US Airways posts small profit, warns of coming cash burn

By Paul Deckelman

New York, July 27 - US Airways Group Inc. posted a wider second-quarter profit than it showed a year ago when it had just emerged from Chapter 11 - but nobody is popping the champagne corks at the air carrier's Arlington, Va.-headquarters. Instead, company officials warned on a conference call Tuesday that it is likely to burn through built-up cash in what are expected to be weak third and fourth quarters.

"Unfortunately, the small profit that we earned in the second quarter this year is not an indication that we have successfully turned the corner to achieve sustained profitability," cautioned US Airways' president and chief executive officer, Bruce Lakeland.

And Lakeland and the company's chief financial officer, David Davis, warned that the clock was ticking on US Air's efforts to put a wide-ranging "transformation" plan in place - a plan which would encompass reduced labor costs, revised agreements with its affiliated regional carriers that feed passengers into the main hub-and-spoke network, and other operating efficiencies. Should such a plan not be in place by the end of the third quarter on Sept. 30, the company would be forced to renegotiate the terms of interim regional jet financing agreements with GE Capital Aviation Services and with plane manufacturer Bombardier Inc. and the Brazilian aerospace manufacturer Empresa Brasileira de Aeronautica SA, known as Embraer.

The company reported second quarter pre-tax and net profit of $34 million (59 cents a share), versus second-quarter 2003 pre-tax income of $26 million and net income of $13 million (26 cents a share). The year-ago quarter included government compensation of $214 million, part of widescale Washington help for the ailing industry; excluding this aid and certain other unusual items, the year-ago pre-tax loss would have been $154 million.

US Airways' operating revenues for the second quarter were $1.96 billion, a 10.1% increase over last year. Much of the improvement, executives said, was related to a 24.4% increase in capacity at the company's express operation, including the deployment of regional jets.

Lakefield said that the improved results versus year-ago levels "are encouraging." But he added the caveat that "it's important to understand our financial results in the proper context. The second quarter is traditionally our strongest quarter - we count on the second quarter to generate cash and earnings to compensate for the comparatively weaker first and fourth quarter."

Little cash build up

Unrestricted cash at the end of the quarter on June 30 was $975 million - essentially flat from $978 million at the beginning of the quarter

"This was somewhat disappointing," Davis said, "given that the second quarter should be our strongest. We can expect that without a lower cost structure, we will be in a cash burn situation in the second half of the year."

Like the other major old-line hub-and-spoke carriers such as American Airlines, United Airlines - currently still in Chapter 11 - Delta Airlines, Northwest Airlines and Continental Airlines - US Air, the smallest of the group, has an antiquated cost structure, including expensive contracts for their unionized workforces, dating from the days before lower cost carriers such as Southwest Airlines and the upstarts Jet Blue, AirTran and ATA began taking big bites out of the older airlines' markets.

$800 million labor savings target

US Air has said that it needs to achieve about a 35% reduction in labor costs, or $800 million, in order for its transformation plan to work. According to published reports, it is seeking $295 million in concessions from pilots, $263 million from mechanics and fleet service workers, $122 million from reservation agents and passenger service and ticket counter employees and $116 million from flight attendants.

The company is currently in talks with the pilots, who have offered 12.5% in pay cuts and said they would be willing to work more hours, and hopes to engage in serious bargaining with the other labor groups as well.

"It is obvious that the current negotiations with our labor unions are a critical aspect of reducing our cost and returning US Airways to sustained profitability," Lakeland told analysts and investors on the conference call.

"For the transformation plan to be successful, however, it is necessary to have all of our labor groups engaged in active negotiations and to conclude these negotiations by late summer."

New financing agreements

Davis noted that the company had recently reached interim agreements with GE Capital Aviation Services, Embraer and Bombardier to continue providing the company with regional jet financing through the end of the third quarter. Reaching these new agreements was made necessary when Standard & Poor's downgraded US Air's corporate credit rating from B- to CCC+ in May.

Davis noted that as part of the agreement reached with Bombardier, the company will convert deliveries of 23 CRJ-200 to the larger CRJ-701 or CRJ-900 models - but to facilitate this conversion as well as to reduce the company's 2004 cash requirements, 19 aircraft previously scheduled for delivery in 2004 will now be delivered in 2005 and 2006.

"Continued financing support for our regional jet program beyond Sept 30 is dependent on the successful implementation of the transformation plan," Davis declared.

Fixed Sept. 30 deadline

When asked by an analyst on the call whether US Air might have a little wiggle room on its Sept. 30 deadline, or might be able to accept smaller cost reductions from its labor unions or others involved in the company's transition, Davis' answer was a flat "no."

"The magnitude and the timing of the required cost reductions are not pushed back at all," he said. "From a liquidity perspective, we are roughly where we expected to be at this point. The second quarter is traditionally a cash-generating quarter for us. We're about flat [from prior-quarter levels] in unrestricted cash. We typically burn cash in the second half of the year. So for liquidity reasons, as well as loan covenant compliance reasons and other reasons, the timing and magnitude of the cost reductions are as urgent as ever."

The loan covenant compliance Davis mentioned refers to US Air's agreement with the Airline Transportation Stabilization Board, which guaranteed most of the $1 billion the company borrowed when it emerged from bankruptcy last year. In March, the company announced that it had amended the terms of its agreement with the ATSB, with US Airways now required to significantly narrow its losses in 2004 and return to profitability in 2005.

Loan covenants get tighter

Also, the company agreed at that time to a covenant that requires its minimum unrestricted cash balance to not fall below the lower of $700 million and the outstanding balance of the loan at each month until the independent auditors' "going concern paragraph" is removed from the company's reports. Once the "going concern" is gone, the unrestricted cash covenant will be reduced to $500 million.

Davis noted on the call that the agreement with the ATSB provided for the waiver - in the second quarter only - of certain loan covenants linked to financial ratios. He said that "in return for removing the uncertainty of complying with second quarter covenants," US Air agreed to alter the amortization of the loan, resulting in larger principal payments beginning in October 2006, when the repayment of the loan is scheduled to begin.

"This agreement did not alter or waive any future financial covenant tests," the CFO said "While we were in compliance as of June 30, these tests are done quarterly and we will need to make another measurement at the end of the third quarter."

The covenants, he said, "get more difficult to make as you go forward - they tighten up a bit."

He sought to reassure the investors and analysts, however, that "if we were in a position where we weren't in compliance with those covenants, we would be discussing potential options with the ATSB. What the outcome of those discussions would be, nobody is clear on. But there's not a like a hard wall with the ATSB on Sept. 30 - we just have another covenant measurement date coming up."

Davis said that "although we achieved year-over-year improvements, operationally and financially, it is clear that the industry fare environment has changed, as a result of both low-cost carrier growth and consumer and business spending patterns. To compete and achieve sustained profitability on a sustained basis, the challenge to reduce our costs and transform the ways we do business remains unchanged.

Looking at all business sectors

The CFO added that "transformation of all aspects of the company are on the table. Right now, with our regional partners, we are looking to reduce costs within the confines of the agreement, but as we go forward into the fourth quarter, we are looking at all aspects of the business."

US Air management," Lakeland asserted, "remains focused on implementing our transformation plan - achieving a cost structure consistent with the realities of the competitive environment of today is the only way to ensure the continued viability of US Airways."

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