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EXHIBIT 99.2
[THE FOLLOWING MATERIAL IS REPRODUCED FROM PAGES 16-24 OF THE COMPANY'S
REFERENCED 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY
11, 2000.]
RISK FACTORS RELATING TO THE COMPANY
HIGH LEVERAGE AND SIGNIFICANT FINANCING NEEDS. Continental has a higher
proportion of debt compared to its equity capital than some of its principal
competitors. In addition, a majority of Continental's property and equipment is
subject to liens securing indebtedness. Accordingly, Continental may be less
able than some of its competitors to withstand a prolonged recession in the
airline industry or respond as flexibly to changing economic and competitive
conditions.
As of December 31, 1999, Continental had approximately $3.4 billion (including
current maturities) of long-term debt and capital lease obligations and had
approximately $1.6 billion of common stockholders' equity. Also at December 31,
1999, Continental had $1.6 billion in cash and cash equivalents and short-term
investments. Continental has lines of credit totaling $225 million.
Continental has substantial commitments for capital expenditures, including for
the acquisition of new aircraft. As of January 14, 2000, Continental had agreed
to acquire a total of 74 Boeing jet aircraft through 2005. The Company
anticipates taking delivery of 28 Boeing jet aircraft in 2000. Continental also
has options for an additional 118 aircraft (exercisable subject to certain
conditions). The estimated aggregate cost of the Company's firm commitments for
Boeing aircraft is approximately $4 billion. Continental currently plans to
finance its new Boeing aircraft with a combination of enhanced pass through
trust certificates, lease equity and other third-party financing, subject to
availability and market conditions. Continental has commitments or letters of
intent for backstop financing for approximately 18% of the anticipated remaining
acquisition cost of future Boeing deliveries. In addition, at January 14, 2000,
Continental has firm commitments to purchase 34 spare engines related to the new
Boeing aircraft for approximately $219 million, which will be deliverable
through March 2005.
As of January 14, 2000, Express had firm commitments for 43 Embraer ERJ-145
("ERJ-145") 50-seat regional jets and 19 Embraer ERJ-135 ("ERJ-135") 37-seat
regional jets, with options for an additional 100 ERJ-145 and 50 ERJ-135
aircraft exercisable through 2008. Express anticipates taking delivery of 15
ERJ-145 and 12 ERJ-135 regional jets in 2000. Neither Express nor Continental
will have any obligation to take any of the firm ERJ-145 or ERJ-135 aircraft
that are not financed by a third party and leased to Continental.
For 1999, cash expenditures under operating leases relating to aircraft
approximated $758 million, compared to $702 million for 1998, and approximated
$328 million relating to facilities and other rentals compared to $263 million
in 1998. Continental expects that its operating lease expenses for 2000 will
increase over 1999 amounts.
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Additional financing will be needed to satisfy the Company's capital
commitments. Continental cannot predict whether sufficient financing will be
available for capital expenditures not covered by firm financing commitments.
CONTINENTAL'S HISTORICAL OPERATING RESULTS. Continental has recorded positive
net income in each of the last five years. However, Continental experienced
significant operating losses in the previous eight years. Historically, the
financial results of the U.S. airline industry have been cyclical. Continental
cannot predict whether current industry conditions will continue.
SIGNIFICANT COST OF AIRCRAFT FUEL. Fuel costs constitute a significant portion
of Continental's operating expense. Fuel costs were approximately 9.7% of
operating expenses for the year ended December 31, 1999 (excluding fleet
disposition/impairment losses) and 10.2% for the year ended December 31, 1998
(excluding fleet disposition/ impairment losses). Recently, spot jet fuel prices
have increased dramatically, rising to 87.3 cents per gallon at January 21, 2000
compared to 58.3 cents per gallon as recently as October 31, 1999. Continental
recently announced that if high fuel costs continue without an improvement in
the revenue environment, the Company may not post a profit in the first quarter
of 2000. Fuel prices and supplies are influenced significantly by international
political and economic circumstances. Continental enters into petroleum swap
contracts, petroleum call option contracts and/or jet fuel purchase commitments
to provide some short-term protection (generally three to six months) against a
sharp increase in jet fuel prices. The Company's fuel hedging strategy could
result in the Company not fully benefiting from certain fuel price declines. If
a fuel supply shortage were to arise from OPEC production curtailments, a
disruption of oil imports or otherwise, higher fuel prices or reduction of
scheduled airline service could result. Significant changes in fuel costs or
continuation of high current jet fuel prices would materially affect
Continental's operating results.
LABOR COSTS. Labor costs constitute a significant percentage of the Company's
total operating costs, and the Company experiences competitive pressure to
increase wages and benefits. In September 1997, the Company announced a plan to
bring all employees to industry standard wages no later than the end of the year
2000. Wage increases began in 1997, and will continue to be phased in through
2000. The Company is currently formulating a plan to bring employees to industry
standard benefits over a multi-year period.
CERTAIN TAX MATTERS. At December 31, 1999, Continental had estimated net
operating loss carryforwards ("NOLs") of $700 million 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 Continental on April 27, 1993, the ultimate utilization
of Continental's NOLs and investment tax credits may be limited. Reflecting this
limitation, Continental has a valuation allowance of $263 million at December
31, 1999.
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Continental had, as of December 31, 1999, deferred tax assets aggregating $611
million, including $266 million of NOLs. The Company has consummated several
transactions which resulted in the recognition of NOLs of the Company's
predecessor. To the extent the Company were to determine in the future that
additional NOLs of the Company's predecessor could be recognized in the
accompanying consolidated financial statements, such benefit would reduce the
value ascribed to routes, gates and slots.
As a result of NOLs, Continental will not pay United States federal income taxes
(other than alternative minimum tax) until it has earned approximately an
additional $700 million of taxable income following December 31, 1999. 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
Continental's stock at the time of the ownership change by the applicable
long-term tax-exempt rate (which was 5.72% for December 1999). Any unused annual
limitation may be carried over to later years, and the amount of the limitation
may under certain circumstances be increased by the built-in gains in assets
held by Continental 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 $172 million per year other than through the recognition of future
built-in gain transactions.
In November 1998, an affiliate of Northwest completed its acquisition of certain
equity of the Company previously held by Air Partners, L.P. and its affiliates,
together with certain Class A common stock of the Company held by other
investors, totaling 8,661,224 shares of the Class A common stock (the "Air
Partners Transaction"). The Company does not believe that the Air Partners
Transaction resulted in an ownership change for purposes of Section 382.
CONTINENTAL MICRONESIA'S DEPENDENCE ON JAPANESE ECONOMY AND CURRENCY RISK.
Because the majority of CMI's traffic originates in Japan, its results of
operations are substantially affected by the Japanese economy and changes in the
value of the yen as compared to the dollar. To reduce the potential negative
impact on CMI's earnings, the Company has entered into forward contracts as a
hedge against a portion of its expected net yen cash flow position. As of
December 31, 1999, the Company had hedged approximately 95% of 2000 projected
yen-denominated net cash flows at a rate of 102 yen to $1 US.
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PRINCIPAL STOCKHOLDER. As of December 31, 1999, Northwest held approximately
13.2% of the common equity interest and 49.1% of the fully diluted voting power
of the Company. In addition, Northwest holds a limited proxy to vote certain
additional shares of the Company's common stock that would raise its voting
power to approximately 50.9% of the Company's fully diluted voting power.
In connection with the Air Partners Transaction, the Company entered into a
corporate governance agreement with certain affiliates of Northwest (the
"Northwest Parties") designed to assure the independence of the Company's Board
and management during the six-year term of the governance agreement. Under the
governance agreement, as amended, the Northwest Parties agreed not to
beneficially own voting securities of the Company in excess of 50.1% of the
fully diluted voting power of the Company's voting securities, subject to
certain exceptions, including third-party acquisitions or tender offers for 15%
or more of the voting power of the Company's voting securities. The Northwest
Parties deposited all voting securities of the Company beneficially owned by
them (other than the shares for which they hold only a limited proxy) in a
voting trust with an independent voting trustee requiring that such securities
be voted (i) on all matters other than the election of directors, in the same
proportion as the votes cast by other holders of voting securities, and (ii) in
the election of directors, for the election of independent directors (who must
constitute a majority of the Board) nominated by the Board of Directors.
However, in the event of a merger or similar business combination or a
recapitalization, liquidation or similar transaction, a sale of all or
substantially all of the Company's assets, or an issuance of voting securities
that would represent more than 20% of the voting power of the Company prior to
issuance, or any amendment of the Company's charter or bylaws that would
materially and adversely affect Northwest (each, an "Extraordinary
Transaction"), the shares may be voted as directed by the Northwest Party owning
such shares, and if a third party is soliciting proxies in an election of
directors, the shares may be voted at the option of such Northwest Party either
as recommended by the Company's Board of Directors or in the same proportion as
the votes cast by the other holders of voting securities.
The Northwest Parties also agreed to certain restrictions on the transfer of
voting securities owned by them, agreed not to seek to affect or influence the
Company's Board of Directors or the control of the management of the Company or
the business, operations, affairs, financial matters or policies of the Company
or to take certain other actions, and agreed to take all actions necessary to
cause independent directors to at all times constitute at least a majority of
the Company's Board of Directors. The Company granted preemptive rights to a
Northwest Party with respect to issuances of Class A common stock and certain
issuances of Class B common stock. The Northwest Parties agreed that certain
specified actions, together with any material transactions between the Company
and Northwest or its affiliates, including any modifications or waivers of the
governance agreement or the alliance agreement, may not be
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taken without the prior approval of a majority of the Board of Directors,
including the affirmative vote of a majority of the independent directors. The
governance agreement also required the Company to adopt a shareholder rights
plan with reasonably customary terms and conditions, with an acquiring person
threshold of 15% (20% in the case of an Institutional Investor) and with
appropriate exceptions for the Northwest Parties for actions permitted by and
taken in compliance with the governance agreement. A rights plan meeting these
requirements was adopted effective November 20, 1998, and amended effective
February 8, 2000.
The governance agreement will expire on November 20, 2004, or if earlier, upon
the date that the Northwest Parties cease to beneficially own voting securities
representing at least 10% of the fully diluted voting power of the Company's
voting securities. However, in response to concerns raised by the Department of
Justice ("DOJ") in its antitrust review of the Northwest Alliance, the Air
Partners Transaction and the related governance agreement between the Company
and the Northwest Parties (collectively, the "Northwest Transaction"), a
supplemental agreement was adopted in November 1998, which extended the effect
of a number of the provisions of the governance agreement for an additional four
years. For instance, the Northwest Parties must act to ensure that a majority of
the Company's Board is comprised of independent directors, and certain specified
actions, together with material transactions between the Company and Northwest
or its affiliates, including any modifications or waivers of the supplemental
agreement or the alliance agreement, may not be taken without the prior approval
of a majority of the Board of Directors, including the affirmative vote of a
majority of the independent directors. The Northwest Parties will continue to
have the right to vote in their discretion on any Extraordinary Transaction
during the supplemental period, but also will be permitted to vote in their
discretion on other matters up to 20% of the outstanding voting power (their
remaining votes to be cast neutrally, except in a proxy contest, as contemplated
in the governance agreement), subject to their obligation set forth in the
previous sentence. If, during the term of the supplemental agreement, the
Company's rights plan were amended to allow certain parties to acquire more
shares than is currently permitted, or if the rights issued thereunder were
redeemed, the Northwest Parties could vote all of their shares in their
discretion. Certain transfer limitations are imposed on the Northwest Parties
during the supplemental period. The Company has granted preemptive rights to a
Northwest Party with respect to issuances of Class A common stock and certain
issuances of Class B common stock that occur during such period. The Company has
agreed to certain limitations upon its ability to amend its charter, bylaws,
executive committee charter and rights plan during the term of the supplemental
agreement. Following the supplemental period, the supplemental agreement
requires the Northwest Parties to take all actions necessary to cause
Continental's Board to have at least five independent directors, a majority of
whom will be required to approve material transactions between Continental and
Northwest or its affiliates, including the
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amendment, modification or waiver of any provisions of the supplemental
agreement or the alliance agreement.
In certain circumstances, particularly in cases where a change in control of the
Company could otherwise be caused by another party, Northwest could exercise its
voting power so as to delay, defer or prevent a change in control of the
Company.
Continental desires to simplify its equity capital structure and is committed to
continuing to repurchase outstanding equity. In connection with its stock
repurchase program, the Company has held preliminary discussions with Northwest
concerning the acquisition by Continental of all the Class A common stock of
Continental held by Northwest in a voting trust (8.7 million shares). The
Northwest alliance is beneficial to both carriers, and any transaction would be
designed to preserve and strengthen the benefits of the alliance. There can be
no assurance as to whether a transaction between Continental and Northwest will
be agreed to or consummated, nor can Continental predict the structure, form or
amount of consideration or other elements of any such transaction.
RISKS REGARDING CONTINENTAL/NORTHWEST ALLIANCE. In November 1998, the Company
and Northwest began implementing a long-term global alliance involving extensive
code-sharing, frequent flyer reciprocity, and other cooperative activities.
Implementation of the Northwest Alliance continued throughout 1999 and is
continuing in 2000.
Continental's ability to finalize implementation of the Northwest Alliance and
to achieve the anticipated benefits is subject to certain risks and
uncertainties, including (a) disapproval or delay by regulatory authorities or
adverse regulatory developments; (b) competitive pressures, including
developments with respect to alliances among other air carriers; (c) customer
reaction to the alliance, including reaction to differences in products and
benefits provided by Continental and Northwest; (d) economic conditions in the
principal markets served by Continental and Northwest; (e) increased costs or
other implementation difficulties, including those caused by employees; and (f)
Continental's ability to modify certain contracts that restrict certain aspects
of the alliance.
The alliance agreement provides that if after four years the Company has not
entered into a code share with KLM or is not legally able (but for aeropolitical
restrictions) to enter into a new trans-Atlantic joint venture with KLM and
Northwest and place its airline code on certain Northwest flights, Northwest can
elect to (i) cause good faith negotiations among the Company, KLM and Northwest
as to the impact, if any, on the contribution to the joint venture resulting
from the absence of the code share, and the Company will reimburse the joint
venture for the amount of any loss until it enters into a code share with KLM,
or (ii) terminate (subject to cure rights of the Company) after one year's
notice any or all of such alliance agreement and any or all of the agreements
contemplated thereunder.
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On October 23, 1998, the DOJ filed a lawsuit against Northwest and Continental
challenging Northwest's acquisition of an interest in Continental. The DOJ did
not seek to preliminarily enjoin the transaction before it closed on November
20, 1998, nor is the DOJ challenging the Northwest Alliance at this time,
although the DOJ has informed the parties that it continues to investigate
certain specific aspects of the alliance. Continental continues to implement its
alliance with Northwest. While it is not possible to predict the ultimate
outcome of this litigation, management does not believe that it will have a
material adverse effect on Continental.
The DOT has continuing jurisdiction to review changes in Continental's ownership
and joint venture agreements between major U.S. airlines such as Continental and
Northwest. In connection with such reviews, the DOT exempted Continental and
Northwest through December 10, 1999, from regulatory approval requirements which
the DOT has interpreted to require approval for what it considers de facto route
transfers when one U.S. airline holding international route authority acquires
control of another U.S. airline holding such authority. The exemption remains in
effect pursuant to the Administrative Procedure Act and a renewal application
has been submitted to the DOT by Continental and Northwest pending possible
further DOT review of the agreements between them to consider whether, in the
DOT's view, there has been a de facto route transfer.
If the DOT were to conclude that a de facto route transfer of Continental routes
to Northwest were occurring, it would institute a proceeding to determine
whether such a transfer was in the public interest. In the past, the DOT has
approved numerous transfers, but it has also concluded on occasion that certain
overlapping routes in limited-entry markets should not be transferred. In those
instances, the DOT has decided those routes should instead become available to
other airlines to enhance competition on overlapping routes or between two
countries. Continental and Northwest operate overlapping flights on certain
limited entry routes and offer service between their primary U.S. hubs and
various other countries. If the DOT were to institute a route transfer
proceeding, it could consider whether certain of Continental's international
routes overlapping with Northwest's on a point-to-point or country-to-country
basis should be transferred to Northwest or to another airline. Continental
believes that Northwest has not acquired control of Continental, and that there
is a significant question as to the DOT's authority to apply a de facto route
transfer theory to the current relationship between Northwest and Continental.
Continental would vigorously oppose any attempt by the DOT to institute a route
transfer proceeding which would consider any reductions in Continental's route
authorities.
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RISKS FACTORS RELATING TO THE AIRLINE INDUSTRY
COMPETITION AND INDUSTRY CONDITIONS. The airline industry is highly competitive
and susceptible to price discounting. Carriers have used discount fares to
stimulate traffic during periods of slack demand, to generate cash flow and to
increase market share. Some of Continental's competitors have substantially
greater financial resources or lower cost structures than Continental.
Airline profit levels are highly sensitive to changes in fuel costs, fare levels
and passenger demand. Passenger demand and fare levels have in the past been
influenced by, among other things, the general state of the economy (both
internationally and domestically), international events, airline capacity and
pricing actions taken by carriers. Domestically, from 1990 to 1993, the weak
U.S. economy, turbulent international events and extensive price discounting by
carriers contributed to unprecedented losses for U.S. airlines. In the last
several years, the U.S. economy has improved and excessive price discounting has
abated. Recently, industry capacity and growth in the transatlantic markets have
resulted in lower yields and revenue per available seat mile in those markets.
Continental cannot predict the extent to which these industry conditions will
continue.
In recent years, the major U.S. airlines have sought to form marketing alliances
with other U.S. and foreign air carriers. Such alliances generally provide for
"code-sharing", frequent flyer reciprocity, coordinated scheduling of flights of
each alliance member to permit convenient connections and other joint marketing
activities. Such arrangements permit an airline to market flights operated by
other alliance members as its own. This increases the destinations, connections
and frequencies offered by the airline, which provide an opportunity to increase
traffic on its segment of flights connecting with its alliance partners. The
Northwest Alliance is an example of such an arrangement, and Continental has
existing alliances with numerous other air carriers. Other major U.S. airlines
have alliances or planned alliances more extensive than Continental's.
Continental cannot predict the extent to which it will benefit from its
alliances or be disadvantaged by competing alliances.
REGULATORY MATTERS. Airlines are subject to extensive regulatory and legal
compliance requirements that engender significant costs. In the last several
years, the FAA has issued a number of directives and other regulations relating
to the maintenance and operation of aircraft that have required significant
expenditures. Some FAA requirements cover, 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. Continental expects to continue incurring expenses in complying with
the FAA's regulations.
Additional laws, regulations, taxes and airport rates and charges have been
proposed from time to time that could significantly
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increase the cost of airline operations or reduce revenues. For instance,
"passenger bill of rights" legislation has been introduced in Congress that
would, among other things, require the payment of compensation to passengers as
a result of certain delays, and limit the ability of carriers to prohibit or
restrict usage of certain tickets in manners currently prohibited or restricted.
The DOT has proposed rules that would significantly limit major carriers'
ability to compete with new entrant carriers. If adopted, these measures could
have the effect of raising ticket prices, reducing revenue and increasing costs.
Restrictions on the ownership and transfer of airline routes and takeoff and
landing slots have also been proposed. See "Industry Regulation and Airport
Access" above. The ability of U.S. carriers to operate international routes is
subject to change because the applicable arrangements between the United States
and foreign governments may be amended from time to time, or because appropriate
slots or facilities are not made available. Continental cannot provide assurance
that laws or regulations enacted in the future will not adversely affect it.
SEASONAL NATURE OF AIRLINE BUSINESS; OTHER. Due to greater demand for air travel
during the summer months, revenue in the airline industry in the second and
third quarters of the year is generally stronger than revenue in the first and
fourth quarters of the year for most U.S. air carriers. 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, weather, air traffic control
delays, foreign currency exchange rates and general economic conditions.
