AAL

Business Context and Reporting Period

This Form 10-K covers AMR Corporation (American Airlines Group Inc.) for the fiscal year ended December 31, 2002. AMR is the parent company of American Airlines, Inc., the world's largest scheduled passenger airline, and AMR Eagle Holding Corporation, which operates regional carriers. The reporting period was heavily impacted by the residual effects of the September 11, 2001 terrorist attacks, a weak U.S. economy, the war in Iraq, and intense competition from low-cost carriers. The company incurred aggregate operating losses of $3.3 billion in 2002 and $2.5 billion in 2001.

Key Financial Metrics

Key Operational Statistics (2002):

• Revenue Passenger Miles: 121.7 billion
• Available Seat Miles: 172.2 billion
• Passenger Load Factor: 70.7%
• Revenue per Available Seat Mile (RASM): 8.39 cents
• Operating Expenses per ASM: 11.14 cents
• Fuel Cost per Gallon: 76.0 cents

Material Changes Versus Prior Period

• Revenue Decline: Total operating revenues decreased 8.8% to $17.3 billion, driven by a 7.2% drop in RASM and a 1.4% decrease in capacity. Passenger revenues fell 8.5% due to reduced business travel demand and fare competition.
• Operating Loss Expansion: Operating loss widened to $3.33 billion from $2.47 billion in 2001. While operating expenses decreased 3.8% due to cost-cutting initiatives, the revenue decline was more severe.
• Goodwill Write-off: The 2002 net loss includes a one-time, non-cash charge of $988 million ($6.35 per share) to write off all goodwill following the adoption of SFAS 142.
• Debt Increase: Long-term debt increased by approximately $2.6 billion to $10.9 billion as the company raised capital to fund operating losses and capital commitments.
• Equity Erosion: Stockholders' equity plummeted from $5.4 billion in 2001 to $957 million in 2002, largely due to the net loss and a $1.1 billion charge to equity for minimum pension liability adjustments.

Guidance, Outlook, Risks, and Contingencies

Management Commentary and Outlook: Management states that recent financial results are unsustainable and that a permanent shift has occurred in the airline revenue environment. The company believes it must reduce annual operating costs by at least $4 billion to become competitive. While $2 billion in reductions have been identified through operational efficiencies, a $2 billion shortfall remains, necessitating significant labor concessions.

Labor Agreements and Bankruptcy Risk: On March 31, 2003, the company reached tentative agreements with three major unions for $1.8 billion in annual savings (wage/benefit reductions and work rule changes). These agreements must be ratified by union members, with results expected April 15, 2003. Failure to ratify these agreements would likely lead to a Chapter 11 bankruptcy filing. Even if ratified, the company may still require Chapter 11 protection due to weak financial conditions and liquidity constraints.

Liquidity and Financing: The company had approximately $2.0 billion in unrestricted cash and short-term investments as of December 31, 2002. Credit ratings have been downgraded significantly below investment grade, increasing borrowing costs and restricting access to capital markets. The company has a fully drawn $834 million credit facility and must maintain $1.0 billion in liquidity under modified covenants effective Q2 2003.

Risks and Contingencies:

• Going Concern: Independent auditors issued a "going concern" opinion, citing substantial doubt about the company's ability to continue operations without additional financing or cost reductions.
• Fuel Prices: Escalating fuel prices (rising from 66.5 cents to 91.0 cents per gallon between Feb 2002 and Feb 2003) pose a significant cost risk.
• Legal Proceedings: The company faces multiple antitrust lawsuits regarding fare practices and travel agent commissions, as well as environmental remediation liabilities at various airports.
• Insurance: Commercial war-risk insurance coverage is limited; the company relies on U.S. government-backed insurance which is subject to extension.

Investor Verification Checklist

• Union Ratification: Verify the outcome of the union votes on the $1.8 billion labor cost reduction agreements scheduled for announcement around April 15, 2003.
• Liquidity Covenant Compliance: Confirm the company's ability to meet the $1.0 billion liquidity requirement for the second quarter of 2003 under its credit facility.
• Chapter 11 Filing: Monitor for any announcement of a Chapter 11 bankruptcy filing if labor agreements fail or if financing cannot be secured.
• Government Assistance: Track the status of the supplemental appropriations legislation for aviation security cost reimbursement and war-risk insurance extensions.
• Fuel Hedging: Assess the effectiveness of the fuel hedging program given the company's deteriorating credit rating and limited ability to enter new contracts.