OPERATING profits on its core air transport business fell at Aer Lingus last year, despite an increase in turnover. In a strong, though competitive market, operating profits on air transport fell to £42.2 million from £43.6 million.

Chief executive, Mr Gary McGann said the fall in core profits was "a significant warning signal that has to be addressed".

However, at the pre tax level, group profits rose to £40.9 million from £17.8 million, resulting from a significant drop in net interest costs and a once off gain of £4.4 million from the write back of earlier provisions. In 1995, profits were depressed by an exceptional charge of £11.7 million and net interest costs of £20.4 million. The net interest charge fell to £1.3 million in 1996.

Attributing the fall in core airline operating profits to pressure on air fares, a change in the business mix towards lower margin, leisure travel and increases in costs, Mrs McGann said management was addressing the issues involved.

"Unit costs are growing faster than unit revenue, he admitted, blaming "industry wide issues" and the company's own cost base. On an industry level, the problems include "sub suppliers who consider themselves immune to changes in the environment".

The cost of air traffic control services rose significantly in 1996, while fuel cost Aer Lingus an additional £3 million, he said. And as the airline industry recovers, aircraft ownership and leasing costs are rising.

On its own cost base, he attributed some of the higher costs to growth in the volume of business But he said the airline needed to tackle all its costs to ensure that they were not growing faster than revenue. On the wage bill, he said management and unions were in "significant discussions" to find ways to "secure long term cost development compatible with its business cycle, the nature of the business and the company's size".

The discussions cover the period 1997 to 2002. Mr McGann said there was general acceptance that there were issues to be faced. "The next step is to agree a method of addressing them. We will conclude discussions and have proposals to address the situation in 1997."

Procurement costs services and products bought in by the airline are being tackled through "tough bidding processes", he said. "Our approach to costs is that all costs are potentially variable," he said.

Because operating losses on other activities fell in 1996 (to £400,000 from £3.4 million), overall group operating profits rose 4 per cent to £41.8 million. Following the sale of most non core assets, the airline's other operations now include TEAM, where losses rose to £5.5 million from £5 million and where break even in 1999 is the target. The other subsidiaries are profitable.

Airmotive is now 60 per cent owned by Lufthansa Technik which has an option until 1999 to raise its stake to 90 per cent. Aer Lingus declined to disclose Lufihansa profit levels. Futura, its Spanish charter company, is looking for expansion opportunities. SRS, the Shannon based aircraft maintenance and ground handling operation, which is looking for a strategic partner, is involved in a three year programme to improve efficiency and profits.

In buoyant market conditions Aer Lingus group turnover rose by 8.5 per cent to £765.7 million. But costs rose faster, with a 9.8 per cent rise in the cost of sales to £557.1 million before exceptional cost savings of £4.2 million.

Other operating expenses - mainly marketing, administration and distribution - were 5.9 per cent higher at £171 million. This figure included the £4.1 million distributed to employees in 1996 under the employee profit sharing scheme, up from £3.3 million - in 1995, and giving the 6,300 employees an average of £650 each.

Overall, costs rose by 9 per cent, excluding once off exceptional items and the impact of discontinued operations - the subsidiaries sold off such as the Copthorne hotel group.

Mr McGann said all Aer Lingus routes were now covering their costs and most were making a contribution to fixed costs. But some routes could be improved, he said.

On new competition from Ryanair on the Paris and Brussels routes, he insisted that the "product, the service and the airports are dramatically different. There will be some displacement and some stimulus to the market but the jury is out on how it will pan out. I think we can both succeed".

By year end, Aer Lingus's balance sheet was healthier, with net cash balances of £3 8.7 million compared with net debt of £41.4 million. Shareholders funds rose by 21 per cent to £190.5 million but Mr McGann said these needed to rise to about £250 million to secure balance sheet strength.