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The following is an excerpt from a 10-K SEC Filing, filed by CONTINENTAL AIRLINES INC /DE/ on 2/21/2002.
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UNITED AIRLINES, INC. - 10-K - 20020221 - PART_I

PART I

 

ITEM 1. BUSINESS.

Continental Airlines, Inc. is a major United States air carrier engaged in the business of transporting passengers, cargo and mail. We are the fifth largest United States airline (as measured by 2001 revenue passenger miles) and, together with our wholly owned subsidiaries, ExpressJet Airlines, Inc. (formerly Continental Express, Inc. and referred to in this Form 10-K as "ExpressJet") and Continental Micronesia, Inc. ("CMI"), each a Delaware corporation, served 216 airports worldwide at January 31, 2002. As of January 31, 2002, we flew to 123 domestic and 93 international destinations and offered additional connecting service through alliances with domestic and foreign carriers. We directly served 15 European cities, seven South American cities, Tel Aviv, Hong Kong and Tokyo as of January 31, 2002, and are one of the leading airlines providing service to Mexico and Central America, serving more destinations there than any other United States airline. Through our Guam hub, CMI provides extensive service in the western Pacific, including service to more Japanese cities than any other United States carrier.

As used in this Form 10-K, the terms "Continental", "we", "us", "our" and similar terms refer to Continental Airlines, Inc. and its subsidiaries, unless the context indicates otherwise. This Form 10-K may contain forward-looking statements. In connection therewith, please see the cautionary statements contained in Item 1. "Business - Risk Factors - Terrorist Attacks", "Business - Risk Factors Relating to the Company" and "Business - Risk Factors Relating to the Airline Industry" which identify important factors that could cause actual results to differ materially from those in the forward-looking statements.

Recent Developments

The terrorist attacks of September 11, 2001 involving commercial aircraft adversely affected our financial condition, results of operations and prospects, and the airline industry generally. Among the effects we experienced from the September 11, 2001 terrorist attacks were significant flight disruption costs caused by the Federal Aviation Administration, or FAA, imposed grounding of the U.S. airline industry's fleet, significantly increased security, insurance and other costs, significantly higher ticket refunds, significantly reduced load factors, and significantly reduced yields. As a result, we reduced our flight schedule and furloughed approximately 8,000 employees in connection with the schedule reduction. For the fourth quarter of 2001, we reduced our systemwide available seat miles by approximately 14.9% as compared with capacity for the same period in the prior year. Due in part to the lack of predictability of future traffic, business mix and yields, we are currently unable to estimate the long-term impact on us of the events of September 11, 2001 and the sufficiency of our financial resources to absorb that impact. However, given the magnitude of these unprecedented events and their potential subsequent effects, the adverse impact to our financial condition, results of operations and prospects may continue to be material. See "Employees" and "Risk Factors - Terrorist Attacks" below.

 

Domestic Operations

We operate our domestic route system primarily through our hubs in New York at Newark International Airport ("Newark"), in Houston, Texas at George Bush Intercontinental Airport ("Bush Intercontinental") and in Cleveland, Ohio at Hopkins International Airport ("Hopkins International"). Our hub system allows us to transport passengers between a large number of destinations with substantially more frequent service than if each route were served directly. The hub system also allows us to add service to a new destination from a large number of cities using only one or a limited number of aircraft. As of January 31, 2002, we operated 61% of the average daily jet departures from Newark, 83% of the average daily jet departures from Bush Intercontinental, and 66% of the average daily jet departures from Hopkins International (in each case including regional jets). Each of our domestic hubs is located in a large business and population center, contributing to a high volume of "origin and destination" traffic.

ExpressJet . Our mainline jet service at each of our domestic hub cities is coordinated with ExpressJet, which operates new-generation regional jets and turboprop aircraft under the name "Continental Express." Effective January 1, 2001, we entered into a capacity purchase agreement with ExpressJet pursuant to which we purchase in advance all of ExpressJet's available seat miles for a negotiated price. Under the agreement, ExpressJet operates regional flights on our behalf, while we are responsible for all scheduling, pricing and seat inventories, and are entitled to all revenue associated with those flights. We pay ExpressJet based on scheduled block hours in accordance with a formula designed to provide them with an operating margin of approximately 10% before taking into account variations in some costs and expenses that are generally controllable by ExpressJet. Accordingly, we assume the risk of revenue volatility associated with fares and passenger traffic, price volatility for specified expense items such as fuel and the cost of all distribution and revenue-related costs. The capacity purchase agreement replaced our prior revenue-sharing arrangement.

As of January 31, 2002, ExpressJet served 76 cities in the U.S., 11 cities in Mexico and five cities in Canada by regional jets. At that date, ExpressJet also served 29 cities by turboprop aircraft. Additional commuter feed traffic is currently provided to us by other code-sharing partners. See "Alliances" below.

We believe ExpressJet's regional jet and turboprop service complements our operations by carrying traffic that connects onto our mainline jets and allowing more frequent flights to smaller cities than could be provided economically with conventional jet aircraft. We believe that ExpressJet's regional jets provide greater comfort and enjoy better customer acceptance than turboprop aircraft. The regional jets also allow ExpressJet to serve certain routes that cannot be served by its turboprop aircraft. We anticipate that ExpressJet's fleet will be entirely comprised of regional jets by 2003.

We originally filed with the Securities and Exchange Commission, or SEC, for a public offering of common stock of ExpressJet's parent last summer, but decided to postpone the offering after September 11, 2001 to allow the financial markets to stabilize and to permit the airline industry to begin its recovery from the events of September 11, 2001. Our current intention is to continue pursuing our strategy of separating the ownership of Continental and ExpressJet by selling a portion of our interest in ExpressJet to the public for cash.

International Operations

We directly serve destinations throughout Europe, Canada, Mexico, Central and South America and the Caribbean, as well as Tel Aviv, Hong Kong and Tokyo, and have extensive operations in the western Pacific conducted by CMI. As measured by 2001 available seat miles, approximately 38.0% of our mainline jet operations, including CMI, were dedicated to international traffic. As of January 31, 2002, we offered 119 weekly departures to 15 European cities and marketed service to 34 other cities through code-sharing agreements.

Our Newark hub is a significant international gateway. From Newark at January 31, 2002, we served 15 European cities, five Canadian cities, four Mexican cities, five Central American cities, four South American cities, 11 Caribbean destinations, Tel Aviv, Hong Kong and Tokyo and marketed numerous other destinations through code-sharing arrangements with foreign carriers.

Our Houston hub is the focus of our operations in Mexico and Central America. As of January 31, 2002, we flew from Houston to 20 cities in Mexico, every country in Central America, six cities in South America, two Caribbean destinations, three cities in Canada, two cities in Europe and Tokyo.

We also fly to Montreal, Toronto and two Caribbean destinations from our hub in Cleveland.

Continental Micronesia . CMI is a United States-certificated air carrier transporting passengers, cargo and mail in the western Pacific. From its hub operations based on the island of Guam as of January 31, 2002, CMI provided service to eight cities in Japan, more than any other United States carrier, as well as other Pacific rim destinations, including Taiwan, the Philippines, Hong Kong, Australia and Indonesia.

CMI is the principal air carrier in the Micronesian Islands, where it pioneered scheduled air service in 1968. CMI's route system is linked to the United States market through Hong Kong, Tokyo and Honolulu, each of which CMI serves non-stop from Guam. CMI and Continental also maintain a code-sharing agreement and coordinate schedules on certain flights from the west coast of the United States to Honolulu, and from Honolulu to Guam, to facilitate travel from the United States into CMI's route system.

Alliances

We have entered into and continue to develop alliances with domestic carriers. We have a long-term global alliance with Northwest Airlines, Inc. ("Northwest Airlines") through 2025, subject to earlier termination by either of us in the event of certain changes in control of either Northwest Airlines or Continental. The Northwest Alliance provides for each carrier placing its code on a large number of the flights of the other, reciprocity of frequent flyer programs and executive lounge access, and other joint marketing activities. Northwest Airlines and Continental also have joint contracts with major corporations and travel agents designed to create access to a broader product line encompassing the route systems of both carriers.

The alliance agreement also provides that subject to certain conditions, including the receipt by Northwest Airlines, KLM Royal Dutch Airlines and us of an adequate grant of antitrust immunity, we will join, as an economic participant, a new transatlantic joint venture with Northwest Airlines and KLM on terms to be negotiated by the parties in good faith. If the parties cannot resolve the terms of our entrance into such a joint venture, the terms of our entrance would be determined by arbitration in accordance with the alliance agreement's dispute resolution procedures. We have not yet applied for such antitrust immunity and neither we nor Northwest has sought to invoke the arbitration provisions relating to our joint venture participation.

We had originally projected that the Northwest Alliance would generate approximately $225 million of incremental annual operating income for us when fully implemented, which we anticipated would be by the end of 2001. Due to implementation delays, we subsequently revised that projection to $160 million for 2001 and projected that the full run-rate benefit would be achieved during the next few years. Due primarily to the effects on our industry of the September 11, 2001 terrorist attacks, the actual incremental contribution for 2001 was $140 million, and it is now unclear whether the full projected benefit will be achieved in the future.

We also have domestic code-sharing agreements with America West Airlines, Inc., Gulfstream International Airlines, Inc., Mesaba Aviation, Inc., Hawaiian Airlines, Inc., Alaska Airlines, Inc., Horizon Airlines, Inc., Champlain Enterprises, Inc. (CommutAir) and American Eagle Airlines, Inc. We own 28% of the common equity of Gulfstream.

In addition to our domestic alliances, we seek to develop international alliance relationships that complement our own flying and permit expanded service through our hubs to major international destinations. International alliances assist in the development of our route structure by enabling us to offer more frequencies in a market, providing passengers connecting service from our international flights to other destinations beyond an alliance partner's hub, and by expanding the product line that we may offer in a foreign destination.

In October 2001, we announced that we had signed a cooperative marketing agreement with KLM that includes extensive codesharing and reciprocal frequent flyer program participation and airport lounge access. On December 1, 2001, we placed our code on selected flights to more than 30 European destinations operated by KLM and KLM Cityhopper beyond its Amsterdam hub, and KLM placed its code on our flights between New York and Amsterdam, as well as on selected flights to U.S. destinations operated by us beyond our New York and Houston hubs. In addition, members of each carrier's frequent flyer program are able to earn mileage anywhere on the other's global route network, as well as the global network of Northwest Airlines. This code-share agreement terminates on March 30, 2002, unless extended by the parties.

We have also implemented international code-sharing agreements with Air Europa, Air China, Emirates (the flag carrier of the United Arab Emirates), EVA Airways Corporation, an airline based in Taiwan, Virgin Atlantic Airways, Societe Air France ("Air France"), and Compania Panamena de Aviacion, S.A. ("Copa"). We own 49% of the common equity of Copa.

Some of our code-sharing agreements involve block-space arrangements (under which carriers agree to share capacity and bear economic risk for blocks of seats on certain routes). Continental and Air France purchase blocks of seats on each other's flights between Houston and Newark and Paris. Continental and Virgin Atlantic Airways exchange seat blocks on each other's flights between Newark and London, and we purchase seat blocks on eight other routes flown by Virgin Atlantic Airways between the United States and the United Kingdom. Our codeshare agreement with Air France will terminate on March 31, 2002.

Marketing

As with other carriers, most tickets for travel on us are sold by travel agents. Travel agents generally receive commissions measured by a certain percentage of the price of tickets sold. We often pay additional commissions to travel agents in connection with special revenue programs.

E-Ticket . In 2001, we continued to expand our electronic ticketing, or E-Ticket, product. E-Tickets result in lower distribution costs to us while providing enhanced customer and revenue information. We recorded over $5.6 billion in E-Ticket sales in 2001, representing 60% of total sales. We have currently replaced our airport E-Ticket machines with new state-of-the-art eService Centers, self-service kiosks for customer check-in, in over 90 U.S. airports. Continental and America West were the first U.S. airlines to implement interline E-Ticketing allowing customers to use electronic tickets when their itineraries include travel on both carriers. We now have interline E-Ticketing arrangements with America West, Northwest Airlines, United Air Lines, Inc. and Gulfstream, and plan to implement interline E-Ticketing with our other alliance partners and some of the other large U.S. carriers. We expect these features to contribute to an increase in E-Ticket usage and a further reduction in distribution costs.

Internet . Our award winning website, continental.com, recorded $487 million in ticket sales in 2001, compared with $320 million in ticket sales in 2000. The site offers customers direct access to information such as schedules, reservations, flight status, cargo tracking and Continental Online travel specials, a free weekly e-mail containing special offers for weekend travel. Combined with online travel agents, we recorded $1 billion in ticket sales through the internet during 2001, compared with $665 million in 2000.

Other . We are using e-commerce to improve our services for the customer and to reduce distribution costs. Continental, United Air Lines, American Airlines, Inc., Delta Air Lines, Inc. and Northwest Airlines, own a comprehensive travel planning website, ORBITZ, which offers customers unlimited access to a wide variety of unbiased travel options. To date, 45 U.S. and foreign carriers have joined the web-based travel service. ORBITZ provides customers with convenient online access to airline, hotel, car rental and other travel services in addition to internet offers. The site features published fares from virtually all carriers worldwide. In addition, we have entered into marketing agreements with other web-based travel service companies such as Hotwire, Travelocity and Expedia.

 

Frequent Flyer Program

We maintain our "OnePass" frequent flyer program to encourage repeat travel on our system. OnePass allows passengers to earn mileage credits by flying us and certain other carriers, including Northwest Airlines, America West Airlines, Alaska Airlines, Alitalia, Air France, Qantas Airways, Copa and Gulfstream. We also sell mileage credits to credit card companies, phone companies, hotels, car rental agencies and others participating in OnePass.

Due to the structure of the program and the low level of redemptions as a percentage of total travel, we believe that displacement of revenue passengers by passengers using flight awards has historically been minimal. The number of awards used on us represented 7.3% of our total revenue passenger miles in 2001.

Employees

As of December 31, 2001, we had approximately 42,900 full-time equivalent employees, including approximately 17,850 customer service agents, reservations agents, ramp and other airport personnel, 7,660 flight attendants, 6,790 management and clerical employees, 6,150 pilots, 4,300 mechanics and 150 dispatchers. Labor costs are a significant component of our expenses and can substantially impact airline results. In 2001, labor costs (including employee incentives) constituted 33.1% of our total operating expenses, excluding special charges and a grant under the Air Transportation Safety and System Stabilization Act (the "Stabilization Act"). While there can be no assurance that our generally good labor relations and high labor productivity will continue, we have established as a significant component of our business strategy the preservation of good relations with our employees, approximately 44% of whom are represented by unions.

As a result of the September 11, 2001 terrorist attacks, we expected to furlough approximately 12,000 employees. We were able to reduce our original estimate to 8,000, of which approximately 55% accepted company-offered leaves of absence or retirements. We have recalled several hundred employees primarily to assist in enhanced security requirements at airports.

See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for a table of Continental's, ExpressJet's and CMI's principal collective bargaining agreements, and their respective amendable dates.

Industry Regulation and Airport Access

We and our subsidiaries operate under certificates of public convenience and necessity issued by the Department of Transportation, or DOT. Such certificates may be altered, amended, modified or suspended by the DOT if public convenience and necessity so require, or may be revoked for intentional failure to comply with the terms and conditions of a certificate.

The airlines are also regulated by the FAA, primarily in the areas of flight operations, maintenance, ground facilities and other technical matters. Pursuant to these regulations, we have established, and the FAA has approved, a maintenance program for each type of aircraft we operate that provides for the ongoing maintenance of such aircraft, ranging from frequent routine inspections to major overhauls.

The DOT allows local airport authorities to implement procedures designed to abate special noise problems, provided such procedures do not unreasonably interfere with interstate or foreign commerce or the national transportation system. Certain airports, including the major airports at Boston, Chicago, Los Angeles, San Diego, Orange County (California) and San Francisco, have established airport restrictions to limit noise, including restrictions on aircraft types to be used and limits on the number of hourly or daily operations or the time of such operations. In some instances, these restrictions have caused curtailments in services or increases in operating costs, and such restrictions could limit our ability to expand our operations at the affected airports. Local authorities at other airports are considering adopting similar noise regulations.

Airports from time to time seek to increase the rates charged to airlines, and the ability of airlines to contest such increases has been restricted by federal legislation, DOT regulations and judicial decisions. Most recently, under the Aviation and Transportation Security Act (the "Aviation Security Act"), funding for airline and airport security is provided in part by a new $2.50 per enplanement ticket tax. The Aviation Security Act also allows the Department of Transportation to assess each airline fees that could total the amount spent by that airline on screening services in 2000. Additionally, because of significantly higher security and other costs incurred by airports since September 11, 2001, and because reduced landing weights since September 11, 2001 have reduced the fees airlines pay to airports, many airports are significantly increasing their rates and charges to air carriers. Some public airports impose passenger facility charges of up to $4.50 per segment for a maximum of $18 per roundtrip. With certain exceptions, these charges are passed on to customers.

The FAA has designated John F. Kennedy International Airport and LaGuardia Airport in New York, O'Hare International Airport in Chicago and Ronald Reagan Washington National Airport in Washington, D.C. as "high density traffic airports" and has limited the number of departure and arrival slots at those airports. In April 2000, legislation was signed phasing out slot restrictions beginning in 2001 at O'Hare, LaGuardia and Kennedy. All slots at O'Hare are scheduled to be eliminated by July 2002 and slots at LaGuardia and Kennedy are scheduled to be eliminated by 2007. The elimination of slots has had no material impact on us.

On April 14, 2000, the DOT implemented legislation which exempted from slot requirements service between high-density airports (except at Reagan National) and small cities using small aircraft. After the commencement of such operations, however, the FAA required airlines to reduce the number of flights operated at LaGuardia pursuant to the new legislation to reduce congestion and delays, and it seems likely such restrictions will continue.

Reagan National was closed to air service from September 11, 2001 through October 4, 2001, and the government is permitting service to be recommenced in phases. As of December 31, 2001, we were servicing Reagan National out of our New York and Houston hubs. Service out of Cleveland resumed in January 2002.

The availability of international routes to U.S. carriers is regulated by treaties and related agreements between the United States and foreign governments. The United States typically follows the practice of encouraging foreign governments to accept multiple carrier designation on foreign routes, although certain countries have sought to limit the number of carriers. Foreign route authorities may become less valuable to the extent that the United States and other countries adopt "open skies" policies liberalizing entry on international routes. We cannot predict what laws and regulations will be adopted or their impact, but the impact could be significant.

Many aspects of operations are subject to increasingly stringent federal, state and local laws protecting the environment. Future regulatory developments could adversely affect operations and increase operating costs in the airline industry.

Risk Factors - Terrorist Attacks

The terrorist attacks of September 11, 2001 involving commercial aircraft adversely affected our financial condition, results of operations and prospects, and the airline industry generally. Those effects continue, although they have been mitigated somewhat by increased traffic, the Stabilization Act and our cost-cutting measures. Moreover, additional terrorist attacks, even if not made directly on the airline industry, or the fear of such attacks, could further negatively impact us and the airline industry.

Among the effects we experienced from the September 11, 2001 terrorist attacks were significant flight disruption costs caused by the FAA-imposed grounding of the U.S. airline industry's fleet, significantly increased security, insurance and other costs, significantly higher ticket refunds, significantly reduced load factors, and significantly reduced yields. Further terrorist attacks using commercial aircraft could result in another grounding of our fleet, and would likely result in significant reductions in load factor and yields, along with increased ticket refunds and security, insurance and other costs. In addition, terrorist attacks not involving commercial aircraft, or other world events, could result in decreased load factors and yields for airlines, including us, and could also result in increased costs. For instance, fuel costs, which have declined since September 11, 2001, could escalate if oil-producing countries were impacted by hostilities or reduce output, which could also impact fuel availability. In February 2002, we purchased out of the money call options to hedge a significant increase in fuel costs for approximately 35% of our projected 2002 fuel requirements for the period March through December. Premiums for aviation insurance have increased substantially, and could escalate further, or certain aviation insurance could become unavailable or available only for reduced amounts of coverage that are insufficient to comply with the levels of insurance coverage required by aircraft lenders and lessors or required by applicable government regulations. Additionally, war-risk coverage or other insurance might cease to be available to our vendors, or might be available only at significantly increased premiums or for reduced amounts of coverage, which could adversely impact our operations or costs.

Due in part to the lack of predictability of future traffic, business mix and yields, we are currently unable to estimate the long-term impact on us of the events of September 11, 2001 and the sufficiency of our financial resources to absorb that impact. However, given the magnitude of these unprecedented events and their potential subsequent effects, the adverse impact to our financial condition, results of operations and prospects may continue to be material.

We may have to recognize further special charges related to grounded aircraft . As of January 31, 2002, we had 56 jet aircraft and 19 turboprop aircraft out of service from our fleet. The majority of these aircraft have been temporarily removed from service and we will continue to evaluate whether to return these temporarily grounded aircraft to service, which will primarily depend on demand and yield in the coming months. It is possible that all or a significant portion of these temporarily grounded aircraft will be permanently removed from service at a later date, which would result in special charges for impairment and lease exit costs. In the fourth quarter of 2001, we incurred a special charge of $61 million ($39 million after taxes) associated primarily with the impairment of various owned aircraft and spare engines, including all of the DC-10-30, ATR-42, EMB-120, and Boeing 747 and 727 aircraft we owned. We could suffer additional impairment of operating aircraft and other long-lived assets in the future if the economic environment in which we operate does not continue to improve or further deteriorates due to unforeseen circumstances. The special charges for all or a significant portion of the temporarily grounded aircraft would, and any additional special charges for impairment of operating aircraft and other long-lived assets could, be material.

The Aviation Security Act will impose additional costs and may cause service disruptions . In November 2001, the President signed into law the Aviation Security Act. This law federalizes substantially all aspects of civil aviation security, creating a new Transportation Security Administration under the Department of Transportation. Under the Aviation Security Act, all security screeners at airports will be federal employees, and significant other elements of airline and airport security will be overseen and performed by federal employees, including federal security managers, federal law enforcement officers, federal air marshals, and federal security screeners. Among other matters, the law mandates improved flight deck security, deployment of federal air marshals onboard flights, improved airport perimeter access security, airline crew security training, enhanced security screening of passengers, baggage, cargo, mail, employees and vendors, enhanced training and qualifications of security screening personnel, additional provision of passenger data to U.S. Customs, and enhanced background checks. Funding for airline and airport security under the law is provided by a new $2.50 per enplanement ticket tax (subject to a $5 per one-way trip cap), and a new annual tax on air carriers in an amount not to exceed the amounts paid in calendar year 2000 by carriers for screening passengers and property. Air carriers began collecting the new ticket tax from passengers, and became subject to the new tax on air carriers, on February 1, 2002. The law requires that the Undersecretary of Transportation for Security will assume all the civil aviation security functions and responsibilities related to passenger screening called for under the law beginning February 17, 2002, and provides that the Undersecretary may assume existing contracts for the provision of passenger screening services at U.S. airports for up to 270 days from that date, after which all security screeners must be federal employees. The law also requires that all checked baggage be screened by explosive detection systems by December 31, 2002, which will require significant equipment acquisitions by the government and may require facility and baggage process changes to implement. Implementation of the requirements of the Aviation Security Act will result in increased costs for us and our passengers and may result in delays and disruptions to air travel.

 

Risk Factors Relating to the Company

We continue to experience significant operating losses . Since September 11, 2001, we have not generated positive cash flow from our operations. Although improved traffic since September has significantly decreased the average daily negative cash flow from operations, our cash flow from operations as of February 20, 2002, remains negative at approximately $2 million per day, and we currently anticipate that we will incur a significant loss in the first quarter of 2002. We also expect to incur a loss for the fourth quarter of 2002 and for the full year 2002. Although load factors continue to improve, they have done so against significantly reduced capacity. The reduced capacity, coupled with the fact that many of our costs are fixed in the intermediate to long term, will continue to cause higher unit costs. Cost per available seat mile for 2002 is expected to increase 5%, holding fuel rate constant, as compared to 2001. This increase is partly attributable to anticipated additional insurance costs in 2002 of approximately $85 million. Business traffic in most markets continues to be weak, and carriers continue to offer reduced fares to attract passengers, which lowers our passenger revenue and yields and raises our break-even load factor. We cannot predict when business traffic or yields will increase.

In addition, our capacity purchase agreement with ExpressJet provides that we purchase in advance all of its available seat miles for a negotiated price, and we are at risk for reselling the available seat miles at market prices. We previously announced our intention to sell or otherwise dispose of some or all of our interests in ExpressJet. If we do so, then we would have greater fixed costs, which could result in lower or more volatile earnings or both. For example, for the year ended December 31, 2001, our pre-tax net loss of approximately $114 million included pre-tax net income for ExpressJet of approximately $80 million.

Our high leverage may affect our ability to satisfy our significant financing needs or meet our obligations . We have a higher proportion of debt compared to our equity capital than some of our principal competitors. We also have significant operating leases and facility rental costs. In addition, we have fewer cash resources than some of our principal competitors. Most of our property and equipment is subject to liens securing indebtedness. Accordingly, we may be less able than some of our competitors to withstand a prolonged recession in the airline industry or respond as flexibly to changing economic and competitive conditions.

As of December 31, 2001, we had approximately $4.6 billion (including current maturities) of long-term debt and capital lease obligations, $250 million liquidation amount of Continental-obligated mandatorily redeemable preferred securities of trust ($243 million net of unamortized discount), and $1.2 billion of stockholders' equity. We have substantial commitments for capital expenditures, including for the acquisition of new aircraft. As of December 31, 2001, we had firm commitments for 87 aircraft from Boeing, with an estimated cost of approximately $3.7 billion, after giving effect to the rescheduling discussed below. We expect that 20 of these aircraft will be delivered between January 2002 and May 2002. Thirteen of these 20 aircraft have been pre-financed, and we expect to finance the remaining seven aircraft. We have agreed with Boeing to reschedule deliveries of the remaining 67 aircraft so that they will be delivered between late 2003 and mid 2008. We do not have backstop financing from Boeing or any other financing currently in place for the remaining 67 aircraft.

As of December 31, 2001, ExpressJet had firm commitments for 137 regional jets from Empresa Brasileira de Aeronautica S.A. ("Embraer"), with an estimated cost of approximately $2.6 billion. We do not have any obligation to take any of these firm Embraer aircraft that are not financed by a third party and leased to us.

In addition, we have significant operating lease and facility rental obligations. For the year ended December 31, 2001 and 2000, cash expenditures under operating leases approximated $1.3 billion and $1.2 billion, respectively.

Additional financing will be needed to satisfy our capital commitments. We cannot predict whether sufficient financing will be available for capital expenditures not covered by firm financing commitments. On several occasions subsequent to September 11, 2001, each of Moody's Investors Service, Standard and Poor's and Fitch Ibca, Duff & Phelps downgraded the credit ratings of a number of major airlines, including our credit ratings. Reductions in our credit ratings may increase the cost and reduce the availability of financing to us.

Significant changes or extended periods of high fuel costs would materially affect our operating results . Fuel costs constitute a significant portion of our operating expense. Fuel costs represented approximately 13.5% of our operating expenses for the year ended December 31, 2001 (excluding severance and other special charges and Stabilization Act grant) and 15.2% of our operating expenses for the year ended December 31, 2000. Fuel prices and supplies are influenced significantly by international political and economic circumstances. From time to time we enter into petroleum swap contracts, petroleum call option contracts and/or jet fuel purchase commitments to provide some short-term protection (generally three to six months) against a sharp increase in jet fuel prices. Our fuel hedging strategy may limit our ability to benefit from declines in fuel prices. In February 2002, we purchased out of the money call options to hedge a significant increase in fuel costs for approximately 35% of our projected 2002 fuel requirements for the period March through December. If a fuel supply shortage were to arise from OPEC production curtailments, a disruption of oil imports or otherwise, higher fuel prices or reduction of scheduled airline service could result. Significant changes in fuel costs or extended periods of high jet fuel prices would materially affect our operating results.

Labor costs impact our results of operations . Labor costs constitute a significant percentage of our total operating costs. In July 2000, we completed a three-year program bringing all employees to industry standard wages and also announced and began implementing a phased plan to bring employee benefits to industry standard levels by 2003. The plan provides for increases in vacation, paid holidays, increased 401(k) matching cash contributions and additional past service retirement credit for most senior employees.

Collective bargaining agreements between us and our mechanics (who are represented by the International Brotherhood of Teamsters) and between both us and ExpressJet and our respective pilots (who are represented by the Air Line Pilots Association) are amendable in January 2002 and October 2002, respectively. Negotiations were deferred due to the economic uncertainty following the September 11, 2001 terrorist attacks. Negotiations with these employee groups have recommenced with the International Brotherhood of Teamsters in the first quarter of 2002 and are scheduled to commence with the Air Line Pilots Association in the summer of 2002. We will incur increased labor costs in connection with the negotiation of our collective bargaining agreements. In addition, certain other U.S. air carriers have experienced work slowdowns, strikes or other labor disruptions in connection with contract negotiations. Although we enjoy generally good relations with our employees, there can be no assurance that we will not experience labor disruptions in the future.

Our ability to utilize certain net operating loss carryforwards or investment tax credits may be limited by certain events . At December 31, 2001, we had estimated net operating loss carryforwards ("NOLs") of $1.5 billion for federal income tax purposes that will expire through 2022 and federal investment tax credit carryforwards of $27 million that will expire through 2002. Due to a change in our ownership on April 27, 1993, the ultimate utilization of our NOLs and investment tax credits may be limited, as described below.

Section 382 of the Internal Revenue Code ("Section 382") imposes limitations on a corporation's ability to utilize NOLs if it experiences an "ownership change." In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percentage points over a three-year period. In the event that an ownership change occurred, utilization of our NOLs would be subject to an annual limitation under Section 382 determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate (which is 4.82% for January 2002). Any unused annual limitation may be carried over to later years, and the amount of the limitation may under certain circumstances be increased by the built-in gains in assets held by us at the time of the change that are recognized in the five-year period after the change. Under current conditions, if an ownership change were to occur, our annual NOL utilization would be limited to approximately $93 million per year other than through the recognition of future built-in gain transactions.

In November 1998, Northwest Airlines Corporation completed its acquisition of certain equity interests in us previously held by Air Partners, L.P. and its affiliates, together with shares of our Class A common stock held by other investors, totaling 8,661,224 shares of the Class A common stock. On January 22, 2001, we repurchased 6,685,279 shares of our Class A common stock from Northwest Airlines Corporation and an affiliate. In addition, each issued share of our Class A common stock was reclassified into 1.32 shares of Class B common stock in a nontaxable transaction. We do not believe that these transactions resulted in an ownership change for purposes of Section 382.

Continental Micronesia's dependence on the Japanese economy may result in currency risk . Because the majority of CMI's traffic originates in Japan, its results of operations are substantially affected by the Japanese economy and changes in the value of the yen as compared to the U.S. dollar. To reduce the potential negative impact on CMI's earnings associated with fluctuations in currency, we have entered into forward contracts as a hedge against a portion of our expected net yen cash flow position. As of December 31, 2001, we had hedged approximately 80% of 2002 projected yen-denominated net cash flows at a weighted average rate of 116 yen to $1 US.

 

Risks Factors Relating to the Airline Industry

The industry in which we compete is highly competitive . The airline industry is highly competitive and susceptible to price discounting. Carriers use discount fares to stimulate traffic during periods of slack demand, to generate cash flow and to increase market share. Some of our competitors have substantially greater financial resources or lower cost structures than we do.

Airline profit levels are highly sensitive to changes in fuel costs, fare levels and passenger demand. Passenger demand and fare levels are influenced by, among other things, the state of the global economy, domestic and international events, airline capacity and pricing actions taken by carriers. The weak U.S. economy, turbulent international events and extensive price discounting by carriers contributed to unprecedented losses for U.S. airlines from 1990 to 1993. Since September 11, 2001, these same factors, together with the effects of the terrorist attacks and the industry's reduction in capacity, have resulted in dramatic losses for us and the airline industry generally. We cannot predict when conditions will improve.

In recent years, the major U.S. airlines have sought to form marketing alliances with other U.S. and foreign air carriers. Such alliances generally provide for code-sharing, frequent flyer reciprocity, coordinated scheduling of flights of each alliance member to permit convenient connections and other joint marketing activities. Such arrangements permit an airline to market flights operated by other alliance members as its own. This increases the destinations, connections and frequencies offered by the airline, which provide an opportunity to increase traffic on its segment of flights connecting with its alliance partners. Our alliance with Northwest Airlines is an example of such an arrangement, and we have existing alliances with numerous other air carriers. Other major U.S. airlines have alliances or planned alliances more extensive than ours. We cannot predict the extent to which we will be disadvantaged by competing alliances.

Since its deregulation in 1978, the U.S. airline industry has undergone substantial consolidation, and it may in the future experience additional consolidation. We routinely monitor changes in the competitive landscape and engage in analysis and discussions regarding our strategic position, including alliances and business combination transactions. We have had, and expect to continue to have, discussions with third parties regarding strategic alternatives. The impact of any consolidation within the U.S. airline industry cannot be predicted at this time.

Our business is subject to extensive government regulation . As evidenced by the enactment of the Aviation Security Act, airlines are subject to extensive regulatory and legal compliance requirements that result in significant costs. The FAA from time to time issues directives and other regulations relating to the maintenance and operation of aircraft that require significant expenditures. Some FAA requirements cover, among other things, retirement of older aircraft, security measures, collision avoidance systems, airborne windshear avoidance systems, noise abatement and other environmental concerns, commuter aircraft safety and increased inspections and maintenance procedures to be conducted on older aircraft. We expect to continue incurring expenses to comply with the FAA's regulations.

Additional laws, regulations, taxes and airport rates and charges have been proposed from time to time that could significantly increase the cost of airline operations or reduce revenues. Additionally, because of significantly higher security and other costs incurred by airports since September 11, 2001, and because reduced landing weights since September 11, 2001 have reduced the fees airlines pay to airports, many airports are significantly increasing their rates and charges to air carriers, including to us. Restrictions on the ownership and transfer of airline routes and takeoff and landing slots have also been proposed. See "Industry Regulation and Airport Access" above. The ability of U.S. carriers to operate international routes is subject to change because the applicable arrangements between the United States and foreign governments may be amended from time to time, or because appropriate slots or facilities are not made available. We cannot provide assurance that laws or regulations enacted in the future will not adversely affect us.

Our operations are affected by the seasonality associated with the airline industry . Due to greater demand for air travel during the summer months, revenue in the airline industry in the second and third quarters of the year is generally stronger than revenue in the first and fourth quarters of the year for most U.S. air carriers. Our results of operations generally reflect this seasonality, but have also been impacted by numerous other factors that are not necessarily seasonal, including the extent and nature of competition from other airlines, fare actions, excise and similar taxes, changing levels of operations, fuel prices, weather, air traffic control delays, foreign currency exchange rates and general economic conditions.

ITEM 2. PROPERTIES.

Flight Equipment

As shown in the following table, our operating aircraft fleet consisted of 352 jets, 137 regional jets and 33 turboprop aircraft at December 31, 2001. Our purchase commitments (orders) and aircraft options as of December 31, 2001 are also shown below.

 

Aircraft

Type   

Total        

Aircraft  (a)

 

Owned

 

Leased

 

Orders

 

Options

Seats in     

Standard     Configuration

Average Age

(In Years)   

               

777-200ER

16 

12 

2

4

283        

2.7       

767-400ER

10

-

235        

1.1       

767-200ER

10 

-

6

174        

0.8       

757-300

13

5

210        

0.1       

757-200

41 

13 

28 

-

-

183        

4.9       

737-900

10 

5

12

167        

0.4       

737-800

73 

20 

53 

42

32

155        

1.9       

737-700

36 

12 

24 

15

24

124        

3.0       

737-500

66 

15 

51 

-

-

104        

5.7       

737-300

59 

11 

48 

-

-

124        

14.5       

MD-80

33  

  5  

28  

-

-

141        

16.6       

Mainline jets

352

 101  

251  

87

 83

              

6.5

               

ERJ-145XR

-  

104

100

50        

-         

ERJ-145

107 

18 

89 

33

-

50        

2.2       

ERJ-135

  30  

    -  

  30  

  -

   -

  37        

1.3

Regional jets

 137  

  18  

119  

137

100

              

 

Total jets

489  

119  

370  

   

              

5.2

               

ATR-42-320

25 

17 

   

46        

11.7       

EMB-120

   8  

   2  

   6  

   

30        

11.9       

 

 33  

10  

 23  

     

       

               

Total

522  

129  

393  

     

 5.7

  1. Excludes 24 DC-10-30 aircraft, two 747-200 aircraft, two 727-200 aircraft, 25 MD-80 aircraft, six 737-300 aircraft, 11 EMB-120 turboprop aircraft, six ATR-42 turboprop aircraft and one Beech-1900D turboprop aircraft removed from service as of December 31, 2001.

Most of the aircraft and engines we own are subject to mortgages.

During 2001, we put into service a total of 36 new Boeing aircraft which consisted of two 767-400ER aircraft, seven 767-200ER aircraft, two 757-300 aircraft, ten 737-900 aircraft and 15 737-800 aircraft. During late 2001, we converted eight firm commitments for Boeing 767 aircraft into 22 firm commitments for Boeing 737 aircraft. ExpressJet took delivery of 29 ERJ-145 aircraft and 12 ERJ-135 aircraft in 2001. We removed from service 17 DC-10-30 aircraft, 32 MD-80 aircraft and six 737-300 aircraft in 2001. ExpressJet removed from service six ATR-42 aircraft, 12 EMB-120 aircraft and 19 Beech 1900 aircraft in 2001.

We anticipate taking delivery of 20 Boeing jet aircraft in 2002 and the remainder of our firm orders through 2008. Also in 2002, we plan to retire from service 18 jet aircraft, the leases for which expire in 2002.

ExpressJet anticipates taking delivery of 51 Embraer regional jet aircraft in 2002 and the remainder of its firm orders through the first quarter of 2005. We plan to retire 27 turboprop aircraft in 2002 and the remaining turboprop aircraft in 2003.

See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Commitments" for a discussion of our order for new firm commitment aircraft and related financing arrangements.

Facilities

Our principal facilities are located at Newark, Bush Intercontinental, Hopkins International and A.B. Won Pat International Airport in Guam. Substantially all of these facilities and our other facilities are leased on a long-term, net-rental basis, and we are responsible for maintenance, taxes, insurance and other facility-related expenses and services. At each of our three domestic hub cities and most other locations, our passenger and baggage handling space is leased directly from the airport authority on varying terms dependent on prevailing practice at each airport. We also maintain administrative offices, airport and terminal facilities, training facilities and other facilities related to the airline business in the cities we serve.

We have entered into agreements with the cities of Houston, Texas and Cleveland, Ohio, the New Jersey Economic Development Authority, the Port Authority of New York and New Jersey, the Hawaii Department of Transportation, the Regional Airports Improvement Corporation (in Los Angeles, California), and the Harris County (Houston) Industrial Development Corporation to provide funds for constructing, improving and modifying facilities that have been or will be leased to us and for acquiring related equipment. In connection therewith, we have unconditionally guaranteed the principal and interest on tax-exempt bonds issued by these entities with a par value in an original principal amount of approximately $1.6 billion (excluding the City of Houston bonds referenced below) and entered into long-term leases with the respective authorities under which rental payments will be sufficient to service the related bonds. The leases generally have terms ranging from 20 to 30 years.

During 2001, construction continued under Continental's Global Gateway Program at Newark International Airport. The program includes construction of a new concourse in Terminal C, which opened in December 2001, a new federal inspection services facility for processing arriving international passengers, which is expected to be completed in the second quarter of 2002, and other facility improvements. The remaining portions of the Global Gateway Program are expected to be completed during 2002.

In August 2001, the City of Houston completed the offering of $324 million aggregate principal amount of tax-exempt special facilities revenue bonds to finance the construction of Terminal E at Bush Intercontinental Airport. In connection therewith, we entered into a long-term lease with the City of Houston requiring that upon completion of construction, with limited exceptions, we will make rental payments sufficient to service the related tax-exempt bonds through their maturity in 2029. Approximately $27 million of the bond proceeds have been expended as of December 31, 2001. During the construction period, we maintain certain risks related to our own actions or inactions while managing portions of the construction. Potential obligations associated with these risks are generally limited based upon certain percentages of construction costs incurred to date. We have also entered into a binding corporate guaranty with the bond trustee for the repayment of the principal and interest on the bonds that becomes effective upon the occurrence of the completion of construction, our failure to comply with the lease agreement (which is within our control), or our termination of the lease agreement. Further, we have not assumed any condemnation risk, any casualty event risk (unless caused by us), or risk related to certain cost overruns (and in the case of cost overruns, our liability for the project would be limited to 89.9% of the capitalized costs) during the construction period. Accordingly, we are not considered the owner of the project and, therefore, have not capitalized the construction costs or recorded the debt obligation in our consolidated financial statements.

We have cargo facilities at Los Angeles International Airport, which we sublease to another carrier. If the carrier failed to comply with its obligations under the sublease, we would be required to perform those obligations. We have guaranteed the repayment of principal and interest on $24 million par value bonds related to this facility, which amount is included in our total $1.6 billion guaranteed obligations described above.

We remain contingently liable until December 1, 2015, for US Airways, Inc.'s obligations under a lease agreement between US Airways and the Port Authority of New York and New Jersey related to the East End Terminal at LaGuardia airport. These obligations include the payment of ground rentals to the Port Authority and the payment of principal and interest on $189 million par value special facilities revenue bonds issued by the Port Authority, which amount is included in our total $1.6 billion guaranteed obligations described above. If US Airways defaulted on these obligations, we could be required to cure the default, at which time we would have the right to occupy the terminal.

 

ITEM 3. LEGAL PROCEEDINGS.

Legal Proceedings

On July 25, 2000, a Concorde aircraft operated by Air France crashed shortly after takeoff from France's Charles de Gaulle airport, killing 114 people, most of whom were tourists on board the chartered aircraft, which was also destroyed. The final investigative report of the French authorities, issued January 15, 2002, suggests that one of the aircraft's tires burst after running over a small piece of metal believed by investigators to have come from one of our DC-10 aircraft that had taken off on the same runway a short time before the Concorde and that portions of the resulting debris struck the underside of a wing of the aircraft which caused the rupture of a fuel tank, leading to a fire and the crash.

The following lawsuits involving us are pending in connection with the accident: Air France and its Insurers v. Continental Airlines, Inc., USAU, Inc, and USAIG filed on September 15, 2000 before the Commercial Court of Pontoise, France, in which the plaintiffs seek damages for indemnification paid to the passengers' families and other parties, for destruction of the aircraft, and for any other expenses and costs incurred by Air France; and Cause No. 2001-37394, Phillippe Fournel , et al. Plaintiffs v. Continental Airlines, Inc. and Goodyear Tire and Rubber Company , Defendants v. Air France S.A., BAE Systems PLC, British Aerospace Corporation, European Aeronautic Defense & Space Company, N.V. and Aerospatiale Matra S.A., Third Party Defendants , filed on July 25, 2001 in the 281 st Judicial District Court of Harris County, Texas, in which plaintiffs seek compensatory and punitive damages in connection with the deaths of five crew members on board the Concorde.

The foregoing cases are in preliminary stages. Although the outcome of such suits or any future litigation cannot be known at this time, our costs to defend these matters and, we believe, any potential liability exposure is covered by insurance. Consequently, we do not expect the foregoing litigation or any additional suits that may arise from the accident to have a material adverse effect on our financial position or results of operations.

Two cases previously disclosed in our reports have been dismissed. Case No.

00-07707, In re: Petition of Ina Frentzen, Rita Frentzen-Bien, and Ralf Frentzen Requesting Depositions Before Suit filed on September 29, 2000 in the District Court for Dallas County, Texas, D-95th Judicial District (Parties in interest include Continental Airlines, Inc. and The Goodyear Tire & Rubber Company), in which the plaintiffs sought to depose certain parties, including our officers and employees, prior to determining whether to file suit against us and certain other parties, was dismissed by the District Court on June 20, 2001 in connection with a settlement agreement among the parties and certain insurers. Case No. 01CIV.0149, Dr. Hans-Joachim Schnitter, Dietmar Schnitter, Kerstin Hoffman, Carola Wagner and Annette Friedland v. Air France, S.A., Continental Airlines, Inc., BAE Systems plc, European Aeronautic Defense and Space Company N.V., The Goodyear Tire and Rubber Company, General Electric Company, MRA Systems, Inc. , filed on January 9, 2001 in the United States District Court for the Southern District of New York, in which the plaintiffs sought compensatory and punitive damages in connection with the deaths of three passengers on board the Concorde, was dismissed by the District Court on June 21, 2001 in connection with a settlement agreement among the parties and certain insurers.

Environmental Proceedings

Under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (commonly known as "Superfund") and similar state environment cleanup laws, generators of waste disposed of at designated sites may, under certain circumstances, be subject to joint and several liability for investigation and remediation costs. We (including our predecessors) have been identified as a potentially responsible party at six federal and two state sites that are undergoing or have undergone investigation or remediation. We have entered into a settlement agreement with the Environmental Protection Agency ("EPA") with respect to five of the federal sites. The settlement agreement provides for the EPA to receive an allowed unsecured claim of approximately $1.3 million under our 1993 Plan of Reorganization and approximately $230,000 in cash, in full satisfaction of any and all of our liabilities relating to such sites. In addition, we have settled one of the state sites for a de minimis amount. With respect to the remaining sites, we believe that, although applicable case law is evolving and some cases may be interpreted to the contrary, some or all of any liability claims associated with these sites were discharged by confirmation of our 1993 Plan of Reorganization, principally because our exposure is based on alleged offsite disposal known as of the date of confirmation. Even if any such claims were not discharged, on the basis of currently available information, we believe that our potential liability for our allocable share of the cost to remedy each site (to the extent we are found to have liability) is not, in the aggregate, material; however, we have not been designated a "de minimis" contributor at any of such sites.

We are also and may from time to time become involved in other environmental matters, including the investigation and/or remediation of environmental conditions at properties we use or previously used. In 2001, we recorded a charge of $17 million, net of anticipated insurance recoveries, to provide additional reserves for potential environmental remediation costs. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. "Liquidity and Capital Resources - Environmental Matters". Although we are not currently subject to any environmental cleanup orders imposed by regulatory authorities, we are undertaking voluntary investigation or remediation at certain properties in consultation with such authorities. The full nature and extent of any contamination at these properties and the parties responsible for such contamination have not been determined, but based on currently available information and our current reserves, we do not believe that any environmental liability associated with such properties will have a material adverse effect on us.

General

Various other claims and lawsuits against us are pending that are of the type generally consistent with our business. We cannot at this time reasonably estimate the possible loss or range of loss that could be experienced if any of the claims were successful. Many of such claims and lawsuits are covered in whole or in part by insurance. We do not believe that the foregoing matters will have a material adverse effect on us.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

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