CASE SUDY

Written by Stephane Duchenne, Carol Ann Fisher, Jeffrey S. Harrison, Cheryl Farr Leas, Yash Krishna, Michel Rugema and Yongqing Yang at the School of Hotel Administration, Cornell University. Copyright c Jeffrey S. Harrison. This case study was written for the purposes of classroom discussion. It is not to be duplicated or cited in any form without the copyright holder’s express permission. For permission to reproduce or cite this case, contact Jeffrey S. Harrison (harrison@richmond.edu). Permission to use in the classroom will be granted free of charge.

The Center for Hospitality Research AT CORNELL UNIVERSITY

CAN CONTINENTAL AIRLINES CONTINUE TO WORK HARD, FLY RIGHT & FUND

THE FUTURE? We weren't just the worst big airline. We lapped the field.

– CEO Gordon Bethune1

When Gordon Bethune arrived in Continental Airlines' executive offices in February 1994, he almost turned around and left again. Continental was the lowest- performing of the major U.S. airlines. It had the worst on-time record, filed the most mishandled-bag reports, and received customer complaints at a rate of nearly three times the industry average.2

1 Bethune, Gordon with Scott Huler. From Worst to First: Behind the Scenes of Continental's Remarkable Comeback. New York: John Wiley & Sons, 1998, p. 4.

2 Ibid.

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Worst of all was employee morale. Sick time, turnover, on-the-job injuries, and worker's compensation claims stood at record highs, and a culture of mistrust reigned. Airport employees were so embarrassed by the company that they ripped their logo patches from their shirts to avoid having to answer for the company's behavior to customers and airport coworkers.3

Within two years, Continental Airlines was transformed from almost-certain doom as one of the worst performers in the airline industry into a standard-bearer in all respects: profitability, reliability, customer service, and employee satisfaction. And despite the turmoil in which the airline industry finds itself in the post-September 11th world, Continental continues to survive. The key is a well-focused brand and a clearly defined corporate culture in which everybody works together to win.

A Short History of Continental Airlines Continental Airlines has such a fascinating history that it has been the subject of at

least two books. Maverick tells the Continental Airlines tale from 1937 to 1980, the 43-year span when the airline's guiding influence was Robert Forman Six, CEO for 40 of those years.4 From Worst to First, takes over the narrative in 1994, revealing how the current CEO, Gordon Bethune, turned a woefully unprofitable company--Continental Airlines declared bankruptcy twice between 1983 and 1990--into one of the most admired airline companies in the industry today.5 Exhibit 1 contains some of the highlights of Continental Airlines’ History.

The Maverick Years Louis Mueller and Walter T. Varney created Varney Speed Lines in 1934. Varney

transported mail and some passengers in the southwestern region of the United States. In July 1936, Mueller sold 40% of the company to Robert Forman Six, who renamed the fledgling carrier Continental Airlines in 1937--and went on to become one of the greatest leaders of the industry. In Maverick, author Serling states: “Without question, he is as complex a person who ever headed an airline. He is hard, quick-tempered, profane and dictatorial. He is also soft, warm-hearted, sentimental, deeply religious and generous.”6

3 Ibid, p. 5-6; also Brenneman, Greg. "Right Away and All At Once: How We Saved Continental," Harvard Business Review, Sept-Oct 1998; HBR OnPoint product no. 4193; p. 12.

4 Serling, Robert J. Maverick. Garden City, NY: Doubleday, 1974. 5 Bethune and Huler. From Worst to First. New York: John Wiley & Sons, 1998. 6 Serling, Maverick, p. 321.

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When Robert F. Six took over as Continental’s CEO, his long-term goal was to provide reliable and profitable flights, which would eventually fly beyond the borders of the United States.7

In the years preceding World War II, Continental flew to destinations that included El Paso, Albuquerque, Las Vegas, and cities within Colorado. As the war approached an end, Continental expanded its regional route structure with service between Denver, Colorado, and Kansas City, Missouri; and between El Paso and San Antonio, Texas. By 1945, the company had 400 employees and was serving 26 cities.8

Determined to expand its role as a regional airline, Six merged Continental with Pioneer Airlines in 1953 and expanded its routes to 46 cities. The new, larger carrier provided service to every city in Texas with a population of more than 100,000 inhabitants.9

In June 1959, Six determined to set Continental apart from its main competitors, who were then just joining the jet age. He introduced the Boeing 707 into the fleet. To maintain its small jet fleet, Continental developed an innovative “progressive maintenance” program that enabled the jet fleet to fly 7 days a week, 16 hours a day.10

In the 1960s, Continental doubled its route structure and achieved its goal of flying internationally. The airline began servicing routes to Southeast Asia, and launched charter services to such European cities as Frankfurt, London, Paris, and Rome. In 1967, Continental won a five-year contract for routes to Micronesia. Out of the pact a new enterprise was born to fly the routes: Air Micronesia (informally known as “Air Mike”).11

The Era of Deregulation Federal regulation of domestic airline fares and markets ended with the U.S.

government's Airline Deregulation Act of 1978.12 What followed was a period of evolution and metamorphosis that changed the nature of flying forever. The goal of the act was to promote competition within the industry: It essentially gave airlines unrestricted rights to enter new routes without Civil Aeronautics Board (CAB) approval. The companies could also exit any market as well as raise and lower fares at will.

7 Ibid., p. 37. 8 Serling, Maverick. Also online at www.boeing.com/commercial/aeromagazine/aero, 11/8/02. 9 Ibid. 10 Ibid. 11 Continental Airlines website, “History 1959 to 1977,” Online at www.continental.com/company/history/1959-

1977.asp (viewed 11/10/02) The contract became a permanent operation that became Continental Micronesia and celebrated 30 years of success in 1998.

12 The Department of Transport and its affiliated agency, the Federal Aviation Administration (FAA) continue to regulate the industry with regard to safety, labor, operating procedures, and aircraft fitness, and emission levels. Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, p. 21.

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At the same time, the oil-producing countries in the Middle East formed a cartel and raised the price of jet fuel 88% in 1979, capped by an additional 23% in 1980. Higher jet fuel costs--combined with tumbling fares and increased passenger loads due to increased competition after deregulation--caused Continental’s profits to drop. Although deregulation allowed Continental to add 18 new routes in 1979, it also brought about an end to the airline’s long stretch of sustained profitability.

By 1980, after 40 years of service at Continental, Robert F. Six was no longer involved with the day-to-day operations at Continental; still, he remained Chairman of the Board of Directors. Due to losses, Continental suffered its first decrease in work force in 45 years of operation. Employee morale was at an all-time low. Help came in the form of a merger with Texas International, led by Frank Lorenzo, in 1982. Lorenzo became Chairman, President, and Chief Executive Officer of the new Continental Airlines. The merger allowed Continental to provided flight service to four continents--and Six’s goals were at last achieved. It did not provide an instant solution to the pressures of deregulation and increasing oil prices, however. Lorenzo was unsuccessful in negotiating restructured salaries for unionized employees, and, in late 1983, Continental was forced to file for Chapter XI bankruptcy reorganization.

Lorenzo reacted strongly to the news: He fired the entire staff, closed the doors to the airline for three days, and emerged with a company about one third Continental’s original size. By firing all employees, Lorenzo was able to reopen Continental with a non- union staff.13 The new company regained its competitive position by the end of the year, posting a small profit by the end of 1984. In 1986, Continental reported the largest profits in the airline’s 51-year history. In the same year, Lorenzo acquired Eastern Airlines, People Express, and Frontier Airlines, which gave Continental the largest route network in the United States.

Under Lorenzo’s direction, Continental adopted the dual strategy of developing hubs and strategic alliances as a way to remain competitive in the era of deregulation. Continental needed a steady flow of passengers to and from its hub cities, so it created Continental Express in 1987 as a means to deliver passengers to hub airports for onward flights, and formed a global alliance with Scandinavian Airlines (SAS) in 1988 in which SAS acquired 18.4% of Continental.

While the partnership with SAS has long since ended, Continental continues to follow this two-pronged strategy today. The airline's hubs in Newark, Cleveland, Houston, and Guam are fundamental to Continental’s route design. Its large family of

13 “Public Broadcasting System, Innovators: Frank Lorenzo,” online at www.pbs.org/kcet/chasingthesun/ innovators/florenzo.html (viewed 12/2/02).

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partners are as important as its hubs, as they allow passengers traveling to overseas markets to connect to other destinations using the alliance’s market routes.

Working under Frank Lorenzo was not an easy experience, however. The CEO position was in constant turmoil between 1980 and 1990, with six chief officers filling the position in ten years. In fact, all employees found conditions under Lorenzo difficult to endure. Labor relations under Lorenzo were amazingly bitter between 1980 and 1990. On October 26, 1989, the Congressional Record noted that “Frank Lorenzo has sabotaged a distinguished airline and disrupted the lives of its employees”--and the United States Congress declares him “unfit” to run an airline. In 1990, Lorenzo was forced out of Continental and Holland Harris took command.

Harris was unable to work a rapid turnaround. Citing rising fuel costs and the onset of the Gulf War, Continental filed for Chapter XI bankruptcy protection for a second time.

Climbing the Ladder from Worst to First14 In 1993, Continental Airlines emerged from bankruptcy when leveraged buyout

firm Air Partners, led by David Bonderman, invested $450 million in the company. In an attempt to compete with low-cost carriers, Continental launched a new company in 1993 called Continental Lite—which turned out to be not only unprofitable, but also detrimental to the already floundering image of Continental Airlines. Continental Lite was dismantled in 1995.

When Gordon Bethune left Boeing to become president of Continental in 1994, stakeholders despised the company—travelers, employees, and shareholders alike. However, under his leadership, Continental achieved 21 consecutive profitable quarters and has won more awards for customer satisfaction than any other airline.

The turnaround of Continental Airlines wasn't magic—far from it. Rather, it was the result of decisive leadership and a simple but clearly defined strategy that focused on understanding who the airline's target market is, improving products to compete in the marketplace, increasing revenues, and giving employees with the power and enthusiasm to make success happen.15

14 Bethune, Gordon with Scott Huler. From Worst to First: Behind the Scenes of Continental's Remarkable Comeback. New York: John Wiley & Sons, 1998.

15 Ibid; introduction, "The Idea in Brief."

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Believing that there was nowhere to go but up, newly minted CEO Gordon Bethune and his chief operating officer Greg Brenneman, sat down and defined the Go Forward Plan.16 Its cornerstones are:

Fly to Win: The marketing plan, focused on identifying who Continental's customers are and how the company can best meet their needs;

Fund the Future: The financial plan that laid the foundation for profitable growth;

Make Reliability a Reality: The product plan geared to realizing tangible results for customers and employees alike; and

Working Together: The people plan, defining a workplace culture of trust, involvement, empowerment, performance-based incentives, civility, and respect.

Major aspects of the plan included bonuses to travel agents to book passengers to Continental, bonuses to employees if the flights landed on time, and a significant reduction in management/employee barriers. This four-point vision statement laid the foundation for Continental's reinvention--and continues to drive both brand identity and corporate culture today.

But Is Continental Ready to Face Fundamental Shifts in the Airline Industry?

On January 17, 2001, Continental Airlines announced its financial results for the year 2000–proudly announcing six straight years of profitability. This continued profitability was even more remarkable when compared with Continental filing for Chapter XI bankruptcy protection for the second time in seven years in 1990. The “Go Forward Plan” allowed Continental to improve operational performance and working environment for employees and achieve sustained profitability.17 In early 2001, all indications pointed to a solid and enduring recovery for Continental Airlines.

But then the foundations of the airline industry were shaken to the core on September 11, 2001. The federal government grounded all flights in response to the terrorist attacks on New York City and Washington, D.C. The unprecedented suspension of airline operations continued until September 14, 2001, when Secretary of Transportation Norman Mineta allowed certain general aviation flights back into the US airspace in late afternoon.18

16 Ibid.; pp. 4-5. 17 Continental Airlines, “History 1991 to Now,” online at www.continental.com/company/history/1991-now.asp

(viewed 11/18/02). 18 Federal Aviation Agency Press Release, “Secretary Mineta Re-Opens Skies to General Aviation,” 11/14/01; reference

DOT 97-01, online at www2.faa.gov/index.cfm/apa/1062?id=1408 (viewed 11/13/02).

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In the last four months of 2001, Continental Airlines, the fifth largest airline company in the United States (as measured by 2001 revenue passenger miles), lost $189 million despite a $417 million grant from the federal government.19 During the first nine months of 2002, Continental’s net loss was $342 million,20 with Continental losing approximately $1.3 million each day of the year; by year's end, Continental's net losses totaled $451 million.21 On August 11, 2002, U.S. Airways filed for Chapter XI bankruptcy protection.22 Given this turbulent environment, will Continental Airlines be able to survive and prosper?

The Environment Continental Airlines is battling for its very survival in an extremely turbulent

broad environment that has forced many carriers, including the mighty United Airlines, to the brink of bankruptcy.23 In fact, the entire commercial air transport industry is mired in a complex web of socio-cultural, economic, technological, political, and competitive forces. Competition is fierce, and investments needed to succeed are high. At the end of 2002, air carriers were still trying to figure out how to navigate the shock waves resulting from the terrorist attacks of September 11, 2001, as well as a sea change in business travel patterns that may well be permanently undermining the legacy carriers' longstanding business models.

Industry Overview The world's airlines carry 1.4 billion passengers per year24, and the airline industry

is a significant part of the American economy. In 2000, the U.S. airline industry launched over 24,600 flights a day, employed roughly 680,000 people, and recorded $129.5 billion in revenues.25

Since 1978, when federal government regulation of domestic fares and markets ended with the Airline Deregulation Act,26 passenger demand for air transportation has

19 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, pp. 6, 18. 20 Continental Airlines. Securities & Exchange Committee Quarterly Report for Continental Airlines, Inc. for period ending

9/30/02. p. 3. 21 Source: Continental Airlines, Inc. 2002 Annual Report, p. 22. 22 Carey, Susan. “UAL Posts $889 Million Loss for Third Quarter,” The Wall Street Journal, 10/21/02, p. A3. Also Power,

Stephen and Susan Carey. "Panel Rejects United's Call for Federal Loan Guarantee," The Wall Street Journal Online, 12/5/02; online at http://online.wsj.com/article/0,,SB1039043151540787993,00.html (viewed 12/5/02).

23 Associated Press, "United Airlines, Mechanics Hoping to Prevent Bankruptcy," 12/1/02; online at www.cnn.com/2002/TRAVEL/12/01/united.airlines.ap/index.html (viewed 12/3/02).

24 Goeldner, Charles R. and J.R. Brent Ritchie. Tourism: Principles, Practices, Philosophies, 9th Edition. Hoboken, NJ: John Wiley & Sons. P. 124.

25 Ibid. p. 125. 26 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, p. 21.

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grown at an average rate of 4% per year. As the Air Transport Association reported in 1999, "Now there are more than twice as many people fly today as did two decades ago, and at prices that have dropped dramatically. These facts reflect that the airline industry is an economically vibrant, highly competitive and productive industry.”27

During 2000, the U.S. airline industry provided services to 666.2 million passengers. However, in 2001, the number of passengers dropped to 622.1 million, a decrease of 6.6%.28 The airline industry measures its capacity in terms of Available Seat Miles (ASMs), and its utilization of that capacity in terms of Revenue Passenger Miles. By comparing the two, the industry calculates its passenger load factor. Exhibit 2 describes recent trends in U.S. airline traffic and operations29.

The airline industry has a clear size-based classification structure, according to

airline revenue base:30

Major Airlines: Carriers that have annual revenues exceeding $1 billion. The leading nine major airlines in the U.S. include United Airlines, American Airlines, Delta Air Lines, Northwest Airlines, Continental Airlines, Southwest Airlines, US Airways, America West Airlines, and Alaska Airlines.

National Airlines: Carriers that have annual revenues that between $100 million and $1 billion. National airlines include JetBlue, Frontier, Midway, and others.

Regional Airlines: Carriers that have annual revenues of less than $100 million. Regional airlines include AccessAir, Ameristar Jet Charter, Falcon Air Express, Laker Airways, Sun Pacific, and many others.

Commercial airlines have two major types of customers: travel passengers, and clients who ship cargo. The U.S. airlines transport more than 665 million passengers and nearly 30 billion ton miles of cargo annually; in the U.S., more than 1.8 million passengers fly every day. On average, airlines generate 75% of their revenues from passengers, while 15% of revenues are from cargo transport fees; another 10% in revenue is generated from additional fees, such as the sale of in-flight alcoholic beverages and entertainment.31 Airlines compete for travel passengers by offering products differentiated by destination,

27 Air Transport Association of America, Facts & Figures of the U.S. Scheduled Airlines 1999 , online at www.air- transport.org.

28 Air Transport Association of America, 2002 Annual Report, p. 6. 29 Ibid., p. 7. 30 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines. March 28, 2002. p. 16. 31 Air Transport Association of America, "Keeping Customers First," online at www.customers-first.org (viewed

11/17/02).

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class of service, frequent-flyer programs, change restrictions, in-flight amenities--and, of course, price.

The industry is characterized by high fixed costs. Roughly 80% of airline costs are fixed in that they do not vary depending on customer demand.32 Equipment costs are very high, especially for aircraft, which require large maintenance expenditures. Airlines also make significant investments in facilities infrastructure, such as airports and maintenance facilities. In 2001, “the total value of these investments, net of depreciation, reached $89.6 billion of assets totaling $158.4 billion,” reports the Air Transport Association of America.33 Labor costs, including both fixed and variable components, absorb about 40% of total industry revenues, and represent the largest portion of expenses for an airline. While they continue to rise sharply, industry watchers report no sign of labor productivity improvements since 1996.34 After salaries and wages, the second-largest operating cost for airlines is jet fuel.

The Airline Industry Changes: Deregulation (1978) Prior to 1978, the Civil Aeronautics Board (CAB) regulated airline activity in the

U.S., controlling routes that airlines could fly and the fares they could charge. The federal Airline Deregulation Act of 1978 phased out the federal government’s control over airfares and services in the domestic market. Since 1978, market forces have determined the price, quantity and quality of domestic air services. The act sparked a fundamental shift in the history of the airline industry, leading to improved service, lower airfares, and increased air travel--all benefits derived from free-market competition.35

Deregulation opened the airline industry market for existing airlines as well as newcomers, since airlines no longer needed to apply to the CAB for authorization to fly the routes they wanted to operate. As a result, the airline industry has witnessed the entry (and exit) of many low-fare carriers, as well as several established airlines that could no longer compete in the new environment, such as Pan Am and Eastern Airlines.36

Increased competition brought more scheduled U.S. passenger carriers and more convenient travel options than what was available 20 years ago. In 1978, there were 30 scheduled passenger airlines classified by the Civil Aeronautics Board; after deregulation,

32 Dr. Rob Britton, Managing Director of Advertising, American Airlines; lecture at Cornell University School of Hotel Administration, 11/22/02.

33 Air Transport Association of America, 2002 Annual Report, p. 13. 34 Ibid., p. 2, 12. 35 Kahn, Alfred E., “Airline Deregulation,” The Concise Encyclopedia of Economics, online at

www.econlib.org/library/Enc/AirlineDeregulation.html (viewed 12/4/02). 36 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02, p. 8.

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the number of scheduled U.S. carriers peaked at 49 in 1985. At the end of 1998, there were 42 large scheduled certificated air carriers.37

However, significant operational limits hamper the development of new airlines. At an increasing number of major airports, the lack of access to gate stands in the way of new entrants and becomes the new entry barrier.38 Existing leases for gate access give leaseholding airlines exclusive rights to an airport’s gates over a long period of time, commonly 20 years, which prevent entrants to a market access to these gates. In some cases, major airlines that have the exclusive-use gate leases will sublease to other airlines, including startup airlines, at non-preferred times and at high premiums.39

Since deregulation, consumers have experienced some dramatic changes in the level of air service in most U.S. communities. The General Accounting Office defines service levels for a given community as a combination of several factors: number of departures, number of available seats, number of destinations served non-stop from the community, and number of jet departures (compared to the number of turboprop departures). “In general, airports serving larger communities have benefited from a greater increase in overall quality of air service . . . than those serving smaller communities.”40 Thanks to the hub-and-spoke operating structure favored by the major airlines--particularly such legacy carriers as American, Delta, Continental, and United-- domestic destination availability has increased by 35% to 40% over the last 20 years.41

During the period 1978 through 1998, domestic Revenue Passenger Miles (RPM) grew at almost double the rate of the growth of the economy, while regional RPMs grew at over five times the rate. (From 1978 to 1998, average GDP increased 2.6% per year, while air carrier RPMs increased 4.8% and regional RPMs increased 14.3%.) International travel has grown at an even faster pace than domestic travel: In the past 20 years, international RPMs have grown at 1.5 times the rate of growth of domestic RPMs, reaching 7.0% per year.42

Increased competition following deregulation also resulted in lower airfares for passengers. The U.S. General Accounting Office reports that, overall, average airfares declined by about 21% in constant dollars between 1990 and second quarter 1998.43 Price competition was unleashed by deregulation, according to the Air Transport Association:

37 U.S. General Accounting Office. “Barriers to Entry Continue to Limit Benefits of Airline Deregulation,” 5/13/97. 38 Ibid. 39 Ibid. 40 United States General Accounting Office. “Airline Deregulation: Changes in Airfares, Service Quality and Barriers to

Entry,” March 1999. p. 11. 41 Kahn. “Airline Deregulation,” The Concise Encyclopedia of Economics. 42 U.S. General Accounting Office. 20 Years of Deregulation, 1978 to 1998, 1998. 43 U.S. General Accounting Office. Airline Deregulation: Changes in Airfares, Service Quality and Barriers to Entry, March

1999. p. 2.

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By the end of the 1990s, roughly 90% of all passenger miles traveled were traveled on discounted-fare tickets, at an average discount of 65% off the posted coach fare.44

Another Sea Change: The Terrorist Attacks of September 11, 2001 The terrorist attacks on New York City's World Trade Center and the Pentagon on

September 11, 2001, changed the airline industry forever. In an unprecedented move by order of the federal government, the U.S. airline system was suspended for several days following the attacks. According to the Air Transport Association, the industry suffered losses of approximately $1.4 billion as a result of the shutdown. Furthermore, the global airline business lost $11 billion in 2001, with losses in the U.S. market along reaching $9 billion. The ATA's forecast that the U.S. airline industry would lose another $6 billion in 2002 as the turbulence from 9-11 persisted45 proved to be a conservative estimate; ultimately, the net losses incurred by the top ten U.S. carriers alone totaled $11.3 billion in 2003.46

Influential Forces in the Industry Environment Customers

Airline passengers include business travelers and leisure travelers. Business travelers accounted for about 34% of domestic airline revenue in 2000 and 36.3% in 1999, but account for only about 15% of domestic RPMs (Revenue Passenger Miles) and some 10% of capacity.47 Business travelers have historically paid a premium for travel: Despite leisure travelers accounting for around 85% of RPMs, their fares only generated 66% of the revenues.

Leisure travelers are traditionally price-sensitive, so airlines have discounted fares for leisure travelers – typically requiring advance purchase and including restrictions on changes and refunds. Airlines will also offer deeply-discounted last-minute fares to leisure travelers to fill capacity on undersold flights.

Travel-agent intermediaries are the primary distribution channels of air travel to customers, generating roughly 70% to 80% of all airline bookings. Some 135,000 travel agents and 29,000 travel agencies operate throughout the United States.48 However, the rate of bookings conducted through travel agents is declining as travelers have easier access to direct travel bookings through online services. 49

44 Kahn. “Airline Deregulation,” The Concise Encyclopedia of Economics. 45 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02, p. 1. 46 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 9/25/03, p. 1. 47 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02, p. 3. 48 Ibid., p. 20. 49 Ibid.

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Suppliers In the large commercial aircraft market, there are two main worldwide

manufacturers: Boeing and Airbus. For smaller regional jets, the main suppliers are Embraer, Bombardier, and Saab. Even though these aircraft manufacturers’ business success is significantly intertwined with the success of the commercial airline industry, they also make significant sales to governments and military establishments. For example, 60% revenue of Boeing comes from commercial airplane and 39% from integrated defense system funded by government and 1% from others.50

When acquiring the aircraft, airlines also deal with multiple other vendors, selecting options such as engines--essentially from Pratt & Whitney, General Electric, and Rolls Royce--interiors, and entertainment systems vendors. Most airlines also work with specialty finance companies who structure financing in loans or leases. GE Capital, Boeing Capital, International Lease Finance (ILFC), GATX, and CIT are the leading financiers of aircraft in the world.

Fuel supply enables airlines’ daily operation, and it is a significant expense for the industry. In 2001, fuel costs accounted for about 14.9% of total airline expense. For each airline, fuel expenditures can vary significantly, depending on the age and fuel efficiency of the fleet, and the length of flights conducted by the airline. Variations also come from the fluctuation in oil prices on the world’s commodity markets. Fuel cost in 2001 was lower than in 2000, only 14.9% of total expenses in 2001 compared to 15.4% in 2000. Standard & Poor's reported in early 2002 that “jet fuel price changes are less important today than they were in 1980, when fuel accounted for 30% of industry cost.”51

Most airline carriers have to hedge their fuel costs by striking deals with suppliers or by buying and selling futures on the commodities market. In this way, by setting up financial options, they can limit the fluctuations in fuel prices and have more predictable operating costs.

Another key supplier in the airline industry is the labor unions. Wages and salaries are the single largest operating expense of any airline. The industry is highly unionized, leading to inflexible wage costs and labor structures. There are three large unions in this industry: the Airline Pilots Association; the International Association of Machinists and Aerospace Workers; and the Association of Flight Attendants. Over the last business cycle, from 1992 to 2001, labor costs in the airline industry increased dramatically and gave airlines a heavy financial load. For example, “pilot costs increased by 127% at Continental, 79% at America West, and 59% at American.”52 Labor negotiations between

50 The Boeing Company, online at www.boeing.com, 11/13/02. 51 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02, p. 3 52 Unisys, Unisys R2A Scorecard: Airline Industry Cost Measurement, Vol. 1, Issue 1, Oct. 2002; p. 14.

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the airlines and unions consume significant time and effort by management and union representatives, as “at any given time, a half-dozen or more contracts may be in negotiation.”53 Negotiations and concessions at one airline typically causesunions at the other airlines to demand reopening of negotiations to match industry standards--and these tactics and negotiations often causes strife and contention in the industry. Some newer entrants to the industry, such as JetBlue, are not yet unionized, giving them a significant competitive advantage.

Competitors The airline industry is highly competitive, with numerous airlines operating in all

sectors. In the U.S. alone, according to the Air Transport Association, at the end of 2001 there were 15 major airlines (with annual revenues exceeding $1 billion), 39 national airlines (revenues from $100 million to $1 billion), and 46 regional airlines (revenues under $100 million).54 In addition, U.S. airlines compete with non-U.S. airlines for international routes and for alliances that allow customers to find continuing services in routes not covered by U.S. airlines.

In general, there are two basic business models for major U.S. airlines: a full- service model based on hub-and-spoke route maps, and a limited-service, low-cost point- to-point model. In general, airlines that existed prior to the 1978 Deregulation Act operate in the hub-and-spoke model. This is often called the “legacy” model.55 Other airlines, notably Southwest Airlines, developed the low-cost point-to-point model after deregulation.

Legacy carriers may have profound structural disadvantages thanks to the high cost of unionized labor, overly complex route networks, and decades of intensive economic regulation in both the United States and Europe56--which is why newly created airlines like jetBlue Airways are avoiding the limited flexibility imposed by the hub-and- spoke structure by basing their business models on the Southwest model. This new breed of low-cost carriers boasts a less expensive, less unionized workforce as well as the more flexible point-to-point (rather than hub-and-spoke) route structure. In addition to jetBlue, this alternative business model is serving a growing list of profitable carriers like the UK's easyjet, Canada's WestJet, and Ireland's Ryanair,57 which are able to compete toe-to-toe with legacy carriers in many major markets. Their presence benefits even consumers who don't choose to fly them simply by exerting downward pressure on prices.

53 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines. March 28, 2002. p. 19. 54 Air Transport Association of America, 2002 Annual Report. p. 19. 55 For instance, see comments about “legacy carriers” on p. 3 of Unisys’s Unisys R2A Scorecard: Airline Industry Cost

Measurement report, Vol. 1, Issue 1, Oct. 2002. 56 Dr. Rob Britton lecture at Cornell University, 11/22/02. 57 Unisys, Unisys R2A Scorecard: Airline Industry Cost Measurement, Vol. 1, Issue 1, Oct. 2002, p. 3.

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Despite the inherent competitiveness of this industry, airlines do work together when part of alliance and strategic partnerships. Partnering with one or more competing or complementary carriers allows airlines to offer more services--a broader route network serving more destinations, increased flight frequency, better frequent-flyer programs--at the same time they expand their access to customers and lower their own costs by sharing airport infrastructure, engaging in joint procurement, developing cooperative advertising budgets, and much more.58 Benefits depend on the nature of the alliance--whether it's a marketing or code-share agreement, or even a franchise or equity-transfer relationship. In order to provide international service, for instance, having a global partner means a U.S. airline can feed traffic through to this partner through an international hub, generating cost savings and smooth connection for all parties. For example, Northwest and China Air have developed a code-sharing strategy to exploit the promising China/U.S. line. In the domestic market, airline companies may share cargo and passenger terminals to save cost and consolidate sales. Continental Airlines has an extensive marketing alliance with Northwest Airlines that includes code-sharing and shared frequent-flyer programs.

But airlines also continue to compete fiercely for client bases on particular routes, many times in spectacular price wars. When jetBlue announced a deeply discounted tickets on Oakland, CA to Washington D.C. route in August 2002, it triggered a new “price-war” on east-west coast line. United Airlines responded immediately by matching its fares at the same price level as jetBlue, in the hopes that United will be able to maintain higher fares on other non-competing flights. These price wars have put pressure on airfare yields since deregulation occurred in 1978.

One way to avoid price wars is to develop frequent-flyer loyalty programs. In many cases, the privileges that come with membership in these reward programs-- upgrades, priority on standby, access to business lounges, and so on---are enough to convince members to fly with an airline at a somewhat higher fare than one offered by the competition on the same route.

Flying in Turbulence: The Broad Environment It's scarcely news that 2001 was the worst year ever for U.S. airlines.

– Unisys R2A Transportation Management Consultants 59

External factors have a tremendous impact on any industry--and possibly more on airlines than most industries, due to their high fixed costs and limited flexibility in adapting to changes.

58 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02, p. 14. 59 Unisys, Unisys R2A Scorecard: Airline Industry Cost Measurement, Vol. 1, Issue 1, Oct. 2002; p. 1.

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Socio-Cultural Forces Baby boomers believe they possess an inalienable right to travel. Real median

family income (after adjusting for inflation) has increased by 11.8 percent since 1982 alone.60 And as post-World War II babies have matured into affluent boomers with a great deal more discretionary income than previous generations enjoyed, they are using those extra dollars to travel more.61 Younger generations have also been bitten by the travel bug; as travel has become more accessible and affordable, they consider a long- haul flight to Eastern Europe or Southeast Asia to be just as viable as a road trip to the Grand Canyon.62 With increased globalization of business, international travel has also become extremely common for business travelers. According to a 1997-1998 Gallup poll, 81% of the entire U.S. adult population had flown at least once, and two out of every five U.S. citizens flew during 1997-1998.63

However, seasonality in travel demand is a constant issue for airlines. Temporal changes in patterns of travel demand result in overdemand for air travel in some periods and low load factors in others.64 The airlines' product – seat miles – are highly perishable, and excess capacity is a chronic problem. In fact, American Airlines reports that 30% of its seat capacity went unused in 2001.65

Demand for flights in all seasons has turned downward in the wake of the terrorist attacks of September 11, 2001. North Americans felt a new vulnerability to terrorism which they had largely been able to dismiss as somebody else's problem. Airlines – the vehicle of choice for the most devastating terrorist attack on U.S. soil ever – have borne the brunt of travelers' resulting security fears. The tangible results have been devastating: The airline industry experienced a record loss of $7.7 billion in 2001, with air traffic down in all domestic and international markets a total of 5.9 % – the largest drop in air traffic in U.S. history.66 All of the major domestic carriers with the exception of Southwest Airlines experienced substantial financial losses in 2001.67 Similar (albeit less devastating) declines also occurred following the TWA and related hijackings in 1985-86; the Pan Am Lockerbie disaster of 1988; and the Gulf War in 1990-91.

As a result, carriers have been forced to respond with cuts in service; available seat miles were down 2.8% in 2001 over the previous year, with the number of scheduled

60 Goeldner and Ritchie, Tourism, p. 307. 61 Neilsen, Stefan K. "Determinants of Air Travel Growth," World Transport Policy & Practice, Vol. 7, No. 2, 2001; pp. 28-

37. 62 Ibid. 63 Goeldner and Ritchie, Tourism, p. 127. 64 Ibid., p. 124. 65 Dr. Rob Britton, Managing Director of Advertising, American Airlines; lecture at Cornell University School of Hotel

Administration, 11/22/02. 66 Air Transport Association of America, 2002 Annual Report. p. 9. 67 Unisys, Unisys R2A Scorecard: Airline Industry Cost Measurement, Vol. 1, Issue 1, Oct. 2002; p. 1.

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flights are down by about 600 a day. Furthermore, carriers shrunk their fleet size by decommissioning less fuel-efficient and more maintenance-intensive aircraft, and by postponing deliveries on roughly one-third of the new aircraft that they had planned to take delivery on in 2002 and 2003.68

Based on the recovery pattern that followed each of these blows, the airline industry is facing a slow turnaround; it is likely to take some time to build air travel back to what are considered "normal" levels of demand.69 The outbreak of war in Iraq in early 2003 made the possibility of quick recovery little more than a pipe dream for the suffering air carriers.

Further complicating matters post-September 11th has been the increased security measures at airports, which can substantially lengthen flight-departure lead time – sometimes by as much as an hour or more –and add to an increased distaste for unnecessary air travel as travelers find themselves subjected to multiple body and bag searches. Furthermore, extra security taxes have been passed on to passengers,70 resulting in increased ticket prices without any revenue benefit for the already strained carriers. Many short-haul travelers are resorting to other forms of travel in order to avoid such delays and hassles, such as the train;71 Amtrak's Acela trains, for example, can deliver travelers point-to-point along Northeast Corridor routes such as New York to Boston or Washington, D.C., in roughly the same amount of time it takes to fly.

Technological Forces The Internet has revolutionized the way airline passages are bought and sold, and

has opened up a whole new world of direct distribution for carriers. Airlines can sell directly to consumers via their own websites at a fraction of the cost of employing customer service agents to take call-center reservations. Furthermore, easy-to-navigate websites with up-to-the-minute availability, pricing, schedule, and fleet information as well as one-click reservations have diminished the need for intermediaries; as a result, carriers have been able to cut back on base commissions to travel agents.72 According to Standard & Poor's, most major airlines had cut their commission rates to 5% of fares, with a $20 cap on domestic round-trip fares, by late 2001 (down from 8% of fares with a $50

68 Air Transport Association of America, 2002 Annual Report. p. 10. 69 Goeldner and Ritchie, Tourism, p. 125. 70 The Bulletin, "The Price of Airport Security," online at http://bulletin.ninemsn.com.au/bulletin/eddesk.nsf/

All/4DD4F67689A6B1B3CA256C47001FB3DC (viewed 12/2/02). Also ABC KGO-TV, "The Price of Security," 10/18/02, online at http://abclocal.go.com/kgo/news/101801_nw_airport_baggage.html (viewed 12/02/02).

71 About.com, "Airport Estimated Wait Times," online at http://businesstravel.about.com/library/ weekly/aa010102a.htm (viewed 12/3/02).

72 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, 3/28/02, pp. 11-12. Also Goldman Sachs Global Equity Research, Airlines: United Statess, 4/23/02, p. 12.

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cap); total commissions paid in 2001 accounted for approximately 4% of airline industry costs, down from 6.2% in 2000 and 10.9% in 1993.73

However, airlines have discovered a serious dark side to the new distribution frontier and transparency of pricing information. Now that anyone with a web browser has access to the same global distribution systems as travel agents via such websites as Expedia, Travelocity, and Orbitz, airfare pricing is now approaching the economist's ideal of "perfect" information.74 Thus, the legacy carriers must be willing to match their competitors' prices – including the prices offered by their more flexible low-cost competitors, such as Southwest, jetBlue, easyjet, and a variety of regional carriers – or lose market share.75 As a result, leisure airfares were running at approximately 20% below their five-year average by mid-2002.76

Technology has dramatically changed all aspects of airline operations, from reservations through engineering; the result has been reduced labor costs, greater efficiency, and improved customer service.77 Reservation systems have evolved from telephone operators to airline websites, while airlines now have the ability to trace luggage is a matter of minutes rather than days. "Ticketless travel" – e-ticketing – has been embraced by customers and airlines alike for its ease-of-use and cost-effectiveness. United Airlines reports that electronic ticketing costs 50 cents per ticket, while issuing a paper ticket costs $8, since 14 additional accounting and processing procedures are required; the other major carriers are experiencing similar cost benefits from e-ticketing.78

Self-service electronic check-in, automatic upgrades for loyalty-program members, and other innovations have also become a norm for travelers. Such innovations have helped to allay travelers' frustrations with increased security measures and other post- September 11th bureaucracies associated with flying.

Global Economic Forces Had terrorists not attacked, the major hub-and-spoke carriers

would still be facing the competitive Waterloo today.

– Holman Jenkins, The Wall Street Journal79

While it's easy for the airline industry to place the blame for its economic troubles on the trauma of September 11th, the reality is that corporate belt-tightening and the

73 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02. p. 20. 74 Dr. Rob Britton lecture, Cornell University, 11/22/02. 75 Ibid. 76 Goldman Sachs Global Equity Research, Airlines:United States, 4/23/02, p. 9. 77 Ibid. 78 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, 3/28/02; p. 12. 79 Unisys, Unisys R2A Scorecard: Airline Industry Cost Measurement, Vol. 1, Issue 1, Oct. 2002; p. 2.

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prevailing economic recession had been putting enormous financial pressure on the airlines since early 2001. As a result, major carrier revenues were already in steep decline in the first six months of that year.80 However, financial pressure on airlines was exacerbated by September 11th, when air traffic was completely stalled for days, followed by an unprecedented decline in ticket sales. The downturn in business travel had already begun in early 2001, when corporate earnings fell. "Based on information from a sampling of ATA member airlines, domestic business traffic fell 5.5% during the first eight months of the year [2001], while personal and pleasure traffic increased 5.1%. Over the last four months of [2001], the decline in business traffic quadrupled to 24.2% and personal pleasure traffic reversed its course, falling 18.0%."81

Furthermore, cost-conscious corporations have become newly price sensitive. Businesses are no longer willing to pay the exorbitant full fares that they used to consider a fact of life in the days before the economic downturn took hold and scandal rocked the corporate world. Companies have also realized a new willingness to rely on "virtually there" technologies such as e-mail, video conferencing, and instant messaging in lieu of actually sending their employees on the road for face-to-face meetings around the globe. As a result, business travel--the most lucrative business in the industry--only generated about 30% of airline revenues in 2001, down from roughly 52% of total airline revenues in 1982, and about 15% of total passenger revenue miles (RPMs) in 2001 according to Standard & Poor's estimates.82 While the horizon got a little brighter in 2002--with business travel accounting for 37% of aggregate industry revenues and 21% of RPMs, according to Standard & Poor's83—a return to historic levels is unlikely.

All signs seem to indicate that the recession-era decline in business travel, combined with the new transparency in pricing available online and the decline in air travel due to fears of terrorism, likely signal a permanent sea change in both business and leisure travel purchasing patterns. These fundamental shifts have lead to the commodization of airlines, with price--rather than competitive advantages in service-- being the primary driver behind consumer behavior.84 Carriers haven't given up on creating competitive advantage for themselves, however; most airlines currently see frequent-flyer loyalty programs targeted to keep regular customers coming back to be their best long-term hedge against commodization.

Further aggravating the industry's financial problems are high fixed costs, which allow airlines little elasticity, or freedom, to shrink and grow as demand dictates.85 As a

80 Ibid. 81 Air Transport Association of America, 2002 Annual Report. p. 9. 82 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, 3/28/02; p. 15. 83 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, 9/25/02; p. 18. 84 Dr. Rob Britton lecture at Cornell University, 11/22/02. 85 Ibid.

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result, enormous losses resulting from the convergence of the recession pattern, increasing price competition, and the downturn of demand resulting from September 11th have driven cash flows deeply into negative territory, and the overall health of the industry is threatened.86 U.S. carriers have laid off 80,300 employees post-September 11; the largest layoffs occurred at American Airlines and United Airlines, who furloughed 20,000 employees each, followed by US Airways (11,000 employees), Northwest Airlines (10,000), and Continental (8,500). Only Southwest Airlines and Alaska Airlines did not lay off staff.87

Uncertainty in the price of oil is a major destabilizing factor. While jet fuel prices actually declined from $0.83 to $0.73 per gallon from 2001 to 2002, Goldman Sachs' Energy Research Group reported that a decline in available inventories would make oil prices increasingly volatile in the future.88

Political & Legal Forces Few other industries are as dependent on world governments as the airlines

industry.89 Despite the end of deregulation in 1978, U.S.-based airlines continue to answer to governmental agencies: The Federal Aviation Administration (FAA), an offshoot of the Department of Transportation, is the industry's primary regulatory body, policing the safety, labor, and operating procedures as well as aircraft fitness and emissions levels.90 The most recent trend from the FAA has been the opening of new gate slots and expanded landing rights at congested airports.91

The Air Transport Association of America (ATA) is the cooperative trade association maintained by the domestic airlines that, in effect, serves as the industry's own self-policing agency, focusing largely on issues of safety, security, technological innovations, and cooperative industry-wide service improvements. A similarly structured agency, the International Air Transport Association (IATA), serves as the global self-regulating body for the worldwide air transport network.92

U.S. airlines are subject to whatever local regulations are in place whenever they fly international skies. The degree of regulation varies from country to country; formal

86 Air Transport Association of America, State of the U.S. Airline Industry: A Report on Recent Trends for U.S. Air Carriers, 2002-2003; online at www.airlines.org/public/industry/bin/state.pdf, pp. 1, 11.

87 Air Transport Association of America, 2002 Annual Report, p. 2. 88 Goldman Sachs Global Equity Research, Airlines: United States, 4/23/02, p. 12. 89 Dr. Rob Britton, Managing Director of Advertising, American Airlines; lecture at Cornell University School of Hotel

Administration, 11/22/02. 90 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, 3/28/02, p. 21. 91 Federal Reserve Bank of San Francisco, "FRBSF Economic Letter: Competition and Regulation in the Airline

Industry," 1/18/02, online at www.frbsf.org/publications/economics/letter/2002/el2002-01.html (viewed 12/4/02). 92 Goeldner and Ritchie, Tourism, p. 129-130, 589, 591.

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bilateral accords govern reciprocal landing rights, the number of international carriers that can operate within the country, and other matters93--and the reins on the international operation of U.S. carriers can be tight.

But the U.S. had signed “open skies” agreements with nearly 100 countries as of 2002, reducing economic regulations, lower entry barriers, and open the playing field for code-sharing and other strategic partnering alliances between U.S. and international carriers. Still, some legislators have tried to regulate competition by curbing the formation of global alliances, especially those between U.S. and European Union carriers,94 and restricting the foreign ownership of U.S. airlines.95 Still, Standard & Poor's reported in 2002 that “international deregulation seems unstoppable and it will follow the pattern seen in the U.S. industry.”96

The Internal Organization During this past year of unimaginable challenges, Continental relied even more

heavily on the fundamentals that have made us successful. Although no one could

have anticipated the events of last year, our culture of Working Together

developed over the last years, including relationships with employees, customers,

vendors, and distribution partners, proved to be our most valuable resource for

weathering the storm precipitated by the terrorist attacks of Sept. 11.

– Gordon Bethune, CEO, and Larry Kellner, President97

Continental Airlines. is a major U.S. air carrier engaged in the business of transporting passengers, cargo, and mail. As of January 31, 2002, Continental flew to 123 domestic and 93 international destinations and offered additional connecting services through domestic and foreign alliances. These destinations are serviced by Continental; by Continental’s wholly owned subsidiary, Continental Micronesia, Inc. (CMI); and by ExpressJet Airlines, Inc., doing business as Continental Express. Continental does have a

93 Corridore, Jim. Standard & Poor's Industry Surveys: Airlines, 3/28/02, p. 21. 94 Goldman Sachs Global Equity Research, 4/23/02. 95 Federal Reserve Bank of San Francisco, "FRBSF Economic Letter: Competition and Regulation in the Airline

Industry." 96 Corridore, Jim. Standard & Poor’s Insdustry Surveys: Airlines, 3/28/02, p. 14. 97 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, p. 3.

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controlling interest in ExpressJet, holding 53.1% of its shares, following an initial public offering (IPO) for ExpressJet in April 2002.

Continental is the second largest U.S. carrier to Latin America and serves more destinations in Mexico than any other U.S. airline. Continental is the largest carrier in the New York City metropolitan area and operates the only hub in the region (across the Hudson River from Manhattan in Newark, N.J.).

Strategic Direction Our goals are simple--they are our customers’ goals. We continue to deliver a

high-quality product each and every day, getting our customers where they want

to go, on-time and with their bags, while providing pre-flight and in-flight service

that is globally recognized for consistency and excellence.98

Continental Airlines has clearly defined set of goals that portray their strategic direction. Theirs is a simple, straightforward, and flexible mantra. The Go Forward Plan plainly explains what the company's goals are, what the challenges are it faces, and how the company will measure success.

The Go Forward Plan is a four-pronged approach:

• Fly to Win -- The Market Plan • Fund our Future -- The Financial Plan • Make Reliability a Reality -- The Product Plan • Working Together -- The People Plan

In practice since 1995, the “Go Forward Plan” has enabled Continental to achieve one of the most impressive turnarounds in American corporate history.

Fly to Win (The Market Plan) Achieve above-average profits in a changed industry environment. Grow the airline

where it can make money and keep improving the business/leisure mix. Maximize

distribution channels while reducing distribution costs and eliminating non-value-

added costs.99

98 Ibid., p. 4. 99 Ibid., p. 5.

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Continental’s marketing plan focuses on meeting the needs of the changing market to maximize profits for stakeholders. Continental concentrates on flying to cities where people want to go, and doing so in a clean, safe, and reliable manner. Continental leverages hubs with significant market strength that generate large amounts of revenue-- namely New York City; Houston, TX; Cleveland, OH; and Guam in the Pacific.

Continental wants to provide the products and services that customers value, such as new airplanes with large overhead baggage bins, an award-winning frequent flyer program, and good food. The airline uses technology to eliminate non-value-added costs. They have updated their Continental.com website so customers can book flights, review their frequent-flyer accounts, and check flight status all from a personalized home page.100

Funding Our Future (The Financial Plan) Manage our assets to maximize stockholder value and build for the future.

Reduce costs with technology. Generate strong cash flow and improve financial

flexibility by increasing our cash balance.101

“Fund the Future” lays the foundation for Continental’s profitable growth by focusing on strengthening their balance sheet, reducing fleet age, and building and financing new hubs.

The events of September 11, 2001, has had a staggering effect on Continental’s financial health. The subsequent Stabilization Act provided Continental with $400 million in direct grants, out of a total of $5 billion granted to the industry, to cover the losses caused by the government-imposed shutdown and the terrorist attacks. The act also authorized up to $10 billion in loan guarantees, an offer Continental has yet to apply for. But the airline has announced a series of cost-saving initiatives that include the continued grounding of aircraft and a roughly 20% reduction in flight schedules.

Making Reliability a Reality (The Product Plan) Deliver an industry-leading product we are proud to sell. Rank among the top of

the industry in the key DOT measurements: On-time arrivals, baggage handling,

complaints and involuntary denied boarding. Keep improving our product.102

100 Yahoo! Finance, "Continental Redesigns Web Sit to Offer More Functionality for Customers," 9/16/02; online at http://biz.yahoo.com/prnews/020916/dam021_1.html (viewed 11/14/02).

101 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, p. 10. 102 Ibid., p. 13.

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Continental has focused its efforts over the past six years on running a great airline that takes customers where they want to go safely, on time, and with their bags meeting them when they get off the plane. The airline has a trophy case full of awards to prove their success with customer satisfaction. In 2001, Continental was once again ranked number 1 in on-time performance among major U.S. hub carriers. In 2001, Continental had an 82.2% on-time arrivals rate and a 99.2% completion factor. They were also named the Air Transport World’s airline of the year in 2001 for the second time in five years.103

Continental has worked closely with the federal government to increase security at airports and in airplanes. The number of security screening lanes at hubs has been increased to reduce waiting time. Cockpit doors have been replaced with stronger, more impenetrable ones. Continental plans to keep the standards high even with the loss in demand.

Continental also looks to technology to make air travel quicker, more reliable, more convenient, and more user-friendly for their customers. Almost 90% of their tickets sold are e-tickets, and the airline has been aggressive about introducing eService check-in kiosks, which allow customers to check-in, change seats, request upgrades, or purchase new tickets at airports where they have a presence.104

Working Together (The People Plan) Help well-trained employees build careers they enjoy every day. Treat each other

with dignity and respect. Focus on safety; make employee programs easy to use

and keep improving communication. Pay compensation that is fair to employees

and fair to the company.105

Continental strives to be a company whose employees enjoy coming to work every day and are valued for their contributions. By becoming more involved in company decisions, working in an environment of civility and respect and receiving performance- based incentives, Continental’s employees are motivated to keep the airline on top. In 2001, Continental was once again placed in Fortune’s list of the top “100 Best Companies to Work For”.106

103 Ibid. See Appendix 1 for an expanded list of Continental's most recent awards. 104 ProQuest, "Continental Introduces 'New Functionality' To Its Self-Service Check-In System Airports," 10/15/02. 105 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, p. 16. 106 Continental Airlines. Press Release, “Continental Airlines Makes the Fortune 100 Best Companies to Work For List

For Fourth Year in a Row.” January 22, 2002. Online. Viewed 11/19/02.

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Ownership Structure Continental’s stocks are traded under CAL at the New York Stock Exchange.

Continental offers Preferred Securities of Trust, Preferred Stock, Common Stock, and Treasury Stock.

Preferred Securities of Trust Trust Preferred Securities are issued in certain structured finance transactions,

generally to raise capital. Trust Preferred Securities pay regular dividends, are immensely flexible and may be converted into shares of Common Stock.

In November 2000, Continental Airlines Finance Trust II, which is wholly owned by Continental, completed a private placement of 5,000,000 6% Convertible Preferred Securities. These Term Income Deferrable Equity Securities have a liquidation value of $50 per preferred security and are readily convertible into shares of Class B common stock at a conversion rate of $60 per share of Class B common stock. Distributions on the preferred securities are payable by the Trust at an annual rate of 6% of the liquidation value of $50 per preferred security.107

Preferred Stock The year 2001 began with the completion of a transaction with Northwest Airlines

that resulted in a single class of common stock and equal rights for all holders of common stock, while strengthening and extending the broad commercial alliance between Continental and Northwest to make sure their customers have the long-term benefits of an expanded network. Judge Dennis Page Hood called the arrangement "a victory for consumers, who will benefit from lower fares and better airline service. This is the result we have sought all along. It will ensure that Northwest and Continental remain independent competitors."108

Northwest acquired stock representing more than 50 percent of the voting interest in Continental in 1998 and entered into a separate marketing alliance at the same time. As of December 31, 2001, one share of Series B preferred stock was outstanding, which is owned by Northwest Airlines. On September 30, 2002 (3rd quarter), Continental had $248,000,000 as redeemable preferred stock.

On August 23, 2002, Delta, Continental, and Northwest confirmed that they were seeking approval for a 10-year marketing pact, which would begin next spring. The agreement requires Northwest to exchange its Class A Continental shares that carry 10 votes per share for $450 million in cash and a lesser number of Continental B shares that

107 Continental Airlines, Inc. 2001 Annual Report, p. 27. 108 U.S. Department of Justice press release, "Department Announces Tentative Settlement in Northwest-Continental

Lawsuit," 11/6/00; online at www.usdoj.gov/atr/public/press_releases/2000/6905.htm (viewed 12/02/02).

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carry one vote per share. In addition, Northwest would receive preferred stock in Continental that would give it the right to veto a pro-posed combination between Continental and other carriers under certain conditions. After the new deal is completed, Northwest will retain 7 percent of the voting interest in Continental and less than a 5 percent equity stake. 109

Common Stock Continental currently has one class of common stock issued and outstanding,

Class B common stock. Each share of Class B common stock is entitled to one vote per share.

Treasury Stock A stock repurchase program was started in 1998 under which Continental

repurchased a total of 28.2 million shares of Class B common stock for a total of approximately $1.2 billion through September 30, 2002. The program was suspended during 2001.

Employee Stock Purchase Program All Continental employees are eligible to participate in an employee stock

purchase program under which they may purchase shares of Class B common stock at 85% of the lower of the fair market value on the first day of the option period or the last day of the option period. During 2001, Continental issued 710,394 shares of Class B common stock.

Stock Price The Stock price for the 52-week period ending November 17th, 2002 ranged from $

3.59 and $ 35.25.110 The shares showed a slight growth, in the intervening weeks due to the steps taken by Continental towards financial recovery. With threats of war with Iraq and the constantly changing broad environment, however, the market found it difficult to predict how Continental will be affected next. The airline fluctuated throughout most of 2003, but started a persistent climb toward the $20 mark in the third quarter.111

Operating Characteristics Continental’s primary business is focused on transporting passengers to various

destinations in the US and throughout the world. Though Continental does provide some

109 Airwise News. "Thre U.S. Airlines Seek Marketing Deal," 8/23/02; online at http://news.airwise.com/stories/2002/08/1030123190.html (viewed 12/5/02).

110 As quoted at Yahoo! Finance (viewed 11/17/02). 111 52-week range $4.16 to $21.70 for the 52-week period ending October 29, 2003; as quoted at Yahoo! Finance

(viewed 10/30/03). See Exhibit 5 for annual diluted earnings/loss per share.

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cargo and mail service, this business generates only 6% of the revenue of the whole group while passenger services generate the remaining 94% of revenue.

Prior to the September 11, 2001 terrorist attacks, Continental flew over 2,500 flights a day. For the year ending December 31, 2000, Continental had 86,100 million available seat miles. On September 15, 2001, Continental announced a 20% system wide reduction in its flight schedule.112 On September 17, 2001, Continental announced complete discontinuation of service on ten different routes 113 (see exhibit 3). By the end of December 2001, Continental had reduced its operations to 84,845 million available seat miles.

In the United States, Continental has designed its route network based on a hub- and-spoke system. This system allows airlines to bring passengers from lightly traveled areas, typically in smaller planes, to a single point where passengers can take a second flight, typically on larger planes. The goal is to generate higher load factors on the longer flights. This system is the opposite of a point-to-point system, where direct flights connect each airport to the others. The major airlines also use the hub-and-spoke design to achieve significant market penetration in the hub cities. Continental has four principal hubs: Newark, Cleveland, Houston, and Guam. By building hubs in strategic cities, airlines can build significant market share in their hub locations. For instance, Continental had a 73.7% market share in Houston and a 56.0% market share in Newark for the 12 months ending June 2001.114

The hub-and-spoke model does create some inflexibilities for an airline. It becomes almost impossible to develop direct point-to-point route between non-hub cities even if there is demand for it. Some sources of inflexibility include the difficulty obtaining gate space in the point-to-point cities, and not having local crews available to service the routes.

Equipment Fleet As of December 31, 2002, Continental had 554 aircraft in its fleet, of which

approximately one-fourth are owned and three-fourths are leased.115 Continental has purchase commitments (orders) for an additional 86 aircraft, and options to acquire 100

112 Continental Airlines, press release. “Continental Airlines Announces Long-Term Schedule Reduction and Furlough of 12,000 Employees," 9/15/01; online at www.continental.com (viewed 11/19/02).

113 Continental Airlines, press release. “Continental Airlines Capacity Reduction Ends Service to 10 Cities," 9/17/01; online at www.continental.com (viewed 11/19/02).

114 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines, 3/28/02, p. 9. 115 Continental Airlines, Inc. Continental Airlines 2002 Annual Report, p. 21. Also Continental Airlines. Securities &

Exchange Committee Quarterly Report for Continental Airlines, Inc.; own/lease proportions for period ended 9/30/02, p. 14.

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more aircraft. Exhibit 4 details the types of aircrafts and the manufacturers116. It does not include the 56 jet aircraft and 19 turboprop aircraft that Continental has put out of service in the aftermath of the September 11, 2001 terrorist attack.

Despite putting scores of aircraft out of service, Continental took delivery of 20 Boeing jet aircraft during the first 9 months of 2002. Continental has been progressively updating its fleet of aircraft, and reducing the number of models used. “Since the beginning of 1996, Continental has reduced the number of fleet types from eight to five (777, 767, 757, 737 and eventually outgoing MD80s) and cuts its average mainline fleet age to 6.5 years from 13.6 years.”117

Service Continental has made great strides to improve service performance during the ticketing

and check-in process, both to make the process more efficient for customers as well as to reduce its own operating costs.118 One of the key measures of service in the airline industry is on- time arrivals. Continental offers superb performance for on-time arrivals. For all of 2002, over 84% of Continental’s flights arrived within 14 minutes of the planned arrival time, compared to an industry average of around 82%.119

Continental Airlines decided, in the wake of September 11, 2001, that they would not decrease the services they provide during flights, unlike most other major airlines. Continental continued to offer meals, including hot meals, during their flights. They continue to offer free magazines to flyers. This continued service may make up for some of the increased frustration that travelers have with air transportation post-September 11th. The increased security measures have meant longer lines at the airport, waiting to check in and screen bags, waiting to pass through security checkpoints, and waiting to board the aircraft while random screening is being conducted.

Financial Concerns Prior to September 11, 2001, the financial perspective for the U.S. airline industry

as a whole was mired with problems--but these problems were masked by a boom in travel. As a result, most major airlines posted significant profits during the 1990s.

The financial problems stem from the high fixed costs the industry has, primarily from equipment costs and expensive union labor contracts. As an example of equipment costs, JetBlue Airways purchased 10 Airbus A320’s in January 2002, valued in excess of $500 million.120 In another example of the high industry costs, the pilots at United

116 Continental Airlines, Inc. 2002 Annual Report, p. 21. 117 Engel, Glenn and Gruetzmacher, Michael. Goldman Sachs Global Equity Research: Continental Airlines 6/17/02, p.11. 118 Continental Airlines Presentation to Salomon Smith Barney Transportation Conference, 11/14/02. 119 Continental Airlines Presentation to Salomon Smith Barney Transportation Conference, 11/14/02. 120 jetBlue Airways, Press Release, “JetBlue Orders 10 Airbus A320 Aircraft Valued In Excess Of $500 Million,” 1/14/02.

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Airlines staged a strike in 2000 that cost the airline around $700 million. As a result of the strike, the pilots received “the most expensive contract in history: An immediate pay raise of 22% to 28% and a 4.5% annual raise through 2004.”121 Although this is an extreme case, all airlines must work with a number of different unions – pilots, flight attendants and mechanists unions especially – which creates high labor cost for the industry as a whole.

As each airline has pursued different equipment acquisition tactics and different labor relations strategies, the cost structure between different airlines varied widely; however, most of them were fairly profitable during the 1990s.122 The combined effect of the economic downturn and the reduced travel after September 11th caused the airline industry’s finances to veer significantly off course in 2001. Air Transport World estimates that the global airline industry losses in 2001 were the worst in history, an estimated $11.0 billion, and expected industry losses of $7.5 billion in 2002. For the U.S. airline industry specifically, ATW estimated losses of $9.0 billion in 2001 and $6.0 billion in 2002;123 In reality, the top ten U.S. carriers alone shouldered a loss of $11.3 billion in 2002, with Standard & Poor's forecasting a narrower $6.4 billion loss for 2003.124 Continental was operating at about a 75% passenger load factor through 2002, with a breakeven passenger load factor of nearly 78%.125

Continental generates its revenues through a combination of traffic volumes and pricing. Continental reduced its flight schedule following September 11th, which resulted in reduced revenue per seat miles and available seat miles. In addition, Continental practiced fare discounting in an attempt to generate more demand for its services, and persuade those who might wish to cancel or delay their travel to fly with Continental. In one example, Continental offered double miles to frequent flyers, leading to increased free trips, thereby discounting flights overall.126

As a result, Continental announced a 3.0% decrease in passenger revenue in the three months ending September 2002, compared to the same period in 2001. The airline attributes this to “continued traffic and capacity declines and fare discounting following the September 11, 2001 terrorist attacks and the continuing weak economy. Yield was 3.4% lower…”127

121 “United They Fall,” The Wall Street Journal, 10/21/02, p. A14. 122 McCartney, Scott. “Southwest Sets Standard on Costs,” Wall Street Journal, 10/9/02, p. A2. 123 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines. 3/28/02, p. 1. 124 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines. 9/25/03, p. 1. 125 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines. 3/28/02. p. 33. 126 Continental Airlines press release. “Continental Airlines Offers Double Miles for Its Frequent Flyers,” 11/5/01. 127 Continental Airlines. Securities & Exchange Committee Quarterly Report for Continental Airlines, Inc. for period ended

9/30/02, p. 19.

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The U.S. Congress passed the Air Transportation Safety and System Stabilization Act (H.R. 2926) on September 22, 2001, in response to the crisis in the airline industry after the September 11th terrorist attacks. Continental accepted slightly over $400 million in a grant from the federal government as part of the Stabilization Act. This grant was considered revenue, to make up for the immediate lost business due to the temporary suspension of all flights on September 11, 2001. The federal government was also granting debt guarantees, based on an application review process. Continental had not applied for any of these guarantees by the close of 2002, but reserved the right to do so in the future depending on liquidity needs.128

Security costs have increased overall since September 11, 2001. For instance, all cockpit doors needed to be reinforced, an operation that Continental completed on October 22, 2001. Continental feels that most of these additional costs cannot be passed on to the consumer.129 Given the low customer demand for air travel and the substantial discounts that most air carriers are marketing to customers, airlines will have to absorb the additional security costs themselves.

In addition to the costs to increase security on Continental’s fleet, the airline is also responsible for its share in the costs of installing baggage screening equipment in each airport. These machines, some of which cost $1 million each, will be purchased by the airlines and operated by the new Transportation Security Agency.130

Continental’s wages and salaries represented 35% of total operating revenues in 2001. Wages have always been the largest expense item for all airlines, as a services industry requires significant labor investment. Immediately following September 11, 2001, Continental announced that it would furlough 12,000 of its employees. Continental has been able to reduce this number to about 8,000, but has in any case significantly reduced its workforce. The costs of this reduction were significant, around $29 million in severance and continued benefits for furloughed employees.131

Continental has firm purchase commitments for 171 jets, including 67 Boeing jets and 104 Embraer regional jets.132 The estimated aggregate cost of Continental’s firm commitments for 67 Boeing aircraft is approximately $2.5 billion. No aircraft deliveries are planned until the fourth quarter of 2003 and continue through 2008. No financing is

128 Ibid., p. 32. 129 Continental Airlines. Securities & Exchange Committee Quarterly Report for Continental Airlines, Inc. for period ended

9/30/02, p. 28. 130 Corridore, Jim. Standard & Poor’s Industry Surveys: Airlines. March 28, 2002. p. 2. 131 Continental Airlines. Securities & Exchange Committee Quarterly Report for Continental Airlines, Inc. for period ended

9/30/02, p. 15. 132 Embraer regional jet orders were cut to 86 by December 31, 2002, although Boeing mainline jet orders held firm.

Continental Airlines, Inc. 2002 Annual Report, p. 21.

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currently in place for these acquisitions. As for the Embraer regional jets, the estimated total cost is $2.1 billion.133

Continental has been successful in managing its fuel costs, which account for 14% of its revenues. There was a significant decrease in fuel costs in 2002 compared to 2001.134 In addition, Continental’s younger fleet is more fuel efficient, further enhancing fuel cost savings. Another benefit of the younger fleet of aircraft will be lower maintenance costs, especially when compared to other major US air carriers.

In its 2001 Annual Report, Continental indicated that its goal is to have $1.5 million in cash on hand, a significant increase from its previous target of $1 million, as a buffer against operating at a loss for the next few period and against additional unknown changes to the economy and the airline industry. In its search for the additional cash balance, Continental decided to sell off part of one of its subsidiaries. As of December 31, 2001, Continental Airlines, Inc. was the parent company of two wholly owned subsidiaries:

• ExpressJet Airlines, Inc. (formerly Continental Express, Inc.)

• Continental Micronesia, Inc.

In April 2002, Continental conducted an initial public offering (IPO) for 30 million of the common shares in ExpressJet as a way of increasing the company’s cash balance. After the IPO, Continental retains a 53.1% controlling interesting in ExpressJet. In addition, this IPO raised a significant amount of cash for Continental, as net proceeds totaled $300 million.135 Continental retains the right to liquidate the remaining 53.1% of its interest in ExpressJet, once the 180-day lock-up period is expired.136 At the present time, Continental does not plan to sell its remaining ownership stake in ExpressJet, however it could be used to raise cash if needed at some point in the future.

See Exhibit 5 for five years of financial statements (1998 through 2002) for Continental Airlines.

Marketing It's one thing for a company to know itself--and another thing altogether to be able

to tell its story to everyone else. Continental Airlines has enjoyed great success by

133 Ibid., p. 14-15. 134 Ibid., p. 22. 135 Continental Airlines. Securities & Exchange Committee Quarterly Report for Continental Airlines, Inc. for period ended

9/30/02, p. 8. 136 Continental Airlines press release, “Continental Airlines Announces Pricing of Initial Public Offering of Regional

Airline Subsidiary,” 4/17/02; online at www.continental.com (viewed 11/19/02).

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formulating a smart, no-nonsense public image that goes hand-in-hand with its strategic mission.

Brand Definition : "Work Hard. Fly Right" The public knows Continental's "Go Forward" program as "Work Hard. Fly Right."

The simple, snappy ad campaign--which features little more than the airline's signature blue-and-white globe and a series of short, to-the-point messages137--was launched in 1998 under the creative guidance of advertising firm NW Ayer & Partners. The campaign continues to be a strong public face for the airline. In fact, while other airlines worked to redefine their public images in the wake of the September 11th attacks, Continental recommitted to its "Work Hard. Fly Right" branding.138

The Kaplan Thayer Group (KTG) took over Ayer in April 2002139 without causing a hiccup in Continental's public image. In fact, KTG--one of Madison Avenue's most brazen and successful ad agencies--seems to taking "Work Hard. Fly Right" in fresh new directions: The agency allied with digital innovator Semaphore Partners in July 2002 to unify the ad campaign and Continental's interactive solutions,140 and recently partnered with cutting-edge cartoonists FlickerLab to create animated TV spots for the airline.141 Continental's willingness to invest in its public image--it was the lone major carrier to increase its media budget at end of 2001142--has helped the airline maintain one of the sleekest images among an increasingly ragtag band of competitors.

Commitment to Customer Service Guess which two airlines constantly top industry studies for customer satisfaction?

You got it, Continental and Southwest.

--Investor's Business Daily143

When Gordon Bethune took over Continental as CEO, he understood the value of branding--so much so that he cut the advertising budget in half until the company could

137 See appendix for examples from the October 2002 issue of Continental, Continental Airlines' in-flight magazine. 138 Petrecca, Laura. "Air Leaders Struggle for a Way Back," Advertising Age, Midwest region edition, 6/24/02, Vol. 73,

Issue 25, p. S24. 139 Fass, Allison. "Ayer, One of Madison Avenue's Oldest Names, Is Fading Away," New York Times, 4/8/02; online at

http://query.nytimes.com/search/restricted/article?res=F7091FF93E590C7B8CDDAD0894DA404482 (viewed 11/14/02).

140 Semaphore Partners press release. "Kaplan Thaler and Semaphore Partners Forge Alliance," 7/23/02; online at www.semaphorepartners.com/site/WhoWeAre/PressRelease.aspx?cid=1284 (viewed 11/16/02)

141 FlickerLab press release. "FlickerLab Completes Another National TV Spot for Continental Airlines," August 2002; online at www.flickerlab.com (viewed 11/16/02).

142 "Air Leaders Struggle for a Way Back," Advertising Age, 6/24/02, p. S24. 143 Keri, Jonah. "Satisfaction, Profits Fly Hand in Hand," Investors Business Daily, 1/30/01; online at

www.investors.com/ibdArchives/ArtShow.asp?atn=657041934134188 (viewed 11/14/02).

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build a product worth promoting.144 To be reborn, the airline need more than a Madison Avenue image--it needed results.

Key to Continental's turnaround has been an emphasis on empowering employees at every level to offer the best service possible, and gauging success with tangible performance measures, both internally and against competitors. Doing so "got every employee heading in the same direction," reflected president and COO Greg Brenneman in 1998.145

Keeping the eye on the prize has resulted in unprecedented success for a major U.S. carrier. Continental Airlines has enjoyed the industry's strongest consistency in service metrics over the past four years. 146 Operational performance included an 82.2% on-time arrivals rate for 2001--making Continental number one among U.S. hub carriers for on-time performance--and a 99.2% flight completion rate in 2001.147 Its on-time record and mishandled-bags record were best-of-industry for the first half of 2002.148 What's more, the carrier cancels half as many flights than the industry as a whole, and had cancelled only 0.2 of its scheduled flights in the first half of 2002. The result has been a slate of industry and customer-service awards unrivaled by another U.S. carrier in recent years.149

The airline is an innovator behind the scenes, too: Its call-center quality assurance program is an industry leader.150 In fact, Continental is so widely acknowledged for it success in the customer-service arena that it sells consulting service to outside firms--both within and outside the airline industry--in Business and Training solutions, including call center management, customer service, and sales training.151

Target One: Business Travelers By placing greater emphasis on product differentiation over pricing relative to its

competitors, Continental has continued to emphasize its commitment to business travelers,152 despite the fact that the business world is cutting back on travel budgets, redirecting its traveling executives to the coach seats, replacing face-to-face meetings with

144 Brenneman, Greg. "Right Away and All At Once: How We Saved Continental," Harvard Business Review, Sept-Oct 1998; HBR OnPoint product no. 4193; p. 9.

145 Ibid.; introduction, "The Idea at Work." 146 Engel and Gruetzmacher. Goldman Sachs Global Equity Research, 6/17/02, p. 6. 147 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, "2001 Accomplishments" (p. ii) and pp. 11-12;

completion factor excludes flights cancelled due to the events of September 11, 2001. 148 Engel and Gruetzmacher. Goldman Sachs Global Equity Research, 6/17/02, p. 6; also "Airline Performance Hot; 88% of

Flights on Time in September," USA Today, 11/8/02, p. B5. 149 See appendix for partial list. 150 Hollman, Lee. "A Not-So-Quixotic Quest for Quality," Call Center Magazine, July 2002, pp. 18-32. 151 Continental.com. "Business Training Solutions," www.continental.com/programs/solutions/default.asp?

SID=191C87255FE14B0EA62F1DF96F4D55B9 (viewed 11/14/02). 152 Jonas, David. "CO Puts Premium on Biz Travel," Business Travel News, 3/25/02, p. 3.

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video and teleconferencing, and generally cutting back on corporate travel across the board.153

Establishing the goal to earn and retain business travelers as part of the "Go Forward Plan," a post-turnaround Continental has proven its willingness to do almost anything to keep them on board: Bethune has even thrown a party at home for the 100 top flyers in the innovative and award-winning OnePass program,154 an Inside Flyer Freddie Awards "Best Elite-Level Program" winner in 2000 and 2001155 as well as a key factor in Continental's five consecutive JD Power and Associates consumer satisfaction awards.156 These key travelers played a key factor in the airline's return to profitability, increasing from 32 to 48% of business between 1994 and 2001.157

Today, the emphasis is on providing a competitive advantage via cutting-edge technology and convenience. The airline caused a stir by introducing the world's widest business-class seats--offering 170-degree recline, 6 1/2 feet of sleeping space, and privacy hoods with personal reading lights--to its award-winning "Business First" class at cost of $15 million in March 2002--exactly the time that all of its competitors were looking for ways to cut costs.158 Other perks added post-9/11 to keep business travelers Continental have included adding security checkpoints, automated check-in kiosks, and free inflight movies. As a result of Continental's heightened appeal to business travelers, the airline has realized the smallest relative decline in traffic of the six largest carriers.159

Strategic Alliances Continental has realized incredible successes with strategic partnerships that

expand their reach both domestically and around the globe. The carrier's long-term alliance with Northwest Airlines, in place through 2025,160 is unprecedented in scope. The two carriers have built one of the industry's largest international route maps through extensive code-sharing and route system design. They also offer frequent flyer and executive club reciprocity; regularly engage in cooperative marketing efforts; and have negotiated joint contracts with major corporate clients and travel agents.161

153 "Air Leaders Struggle for a Way Back," Advertising Age, 6/24/02, p. S24. 154 Hammonds, Keith H. "Business Fights Back: Continental's Turnaround Pilot," Fast Company, Dec. 2001, Issue 53, p.

96. 155 The Freddie Awards, online at www.freddieawards.com/live@event/fred14th/ (11/19/02). 156 JD Power Consumer Center, online at www.jdpower.com/travel/search.asp?CatID=4 (11/14/02). 157 "Business Fights Back: Continental's Turnaround Pilot," Fast Company, Dec. 2001p. 96. 158 Jonas, David. "CO Puts Premium on Biz Travel" and "Continental Broadening BusinessFirst Seats," Business Travel

News, 3/25/02, p. 3 and 14. 159 McCartney, Scott. "Flights of Fancy: Continental Airlines Keeps Little Things, And It Pays Off Big," Wall Street

Journal, 2/4/02, p. A1. 160 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, pp. 18-19. 161 Ibid., p. 19.

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Current Continental Airlines president Larry Kellner calls the alliance with Northwest, which generated $140 million in incremental revenue in 2001, "an absolute homerun." It is considered to be the only domestic alliance offering enough scope and utility to attract corporate buyers.162 The domestic network expands as of August 2002, when a marketing agreement with Delta163 formed a Continental-Northwest-Delta alliance controlling a remarkable 36% of the domestic market share.

Other domestic code-sharing partners include Gulfstream International Airlines (in which Continental owns 28%),164 Hawaiian Airlines, Alaska Airlines, Horizon Air, Mesaba Aviation (Northwest's commuter airline), CommutAir, and American Eagle Airlines. The airline's international code-share alliance partners include KLM Royal Dutch Airlines; Virgin Atlantic Airways; Air China; Air Europa, Spain's largest carrier; Panama-based Copa Airlines (in which Continental owns a 49% equity stake); Emirates, the official airline of the United Arab Emirates; and Taiwan-based EVA Air.165 A new code-share alliance with regional carrier British European flybe was awaiting final approval in November 2002.166 Continental believes that forming such strategic alliances are the best way to expand the airline's foreign product line.

Continental's partnering emphasis is on quality rather than quantity, however: The airline dropped an eight-year-old code-share agreement with America West in March of 2002, 167 and passed on an alliance with troubled carrier US Airways in June.168

Continental Airlines expanded its code-share options further in March 2002 by launching a creative air/rail alliance with Amtrak. Under the bilateral code-share agreement, passengers are now able to travel between one of the 17 Amtrak connection cities on the Northeast Corridor line and Newark Airport under one reservation.169

Another example of Continental's "outside the box" thinking was the November 2002 announcement that Dallas-based Travelweb had forged an agreement with Continental Airlines to become a private-label net-rate hotel distribution affiliate for the airline's consumer website. Under the agreement, Continental plans to provide their

162 "CO Puts Premium on Biz Travel," Business Travel News, 3/25/02, p. 3. Also Jonas, David. "CO-NW Deals with KLM Further Transatlantic Alliance," Business Travel News, 5/13/02, p. 3.

163 Delta Air Lines. "Delta Air Lines Signs Marketing Agreement with Continental Airlines and Northwest Airlines," press release, 8/23/02; online at www.delta.com (viewed 11/14/02).

164 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, p. 19. 165 Ibid.; also www.continental.com/company/alliance/default.asp?SID=AE733239090942C3916E1BDDF2D9F3A0

(viewed 11/19/02). 166 www.continental.com/company/alliance/flybe.asp?SID=AE733239090942C3916E1BDDF2D9F3A0 (11/19/02). 167 Consumer Reports Travel Letter, June 2002, Vol. 18, Issue 6; p. 4. 168 Airwise News. "Continental Shelves US Airways Alliance Talks," 6/3/02; online at http://news.airwise.com/

stories/202/07/1025721393.html (viewed 11/15/02). 169 "Continental Airlines and Amtrak Will Launch an Air/Rail Codeshare Agreement," Airports, 3/12/02, Vol. 8, issue

11, p. 4.

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customers with one-stop shopping--and themselves with a level of vertical integration-- by marketing Travelweb's net-rate hotel room inventory to customers through Continental.com starting in the first quarter of 2003.170

Corporate Culture We knew we had to balance those three elements:

The customers, the employees, and the shareholders.

---Chief Financial Officer Larry Kellner171

We treat our people well, and in turn, they treat our customers well.

Happy employees equal customer satisfaction.

--Chief Executive Office Gordon Bethune172

The Continental "Go Forward" plan has defined a corporate culture that

emphasizes superior customer service; employee involvement, open bilateral communication, and tangible goal-reward systems at every level; and strong, transparent leadership that employees could see in action; and pro-active decision making, for better and worse.

Vocal, Action-Oriented Leadership In 1994, one of Gordon Bethune's first acts as CEO was to dismantle the troubled

airline's ivory tower and bridge the gulf between executives and employees.173 He promoted a culture of openness rewarding good work with tangible rewards. "We wanted to let our people feel involved, that they belonged, that they were important--no matter what their role or position in the company," says Bethune.174

The emphasis continues to be on keeping employees informed at every level. Company goals, plans, initiatives are regularly communicated to all employees, from senior managers to baggage handlers.175 Employees receive daily on-time arrival updates via email, as well as weekly voice-mail messages from their CEO.176 "When management

170 Yahoo! Finance. "Travelweb Selected by Continental Airlines as Online Net-Rate Hotel Distribution Affiliate," 11/18/02; online at http://biz.yahoo.com/bw/021118/180118_1.html (viewed 12/02/02).

171 "Satisfaction, Profits Fly Hand in Hand," Investors Business Daily, 1/30/01. 172 "Top Talent and Passionate Employees," HRM Guide USA, 4/10/02; online at www.hrmguide.net/usa/

commitment/passionate_employees.htm (viewed 11/15/02). 173 "Satisfaction, Profits Fly Hand in Hand," Investors Business Daily, 1/30/01. 174 "Top Talent and Passionate Employees," HRM Guide USA, 4/10/02. 175 Ibid. 176 Raphael, Todd. "Continental Stays on Course," Workforce, June 2002, Vol. 81, Issue 6, p. 16.

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wakes up in the morning, it's 'What do we need to tell people today?'," states David Messing, Continental's PR Managing Director.177

Post-9/11 layoffs were announced to employees throughout the company hours before the press was informed.178 "Consistent--even persistent--communications is our mantra," reports Bonnie Reitz, the airline's senior vice president of Sales and Marketing.179

Outspoken leadership is also key to Continental's spearheading industry position. The airline was the first to respond to the attacks of September 11th with fiscal and job cuts. Bethune was the first industry leader to raise the need for government financial assistance,180 and the first top airline executive to make the talk-show rounds to assure U.S. flyers that it was safe to board domestic carriers again. He has also leads the call for a "common sense" approach to airline security.181

The media has responded in kind to Continental's openness. Journalists report that Continental's executive and public relations staffs are responsive and available both in good times and in bad.182

Employees Continental Airlines employed 42,900 employees as of December 31, 2001.183 While

layoffs of 12,000 were announced on September 15, 2001, in connection with a post-9/11 reduction on flight schedule, the company was ultimately able to limit furloughs to 8,000,184 or about 21% of the total workforce. Approximately 55% of furloughed employees voluntarily accepted leaves of absence and retirements. Not only has the company avoided further large-scale layoffs as of November 2002, but several hundred employees were recalled to assist with enhanced airport security requirements around the country.185

177 Green, Sherri Deatherage. "Internal PR Keeps Continental Flying Toward Profit," PRWeek USA, 2/18/02; online at www.sherrigreen.com/Internal%20pr%20keeps%20continental%20flying.htm (viewed 11/15/02).

178 Ibid. 179 Grant, Robert A. "Making the Connection," Lodging, March 2002; online at www.lodgingnews.com/lodgingmag

/2002_03/2002_03_19.asp (11/16/02). 180 "Internal PR Keeps Continental Flying Toward Profit," PRWeek USA, 2/18/02. 181 Fiorino, Frances. "Bethune Urges Common Sense Approach to Airline Security," Aviation Week & Space Technology,

6/24/02, Vol. 156, Issue 25, p. 65. 182 "Internal PR Keeps Continental Flying Toward Profit," PRWeek USA, 2/18/02. 183 Continental Airlines, Inc. 2001 Annual Report, p. 7. 184 Ibid., p. 20. 185 Ibid.

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The Value of High Morale When Fortune magazine named Continental no. 55 of its "100 Best Companies to

Work For" in January 2002--it's the company's fourth year in a row on the list--the magazine reported that 90% of employees reported that they intended to work at Continental until they retire.186 What's more, the company is recognized for its diversity; Hispanic magazine named Continental to its "Most Opportunities for Hispanics" list of employers for the third year in a row in 2001.187

The value of Continental's workforce and the high morale that the executive team has been able to generate among its employees should not be underestimated. In fact, in its mid-year "Buy" report, Goldman Sachs named Continental's employees as the company's most distinctive competitive advantage: "High employee morale helps produce a more consistently reliable service product, sustaining Continental's revenue edge."188

The "Pay-for-Performance" Innovation When the customers won, the employees did, too.

--President and COO Greg Brenneman189

An innovative monthly cash-reward incentive program has been a key driver in transforming Continental's on-time performance "from worst to first": In 1995, as a key component of their turnaround plan, Bethune and Brenneman introduced a pay-for- performance plan in which each of its (then) 35,000 non-managerial employees would receive a $65 cash bonus in any month that Continental ranked among the top five airlines for on-time departures.190

Everyone in the company won when the airline hit its on-time goals: "Booking agents, public relations folks, even that guy who waved the orange flashlights."191 The incentive plan turned out to be a direct driver of performance: The carrier was first in on- time performance within two months of instituting the program.192 The program was such a success that, in 1996, the $65 payout occurred only if Continental ranked among the top three on-time airlines; if it ranked first, the reward was $100.

186 As quoted in Continental Airlines 2001 Annual Report, p. 14. 187 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, "2001 Accomplishments" (p. ii). 188 Engel and Gruetzmacher. Goldman Sachs Global Equity Research: Continental Airlines, 6/17/02, p. 1. 189 Brenneman. "Right Away and All At Once: How We Saved Continental," Harvard Business Review; p. 10. 190 Knez, Marc and Duncan Simester, "Making Across-the-Board Incentives Work," Harvard Business Review, Feb. 2002,

Vol. 80, Issue 2, pp. 16-17. 191 "Satisfaction, Profits Fly Hand in Hand," Investors Business Daily, 1/30/01. 192 Ibid.

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The power of teamwork instituted a sea change in employee morale: It also played a central role in reducing employee turnover, sick days, and on-the-job injuries, as well as setting new standards for employee empowerment.193

The airline renewed its commitment to the plan in 2002, despite its annual cost of approximately $44 million, coupled with the devastating financial losses following September 11, 2001;194 in fact, the company paid out the cash rewards in 11 out of 12 months in 2001.195 While some might view cutting the pay-for-performance program as a way for the company to save cash in the short term, Continental sees it as essential to the airline's continued success in the long term.

Other Rewards Continental has also won over its employees with its Perfect Attendance

Recognition Program, which awards quarterly bonuses to employees with a spotless attendance record. In addition to the monetary reward, the company awarded 18 new Ford Explorers to employees in 2001 as part of the program.196

Continental's profit-sharing plan ties employee compensation to company objectives, "to ensure that our coworkers would win when our investors did," notes Greg Brenneman.197 Virtually all Continental employees (except those whose collective bargaining agreements require other compensation) receive about 15% of the company's annual pre-tax earnings.198 Continental also supports a scholarship program that funded educations for 96 Continental employees in 2002.199

The company's high employee satisfaction rate is still surprising, considering its reputation for low pay relative to the rest of the industry.200 Goldman Sachs analysts report that mechanics wage rates are 20% below other large-hub carriers (a gap that has closed somewhat with a new contract signed in October 2002; see below); Continental pilots receive 40% less pay than their peers at other airlines; and pensions and benefits packages are comparatively smaller across the workforce, relative to the rest of the industry.201

193 "Making Across-the-Board Incentives Work," Harvard Business Review, Feb. 2002, pp. 16-17. 194 "Continental Stays on Course," Workforce, June 2002, p. 16. 195 Continental Airlines, Inc. Continental Airlines 2001 Annual Report, " introduction, "2001 Accomplishments." 196 Ibid.; also "Internal PR Keeps Continental Flying Toward Profit," PRWeek USA, 2/18/02. 197 Brenneman. "Right Away and All At Once: How We Saved Continental," Harvard Business Review; p. 11. 198 Ibid.; also Continental Airlines, Inc. Continental Airlines 2001 Annual Report, pp. 28-29. 199 Continental Airlines 2001 Annual Report, p. 14. 200 Vault.com, "Continental Airlines," online at www.vault.com/companies/company_main.jsp?

co_page=1&product_id=720&ch_id=283 (11/14/02) 201 Engel and Gruetzmacher. Goldman Sachs Global Equity Research, 6/17/02. p. 10.

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Union Relations While corporate-union relations are traditionally fraught with tension across any

industry, Continental has managed to establish generally better-than-cordial relations with the majority of its heavily unionized employee ranks: roughly 45% of employees below to unions.202 This has been no small feat, thanks to bitter union relations history formed under former owner Frank Lorenzo, who alienated his workforce in the 1980s by breaking union contracts as a cost-cutting measure,203--not to mention the pay gulf between Continental employees and their industry peers.

The airline has been able to quell some labor unrest by striking a four-year deal with the International Brotherhood of Teamsters, which represents the airline's 3,400 unionized mechanics and related workers, in October 2002. The airline agreed to attractive wage and retirement-benefit increases as well as strengthened job protections, at the same time that rival United Airlines was trying to squeeze wage cuts out of its labor groups.204 The airline's 6,750 flight attendants, represented by the AFL-CIO's Association of Flight Attendants, have contracts in place through September 2004.205

Most vocal about compensation, job protection, and other issues is the Air Line Pilots Association, the United States' largest pilots' union. The union's Continental Master Executive Council (CAL ALPA) represents the approximately 6,500 pilots employed by Continental Airlines and Continental Express.206 The union does not hesitate to speak out: When Gordon Bethune and his senior staff accepted 62.5% bonuses for first-quarter 2002 because the airline bettered its loss targets--even though hundreds of pilots remained on furlough--union spokesman John Prater called move "galling."207

Despite ongoing contract negotiations between Continental and the Air Line Pilots' Association, rough waters between seemed to be smoothing over in mid-November 2002, when the pilots' union gave the green light Continental's code-share plan with Northwest and Delta Airlines.208

202 Ibid. 203 "Internal PR Keeps Continental Flying Toward Profit," PRWeek USA, 2/18/02. 204 Reuters, "Continental, Mechanics in Tentative Deal," 10/18/02; online at Yahoo! Finance,

http://biz.yahoo.com/rb/021018/airlines_continental_union_1.html. Also "Continental and Teamsters Settle," New York Times, 10/19/02, p. C4. Also Goldman Sachs Global Equity Research, 6/17/02, p. 10.

205 Association of Flight Attendants, AFL-CIO website, www.flightattendant-afa.org/negotiations_status.asp (11/19/02). Also Goldman Sachs Global Equity Research, 6/17/02, p. 10.

206 Continental Airlines Master Executive Council press release, "Pilots Wait to See What Continental Airlines' New Code-Sharing Contracts Mean for Them," 8/26/02; online at www.calalpa.org/cgi/newssystem/one_press.asp? IDNews=398 (viewed 11/19/02).

207 Dan Reed, "Continental Execs Qualify for Bonuses," USA Today, 10/15/02. 208 Brannigan, Martha and Nicole Harris. "Delta Pact With Pilots Bolsters Code-Share Plan," Wall Street Journal,

11/18/02, p. 2.

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Conclusion By the end of 2001, Continental Airlines was the fifth largest airline209 company in

the world, employing 50,000 people and flying to 216 destinations. Continental serves more destinations in Mexico and Central America than any other U.S. airline. It also serves more Japanese cities than all other U.S. carriers.210 In 2002, Continental recorded the highest on-time performance among the large hub carriers. It received the Freddie award--the Oscar of frequent flyer programs--for the eighth consecutive year for the best elite program.211

However, the events of September and the poor industry situation since has lead Continental to make huge cuts in capacity and introduce a series of cost-cutting measures to meet what the airline considers to be dramatic changes in the market place. “These are challenging times in our industry and we need to do something now,” said Gordon Bethune. “US Airways declared bankruptcy and United is likely to soon follow. While we remain committed to running a clean, safe, and reliable operation, we need to do some aggressive belt tightening so we don't end up like them.”212 Continental posted USD$139 million losses in its second quarter 2002 and total capacity was expected to be down by roughly 17% for 2002 compared to the previous year.213

The economic slowdown of the economy forced some changes upon the company, but they have stuck to their four-part mission. Their Go-forward Plan has helped them make the remarkable turnaround, and the airline hopes this will see them through present and future.

Still, Continental faces significant future challenges on all fronts. The emphasis has been on increasing customer fees, emphasizing operations belt-tightening and natural attrition over layoffs, as well as cost efficiency through e-ticket distribution innovations. But with the airline bleeding cash and their stock price that has shown a decline and high variability, how long can it hold its shareholders at bay? Given the current turmoil in which the industry finds itself, can the airline maintain the programs that have been key to its turnaround success?

209 As measured by 2001 revenue passenger miles. 210 Engel, Glenn and Gruetzmacher, Michael. Goldman Sachs Global Equity Research: Continental Airlines. June 17, 2002. p.

2. 211 The Freddie Awards, online at www.freddieawards.com/winners.htm (viewed 12/4/02). For a list of Continental's

most recent awards, see Appendix 1. 212 Continental Airlines Press Release, “Continental Airlines, Responding to Market Changes, Implements Measures To

Increase Revenue, Reduce Costs,” 8/20/02; online at www.continental.com (viewed 12/03/02). 213 Airwise News. “Continental Tightens Its Belt," 8/20/02; online at http://news.airwise.com (viewed 12/03/02).

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In the even bigger picture, can this “legacy” carrier, designed around a hub-and- spoke system with rigid labor-union commitments and significant fixed costs in equipment and facilities, modify its business fundamentals enough to compete effectively with the new breed of low-cost point-to-point carriers to ultimately return to profitability?

With a glorious past and an unsure future, only time will tell if Continental will come out of one of the worst tourism slowdowns as a winner or a loser.

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Exhibit 1 Highlights of Continental Airlines’ History

1934 Louis Mueller and Walter T. Varney create Varney Speed Lines 1936 Mueller sells 40% of the company to Robert Forman Six who will manage the

company for 40 consecutive years 1937 Varney Speed Lines is renamed Continental Airlines 1945 Continental has 400 employees and serves 26 cities 1953 Continental merges with Pioneer Airlines and expands its route to 46 cities 1959 The Boeing 707 is introduced to the fleet 1967 Air Micronesia is created to serve routes in Micronesia region 1978 The Airline Deregulation Act is enacted and will change the nature of flying forever 1979 Some oil producing countries create a cartel – the price of jet fuel skyrocketed 1980 Robert Forman Six retires 1980 Frank Lorenzo buys Continental 1983 Continental Airlines files for Chapter 11 bankruptcy protection for the first time 1986 Lorenzo acquires Eastern Airlines, People Express and Frontier Airlines 1987 “Continental Express” is created to bring increased traffic to hub cities 1988 Continental negotiates an alliance with SAS who invest 18.4% in Continental 1990 Frank Lorenzo is declared “unfit” by U.S. Congress and is forced out of the company 1990 Continental Airlines filed for Chapter 11 bankruptcy protection a second time, citing

rising fuel costs and reduced travel following the Gulf War 1994 Gordon Bethune is elected CEO of Continental Airlines 1995 The “Go Forward Plan” is adopted and will lead Continental Airlines to success 1997 Continental achieves a record annual profit of $640 million 1998 Northwest and Delta issue competing bids for the acquisition of Continental –

Continental chooses a complex code-share strategic relationship with Northwest and Northwest agrees to have Continental run as an independent but complementary business

2001 Continental buys back all common shares held by Northwest Airlines – for the first time since 1983, the carrier no longer has an outside controlling shareholder

2001 Terrorists attack the USA using commercial aircraft as weapons, with strikes on New York, Washington and Pennsylvania on September 11th

2002 Continental announced a USD$ 139 million loss for the second quarter of 2002. The company promises a return to profitability – but will they be able to find profitability and avert the crisis of filing for Chapter 11 bankruptcy protection for a third time?

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Exhibit 2 U.S. Airline Traffic and Operations

(All figures in millions) 1997 1998 1999 2000 2001 Revenue Passenger Enplaned 594.7 612.9 636.0 666.2 622.1 Revenue Passenger Miles 603,419 618,087 652,047 692,757 651,663 Available Seat Miles 857,232 874,089 918,419 956,950 930,486 Passenger Load Factor (%) 70.4% 70.7% 71.0% 72.4% 70.0%

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Exhibit 3 Discontinued Routes After September 11, 2001

Cleveland – Atlantic City Newark – Daytona Beach, FL Houston – Abilene, TX Newark – Dusseldorf, Germany Houston – San Angelo, TX Newark – Houston / Hobby Houston – Tyler, TX Newark – London Stansted Houston – Waco, TX Newark – Melbourne, FL

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Exhibit 4 Composition of Continental’s Fleet

Aircraft Type Total Aircraft

Firm Orders

Options Seats in Standard

Configuration

Average Age

(in Years) 777-200ER 18 -- 3 283 3.3 767-400ER 16 -- -- 235 1.3 767-200ER 10 -- 2 174 1.8

757-300 4 11 11 210 1.0 757-200 41 -- -- 183 5.9 737-900 12 3 12 167 1.3 737-800 77 38 35 155 2.8 737-700 36 15 24 124 4.0 737-500 65 -- -- 104 6.7 737-300 58 -- -- 124 16.1 MD-80 29 -- -- 141 16.7

Total Mainline Jets 366 67 87 7.0

ERJ-145XR 18 86 100 50 0.1 ERJ-145 140 -- -- 50 2.6 ERJ-135 30 -- -- 37 2.3

Regional Jets 188 86 100 2.3

Grand Total 554 Source: Continental Airlines, Inc. 2002 Annual Report, for period ended 12/31/02, p. 21.

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Exhibit 5 Financial Statements olidated Balance Sheet ons, except per share data)

Year Ended December 31,

Fiscal Year End 2002214 2001215 2000216 1999217 1998218 Assets Current Assets: Cash & Equivalents $1,225 $1,132 $1,371 $1,198 $1,399 Short-Term Investments 117 -- 24 392 -- Accounts receivables, net 377 404 495 506 449 Spare parts and supplies, net 248 272 280 236 166 Deferred Income Taxes, Prepayments & Other Current

Assets 310 336 289 274 340 Total Current Assets 2,277 2,144 2,459 2,606 2,606 Property & Equipment, net 6,968 6,153 5,163 4,173 3,065 Other Non-Current Assets (including routes, airport

operating rights & other intangibles, net) 1,495 1,494 1,579 1,444 1,667 Total Assets $10,740 $9,791 $9,201 $8,223 $7,086 Liabilities & Stockholders' Equity Current Liabilities: Accounts Payable $930 $1,008 $1,016 $856 $843 Current Maturities of Long-Term Debt & Capital Leases 493 355 304 321 231 Air Traffic Liability 882 1,014 1,125 962 854 Accrued Payroll & Other Current Liabilities 621 569219 535 636 514 Total Current Liabilities 2,296 2,946 2,980 2,775 2,442 Long-Term Debt & Capital Leases 5,222 4,198 3,374 3,055 2,480 Other Long-Term Liabilities 1,572 1,243220 995 800 860 Commitments & Contingencies Mandatorily Redeemable Preferred Securities of Subsidiary

Trust Holding Solely Convertible Subordinated Debentures 241 243 242 -- 111 Minority Interest & Redeemable Preferred Stock of

Subsidiary 12 -- -- -- -- Redeemable Common Stock -- -- 450 -- -- Stockholders' Equity: Preferred Stock -- -- -- - - Class B Common Stock 1 1 1 1 1 Additional Paid-In Capital 1,391 1,069221 379 871 634

214 Source: Continental Airlines, Inc. 2002 Annual Report, p. 23. 215 Ibid. 216 Source: Continental Airlines, Inc. 2001 Annual Report, p. 24. 217 Source: Continental Airlines, Inc. 1999 Annual Report, pp. 38-39. 218 Ibid. 219 $523 in accrued payroll and pensions and $291 in accrued other liabilities, resulting in $3,191 in total current

liabilities reported in 2001 Annual Report, p. 24. 220 $998 in other long-term liabilities reported in 2001 Annual Report, p. 24. 221 $1,071 in additional paid-in capital reported in 2001 Annual Report, p. 24.

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Retained Earnings 910 1,361 1,456 1,114 659 Accumulated Other Comprehensive Income (Loss) (395) (130)222 13 (1) (88) Treasury Stock, at Cost (1,140) (1,140) (689) (392) (13) Total Stockholders' Equity 767 1,161 1,160 1,593 1,193 Total Liabilities & Stockholders' Equity $10,740 $9,791 $9,201 $8,223 $7,086

222 ($132) in accumulative other comprehensive loss reported in 2001 Annual Report, p. 24.

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Financial Statements (Cont'd) Income Statement ($ millions) Year Ended December 31, Fiscal Year End 2002223 2001224 2000225 1999226 1998227 Operating Revenue: Passenger-related revenues $ 7,862 $ 8,457 $ 9,308 $ 8,116 $7,456 Cargo, mail and other 540 512 591 523 471 8,402 8,969 9,899 8,639 7,927 Operating Expenses: Wages, salaries and related costs 2,959 3,021 2,875 2,510 2,218 Aircraft fuel 1,023 1,229 1,393 756 727 Aircraft rentals, landing fees and other rentals 1,535 1,484 1,376 1,268 659 Maintenance, materials and repairs 476 568 646 603 582 Depreciation & Amortization 444 467 402 360 583 Reservation and sales, commissions 592 809 981 990 414 Passenger services 296 347 362 352 294 Fleet impairment losses, severance and other special charges 242 124 - 81 122 Other 1,135 1,193 1,135 1,104 1,627 Stabilization Act grant 12 (417) -- -- -- 8,714 8,825 9,170 8,024228 7,226 Operating Income (312) 144 729 615229 701 Nonoperating Income (Expense): Interest expense (356) (295) (251) (233) (178) Interest capitalized 36 57 57 55 59 Interest income 24 45 87 71 -- Gain on sale of Amadeus - - 297 55 Other, net (7) (65) (60)230 (7)231 11 (303) (258) (167)232 183233 (53) Income (Loss) before Income Taxes and Extraordinary Charge (615) (114) 562234 798 648 Income Tax (Expense) Benefit 202 29 (219)235 (310) (248) Distributions on Preferred Securities of Trust (10) (10) (1) -- (13)

223 Source: Continental Airlines, Inc. 2002 Annual Report, p. 22. 224 Ibid. 225 Ibid. 226 Source: Continental Airlines, Inc. 2001 Annual Report, p. 23. 227 Source: Continental Airlines, Inc. 1999 Annual Report, p. 37. 228 $8,039 in total operating expenses reported in 1999 Annual Report, p. 37. 229 $600 in total operating income reported in 1999 Annual Report, p. 37. 230 ($51) in other non-operating income (expenses) reported in 2001 Annual Report, p. 23. 231 $8 in other non-operating income reported in 1999 Annual Report, p. 37. 232 ($158) in total non-operating income (expense) reported in 2001 Annual Report, p. 23. 233 $198 in total non-operating income reported in 1999 Annual Report, p. 37. 234 $571 in income (loss) before income taxes and extraordinary charges reported in 2001 Annual Report, p. 23. 235 ($222) in income tax benefit (expense) reported in 2001 Annual Report, p. 23.

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rest (28) -- -- -- -- come (Loss) before Income Taxes and Extraordinary Charge -- $ (95) 348 488 387 mulative Effect of Accounting Changes, Net of Taxes -- -- -- (33) -- traordinary Charge, net of income taxes -- -- (6) -- (4) Income (Loss) $ (451) $ (95) $ 342 $ 455 $383

sic Earnings (Loss) per Share $ (7.02) $ (1.72) $ 5.62 $ 6.54 $6.34 uted Earnings (Loss) per Share $ (7.02) $ (1.72) $ 5.45 $ 6.20 $5.02

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Financial Statements (Cont'd) Consolidated Statement of Cash Flows ($ millions) Year Ended December 31, Fiscal Year End 2002236 2001237 2000238 1999239 1998240 Cash Flows from Operating Activities: Net Income (Loss) $ (451) $ (95) $ 342 $ 455 $ 383 Adjustments to reconcile net income (loss) to net cash: Depreciation & Amoritization 444 467 402 360 294 Fleet disposition/impairment losses 242 61 -- 81 122 Deferred Income Taxes (179) (40) 224 293 224 Gain on sale of Amadeus -- -- -- (297) -- Gain on sale of other investments -- -- -- (29) (6) Changes in operating assets & liabilities: (138) 101 (4) (37) (137) Cumulative Effect of Change in Accounting Principles -- -- -- 33 -- Other 4 51 (58) (83) (4) Net Cash Provided by Operating Activities (78) 545 906 776 876 Cash Flows from Investing Activities: Purchase deposits refunded (paid) in connection with aircraft deliveries 146 (95) (63) (1,174)

(818)

Capital expenditures (539) (568) (511) (706) (610) Sale (purchase) of short-term investments (117) 24 368 (392) -- Proceeds from sale of Amadeus, net -- -- -- 391 -- Other (34) (15) 138 (6) (30) Net Cash Used in Investing Activities (544) (654) (68) (659) (698) Cash Flows from Financing Activities: Proceeds from Issuance of Long-Term Debt, net 596 436 157 453 737 Issuance Capital Stock 241 334 38 56 Payments on Long-Term Debt & Capital Lease Obligations (383) (367) (707) (295) (423) Proceeds from sale of ExpressJet, net 447 -- -- -- -- Proceeds from issuance of Preferred Securities of Trust, net -- -- 242 -- -- Purchase of Common Stock -- (451) (450) (528) (223) Proceeds from Issuance of Common Stock 23 241 92 38 56 Other -- (11) 3 -- -- Net Cash Used in Financing Activities 683 (152) (663) (318) 196 Net Change in Cash & Cash Equivalents 61 (261) 175 (201) 374 Cash & Cash Equivalents -- Beginning of Period 1,102 1,363 1,188 1,399 1,025 Cash & Cash Equivalents -- End of Period $ 1,163 $ 1,102 $ 1,363 $ 1,198 $ 1,198

236 Source: Continental Airlines, Inc. 2002 Annual Report, p. 24. 237 Ibid. 238 Ibid. 239 Source: Continental Airlines, Inc. 1999 Annual Report, pp. 40-41. 240 Ibid.

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Supplemental Cash Flows Information: Interest Paid $ 345 $ 314 $ 276 $221 $ 157 Income Taxes Paid (Refunded) (31) (4) 7 18 25 Investing & Financing Activities Not Affecting Cash: Property & Equipment Acquired Through Issuance of Debt 908 707 808 774 425 Capital Lease Obligations Incurred 36 95 53 50 124 Conversion of 6-3/4% Convertible Subordinated Notes -- -- -- 230 -- Conversion of Trust Originated Preferred Securities -- -- -- 111 134 Sale-Leaseback of Beech 1900-D Aircraft -- -- -- 81 --