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When Arrow Air executives realized the Miami-based cargo carrier couldn’t pay a large insurance premium that was coming due this year, they booked the airline for a trip to bankruptcy court. Five months later, the international carrier of fresh cut flowers, fish and other perishables emerged from its second bankruptcy stint in two years, and third filing in its 50-year history. The company has the same management team, the same business model and a similar schedule of flights to and from Latin America and the Caribbean. The big difference: The airline has dumped $27 million in unsecured debt. Arrow has cut its secured debt in half to about $15 million. The airline is paying back that amount on more favorable terms after convincing some creditors to accept stock in lieu of cash payments for some of the debts they were owed. “Arrow stands today as a stronger competitor than it would have been,” said Arrow Air’s bankruptcy counsel, Jonathan Vair, a partner with Stearns Weaver Miller Weissler Alhadeff & Sitterson in Miami. “It is a lot leaner in terms of secured debt. It erased most of its unsecured debt.” STORM CLOUDS FOR CREDITORS But the deal that kept Arrow aloft is only a snapshot of more onerous developments to come for banks, vendors, employees and other creditors who serve an industry plagued by heavy debt, cutthroat competition, rising fuel and security costs and nervous consumers who live in fear of terrorist attacks. Every airline bankruptcy inflicts a heavy dose of pain on the companies and people whose economic lives depend on an airline’s financial fortunes. In the 1980s and early 1990s, bankruptcy was a fatal blow for thousands of aviation careers in South Florida as Air Florida, Eastern Airlines, Northeastern International Airways, and Pan American World Airways vanished from airline schedules. Although a skeletal version of Pan Am emerged several years ago after a bankruptcy filing, the new company bears no resemblance to a worldwide carrier. Even when airlines do achieve makeovers in bankruptcy, vendors are forced to absorb millions of dollars in unpaid bills. Employees who aren’t laid off are asked to take pay cuts. And taxpayers may have to buck up billions of dollars to cover unfunded pension liabilities that wobbly airlines might not cover as promised. Vendors and employees have little leverage in bankruptcy court. While they can plead with a judge to limit their financial pain, if they push too hard an airline could choose to liquidate its assets, paying them pennies on the dollar. Vendors, especially, have to press gingerly. Airlines are powerful buyers, analysts say, and the aviation industry is so small that most vendors cannot afford to offend an airline they want as a customer after it re-emerges from bankruptcy. “You have to take it,” said an executive with a South Florida jet fuel supplier of Arrow who asked not to be identified. “I am not sure there is a nice way of putting that.” But Vair said his clients were keen to provide something to the unsecured creditors. “In the cargo industry, your loyalty is important to them and your making good on your debt is important to them,” he said. “They take it very seriously. Your reputation is extremely important. If you just throw up your hands and say, ‘We are going to file for bankruptcy,’ you are screwed.” He said Arrow’s new owners agreed to provide a pro rata share of any future money that may come from so-called avoidance action claims that amount to between $1.5 million and $2 million. Those claims pertain to any insiders and creditors who received money from the company shortly before the airline filed for Chapter 11. Under the law, a bankruptcy estate is entitled to take action to recover that money. The new ownership has provided $50,000 to the Arrow unsecured creditors so they may undertake a recovery effort. If the effort is fruitful, the Arrow ownership estimates the money could produce a return of between 3 cents and 5 cents on the dollar for nonsecured creditors. “They have been very willing to help the unsecured creditors because they want to be a stronger competitor coming out of bankruptcy,” Vair said. “They know that they will be dealing with these same creditors in the future, or at latest a lot of them. It is to the company’s benefit to make good on it as much as possible. I think it is a show of good faith that they are doing what they can.” SECOND AND THIRD CHANCES Airlines are increasingly using bankruptcy — or the threat of it — to retool for today’s changing aviation climate. By seeking court protection, airlines can rapidly purge some loans, and defer other debt payments and bills until after they emerge from the court protection. With creditors at bay, cash-strapped airlines can replenish their coffers. The winners are also air travelers, who are offered cut-rate fares by airlines that have reduced their costs through the bankruptcy process. “Ordinarily, it provides a positive cash flow to be in bankruptcy,” said Miami bankruptcy attorney Scott Baena, who represented unsecured creditors in this year’s bankruptcy of the cargo carrier Atlas Air, which operates at Miami International Airport. “Airlines have been realizing that lately. It has created a competitive disadvantage to airlines that are not in bankruptcy because they are still paying their creditors.” Baena is a senior partner with Bilzin Sumberg Baena Price & Axelrod. He has represented creditors and debtors in a number of aviation bankruptcies, including the disastrous failure of Miami-based Eastern Airlines, which stopped flying in 1991. Bankruptcy has its share of negatives for an airline too. Besides significant legal bills, airlines that seek bankruptcy protection harm their reputation, analysts say. Passengers are often less inclined to book a flight on an airline that admits it’s broke because of concerns that the carrier might soon be unable to fly. A revenue drop can compound problems for cash-starved companies. “People are leery about flying a bankrupt airline,” said Stuart Klaskin, KKC Aviation Consultants in Coral Gables. “It creates a shadow over the brand.” That shadow extends beyond passengers to regulators, employees and vendors. Regulators often pay closer attention to an airline seeking to reorganize under Chapter 11 of the U.S. Bankruptcy Code. They want to ensure the companies don’t defer maintenance in an effort to save cash, Klaskin said. Employees who aren’t laid off as part of an effort to cut costs often are anxious that their employer will be grounded by a lack of cash. Executives and managers are inclined to leave for more secure paychecks; those who do stay are enticed with salary increases and attractive incentives. Vendors who have been stiffed are skeptical about providing goods and services again without being paid in advance or on delivery. Finally, shareholders fare worst because they are often wiped out after an airline emerges from bankruptcy protection. Their pre-Chapter 11 shares are often cancelled. A post-bankruptcy company usually issues fresh stock as part of it plan to repay banks and other secured creditors. While the bankruptcy process creates uncertainty and with it financial tensions for everyone involved, attorneys involved in carrier reorganizations say that negotiations are for the most part civilized. One reason is that the bankruptcy bar is a small one. In South Florida, roughly 250 to 300 lawyers count themselves as bankruptcy practitioners out of some 20,000 in the region. Another reason is that a lawyer who represents a carrier today could represent a creditor tomorrow. Attorneys say familiarity of firms and frequent switching of roles eases adversary tensions. BRIGHTER HORIZONS For all of the financial pain caused, bankruptcy does put some airlines on more solid footing. Arrow Air is one of three cargo carriers with a significant Miami presence that has filed for bankruptcy in the past three years and has used the protection period to improve its balance sheet. Atlas Air, a New York-based cargo carrier that was previously Miami’s largest cargo carrier based on tonnage, is shedding its scheduled service business to become a charter company serving private and public clients, including the U.S. military. Atlas emerged from bankruptcy protection on July 26, free of $600 million of unsecured debt. Fort Lauderdale-based Amerijet remade itself into a logistics company from a charter and scheduled cargo carrier after the loss of a big customer forced it into bankruptcy in August 2001. Amerijet eliminated $6 million in unsecured debt and returned all 12 of its aircraft before leasing back six of them at favorable terms from owners anxious for a lessee. But bankruptcy may pay the most dividends for established passenger carriers whose history of higher operating costs has made it difficult for them to compete with lower-cost carriers. Think United vs. Southwest, the longtime profitable discount carrier based in Dallas. The nation’s six oldest airlines are already in bankruptcy or seriously considering filing for protection within the next six months. United Airlines of Chicago has been in Chapter 11 since December 2002 and has missed an initial target of May of this year for leaving court custodianship. US Airways Group of Arlington, Va., could seek court protection from creditors as soon as October, analysts say, even though it just finished a flight through Chapter 11 in March 2003. Atlanta-based Delta Air Lines is another passenger carrier contemplating a filing, possibly as soon as the first quarter of 2005, unless it can dramatically reduce its labor costs. Analysts said the other three “legacy” airlines — American, Continental and Northwest — all have enough cash on hand to get them through the next nine months. Their futures after that are uncertain. American and Northwest are hobbled by lingering debt and high cost structures that date back to the years before the industry was deregulated in 1978. “The cost point of an employee at a 50-year-old company is a lot higher than an employee at a 5-year-old company because they haven’t reached that level of maturity,” said aviation consultant Klaskin. Thus, a 4-year-old airline like JetBlue Airways or even the 33-year-old Southwest Airlines has a cost structure better suited to squeezing every penny out of revenue and keeping down expenses. High crude oil prices in recent months have only exacerbated the situation for cash-starved airlines that cannot afford to lock in fuel costs by purchasing futures contracts. Fuel is one of the biggest expenditures for any airline, and an uncontrolled rise can batter an airline’s bottom line. To understand the importance, consider that crude oil — from which jet fuel is made — sells for $44 a barrel today compared to $31 in 2003 and $26 in 2002. Crude oil prices averaged about $20 a barrel from 1992 to 2001, according to the Air Transportation Association, an industry trade group based in Washington, D.C. Passenger airlines have seen their fuel expenses increase by 120 percent within the last four years, as revenues from seat sales have remained flat and even dropped due to increased competition from well-capitalized startup carriers such as New York-based JetBlue. The older carriers have mitigated the effects of rising fuel prices by applying billions of dollars in emergency loans from the U.S. government flowed to airlines following the Sept. 11 terrorist attacks. But most of that money has been spent to overcome record losses incurred in 2002 and 2003 when people feared that flights were not safe from terrorist attacks. A day of reckoning is near, and analysts say that if United, US Airways and Delta are operating in bankruptcy, American, Continental and Northwest could be forced to join them if for no other reason than to save money. “In the next two or three years, there will be a major restructuring in the industry,” said aviation analyst Raymond Neidl of Blaylock & Partners in New York. “There is probably going to be more market share taken by the low-cost carriers and there are probably going to be certain hubs closed. And there is a good chance that certain legacy carriers may disappear.” Established carriers faced and beat back competition from startup airlines before, but this time the conditions favor the newer carriers. The competition between established airlines and startups goes back to the industry’s deregulation of 1978 when the federal government allowed carriers to dictate their own fares and route structures. Neidl said today’s situation differs greatly from the 1980s because low-cost carriers are no longer a new concept for consumers. And corporate America increasingly uses low-cost carriers to reduce travel expenses. Both consumers and businesses are also more comfortable using the Internet and other online networks to shop fares and flights. Internet ticket sales by airlines and travel Web sites now produce a steady stream of buyers that had no electronic access in the ’80s. “The big guys don’t have the computer system to run the small guys out of business any more,” Neidl said, referring to proprietary reservation systems controlled by the nation’s largest airlines. Fierce competition for passengers and the addition of Internet ticketing has many large carriers willing to accept a lower fare to fill a seat rather than letting the plane leave empty. Some seats may be cheaper for fliers, but airlines aren’t seeing operating costs drop. Low-cost carriers operate with an average labor cost of between 6 cents and 8 cents a seat per passenger mile compared with a legacy carrier spending between 9 cents and 11 cents for the same mile, Neidl said. Low-cost carriers have another advantage in that they fly to cheaper alternative airports rather than the expensive gateway airports of the region like the established carriers. Many times the savings are dramatic, and consumers have proven that they don’t mind flying from a second-tier airport for a lower price. Another critical element working against the established carriers is the cost of their hub-and-spoke business model that requires most flights to come to one or two centers where passengers can transfer onto flights to their final destination. This model has been replaced by the point-to-point route, which operates like a train in that passengers embark and disembark as the aircraft makes a few stops on its way to the final destination in order to maximize earning potential. “They are working diligently to have a more efficient use of the aircraft,” said Miami aviation consultant Robert Booth, a former marketing executive for Miami-based Air Florida and Dallas-based Braniff Airways, both of which disappeared after filing for bankruptcy in the early 1980s. SMALLER JETS, SMALLER MARKETS Airlines are also shifting toward service to smaller markets with more cost-effective regional jets instead of larger aircraft, Booth said. Established airlines are trying to get away from flying a moderately filled 210-seat aircraft into a small market once a day. Instead, they want to fly a 70-seat regional jet to that market three times a day, offering more departure times. “You need frequency,” Booth said. Booth said airlines are now able to do this because of the technological advancements in regional jets. The labor costs are also less for airlines because less-experienced pilots collecting lower salaries typically fly the routes. Even with the changes, Klaskin doesn’t expect the airline industry’s bottom line to strengthen until the supply of seats dwindles. He said that would only happen if the government allows the large, established airlines such as United to fail and be sold off in pieces to the competition. Klaskin said the government’s refusal to guarantee a $1 billion emergency loan to United is a sign that may happen. But Klaskin doubts the government will allow United or bankruptcy plagued US Airways to fail, putting thousands of people out of work in an election year. “The best prescription today is to let the US Airways and Uniteds just shut down,” Klaskin said. “That will strengthen the overall performance of the industry.” Klaskin expects the typical airline business model in the future to look more like the low-cost carriers with some aspects of the legacy carriers, including various seating classes and alliances that provide greater coverage. He said low-cost carriers are also interested in expanding into the international market to compete with expensive foreign carriers. “The industry as a whole is making fairly rapid progress toward a best-of-breed business model,” Klaskin said. “They are taking the best practices from all segments of the industry.” The economic lessons are being learned. Arrow’s stronger balance sheet combined with an improving Latin American market has the cargo carrier ready to expand its fleet. Arrow has leased a wide-body DC-10 to go along with its fleet of eight narrow-body DC-8s. The wide-body aircraft will eliminate Arrow’s need to charter a DC-10 by the hour when required, said Arrow’s general counsel Richard Richards. “Morale is up and everyone is hopeful,” he said.

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