US Airways Group Inc said on Thursday it had dropped out of merger discussions with United Airlines parent UAL Corp, immediately raising the stakes for similar talks involving United and Continental Airlines Inc.

Rebounding shares of Continental were down 1.3 percent at midday on the New York Exchange after falling by as much as 7 percent in earlier trading on news that its first-quarter results missed Wall Street estimates.

The US Airways statement was the first acknowledgment by the company that it had been in talks with UAL, their second round of merger discussions in two years. A lone US Airways/United merger proposal foundered in 2001 on competition concerns.

After an extensive review and careful consideration, our board of directors has decided to discontinue those discussions, US Airways said.

It remains our belief that consolidation makes sense in an industry as fragmented as ours, the company added.

Shares of UAL were down 1.5 percent, while US Airways shares tumbled 4.6 percent.

Continental Chief Executive Jeff Smisek declined to comment on the merger developments in a conference call with analysts on the company's results.

Although Continental will not confirm it is in talks with UAL, a source familiar with the matter has said the two have recently launched discussions. Similar talks in 2008 broke off without any proposal.

The disclosure by US Airways added more volatility to a sector struggling to gain altitude heading out of a two-year financial downturn triggered by high fuel costs and weak passenger demand.

The first wave of financial results for 2010 have been mixed. Carriers, in most cases this week, reported improved revenues and effective cost controls, save for stubbornly high fuel expenses.

Continental said its rising fuel bill and expenses tied to East Coast snow storms pressured its results. American Airlines parent AMR Corp also fell short of analysts' expectations this week.

Separately, low-cost carriers Southwest Airlines Co and Alaska Air Group Inc reported quarterly profits on higher revenue from stronger demand and tighter capacity.

Shares of Southwest were down 2.1 percent on the New York Exchange, while Alaska Air shares were up more than 0.9 percent.

Continental's widening loss illustrates challenges faced by airlines under pressure by some analysts and executives to consolidate to accelerate capacity reductions. Airline executives also believe the slow pace of economic recovery is a stress on future profits, even though demand is up and fares are higher.

Houston-based Continental said its loss widened to $146 million, or $1.05 per share, from $136 million, or $1.10 per share, a year earlier, when there were fewer outstanding shares.

The airline lost 98 cents per share, excluding $10 million of severance and aircraft-related special charges.

Analysts, on average, had expected the company to report a loss of 86 cents, according to Thomson Reuters I/B/E/S.

Stifel Nicolaus analyst Hunter Keay said expenses were about $3 million more than he had projected. But stripping some expenses, the company would still have missed his forecast.

Continental had to suspend operations at its Newark, New Jersey, hub in February due to severe winter storms that hammered the East Coast.

A modest improvement in business travel and higher revenue helped Southwest Airlines post a profit, reversing a year-earlier loss.

First-quarter unit revenue rose 19.3 percent.

Thus far, strong load factor and yield trends have continued in April and, assuming trends continue, we expect another significant year-over-year unit revenue gain in second quarter 2010, said Chief Executive Gary Kelly in a statement.

(Additional reporting by John Crawley in Washington)

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