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American Airlines showing signs of recovery

American's parent company, AMR Corp., reported on Wednesday that revenue set a record in the second quarter as fares rose and more passengers filled its planes. And it turned an operating profit, minus the millions it spent on bankruptcy lawyers and severance pay.

The airline is cutting costs and making progress in labour negotiations. It's even losing fewer bags.

But the nation's third-biggest airline still faces huge challenges to succeed against United and Delta, which are similar to American in structure but much bigger. They're also profitable.

Analysts say American must expand and improve its route network to attract high-paying business travellers. It's weak on both the East and West coasts. It ranks below average in government ratings for on-time flights and consumer complaints.

US Airways CEO Doug Parker says the best way for American to grow its network is by merging with his airline. Many Wall Street analysts agree. American's unions support a potential US Airways takeover because they believe it will mean fewer layoffs and other concessions.

AMR CEO Thomas Horton has preferred a go-it-alone strategy, although he said last week that AMR will examine merger possibilities. Bankruptcy creditors will decide between Parker's proposal, Horton's independent path and any other plans that pop up.

To control its own fate, AMR will have to prove to creditors that it can do better on its own than it would if paired with US Airways. Its report Wednesday on second-quarter financial results might bolster its case.

AMR narrowed its second-quarter loss to $241 million from $286 million a year ago. But excluding bankruptcy-related costs ranging from employee severance obligations to legal fees, AMR said it would have earned $95 million — its first operating profit for the early-summer quarter since 2007.

Revenue rose 5.5 per cent to an all-time high of $6.46 billion. The company credited an increase in corporate-travel accounts and its revenue-sharing ventures with British Airways, Iberia and Japan Airlines. Average fares increased 7 per cent over last summer. But even while they charged more for tickets, American and regional
affiliate American Eagle sold 85.1 per cent of their seats, another company record. And by a closely watched measure of revenue per seat, American is improving faster than its rivals.

Horton called the quarter "exceptional improvement.'' He said the restructuring was just beginning to take hold, and that momentum would build until "American re-emerges as an industry leader.''

AMR's case to creditors will also be stronger if it can show the ability to control costs. The company wants to cut annual spending by $2 billion a year — it was $25 billion last year — with more than half coming from labour. American employees are not the highest paid in the industry, but AMR argues that inefficiency and cumbersome work rules result in labour costs that are hundreds of millions too high.

In late June, American was struggling to get its union on board with the cost-cutting plan. It had agreements only with a few groups of ground workers. Then it scored a breakthrough: Directors of the pilots' union narrowly approved an American contract proposal and sent it to the airline's 7,500 pilots for a ratification vote that will end Aug. 8. American says the deal would cut spending on pilots by 17 per cent or about $315 million a year even with pay raises.

Union President David Bates said the union's financial and legal advisers recommended the offer largely because the pilots would own 13.5 per cent of the new AMR that emerges from bankruptcy.

The tentative contract would also let American expand its use of smaller regional jets and boost revenue through closer partnerships with other U.S. airlines. American wants to "code-share'' with JetBlue Airways and Alaska Airlines, in which it would sell seats on the other airlines as if they were American flights and share in the revenue.

"It was an important milestone in our restructuring,'' AMR chief commercial officer Virasb Vahidi says of the deal. "It accelerated the momentum of our labour negotiations.''

A few days after the agreement with pilots, American had a similar deal with mechanics, who are also expected to vote by early August. Long-stalled negotiations with the flight attendants' union resumed.

The unions have a powerful incentive to bargain. If they don't, a federal bankruptcy judge in New York could rule next month that American can simply throw out its labour contracts and impose pay and other terms on workers.

American has used bankruptcy to get rid of some leased aircraft and is negotiating with aircraft lessors and suppliers for more savings. It has taken a sharper pencil to money-losing flights, dropping service between Chicago and New Delhi and closing operations at Burbank, Calif.

To reduce empty seats, it put smaller planes on some routes where it couldn't fill 140-seat MD-80s, including new service between New York's LaGuardia Airport and Atlanta and many flights between Chicago's O'Hare Airport and Newark, New Jersey, San Antonio, Texas, and Denver.

Since bankruptcy, American is operating better by some measures. Its rate of lost or damaged bags was down nearly 40 per cent in May from a year ago. In the first quarter, the percentage of flights arriving on time was its best in 10 years and cancelled flights were the lowest in five years, although American still ranks below
average in both categories, according to government figures.

Even if American solves its operating weaknesses and labour problems, it faces other challenges.

It must fix a route network that is weaker than key rivals on the East and West coasts. American has pulled out of many secondary cities, leaving weak connections. For example, to fly from Rochester, New York, to London, American sends passengers west to Chicago, then back east to London. That's a tough sell when United will route them to London via New York City or Washington.

American could bolster its position in the eastern U.S. by code-sharing with or even buying JetBlue, which is strong at New York's Kennedy airport.

Publicly, JetBlue isn't interested. "Our path forward,'' says CEO David Barger, "is one of independence.''

And that brings American back to a potential combination with US Airways, which many analysts consider to be American's best option — but not necessarily for AMR's top management.

"In all probability,'' says longtime airline industry analyst Ray Neidl of Maxim Group LLC, "it would be the US Airways management that would survive.''