (ATA), an industry group whose members include most of the large US airlines and air cargo companies. The Federal Aviation Administration (FAA) estimates that the total number of aircraft in the US commercial fleet, including regional carriers, was 7,626 at the end of 2006. This includes 3,886 mainline air carrier passenger aircraft (jets with more than 90 seats), 997 mainline air carrier cargo aircraft, and 2,743 regional aircraft (smaller jets, turboprops, and pistons). Based on carrier revenues, the largest domestic airline in 2006 was American Airlines, a unit of AMR Corp., which is also the largest
AIRLINE MARKET SHARE LEADERS
(Based on revenue passenger-miles)
2007* RANK COMPANY % MARKET SHARE 1997 RANK % MARKET SHARE
COMPANY
Totals may not add due to rounding. *8 months ending August. Source: US Department of Transportation.
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.
American United Delta Northwest Southwest US Airways Continental JetBlue Alaska SkyWest AirTran American Eagle Frontier Republic Hawaiian Others
17.8 15.2 13.4 9.4 9.3 8.1 6.9 3.4 2.4 2.3 2.2 1.4 1.3 1.1 1.0 4.8
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.
United American Delta Northwest Continental US Airways Southwest TWA America West Alaska American Trans Air Hawaiian Tower Reno Air AirTran Holding Others
20.0 17.6 16.4 11.9 7.9 6.9 4.7 4.1 2.7 1.7 1.5 0.7 0.6 0.5 0.4 2.4
carrier in the world. American reported revenues for 2006 of $22.6 billion (which included its American Eagle unit). United Airlines, a unit of UAL Corp., took second place with revenues of $19.3 billion. Delta Air Lines Inc. was in third place with $17.2 billion. According to the US Department of Transportation (DOT), the US airline industry (the majors, nationals, and regionals) generated total revenues of $163.8 billion in 2006, up 8.3% from $151.25 billion in 2005. In terms of traffic, DOT statistics show that the US airline industry logged a record 797.4 billion revenue passenger-miles (RPMs, the number of passengers multiplied by the number of miles flown) in 2006, surpassing by 2.4% the prior years record of 779.0 billion. Also setting records in 2006 were enplanements (the total number of passengers) at 744.5 billion and available seatmiles at 1,006.4 billion. Enplanements rose 0.8% over 2005, while available seat-miles (ASMs, the number of seats in the active fleet multiplied by the number of miles flown) were 0.3% higher than the prior year. American (excluding its regional affiliates) tallied 139.5 billion RPMs in 2006, followed by United with 117.5 billion RPMs and Delta with 116.1 billion RPMs. While the US industry has incurred the heaviest losses in recent years, airlines around the world have also faced a difficult environment. In 2006, the global airline industry lost an estimated $500 million, a sharp reduction from $6.0 billion in losses in 2005 and a loss of $4.8 billion in 2004, according to the International Air Transport Association (IATA), a coalition made up of some 260 airlines throughout the world. From 2001 to 2003, the industry lost an estimated $37.6 billion, including a record loss of $18 billion in 2001, according to the IATA. For 2007, the IATA estimated on September 17, 2007, that the industry would post a profit of $5.6 billion.
INDUSTRY TRENDS
The US airline industrys operating environment has finally recovered from five years of multibillion-dollar losses that began after the events of September 11, 2001, when four US commercial jetliners were hijacked for use in terrorist attacks on America. Passenger revenues and passenger traffic have recovered from the sustained industry downturn, and the US industry returned to profitability in 2006. The impact of the high level of sustained losses on the US airline industry, along with the changes necessitated in how an airline operates in the wake of 9/11, have had lingering effects on the US airline industry. In the past, economic downturns have led to large industry losses, but none of those periods posed as severe a threat to the industrys survival as did the aftermath of the 9/11 attacks. In addition to the near-term disruption to revenues and the large industry losses, the industry has faced longer-term problems, including a liquidity crunch and a severely weakened financial condition.
The impact of five years of multibillion-dollar losses

In the first few months after September 2001, air travel dropped off dramatically. As the airlines losses mounted and available cash was rapidly depleted, most carriers were forced to shoulder new debt by tapping their credit lines and/or issuing bonds. These actions were vital to help the carriers survive the dramatic decline in passenger levels and fares, as well as the sharp increase in losses, but they left most of the major airlines burdened with huge debt loads. Five years of multibillion-dollar losses led to the bankruptcy of five of the 10 largest major airlines and an increased debt burden for many of the others. The higher interest expense and the lower interest and investment income that resulted weakened the airlines earnings power. In addition, weakened balance sheets limited carriers ability to increase capital expenditures, add to their networks, and survive another downturn. Thus, the effects of the recent financial deterioration are still playing out. One side effect of this has been the carriers insistence on carrying sharply higher cash levels than at anytime in the past in order to
allow it to survive any future shocks to the system. For example, AMR Corp. had a cash balance of $5.9 billion, including restricted cash, at the end of the second quarter of 2007, versus cash levels of $1.3 billion at the end of the second quarter of 2001. Similarly, Continental Airlines had second quarter 2007 cash levels of $3.2 billion, including restricted cash, versus $1.0 billion at the end of the second quarter of 2001. Today, when investors are increasingly worried about balance sheet stability after the collapse of such companies as Enron Corp., WorldCom Inc., and others, many airlines have extremely high debt levels. For example, AMR Corp., parent company of American Airlines, ended 2006 with total debt (including current maturities) of $18.4 billion and negative stockholders equity of $606 million. Delta Air Lines Inc. ended 2004 with debt of $13.9 billion and a negative stockholders equity of $5.8 billion; the company subsequently filed for bankruptcy on September 14, 2005. Before it filed for bankruptcy, Northwest Airlines Corp. also had negative stockholders equity. In contrast, Southwest Airlines Co. which Standard & Poors believes has the healthiest balance sheet among all US airlines had $1.7 billion in debt (including current maturities) and $6.4 billion in stockholders equity at year-end 2006, for a debt-to-total capital ratio of 21% (excluding operating leases).
Airlines struggle to survive

In todays environment, the legacy major carriers face intense pressure to change cost structures and operational strategies. Delta and Northwest both filed for bankruptcy in September 2005. Delta emerged on April 30, 2007, and Northwest emerged on May 31, 2007. UAL Corp., the parent company of United Airlines, filed for bankruptcy in December 2002, marking the largest bankruptcy filing in the history of the US aviation industry. UAL emerged from bankruptcy in February 2006. UAL was the second major US airline company to file for Chapter 11 protection in 2002, following US Airways Group Inc. US Airways subsequently emerged from bankruptcy, reentered it, and finally emerged again in September 2005, after merging with America West
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Holdings Corp. ATA Holdings Corp., parent of ATA Airlines (the tenth largest US airline at the time), filed for bankruptcy protection in October 2004; the company emerged from bankruptcy in February 2006. (See the Current Environment section of this Survey for further discussion of this topic.)
Federal grants, loan guarantees bailed out industry

After fierce lobbying by the airline industry, which contended that costs of the war in Iraq and government-mandated security measures were harming the industry, President George W. Bush signed the Emergency Wartime Supplemental Appropriations Act on April 16, 2003. Under the law, the Transportation Security Administration (TSA) disbursed pretax payments totaling $2.29 billion in May 2003. This money was intended to reimburse carriers for the security fees that they had paid to the TSA since February 2002. Congress set aside an additional $100 million to compensate airlines for reinforcing airline cockpit doors. Because of the cash grants, most of the top 10 carriers reported a profit in the second quarter of 2003 and were able to sharply curtail net losses for the full year. The cash grants in May 2003 represented the second round of bailouts to the airline industry. On September 22, 2001, President Bush signed into law the Air Transportation Safety and System Stabilization Act, which was intended to compensate the airlines for direct and indirect losses associated with the terrorist attacks in September 2001. Included in the plan was $5 billion in direct cash grants to be distributed to carriers based on traffic and the possible granting of $10 billion in industry loan guarantees.
Before the US Airways merger, there had been no significant merger and acquisition activity in the US airline industry since the US Department of Justice (DOJ) blocked the proposed combination of US Airways and United Airlines in July 2001. That deal was blocked because the DOJ felt it would have given United too large a share in too many markets. Both carriers eventually ended up in bankruptcy court. Standard & Poors thinks that the merger of America West and US Airways, in conjunction with the increase of private equity leveraged buyout deals in the US over the past two years, is likely to have led to increased interest in potential mergers in the airline industry. Whether this translates into any actual consolidation, however, remains to be seen. The industrys overcapacity, combined with many carriers weakened balance sheets and high debt levels, remain as significant barriers to major airline mergers. Indeed, many of the carriers that would traditionally do the acquiring are not in a position to finance mergers. We expect the largest carriers to continue to shrink capacity, conserve cash, and try to restore profitability before chasing market share gains. Still, we no longer think it is out of the question for one of the smaller carriers to be snapped up by Southwest or another lowercost carrier with the financial resources to make a deal. We also think a combination of major airlines that includes one of the carriers in bankruptcy, or one that recently emerged from bankruptcy, like UAL Corp., is a possibility.
US Airways merger with America West creates the fifth largest US carrier
On September 27, 2005, US Airways, then the seventh largest US carrier, completed its merger with America West Holdings, the parent company of America West Airlines (eighth largest). America West was the surviving company in the merger, but it adopted the corporate name US Airways Group Inc. The combined company, now the fifth largest US airline, started out with about $2.5 billion in cash, 38,000 employees, and a network that offers about 2,700 flights, serving 233 destinations from major hubs in Phoenix, Charlotte, and Philadelphia, with secondary hubs in Las Vegas, Pittsburgh, Boston, New York (LaGuardia), and WashNOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY
Will merger activity pick up?

The merger in September 2005 of bankrupt US Airways with America West Holdings Corp., which created the new US Airways, could have been the start of a new focus on mergers in the US airline industry. However, US Airways subsequent attempt to merge with Delta Air Lines was blocked by Delta, which successfully argued to its creditors that Deltas own standalone plan would create more value for creditors and other stakeholders. (See the Current Environment section of this Survey for further discussion of this topic.)
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OPERATING STATISTICS OF THE MAJOR US AIRLINES

YEAR AIRTRAN ALASKA AMERICA WEST AMERICAN CONTINENTAL DELTA JETBLUE NORTHWEST SOUTHWEST UNITED US AIRWAYS TOTAL ALL MAJORS
AVAILABLE SEAT-MILES (MILLIONS) 2006 19,007 23,278 29,555 2005 15,370 22,292 30,503 2004 11,977 22,277 30,152 2003 *10,046 20,804 27,888 2002 *8,256 19,360 27,008 2001 *6,538 17,919 26,539 2000 *5,859 17,315 27,112 1999 *5,467 17,881 26,503 1998 *5,442 16,769 24,260 1997 *3,018 15,393 23,463
174,021 175,924 173,836 164,792 172,073 184,436 167,007 152,918 155,174 153,748
97,667 89,646 85,686 78,390 80,122 84,484 86,099 81,106 70,525 61,667
147,995 133,935 129,974 120,462 132,133 141,521 147,159 141,285 141,961 138,698
28,594 23,703 18,911 *13,639 *8,240 *4,208 *1,372 NA NA NA
92,944 91,775 91,378 88,593 93,417 98,356 103,356 98,335 91,266 96,917
92,663 85,173 76,861 71,790 68,887 65,295 59,910 65,399 47,550 40,915
143,095 139,806 144,543 135,865 148,698 164,771 175,393 164,771 173,891 168,996
47,428 51,519 53,219 51,583 56,360 66,704 66,851 66,680 56,721 58,289
896,247 859,645 838,814 760,167 798,057 850,026 850,202 814,878 778,119 758,086
REVENUE PASSENGER-MILES FLOWN (MILLIONS) 2006 13,836 17,822 23,559 139,454 2005 11,302 16,915 24,257 138,230 2004 8,479 16,231 23,334 130,029 2003 *7,143 14,554 21,294 120,013 2002 *5,581 13,186 19,872 121,675 2001 *4,506 12,249 19,074 126,964 2000 *4,116 11,986 19,113 120,671 1999 *3,473 12,229 19,060 106,146 1998 *3,245 11,266 16,357 108,873 1997 *1,598 10,362 16,171 106,936 PASSENGER LOAD FACTOR (PERCENT) 2006 72.8 76.6 79.7 2005 73.5 75.9 79.5 2004 70.8 72.9 77.4 2003 *71.1 70.0 76.4 2002 *67.6 68.1 73.6 2001 *68.9 68.4 71.9 2000 *70.3 69.2 70.5 1999 *63.5 68.4 71.9 1998 *59.6 67.2 67.4 1997 *52.9 67.3 68.9
79,192 71,261 65,734 59,167 59,348 61,139 64,161 58,692 50,943 44,072
116,133 103,742 98,279 89,432 95,669 97,787 107,822 97,604 103,245 99,624
23,320 20,200 15,730 *11,527 *6,836 *3,282 *1,004 NA NA NA
78,044 75,820 73,312 68,476 72,027 73,126 79,128 73,111 66,706 71,998
67,691 60,223 53,418 47,943 45,392 44,494 42,215 44,501 31,423 26,204
117,470 113,898 114,534 103,856 109,392 116,597 126,879 116,597 124,540 121,350
37,130 38,895 39,964 37,740 40,038 45,948 47,012 45,933 41,252 41,578
713,651 674,743 639,044 562,475 576,599 597,377 618,988 573,873 554,605 538,295
80.1 78.6 74.8 72.8 70.7 68.8 72.3 69.4 70.2 69.6
81.1 79.5 76.7 75.5 74.1 72.4 74.5 72.4 72.2 71.5
78.5 77.5 75.6 74.2 72.4 69.1 73.3 69.1 72.7 71.8
81.6 85.2 83.2 *84.5 *83.0 *78.0 *73.2 NA NA NA
84.0 82.6 80.2 77.3 77.1 74.3 76.6 74.3 73.1 74.3
73.1 70.7 69.5 66.8 65.9 68.1 70.5 68.0 66.1 64.0
82.1 81.5 79.2 76.4 73.6 70.8 72.3 70.8 71.6 71.8
78.3 75.5 75.1 73.2 71.0 68.9 70.3 68.9 72.7 71.3
79.6 78.5 76.2 74.0 72.3 70.3 72.8 70.4 71.3 71.0
*For comparison only; not included in total. Company was not classified as a major airline until 2004. NA-Not available. Sources: Aviation Daily; US Department of Transportation.
ington, D.C. (Reagan National). Under Federal Aviation Administration safety and other regulations, the two companies have continued to fly separately (for a period of about two years), but they immediately combined scheduling and other operations. Standard & Poors thinks that the merger has been a success, as the new US Airways has sharply cut costs and has achieved many of its revenue and cost synergy targets. We think the combined carrier is financially stronger then either carrier was on a standalone basis, and it should be better equipped to handle the next industry downturn, when it occurs. In our view, it is favorable that the merger combined a carrier with too much of its route network locked on the East Coast (US Airways) with a highly West Coastcentric airline (America West) to form an airline with a
more diversified geographic footprint across the United States. In addition, US Airways, in bankruptcy, had already done a lot of the hard work of cutting costs and eliminating its pension plan; as a result, its overall cost structure was close to that of America West. Finally, the merger attracted more capital both new equity and new debt financing than the company had expected. US Airways originally filed for bankruptcy protection on August 11, 2002, despite having gained concessions from its work force and conditional approval of a loan guarantee of $900 million from the Air Transportation Stabilization Board (ATSB). After emerging from that bankruptcy filing on March 18, 2003, the carrier continued to have a higher cost structure than its peers, and it experienced large losses. External fac-
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tors exacerbated the companys difficulties: the industry environment worsened further, with high oil prices, overcapacity, and depressed airfares. On September 14, 2004, US Airways filed for bankruptcy for the second time in three years, where it stayed until the merger with America West was completed.
AIRLINE BANKRUPTCIES
AIRLINE DATE CHAPTER
Security costs rise

Since the terrorist strikes in 2001, a number of federally mandated security measures have been put into effect both to reassure the flying public and to prevent future occurrences. Although the government has subsidized the added security costs and provided a $2.3 billion cash grant in 2003, the industry will continue to bear significant ongoing security costs. Airlines are now required to either screen all bags for explosives or make sure each bag is matched to a passenger seated on that flight. Both are time-consuming and expensive initiatives. The new security measures have made flying less convenient for travelers. The increased security measures and new baggage checking requirements mean longer lines at airports, both to check in and to pass through security. Most airlines, though, have done a good job of reducing wait times by adding security lanes.
Start-ups: many fail, a few thrive

The US airline industry historically has seemed to attract funding for new start-ups, even though the failure rate for these companies is high. The airline business is notorious for profit volatility, and the problems faced by start-ups have been exacerbated in the aftermath of September 2001, as large losses and lower traffic levels have tested their staying power. New carriers are more likely to pursue niche markets or regional service agreements than to go head-to-head against a major airline, since they cannot offer the same frequency of flights. If start-ups offer deeply discounted fares, the major airlines will match the fares, while maintaining high fares on all noncompeting flights. Overall, the current crop of low-fare, start-up carriers has not proven to be better managed or capitalized than its predecessors.
One major exception is JetBlue Airways Corp., which we think is the biggest threat to industry price stability since Southwest Airlines entered the business in 1971. JetBlue
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Kitty Hawk Aircargo Florida Coastal Airlines Independence Air Era Aviation Independence Air Mesaba Airlines TransMeridian Airlines Delta Air Lines Northwest Airlines Aloha Airlines Southeast Airlines ATA Airlines US Airways Atlas Air/Polar Air Cargo Great Plains Airlines Midway Airlines Hawaiian Airlines United Airlines US Airways Vanguard Airlines Sun Country Airlines Midway Airlines Trans World Airlines National Airlines Legend Airlines Fine Air Services Pro Air Kitty Hawk Tower Air Access Air Eastwind Airlines Sunjet International/Myrtle Beach Jet Express Kiwi International Airlines Euram Flight Centre Pan American World Airways Mountain Air Express Western Pacific Airlines Air South Mahalo Kiwi International Airlines Conquest Airlines Business Express GP Express The Krystal Company Grand Airways Trans World Airlines Markair Crescent Airways
10/15/07 2/21/06 1/6/06 12/28/05 11/7/05 10/13/05 9/29/05 9/14/05 9/14/05 12/30/04 12/1/04 10/26/04 9/12/04 1/30/04 1/23/04 10/30/03 3/21/03 12/9/02 8/11/02 7/30/02 1/2/02 8/13/01 1/10/01 12/6/00 12/3/00 9/27/00 9/19/00 5/1/00 2/29/00 11/29/99 9/30/99 6/25/99 3/23/99 7/29/98 2/26/98 11/6/97 10/5/97 8/28/97 7/25/97 9/30/96 1/23/96 1/22/96 1/10/96 12/15/95 11/28/95 6/30/95 4/14/95 2/3/95
11 11 7 11 11 11 7 11 11 11 7 11 11 11 11 7 11 11 11 11 7 11 11 11 11 11 11 11 11 11 7 11 11 11 11 11 11 11 11 11 11 11 11 11 11 11 11 11
initiated service out of New York Citys John F. Kennedy International Airport in February 2000. The carrier is well capitalized, uses brand-new jets, and, since its launch, has generated high load factors on its point-topoint route structure. However, rising fuel prices and intense price competition led to a loss for the carrier in 2005 and 2006, though Standard & Poors predicts a modest return to profitability for the carrier in 2007.
cost jet planes, with 50 to 70 seats, for $15 million to $20 million each.
Regional jets open new markets

The regional jet has stimulated air travel over shorter segments by getting people out of cars, buses, and trains and onto planes. With its low purchase price and operating costs, the regional jet has transformed shorthaul markets, previously abandoned by major airlines, into viable destinations. The regional jet also offers greater range and passenger comfort than does the turboprop plane. It can handle routes of 1,300 miles up to 2,300 nautical miles in some cases while most propeller planes are confined to flights of 350 miles or less. Major airlines regional affiliates use these small jets to provide off-peak service when demand is insufficient to warrant a standard 100-plus seat aircraft. Regional jets can be profitable for such service because their break-even can approach a 50% level, versus a much higher load factor historically about 65%, but in the past few years, closer to 85% needed for large jets in a normal industry environment. By offering round-theclock service in this manner, an airline gains appeal among business travelers, who account for some 70% of regional jet passengers. With regional jets gaining in range, they are increasingly being used not only to feed passengers into hub airports, but also to provide point-to-point competition against carriers employing full-sized jets.
Recent failures
Among recent airline failures, Independence Airlines a regional airline that was originally a regional partner of United Airlines before trying to compete against United and the other majors filed for Chapter 7 liquidation on January 6, 2006, after a previous Chapter 11 filing on November 7, 2005. Mesaba Airlines, a regional airline that operates as a Northwest connection carrier, filed for bankruptcy on October 13, 2005, shortly after Northwest failed to make certain financial payments to Mesaba and announced severe cutbacks in its contract with the company. Transmeridian Airlines, a small charter airline operating out of about a dozen cities, filed for Chapter 7 liquidation on September 29, 2005. Aloha Airlines filed for Chapter 11 protection on December 30, 2004, but emerged on February 17, 2006. ATA Holdings, parent company of ATA Airlines, filed for Chapter 11 protection on October 26, 2004; at the time, ATA was the tenth largest US airline. The carrier emerged from Chapter 11 protection on February 28, 2005. Hawaiian Airlines Inc., a subsidiary of Hawaiian Holdings Inc., filed for Chapter 11 bankruptcy protection on March 21, 2003; the carrier emerged from bankruptcy on June 2, 2005. (See the Airline bankruptcies table for a larger list.)
Regional airlines and majors have a symbiotic relationship

Given the severe financial trouble that the US airline industry has faced in the past few years, many of the major carriers have been forced to sell or reduce their investments in regional airlines in order to raise cash. Notably, in September 2005, Delta sold its regional subsidiary, Atlantic Southeast Airlines, to SkyWest Airlines in order to raise cash. Continental Airlines Inc. gradually sold its stake in ExpressJet Holdings Inc., which was once wholly owned by Continental. In 2003, Northwest contributed the stock of one of its regional airline subsidiaries, Pinnacle Airlines, to its pension plan to offset plan liabilities. The relationship between the major and regional airlines is reciprocal. The majors
Small jets create opportunities in regional markets

Regional jets small jet planes that fly shorter distances and have fewer seats than do large mainline jets were first introduced in the late 1980s. The first airline to embrace the regional jet was Comair Inc. (now wholly owned by Delta). Demand for these planes began to take off about 1995, when Brazils Embraer-Empresa Brasileira de Aeronutica SA and Canadas Bombardier Inc. introduced low-
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cannot rely solely on their own expensive aircraft and crews to gather passengers to feed into their hubs. The regionals depend on major carriers to provide connecting flights at central hub airports for up to 60% of their passengers. The major airlines also provide credibility, worldwide marketing power, and the all-important designator code in the computer reservation system (CRS). To be successful, regional and major airlines must work as a seamless operation using a single system for booking and boarding. According to the Regional Airline Association, a trade group representing smaller airlines, about 70 regional airlines were in operation in 2005 (latest available). Back Aviation Solutions, a provider of consulting and data information services to the aviation industry, predicts that no more than 50 regional carriers will exist by 2010. At the same time, the overall number of regional jets in operation should continue to rise sharply. The Federal Aviation Administration (FAA) predicts that the US regional aircraft fleet (both jets and turboprops) will reach 3,851 by 2017, up from 2,862 as of December 31, 2005. Although many of the new regional jets on order are intended to replace older turboprops, the large number of incoming jets should lead to an overall increase in the number of regional aircraft in service.
Embracing the Internet...

The Internet has had a profound effect on the way airlines price and distribute their product. By selling tickets online, airlines have dramatically cut distribution costs by eliminating paper shuffling, bypassing agents, and reducing airline staff. On the other hand, the Internet has led to more competitive pricing. Since 1995, carriers have had home pages on the World Wide Web. Initially, these sites displayed schedule and fleet information, as well as promotional material. Today, travelers can use these sites to check the status of their frequent-flyer accounts, and more importantly, to book flights and select seats. Online travel operations, such as Expedia Inc., Travelocity.com LP, and Orbitz Inc., have taken significant market share from traditional travel agents. Despite the Internets commercial success in this market, accurate measurements of the amount of air travel being booked online are hard to come by. According to PhoCusWright, an independent travel tourism and hospitality industry research firm, online travel sales will account for about 52% of all bookings in 2007, surpassing offline bookings for the first time. In 2007, according to eMarketer, an Internet market research and trend analysis firm, US online travel sales will total $94 billion, rising 19% over 2006.
Labor contracts restrict use of regional jets

All pilot contracts have scope clauses, which establish the definition (or scope) of pilots jobs, and dictate who may or may not perform those jobs. Scope clauses in many existing labor contracts severely limit the ability of some airlines to participate in the regional jet market boom. American Airlines, for instance, can fly an unlimited number of regional jets with 45 seats or less, but can fly a maximum of 67 jets with 45 to 70 seats. Many observers see the biggest emerging segment of the regional jet market in 70- to 100-seat aircraft, which began rolling off the assembly lines in 2002. Bombardier and Embraer are the two main manufacturers of these regional jets. Pilots at mainline carriers, who make substantially higher salaries than those at regional operators, have seen many of their routes displaced by regional affiliates operating these larger jets.
...to help cut costs

In 1995, Alaska Airlines (a unit of Alaska Air Group Inc.) became the first airline to allow tickets to be booked via the Internet. Alaska booked about 39% of its tickets on its own Web site in 2006. The company has since been surpassed by many of its competitors, particularly discounters like JetBlue, whose strategy is to keep costs low through extensive use of its own Web site and reservation agents. JetBlue, which is now considered a major airline, leads all majors in bookings over the Internet. In 2006, JetBlue booked 79% of its sales on its own Web site. Most US airlines now get a significant portion of revenues from online bookings. Southwest Airlines obtained 70% of its revenues from sales through its own Web site in 2006. Continental Airlines, a former laggard in online bookings, got about 24% of its revenues in 2006 from its own Web site.
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The Internets appeal for airlines is apparent. A commercial Web site can be kept open for business 24 hours a day, seven days a week. It allows an airline to reduce the number of customer service agents, since fewer such employees are needed to answer flight information questions. Southwest Airlines reported in 2002 that its Internet bookings cost about one dollar to make, while its cost to book with a travel agent was between $6 and $8. Tickets booked through Southwests own agents cost several dollars. Indeed, a big incentive for airlines to distribute tickets via the Internet is to reduce travel agent commissions. In 2002, US airlines cut base commission rates entirely on domestic flights (as discussed in the How the Industry Operates section of this Survey). Recent cuts in commission rates and increased Internet sales are the major reasons for the trend toward lower commission costs. On the down side, however, the Internet may ultimately hurt airline profitability by making travelers too price-sensitive. With airfares changing at lightning speed and the Internet keeping customers apprised of these changes, airlines must respond quickly to match rivals fare cuts. Consequently, the range of fares that competing airlines can charge on a point-to-point route will tend to be extremely compressed. In addition, the premium charged for travel booked on short notice has eroded. Airlines cannot use business travel as effectively to subsidize discounted pleasure travel, now that business travelers can make low-price, near-term travel arrangements online.
cessing procedures and thus costs just 50 cents per ticket, versus $8 for paper. Much of the savings comes from not having to mail actual tickets. Travelers can get a receipt and itinerary via fax or e-mail, or at the airport. E-tickets are now the norm: Standard & Poors estimates that they accounted for about 96% of tickets sold in 2006.
Improving service
Many travelers appreciate the speed of air travel. However, the process leaves much to be desired, with long lines to check in and obtain boarding passes, and frequent delays or cancellations of flights. Conditions worsened when the airlines had to institute heightened security measures. Technology has helped with some of these problems. For example, many airlines passengers can skip the boarding pass counter by printing their own documents through their personal computers. In addition, a growing number of airlines have installed hundreds of self-service kiosks that allow passengers to check in luggage, obtain boarding passes, and check their frequent-flyer credits. Such kiosks have been around in one form or another since 1995.
International markets provide growth

Particularly in light of the brutal competition in the US domestic market, many US airlines see international markets as an avenue for profitable growth. For US-based airlines, international revenue passenger-miles (RPMs) and enplanements climbed at compound annual growth rates of 4.3% and 2.7%, respectively, between 1993 and 2000, versus 5.3% and 4.5% growth for domestic travel. However, along with the domestic US market, international travel slowed after September 11, 2001. International enplanements declined 6.3% in 2001, then another 0.2% in 2002 and 1.8% in 2003. In 2004, however, international enplanements increased 13.9%, breaking the downward trend and outpacing domestic growth (domestic enplanements rose 4.8% that year). International enplanements increased 9.4% in 2005 and 6.8% in 2006; in both 2005 and 2006, international enplanements outpaced growth in domestic enplanements. To compete effectively for international traffic, airlines need a level playing field.
E-tickets reduce costs

Ever on the lookout to cut costs, airlines have enthusiastically embraced ticketless travel the practice of issuing electronic tickets (e-tickets) to customers. E-tickets are booked in the usual manner online, through a travel agent, or directly through the airline but no paper ticket is issued. Instead, passengers are issued an e-ticket number. They can print boarding passes at home, obtain boarding passes at the airport check-in counter, or get them from an automated dispensing machine, which is activated with a credit card, frequent-flyer card, or eticket number. According to United Airlines, electronic ticketing eliminates 14 accounting and proNOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY
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This requires the enactment of open skies aviation treaties: bilateral agreements that reduce economic regulation of airlines and allow code sharing, alliances, and partial ownership deals among international carriers. However, domestic routes in the United States and overseas remain closed to foreign competition. The practice of cabotage the transport of passengers by a foreign carrier for purely domestic flights is illegal in all nations. Since the late 1970s, the US government has favored deregulation of international aviation markets. Because domestic carriers suffered heavy losses following US deregulation, the government did not pursue open skies policies until the early 1990s. In the past few years, the government has been pursuing open skies treaties aggressively. Most notably, on March 23, 2007, the US signed an open skies agreement with the European Union; this agreement, scheduled to go into effect in March 2008, supersedes individual open skies treaties with individual European nations. (For more details, see the Current Environment section of this Survey.) The worlds first open skies pact was reached in 1992 between the United States and the Netherlands. By November 2006, some 77 nations had signed agreements with the United States. Not all of these aviation pacts provide for unfettered competition, but all move strongly in that direction, providing for phased-in deregulation.
entities, but with coordinated schedules and combined frequent-flyer programs.
Alliances aid airlines abroad

There are currently three major global airline alliances: Star Alliance, anchored by United Airlines and Deutsche Lufthansa AG (which also includes US Airways); OneWorld, with American Airlines and British Airways PLC; and SkyTeam, with Delta, Continental, Northwest, Air FranceKLM SA, and Royal Dutch Airlines. Each alliance also involves several secondary carriers. For now, Star remains the biggest alliance, with over 16,000 daily departures to 855 airports as of May 2007.
HOW THE INDUSTRY OPERATES

Few inventions have had as profound an influence on the way people live, work, and experience the world as the airplane. By shortening travel time from weeks to hours, air travel has altered our concept of distance. The world has become smaller, as people can visit and conduct business in places once considered far-flung. The transformation of the Wright brothers early twentieth-century invention from a novelty to a commercial industry required considerable technological refinements and government assistance. Until the 1920s, the airplane was envisioned principally as a military tool. That view broadened in 1925, when airplanes began carrying mail. With the passage of the Air Commerce Act of 1926, the US airport and air traffic control infrastructure began to take shape. To promote the then-fledgling passenger travel industry, the Watres Act of 1930 changed the airmail fee structure: fees paid to air carriers to move mail were increased expressly to subsidize passenger service. Furthering the cause of air travel was the introduction in the United States of the jet aircraft for passenger service in 1958. With greater seating capacity and faster speeds, the jet dramatically cut operating costs and thus facilitated lower fares. The industry was deregulated in 1978, freeing it from government control of fares, routes, merger and acquisition activity, and alliances. This step helped to complete the transformation of air travel from a luxury to
Global partnering
International alliances are crucial to achieving profits on many international routes. Having a global partner that feeds traffic through a hub generates numerous benefits. By facilitating smoother connections and stimulating traffic, an alliance can help a carrier to dramatically lower its costs, cut fares, and increase flight frequency, without requiring substantial investment in additional aircraft, airport facilities, or route authority. Alliance partners realize cost savings in several ways: by sharing cargo and passenger terminal facilities; integrating frequent-flyer programs; consolidating sales, maintenance, and administrative operations; combining information technologies; coordinating advertising; and engaging in joint procurement where feasible. Alliances are currently structured so that partners remain independent
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a mass-market service. Government involvement is still evident in controls over international routes, however, and the US Department of Justice (DOJ) has halted some merger attempts, as discussed in the Industry Trends section of this Survey.
Providing transportation
Airlines today derive most of their revenues from the fares charged to passengers, but they also generate revenues by carrying mail and cargo, selling alcoholic beverages, and offering in-flight entertainment and services to passengers. Additionally, airlines sell frequent-flyer credits to hotels, auto rental agencies, credit card issuers, and other organizations, which in turn offer these credits as premiums or as a way to build goodwill. Some airlines have begun selling food to coach customers on board the plane, replacing the long-time custom of supplying it free. The latest revenue-generating attempt by some carriers has been charging an extra fee for aisle seats or exit row seats with extra legroom.
online ticket distribution has made it far easier to obtain a lower fare for travel even on short notice. Airlines actively solicit the business traveler. Many larger aircraft contain designated business sections, which offer roomier seats and premium food service. Recently, some airlines have expanded their business-class sections. Airlines compete for business passengers by offering priority check-in, expedited baggage handling, luxurious airport lounges, and in-flight amenities such as faxes, telephones, and power outlets for recharging laptop computers. To appeal to this class of traveler, airlines must provide frequent flights, reliable on-time performance, and top safety records.
Leisure travelers look for price breaks

Compared with the business traveler, the leisure traveler is highly price-sensitive. The cheaper fares resulting from deregulation have allowed people from all walks of life to travel by air to visit distant friends and relatives or take vacations more frequently. Leisure travelers can secure discount fares in two ways. First, low fares are available to individuals who book flights at least 14 days in advance. Second, deeply discounted fares are also available, mainly via the Internet, a few days before departure. Many leisure travelers defer making trip arrangements until a fare sale is offered. The upshot of these patterns is that over short periods, leisure travel can be erratic. Over the longer term, leisure travel is more cyclical than business travel; it waxes and wanes together with consumer sentiment and disposable income levels.
Business travelers: less willing to pay up

The airline industry has promoted the globalization of commerce, making the world into one big marketplace. Many business people use air travel to conduct sales trips, visit remote factories, and attend industry conventions. Business trips are often scheduled within seven days of the flight, so business fares have historically been the highest, whether for coach or first-class seats. Because their firms pick up the tab, business travelers long tended to be relatively priceinsensitive. Business fares climbed significantly faster than leisure fares; in recent years, however, corporations became more cost-conscious. The economic slowdown that began in 2001 led to significant cuts in corporate travel budgets. In addition, corporate downsizing has left leaner organizations, with fewer managers and executives authorized to travel. As part of their cost-cutting efforts, some companies are directing employees to travel coach or to patronize low-fare carriers. To reduce travel costs further, many companies enter into negotiated travel deals, under which they promise to do most of their travel with a certain airline in exchange for sharp fare discounts. In addition, the rising prominence of
Small world, big bucks

International travel (defined here as flights between the United States and a second nation) encompasses both business and leisure travel. In 2006, international travel accounted for 9.8% of enplanements for US airlines, versus 9.2% in 2005, according to the US Department of Transportation. Because the average stage (or flight) length is nearly four times longer for international than for domestic flights, international travel generates a disproportionately high level of revenue passenger-miles: 26.6% of total revenue passenger-miles in 2006, compared with 25.6% in 2005.
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Cargo and cocktails

All passenger aircraft are capable of carrying cargo, but most freight moves on widebody jets on long stage lengths. Major airlines carry significantly more mail and cargo in the belly space under the passenger cabin than do regional and commuter airlines. Passenger airlines view freight transport as a sideline to their main business. They garner freight business by offering discounted rates compared with those charged by specialized air freight carriers, and do not rely on large sales forces to pursue this business. Airlines often accept freight from only a few air forwarders. Among passenger airlines, Northwest Airlines Corp. generated the most revenue from cargo in 2006: $946 million, or 7.5% of its revenues that year. In second place was AMR Corp. with $827 million (3.7%). For the 10 largest US airlines, cargo and mail together accounted for just 3.4% of total revenues in 2006. In addition, airlines generate revenues from the sale of in-flight alcoholic beverages and various amenities and services, accounted for as other revenue. This category may also include income from international code-sharing programs. On long-haul flights, most carriers provide telephone, automated teller machine (ATM), fax, and television and entertainment services for a fee. Some international flights even offer video gambling. Although such supplementary sales carry high margins, they account for a relatively small portion of industry revenues.
national flights can travel 5,000 miles before refueling. National airlines. Carriers whose revenues fall between $100 million and $1 billion are classified as national airlines. Despite this designation, some of these carriers limit their service to regional markets, while others offer international service. Their aircraft, with about 100 to 150 seats, are usually smaller than those of the majors. National carriers may operate more short-haul flights than the majors do; they typically specialize in point-to-point service. Regional airlines. Regional airlines (those with revenues of less than $100 million) comprise two distinct types of carrier: short-haul/commuter airlines and start-ups. Commuter airlines primarily serve lowdensity, short-haul markets that are, strictly speaking, regional in scope. Their average stage length is about 245 miles, but they often provide point-to-point service for flights of up to 400 miles. Most commuter airlines are partners with major airlines, sharing the majors gate space at hub airports and their computer reservation system (CRS) codes. They shuttle passengers to and from the secondary cities on major airlines hub-and-spoke systems, sometimes using turboprop aircraft that seat 20 to 40 persons (though they have recently begun using jets with up to 100 seats). A few small commuter airlines, however, operate independently of the majors and provide service on low-density rural routes. Start-up carriers often are classified as regional airlines based on their revenues. With an average stage length of 400 to 600 miles, they may initially serve a single region, although their ultimate goal is typically to offer broad coverage. Indeed, few start-ups stay in the regional category for long; either they quickly grow into the national and/or major classification, as did AirTran Holdings Inc. and JetBlue Airways Corp., or they fail. Start-up airlines often either cannot obtain or cannot afford gate space during peak business travel hours at the major airlines hub airports a significant disadvantage. Moreover, even if they do get the space, the big carriers frequently match their discounted fares. Consequently, successful start-up
Industry structure
The airline industry is an imperfect oligopoly. A few carriers dominate long-haul passenger traffic, while several dozen small carriers compete for short-haul flights.
Size categories
The US Department of Transportation (DOT) classifies airlines as major, national, or regional carriers, according to revenue base. Major airlines. To be classified as a major airline, a carrier must have annual revenues of more than $1 billion. Major airlines typically operate jet aircraft that have 130 to 450 seats and average stage lengths of about 1,000 miles. The large aircraft used for inter-
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airlines have chosen to fill niche markets overlooked by the larger carriers.
Charter airlines
Charter or unscheduled service is another form of airline operation. It consists of transporting passengers on call an irregular service like that of a taxicab. Charter service is popular with tour operators, the military, and professional sports teams. Major airlines sometimes book charter space on other airlines when they have a capacity shortfall. Most airlines provide some charter service, but only a few specialize in this line; those that do may be classified as major, national, or regional carriers. Charters aircraft types and stage lengths are similar to those of other airlines.
Two-tier operators
A relatively new breed of airline is the two-tier operator. Typically, these carriers are major airlines that service long-haul markets via a hub-and-spoke system, but which also operate a fully independent, point-to-point air service in the discount excursion market. Most routes served by low-fare affiliates are shorter haul and consequently use smaller capacity aircraft. These affiliates also typically operate with separate wage scales. Some examples are AMR Corp.s American Eagle and Continental Airlines Inc.s Continental Express. Delta Air Lines Inc. discontinued its own Delta Express service and now operates through a network of regional affiliates operating under the Delta Express name. In 2003, Delta launched a new lowfare service named Song, in an attempt to compete with JetBlue and other discount carriers that had been gaining market share. As part of its restructuring in bankruptcy, Delta discontinued Song service in May 2006.
Competitors on all sides

Airlines confront a variety of competitors. In some markets, major airlines face competition from other majors, and from national and regional airlines as well. All airlines compete with other transportation modes, such as automobiles, railroads, and buses. Before 1978, the Civil Aeronautics Board regulated the fares that airlines could charge and which routes they could fly, severely limiting new entrants into the industry. Following
deregulation in 1978, competition in the airline industry intensified. As regulatory barriers to entry were dismantled and risk capital poured in, established carriers faced an unending parade of aggressive start-up airlines that targeted the larger carriers high-margin business. In recent years, competitive pressures have eased as risk capital has become scarcer for start-ups and as established carriers have limited their geographic horizons. The automobile is the airline industrys chief competitor. For short trips, airline travel is neither practical nor economical. For long distances, however, travelers prefer flying to driving. Airlines face competition from intercity railroads (specifically Amtrak), which have fares that have been partly subsidized by the US government. While Amtrak operates some long-distance routes, its passengers use it for an average journey length of about 280 miles. Intercity bus travel, although much more popular than railroads, rarely competes directly with air travel, because the typical bus journey is just 140 miles. Airlines compete with each other on both service and price. For business travelers, the frequency and reliability of flights are critical factors; frequent-flyer programs, cuisine, and other amenities are also influential. Small airlines that cannot obtain gate space during peak travel periods have difficulty attracting business travelers. Service information is disseminated by the DOTs Office of Consumer Affairs, which each month reports the on-time performance for the larger airlines. The DOT also collects and disseminates information about airlines performance in baggage handling, passenger bumping, and overall complaint record statistics that can influence business travelers carrier selection. Such reports have less effect on leisure travelers; aside from the few first-class nonbusiness passengers, price is the leisure travelers main criterion for carrier selection. To differentiate themselves from their competitors, airlines may strive to build brand loyalty through frequent-flyer programs. Targeting mainly business travelers, frequent-flyer programs let travelers chalk up bonus miles by booking flights or by conducting business with other organizations that have tie-ins with the airlines. Bonus miles can be redeemed for free air tickets or service upgrades. Frequent-flyer programs
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are designed to promote repeat business for an airline; members tend not to defect to other carriers to reap minor price savings.
Airline fares: variable pricing

Price competition is a fundamental weapon that carriers commonly use to seek a greater share of the market. Fare differentials of just a few dollars can persuade leisure travelers to select one airline over another or to make their journey by a different mode. Business travelers are also becoming more price-sensitive (as discussed in the Industry Trends section of this Survey). To attract leisure travelers, airlines advertise deeply discounted fares. However, most passengers do not get these fares: by law, carriers do not have to offer more than 10% of the seats on a flight at the discounted rate. On a given flight, passengers who fly coach may have booked fares at as many as a dozen different prices. Fares differ in part according to how far ahead of time the seat is booked. Walk-up fares, paid by passengers at the airport gate at departure time, tend to be high. Last-minute discounts have become increasingly prevalent since the advent of online sales. Consumers level of price sensitivity varies. At one extreme are passengers willing to make several connections and book red eye flights through online ticket auctioneers such as priceline.com Inc. Other travelers are willing to pay somewhat higher fares for direct flights at convenient times.
sumers even more price-conscious, which is exerting downward pressure on yields. Yield management helps carriers to estimate the number of passengers who will cancel their flights and how many seats can be overbooked without the risk of having to bump customers (deny them seating on an overcrowded flight). Only 0.2% of all passengers are bumped. The industry tries to avoid bumping, since by law they must pay $400 to passengers involuntarily denied boarding. Carriers use computer programs to redeploy smaller aircraft to routes where sales are slower than anticipated and put their larger-capacity jets into markets that are more popular.
Igniting fare wars

Since deregulation, the airline industry has been prone to periodic bursts of destructive fare wars. Some of the blame lies in the aggressive pricing tactics of start-up carriers, which operate with substantially lower costs than the major airlines and are eager to gain a foothold in the market. Southwest Airlines Co. and JetBlue (though no longer start-ups) have been the source of much fare pressure. Generally, the industry is susceptible to fare wars when capacity levels far exceed demand. Because airlines have high fixed costs (for equipment and maintenance facilities) relative to their marginal costs (the cost of flying one additional passenger), fare wars can reach extremes before order is restored. Airline yields remain in a downtrend. Between 1991 and 2006, real (inflation-adjusted) yields dropped 2.5% annually. Real yields fell 10.7% in 2001, declined 9.2% in 2002, rose 0.2% in 2003, dropped 4.6% in 2004, and slipped 0.7% in 2005, according to the ATA. In 2006, real yields gained 2.2%. The yield declines from 2001 to 2005 reflected reduced business travel, increased fare competition, and the impact of the September 2001 terrorist attacks. Inflation also accounts for much of the decline shown. Nominal yields (not adjusted for inflation) dropped from 1991 to 2006 at an annual rate of only 0.2%, a much slower rate of decline, and actually rose 5.8% in 2006.
Perishable inventory
Airline seats are perishable inventory: once a plane is aloft, its empty seats can no longer be sold. To minimize such losses, the industry has developed sophisticated computer programs to help determine how much demand there will be for each route at different times of the day, days of the week, and seasons of the year. Airlines attempt to calculate how much of a flight should be booked by a given point in time through a practice known as yield management. Yield management alerts the carrier to abnormal booking patterns, to which it can react by either cutting or raising fares well before a flight is scheduled to depart. By offering deeply discounted last-minute fares via the Internet, airlines can now fill seats that otherwise would have gone empty. The down side is that the Internet is making con-
Airline costs
The airline industry is both labor- and capital-intensive. Additionally, fuel costs
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have absorbed a large portion of revenues in recent periods.
Labor
Labor has dropped to the second largest expense category due to the recent sharp rise in fuel costs. Labor accounted for 24.5% of total revenues at the 10 largest US carriers in 2006, down from 28.2% in 2005. Employment can be divided into several broad positions: flight crews (pilots and engineers), flight attendants, ground service (including baggage handlers, ramp workers, and reservationists), dispatchers, maintenance, and customer service (bookings and boardings). Most airline workers belong to one of a dozen major unions. The larger unions include the Association of Flight Attendants, the Air Line Pilots Association, and the International Association of Machinists and Aerospace Workers. At any given time, an airline might be in negotiation over a half dozen or more labor contracts. Union contract talks tend to be protracted, often lasting two years or more before settlement, largely because the industry follows procedures laid out by the Railway Labor Act of 1926 (RLA). Strikes occur infrequently because under the RLA, airline contracts do not expire, but become amendable. Before a strike can occur, labor disputes must be submitted to the National Mediation Board, an impasse must be declared, and a cooling-off period served.
Carriers incur the costs of maintaining their fleets, whether leased or owned. Most carriers perform routine maintenance, but many outsource heavier repairs to firms that specialize in such work. Even if they contract out the maintenance work, though, airlines are still responsible for the airworthiness of their aircraft.
Fuel
Airlines are energy-intensive operations; fuel accounted for 25.7% of total revenues in 2006 at the 10 largest US carriers and was the single largest cost category, up from 24.2% in 2005. How much a carrier spends on fuel depends not only on fuel prices but also on consumption, which varies with the age of its aircraft and its average flight length. The fuel efficiency of different aircraft varies widely, with the number of engines a major determinant. Takeoffs and landings (which are more frequent for shorthaul carriers) consume a lot of fuel. Some carriers attempt to hedge their fuel costs by striking deals with suppliers or by buying and selling futures on the commodities market. Because the jet fuel futures market is thin, carriers sometimes hedge with crude oil or heating oil neither of which moves in exact harmony with jet fuel prices.
The high cost of bad weather

Weather is another unpredictable variable that can have a profound short-term effect on airline costs and operations. Wind speeds and air temperatures influence how much fuel an aircraft will require to reach its destination. Floods, fog, ice, and snow can shut airports and force the cancellation of flights.
FUEL EFFICIENCY
(Gallons consumed per available seat-mile)
0.0225 0.0220 0.0215 0.0210 0.0205 0.0200 0.0195 0.0190 0.0185 0.0180 1984 86 88 90 92 94 96 98 00 02 04 2006
Equipment
Airline equipment costs, excluding fuel and maintenance, are equal to about 10% of total expenses. Aircraft may be obtained new or secondhand, or they may be leased. For carriers with balance sheets that are stretched, leasing is the most affordable method of obtaining equipment. Many major airlines lease the bulk of their aircraft about 55% of their fleets from intermediary companies known as lessors. Lessors often can finance the purchase of new aircraft more cheaply than airlines can because of their superior credit rating. They then pass on some of the savings to the airlines, reducing carriers equipment costs while earning a profit for themselves. For financially strong carriers, however, it is cheaper to buy aircraft outright than to lease them.
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Weather is the second largest cause of airline accidents, after pilot error. The industry must obtain detailed weather forecasts that include cloud height, horizontal visibility, and wind speeds and direction. Some airlines have their own meteorology departments to provide this information, although most rely on government agencies and pilot reports.
A larger airline leases an aircraft accompanied by a full crew to provide service on a route that it cannot or does not choose to operate directly. Once traffic on the new route reaches a level where the carrier can use its own aircraft and crew, it often drops the wet lease.
Distribution changing with technology

The airline industry historically distributed tickets primarily through travel agents. However, it also books flights directly through company clerks and via the Internet. In addition, online travel sites are gaining market share. According to the American Society of Travel Agents (ASTA), travel agents generated about 51% of total airline bookings in 2004 (latest available), down from 70% in 2003. Approximately 88,590 travel agents operated in the United States as of May 2005; 19,393 travel agencies were in operation at the end of 2006. These numbers have been declining due to a more difficult operating environment, in which airlines are reducing commissions while Internet competition is growing. In April 2002, most of the major US airlines eliminated the payment of base commissions to travel agents on domestic tickets. Many airlines substituted incentive commissions to travel agents that booked a predetermined volume of tickets for that airline. Total commissions paid in 2003 by the 10 major US airlines averaged 3.9% of revenues, down from 4.6% in 2002. That percentage fell further in 2004, to the point where most major airlines no longer break out the expense category separately in their financial statements. According to Standard & Poors estimates, commissions in 2005 averaged about 1% of revenues for the top 10 major airlines. Many travel agents have responded to these cuts by charging customers a service fee to book air travel, which means that the airlines have essentially passed much of the cost of booking tickets on to the consumer. Airlines try to encourage travel agents to steer customers their way by offering commission overrides. A commission override is an incentive whereby an airline agrees to compensate an agent at a higher-thancustomary rate once the agents bookings exceed a predetermined level.
Operations overview
Airline flights are either nonstop or connecting. A nonstop flight has a point-topoint itinerary, in which the aircraft flies from origin to destination without interruption. A connecting flight is one that involves at least two legs and passes through at least one hub. Short flights typically have no intermediate stops, while flights covering longer distances tend to be routed through a hub. The hub-and-spoke system lets airlines gather passengers from lightly traveled markets to a single point to build up densities for the longer leg of a flight. To bring passengers to the hub, the hub carrier will use either its own smaller capacity aircraft or the services of a regional airline, which the major airline often owns wholly or in part. Until recently, the regionals typically employed only turboprop aircraft, but they are aggressively phasing out these small, noisy aircraft in favor of comparatively larger jets. On the longer leg of the route, larger capacity jets are used. To connect flights from central hubs to low-density destinations or vice versa, large airlines and small regional carriers often complete different portions of a trip a practice known as interlining passengers. Such joint flights are typically scheduled through a code-sharing arrangement. Through code sharing, a carrier sells seats for flights on joint routes. Although two carriers are to provide the service, the customer receives a single ticket. Typically in these arrangements, the regional airline operates under the major airlines code, and flights are booked as such in computer reservation systems. Federal regulations require airlines to inform passengers when they are booking a flight that involves code sharing. Another technique, used mainly for short duration, is a wet lease arrangement, in use both in the United States and overseas.
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To book a flight, the travel agent harnesses one of several major CRSs. Nearly all airlines now supply their flight and fare information to CRS operators, though most carriers hold back special fares for their own Internet sites. When a flight is booked, the airline pays the CRS operator a fee of between $2.50 and $3.00 per ticket. In addition to offering real-time airfare and route information, the CRS can be used to book hotels and cruises and to rent cars. The leading CRS is Sabre Holdings Corp., which began as the internal reservations system for American Airlines before it was opened to other airlines in 1976. Air carriers have recently sold or spun off controlling stakes in Sabre and other CRS operators such as Amadeus Global Travel Distribution SA, Galileo International Inc., and Worldspan Technologies Inc. In March 2007, Sabre was acquired by private equity groups Silver Lake Partners and Texas Pacific Group. After deregulation, CRSs became indispensable, as air carriers began offering a multitude of fares per flight and making frequent changes in their fare offerings. These systems contribute to a more efficient market in airfare pricing, because they provide customers and carriers with full knowledge of existing fares. Air travelers can book flights and secure fare information via the Internet. Airlines allow flights to be booked through their home pages on the World Wide Web. Another option for passengers is to book flights via the Internet by utilizing cyber-travel agents intermediaries that pull together all airline schedules into a synthetic variant of a CRS. The Internet version of the CRS is accessible to all PC owners and is in a format that is more user-friendly than a traditional CRS.
noise standards, though the standards are not legally binding in a given country unless the country has formally agreed to them. The FAA, established in 1958, primarily promotes safe air travel. It does this by monitoring the industrys maintenance and operating practices. The FAA certifies aircraft and airlines and establishes age and medical requirements for pilots. One of the agencys chief functions is to operate the nations air traffic control system at some 288 airports. Another 161 airports are operated under contract from the FAA. The DOT levies civil penalties against airlines that engage in fraudulent marketing practices or that violate code-sharing rules. It also oversees compliance with denied boarding (bumping) compensation rules and renders decisions on airline ownership and control issues. The DOT plays an important role in negotiating bilateral aviation treaties with foreign nations. When US airlines operate in international markets, they are subject to economic regulation by individual foreign governments and collective organizations such as the European Commission. The degree of regulation varies from country to country, and the rules are laid out through formal bilateral aviation treaties. These accords govern reciprocal landing rights and typically limit the number of carriers that can operate in a country, the level of rates, the type of aircraft, and the frequency of flights.
Feds take jurisdiction over airport security

In response to public worries about air travel security following the terrorist attacks of September 2001, President George W. Bush signed the Aviation and Transportation Security Act in November 2001. The law federalized the airport security industry and created the Transportation Security Agency (TSA). As of March 2005, there were roughly 45,000 federal screeners, who were deployed at all 429 US commercial airports. Federal control of airport security is expected to facilitate the use of information from the Federal Bureau of Investigation and other agencies in the screening process. The government will pay workers salaries; the airlines are responsible for some additional costs, including equipment expenditures and
Regulation under deregulation

Federal regulation of domestic airline fares and markets ended with the Airline Deregulation Act of 1978. However, the DOT and its affiliated agency, the Federal Aviation Administration (FAA), continue to regulate the industry with regard to safety, labor, operating procedures, aircraft fitness, and emission levels. The International Civil Aviation Organization (ICAO), an entity affiliated with the United Nations, proposes
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airport charges. In addition, airlines will pay a federal tax of $5 per passenger per segment to cover a portion of the governments added security costs. The 2001 law also required that all bags be checked for explosives. At present, this is done by passing bags through a bomb detector or by assuring that each bag is matched to a passenger who actually boards the same plane. Ultimately, all checked baggage must pass through scanning equipment (as discussed in the Industry Trends section of this Survey). The Federal Air Marshal Program, operated by the FAA, deploys specially trained, armed teams of security specialists on both domestic and international flights. While the number of total marshals in place and their itineraries are kept secret, the FAA says that it has taken steps to sharply increase the number of marshals in the sky.
AIRLINE TRAFFIC STATISTICS

(Domestic operations)
1100 1000 900 800 700 600 500 400 300 200 100 1993 94 95 96 97 98 99 00 01 02 03 04 05 2006 80 78 76
ASM (in billions, left scale)
74 72 70 68 66
RPM (in billions, left scale) PLF (in %, right scale)
64 62 60
ASM-Available seat-miles. PLF-Passenger load factor. RPM-Revenue passenger-miles. Source: Air Transport Association of America.
KEY INDUSTRY RATIOS AND STATISTICS

Revenue passenger-miles (RPMs). This measure of airline traffic is calculated by multiplying the total number of passengers carried by the number of miles flown. The most frequently reported aggregate figure is RPMs for the 10 largest carriers, a group for which data are available on a timely basis. Accounting for about 90% of total US traffic in 2006, the 10 largest airlines are a good proxy for the entire industry. Industrywide RPM numbers are available on a monthly basis from the Air Transport Association of America (ATA), an industry trade group representing larger passenger airlines and leading air cargo companies. Examining this indicators year-over-year change for each month shows the pace at which the industry is growing or contracting. (An examination of month-to-month changes is irrelevant, however, because the indicator is not adjusted for seasonal factors.) For the US industry as a whole, RPMs (including domestic and international flights) increased 1.3% in 2006, to 653.6 billion. Year-to-date through July 2007, RPMs were up 1.7%, year over year. Available seat-miles (ASMs). This capacity indicator measures the total number
of seats in the active fleet, multiplied by the number of miles flown; it can be calculated for an individual airline or for the entire industry. The ATA compiles an industrywide figure on a monthly basis. Changes in ASMs are influenced by the net addition of aircraft to the fleet, by the pitch and mix of aircraft seats (number of first-class seats versus business and economy), the average length of flights, and by how quickly the airline (or industry) turns around its aircraft between flights. For the US industry as a whole (including domestic and international flights), ASMs totaled 815.4 billion in 2006, a 0.9% decrease from 2005. Through July 2007, ASMs were up 0.4%, year over year. Load factor. This indicator, compiled monthly by the ATA, measures the percentage of available capacity (as measured in ASMs) that is taken up by revenue-paying passenger traffic. It may be calculated as a single airlines capacity utilization, or for the entire industry. Once the industrys load factor exceeds the break-even point (which is a moving target), profit margins can expand dramatically as incremental revenues flow to the bottom line. Because seasonal elements influence the load factor, year-over-year comparisons are more meaningful than month-to-month changes. As deregulation has forced down fares and helped fill aircraft cabins, the direction of the industrys load factor has generally been upward. In the early 1970s, the average flight was half empty.
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AIR TRAVEL PLANS

(Percentage of consumers planning a vacation in the next six months)
52.5 25
Planning a vacation (left scale)

50.0
Traveling by air (in %, right scale)

20
47.5
15
45.0
10
positive, real (inflation-adjusted) disposable income rises and falls with the economic cycle. After falling in 1991, a recession year, real disposable income has risen each year. It was up 5.2% in 2002, 4.2% in 2003, 6.1% in 2004, and 4.1% in 2005. As of September 20, 2007, Standard & Poors was projecting disposable personal income to rise 5.9% in 2007 and 4.9% in 2008, following a 5.9% increase in 2006. Corporate profits. Reported quarterly by the US Department of Commerce, this figure is a measure of aggregate business profits, in dollars. Although corporate profits are reported both before and after taxes, the pretax number is more useful. Changes in corporate profits, unless extremely minor, have some bearing on business travel. For example, the sharp drop in corporate earnings that often accompanies a recession will ultimately lead to a curtailment in business travel. Pretax corporate profits rose 13.0% in 2004, 32.7% in 2005, and 14.3% in 2006. As of September 20, 2007, Standard & Poors was projecting growth of just 2.2% in 2007 and a 1.3% decline in 2008. Jet fuel prices. The spot price for jet fuel (at New York Harbor) can be found on the Bloomberg Terminal, which tracks transactions with a 15-minute delay. Changes in jet fuel prices are often the swing factor in airline profits. Jet fuel prices climbed sharply beginning in mid-1999, reaching what seemed like an astronomical $1.690 per gallon in February 2000 a fivefold increase from the low in February 1999. It is important to remember that, because of purchase contracts and hedging strategies, airlines buy very little of their fuel at the spot market price. In the wake of the September 2001 terrorist attacks, jet fuel prices came down sharply, hitting a low of $0.570 per gallon in December 2001. More recently, sparked by worries about global oil supply and refining capacity in the wake of Hurricanes Katrina and Rita, jet fuel prices hit record levels. In October 2005, the price of jet fuel hit a record high of $2.145 a gallon. For full-year 2006, the average price of jet fuel was $1.970, an increase of 14% over 2005.
42.5
40.0 1998
0 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: The Conference Board.
In every year from 1994 through 2000, gains in domestic passenger traffic outpaced growth in available seat-miles, so load factors rose. In 2001, the percentage decline in traffic exceeded capacity cutbacks, leading to a 70.4% load factor, versus 72.4% in 2000. In 2006, load factor hit a record high of 80.2%, up from the previous record of 78.4% in 2005. Through July 2007, load factor averaged 82.2%, an improvement of 1.1 percentage points over the same period in 2006. Consumer confidence. The Conference Board, a private research firm, compiles this index monthly. Consumers from every US geographic region are surveyed about their near-term spending plans and overall economic expectations. The index peaked at 144.7 (1985=100) in January 2000, surpassing the record high that had stood since October 1968. Subsequently, however, consumer confidence fell sharply, reflecting the economic slowdown and fears of war in Iraq. In February 2003, the index plunged to 64.0 down nearly 15 points from the month before, and the indexs lowest level since October 1993. As of September 25, 2007, the index stood at 99.8, down from 105.6 in August. Disposable personal income. Reported each month by the US Department of Commerce, this measure calculates aggregate consumer income (in dollars) after taxes. Changes in disposable income have a bearing on leisure travel. Although growth in nominal disposable income (unadjusted for inflation) tends to be
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HOW TO ANALYZE AN AIRLINE

Factors to examine when analyzing an airline include traffic, pricing, costs, profitability, route structure, fleet planning, service performance, various financial measures, and equity valuation, as discussed following. Other important factors are managerial strength and employee morale. Although difficult to quantify, these characteristics are typically reflected in cost and asset performance measures.
proportion of business travelers, these seasonal swings may be largely absent. Consequently, using data for the off-season winter travel period might lead one to conclude erroneously that small, business-oriented airlines were outperforming their larger competitors.
Yield: a look at pricing trends

The other component of revenues is pricing, or fare levels. The passenger revenue generated per RPM is commonly referred to as the yield. It is useful to compare the trend in a carriers yield with the trend in yield for other airlines; however, comparing the yield levels for different carriers is useful only if the carriers provide a similar mix of flights. Yields for international flights tend to be lower than those for domestic routes, yet they also may be more profitable. Thus, one should take into consideration the percentage of domestic versus international travel in a carriers mix. In addition, airlines that have a larger mix of business or first-class seats will report higher yields than carriers flying the leisure trade on identical routes. While shorthaul flights tend to have higher yields, their costs are also higher, and their load factors tend to be lower.
Revenue-related factors
Traffic is the starting point in analyzing a passenger airline. It can be measured in terms of revenue passenger-miles (RPMs) or enplanements (the total number of people carried). Both provide useful measures of a carriers market share. Traffic levels and yield, a measure of pricing trends, are the two determinants of revenues.
Traffic: revenue passenger-miles

For any given period, revenue passengermiles (RPMs) equal the total number of passengers enplaned, multiplied by the average distance flown. This measure is superior to enplanements as an analytical tool, because airline revenues closely correspond to RPM levels. Short-haul carriers sometimes rank high based on total enplanements, but appear smaller when measured by RPMs or revenues. Changes in RPMs should be compared with industry averages to determine whether a carrier is gaining or losing market share. Traffic performance must be viewed in conjunction with yield analysis to determine whether a carrier is buying market share at the cost of profits. Each month, scheduled airlines report their traffic data to the US Department of Transportation (DOT). Start-up carriers and regional and charter airlines typically outperform the majors in RPM growth because their traffic base is much smaller. Again, growth rates should not be confused with profitability. A comparative analysis of different carriers RPM performance over a short period can yield a distorted picture. Vacation travel tends to be concentrated during the summer months, creating uneven seasonal traffic patterns. For small regional airlines with a high
Market share and geographic mix

The best method for determining a carriers relative market performance is to look at the specific city pairs that it serves its share of total enplanements at the airports where it operates. An analysis of city-pair traffic can pinpoint exactly where a carrier is facing the greatest degree of competitive pressure. In todays environment, it is not unusual to find major airports where a single airline accounts for 75% or more of total enplanements. Carriers that have low market share or that serve cities where no single airline dominates will face greater competitive pressure on fares. An airlines geographic mix is important. Economic growth and the level of discretionary spending and, hence, air travel vary from region to region and nation to nation. Airlines that serve a limited market can see their traffic diverge from overall national trends. A carrier that primarily serves Hawaii, the Florida tourist market, or the oil-patch states could beat or underperform other carriers at times. Likewise, carriers that
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derive a high percentage of their total RPMs from international travel may see their traffic occasionally out of step with those that serve domestic markets exclusively. Whatever markets an airline serves, however, it is not locked into them in the same way that a railroad is because airlines can reposition their assets depending on where the best growth opportunities lie. Airlines can shift resources out of weaker international locations and into stronger ones, or out of weak, underperforming, or money-losing domestic markets into those with better growth potential. Not all aircraft types can be operated profitably in every market, though. For example, jumbo jets need dense, long-haul routes, and can be accommodated only by airports with long runways.
Costs
When evaluating an airline, it is often more important to analyze its cost performance than its traffic. Among start-up airlines, the aggressive, high-growth carrier is frequently the one to suffer defeat. In contrast, carriers that pursue a manageable level of growth while controlling costs tend to thrive.
Labor
Labor has historically been the industrys largest cost item, though in 2005 and again in 2006, fuel surpassed labor as the largest cost category for some carriers. According to data compiled by Standard & Poors, labor costs at the 10 major US airlines averaged 24.5% of total revenues in 2006 (compared with 28.2% in 2005), ranging from a low of 18.0% (US Airways Group Inc.) to a high of 34.0% (Southwest Airlines Co., surprisingly to many). How much an airline spends on labor depends on its efficiency and the labor-intensity of its routes. For example, short routes on which meals are not served have lower personnel and cleaning costs than those that require meal service. They also have lower gate rental fees. Aircraft can be turned around quickly because they do not require catering entrances and other facilities needed by longhaul flights; also, they do not need to refuel as often. Thus, short-haul operators typically incur lower labor costs than do the major national airlines.
Outsourcing certain functions, such as maintenance or reservation services, reduces labor costs as a percentage of the total and can cut total costs as well. Similarly, a technology-intensive airline one with a high percentage of sales booked over the Internet, for example, and/or electronic ticketing and self-service check-in kiosks will enjoy high labor productivity. While most airline employees are union members, wages and work rules differ from carrier to carrier. Aircraft type and design will determine the size of the flight crew: some aircraft require two copilots, while others need only one. Nonunion airlines instruct flight attendants to perform tasks that are restricted to fleet service operators in union airlines. Some airlines offer sizable profit-sharing programs or may have employee stock ownership programs (ESOPs) in addition to salaries and benefits. Although these may not be recognized as an expense category on the income statement, such airlines will record a charge to earnings to cover distributions under the ESOP plan equaling as much as 5% of revenues. Labor efficiency should be measured relative to output; in the airline industry, this translates into RPMs per worker. Labor productivity averages about 1.4 million RPMs annually per worker, with major carriers recording between 1.1 million and 1.6 million RPMs per worker per year.
Fuel
Airlines are energy-intensive operations, but carriers have different levels of exposure to changes in fuel prices. In the past, fuel costs at the major airlines ranged from as little as 10% of their revenues to as much as 18%. Rising oil prices have hit all the major carriers, however. In 2006, fuel costs averaged 26% of revenues among the 10 major US airlines, with costs ranging from 22.5% to 37.0% of revenues. Along with the number of engines, the age of a carriers aircraft greatly influences fuel consumption rates, as newer planes are more fuel-efficient than older models. Carriers specializing in short hauls, which involve frequent departures, consume more fuel than do long-haul airlines, because a disproportionate amount of fuel is burned during takeoff and landing. In addition, short-haul
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carriers operating turboprop aircraft consume less fuel than those employing jets. Meanwhile, carriers based in the western United States typically pay more per gallon than do other US airlines. Under normal conditions, the average price per gallon of jet fuel may vary by 10% to 15% from carrier to carrier, as airlines engage in fuel hedging to varying degrees. Most airline managers now see the value of using futures and swaps to hedge a majority of their fuel price exposure; but, given the recent weakness in many airlines balance sheets, many carriers have been unable to hedge against rising oil prices to the extent that they would like. In addition, with oil prices recently near record highs, many carriers have been unwilling to enter into new hedge positions as older ones expire; they are afraid to lock in high oil prices, which could lead to hedging losses if oil prices recede.
Profitability and load factor

A key determinant of profitability is capacity utilization, as measured by load factor (a carriers RPMs divided by its available seat-miles, or ASMs). ASMs are calculated as aircraft miles flown, multiplied by the number of seats available for revenue passenger use. Given airlines high fixed costs, the more passengers that can be boarded before each departure, the more profitable the flight will be, provided variable costs are covered. In late 2000 and early 2001, load factors rose at UAL Corp. (United Airlines) and AMR Corp. (American Airlines), reflecting a decrease in capacity as the airlines removed thousands of seats to expand legroom. Immediately after September 11, 2001, load factors dropped sharply to well below 50% but they have since risen above historical averages as low fares have spurred demand, albeit at the cost of lower industry yields. It is important to realize, however, that rising load factors show only that capacity utilization is increasing, not necessarily that passenger volumes or profitability are improving. Carriers load factors are always highest during the peak summer travel season, usually as high as 80.00%; in July 2006, passenger load factor averaged 86.67%, which we believe is a record for any month. During the off-season, load factors may be closer to 60%. Short-haul commuter airlines, which typically operate small turboprop aircraft, often sustain load factors well below those of the majors. However, they can operate profitably at load factors of 50% or less, because they turn their planes around more frequently. For longer-haul flights, break-even load factors would likely be above 60% under normal conditions. For the legacy majors, they have been much higher in recent periods due to reductions in capacity and sharp discounting, which has filled planes but at below break-even revenue levels. A carriers break-even load factor depends on its revenue per passenger-mile and the cost of providing each available seat-mile.
Maintenance
The average carrier spent about 4.9% of its revenues on maintenance in 2006; the industrys range was 3.6% to 7.9%. Maintenance spending per carrier varies materially with the amount of work outsourced. Aircraft age greatly influences the level of maintenance required. Just as important, however, is the spacing of fleet ages. Every six to eight years (or 20,000 flight hours), each aircraft must undergo an intensive maintenance program known as the D-check. Airlines that fail to space orders evenly, or that buy secondhand aircraft of the same age, will face a bunched-up maintenance program at some point. If this happens, it will distort the results of a comparative analysis.
Financing aircraft purchases

For major airlines, interest expense (net of interest income and capitalized interest), averaged about 2.7% of revenues in 2006, compared with 3.4% in 2005. The revenues consumed by interest expense in 2006 ranged from 1.6% (AirTran Holdings Inc.) to 7.4% (Delta Air Lines Inc.). Many airlines lease some portion of their fleets from equipment lessors. Aircraft rental costs averaged about 3.5% of revenues in 2006, down from 4.1% in 2005; the costs in 2006 ranged from a low of 1.7% (Southwest Airlines) to a high of 12.2% (AirTran).
RASM versus CASM

Comparing passenger revenues per available seat-mile (RASM) with costs per ASM (CASM) is a common way of measuring airline profitability. RASM is the indicator most
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closely watched by financial analysts, but both measures are crucial. In past years, United Airlines and American Airlines demonstrated that simply removing seats could increase RASM. This increase, however, clearly was not enough to make them profitable. Since airlines often earn an additional 10% of their income from other sources, Standard & Poors also likes to consider a total RASM measure, including cargo operations, sales of frequent-flyer miles, in-flight liquor, entertainment, or telephone services, and other amenities. These nonpassenger revenue sources can make the difference between an operating loss and a profit.
Balance sheet stability and cash burn

Given the high debt levels carried by many airlines, and the frequency of large operating losses, it is important to assess the strength of an airlines balance sheet. Metrics such as debt-to-equity and debt-to-totalcapitalization should be examined, as should cash on hand to cover interest payments and other liquidity needs. During times of industry losses, it is important to determine how quickly an airline may be using its available cash (its cash burn rate). For example, in the case of UAL Corp. before its bankruptcy filing in December 2002 and, more recently, in Delta Air Lines precarious financial state in late September 2004 and again in March 2005 these airlines were burning through millions of dollars in cash each day. In such cases, it is important to gauge how long an airline can withstand a downturn and remain solvent.
Service and safety record

One way to measure an airlines service performance is by the percentage of its flights that arrive on time, as published in the DOTs Air Travel Consumer Report. Typically, 75% to 80% of all flights arrive within 15 minutes of their scheduled time. Carriers that route passengers through hubs into connecting flights are more likely to have a lower on-time performance than those offering direct point-to-point flights. On-time performance is generally worse during the winter, when weather can wreak havoc with schedules. This is especially vexing for carriers that serve more northern
than southern states in the United States. Airlines serving congested metropolitan markets often suffer from poor on-time performance caused by air traffic control-related delays. The on-time numbers must be taken with a grain of salt, though, because some airlines lengthen their estimated flight times to allow for delays. The DOT collects and disseminates information about consumer complaints, which is usually a relatively reliable indicator of service levels. Sometimes a poor service performance reflects low employee morale, particularly if a carriers labor talks have reached a stalemate. One also can look at the bumping ratio the percentage of passengers denied boarding. Airlines that overbook flights will have high bumping ratios. Some 0.2% of all passengers are bumped; of that total, however, only 5% are bumped involuntarily the rest take an offer from the airline to be voluntarily bumped. Bumped passengers are compensated for their inconvenience, often with as much as $400 in cash, vouchers, or frequent-flyer credits. Consequently, airlines with high levels of overbooking still may have high levels of consumer satisfaction. A case could even be made that high bumping ratios coincide with wider profit margins, because it indicates that flights are fully loaded with passengers. A carriers safety performance can sometimes play an important role in determining consumers choice of airline. The Federal Aviation Administration measures carriers accident rates per 100,000 departures. Most carriers have low accident rates, and their safety records tend not to vary significantly. In general, airline safety has been on the rise. In 2004, the National Transportation Safety Board reported one fatal accident in more than 10 million scheduled departures, according to the Air Transport Association of America, a trade group that represents the larger passenger airlines and leading air cargo companies. Between 2002 and 2004, airlines in the United States provided 31 million scheduled commercial flights, carrying nearly two billion passengers, while recording a total of 34 fatalities.
Fleet planning and management

An analysis of an airlines asset performance determines how well it manages its
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fleet. The faster a carrier can get its aircraft back into revenue service, the more profitable it will be. Jet utilization is measured by the number of hours the average aircraft is in service. The most efficient (and usually the most profitable) carriers tend to have their aircraft up for 11 to 12 hours per day. Fleet age is an important statistic because it provides an early warning of when a carriers capital spending may have to be ramped up to replace equipment. The age of an aircraft is less important than the number of takeoff and landing cycles, which puts stress on the fuselage. In addition, the age of the aircrafts engines and number of hours flown is a better gauge for the condition of the aircraft. While many start-up airlines operate with older planes, established regional and commuter airlines tend to own fairly new fleets, even those operating primarily with turboprops.
ondary consideration in this regard; investors tend to favor growth airlines with wide profit margins. During a rally in airline equities, however, the biggest percentage gain in stock price may go to the worst airline, because investors anticipate a greater gain (off a depressed base) in that carriers bottom line. Thus, in the perverse logic of Wall Street, an airlines quality may have an inverse relationship with its stock performance at least during a bull market. In a bear market, however, quality usually shines through.
Equity valuation
Airline stocks are among the most volatile shares on the market. Investors tend to bid up shares of airlines when they are incurring substantial losses and things look bleakest, although the downturn in the industry which began after September 11, 2001, and persisted through 2005 seems to have shaken that historical pattern due to the sheer size of the losses and the extreme difficulties the carriers are facing. Once profits are fat, investors normally move on, racing to lighten their airline holdings before the next downturn. In light of this volatility, many airline stocks have historically been viewed as trading vehicles. Speculators tend to trade airlines as plays on falling oil prices or the expectation of falling prices. The stock movements can exaggerate the effect that changes in fuel costs have on an airline companys bottom line. For example, while a 10% jump in crude oil may increase airline fuel costs 10%, total costs might rise only 1.5%, affecting profits somewhere in between. Yet, driven by speculators response to the change in oil prices, an airlines shares may rise or fall 20% or more. Furthermore, the best airlines may not have the richest valuations. A strong service performance and a young fleet are of sec-
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G LOSSARY
Available seat-miles (ASMs) A measure of airline capacity; calculated as aircraft miles flown multiplied by the number of seats available for revenue passenger use. Blended winglets Modified wings that are intended to lessen drag and, therefore, increase fuel efficiency. They can be factory installed or added to planes through wing modification kits. Bumping The practice of denying ticketed passengers the right to board an overbooked flight. Bumped passengers may receive compensation of up to $400. Cabotage The transport of passengers by a foreign carrier for purely domestic flights; illegal in all nations. Charter Nonscheduled service in which all seats are booked by a single entity such as a tour operator. Code sharing An agreement in which one carriers flight schedules are listed under another airlines code on a computer reservation system. Commercial air carrier An air carrier that is certified to carry passengers for a fee. Commuter airline An airline that operates short-haul flights using small-capacity aircraft, typically turboprop planes. Computer reservation system (CRS) One of a number of centralized databases listing fare and flight information used to book flights. Cost per available seat-mile (CASM) A commonly used measure of unit operating costs, calculated as total operating costs divided by available seat-miles. Enplanements The total number of passengers, both originating and connecting, who board an aircraft. Hub-and-spoke system An air carrier route structure providing broad coverage across the United States, though not point-to-point service between every small airport. Feeder flights connect passengers from outlying cities with a hub airport, where they may continue on the same plane or transfer to another flight to reach their destination. Hush kit A device used to modify an aircraft engine to reduce noise levels. Interlining The process of transferring passengers between two carriers flights, typically through a code-sharing arrangement. Jet An engine that creates propulsive thrust by expelling air at a much higher velocity than it has taken it in; introduced to US passenger aircraft in 1958.
Load factor A measurement of the total aircraft seating capacity sold; it is calculated as revenue passengermiles divided by available seat-miles on flights offering revenue passenger services. Major airline An air carrier with annual operating revenues greater than $1 billion. National airline An air carrier with annual operating revenues between $100 million and $1 billion. Open skies pact An aviation accord between two nations giving their respective air carriers greater access to each others markets and the freedom to set fares. Outsourcing Contracting certain tasks, such as maintenance, to an outside vendor to reduce operating costs. Overrides Bonus commission paid by airlines to travel agents for exceeding a sales target. Oversales Practice of booking more passengers than available seats; results in bumping. Pitch Passenger legroom; the distance between seats in an airline cabin. Recently, carriers eager to differentiate their service have touted expanded pitch as a selling strategy. Regional airline An air carrier with annual operating revenues less than $100 million. Revenue passenger-mile (RPM) A measurement representing one passenger transported one mile in revenue service. Revenue per available seat-mile (RASM) A measure of unit operating revenue, computed by dividing total passenger revenues by available seat-miles. Slot A rationed position in an airports schedule for takeoff or landing. Only a handful of airports those that are at designed capacity use a slot system. Stage length The distance of a flight in miles. It is frequently shorter than trip length, since a flight may consist of more than one stage (or leg). Turboprop An engine that uses propellers to develop its thrust; generally found in smaller regional or commuter aircraft. Yield A measure of unit revenues, computed by dividing passenger revenues by revenue passenger-miles.
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I NDUSTRY R EFERENCES
PERIODICALS
BOOKS
Air Carrier Financial Statistics Air Carrier Traffic Statistics Bureau of Transportation Statistics (BTS) 1200 New Jersey Ave. SE, Washington, DC 20590 (800) 853-1351 Web site: http://www.bts.gov The first is quarterly financial statistics for Form 41 carriers; the second, monthly traffic statistics for Form 41 carriers. Air Transport World Penton Media Inc. The Blair Bldg., 8380 Colesville Rd., Ste. 700 Silver Spring, MD 20910 (301) 650-2420 Web site: http://www.atwonline.com Monthly; articles on all aspects of the airline industry. Annual Report of the Regional Airline Association Regional Airline Association (RAA) 2025 M St. NW, Ste. 800, Washington, DC 20036 (202) 367-1170 Web site: http://www.raa.org A comprehensive annual review of issues concerning regional airlines; contains a statistical summary of carriers operating performance. Aviation Daily Aviation Week & Space Technology The McGraw-Hill Cos. Inc. 1200 G St. NW, Ste. 922, Washington, DC 20005 (202) 383-2350 Web site: http://www.aviationnow.com The first is a daily, with current news on the air transport industry and useful statistics; the second is a weekly, with complete coverage of the aviation and space industries. FAA Aerospace Forecasts Federal Aviation Administration (FAA) Office of Aviation Policy and Plans 800 Independence Ave. SW, Washington, DC 20591 (866) 835-5322 Web site: http://www.faa.gov/data_statistics/aviation/ aerospace_forecasts Annual forecasts of aviation activity at FAA facilities. Travel Weekly NORTHSTAR Travel Group 100 Lighting Way, Secaucus, NJ 07094 (201) 902-1954 Web site: http://www.twcrossroads.com Semiweekly; news about travel and tourism.
Handbook of Airline Economics Darryl Jenkins, Ed. New York: The McGraw-Hill Cos. Inc., 2002 Essays providing a thorough review of all major aviationrelated financial, operational, and regulatory issues, with contributions from leading industry executives.
INTERNET NEWS SERVICES
Aviation Safety Network Web site: http://aviation-safety.net Comprehensive statistics related to airliner accidents and safety records. Plane Business Web site: http://www.planebusiness.com Airline news; site contains free sections and parts restricted to paid subscribers.
CONSULTING FIRMS
BACK Aviation Solutions 1270 National Press Bldg., Washington, DC 20045 (202) 783-1101 Web site: http://www.backaviation.com An independent provider of consulting and data information services to the aviation industry.
TRADE ASSOCIATIONS
Air Transport Association of America Inc. (ATA) 1301 Pennsylvania Ave. NW, Ste. 1100 Washington, DC 20004 (202) 626-4000 Web site: http://www.airlines.org Primarily represents larger passenger airlines and leading air cargo companies. Produces the Air Transport Annual Report, a detailed annual summary of operating and financial statistics of leading carriers. Other reports include the monthly Scheduled Passenger Traffic Statistics. International Air Transport Association (IATA) 800 Place Victoria, PO Box 113 Montreal H4Z 1M1, Quebec, Canada (514) 874-0202 Web site: http://iata.org A global trade organization; its members some 260 airlines throughout the world account for approximately 94% of scheduled international air travel. Regional Airline Association (RAA) 2025 M St. NW, Ste. 800, Washington, DC 20036 (202) 367-1170 Web site: http://www.raa.org Trade group representing smaller airlines.
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Travel Industry Association of America (TIA) 1100 New York Ave. NW, Ste. 450 Washington, DC 20005 (202) 408-8422 Web site: http://www.tia.org Representing all components of the US travel industry, the TIA promotes US travel and tourism and is an authoritative source for travel industry research, analysis, and forecasts.
REGULATORY AGENCIES
Energy Information Administration (EIA) 1000 Independence Ave. SW, Washington, DC 20585 (202) 586-8800 Web site: http://www.eia.doe.gov A statistical agency of the US Department of Energy that provides independent data, forecasts and analysis regarding energy and its interaction with the economy and the environment. Federal Aviation Administration (FAA) 800 Independence Ave. SW, Washington, DC 20591 (866) 835-5322 Web site: http://www.faa.gov An agency within the Department of Transportation (DOT) that monitors commercial and general aviation safety, records and investigates complaints filed against airlines, certifies carriers, compiles statistics, promotes aviation education, and crafts regulations governing aviation safety. National Transportation Safety Board (NTSB) 490 LEnfant Plaza SW, Washington, DC 20594 (202) 314-6000 Web site: http://www.ntsb.gov An independent federal agency (not part of the DOT) charged with investigating accidents involving all transportation modes. The NTSB makes recommendations, but cannot write regulations. Transportation Security Administration (TSA) 601 S. 12th St., Arlington, VA 22202 (866) 289-9673 Web site: http://www.tsa.gov An agency within the DOT that was formed on November 19, 2001, in the aftermath of the attacks of 9/11. The TSA is charged with protecting the US transportation system and ensuring free movement of people and commerce. US Department of Transportation (DOT) 1200 New Jersey Ave. SE, Washington, DC 20590 (202) 366-4000 Web site: http://www.dot.gov Federal agency responsible for regulation of all transport modes, including airlines. Among other reports, the DOT produces the Department of Transportation Annual Report, a summary of the agencys activities during the past fiscal year.
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D EFINITIONS
FOR
C OMPARATIVE C OMPANY A NALYSIS TABLES
Operating revenues Net sales and other operating revenues. Excludes interest income if such income is nonoperating. Includes franchised/leased department income for retailers and royalties for publishers and oil and mining companies. Excludes excise taxes for tobacco, liquor, and oil companies. Net income Profits derived from all sources, after deductions of expenses, taxes, and fixed charges, but before any discontinued operations, extraordinary items, and dividend payments (preferred and common). Return on revenues Net income divided by operating revenues.
Price/earnings ratio The ratio of market price to earnings, obtained by dividing the stocks high and low market price for the year by earnings per share (before extraordinary items). It essentially indicates the value investors place on a companys earnings. Dividend payout ratio This is the percentage of earnings paid out in dividends. It is calculated by dividing the annual dividend by the earnings. Dividends are generally total cash payments per share over a 12-month period. Although payments are usually calculated from the ex-dividend dates, they may also be reported on a declared basis where this has been established to be a companys payout policy. Dividend yield
Return on assets Net income divided by average total assets. Used in industry analysis and as a measure of asset-use efficiency. Return on equity Net income, less preferred dividend requirements, divided by average common shareholders equity. Generally used to measure performance and to make industry comparisons. Current ratio Current assets divided by current liabilities. It is a measure of liquidity. Current assets are those assets expected to be realized in cash or used up in the production of revenue within one year. Current liabilities generally include all debts/obligations falling due within one year. Debt/capital ratio Long-term debt (excluding current portion) divided by total invested capital. It indicates how highly leveraged a company might be. Long-term debt includes those debts/obligations due after one year, including bonds, notes payable, mortgages, lease obligations, and industrial revenue bonds. Other long-term debt, when reported as a separate account, is excluded; this account generally includes pension and retirement benefits. Total invested capital is the sum of stockholders equity, longterm debt, capital lease obligations, deferred income taxes, investment credits, and minority interest. Debt as a percent of net working capital Long-term debt (excluding current portion) divided by the difference between current assets and current liabilities. It is an indicator of a companys liquidity.
The total cash dividend payments divided by the years high and low market prices for the stock. Earnings per share The amount a company reports as having been earned for the year (based on generally accepted accounting standards), divided by the number of shares outstanding. Amounts reported in Industry Surveys exclude extraordinary items. Tangible book value per share This measure indicates the theoretical dollar amount per common share one might expect to receive should liquidation take place. Generally, book value is determined by adding the stated (or par) value of the common stock, paid-in capital, and retained earnings, then subtracting intangible assets, preferred stock at liquidating value, and unamortized debt discount. This amount is divided by the number of outstanding shares to get book value per common share. Share price
This shows the calendar-year high and low of a stocks market price. In addition to the footnotes that appear at the bottom of each page, you will notice some or all of the following: NANot available. NMNot meaningful. NRNot reported. AFAnnual figure. Data are presented on an annual basis. CFCombined figure. In this case, data are not available because one or more components are combined with other items.
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C OMPARATIVE C OMPANY A NALYSIS A IRLINES
Operating Revenues
Million $ Yr. End DEC DEC # MAR DEC SEP DEC DEC DEC DEC DEC 22,563.0 13,128.0 664.5 20,712.0 11,208.0 523.0 18,645.0 9,899.0 415.2 17,440.0 8,846.0 383.9 17,299.0 8,402.0 427.0 18,963.0 A 8,969.0 457.4 17,753.0 6,360.0 304.7 2.4 7.5 8.1 3.5 7.9 7.8 3,114.7 9,086.0 1,964.0 A 7,584.0 1,156.0 6,530.0 888.0 5,937.0 774.4 C 5,485.8 601.9 5,555.2 283.3 3,406.2 27.1 10.3 38.9 10.3 58.6 19.8 8.9 17.1 27.1 1,893.4 3,334.4 NA 2,363.0 1,337.2 1,450.5 2,975.3 994.3 1,701.3 1,136.3 1,041.4 2,723.8 833.6 1,268.0 896.8 918.0 2,444.8 643.7 998.4 600.0 733.4 2,224.1 C 469.9 635.2 A 496.8 665.2 2,152.8 445.1 320.4 523.4 219.6 1,592.2 116.5 NA 500.4 24.0 7.7 NA NA 10.3 23.3 9.1 NA 49.1 20.6 30.5 12.1 NA 38.9 17.7 862 209 NA ** 267 1,099 267 127 206 218 2006 2005 2004 2003 2002 2001 1996 10-Yr. 5-Yr. 1-Yr. 2006 Compound Growth Rate (%) Index Basis (1996 = 100) 2005 660 187 853 ** 227 693 223 117 176 172 2004 474 171 716 ** 179 408 192 105 156 136 2003 418 154 553 ** 120 313 174 98 139 126 2002 334 140 403 NA 99 273 161 97 132 140
Ticker
Company
AIRLINES AAI ALK FRNT JBLU MESA
AIRTRAN HOLDINGS INC ALASKA AIR GROUP INC FRONTIER AIRLINES HOLDINGS JETBLUE AIRWAYS CORP MESA AIR GROUP INC
SKYW LUV
SKYWEST INC * SOUTHWEST AIRLINES
OTHER AIRLINE OPERATORS AMR AMR CORP/DE CAL CONTINENTAL AIRLS INC -CL B MEH MIDWEST AIR GROUP INC
Note: Data as originally reported. S&P 1500 Index group. * Company included in the S&P 500. Company included in the S&P MidCap. Company included in the S&P SmallCap. # Of the following calendar year. ** Not calculated; data for base year or end year not available. A - This year's data reflect an acquisition or merger. B - This year's data reflect a major merger resulting in the formation of a new company. C - This year's data reflect an accounting change. D - Data exclude discontinued operations. E - Includes excise taxes. F - Includes other (nonoperating) income. G - Includes sale of leased depts. H - Some or all data are not available, due to a fiscal year change.
Net Income
Million $ Yr. End DEC DEC # MAR DEC SEP DEC DEC DEC DEC DEC 231.0 369.0 5.4 (861.0) (68.0) (64.9) 145.8 499.0 112.3 548.0 82.0 313.0 (761.0) (409.0) (43.1) 66.8 442.0 (1,228.0) 38.0 (13.3) 15.5 (52.6) NA (1.0) 34.0 8.1 84.5 (14.0) (20.3) 56.9 12.3 (15.3) (23.4) 47.5 26.3 100.5 13.5 12.6 103.9 25.3 2006 2005 2004 2003 2002 10.7 (67.2) (24.9) 54.9 (9.3) 78.3 241.0 (2,523.0) (451.0) (10.6) 2001 (2.1) (43.4) 16.5 38.5 (48.1) 56.4 511.1 (1,762.0) (95.0) (14.9) 1996 (41.5) 38.0 (12.2) NA 30.4 10.1 207.3 1,105.0 325.0 21.8 Compound Growth Rate (%) 10-Yr. NM NM NA NA 1.1 30.6 9.2 (14.5) 1.3 (13.0) 5-Yr. NM NM NA NM NM 20.9 (0.5) NM NM NM 1-Yr. 92.1 NM NA NM (40.3) 29.9 (8.9) NM NM NM 2006 NM (138) ** ** 112 1,442 241 21 114 25 Index Basis (1996 = 100) 2005 NM 222 NM ** 187 1,110 264 (78) (21) (298) 2004 NM (40) NM ** 86 811 151 (69) (126) (198) 2003 NM 36 NM ** 83 661 213 (111) 12 (61) 2002 NM (177) NM NA (31) 774 116 (228) (139) (49)
Ticker
Company
SKYW LUV
Note: Data as originally reported. S&P 1500 Index group. * Company included in the S&P 500. Company included in the S&P MidCap. Company included in the S&P SmallCap. # Of the following calendar year. ** Not calculated; data for base year or end year not available.
Return on Revenues (%)

Yr. End DEC DEC # MAR DEC SEP DEC DEC DEC DEC DEC 1.0 2.8 0.8 NM NM NM NM NM NM NM 0.4 NM NM NM NM 0.8 3.4 1.5 NM NM NM NM NM NM NM 0.4 NM NM NM NM NA 128.8 27.7 4.7 5.5 5.7 7.2 7.1 4.8 7.5 7.4 10.1 4.4 4.1 3.6 4.5 4.3 5.1 3.0 5.3 4.7 8.6 2.7 13.9 7.6 13.3 9.0 NA NM NM 0.8 NM NA NM 2.5 0.6 2.8 NM NM 5.0 1.2 NM NM 3.7 2.9 10.9 0.6 2.0 10.4 4.2 1.5 NM NM 8.6 NM 1.1 NM NA NM 2.8 0.8 2.4 NM NM 5.0 1.4 NM NM 1.9 2.9 15.7 0.4 1.9 5.8 4.7 2.2 NM NM 4.8 NM 4.2 NM NA NM 15.4 2.3 11.3 NM NM 37.2 2006 2005 2004 2003 2002 2006 2005 2004 2003 2002 2006 2005 2004 3.9 NM NM 6.7 21.8 11.0 5.9 NA NM NM
Return on Assets (%)
Return on Equity (%)

2003 56.8 2.0 6.1 19.1 25.2 9.9 9.3 NM 4.9 NM 2002 25.2 NM NM 25.6 NM 13.2 5.7 NM NM NM
Ticker
Company
SKYW LUV
Note: Data as originally reported. S&P 1500 Index group. * Company included in the S&P 500. Company included in the S&P MidCap. Company included in the S&P SmallCap. # Of the following calendar year.
Current Ratio
Yr. End DEC DEC # MAR DEC SEP DEC DEC DEC DEC DEC 0.8 1.0 1.1 0.7 1.0 1.0 0.7 0.9 1.3 0.7 0.9 1.4 2.7 0.9 1.1 0.9 4.1 1.0 4.4 1.3 4.2 1.6 0.7 0.8 0.7 1.1 1.3 NA 1.1 1.7 1.4 1.3 1.3 0.9 2.1 2.0 1.3 1.2 1.1 1.0 2.6 1.1 1.5 1.7 0.8 1.1 1.3 1.5 1.0 1.8 2006 2005 2004 2003 2002 2006 65.4 50.8 NA 70.7 63.7 52.7 15.5 105.3 90.5 60.8
Debt / Capital Ratio (%)

2005 53.0 49.6 62.7 67.2 75.9 56.1 14.0 112.3 93.0 71.4 2004 47.3 54.1 52.6 61.4 81.0 32.4 19.2 104.5 90.6 42.0 2003 42.4 51.1 49.1 56.8 64.0 34.9 17.1 99.7 81.8 37.0 2002 79.4 51.3 59.4 58.5 54.9 15.2 21.6 92.8 80.8 26.6
Debt as a % of Net Working Capital

2006 NM 307.4 NA NM 277.2 243.9 NM NM NM 175.1 2005 288.9 258.6 450.8 NM 269.6 NM NM NM NM NM 2004 146.7 347.2 678.2 NM NM 86.3 NM NM NM 211.9 2003 87.5 692.8 317.9 366.4 NM 89.3 225.8 NM NM 206.0 2002 901.5 431.8 430.6 NM 148.2 32.0 194.6 NM NM NM
Ticker
Company
SKYW LUV
37
38
Price / Earnings Ratio (High-Low)

Yr. End DEC DEC # MAR DEC SEP DEC DEC DEC DEC DEC 30-16 11-4 40-13 NM-NM NM-NM NM-NM NM-NM NM-NM NM-NM NM-NM 37-7 NM-NM NM-NM NM-NM NM-NM 0 0 0 NM NM NM NM NM NM NM 0 NM NM NM NM 0.0-0.0 0.0-0.0 0.0-0.0 13-9 29-23 18-8 24-19 15-9 43-32 18-7 35-21 21-8 71-35 5 3 6 3 8 4 7 3 6 6 0.6-0.4 0.1-0.1 0.7-0.4 0.1-0.1 0.0-0.0 0.0-0.0 0.0-0.0 NM-53 NM-NM NA-NA NM-NM 13-7 NM-82 12-8 NM-NM NM-NM 6-3 NM-67 NM-NM NM-NM 67-43 16-6 16-3 62-30 50-9 44-14 17-4 50-16 NM-NM NM-NM 50-21 NM-NM 0 NM NA NM 0 0 0 NM NM 0 0 NM NM 0 0 0 0 0 0 0 0 NM NM 0 NM 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.9-0.6 0.1-0.1 0.0-0.0 0.0-0.0 0.0-0.0 2006 2005 2004 2003 2002 2006 2005 2004 2003 2002 2006 2005 2004 2003
Dividend Payout Ratio (%)
Dividend Yield (High-Low, %)

2002 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.9-0.4 0.2-0.1 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.0-0.0 0.7-0.3 0.2-0.1 0.0-0.0 0.0-0.0 0.0-0.0
Ticker
Company
SKYW LUV
Earnings per Share ($)

Yr. End DEC 0.17 DEC (1.39) # MAR NA DEC 0.00 SEP 1.01 DEC DEC DEC DEC DEC 1.13 4.15 0.30 (5.21) (0.96) (3.71) (4.74) (6.19) (2.47) (7.76) (16.22) 0.58 (7.02) (0.85) (0.72) (7.98) (2.80) 1.10 2.33 0.63 1.94 0.70 1.42 0.40 1.16 0.56 1.37 0.31 17.94 8.23 J 14.99 13.51 8.33 J 6.99 (14.62) (11.19) (5.23) (12.10) 0.97 4.66 0.09 3.06 (0.39) (0.13) 1.95 0.14 (0.57) (0.66) 0.31 0.83 1.33 0.51 0.39 0.71 0.80 0.15 (2.53) (0.84) 0.49 (0.28) 3.87 21.98 NA 5.18 7.79 3.67 23.73 6.25 5.03 6.12 3.51 23.08 6.61 4.49 4.29 3.23 23.49 7.25 3.98 3.53 12.23 6.40 (7.56) (3.12) 7.14 2006 2005 2004 2003 2002 2006 2005 2004 2003 2002 0.25 22.76 5.36 2.41 2.79 11.12 5.69 (2.15) (5.87) 7.87
Tangible Book Value per Share ($)

2006 18.85-9.06 45.85-29.44 9.40-5.66 15.60-8.93 12.87-7.30 30.44-20.88 18.20-14.61 34.40-18.24 46.29-16.74 12.15-4.00
Share Price (High-Low, $)

2005 16.70-7.40 37.86-25.55 13.01-7.57 16.85-11.34 12.06-4.99 34.09-16.04 16.95-13.05 23.53-7.83 21.97-8.50 6.00-1.40 2004 15.56-9.37 33.67-18.74 15.17-6.71 20.67-13.25 12.90-4.94 20.70-13.00 17.06-12.88 17.65-6.34 18.70-7.63 4.90-2.70 2003 20.84-3.90 31.86-15.28 19.40-3.51 31.43-10.29 13.96-2.95 21.10-8.60 19.69-11.72 15.46-1.25 21.70-4.16 6.00-0.99 2002 7.45-2.34 33.90-13.66 23.75-4.00 24.51-10.37 11.74-2.46 29.36-11.20 22.00-10.90 29.20-3.01 35.25-3.59 20.53-3.90
Ticker
Company
SKYW LUV
Note: Data as originally reported. S&P 1500 Index group. * Company included in the S&P 500. Company included in the S&P MidCap. Company included in the S&P SmallCap. # Of the following calendar year. J-This amount includes intangibles that cannot be identified.
The analysis and opinion set forth in this publication are provided by Standard & Poors Equity Research Services and are prepared separately from any other analytic activity of Standard & Poors. In this regard, Standard & Poors Equity Research Services has no access to nonpublic information received by other units of Standard & Poors. The accuracy and completeness of information obtained from third-party sources, and the opinions based on such information, are not guaranteed.
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Industry Surveys

November 22, 2007

CURRENT ENVIRONMENT..................................................................1 Chronic delays prompt increased government scrutiny

Jim Corridore Airlines Analyst

GLOSSARY .............................................................................................32 INDUSTRY REFERENCES.....................................................................33 COMPARATIVE COMPANY ANALYSIS .............................................36

Standard & Poors Industry Surveys

Chronic delays prompt increased government scrutiny

Source: Air Transport Association of America.

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Profitability seen for 2007 and 2008

Delays unlikely to ground profitability

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

FUEL COSTS & CONSUMPTION

Consumption (millions of gallons; left scale)

Price per gallon (in cents; right scale)

Source: Air Transport Association of America.

Fuel costs near historic highs

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Crack spread exacerbates the pain of high oil prices

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Fares, yields have risen

Higher fares limit travel demand somewhat

Terror fears to remain with us

Where are the mergers?

Open skies ahead?

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Airline industry restructures

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Low-cost carriers feel the heat

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Labor costs down sharply, but still too high

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Airlines still face extreme challenges

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

The impact of five years of multibillion-dollar losses

Airlines struggle to survive

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Federal grants, loan guarantees bailed out industry

Will merger activity pick up?

OPERATING STATISTICS OF THE MAJOR US AIRLINES

28,594 23,703 18,911 *13,639 *8,240 *4,208 *1,372 NA NA NA

23,320 20,200 15,730 *11,527 *6,836 *3,282 *1,004 NA NA NA

81.6 85.2 83.2 *84.5 *83.0 *78.0 *73.2 NA NA NA

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Security costs rise

Start-ups: many fail, a few thrive

Source: Air Transport Association of America.

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Regional jets open new markets

Regional airlines and majors have a symbiotic relationship

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

Small jets create opportunities in regional markets

Embracing the Internet...

Labor contracts restrict use of regional jets

...to help cut costs

NOVEMBER 22, 2007 / AIRLINES INDUSTRY SURVEY

International markets provide growth

E-tickets reduce costs

entities, but with coordinated schedules and combined frequent-flyer programs.

Alliances aid airlines abroad

HOW THE INDUSTRY OPERATES

S&P Airlines

S&P Airlines

28,594 23,703 18,911 13,639 8,240 4,208 1,372 NA NA NA

23,320 20,200 15,730 11,527 6,836 3,282 1,004 NA NA NA

81.6 85.2 83.2 84.5 83.0 78.0 73.2 NA NA NA