AAL

Business Context and Reporting Period

Company: AMR Corporation (American Airlines Group Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Filing Date: February 20, 2008

AMR Corporation operates primarily through its principal subsidiary, American Airlines, Inc., the largest scheduled passenger airline in the world by available seat miles. The company also operates regional carriers under the "American Eagle" brand and manages investment assets through American Beacon Advisors. In late 2007, the company announced a strategic review of its assets, culminating in a plan to divest its regional carrier subsidiary, AMR Eagle, in 2008.

Key Financial Metrics

Note: 2007 Net Earnings include a $138 million gain on the sale of ARINC and a $39 million gain from changes to the AAdvantage frequent flyer program. Operating expenses were $21.97 billion, with fuel costs totaling $6.67 billion (30.4% of operating expenses).

Material Changes vs. Prior Period

• Profitability: The company achieved its second consecutive annual profit, with net earnings increasing $273 million (118%) from 2006 to 2007. This followed significant losses in the five years prior to 2006.
• Revenue Growth: Operating revenues increased 1.6% to $22.9 billion, driven by a 2.1% increase in passenger revenues despite a 2.4% reduction in capacity (available seat miles). Passenger yield increased 2.4% year-over-year.
• Cost Pressures: Fuel prices rose 11.7 cents per gallon from 2006 to 2007, increasing fuel expense by $268 million. However, the company's fuel hedging program reduced fuel expense by approximately $239 million in 2007.
• Balance Sheet: Long-term debt and capital lease obligations were reduced by $2.3 billion during the year. Stockholders' equity turned positive ($2.66 billion) from a deficit in 2006, largely due to a $1.7 billion reduction in pension liabilities resulting from actuarial changes and new legislation raising the pilot retirement age.
• Strategic Divestiture: The company announced plans to divest AMR Eagle (American Eagle Airlines and Executive Airlines) in 2008 to unlock shareholder value and focus on the mainline business.

Guidance, Outlook, and Risks

Outlook and Guidance:

• Capacity for mainline jet operations is expected to decrease 0.6% in Q1 2008 versus Q1 2007.
• Full-year 2008 mainline capacity is projected to increase approximately 0.2%, with a 1.1% reduction in domestic capacity offset by a 2.5% increase in international capacity.
• Consolidated capacity is expected to be flat compared to 2007.
• Management expects to provide revised unit cost guidance in March 2008.

Management Commentary:

• Management attributes improved results to the "Turnaround Plan," which has implemented cost savings initiatives estimated at $3.8 billion annually.
• Passenger yield remains low by historical standards due to intense competition, particularly from low-cost carriers and reorganized competitors.

Risks and Contingencies:

• Fuel Volatility: Continued high fuel prices or supply disruptions could materially adversely affect financial condition. The company has hedged approximately 24% of its 2008 fuel requirements.
• Competition: The company faces competition from carriers with lower cost structures resulting from Chapter 11 reorganizations (e.g., United, Delta, Northwest).
• Regulatory/Legal: The European Commission issued a Statement of Objection alleging a conspiracy to set cargo surcharges, which could result in fines. The company is also subject to various antitrust investigations in the U.S. and other jurisdictions.
• Labor Relations: Negotiations with major unions (pilots, flight attendants, mechanics) are ongoing or expected to commence in 2008. Labor costs represent approximately 31% of operating expenses.
• Liquidity Covenants: The company must maintain specific liquidity and cash flow-to-fixed-charge ratios under its credit facility. While compliant as of year-end, high fuel prices create uncertainty regarding future compliance.

Key Facts for Investor Verification

• Debt Reduction: Verify the sustainability of the $2.3 billion debt reduction and the company's ability to meet future debt maturities ($902 million in 2008, $1.2 billion in 2009) without additional financing.
• AMR Eagle Divestiture: Monitor the progress and structure of the planned 2008 divestiture of AMR Eagle, as the financial impact is currently unquantifiable.
• Fuel Hedging Effectiveness: Assess the remaining exposure to fuel price volatility given that only 24% of 2008 requirements are hedged.
• Antitrust Exposure: Track the outcome of the European Commission's cargo surcharge investigation and other global antitrust probes, as fines could be material.
• Labor Contract Renewals: Watch for the results of upcoming labor negotiations, as the company's cost structure is significantly higher than reorganized competitors.
• Pension Funding: Verify the company's ability to meet estimated 2008 pension contributions of approximately $350 million, which exceed minimum legal requirements.