Summary of AMR CORP - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

Statements in this report contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events. When used in this document and in documents incorporated herein by reference, the words "expects," "plans," "anticipates," "indicates," "believes," "forecast," "guidance," "outlook," "may," "will," "should," "seeks," "targets" and similar expressions are intended to identify forward-looking statements. Similarly, statements that describe the Company's objectives, plans or goals are forward-looking statements. Forward-looking statements include, without limitation, the Company's expectations concerning operations and financial conditions, including changes in capacity, revenues, and costs; future financing plans and needs; the amounts of its unencumbered assets and other sources of liquidity; fleet plans; overall economic and industry conditions; plans and objectives for future operations; regulatory approvals and actions, including the Company's application for antitrust immunity with other oneworld alliance members; and the impact on the Company of its results of operations in recent years and the sufficiency of its financial resources to absorb that impact. Other forward-looking statements include statements which do not relate solely to historical facts, such as, without limitation, statements which discuss the possible future effects of current known trends or uncertainties, or which indicate that the future effects of known trends or uncertainties cannot be predicted, guaranteed or assured. All forward-looking statements in this report are based upon information available to the Company on the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. Guidance given in this report regarding capacity, fuel consumption, fuel prices, fuel hedging, and unit costs, and statements regarding expectations of regulatory approval of the Company's application for antitrust immunity with other oneworld members are forward-looking statements.

Forward-looking statements are subject to a number of factors that could cause the Company's actual results to differ materially from the Company's expectations. The following factors, in addition to other possible factors not listed, could cause the Company's actual results to differ materially from those expressed in forward-looking statements: the materially weakened financial condition of the Company, resulting from its significant losses in recent years; weaker demand for air travel and lower investment asset returns resulting from the severe global economic downturn; the Company's need to raise substantial additional funds and its ability to do so on acceptable terms; the ability of the Company to generate additional revenues and reduce its costs; continued high and volatile fuel prices and further increases in the price of fuel, and the availability of fuel; the Company's substantial indebtedness and other obligations; the ability of the Company to satisfy existing financial or other covenants in certain of its credit agreements; changes in economic and other conditions beyond the Company's control, and the volatile results of the Company's operations; the fiercely and increasingly competitive business environment faced by the Company; potential industry consolidation and alliance changes; competition with reorganized carriers; low fare levels by historical standards and the Company's reduced pricing power; changes in the Company's corporate or business strategy; government regulation of the Company's business; conflicts overseas or terrorist attacks; uncertainties with respect to the Company's international operations; outbreaks of a disease (such as SARS, avian flu or the H1N1 virus) that affects travel behavior; labor costs that are higher than those of the Company's competitors; uncertainties with respect to the Company's relationships with unionized and other employee work groups; increased insurance costs and potential reductions of available insurance coverage; the Company's ability to retain key management personnel; potential failures or disruptions of the Company's computer, communications or other technology systems; losses and adverse publicity resulting from any accident involving the Company's aircraft; changes in the price of the Company's common stock; and the ability of the Company to reach acceptable agreements with third parties. Additional information concerning these and other factors is contained in the Company's Securities and Exchange Commission filings, including but not limited to the Company's 2008 Form 10-K, as updated by the Form 8-K and Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2009.

Overview

The Company recorded a net loss of $390 million in the second quarter of 2009 compared to a net loss of $1.5 billion in the same period last year (second quarter 2008 results include the $1.1 billion impact of the write down of the McDonnell Douglas MD-80 and Embraer RJ-135 fleets and certain related long-lived assets to their estimated fair values due to capacity reductions made in response to unprecedentedly high fuel expenses). The Company's second quarter 2009 loss is primarily attributable to a significant decrease in passenger revenue due to lower traffic and passenger yield. The Company is experiencing significantly weaker demand for air travel driven by the continuing severe downturn in the global economy. Mainline passenger revenue decreased by $1.1 billion to $3.7 billion in the three months ended June 30, 2009 compared to the same period last year. Mainline passenger unit revenues decreased 16.0 percent for the second quarter due to a 15.4 percent decrease in passenger yield (passenger revenue per passenger mile) compared to the same period in 2008 and a load factor decrease of approximately one point.

In addition, during the second quarter of 2009, there was an outbreak of the H1N1 Influenza virus which had an estimated $50 to $80 million adverse revenue impact throughout the Company's network, but primarily on operations to and from Mexico. As a part of the second quarter 2009 net loss, the Company also incurred approximately $70 million in non-recurring charges related to the sale of certain aircraft and the grounding of leased Airbus A300 aircraft prior to lease expiration.

The Company implemented capacity reductions in 2008 and in the first quarter of 2009 in response to record high fuel prices. These capacity reductions have somewhat mitigated the weakening of demand and in June 2009, the Company announced additional capacity reductions in a further effort to balance supply and demand. AMR will reduce mainline seating capacity by approximately 7.5 percent for the full year 2009 versus 2008. The reduction consists of an approximately 9.0 percent reduction in mainline domestic capacity and more than 4.0 percent reduction in mainline international capacity compared to the year ending December 31, 2008. As a result, for the quarter ending September 30, 2009, AMR expects mainline domestic capacity to decline by approximately 10.5 percent and mainline international capacity to decline by 6.0 percent compared to the quarter ending September 30, 2008. No assurance can be given that any capacity reductions or other steps the Company may take will be adequate to offset the effects of reduced demand.

The decrease in total passenger revenue was partially offset by significantly lower year over year fuel prices; the Company paid an average of $1.90 per gallon in the second quarter 2009 compared to an average of $3.19 per gallon in the same period of 2008, including effects of hedging.

The Company's unit costs excluding fuel and special charges were greater for the quarter ended June 30, 2009 than for the same period in 2008, and are expected to be higher for each period for the remainder of 2009 compared to the corresponding prior year period. Factors driving the increase include increased defined benefit pension expenses (due to the stock market decline in 2008) and retiree medical and other expenses, and cost pressures associated with the Company's previously announced capacity reductions and dependability initiatives.

In reaction to these challenges, the Company has continued to work to implement and maintain several key actions designed to help it manage through these near term challenges while seeking to position itself for long-term success, including the range of service charges introduced in 2008 to generate additional revenue, execution of its fleet renewal and replacement plan, initiatives to improve dependability and on-time performance, and an initiative to strengthen its global network through the application pending with the U.S. Department of Transportation for global antitrust immunity with four members of the oneworld global alliance.

The Company's ability to become profitable and its ability to continue to fund its obligations on an ongoing basis will depend on a number of factors, many of which are largely beyond the Company's control. Certain risk factors that affect the Company's business and financial results are discussed in the Risk Factors listed in Item 1A in the 2008 Form 10-K and as amended in Item 1A in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2009. In addition, most of the Company's largest domestic competitors and several smaller carriers have filed for bankruptcy in the last several years and have used this process to significantly reduce contractual labor and other costs. In order to remain competitive and to improve its financial condition, the Company must continue to take steps to generate additional revenues and to reduce its costs. Although the Company has a number of initiatives underway to address its cost and revenue challenges, some of these initiatives involve changes to the Company's business which it may be unable to implement. In addition, the Company expects that, as time goes on, it will be progressively more difficult to identify and implement significant revenue enhancement and cost savings initiatives. The adequacy and ultimate success of the Company's initiatives to generate additional revenues and reduce costs are not known at this time and cannot be assured. Moreover, whether the Company's initiatives will be adequate or successful depends in large measure on factors beyond its control, notably the overall industry environment, including passenger demand, yield and industry capacity growth, and fuel prices. It will be very difficult for the Company to continue to fund its obligations on an ongoing basis, and to return to profitability, if the overall industry revenue environment does not improve substantially or if fuel prices were to increase and persist for an extended period at high levels.

LIQUIDITY AND CAPITAL RESOURCES

Significant Indebtedness and Future Financing

The Company remains heavily indebted and has significant obligations (including substantial pension funding obligations), as described more fully under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 8-K. Indebtedness is a significant risk to the Company as discussed in the Risk Factors listed in Item 1A in the 2008 Form 10-K and as amended in Item 1A in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2009. During 2006, 2007, 2008 and 2009 (through the date of this filing), the Company raised an aggregate of approximately $3.4 billion in financing to fund capital commitments (mainly for aircraft and ground properties), debt maturities, and employee pension obligations, and to bolster its liquidity. As of the date of this Form 10-Q, although the Company believes it can access sufficient liquidity to fund its operations and obligations for the remainder of 2009, including repayment of debt and capital leases, capital expenditures and other contractual obligations, there can be no assurance that the Company will be able to do so. To meet the Company's commitments, to maintain sufficient liquidity and because the Company has significant debt, lease and other obligations in the next several years, including commitments to purchase aircraft, as well as substantial pension funding obligations (refer to Contractual Obligations in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 8-K), the Company will need access to substantial additional funding.

As of June 30, 2009, the Company is required to make scheduled principal payments of approximately $779 million on long-term debt and approximately $85 million in payments on capital leases, and the Company expects to spend approximately $1.0 billion on capital expenditures for the remainder of 2009. In addition, the global economic downturn, potential increases in the amount of required reserves under credit card processing agreements, and the obligation to post cash collateral on fuel hedging contracts have negatively impacted, and may in the future negatively impact, the Company's liquidity.

Despite the current disruptions in the capital markets, in the six months ended June 30, 2009, the Company obtained an aggregate of approximately $470 million of financing under loans secured by various aircraft and sale leaseback financings of certain aircraft

The Company's possible financing sources primarily include: (i) a limited amount of additional secured aircraft debt or sale leaseback transactions involving owned aircraft; (ii) leases of or debt secured by new aircraft deliveries; (iii) debt secured by other assets; (iv) securitization of future operating receipts;
(v) the sale or monetization of certain assets; (vi) unsecured debt; and (vii) issuance of equity and/or equity-like securities. Besides unencumbered aircraft, the Company's most likely sources of liquidity include the financing of AAdvantage program miles and takeoff and landing slots, and the sale or financing of certain of the Company's business units and subsidiaries, such as AMR Eagle. The Company's ability to obtain future financing is limited by the value of its unencumbered assets. A very large majority of the Company's aircraft assets (including most of the aircraft eligible for the benefits of
Section 1110 of the U.S. Bankruptcy Code) are encumbered. Also, the market value of these aircraft assets has declined in recent years, and may continue to decline. The Company believes it has at least $3.7 billion in unencumbered assets and other sources of liquidity as the date of this filing. However, the availability and level of the financing sources described above cannot be assured, particularly in light of the Company's and American's financial results in recent years, the Company's and American's substantial indebtedness, the difficult revenue environment they face, their reduced credit ratings, recent historically high fuel prices, and the financial difficulties experienced in the airline industry. In addition, the global economic downturn and recent severe disruptions in the capital markets and other sources of funding have resulted in greater volatility, less liquidity, widening of credit spreads and substantially more limited availability of funding. The inability of the Company to obtain necessary additional funding on acceptable terms would have a material adverse impact on the Company and on its ability to sustain its operations.

The Company's substantial indebtedness and other obligations have important consequences. For example, they: (i) limit the Company's ability to obtain additional funding for working capital, capital expenditures, acquisitions and general corporate purposes, and adversely affect the terms on which such funding could be obtained; (ii) require the Company to dedicate a substantial portion of its cash flow from operations to payments on its indebtedness and other obligations, thereby reducing the funds available for other purposes; (iii) make the Company more vulnerable to economic downturns; and (iv) limit the Company's ability to withstand competitive pressures and reduce its flexibility in responding to changing business and economic conditions.

In June 2009, American entered into an amendment to a purchase agreement with Boeing. Pursuant to the amendment, American exercised rights to purchase an additional eight 737-800 aircraft and the delivery dates of certain aircraft were rescheduled. As a result, American's total 737-800 purchase commitments for 2009 (including nine aircraft that have been delivered as of June 30, 2009) have increased from 29 as of March 31, 2009 to 31 as of June 30, 2009, and American's 737-800 purchase commitments for 2010 have increased from 39 as of March 31, 2009 to 45 as of June 30, 2009. American's 737-800 purchase commitments remain at eight in 2011. In addition to these aircraft, American has firm commitments for eleven 737-800 aircraft and seven Boeing 777 aircraft scheduled to be delivered in 2013-2016.

As of June 30, 2009, payments for American's 737-800 and 777 aircraft purchase commitments will approximate $716 million for the remainder of 2009, $1.3 billion in 2010, $354 million in 2011, $217 million in 2012, $399 million in 2013, and $556 million for 2014 and beyond. These amounts are net of purchase deposits currently held by the manufacturer.

American previously arranged backstop financing which, together with other financing arranged through the date of this filing, including the pass through certificate financing referred to in the following paragraph, covers all of its 2009-2011 Boeing 737-800 aircraft deliveries, subject to certain terms and conditions (including, in the case of one of the financing arrangements covering twelve aircraft, a condition that at the time of borrowing, the Company has a certain amount of unrestricted cash and short term investments).

As more fully described in Note 5 to the condensed consolidated financial statements, on July 7, 2009, American obtained financing for four Boeing 777-200ER aircraft owned by American and 16 Boeing 737-800 aircraft to be delivered to American through the issuance of the Certificates which raised $520 million. The Certificates bear interest at 10.375% per annum. A majority of the proceeds were placed in escrow. As American takes delivery of each Boeing 737-800 aircraft it finances under this arrangement, American will issue equipment notes secured by such aircraft to the trust, which will purchase such notes with an allocable portion of the escrowed funds. American will use such funds to finance the purchase of the aircraft and the Company will record the principal amount of such equipment notes as debt on its consolidated balance sheet.

The Company's continued aircraft replacement strategy, and its execution of that strategy, will depend on such factors as future economic and industry conditions and the financial condition of the Company.

Credit Facility Covenants

American has a secured $433 million term loan credit facility with a final maturity on December 17, 2010. American's obligations under the Credit Facility are guaranteed by AMR. The Credit Facility contains a covenant (the Liquidity Covenant) requiring American to maintain, as defined, unrestricted cash, unencumbered short term investments and amounts available for drawing under committed revolving credit facilities of not less than $1.25 billion for each quarterly period through the life of the Credit Facility. AMR and American were in compliance with the Liquidity Covenant as of June 30, 2009. In addition, the Credit Facility contains a covenant (the EBITDAR Covenant) requiring AMR to maintain a ratio of cash flow (defined as consolidated net income, before interest expense (less capitalized interest), income taxes, depreciation and amortization and rentals, adjusted for certain gains or losses and non-cash items) to fixed charges (comprising interest expense (less capitalized interest) and rentals). In June 2009, AMR and American entered into an amendment to the Credit Facility which waived compliance with the EBITDAR Covenant for the quarter ended June 30, 2009; however, even absent this waiver the Company would have complied with this covenant as of June 30, 2009. In addition, the amendment reduced the minimum ratios AMR is required to satisfy to 0.95 to 1.00 for the one, two and three quarter periods ending September 30, 2009, December 31, 2009 and March 31, 2010, respectively, to 1.00 to 1.00 for the four quarter period ending June 30, 2010, and to 1.05 to 1.00 for the four quarter period ending September 30, 2010.

Given the volatility of fuel prices and revenues, uncertainty in the capital markets and uncertainty about other sources of funding, and other factors, it is difficult to assess whether the Company will be able to continue to comply with the Liquidity Covenant and the EBITDAR Covenant, and there are no assurances that it will be able to do so. Failure to comply with these covenants would result in a default under the Credit Facility which - if the Company did not take steps to obtain a waiver of, or otherwise mitigate, the default - could result in a default under a significant amount of its other debt and lease obligations, and otherwise have a material adverse impact on the Company and its ability to sustain its operations.

Credit Card Processing and Other Reserves

American has agreements with a number of credit card companies and processors to accept credit cards for the sale of air travel and other services. Under certain of American's current credit card processing agreements, the related credit card company or processor may hold back, under certain circumstances, a reserve from American's credit card receivables.

Under one such agreement, which was recently amended, the amount of such reserve generally is based on the amount of unrestricted cash (not including undrawn credit facilities) held by the Company and the processor's exposure to the Company under the agreement. Given the volatility of fuel prices and revenues, uncertainty in the capital markets and uncertainty about other sources of funding, and other factors, it is difficult to forecast the required amount of such reserve at any time. The amount of the reserve was $154 million as of June 30, 2009. The agreement limits the maximum amount of the reserve (determined as described above) during the period ending February 15, 2010, and the Company currently estimates such maximum amount during that period to be approximately $300 million. However, if current conditions persist, absent a waiver or modification of the agreement, such required amount could be substantially greater after such period.

Pension Funding Obligation

The Company is required to make minimum contributions to its defined benefit pension plans under the minimum funding requirements of the Employee Retirement Income Security Act (ERISA), the Pension Funding Equity Act of 2004 and the Pension Protection Act of 2006. The Company is not required to make any 2009 contributions to its defined benefit pension plans under the provisions of these acts.

Although the Company is not required to make contributions to its defined benefit pension plans in 2009, based on current funding levels of the plans, the Company expects that the amount of the required contributions will be substantial in 2010 and future years. The Company expects to contribute approximately $13 million to its retiree medical and other benefit plan in 2009.

Cash Flow Activity

At June 30, 2009, the Company had $2.8 billion in unrestricted cash and short-term investments, reflecting a decrease of $299 million from the balance of $3.1 billion at December 31, 2008. Net cash provided by operating activities in the six-month period ended June 30, 2009 was $938 million, a decrease of $216 million over the same period in 2008. The decline in unrestricted cash and short-term investments is primarily due to the significant decline in the demand for air travel, which resulted in a 22.7 percent decrease in passenger revenue, and principal payments made during the first six months of 2009. The impact of these two factors was somewhat offset by the year-over-year decrease in fuel prices from $2.97 per gallon for the first six months of 2008 to $1.90 per gallon for the same period in 2009. The fuel price decrease resulted in $1.5 billion in decremental year-over-year expense in the six months ended June 30, 2009 (based on the year-over-year decrease in the average price per gallon multiplied by gallons consumed).

The Company made scheduled debt and capital lease payments of $1.2 billion in the first six months of 2009. Included in this amount, AMR retired, by purchasing with cash, the $318 million principal amount of its 4.50 Notes. Virtually all of the holders of the 4.50 Notes exercised their elective put rights and the Company purchased and retired these notes at a price equal to 100 percent of their principal amount. Under the terms of the 4.50 Notes, the Company had the option to pay the purchase price with cash, stock, or a combination of cash and stock, and the Company elected to pay for the 4.50 Notes solely with cash. Also included in total scheduled debt payments, the Company retired, at maturity, its $255 million secured bank revolving credit facility in June 2009.

Capital expenditures for the first six months of 2009 were $602 million and primarily consisted of new aircraft and certain aircraft modifications.

Due to the current value of the Company's derivative contracts, some agreements with counterparties require collateral to be deposited by the Company. As of June 30, 2009, the cash collateral held by such counterparties from AMR was $59 million. The amount of collateral required to be deposited with the Company or with the counterparty by the Company is based on fuel price in relation to the market values of the derivative contracts and collateral provisions per the terms of those contracts and can fluctuate significantly. The Company was over-collateralized as of June 30, 2009 due to a timing lag in collateral reconciliation with a certain counterparty. The Company is currently required to collateralize approximately 100 percent of the outstanding liability hedge contracts. As such, when these contracts settle, the collateral posted with counterparties will effectively offset the loss position and minimal further cash impact will be recorded assuming a static forward heating oil curve from June 30, 2009. Under the same assumption, the Company does not currently expect to be required to deposit significant additional cash collateral above June 30, 2009 levels with counterparties with regard to fuel hedges in place as of June 30, 2009. Additional information regarding the Company's fuel hedging program is also included in Item 3 "Quantitative and Qualitative Disclosures about Market Risk" and in Note 9 to the condensed consolidated financial statements.

War-Risk Insurance

The U.S. government has agreed to provide commercial war-risk insurance for U.S. based airlines until September 30, 2009, covering losses to employees, passengers, third parties and aircraft. If the U.S. government does not extend the policy beyond that date, or if the U.S. government at anytime thereafter ceases to provide such insurance, or reduces the coverage provided by such insurance, the Company will attempt to purchase similar coverage with narrower scope from commercial insurers at an additional cost. To the extent this . . .