UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission File Number 0-9781
CONTINENTAL AIRLINES, INC.
(Exact name of registrant as specified in its charter)
Delaware 74-2099724
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2929 Allen Parkway, Suite 2010
Houston, Texas 77019
(Address of principal executive offices)
(Zip Code)
713-834-2950
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes X No _____
Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13 or
15(d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court.
Yes X No _____
_______________
As of August 1, 1997, 8,499,464 shares of Class A common stock and
50,032,394 shares of Class B common stock were outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
<TABLE>
CONTINENTAL AIRLINES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1996 1997 1996
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Operating Revenue:
Passenger . . . . . . . $1,646 $1,519 $3,210 $2,894
Cargo, mail and other . 140 120 274 234
1,786 1,639 3,484 3,128
Operating Expenses:
Wages, salaries and
related costs. . . . . 429 378 843 742
Aircraft fuel . . . . . 210 180 439 357
Aircraft rentals. . . . 128 127 259 251
Commissions . . . . . . 147 137 285 263
Maintenance, materials
and repairs. . . . . . 128 119 253 231
Other rentals and
landing fees . . . . . 98 85 195 169
Depreciation and
amortization . . . . . 62 67 122 132
Other . . . . . . . . . 353 317 711 634
1,555 1,410 3,107 2,779
Operating Income . . . . 231 229 377 349
Nonoperating Income
(Expense):
Interest expense. . . . (42) (42) (84) (89)
Interest capitalized. . 8 - 14 1
Interest income . . . . 14 10 27 19
Other, net. . . . . . . (3) 9 (2) 21
(23) (23) (45) (48)
Income before Income
Taxes and Minority
Interest. . . . . . . . 208 206 332 301
Income Tax Provision . . (77) (35) (123) (37)
</TABLE>
(continued on next page)
<TABLE>
CONTINENTAL AIRLINES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1996 1997 1996
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Income before Minority
Interest. . . . . . . . $ 131 $ 171 $ 209 $ 264
Minority Interest. . . . - (1) - (2)
Distributions on
Preferred Securities
of Trust, net of
applicable income
taxes of $2, $2, $4
and $4, respectively. . (3) (3) (7) (7)
Net Income . . . . . . . 128 167 202 255
Preferred Dividend
Requirements. . . . . . - (1) (2) (2)
Income Applicable to
Common Shares . . . . . $ 128 $ 166 $ 200 $ 253
Earnings per Common
and Common Equivalent
Share . . . . . . . . . $ 2.01 $ 2.53 $ 3.13 $ 3.90
Earnings per Common
Share Assuming Full
Dilution. . . . . . . . $ 1.64 $ 2.04 $ 2.58 $ 3.25
Shares used for
Computation:
Primary . . . . . . . . 63.4 65.6 63.9 64.8
Fully diluted . . . . . 81.6 84.0 82.2 81.3
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
<TABLE>
CONTINENTAL AIRLINES, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except for share data)
<CAPTION>
June 30, December 31,
ASSETS 1997 1996
(Unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents, including
restricted cash and cash equivalents
of $74 and $76, respectively . . . . . . $ 994 $1,061
Accounts receivable, net. . . . . . . . . 439 377
Spare parts and supplies, net . . . . . . 117 111
Prepayments and other . . . . . . . . . . 129 85
Total current assets . . . . . . . . . . 1,679 1,634
Property and Equipment:
Owned property and equipment:
Flight equipment . . . . . . . . . . . . 1,457 1,199
Other. . . . . . . . . . . . . . . . . . 396 338
1,853 1,537
Less: Accumulated depreciation. . . . . 412 370
1,441 1,167
Purchase deposits for flight equipment 274 154
Capital leases:
Flight equipment. . . . . . . . . . . . . 263 396
Other . . . . . . . . . . . . . . . . . . 35 31
298 427
Less: Accumulated amortization . . . . . 128 152
170 275
Total property and equipment . . . . . . 1,885 1,596
Other Assets:
Routes, gates and slots, net. . . . . . . 1,454 1,473
Reorganization value in excess of
amounts allocable to identifiable
assets, net. . . . . . . . . . . . . . . 230 237
Investments . . . . . . . . . . . . . . . 132 134
Other assets, net . . . . . . . . . . . . 136 132
Total other assets . . . . . . . . . . . 1,952 1,976
Total Assets. . . . . . . . . . . . . . $5,516 $5,206
</TABLE>
(continued on next page)
<TABLE>
CONTINENTAL AIRLINES, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except for share data)
<CAPTION>
June 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
(Unaudited)
<S> <C> <C>
Current Liabilities:
Current maturities of long-term debt. . . $ 282 $ 201
Current maturities of capital leases. . . 50 60
Accounts payable. . . . . . . . . . . . . 676 705
Air traffic liability . . . . . . . . . . 811 661
Accrued payroll and pensions. . . . . . . 183 149
Accrued other liabilities . . . . . . . . 322 328
Total current liabilities. . . . . . . . 2,324 2,104
Long-Term Debt . . . . . . . . . . . . . . 1,439 1,368
Capital Leases . . . . . . . . . . . . . . 142 256
Deferred Credits and Other Long-Term
Liabilities:
Deferred income taxes . . . . . . . . . . 191 75
Accruals for aircraft retirements and
excess facilities. . . . . . . . . . . . 160 188
Other . . . . . . . . . . . . . . . . . . 304 331
Total deferred credits and other
long-term liabilities . . . . . . . . . 655 594
Commitments and Contingencies
Minority Interest. . . . . . . . . . . . . 15 15
Continental-Obligated Mandatorily
Redeemable Preferred Securities of
Subsidiary Trust Holding Solely
Convertible Subordinated
Debentures (A). . . . . . . . . . . . . . 242 242
Redeemable Preferred Stock . . . . . . . . - 46
</TABLE>
(A) The sole assets of the Trust are convertible subordinated
debentures with an aggregate principal amount of $250 million,
which bear interest at the rate of 8-1/2% per annum and mature
on December 1, 2020. Upon repayment, the Continental-
Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust will be mandatorily redeemed.
(continued on next page)
<TABLE>
CONTINENTAL AIRLINES, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except for share data)
<CAPTION>
June 30, December 31,
1997 1996
(Unaudited)
<S> <C> <C>
Common Stockholders' Equity:
Class A common stock - $.01 par,
50,000,000 shares authorized;
8,546,064 and 9,280,000 shares issued
and outstanding, respectively. . . . . . $ - $ -
Class B common stock - $.01 par,
200,000,000 shares authorized;
49,830,545 and 47,943,343 shares
issued and outstanding, respectively . . - -
Additional paid-in capital . . . . . . . 609 693
Retained earnings (accumulated deficit) . 93 (109)
Other . . . . . . . . . . . . . . . . . . (3) (3)
Total common stockholders' equity. . . . 699 581
Total Liabilities and Stockholders'
Equity . . . . . . . . . . . . . . . . $5,516 $5,206
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
<TABLE>
CONTINENTAL AIRLINES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
<CAPTION>
Six Months
Ended June 30,
1997 1996
(Unaudited)
<S> <C> <C>
Net Cash Provided by Operating
Activities. . . . . . . . . . . . . . . $414 $435
Cash Flows from Investing Activities:
Capital expenditures. . . . . . . . . . (176) (79)
Purchase deposits paid in connection
with future aircraft deliveries. . . . (116) (17)
Purchase of warrants. . . . . . . . . . (94) -
Purchase deposits refunded in
connection with aircraft delivered . . 16 12
Proceeds from sale of America West
stock and warrants . . . . . . . . . . - 32
Proceeds from sale/leaseback
transaction. . . . . . . . . . . . . . - 12
Other . . . . . . . . . . . . . . . . . - 4
Net cash used by investing
activities. . . . . . . . . . . . . . (370) (36)
Cash Flows from Financing Activities:
Payments on long-term debt and
capital lease obligations. . . . . . . (219) (516)
Proceeds from issuance of long-term
debt, net. . . . . . . . . . . . . . . 155 241
Redemption of preferred stock . . . . . (48) -
Proceeds from issuance of common
stock. . . . . . . . . . . . . . . . . 14 5
Dividends paid on preferred securities
of trust . . . . . . . . . . . . . . . (11) (11)
Net cash used by financing activities. (109) (281)
Net Increase (Decrease) in Cash and
Cash Equivalents. . . . . . . . . . . . (65) 118
Cash and Cash Equivalents - Beginning
of Period (A) . . . . . . . . . . . . . 985 603
Cash and Cash Equivalents - End of
Period (A). . . . . . . . . . . . . . . $920 $721
</TABLE>
(A) Excludes restricted cash of $76 million and $144 million at
January 1, 1997 and 1996, respectively, and $74 million and
$104 million at June 30, 1997 and 1996, respectively.
(continued on next page)
<TABLE>
CONTINENTAL AIRLINES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
<CAPTION>
Six Months
Ended June 30,
1997 1996
(Unaudited)
<S> <C> <C>
Supplemental Cash Flow Information:
Interest paid . . . . . . . . . . . . . $ 75 $ 85
Income taxes paid . . . . . . . . . . . $ 5 $ 1
Investing and Financing Activities
Not Affecting Cash:
Property and equipment acquired
through the issuance of debt . . . . . $183 $ 41
Reduction of capital lease
obligations in connection with
refinanced aircraft. . . . . . . . . . $ 97 $ -
Financed purchase deposits for
flight equipment, net. . . . . . . . . $ 13 $ 13
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
CONTINENTAL AIRLINES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In the opinion of management, the unaudited consolidated financial
statements included herein contain all adjustments necessary to
present fairly the financial position, results of operations and
cash flows for the periods indicated. Such adjustments are of a
normal, recurring nature. The accompanying consolidated financial
statements should be read in conjunction with the consolidated
financial statements and the notes thereto contained in the Annual
Report of Continental Airlines, Inc. (the "Company" or
"Continental") on Form 10-K for the year ended December 31, 1996.
NOTE 1 - EARNINGS PER SHARE
The earnings per common share ("EPS") computations are based upon
earnings applicable to common shares and the average number of
shares of common stock, common stock equivalents (stock options,
warrants and restricted stock) and potentially dilutive securities
(e.g., convertible securities) outstanding. For fully diluted
purposes, net income has been adjusted for the distributions on the
preferred securities of trust and interest expense (net of tax) on
the convertible debt. Preferred stock dividend requirements
decreased net income in the EPS computations by approximately $2
million for the six months ended June 30, 1997, and $1 million and
$2 million for the three and six months ended June 30, 1996,
respectively. In April 1997, Continental redeemed for cash all of
the 460,247 outstanding shares of its Series A 12% Cumulative
Preferred Stock ("Series A 12% Preferred") held by an affiliate of
Air Canada, a Canadian corporation ("Air Canada"). See Note 4.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 - "Earnings per
Share" ("SFAS 128") which specifies the computation, presentation
and disclosure requirements for EPS. SFAS 128 replaces the
presentation of primary and fully diluted EPS pursuant to
Accounting Principles Board Opinion No. 15 - "Earnings per Share"
("APB 15") with the presentation of basic and diluted EPS. Basic
EPS excludes dilution and is computed by dividing net income
available to common stockholders by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that then
shared in the earnings of the entity. The Company is required to
adopt SFAS 128 with its December 31, 1997 financial statements and
restate all prior-period EPS data. The Company will continue to
account for EPS under APB 15 until that time.
Under SFAS 128, the Company's basic and diluted EPS were:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Basic EPS $2.22 $3.05 $3.50 $4.65
Diluted EPS $1.63 $2.09 $2.58 $3.31
</TABLE>
NOTE 2 - INCOME TAXES
Income taxes for the three and six months ended June 30, 1997 were
provided at the estimated annual effective tax rate. Such rate
differs from the federal statutory rate of 35%, primarily due to
state and foreign income taxes and the effect of certain expenses
that are not deductible for income tax purposes. Income taxes for
the three and six months ended June 30, 1996 were provided at the
estimated effective tax rate, which differs from the federal
statutory rate of 35%, primarily due to net operating loss
carryforwards ("NOLs") for which a tax benefit had not previously
been recorded, state and foreign income taxes and the effect of
certain expenses that are not deductible for income tax purposes.
At December 31, 1996, the Company had estimated NOLs of $2.3
billion for federal income tax purposes that will expire through
2009 and federal investment tax credit carryforwards of $45 million
that will expire through 2001. As a result of the change in
ownership of the Company on April 27, 1993, the ultimate
utilization of the Company's NOLs and investment tax credits could
be limited. Reflecting this possible limitation, the Company has
recorded a valuation allowance of $694 million at December 31,
1996.
The Company has consummated several built-in-gain transactions,
which resulted in the realization of tax benefits related to NOLs
and investment tax credit carryforwards attributable to the
Company's predecessor that were previously recorded. To the extent
the Company consummates additional built-in-gain transactions, such
benefits will reduce the valuation allowance and reorganization
value in excess of amounts allocable to identifiable assets. If
such reorganization value is exhausted, reductions in the valuation
allowance would decrease other intangibles.
NOTE 3 - OTHER
Aircraft Financing Transactions
In March 1997, Continental completed an offering of $707 million of
pass-through certificates. The pass-through certificates are not
direct obligations of, or guaranteed by, Continental and are
therefore not included in the accompanying consolidated financial
statements. The cash proceeds from the transaction were deposited
with an escrow agent and will be used to finance (through either
leveraged leases or secured debt financings) the debt portion of
the acquisition cost of up to 30 new aircraft from The Boeing
Company ("Boeing") scheduled to be delivered to Continental through
February 1998. In connection therewith, owner participants have
committed to approximately $184 million of equity financing to be
used in leveraged leases of 27 of such aircraft. If any funds
remain as deposits with the escrow agent for such pass-through
certificates at the end of the delivery period (which may be
extended to June 1998), such funds will be distributed back to the
certificate holders. Such distribution will include a make-whole
premium payable by Continental. Management believes that the
likelihood that the Company would be required to pay a material
make-whole premium is remote.
In April 1997, Continental entered into a $160 million floating
rate (e.g., LIBOR plus 1.125% or prime) secured revolving credit
facility (the "Facility"). The revolving loans made under the
Facility will be used for the purpose of making certain predelivery
payments to Boeing for new Boeing aircraft to be delivered through
December 1999. The Facility contains certain financial covenants,
including maintenance of a minimum fixed charge ratio, a minimum
net worth and a minimum unrestricted cash balance. Continental is
also restricted from making cash dividends and certain other
payments.
In June 1997, the Company acquired 10 aircraft previously leased by
it. The debt financing for the acquisition of the six Boeing 737-
300 aircraft and the four McDonnell Douglas MD-82 aircraft was
funded by the private placement of $155 million of pass-through
certificates. The pass-through certificates, which were issued by
separate pass-through trusts that acquired equipment trust notes
issued on a recourse basis by Continental, consist of $75 million
of 7.148% Class A certificates, maturing in June 2007, $26 million
of 7.149% Class B certificates, maturing in June 2005, $27 million
of 7.206% Class C certificates, maturing in June 2004, and $27
million of 7.522% Class D certificates, maturing in June 2001.
Aircraft maintenance expense in the second quarter of 1997 was
reduced by approximately $16 million due to the reversal of
reserves that are no longer required as a result of the
transaction.
Facility Financing Transactions
In April 1997, the City of Houston (the "City") completed the
offering of $190 million aggregate principal amount of tax-exempt
special facilities revenue bonds (the "IAH Bonds") payable solely
from rentals paid by Continental under long-term lease agreements
with the City. The IAH Bonds are unconditionally guaranteed by the
Company. The proceeds from the IAH Bonds will be used to finance
the acquisition, construction and installation of certain terminal
and other airport facilities located at Continental's hub at George
Bush Intercontinental Airport in Houston, including a new automated
people mover system linking Terminals B and C and 20 aircraft gates
in Terminal B into which Continental intends to expand its
operations. The expansion project is expected to be completed by
the summer of 1999.
The Company announced plans to expand its facilities at its Hopkins
International Airport hub in Cleveland which is expected to be
completed in the first quarter of 1999. The expansion, which will
include a new jet concourse for the new regional jet service
offered by Continental's wholly owned subsidiary, Continental
Express, Inc. ("Express"), as well as other facility improvements,
is expected to cost approximately $120 million, which the Company
expects will be funded principally by the issuance of a combination
of tax-exempt special facilities revenue bonds and general airport
revenue bonds by the City of Cleveland. In connection therewith,
the Company expects to enter into long-term leases with the City of
Cleveland under which rental payments will be sufficient to service
the related bonds.
In February 1997, the Company began construction of a new hangar
and improvements to a cargo facility at the Company's hub at Newark
International Airport which is expected to be completed in the
fourth quarter of 1997. The Company expects to finance these
projects, which will cost approximately $21 million, through tax-
exempt bonds to be issued by the New Jersey Economic Development
Authority. In addition, the Company is also planning a facility
expansion at Newark which would require, among other matters,
agreements to be reached with the applicable airport authority.
The Company announced plans to build a wide-body aircraft
maintenance hangar in Honolulu, Hawaii at an estimated cost of $24
million. Construction of the hangar, anticipated to be completed
by the second quarter of 1998, is expected to be financed by tax-
exempt special facilities revenue bonds issued by the State of
Hawaii. In connection therewith, the Company expects to enter into
long-term leases under which rental payments will be sufficient to
service the related bonds.
Commitments
In June 1997, Continental signed a letter of intent with Boeing to
purchase 35 new widebody aircraft. The order consists of five firm
Boeing 777-200 aircraft and 30 firm new generation Boeing 767-400ER
aircraft, with options for additional 777 and 767 aircraft to be
negotiated by the parties. This order is in addition to the five
firm 777 aircraft which the airline already has on order with
Boeing, the deliveries of which will be accelerated as part of this
order. The new widebody aircraft will replace Continental's fleet
of six DC-10-10 and 31 DC-10-30 aircraft, which will be retired as
the new Boeing aircraft are delivered, and will also be used to
expand the airline's international and transcontinental service.
The ten firm delivery 777 aircraft (including the five aircraft the
Company already had on order) are scheduled to be delivered from
September 1998 through May 1999, and the thirty firm 767 aircraft
are scheduled to be delivered from mid-2000 through the end of
2004. The new order with Boeing is subject to the negotiation and
execution of definitive documentation.
In June 1997, Express exercised its option to order 25 Embraer
("EMB")-145 regional jets. Express is scheduled to take delivery
of these 50-seat aircraft from June 1998 through September 1999.
Neither Express nor Continental will have any obligation to take
aircraft that are not financed by a third party and leased to the
Company. The Company expects to account for all of these aircraft
as operating leases.
Other
On May 16, 1997, the stockholders of the Company approved the
Continental Airlines, Inc. 1997 Stock Incentive Plan (the
"Incentive Plan"). The Incentive Plan provides that the Company
may issue shares of restricted Class B common stock or grant
options to purchase shares of Class B common stock to non-employee
directors of the Company or employees of the Company or its
subsidiaries. Subject to adjustment as provided in the Incentive
Plan, the aggregate number of shares of Class B common stock that
may be issued under the Incentive Plan may not exceed 2,000,000
shares, which may be originally issued or treasury shares or a
combination thereof. The maximum number of shares of Class B
common stock that may be (i) subject to options granted to any one
individual during any calendar year may not exceed 200,000 shares
and (ii) granted as restricted stock may not exceed 100,000 shares
(in each case, subject to adjustment as provided in the Incentive
Plan).
Also on May 16, 1997, the stockholders of the Company approved the
Continental Airlines, Inc. 1997 Employee Stock Purchase Plan (the
"Purchase Plan"). Under the Purchase Plan, all employees of the
Company, including Continental Micronesia, Inc. ("CMI") and
Express, may purchase shares of Class B common stock of the Company
at 85% of the lower of the fair market value on the first day of
the option period or on the last day of the option period. Subject
to adjustment, a maximum of 1,750,000 shares of Class B common
stock are authorized for issuance under the Purchase Plan.
The Company recently began collective bargaining agreement
negotiations with its Continental Airlines pilots, whose contract
became amendable in July 1997, and Express pilots, whose contract
becomes amendable in October 1997. The Company believes that
mutually acceptable agreements can be reached with such employees,
although the outcome of the negotiations cannot be determined at
this time.
In February 1996, the Company sold approximately 1.4 million of its
1.8 million shares of America West Airlines, Inc. ("America West")
common stock for net proceeds of approximately $25 million in an
underwritten public offering. A $13 million gain was realized on
the transaction. In addition, in May 1996, the Company sold all of
its 802,860 America West warrants, realizing net proceeds of $7
million and recognizing a gain of $5 million. The gains are
included in other nonoperating income in the accompanying
consolidated statement of operations.
Continental has entered into block space arrangements with certain
other carriers whereby one of the carriers is obligated to purchase
capacity on the other carrier. One such arrangement began on June
1, 1997 pursuant to which the other carrier is sharing the costs of
operating certain flights by committing to purchase capacity on
such flights. Under this arrangement, the Company's statements of
operations reflect the reimbursement from the other carrier as an
offset to the Company's operating expenses.
NOTE 4 - RELATED PARTY TRANSACTIONS
In January 1997, Air Canada divested the remainder of its April
1993 investment in Continental common stock by selling on the open
market 5,600,000 shares of the Company's Class B common stock.
In April 1997, Continental redeemed for cash all of the 460,247
outstanding shares of its Series A 12% Preferred held by an
affiliate of Air Canada for $100 per share plus accrued dividends
thereon. The redemption price, including accrued dividends,
totaled $48 million.
On June 2, 1997, the Company purchased for $94 million from Air
Partners, L.P. ("Air Partners") warrants to purchase 3,842,542
shares of Class B common stock (representing a portion of the total
warrants held by Air Partners). The purchase price represents the
intrinsic value of the warrants (the difference between the closing
market price of the Class B common stock on May 28th and the
applicable exercise price). The warrants sold by Air Partners
consisted of 2,314,687 Class B warrants exercisable for $7.50 per
share and 1,527,855 Class B warrants exercisable for $15.00 per
share.
NOTE 5 - SUBSEQUENT EVENTS
In July 1997, Continental entered into a $575 million credit
facility (the "Credit Facility"), including a $275 million term
loan. The proceeds of the term loan were loaned by Continental to
Air Micronesia, Inc. ("AMI"), reloaned to CMI, and used by CMI to
repay its existing secured term loan. In connection with this
prepayment, Continental will record a $4 million after tax
extraordinary charge to consolidated earnings in the third quarter
of 1997. The facility also includes a $225 million revolving
credit facility and a $75 million term loan commitment for general
corporate purposes.
The Credit Facility is secured by substantially all of CMI's assets
(other than aircraft subject to other financing arrangements) but
does not contain any financial covenants relating to CMI other than
covenants restricting CMI's incurrence of certain indebtedness and
pledge or sale of assets. AMI's rights with respect to its loan to
CMI and Continental's rights with respect to its loan to AMI (as
well as Continental's stock in AMI) are pledged as collateral for
loans to Continental under the Credit Facility. Upon funding of
the $75 million term loan commitment, CMI and AMI will also enter
into a guaranty of all of Continental's obligations under the
Credit Facility. In addition, the Credit Facility contains certain
financial covenants applicable to Continental and prohibits
Continental from granting a security interest on certain of its
international route authorities and domestic slots.
In July 1997, the Company purchased (i) the rights of United
Micronesia Development Association, Inc. ("UMDA") to receive future
payments under a services agreement between UMDA and CMI (pursuant
to which CMI pays UMDA approximately 1% of the gross revenues of
CMI, as defined, through January 1, 2012, which payment by CMI to
UMDA totaled $6 million in 1996) and (ii) UMDA's 9% interest in
AMI, terminated the Company's obligations to UMDA under a
settlement agreement entered into in 1987, and terminated
substantially all of the other contractual arrangements between the
Company, AMI and CMI, on the one hand, and UMDA on the other hand,
for an aggregate consideration of $73 million.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The following discussion may contain forward-looking statements.
In connection therewith, please see the risk factors set forth in
the Company's Form 10-K for the year ended December 31, 1996 and
the Company's registration statements filed with the Securities and
Exchange Commission under the Securities Act of 1933, as amended,
since December 31, 1996. The risk factors filed as an exhibit to
this report are hereby incorporated by reference. These risk
factors identify important factors that could cause actual results
to differ materially from those in the forward-looking statements.
Due to the greater demand for air travel during the summer months,
revenue in the airline industry in the third quarter of the year is
generally significantly greater than revenue in the first quarter
of the year and moderately greater than revenue in the second and
fourth quarters of the year for the majority of air carriers.
Continental's results of operations generally reflect this
seasonality, but have also been impacted by numerous other factors
that are not necessarily seasonal, including the extent and nature
of competition from other airlines, fare wars, excise and similar
taxes, changing levels of operations, fuel prices, foreign currency
exchange rates and general economic conditions.
RESULTS OF OPERATIONS
The following discussion provides an analysis of the Company's
results of operations and reasons for material changes therein for
the three and six months ended June 30, 1997 as compared to the
corresponding periods ended June 30, 1996.
Comparison of Three Months Ended June 30, 1997 to Three Months
Ended June 30, 1996
The Company recorded consolidated net income of $128 million for
the three months ended June 30, 1997 as compared to consolidated
net income of $167 million for the three months ended June 30,
1996. Management believes that the Company benefitted in the
second quarter of 1996 from the expiration of the aviation trust
fund tax (the "ticket tax"). The ticket tax, which expired on
December 31, 1995, was reinstated on August 27, 1996. Management
believes that the ticket tax has a negative impact on the Company,
although neither the amount of such negative impact directly
resulting from the reimposition of the ticket tax, nor the benefit
realized by its expiration, can be precisely determined.
Additionally, the Company benefitted in the second quarter of 1996
from the recognition of previously unbenefitted post-reorganization
NOLs.
Passenger revenue increased 8.4%, $127 million, during the quarter
ended June 30, 1997 as compared to the same period in 1996, which
was primarily due to a 13.3% increase in revenue passenger miles,
offset by a 4.4% decrease in yield.
Cargo, mail and other revenue increased 16.7%, $20 million, in the
three months ended June 30, 1997 as compared to the same period in
the prior year, principally as a result of an increase in freight
and mail volumes and an increase in revenue related to frequent
flyer mileage credits sold to participating partners in the
Company's frequent flyer program.
Wages, salaries and related costs increased 13.5%, $51 million,
during the quarter ended June 30, 1997 as compared to the same
period in 1996, primarily due to an 8.7% increase in average full-
time equivalent employees in the second quarter of 1997 compared to
the second quarter of 1996 and an increase in wage rates resulting
from a longevity pay increase for substantially all employee groups
effective July 1, 1996.
Aircraft fuel expense increased 16.7%, $30 million, in the three
months ended June 30, 1997 as compared to the same period in the
prior year. The average price per gallon, net of fuel hedging
gains of $15 million in 1996, increased 5.8% from 57.81 cents in
the second quarter of 1996 to 61.17 cents in the second quarter of
1997. In addition, there was a 10.0% increase in the quantity of
jet fuel used from 301 million gallons in the second quarter of
1996 to 331 million gallons in the second quarter of 1997,
principally reflecting increased capacity.
Commissions expense increased 7.3%, $10 million, in the quarter
ended June 30, 1997 as compared to the same period in the prior
year, primarily due to increased passenger revenue.
Maintenance, materials and repairs increased 7.6%, $9 million,
during the quarter ended June 30, 1997 as compared to the same
period in 1996, due principally to the volume and timing of engine
overhauls and routine maintenance as part of the Company's ongoing
maintenance program. Aircraft maintenance expense in the second
quarter of 1997 was reduced by $16 million due to the reversal of
reserves that are no longer required as a result of the acquisition
of 10 aircraft previously leased by the Company.
Other rentals and landing fees increased 15.3%, $13 million, for
the three months ended June 30, 1997 compared to the same period in
1996, due to higher facilities rentals and higher landing fees
resulting from increased operations.
Depreciation expense decreased 7.5%, $5 million, in the second
quarter of 1997 compared to the second quarter of 1996 primarily
due to the previous writedown of Stage 2 aircraft inventory in the
third quarter of 1996.
Other operating expense increased 11.4%, $36 million, in the three
months ended June 30, 1997 as compared to the same period in the
prior year, as a result of increases in passenger services,
advertising and publicity, reservations and sales expense and other
miscellaneous expense.
Interest capitalized increased $8 million in the second quarter of
1997 as compared to the second quarter of 1996 as a result of
higher average purchase deposits for flight equipment.
Interest income increased 40.0%, $4 million, in the second quarter
of 1997 as compared to the same period in 1996 principally due to
an increase in the average invested balance of cash and cash
equivalents.
The Company's other nonoperating income (expense) in the quarter
ended June 30, 1997 included foreign exchange losses primarily
related to the Japanese yen. Other nonoperating income (expense)
in the second quarter of 1996 consisted primarily of a $5 million
gain related to the sale of the America West warrants and foreign
exchange gains (primarily related to the Japanese yen).
The income tax provision for the three months ended June 30, 1997
and 1996 of $77 million and $35 million, respectively, consisted of
federal, state and foreign income taxes. During the second quarter
of 1996, the Company utilized previously unbenefitted post-
reorganization NOLs and began accruing income tax expense.
Comparison of Six Months Ended June 30, 1997 to Six Months Ended
June 30, 1996
The Company recorded consolidated net income of $202 million and
$255 million for the six months ended June 30, 1997 and 1996,
respectively. The Company's net income in the first six months of
1996 included a gain of $18 million on the sale of certain shares
of America West common stock and warrants. Management believes
that the Company benefitted in the first quarters of 1996 and 1997
from the expiration of the ticket tax on December 31, 1995 and
December 31, 1996, respectively. The ticket tax was reinstated on
August 27, 1996 and again on March 7, 1997, respectively.
Management believes that the ticket tax has a negative impact on
the Company, although neither the amount of such negative impact
directly resulting from the reimposition of the ticket tax, nor the
benefit realized by its expiration, can be precisely determined.
Additionally, the Company benefitted in the first six months of
1996 from the recognition of previously unbenefitted post-
reorganization NOLs.
Passenger revenue increased 10.9%, $316 million, during the six
months ended June 30, 1997 as compared to the same period in 1996.
The increase was due to a 12.5% increase in revenue passenger miles
offset by a 1.5% decrease in yield.
Cargo, mail and other revenue increased 17.1%, $40 million, in the
six months ended June 30, 1997 as compared to the same period in
the prior year, principally as a result of an increase in freight
and mail volumes and an increase in revenue related to frequent
flyer mileage credits sold to participating partners in the
Company's frequent flyer program.
Wages, salaries and related costs increased 13.6%, $101 million,
during the six months ended June 30, 1997 as compared to the same
period in 1996, primarily due to an 8.6% increase in average full-
time equivalent employees in the first six months of 1997 compared
to the first six months of 1996 and an increase in wage rates
resulting from a longevity pay increase for substantially all
employee groups effective July 1, 1996. In addition, there were
increases in employee incentives in the first half of 1997 compared
to the first half of 1996.
Aircraft fuel expense increased 23.0%, $82 million, in the six
months ended June 30, 1997 as compared to the same period in the
prior year. The average price per gallon, net of fuel hedging
gains of $21 million in 1996 and $3 million in 1997, increased
11.4% from 58.55 cents in the first six months of 1996 to 65.20
cents in the first six months of 1997. In addition, there was a
10.2% increase in the quantity of jet fuel used from 591 million
gallons in the first six months of 1996 to 651 million gallons in
the first six months of 1997, principally reflecting increased
capacity.
Commissions expense increased 8.4%, $22 million, in the six months
ended June 30, 1997 as compared to the same period in the prior
year, primarily due to increased passenger revenue.
Maintenance, materials and repairs increased 9.5%, $22 million,
during the six months ended June 30, 1997 as compared to the same
period in 1996, principally due to the volume and timing of engine
overhauls as part of the Company's ongoing maintenance program.
Aircraft maintenance expense in the second quarter of 1997 was
reduced by $16 million due to the reversal of reserves that are no
longer required as a result of the acquisition of 10 aircraft
previously leased by the Company.
Other rentals and landing fees increased 15.4%, $26 million, for
the six months ended June 30, 1997 compared to the same period in
1996, due to higher facilities rentals and higher landing fees
resulting from increased operations.
Depreciation expense decreased 7.6%, $10 million, in the first six
months of 1997 compared to the same period in 1996 primarily due to
the previous writedown of Stage 2 aircraft inventory in the third
quarter of 1996.
Other operating expense increased 12.1%, $77 million, in the six
months ended June 30, 1997 as compared to the same period in the
prior year, primarily as a result of increases in passenger
services, advertising and publicity, reservations and sales expense
and other miscellaneous expense.
Interest capitalized increased $13 million in the first six months
of 1997 compared to the first six months of 1996 as a result of
higher average purchase deposits for flight equipment.
Interest income increased 42.1%, $8 million, in the first six
months of 1997 compared to the same period in the prior year,
principally due to an increase in the average invested balance of
cash and cash equivalents.
The Company's other nonoperating income (expense) in the six months
ended June 30, 1997 included foreign currency losses primarily
related to the Japanese yen. Other nonoperating income (expense)
in the first six months of 1996 consisted of an $18 million gain
related to the sale of America West common stock and warrants, and
foreign currency gains (primarily related to the Japanese yen).
The income tax provision for the six months ended June 30,1997 and
1996 of $123 million and $37 million, respectively, consists of
federal, state and foreign income taxes. During the second quarter
of 1996, the Company utilized previously unbenefitted post-
reorganization NOLs, and began accruing income tax expense.
Certain Statistical Information
An analysis of statistical information for Continental's jet
operations, excluding regional jet operations, for the periods
indicated is as follows:
<TABLE>
<CAPTION>
Three Months Ended Net
June 30, Increase/
1997 1996 (Decrease)
<S> <C> <C> <C>
Revenue passenger miles
(millions) (1). . . . . . . . . . 11,922 10,527 13.3 %
Available seat miles
(millions) (2). . . . . . . . . .16,486 15,152 8.8 %
Passenger load factor (3). . . . . 72.3% 69.5% 2.8 pts.
Breakeven passenger load
factor (4). . . . . . . . . . . . 62.4% 59.4% 3.0 pts.
Passenger revenue per available
seat mile (cents). . . . . . . . 9.31 9.35 (0.4)%
Total revenue per available
seat mile (cents) . . . . . . . . 10.24 10.23 0.1 %
Operating cost per available
seat mile (cents) . . . . . . . . 8.90 8.81 1.0 %
Average yield per revenue
passenger mile (cents) (5) . . . 12.87 13.46 (4.4)%
Average fare per revenue
passenger . . . . . . . . . . . .$146.66 $144.55 1.5 %
Revenue passengers (thousands) . .10,462 9,799 6.8 %
Average length of aircraft
flight (miles) . . . . . . . . . 944 888 6.3 %
Average daily utilization of
each aircraft (hours) (6). . . . 10:09 9:56 2.2 %
Actual aircraft in fleet at
end of period (7) . . . . . . . . 325 313 3.8 %
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended Net
June 30, Increase/
1997 1996 (Decrease)
<S> <C> <C> <C>
Revenue passenger miles
(millions) (1). . . . . . . . . . 22,813 20,279 12.5 %
Available seat miles
(millions) (2). . . . . . . . . .32,318 29,703 8.8 %
Passenger load factor (3). . . . . 70.6% 68.3% 2.3 pts.
Breakeven passenger load
factor (4). . . . . . . . . . . . 62.3% 60.2% 2.1 pts.
Passenger revenue per available
seat mile (cents). . . . . . . . 9.30 9.13 1.9 %
Total revenue per available
seat mile (cents) . . . . . . . . 10.23 10.00 2.3 %
Operating cost per available
seat mile (cents) . . . . . . . . 9.08 8.86 2.5 %
Average yield per revenue
passenger mile (cents) (5) . . . 13.17 13.37 (1.5)%
Average fare per revenue
passenger . . . . . . . . . . . .$148.78 $143.59 3.6 %
Revenue passengers (thousands) . .20,201 18,886 7.0 %
Average length of aircraft
flight (miles) . . . . . . . . . 935 882 6.0 %
Average daily utilization of
each aircraft (hours) (6). . . . 10:12 9:47 4.3 %
Actual aircraft in fleet at
end of period (7) . . . . . . . . 325 313 3.8 %
</TABLE>
Continental has entered into block space arrangements with certain other
carriers whereby one of the parties is obligated to purchase capacity on
the other carrier. One such arrangement began on June 1, 1997 where the
other carrier is sharing the costs of operating certain flights by
committing to purchase capacity on such flights. The tables above do
not include the statistics (which were not material) for the capacity
that was purchased by another carrier.
(1) The number of scheduled miles flown by revenue passengers.
(2) The number of seats available for passengers multiplied by the
number of scheduled miles those seats are flown.
(3) Revenue passenger miles divided by available seat miles.
(4) The percentage of seats that must be occupied by revenue
passengers in order for the airline to break even on an income
before income taxes basis, excluding nonoperating items.
(5) The average revenue received for each mile a revenue passenger is
carried.
(6) The average block hours flown per day in revenue service per
aircraft.
(7) 1997 excludes four all-cargo 727 aircraft at CMI and one A300
aircraft that was removed from service in 1995. 1996 excludes
four all-cargo 727 aircraft at CMI and three A300 and one 747
Continental aircraft that were removed from service in 1995.
LIQUIDITY AND CAPITAL COMMITMENTS
During 1997, the Company completed several transactions intended to
strengthen its long-term financial position and enhance earnings.
- - In March 1997, Continental completed an offering of $707 million of
pass-through certificates to be used to finance (through either
leveraged leases or secured debt financings) the debt portion of the
acquisition cost of up to 30 new Boeing aircraft scheduled to be
delivered to Continental through February 1998.
- - In April 1997, Continental completed an offering of $190 million
aggregate principal amount of tax-exempt special facilities revenue
bonds to finance Continental's expansion of its hub at George Bush
Intercontinental Airport in Houston. These bonds are solely payable
from rentals paid by Continental under long term lease agreements
with the City of Houston.
- - In April 1997, Continental entered into a $160 million secured
revolving credit facility to be used for the purpose of making
certain predelivery payments to Boeing for new Boeing aircraft to be
delivered through December 1999.
- - In April 1997, Continental redeemed for cash all of the 460,247
outstanding shares of its Series A 12% Preferred held by an affiliate
of Air Canada for $100 per share plus accrued dividends thereon. The
redemption price, including accrued dividends, totaled $48 million.
- - In June 1997, Continental purchased from Air Partners warrants to
purchase 3,842,542 shares of Class B common stock of the Company for
$94 million in cash.
- - In June 1997, Continental completed an offering of $155 million of
pass-through certificates which were used to finance the acquisition
of 10 aircraft previously leased by the Company.
- - In July 1997, Continental entered into a $575 million credit
facility, including a $275 million term loan. The proceeds of the
$275 million term loan were used by CMI to repay its existing secured
term loan. The facility also includes a $225 million revolving
credit facility and a $75 million term loan commitment for general
corporate purposes.
- - In July 1997, the Company purchased (i) UMDA's right to receive
future payments under a services agreement between UMDA and CMI and
(ii) UMDA's 9% interest in AMI, terminated the Company's obligations
to UMDA under a settlement agreement entered into in 1987, and
terminated substantially all of the other contractual arrangements
between the Company, AMI and CMI, on the one hand, and UMDA on the
other hand, for an aggregate consideration of $73 million.
As of August 1, 1997, Continental had firm commitments with Boeing to
take delivery of a total of 121 principally narrowbody jet aircraft
during the years 1997 through 2003 with options for an additional 90
aircraft (exercisable subject to certain conditions). These aircraft
will replace older, less efficient Stage 2 aircraft and allow for growth
of operations. In addition, the Company has recently signed a letter of
intent with Boeing to purchase 35 new widebody jet aircraft. This new
order consists of five firm Boeing 777-200 aircraft and 30 firm Boeing
767-400ER aircraft, with options for additional 777 and 767 aircraft to
be negotiated by the parties. The new widebody aircraft will replace
Continental's fleet of DC-10-10 and DC-10-30 aircraft, which will be
retired as the new Boeing aircraft are delivered, and will also be used
to expand the airline's international and transcontinental service. Ten
firm delivery 777 aircraft (including five aircraft the Company already
had on order, the deliveries of which will be accelerated) will be
delivered in September 1998 through May 1999, and the thirty firm
delivery 767 aircraft will be delivered starting in mid-2000 through the
end of 2004. In connection with this new order, the Company will obtain
the flexibility to substitute certain aircraft on order with Boeing and
will obtain other benefits. The new order with Boeing is subject to
negotiation and execution of definitive documentation. It provides that
the Company will purchase from Boeing the carrier's requirements for new
jet aircraft (other than regional jets) over the next 20 years, subject
to certain conditions; provided, however, Boeing has agreed with the
European Commission not to enforce such provision. The Company
requested a business offer from Boeing which would include the
requirements commitment in order to obtain more favorable terms and
flexibility.
The estimated aggregate cost of the Company's firm commitments for the
121 Boeing aircraft previously ordered and the 35 widebody aircraft
included in the recent Boeing letter of intent is approximately $7
billion. The Company has completed or has third party commitments for
a total of approximately $662 million in financing for its future
narrowbody Boeing deliveries, and has commitments or letters of intent
from various sources for backstop financing for approximately one-fourth
of the anticipated acquisition cost of its future narrowbody and
widebody Boeing deliveries. The Company currently plans on financing
the new Boeing aircraft with enhanced equipment trust certificates or
similar financing and lease equity, subject to availability and market
conditions. However, further financing will be needed to satisfy
Continental's capital commitments for other aircraft and aircraft-
related expenditures such as engines, spare parts, simulators and
related items. There can be no assurance that sufficient financing will
be available for all aircraft and other capital expenditures not covered
by firm financing commitments. Deliveries of new Boeing aircraft are
expected to increase aircraft rental, depreciation and interest costs
while generating cost savings in the areas of maintenance, fuel and
pilot training.
Continental has also entered into agreements or letters of intent with
several outside parties to lease three and purchase one DC-10-30
aircraft and will take delivery of such aircraft in 1997.
In September 1996, Express placed an order for 25 firm EMB-145 regional
jets, with options for an additional 175 aircraft. In June 1997,
Express exercised its option to order 25 of such option aircraft.
Express now has options for an additional 150 regional jets exercisable
at the election of the Company over the next 12 years. Neither Express
nor Continental will have any obligation to take aircraft that are not
financed by a third party and leased to the Company. Express has taken
delivery of ten of the firm aircraft through August 1, 1997 and will
take delivery of the remaining 40 firm aircraft through the third
quarter of 1999. The Company expects to account for all of these
aircraft as operating leases.
Continental expects its cash outlays for 1997 capital expenditures,
exclusive of fleet plan requirements, to aggregate $125 million,
primarily relating to mainframe, software application and automation
infrastructure projects, aircraft modifications and mandatory
maintenance projects, passenger terminal facility improvements and
office, maintenance, telecommunications and ground equipment.
Continental's capital expenditures during the six months ended June 30,
1997, aggregated $59 million, exclusive of fleet plan requirements.
Continental has significant encumbered assets.
The Company expects to fund its future capital commitments through
internally generated funds together with general Company financings and
aircraft financing transactions. However, there can be no assurance
that sufficient financing will be available for all aircraft and other
capital expenditures not covered by current financings or firm financing
commitments.
As of June 30, 1997, the Company had $920 million in cash and cash
equivalents (excluding restricted cash of $74 million), compared to $985
million (excluding restricted cash of $76 million) as of December 31,
1996. Net cash provided by operating activities decreased $21 million
during the six months ended June 30, 1997 compared to the same period in
the prior year primarily due to a change in net working capital. Net
cash used by investing activities increased $334 million for the six
months ended June 30, 1997 compared to the same period in the prior
year, principally due to an increase in fleet-related capital
expenditures as well as the purchase of warrants from Air Partners. Net
cash used by financing activities for the six months ended June 30, 1997
compared to the same period in the prior year decreased $172 million
primarily due to a decrease in payments on long-term debt and capital
lease obligations.
See Note 3 in the Notes to the Financial Statements for a discussion of
the Company's plans to expand its airport facilities and the related
financing thereof.
The Company had, as of December 31, 1996, deferred tax assets
aggregating $1.3 billion, including $804 million of NOLs. The Company
recorded a valuation allowance of $694 million against such assets as of
December 31, 1996. The Company has consummated several built-in-gain
transactions, which resulted in the realization of tax benefits related
to NOLs and investment tax credit carryforwards attributable to the
Company's predecessor that were previously recorded. To the extent the
Company consummates additional built-in-gain transactions, such benefits
will reduce the valuation allowance and reorganization value in excess
of amounts allocable to identifiable assets. If such reorganization
value is exhausted, reductions in the valuation allowance would decrease
other intangibles.
As a result of NOLs, the Company will not pay United States federal
income taxes (other than alternative minimum tax) until it has recorded
approximately an additional $1.1 billion of taxable income following
December 31, 1996. Section 382 of the Internal Revenue Code ("Section
382") imposes limitations on a corporation's ability to utilize NOLs if
it experiences an "ownership change." In general terms, an ownership
change may result from transactions increasing the ownership of certain
stockholders in the stock of a corporation by more than 50 percentage
points over a three-year period. In the event that an ownership change
should occur, utilization of Continental's NOLs would be subject to an
annual limitation under Section 382 determined by multiplying the value
of the Company's stock at the time of the ownership change by the
applicable long-term tax-exempt rate (which is 5.64% for July 1997).
Unused annual limitation may be carried over to later years, and the
amount of the limitation may under certain circumstances be increased by
the built-in gains in assets held by the Company at the time of the
change that are recognized in the five-year period after the change.
Under current conditions, if an ownership change were to occur,
Continental's annual NOL utilization would be limited to approximately
$117 million.
Continental has entered into block space arrangements with certain other
carriers whereby one of the carriers is obligated to purchase capacity
on the other carrier. One such arrangement began on June 1, 1997
pursuant to which the other carrier is sharing the costs of operating
certain flights by committing to purchase capacity on such flights.
Under this arrangement, the Company's statements of operations reflect
the reimbursement from the other carrier as an offset to the Company's
operating expenses.
As a result of the recent weakness of the yen against the dollar and
increased fuel costs, CMI's operating earnings declined during the past
four quarters as compared to similar periods in the prior period, and
are not expected to improve materially absent a stronger yen or reduced
fuel costs.
The Taxpayer Relief Act was enacted on August 5, 1997 and contains an
extension and modification of the ticket tax, plus new airline industry
taxes. The new law increases the tax on international departures from
$6 to $12, imposes a new tax on international arrivals of $12, imposes
a domestic flight segment fee of $1 (increasing over a five-year phase-
in period to $3) per passenger per segment, reduces the ticket tax from
10% to 9% (decreasing over a three-year phase-in period to 7.5%) and
imposes a 7.5% tax on the sale of frequent flyer miles. The departure
and arrival taxes apply to amounts paid for tickets on or after August
13, 1997, for travel beginning on or after October 1, 1997. The new
domestic segment tax and the reduction in the ticket tax apply to
amounts paid and travel beginning on or after October 1, 1997.
Management believes that this new law will have a negative impact on the
Company, although the amount of such negative impact cannot be precisely
determined.
The Company recently began collective bargaining agreement negotiations
with its Continental Airlines pilots, whose contract became amendable in
July 1997, and Express pilots, whose contract becomes amendable in
October 1997. In addition, the Company's collective bargaining
agreements with its CMI mechanics and mechanic-related employees became
amendable in March 1997. Negotiations are in progress to amend these
contracts. The Company believes that mutually acceptable agreements can
be reached with all such employees, although the ultimate outcome of the
negotiations is unknown at this time. The CMI agent-classification
employees' collective bargaining agreement, which became amendable in
March 1997, was ratified and approved in April 1997. The agreement,
which becomes amendable in March 2001, provides for an 8.7% increase in
wages over a four-year period. The CMI flight attendants' contract,
which became amendable in September 1996, was ratified and approved in
April 1997 and becomes amendable in June 2000. The CMI flight
attendants' new contract provides for a 19.6% increase in wages in the
first year of the contract and 4-5% increases over subsequent years.
The Company's mechanics and related employees recently voted to be
represented by the International Brotherhood of Teamsters. The Company
does not believe that this union representation will be material to the
Company.
Management believes that the Company's costs are likely to be affected
in the future by, among other matters, (i) higher aircraft rental
expense as new aircraft are delivered, (ii) higher wages, salaries and
related costs as the Company continues to compensate its employees
comparable to industry average, (iii) changes in the costs of materials
and services (in particular, the cost of fuel, which can fluctuate
significantly in response to global market conditions), (iv) changes in
governmental regulations and taxes affecting air transportation and the
costs charged for airport access, including new security requirements,
(v) changes in the Company's fleet and related capacity and (vi) the
Company's continuing efforts to reduce costs throughout its operations,
including reduced maintenance costs for new aircraft, reduced
distribution expense from using Continental's electronic ticket product
("E-Ticket") and the Internet for bookings, and reduced interest
expense.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's Annual Meeting of Stockholders was held on May 16,
1997. The following individuals were elected to the Company's Board
of Directors to hold office for the ensuing year:
Nominee Votes for Votes Withheld
Thomas J. Barrack, Jr. 113,417,588 241,266
Lloyd M. Bentsen, Jr. 113,409,824 249,030
Gordon M. Bethune 113,416,040 242,814
David Bonderman 113,416,504 242,350
Gregory D. Brenneman 113,417,346 241,508
Patrick Foley 112,648,697 1,010,157
Douglas H. McCorkindale 112,649,027 1,009,827
George G.C. Parker 113,417,390 241,464
Richard W. Pogue 113,416,116 242,738
William S. Price III 113,418,592 240,262
Donald L. Sturm 113,416,610 242,244
Karen Hastie Williams 113,417,196 241,658
Charles A. Yamarone 113,418,386 240,468
A third amendment to the Company's 1994 Incentive Equity Plan (the
"1994 Plan) was proposed to (i) increase the number of shares subject
to stock options granted to the Company's outside directors each year
from 3,000 shares of Class B common stock to 5,000 such shares and
(ii) an automatic grant of an option to purchase 5,000 such shares of
Class B common stock upon a director's first election to the Board of
Directors other than at an annual meeting and was voted on by the
stockholders as follows:
Votes Votes Broker
Votes For Against Abstaining Non-Votes
101,519,004 11,454,928 260,300 424,622
The approval of the Company's 1997 Employee Stock Purchase Plan was
proposed to provide for an incentive to employees to acquire or
increase an ownership interest in the Company through the purchase of
shares of Class B common stock and was voted on by the stockholders
as follows:
Votes Votes Broker
Votes For Against Abstaining Non-Votes
86,569,242 407,456 261,632 26,420,524
The Board of Directors adopted the Continental Airlines, Inc. 1997
Stock Incentive Plan (the "Incentive Plan") on February 28, 1997,
subject to approval by the stockholders of the Company. The purpose
of the Incentive Plan is to enable the Company and its subsidiaries
to attract able persons to serve as directors and employees and to
provide such individuals with additional incentive and reward
opportunities. The Incentive Plan was voted on by the stockholders
as follows:
Votes Votes Broker
Votes For Against Abstaining Non-Votes
75,357,217 11,493,606 387,517 26,420,514
A proposal to ratify the appointment of Ernst & Young LLP as the
Company's independent auditors for the fiscal year ending December
31, 1997 was voted on by the stockholders as follows:
Votes Votes Broker
Votes For Against Abstaining Non-Votes
113,396,910 66,610 195,334 -0-
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
11.1 Statement Regarding Computation of Per Share Earnings
27.1 Financial Data Schedule.
99.1 Risk Factors.
(b) Reports on Form 8-K:
(i) Report dated April 18, 1997 reporting an Item 5. "Other
Event". No financial statements were filed with the
report, which announced that Continental had redeemed all
outstanding shares of its Series A 12% Cumulative
Preferred Stock held by an affiliate of Air Canada for
$47.7 million in cash.
(ii) Report dated May 27, 1997 reporting an Item 5. "Other
Event". No financial statements were filed with the
report, which announced that Continental had agreed to
purchase from Air Partners, L.P. warrants to purchase
3,842,542 shares of Class B common stock of the Company
for $94.2 million in cash.
(iii) Report dated June 10, 1997 reporting an Item 5. "Other
Event". No financial statements were filed with the
report, which announced that Continental has entered into
a letter of intent with The Boeing Company to purchase 35
new widebody aircraft (five firm 777-200 aircraft and 30
firm 767-400ER aircraft), with options for additional 777
and 767 aircraft to be negotiated by the parties.
(iv) Report dated June 25, 1997 reporting an Item 5. "Other
Event". No financial statements were filed with the
report, which announced that Continental had acquired ten
aircraft previously leased by it. The debt financing for
the acquisition of the aircraft was funded by the private
placement of $155 million of pass-through certificates.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CONTINENTAL AIRLINES, INC.
(Registrant)
Date: August 14, 1997 by: /s/ Lawrence W. Kellner
Lawrence W. Kellner
Executive Vice President and
Chief Financial Officer
(On behalf of Registrant)
Date: August 14, 1997 /s/ Michael P. Bonds
Michael P. Bonds
Vice President and Controller
(Chief Accounting Officer)
Exhibit 11.1
Page 1 of 2
<TABLE>
CONTINENTAL AIRLINES, INC.
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
(In millions, except per share amount)
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Primary:
Weighted average shares
outstanding. . . . . . . . . . . . 57.5 53.2 57.1 53.1
Dilutive effect of outstanding
stock options, warrants and
restricted stock grants (as
determined by the application
of the treasury stock method). . . 5.9 12.4 6.8 11.7
Weighted average number of common
shares outstanding, as adjusted. . 63.4 65.6 63.9 64.8
Income applicable to common
shares . . . . . . . . . . . . . . $ 128 $ 166 $ 200 $ 253
Per share amount. . . . . . . . . . $2.01 $2.53 $3.13 $3.90
</TABLE>
(continued on next page)
Exhibit 11.1
Page 2 of 2
<TABLE>
CONTINENTAL AIRLINES, INC.
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
(In millions, except per share amount)
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Fully diluted:
Weighted average shares
outstanding. . . . . . . . . . . . 57.5 53.2 57.1 53.1
Dilutive effect of outstanding
stock options, warrants and
restricted stock grants (as
determined by the application
of the treasury stock method). . . 6.2 12.9 7.2 12.5
Dilutive effect of Series A
debentures . . . . . . . . . . . . - - - 1.3
Dilutive effect of 8-1/2%
convertible trust originated
preferred securities . . . . . . . 10.3 10.3 10.3 10.3
Dilutive effect of 6-3/4%
convertible subordinated notes . . 7.6 7.6 7.6 4.1
Weighted average number of
common shares outstanding,
as adjusted. . . . . . . . . . . . 81.6 84.0 82.2 81.3
Income applicable to
common shares. . . . . . . . . . . $ 128 $ 166 $ 200 $ 253
Add distributions associated
with the assumed conversion of
8-1/2% convertible trust
originated preferred securities,
net of federal income tax
effect . . . . . . . . . . . . . . 3 3 7 7
Add interest expense associated
with the assumed conversion of
6-3/4% convertible subordinated
notes, net of federal income
tax effect . . . . . . . . . . . . 2 2 5 3
Income, as adjusted . . . . . . . . $ 133 $ 171 $ 212 $ 263
Per share amount. . . . . . . . . . $1.64 $2.04 $2.58 $3.25
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 994
<SECURITIES> 0
<RECEIVABLES> 439
<ALLOWANCES> 0
<INVENTORY> 117
<CURRENT-ASSETS> 1679
<PP&E> 1885
<DEPRECIATION> 540
<TOTAL-ASSETS> 5516
<CURRENT-LIABILITIES> 2324
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 699
<TOTAL-LIABILITY-AND-EQUITY> 5516
<SALES> 3484
<TOTAL-REVENUES> 3484
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 3107
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 84
<INCOME-PRETAX> 332
<INCOME-TAX> 123
<INCOME-CONTINUING> 202
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 202
<EPS-PRIMARY> 3.13
<EPS-DILUTED> 2.58
</TABLE>
EXHIBIT 99.1
The following risk factors are incorporated by reference to pages
35-40 of the Company's prospectus dated July 25, 1997 and filed on
July 29, 1997 pursuant to Rule 424(b) under the Securities Act of
1933, as amended.
Risk Factors Relating to the Company
Leverage and Liquidity
Continental has successfully negotiated a variety of agreements to
increase its liquidity. Nevertheless, Continental remains more
leveraged and has significantly less liquidity than certain of its
competitors, several of whom have available lines of credit and/or
significant unencumbered assets. Accordingly, Continental may be
less able than certain of its competitors to withstand a prolonged
recession in the airline industry and may not have the flexibility
to respond to changing economic conditions or to exploit new
business opportunities.
As of March 31, 1997, Continental had approximately $1.8 billion
(including current maturities) of long-term debt and capital lease
obligations and had approximately $1.0 billion of minority
interest, Continental-obligated mandatorily redeemable preferred
securities of subsidiary trust, redeemable preferred stock and
common stockholders' equity. Common stockholders' equity reflects
the adjustment of the Company's balance sheet and the recording of
assets and liabilities at fair market value as of April 27, 1993 in
accordance with the American Institute of Certified Public
Accountants' Statement of Position 90-7 - "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7").
During the first and second quarters of 1995, in connection with
negotiations with various lenders and lessors, Continental ceased
or reduced contractually required payments under various
agreements, which produced a significant number of events of
default under debt, capital lease and operating lease agreements.
Through agreements reached with the various lenders and lessors,
Continental cured all of these events of default. The last such
agreement was put in place during the fourth quarter of 1995.
As of March 31, 1997, Continental had $848 million of cash and cash
equivalents, (excluding restricted cash and cash equivalents of $79
million). Continental has significant encumbered assets.
For 1997, Continental expects to incur cash expenditures under
operating leases relating to aircraft of approximately $624
million, compared to $568 million for 1996, and approximately $232
million relating to facilities and other rentals, compared to $210
million in 1996. In addition, Continental has capital requirements
relating to compliance with regulations that are discussed below.
See "- Risk Factors Relating to the Airline Industry - Regulatory
Matters".
As of July 1, 1997, the Company had firm commitments with The
Boeing Company ("Boeing") to take delivery of a total of 124
principally narrowbody jet aircraft during the years 1997 through
2003 with options for an additional 90 aircraft (exercisable
subject to certain conditions). These aircraft will replace older,
less efficient Stage 2 aircraft and allow for growth of operations.
In addition, the Company has recently signed a letter of intent
with Boeing to purchase 35 new widebody jet aircraft. This new
order consists of five firm Boeing 777-200 aircraft and 30 firm
Boeing 767-400ER aircraft, with options for additional 777 and 767
aircraft to be negotiated by the parties. The new widebody
aircraft will replace Continental's fleet of DC10-10 and DC10-30
aircraft, which will be retired as the new Boeing aircraft are
delivered, and will also be used to expand the airline's
international and transcontinental service. Ten firm delivery 777
aircraft (including five aircraft the Company already had on order,
the deliveries of which will be accelerated) will be delivered in
September 1998 through May 1999, and the thirty firm delivery 767
aircraft will be delivered starting in mid-2000 through the end of
2004. In connection with this new order, the Company will obtain
the flexibility to substitute certain aircraft on order with Boeing
and will obtain other benefits. The new order with Boeing is
subject to the negotiation and execution of definitive
documentation. It provides that the Company will purchase from
Boeing the carrier's requirements for new jet aircraft (other than
regional jets) over the next twenty years, subject to certain
conditions; provided, however, Boeing has agreed with the European
Commission not to enforce such provision. The Company requested a
business offer from Boeing which would include the requirements
commitment in order to obtain more favorable terms and flexibility.
The estimated aggregate cost of the Company's firm commitments for
the 124 Boeing aircraft previously ordered and the 35 widebody
aircraft included in the recent Boeing letter of intent is
approximately $7 billion. The Company has completed or has third
party commitments for a total of approximately $800 million in
financing for its future narrowbody Boeing deliveries, and has
commitments or letters of intent from various sources for backstop
financing for approximately one-fourth of the anticipated
acquisition cost of its future narrowbody and widebody Boeing
deliveries. The Company currently plans on financing the new
Boeing aircraft with enhanced equipment trust certificates or
similar financing and lease equity, subject to availability and
market conditions. However, further financing will be needed to
satisfy the Company's capital commitments for other aircraft and
aircraft-related expenditures such as engines, spare parts,
simulators and related items. There can be no assurance that
sufficient financing will be available for all aircraft and other
capital expenditures not covered by firm financing commitments.
Deliveries of new Boeing aircraft are expected to increase aircraft
rental, depreciation and interest costs while generating cost
savings in the areas of maintenance, fuel and pilot training.
Continental has also entered into agreements or letters of intent
with several outside parties to lease three, and purchase two, DC-
10-30 aircraft. The first of such aircraft was purchased on July
18, 1997, and the Company will take delivery of the remaining four
DC-10-30 aircraft in 1997.
In September 1996, Express placed an order for 25 firm EMB-145 50-
seat regional jets, with options for an additional 175 aircraft.
In June 1997, Express exercised its option to order 25 of such
additional aircraft. Express now has options for an additional 150
regional jets exercisable at the election of the Company over the
next 12 years. Neither Express nor Continental will have any
obligation to take such aircraft that are not financed by a third
party and leased to the Company. Express has taken delivery of
nine of the initial 25 firm aircraft through July 7, 1997 and will
take delivery of the remaining 16 initial firm aircraft through the
second quarter of 1998. The Company expects to account for all of
these aircraft as operating leases.
On July 18, 1997, Continental entered into a credit agreement with
certain banks that provides for the establishment of a $575 million
credit facility (the "$575 million Credit Facility"), of which
tranches of $275 million and $75 million of principal amount will
be term loans and $225 million will be a revolving credit facility.
On July 23, 1997, Continental borrowed the $275 million term loan,
the proceeds of which were loaned by Continental to AMI, reloaned
by AMI to CMI and used by CMI to repay its existing secured term
loan described above. The proceeds of the $75 million term loan
will be used to finance the United Micronesia Development
Association, Inc. ("UMDA") transactions described below. The $575
million Credit Facility is secured by substantially all of CMI's
assets (other than aircraft subject to other financing
arrangements) but does not contain any financial covenants relating
to CMI other than covenants restricting CMI's incurrence of certain
indebtedness and pledge of assets. AMI's rights with respect to
its loan to CMI and Continental's rights with respect to its loan
to AMI (as well as Continental's stock in AMI) are pledged as
collateral for loans to Continental under the $575 million Credit
Facility. In addition, the $575 million Credit Facility contains
certain financial covenants applicable to Continental and will
prohibit Continental from granting a security interest on certain
of its international route authorities.
In late May 1997, the Company entered into a letter of intent with
UMDA, the owner of the 9% minority interest in AMI, to purchase
UMDA's rights to receive future payments under a services agreement
between UMDA and CMI (pursuant to which CMI pays UMDA approximately
1% of the gross revenues of CMI, as defined, through January 1,
2012, which payment by CMI to UMDA totalled $6 million in 1996) and
UMDA's 9% minority interest in AMI, to terminate the Company's
obligations to UMDA under a settlement agreement entered into in
1987, and to terminate substantially all of the contractual
arrangements between the Company, AMI and CMI, on the one hand, and
UMDA on the other hand, for an aggregate consideration of $73
million in cash payable by the Company. Consummation of the
transactions contemplated by the letter of intent is subject to the
negotiation and execution of definitive agreements and the approval
of the stockholders of UMDA. A meeting of the stockholders of UMDA
to consider the approval of such transactions has been called for
July 10,1997. There can be no assurance that the transactions
contemplated by the letter of intent will be consummated.
In June 1997, the Company acquired 10 aircraft previously leased by
it. The debt financing for the acquisition of the six Boeing 737-
300 aircraft and the four McDonnell Douglas MD-82 aircraft was
funded by the private placement of $155 million of pass through
certificates. The pass through certificates, which were issued by
separate pass through trusts which acquired equipment trust notes
issued on a recourse basis by Continental, consist of $75 million
of 7.148% Class A certificates, $26 million of 7.149% Class B
certificates, $27 million of 7.206% Class C certificates and $27
million of 7.522% Class D certificates. The transaction is
expected to decrease aircraft ownership costs by approximately $3
million annually over the next three years, as compared to the
ownership costs the Company would have incurred had it continued to
lease the aircraft. In addition, aircraft maintenance expense in
the second quarter of 1997 will be reduced by approximately $16
million due to the release of reserves that are no longer required
as a result of the transaction.
In April 1997 Continental entered into a $160 million revolving
credit facility with a group of banks (the "Predelivery Deposit
Revolver") to finance predelivery deposits with respect to the
acquisition of new Boeing 737 and 757 aircraft, which is secured by
the purchase agreements with respect to such aircraft, including
the Aircraft.
In February 1997, the Company began construction of a new hangar
and improvements to a cargo facility at the Company's hub at Newark
International Airport which is expected to be completed in the
fourth quarter of 1997. The Company expects to finance these
projects, which will cost approximately $21 million, with tax-
exempt bonds by the New Jersey Economic Development Authority. In
addition, the Company is also planning a facility expansion at
Newark which would require, among other matters, agreements to be
reached with the applicable airport authority.
In March 1997, the Company announced plans to expand its facilities
at its Hopkins International Airport hub in Cleveland. The
expansion, which will include a new jet concourse for the new
regional jet service offered by Express, as well as other facility
improvements, is expected to cost approximately $120 million, which
the Company expects will be funded principally by the issuance of
a combination of tax-exempt special facilities revenue bonds and
general airport revenue bonds by the City of Cleveland. In
connection therewith, the Company expects to enter into long-term
leases under which rental payments will be sufficient to service
the related bonds.
In April 1997, the Company announced plans to build a wide-body
aircraft maintenance hangar in Honolulu, Hawaii at an estimated
cost of $24 million. Construction of the hangar, anticipated to be
completed by the second quarter of 1998, is expected to be financed
by tax-exempt special facilities revenue bonds issued by the State
of Hawaii. In connection therewith, the Company expects to enter
into long-term leases under which rental payments will be
sufficient to service the related bonds.
In April 1997, the City of Houston (the "City") completed the
offering of $190 million aggregate principal amount of tax-exempt
special facilities revenue bonds (the "IAH Bonds") payable solely
from rentals paid by Continental under long-term lease agreements
with the City. The IAH Bonds are unconditionally guaranteed by the
Company. The proceeds form the IAH Bonds will be used to finance
the acquisition, construction and installation of certain terminal
and other airport facilities located at Continental's hub at George
Bush Intercontinental Airport in Houston, including a new automated
people mover system linking Terminals B and C and 20 aircraft gates
in Terminal B into which Continental intends to expand its
operations. The expansion project is expected to be completed by
the summer of 1999.
In April 1997, Continental redeemed for cash all of the 460,247
outstanding shares of its Series A 12% Cumulative Preferred Stock
held by an affiliate of Air Canada, a Canadian corporation, for
$100 per share plus accrued dividends thereon. The redemption
price, including accrued dividends, totaled $48 million.
In June 1997, Continental purchased from Air Partners warrants to
purchase 3,842,542 shares of Class B common stock of the Company
for $94 million in cash.
Continental's History of Operating Losses
Although Continental recorded net income of $74 million in the
first quarter of 1997, $319 million in 1996 and $224 million in
1995, it had experienced significant operating losses in the
previous eight years. In the long term, Continental's viability
depends on its ability to sustain profitable results of operations.
Aircraft Fuel
Since fuel costs constitute a significant portion of Continental's
operating costs (approximately 13.3% for the year ended December
31, 1996 and 14.8% for the three months ended March 31, 1997),
significant changes in fuel costs would materially affect the
Company's operating results. Jet fuel prices have increased
significantly since December 31, 1995, although such prices have
moderated recently. Fuel prices continue to be susceptible to
international events, and the Company cannot predict near or
longer-term fuel prices. The Company enters into petroleum option
contracts to provide some short-term protection (generally three to
six months) against a sharp increase in jet fuel prices. In the
event of a fuel supply shortage resulting from a disruption of oil
imports or otherwise, higher fuel prices or curtailment of
scheduled service could result.
Labor Matters
The Company has recently begun collective bargaining agreement
negotiations with its Continental Airlines and Express pilots whose
contracts become amendable in July 1997 and October 1997,
respectively. In addition, the Company's collective bargaining
agreements with its CMI mechanics and mechanic-related employees
became amendable in March 1997. Negotiations are in progress to
amend this contract. The Company believes that mutually acceptable
agreements can be reached with all such employees, although the
ultimate outcome of the negotiations is unknown at this time. The
CMI agent-classification employees' collective bargaining
agreement, which became amendable in March 1997, was ratified and
approved in April 1997. The agreement, which becomes amendable in
March 2001, provides for an 8.7% increase in wages over a four-year
period. The CMI flight attendants' contract, which became
amendable in September 1996, was ratified and approved in April
1997 and becomes amendable in June 2000. The CMI flight
attendants' new contract provides for a 19.6% increase in wages in
the first year of the contract and 4 to 5% increases over
subsequent years. The Company's mechanics and related employees
recently voted to be represented by the International Brotherhood
of Teamsters. The Company does not believe that this union
representation will be material to the Company.
Certain Tax Matters
The Company's United States federal income tax return for the year
ended December 31, 1996 is expected to reflect net operating loss
carryforwards ("NOLs") of $2.3 billion that will expire through
2009 and federal investment tax credit carry forwards of $45
million that will expire through 2001. For financial reporting
purposes, Continental began accruing tax expense on its income
statement during the second quarter of 1996.
The Company had, as of December 31, 1996, deferred tax assets
aggregating $1.3 billion, including $804 million of NOLs. The
Company recorded a valuation allowance of $694 million against such
assets as of December 31, 1996. The Company has consummated
several built-in-gain transactions, which resulted in the
realization of tax benefits related to NOLs and investment tax
credit carryforwards attributable to the Company's predecessor that
were previously recorded. To the extent the Company consummates
additional built-in-gain transactions such benefits will result in
a reduction of the valuation allowance with an offset to
reorganizational value in excess of amounts allocable to
identifiable assets and other intangibles to zero, and thereafter
as an addition to paid-in capital.
As a result of NOLs, the Company will not pay United States federal
income taxes (other than alternative minimum tax) until it has
recorded approximately an additional $1.1 billion of taxable income
following December 31, 1996. Section 382 of the Internal Revenue
Code ("Section 382") imposes limitations on a corporation's ability
to utilize NOLs if it experiences an "ownership change." In
general terms, an ownership change may result from transactions
increasing the ownership of certain stockholders in the stock of a
corporation by more than 50 percentage points over a three-year
period. In the event that an ownership change should occur,
utilization of Continental's NOLs would be subject to an annual
limitation under Section 382 determined by multiplying the value of
the Company's stock at the time of the ownership change by the
applicable long-term tax-exempt rate (which is 5.64% for July
1997). Unused annual limitation may be carried over to later
years, and the amount of the limitation may under certain
circumstances be increased by the built-in gains in assets held by
the Company at the time of the change that are recognized in the
five-year period after the change. Under current conditions, if an
ownership change were to occur, Continental's annual NOL
utilization would be limited to approximately $117 million per
year.
Continental Micronesia
Because the majority of CMI's traffic originates in Japan, its
results of operations are substantially affected by the Japanese
economy and changes in the value of the yen as compared to the
dollar. Appreciation of the yen against the dollar during 1994 and
1995 increased CMI's profitability while a decline of the yen
against the dollar in 1996 reduced CMI's profitability. As a
result of the recent weakness of the yen against the dollar and
increased fuel costs, CMI's operating earnings declined during the
past three quarters as compared to similar periods a year ago, and
are not expected to improve materially absent a stronger yen or
reduced fuel costs.
To reduce the potential negative impact on CMI's dollar earnings,
CMI, from time to time, purchases average rate options as a hedge
against a portion of its expected net yen cash flow position. Such
options historically have not had a material effect on the
Company's results of operations or financial condition. Any
significant and sustained decrease in traffic or yields (including
due to the value of the yen) to and from Japan could materially
adversely affect Continental's consolidated profitability.
Principal Stockholder
On November 21, 1996, Air Partners, L.P., a Texas limited
partnership and major stockholder of the Company ("Air Partners"),
exercised its right to sell to the Company, and the Company
subsequently purchased, for $50 million, warrants to purchase
2,614,379 shares of Class B common stock (representing a portion of
the total warrants held by Air Partners) pursuant to an agreement
entered into earlier in 1996 with the Company. Also on June 2,
1997, Continental purchased form Air Partners warrants to purchase
3,842,542 shares of Class B common stock of the Company for $94
million. As of June 3, 1997, Air Partners held approximately 9.4%
of the common equity interest and 40.5% of the general voting power
of the Company. If all the remaining warrants held by Air Partners
had been exercised on June 3,1997, approximately 14.5% of the
common equity interest and 51.7% of the general voting power of the
Company would have been held by Air Partners. Various provisions
in the Company's Certificate of Incorporation and Bylaws currently
provide Air Partners with the right to elect one-third of the
directors in certain circumstances; these provisions could have the
effect of delaying, deferring or preventing a change in the control
of the Company.
Risks Factors Relating to the Airline Industry
Industry Conditions and Competition
The airline industry is highly competitive and susceptible to price
discounting. The Company has in the past both responded to
discounting actions taken by other carriers and initiated
significant discounting actions itself. Continental's competitors
include carriers with substantially greater financial resources
(and in certain cases, lower cost structures), as well as smaller
carriers with low cost structures. Airline profit levels are
highly sensitive to, and during recent years have been severely
impacted by, changes in fuel costs, fare levels (or "average
yield") and passenger demand. Passenger demand and yields have
been affected by, among other things, the general state of the
economy, international events and actions taken by carriers with
respect to fares. From 1990 to 1993, these factors contributed to
the domestic airline industry's incurring unprecedented losses.
Although fare levels have increased recently, fuel costs have also
increased significantly. In addition, significant industry-wide
discounts could be reimplemented at any time, and the introduction
of broadly available, deeply discounted fares by a major United
States airline would likely result in lower yields for the entire
industry and could have a material adverse effect on the Company's
operating results.
The airline industry has consolidated in past years as a result of
mergers and liquidations and may further consolidate in the future.
Among other effects, such consolidation has allowed certain of
Continental's major competitors to expand (in particular) their
international operations and increase their market strength.
Furthermore, the emergence in recent years of several new carriers,
typically with low cost structures, has further increased the
competitive pressures on the major United States airlines. In many
cases, the new entrants have initiated or triggered price
discounting. Aircraft, skilled labor and gates at most airports
continue to be readily available to start-up carriers. Competition
with new carriers or other low cost competitors on Continental's
routes could negatively impact Continental's operating results.
Regulatory Matters
In the last several years, the United States Federal Aviation
Administration ("FAA") has issued a number of maintenance
directives and other regulations relating to, among other things,
retirement of older aircraft, security measures, collision
avoidance systems, airborne windshear avoidance systems, noise
abatement, commuter aircraft safety and increased inspections and
maintenance procedures to be conducted on older aircraft. The
Company expects to continue incurring expenses for the purpose of
complying with the FAA's noise and aging aircraft regulations. In
addition, several airports have recently sought to increase
substantially the rates charged to airlines, and the ability to
contest such increases has been restricted by federal legislation,
DOT regulations and judicial decisions.
Management believes that the Company benefitted significantly from
the expiration of the aviation trust fund tax (the "ticket tax") on
December 31, 1995. The ticket tax was reinstated on August 27,
1996, expired on December 31, 1996 and was reinstated again on
March 7, 1997. Congress is currently considering proposals for
significant revisions to the ticket tax, including the imposition
of taxes on components of air travel not previously taxed. The
ultimate outcome or effect of any such tax proposals cannot be
determined by the Company at this time.
Additional laws and regulations have been proposed from time to
time that could significantly increase the cost of airline
operations by imposing additional requirements or restrictions on
operations. Laws and regulations have also been considered that
would prohibit or restrict the ownership and/or transfer of airline
routes or takeoff and landing slots. Also, the availability of
international routes to United States carriers is regulated by
treaties and related agreements between the United States and
foreign governments that are amendable. Continental cannot predict
what laws and regulations may be adopted or their impact, but there
can be no assurance that laws or regulations currently proposed or
enacted in the future will not adversely affect the Company.
Seasonal Nature of Airline Business
Due to the greater demand for air travel during the summer months,
revenue in the airline industry in the third quarter of the year is
generally significantly greater than revenue in the first quarter
of the year and moderately greater than revenue in the second and
fourth quarters of the year for the majority of air carriers.
Continental's results of operations generally reflect this
seasonality, but have also been impacted by numerous other factors
that are not necessarily seasonal, including the extent and nature
of competition from other airlines, fare wars, excise and similar
taxes, changing levels of operations, fuel prices, foreign currency
exchange rates and general economic conditions.
