Low-cost carriers nabbed the spotlight in the second quarter, posting strong profits and surpassing earnings estimates, while the old hub-and-spoke airlines saw deep losses and struggled to right their businesses.

The quarter serves as a good indication of how low-cost carriers plan to make network carriers miserable down the road, by boosting capacity in rivals' key hubs and expanding into profitable markets.

"The network carriers are still losing millions, but at least they're heading in the right direction with costs ... But

JetBlue

(JBLU) - Get Report

and other low-cost carriers came in gangbusters," said Prashanth Kuchibhotla, senior airline analyst at eCLIPSE Advisors.

Indeed,

Continental

(CAL) - Get Report

,

Delta

(DAL) - Get Report

,

Northwest

(NWAC)

and

AMR

(AMR)

unit

American

had a combined second-quarter loss of $778 million, excluding the reimbursement for security fees they received from the government.

In comparison,

Southwest

(LUV) - Get Report

, JetBlue and

AirTran

(AAI)

had a combined second-quarter profit of $151 million, excluding government help.

Both old-line and low-cost carriers were profitable when government assistance was factored in, with the four network carriers raking in a $415 million profit in the second quarter when reimbursements are added in, compared with a profit of $341 million for the trio of low-cost carriers.

The government aid, which will expire on Sept. 30, masked what was a very bad quarter for the network carriers and stole some thunder from the strength of the low-cost model. But as the chart below shows, six low-cost and regional carriers not only posted profits excluding charges, but also blew away analyst expectations.

Of all the earnings reports, JetBlue's was the strongest, said William Alderman, president of Alderman & Co., a boutique aerospace investment firm. JetBlue managed to boost profit, load factors and margins, while flying more flights. "JetBlue was the biggest surprise. I really thought they would see margin erosion as they grew and was truly surprised they could scale up that fast without any erosion to margins," Alderman said.

The New York-based carrier is a good example of how low-cost carriers plan to gnaw away at the network carriers' business. Because JetBlue can charge less for fares and still post a profit, a rival like Delta, which just launched its low-cost Song Airlines unit, is forced to lose money by matching JetBlue's cheap fares out of John F. Kennedy Airport in New York in an attempt to keep market share.

Using the low-cost model to outperform older stalwarts is nothing new -- Southwest has been doing it for three decades -- but the success and scope of the model's success has picked up steam recently. JetBlue boosted capacity by nearly 70% over year-ago levels in the second quarter, while load factor, or the percentage of seats filled, came in at an industry high of 85%. The end result: JetBlue's revenue was $245 million, up 64% over last year and beating Wall Street's lofty expectations.

In comparison, Delta widened its loss and said its new Song unit, which debuted on April 15, filled only about 70% of seats in the second quarter.

"Why is Delta, which has a good reputation for customer service as a business carrier's airline, competing head-to-head with JetBlue?" said Alderman. "The issue with Song isn't even load factor, it's the cost per available seat mile." Citing data from industry tracker

The Airline Monitor

, Alderman pointed out that the cost per available seat mile for JetBlue is 2.86 cents, compared with 4.31 cents per available seat mile for Delta's Boeing 757 fleet. Ultimately, the strong second-quarter results from low-cost carriers make experts wonder how long network carriers can compete if business travelers don't return to the skies.

"That's a 51% premium. Who cares about load factors?" Alderman said. "How are you going to get from here to compete with JetBlue, which Delta has said explicitly was the point of Song?"

And with JetBlue planning to add eight more planes by the end of 2003, along with an order for 100 Embraer 190 planes set to start arriving in mid-2005, Delta and other network carriers will have to figure out a way to beat the low-cost competition. In the second quarter, nearly every low-cost and regional carrier announced expansion plans, with Southwest adding 92 planes by 2006 and AirTran adding one plane a month until 2008.

According to a study by the Department of Transportation released on July 21, low-fare airlines had 30.2% of the market share in the top 1,000 markets through the third quarter of 2002, up from 26.9% two years ago. But even more worrisome for the network carriers is that their market share in the long-haul markets, where network carriers make their bread and butter, rose to 17.3% from 12.5%.

The next quarter is expected to be strong for the low-cost carriers as well, because of the seasonal uptick in summer travel. "The third quarter is going to be solid, especially after seeing how June came off. And comparisons will be easy, since last year on Sept. 11, the one-year anniversary, there was a dip in travel," said Kuchibhotla of eCLIPSE. "I don't think that will be there. So the third quarter, I'm confident in, but the fourth will be a toughie."

Nonetheless, since March 11, when the broader market bottomed, shares of network carriers have fared as well as, if not better than, their low-cost rivals. AMR rose 547% over that span, while Continental gained 256% and Delta added 75%. Southwest rose 36%, while JetBlue gained 91% and AirTran rose 101%. "I think the stock market overreacted when saying the network carriers would all go bankrupt," said Kuchibhotla. "And now they're reacting the other way. If you listened to the conference calls, no one said anything about long-term prospects improving."