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 certain covenants and conditions in certain of its financing 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 September 30, 2009.

Overview

The Company recorded a net loss of $359 million in the third quarter of 2009 compared to net income of $31 million in the same period last year. The Company's third 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. In addition, as a result of reduced demand, there has been substantial fare discounting across the industry, which has resulted in decreased passenger yield (passenger revenue per passenger mile). Mainline passenger revenue decreased by $1.1 billion to $3.9 billion in the three months ended September 30, 2009 compared to the same period last year. Mainline passenger unit revenues decreased 14.5 percent for the third quarter due to a 16.3 percent decrease in passenger yield compared to the same period in 2008 and a load factor increase of approximately 1.8 points.

During the third quarter of 2009, the Company also incurred approximately $94 million in non-recurring charges related to the sale leaseback 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 approximately 4.8 percent reduction in mainline international capacity compared to the year ending December 31, 2008. As a result, for the quarter ending December 31, 2009, AMR expects mainline domestic capacity to decline by approximately 5.0 percent and mainline international capacity to decline by 7.5 percent compared to the quarter ending December 31, 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 $2.07 per gallon in the third quarter 2009 compared to an average of $3.57 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 September 30, 2009 than for the same period in 2008, and are expected to be higher for the fourth quarter 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 initiated a series of actions intended to better position it to meet the industry's economic challenges while continuing to build on its strategy for long term success, including a range of service charges introduced in 2008 to generate additional revenue, execution of its fleet renewal and replacement plan, and initiatives to improve dependability and on-time performance.

In addition, the Company has obtained a total of $4.9 billion in additional liquidity and new aircraft financing in the third quarter of 2009, announced plans to focus its network by reallocating capacity to hubs in Dallas/Fort Worth, Chicago, Miami, New York and Los Angeles and announced plans to enhance its fleet to better serve customers.

Financings completed during the third quarter consist of: $1 billion in cash from the advance sale of AAdvantage Miles to Citibank, $1.6 billion in sale leaseback financing for Boeing 737-800 aircraft to be delivered to American in 2010 and 2011 and the $281.5 million 2009 Loan Facility, the issuance by American of $520 million of pass through trust certificates, the issuance by AMR of convertible senior notes due 2014 and 48 million shares of common stock (for which AMR received net proceeds of approximately $830 million), the issuance by American of $276 million of senior secured notes due in 2016, and other loans secured by aircraft and sale leasebacks of aircraft which raised proceeds of approximately $359 million. See Notes 5 and 11 to the condensed consolidated financial statements for a detailed description of these financing transactions.

In addition, on October 9, 2009, American completed the offering of $450 million aggregate principal amount of its 10.5 percent senior secured notes due 2012. The proceeds from the offering of the notes were used to refinance American's $432 million term loan credit facility which had a scheduled maturity of December 17, 2009 and which was retired prior to maturity on September 28, 2009.

The Company is also in discussions with JAL, a member of the oneworld alliance, about ways to broaden and deepen the relationship between American and JAL. The Company is discussing various options, including a joint business relationship with JAL and possible capital or financing arrangements. The Company believes that JAL is also engaged in strategic discussions with one or more other carriers. No prediction can be made as to the timing or outcome of any of these discussions, or as to any impact of the discussions on the Company.

In 2008, the Company entered into a joint business agreement and related marketing arrangements with British Airways and Iberia, providing for commercial cooperation on flights between North America and most countries in Europe, pooling and sharing of certain revenues and costs, expanded codesharing, enhanced frequent flyer program reciprocity, and cooperation in other areas. Along with these carriers and certain other carriers, the Company has applied to the US Department of Transportation (DOT) for antitrust immunity for this planned cooperation. Implementation of this agreement and the related arrangements is subject to conditions, including various U.S. and foreign regulatory approvals, successful negotiation of certain detailed financial and commercial arrangements, and other approvals.

In September of 2009, the European Union (EU) issued a Statement of Objection (SO) related to the proposed joint business agreement. The SO asserts, among other things, that without remedies, the joint business agreement would infringe certain aspects of EU competition law. The carriers intend to respond to the SO and to demonstrate the consumer benefits of the joint business agreement. The SO process is an anticipated and normal part of and does not impact the process of seeking antitrust immunity from DOT.

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 September 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 September 30, 2009. During 2006, 2007, 2008 and 2009 (through the date of this filing), the Company raised an aggregate of approximately $8.2 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, the Company believes it has sufficient liquidity to fund its operations and obligations, including repayment of debt and capital leases, capital expenditures and other contractual obligations; however there can be no assurances to that effect. 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 September 30, 2009, the Company is required to make scheduled principal payments of approximately $558 million on long-term debt and approximately $10 million in payments on capital leases for the remainder of 2009, and the Company expects to spend approximately $460 million on capital expenditures for the remainder of 2009. In addition, the global economic downturn, rising fuel prices, the possibility of being required to post reserves under credit card processing agreements, and the obligation to post cash collateral on fuel hedging contracts, among other things, may in the future negatively impact the Company's liquidity.

Despite the disruptions in the capital markets, in the nine months ended September 30, 2009, the Company obtained an aggregate of approximately $5.3 billion of financing from debt issuances, equity issuances and sale leasebacks as more fully described in Note 5 and Note 11 to the condensed consolidated financial statements.

The Company's possible remaining financing sources primarily include: (i) a limited amount of additional secured aircraft debt or sale leaseback transactions involving owned aircraft; (ii) debt secured by other assets;
(iii) securitization of future operating receipts; (iv) the sale or monetization of certain assets; (v) unsecured debt; and (vi) issuance of equity or equity-like securities. Besides unencumbered aircraft, the Company's most likely sources of liquidity include the financing of takeoff and landing slots, spare parts, and the sale or financing of certain of AMR'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 approximately $2 billion in assets that could be used as possible financing sources as of the date of this filing. However, many of these assets may be difficult to finance, and the availability and level of the financing sources described above cannot be assured.

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.

As of September 30, 2009, American had twelve Boeing 737-800 purchase commitments for the remainder of 2009, 45 Boeing 737-800 purchase commitments for 2010, and eight Boeing 737-800 purchase commitments 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. Payments for American's aircraft purchase commitments will approximate $315 million for the remainder of 2009, $1.3 billion in 2010, $350 million in 2011, $217 million in 2012, $478 million in 2013, and $552 million for 2014 and beyond. These amounts are net of purchase deposits currently held by the manufacturer.

As a result of recent financing transactions (refer to Note 5 of these condensed consolidated financial statements), American does not expect to use its previously arranged backstop financing to finance any of its Boeing 737-800 aircraft deliveries scheduled for 2010 and 2011; however, such backstop financing arrangement remains in place.

In September 2009, AMR Eagle signed a letter of intent with Bombardier, Inc. to exercise options for the purchase of 22 additional CRJ-700 aircraft for delivery beginning in the middle of 2010. Subject to reaching agreement on acceptable terms with Bombardier, Inc. and certain third party lenders, AMR expects the purchase of the CRJ-700 aircraft to be fully financed. AMR expects that these financing arrangements will involve the pledge of 10 currently owned CRJ-700 aircraft.

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 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, the amount of the reserve that may be required 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. On September 29, 2009, the full amount of the reserve under such agreement, which at that time was approximately $200 million, was released to the Company, and based on its current forecasts, the Company does not currently expect to be required to maintain any reserve for the near term. However, the factors underlying such forecasts are volatile and uncertain. If circumstances were to occur that would allow the credit card processor to require the Company to maintain a reserve, the Company's liquidity could be negatively impacted.

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, but 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 estimates its 2010 required contribution to its defined benefit pension plans to be approximately $525 million.

Cash Flow Activity

At September 30, 2009, the Company had $4.1 billion in unrestricted cash and short-term investments, reflecting an increase of $1.0 billion from the balance of $3.1 billion at December 31, 2008. The increase in unrestricted cash and short-term investments is primarily due to cash from financing activities during the period of approximately $3.1 billion offset by principal payments made during the first nine months of 2009. Net cash provided by operating activities in the nine-month period ended September 30, 2009 was $926 million, an increase of $956 million over the same period in 2008. The increase is primarily due to the decrease in fuel prices from $3.17 per gallon for the first nine months of 2008 to $1.96 per gallon for the same period in 2009. The fuel price decrease resulted in a $2.5 billion reduction in year-over-year expense in the nine months ended September 30, 2009 (based on the year-over-year decrease in the average price per gallon multiplied by gallons consumed). The impact of decreased fuel prices was somewhat offset by a significant decline in the demand for air travel, which resulted in a $2.8 billion, or 20.1 percent, decrease in passenger revenue.

The Company made debt and capital lease payments of $1.8 billion in the first nine 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 and retired its $432 million term loan credit facility, which had a scheduled maturity of December 17, 2010, on September 28, 2009.

In the nine months ended September 30, 2009, the Company obtained an aggregate of approximately $3.1 billion of cash from financing activities through the following actions: $1 billion from the advance sale of AAdvantage Miles to Citibank (of which $110 million of deferred revenue is recorded in cash flow from operations), the issuance by American of $520 million of pass through trust certificates (of which $177 million of cash was received through September 30, 2009), the issuance by AMR of convertible senior notes due 2014 and 48 million shares of common stock (for which AMR received net proceeds of approximately $830 million), proceeds from the 2009 Loan Facility of $225.4 million, and $829 million in other loans secured by various aircraft and sale leasebacks of certain aircraft in the first nine months of 2009. See Notes 5 and 11 to the condensed consolidated financial statements for a detailed description of these financing transactions.

Capital expenditures for the first nine months of 2009 were $1.1 billion and primarily consisted of new aircraft and certain aircraft modifications.

In the past, the Company has from time to time refinanced, redeemed or repurchased its debt and taken other steps to reduce its debt or lease obligations or otherwise improve its balance sheet. Going forward, depending on market conditions, its cash positions and other considerations, the Company may continue to take such actions.

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 September 30, 2009, the cash collateral held by such counterparties from AMR was $78 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 had surplus collateral posted with a certain counterparty as of September 30, 2009 due to a timing lag in collateral reconciliation. 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 September 30, 2009. Under the same assumption, the Company does not currently expect to be required to deposit significant additional cash collateral above September 30, 2009 levels with counterparties with regard to fuel hedges in place as of September 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 August 31, 2010, 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 coverage is not available at commercially reasonable rates, the Company would be adversely affected. While the price of commercial insurance has declined since the premium increases immediately after terrorist attacks of September 11, 2001, in the . . .