American Airlines Group Inc. quarterly report, Q3 FY2011

Business Context and Reporting Period

AMR Corporation, the parent of American Airlines and AMR Eagle, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. The filing predates the current American Airlines Group structure. Operations include mainline passenger service, regional affiliates, cargo, frequent-flyer-related activities and other passenger services.

Financial Performance and Key Metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Operating revenue	$6.376 billion	$5.842 billion	$18.023 billion	$16.584 billion
Operating income (loss)	$39 million	$342 million	$(270) million	$240 million
Net income (loss)	$(162) million	$143 million	$(884) million	$(373) million
Basic EPS	$(0.48)	$0.43	$(2.64)	$(1.12)
Operating margin	0.6%	5.9%	(1.5)%	1.4%
Operating cash flow	Not separately provided	Not separately provided	$346 million	$1.090 billion
Aircraft fuel expense	$2.255 billion	$1.613 billion	$6.299 billion	$4.744 billion

Q3 revenue increased 9.1%, while operating expenses increased 15.2%. Mainline passenger unit revenue increased 8.1%, supported by a 7.0% increase in yield and a 0.9-point increase in load factor to 84.9%. Mainline capacity was essentially flat. Average fuel cost rose to $3.15 per gallon from $2.24, including hedging, and fuel expense increased $642 million year over year. Fuel hedging reduced Q3 expense by approximately $31 million.

For the first nine months, revenue increased 8.7%, but operating expenses increased 11.9%. Mainline passenger revenue per available seat mile increased 5.8% to 11.54 cents, while mainline operating expense per available seat mile increased 9.3% to 13.73 cents. Nine-month fuel expense included approximately $268 million of hedging benefits.

Balance Sheet, Debt, Liquidity and Cash Flow

Cash was $304 million at September 30, 2011, compared with $168 million at December 31, 2010.
Unrestricted cash and short-term investments totaled approximately $4.3 billion, down from $4.5 billion at year-end 2010. Restricted cash and short-term investments totaled $474 million.
Total debt, including current maturities, was $10.926 billion, compared with $10.532 billion at December 31, 2010. Current maturities were $1.374 billion and long-term debt, excluding current maturities, was $9.552 billion.
Stockholders’ deficit increased to $4.833 billion from $3.945 billion, primarily reflecting the nine-month net loss.
Nine-month operating cash flow fell to $346 million from $1.090 billion. Capital expenditures were $1.234 billion, and debt and capital lease payments were $1.527 billion.
Financing activities generated $720 million, including $1.784 billion of debt issuance and $463 million from sale-leaseback transactions.
The company stated that it believed liquidity should be sufficient for operations and contractual obligations, but also said it would require substantial additional funding and provided no assurance that financing would remain available on acceptable terms.

Material Changes Versus the Prior Comparable Period

Q3 performance deteriorated from $143 million of net income in 2010 to a $162 million net loss in 2011; nine-month loss widened from $373 million to $884 million.
Revenue growth was more than offset by fuel inflation, higher revenue-related costs, increased aircraft rentals and foreign-exchange-related expenses.
Operating margin declined from 5.9% to 0.6% in Q3 and from 1.4% to negative 1.5% for the nine-month period.
Operating cash generation declined by $744 million year over year, while debt increased by approximately $394 million.
Regional affiliate revenue increased 18.9% in Q3 and 17.9% for the nine months, with higher traffic, capacity and load factors.
The deferred tax asset valuation allowance increased from $3.0 billion at year-end 2010 to $3.3 billion at September 30, 2011; no income tax benefit was recorded on the reported losses.

Guidance, Outlook, Commentary and Unusual Items

Management expected Q4 2011 mainline capacity to decrease approximately 3.0% year over year and full-year 2011 mainline capacity to increase approximately 0.4%.
Q4 2011 mainline unit costs were expected to increase 11.7% to 12.1%. Full-year 2011 fuel cost per gallon, including hedging, was expected to increase approximately 30% from 2010.
Fuel hedges covered approximately 52% of estimated 2011 fuel requirements as of September 2011. A hypothetical 10% increase in fuel cost per gallon was estimated to increase the next twelve months’ fuel expense by approximately $676 million, after hedging.
American announced major fleet-renewal commitments covering 460 Boeing 737 and Airbus A320-family aircraft scheduled for delivery during 2013–2022, with additional options and purchase rights. Future aircraft purchase commitments totaled approximately $9.1 billion based on the disclosed payment schedule, and future lease payments for all leased aircraft were approximately $18.3 billion.
The company was evaluating the useful lives and recoverability of MD-80, B757 and B767 aircraft. A future impairment or exit-cost charge could be significant if aircraft are grounded or fleet plans change.
AMR Eagle was pursuing a potential spin-off, subject to regulatory, tax, board and other conditions. The transaction was uncertain, and AMR could instead retain Eagle or pursue another form of divestiture.
American was involved in substantial litigation and contract disputes with Sabre, Travelport and Orbitz concerning global distribution systems. An adverse outcome or unfavorable distribution terms could reduce bookings and materially affect results.
Minimum pension contributions were estimated at approximately $520 million for 2011, completed as of the filing date, and no more than $560 million for 2012, subject to change.
Special-charge accruals remaining at September 30, 2011 totaled $75 million, consisting of $50 million for aircraft charges and $25 million for facility exit costs.
A $726 million Series 2011-2 pass-through certificate offering closed on October 4, 2011, after the balance-sheet date.

Principal Risks and Contingencies

Persistent fuel-price volatility, limited ability to pass higher costs to customers and potential fuel-supply disruptions.
Substantial debt, aircraft purchase and lease commitments, pension obligations and limited unencumbered collateral. Approximately $2.9 billion of long-term debt and capital lease principal payments were due during the second half of 2011 and 2012.
Potential future reserves under credit-card processing agreements; none were required at September 30, 2011.
Below-investment-grade credit ratings and the possibility of increased borrowing costs or reduced financing access.
Higher labor costs than competing network airlines, ongoing union negotiations and potential labor disruptions.
Competitive pressure from reorganized or consolidated airlines, low fares, reduced pricing power and changing alliances.
GDS litigation and contract-renewal uncertainty, together with regulatory, antitrust, environmental, security, terrorism, weather, technology and airport-disruption risks.
Potential impairment, grounding or exit costs associated with the accelerated fleet-renewal plan.

Investor Verification Points

Verify the company identity and corporate structure because this filing is for AMR Corporation, not the later American Airlines Group entity.
Reconcile reported liquidity by distinguishing unrestricted cash and short-term investments from restricted assets and ordinary operating cash.
Review debt maturities, aircraft purchase commitments, lease obligations, collateral availability and financing obtained after September 30, 2011.
Test the sensitivity of profitability and liquidity to fuel prices, hedging coverage, fuel collateral requirements and the disclosed $676 million fuel sensitivity.
Monitor the potential AMR Eagle spin-off, associated aircraft and debt transfers, tax attributes and service agreements.
Track the GDS litigation and contract negotiations, labor negotiations, pension funding and any fleet-related impairment or exit charges.