American Airlines Group Inc. quarterly report, Q3 FY2015

American Airlines Group Inc. — 2015 Q3 Form 10-Q Summary

Business context and reporting period

Combined quarterly report for American Airlines Group Inc. (AAG) and wholly owned American Airlines, Inc., covering the three and nine months ended September 30, 2015. AAG’s operations include American, US Airways, wholly owned regional airlines and third-party regional carriers operating primarily under the American Eagle and US Airways Express brands.

The company operated approximately 6,700 daily flights to nearly 350 destinations in more than 50 countries. In the third quarter, approximately 53 million passengers boarded mainline and regional flights. AAG received a single FAA operating certificate in April 2015, and on October 17, 2015, completed the planned integration of American and US Airways reservation systems.

Financial performance and key metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Operating revenues	$10.706 billion	$11.139 billion	$31.360 billion	$32.490 billion
Operating income	$1.999 billion	$1.260 billion	$5.136 billion	$3.389 billion
Net income	$1.693 billion	$942 million	$4.329 billion	$2.285 billion
Diluted EPS	$2.49	$1.28	$6.17	$3.10
Operating margin	18.7%	11.3%	16.4%	10.4%
Net margin	15.8%	8.5%	13.8%	7.0%
Net cash from operating activities	Not separately provided for quarter	Not separately provided for quarter	$6.021 billion	$2.276 billion

Q3 operating income increased 58.7% and net income increased 79.8% year over year. Excluding special items, Q3 operating income was approximately $2.2 billion and net income was approximately $1.9 billion, compared with $1.5 billion and $1.2 billion, respectively, in Q3 2014.

Mainline passenger revenue declined 5.4% in Q3 and 5.4% for the nine-month period. Regional passenger revenue increased 2.0% in Q3 and 2.7% year to date.
Total passenger revenue declined 4.2% in Q3, primarily because passenger yield fell 9.2%. Total passenger revenue per available seat mile declined 6.8% to 13.16 cents.
Fuel expense declined 43.7% in Q3 and 41.3% for the nine-month period. Average fuel price declined to $1.67 per gallon in Q3 from $2.98 in the prior-year quarter.
Salaries, wages and benefits increased 12.5% in Q3 and 11.3% year to date, primarily due to new merger-related labor agreements.
Mainline CASM excluding special items and fuel increased 2.6% in Q3 to 8.56 cents and 3.6% year to date to 8.92 cents.
Mainline and regional passenger load factor improved 2.2 percentage points in Q3 to 85.6%; capacity increased 2.9% and revenue passenger miles increased 5.6%.

Liquidity, cash flow, debt and capital allocation

At September 30, 2015, AAG held $1.016 billion of cash, $7.857 billion of short-term investments and $710 million of restricted cash and short-term investments, totaling $9.583 billion.
AAG reported approximately $1.8 billion of available capacity under undrawn revolving credit facilities. Debt agreements generally require minimum aggregate liquidity of at least $2.0 billion; the company reported compliance with collateral coverage tests.
Long-term debt and capital leases, including current maturities and before debt discount, totaled $20.593 billion, compared with $17.963 billion at December 31, 2014. American Airlines separately reported $13.268 billion.
Nine-month investing cash outflows were $6.032 billion, including $4.621 billion of capital expenditures and aircraft purchase deposits and $1.550 billion of net purchases of short-term investments.
Nine-month financing cash flow was positive $33 million, reflecting $4.463 billion of debt issuance, $1.821 billion of debt and lease repayments, $2.411 billion of share repurchases and $206 million of dividends.
AAG repurchased 59.5 million shares for $2.5 billion during the first nine months and completed its $2.0 billion repurchase authorization in Q3. A further $2.0 billion authorization was approved in July 2015, and another $2.0 billion authorization was announced in October 2015.
The company paid quarterly dividends of $0.10 per share during each of the first three quarters and declared another $0.10 per share dividend in October 2015.

Material changes versus the prior comparable period

Profitability improved substantially despite lower revenue, driven primarily by lower fuel costs and lower special charges.
Revenue pressure reflected competitive capacity growth, weaker international yields and foreign currency devaluation. Cargo revenue declined 16.3% in Q3.
Operating expenses declined 11.9% in Q3 and 9.9% year to date, principally due to fuel savings. Underlying labor costs increased materially.
Operating special charges declined to $165 million in Q3 from $223 million, while total net special charges declined to $192 million from $281 million. Year-to-date total special charges were $654 million versus $795 million.
Special charges in 2015 primarily comprised merger integration costs, pilot contract costs, the dissolution of the Texas Aero Engine Services joint venture, debt-related write-offs and a non-cash deferred tax provision. These were partly offset by a $66 million legal settlement credit.
AAG issued approximately $2.3 billion of enhanced equipment trust certificates and $500 million of 4.625% senior notes. It also refinanced term loans at lower LIBOR margins and repaid the $400 million AAdvantage loan.
The company delivered 84 new aircraft during the first nine months and had 422 aircraft subject to purchase commitments as of September 30, 2015.

Guidance, outlook, commentary, risks and unusual items

The filing does not provide a clear formal earnings or revenue forecast. Management emphasized that profitability remains sensitive to fuel prices, economic conditions, travel demand, competitive capacity and merger integration execution.

AAG had no fuel hedging contracts outstanding and stated that it remains fully exposed to fuel-price changes. Based on forecast 2015 consumption of approximately 4.3 billion gallons, a one-cent-per-gallon fuel-price increase would increase annual expense by approximately $43 million.
The company expects 2015 flight-attendant costs to be approximately $200 million higher under the new agreement and pilot compensation and benefits to be approximately $650 million higher under the ratified pilot agreement. The pilot agreement generated a $99 million special charge in the first nine months.
Deferred tax assets remained subject to a full valuation allowance at September 30, 2015. Management indicated that substantially all of the allowance could be reversed as early as year-end 2015 if profitability and integration milestones continued, but no reversal had been recorded.
AAG held approximately $609 million of unrestricted cash and short-term investments in Venezuelan bolivars, valued using a rate materially more favorable than prevailing external-market rates. Further devaluation or repatriation restrictions could cause material losses.
The Department of Justice opened an investigation into possible illegal agreements or coordination concerning passenger capacity. AAG and other airlines also faced approximately 100 putative class-action lawsuits. The filing states that these matters were in early stages and their ultimate financial impact was uncertain.
Other contingencies include unresolved bankruptcy claims, an OPEB proceeding and union grievances involving approximately $212 million of alleged prefunding-trust recoveries.
Total AAG contractual obligations were reported at $79.207 billion, including aircraft and engine purchases, debt, interest, leases, regional capacity purchase agreements and pension-related obligations. Aircraft and engine purchase commitments totaled approximately $23.878 billion.
Pension funding obligations are expected to increase materially beginning in 2019 under current assumptions. The company also faces substantial floating-rate debt, fixed obligations, aircraft financing needs and credit-card processor holdback risk.

Most important facts for an investor to verify

Whether lower fuel prices and improved margins are sustainable as the company remains unhedged.
The effect of falling yields and PRASM, competitive capacity growth and foreign currency weakness on future revenue.
Progress, cost and operational effects of the American-US Airways integration, including the reservation-system conversion completed after quarter-end.
Debt maturities, floating-rate exposure, collateral requirements and compliance with minimum-liquidity covenants.
Financing availability for aircraft orders, including aircraft deliveries without committed financing.
The potential timing and magnitude of any deferred tax valuation allowance reversal.
Exposure from Venezuelan bolivar holdings and other foreign-currency balances.
Developments in the DOJ investigation, passenger-capacity litigation, bankruptcy claims and OPEB-related proceedings.
The pace and funding impact of share repurchases and dividends relative to fleet investment and contractual obligations.