| CONTINENTAL AIRLINES INC /DE/ ITEM 1A RISK FACTORS Risk Factors Relating to the Company We continue to experience significant losses |
| Since September 11, 2001, we have incurred significant losses |
| We reported a net loss of dlra68 million in 2005 and expect to incur a significant loss for the first quarter of 2006 under current market conditions |
| Losses of the magnitude incurred by us since September 11, 2001 are not sustainable if they continue |
| These losses are primarily attributable to decreased yields on passenger revenue since September 11, 2001 and record high fuel prices |
| Passenger revenue per available seat mile for our mainline operations was 5dtta8prca lower for the year ended December 31, 2005 versus 2000 (the last full year before the September 11, 2001 terrorist attacks) |
| We have been able to implement some fare increases on certain domestic and international routes during 2005, but these increases have not fully offset the substantial increase in fuel prices |
| Our ability to raise our fares is limited due to the substantial price competition in the airline industry, especially in US domestic markets |
| We cannot predict when or if yields will increase |
| Further, we cannot predict the long-term impact of any changes in fare structures, most importantly in relation to business fares, booking patterns, low-cost competitor growth, increased usage of regional jets, customers &apos directly booking on the internet, competitor bankruptcies and other changes in industry structure and conduct, but any of these factors could have a material adverse effect on our results of operations, financial condition or liquidity |
| Record high fuel costs have materially and adversely affected our operating results |
| Fuel costs, which are currently at historically high levels, constitute a significant portion of our operating expense |
| Mainline fuel costs represented approximately 26dtta7prca of our mainline operating expenses for the year ended December 31, 2005 |
| We expect that fuel expense will be our single largest operating expense item in 2006 |
| Based on gallons expected to be consumed in 2006, for every one dollar increase in the price of a barrel of crude oil, our annual fuel expense would increase by approximately dlra42 million |
| Our fuel expense could further increase if the refining margin (the component of the price of jet fuel attributable to the refining of crude oil into jet fuel) increases above current levels |
| We are also at risk for all of ExpressJetapstas fuel costs, as well as a margin on ExpressJetapstas fuel costs up to a negotiated cap of 71dtta2 cents per gallon, under our capacity purchase agreement and a related fuel purchase agreement with ExpressJet |
| Fuel prices and supplies are influenced significantly by international political and economic circumstances, such as increasing demand by developing nations, unrest in Iraq and current diplomatic tension between the US and Iran concerning Iranapstas nuclear energy development, as well as OPEC production curtailments, a disruption of oil imports, other conflicts or instability in the Middle East or other oil producing regions, environmental concerns, weather and other unpredictable events |
| Further, Hurricane Katrina and Hurricane Rita caused widespread disruption in 2005 to oil production, refinery operations and pipeline capacity in portions of the US Gulf Coast |
| As a result of these disruptions, the price of jet fuel increased significantly and the availability of jet fuel supplies was diminished |
| A significant portion of the increase in the price of jet fuel immediately following Hurricane Katrina and Hurricane Rita was attributable to an increase in the refining margin |
| Further increases in jet fuel prices or disruptions in fuel supplies, whether as a result of natural disasters or otherwise, could have a material adverse effect on our results of operations, financial condition or liquidity |
| From time to time we enter into petroleum swap contracts, petroleum call option contracts and/or jet fuel purchase commitments to provide some short-term hedge protection (generally three to six months) against sudden and significant increases in jet fuel prices |
| However, as of December 31, 2005, we did not have any fuel hedges in place |
| In February 2006, we entered into petroleum swap contracts to hedge a minimal portion of our projected 2006 fuel usage |
| Our high leverage may affect our ability to satisfy our significant financing needs or meet our obligations |
| As is the case with our principal competitors, we have a high proportion of debt compared to our equity capital |
| As of December 31, 2005, we had approximately dlra5dtta6 billion (including current maturities) of long-term debt and capital lease obligations, dlra226 million of stockholders &apos equity and dlra2dtta2 billion in consolidated cash, cash equivalents and short-term investments (of which dlra241 million was restricted cash) |
| Our combined long-term debt and capital lease obligations coming due in 2006 total dlra546 million, and we have significant amounts coming due in 2007 and thereafter |
| We also have significant operating lease and facility rental costs |
| For the year ended December 31, 2005, annual aircraft and facility rental expense under operating leases was dlra1dtta4 billion |
| In addition, we have substantial commitments for capital expenditures, including the acquisition of new aircraft and related spare engines |
| As of December 31, 2005, we had firm commitments for 52 new aircraft from Boeing, with an estimated cost of dlra2dtta5 billion, and options to purchase 30 additional Boeing aircraft |
| We are scheduled to take delivery of six new 737-800 aircraft in 2006, with delivery of the remaining 46 new Boeing aircraft occurring from 2007 through 2011 |
| We have backstop financing for six 737-800 aircraft to be delivered in 2006 and two 777-200ER aircraft to be delivered in 2007 |
| By virtue of these agreements, we have financing available for all Boeing aircraft scheduled to be delivered through 2007 |
| However, we do not have backstop financing or any other financing currently in place for the remainder of the aircraft |
| Further financing will be needed to satisfy our capital commitments for our firm aircraft and other related capital expenditures |
| We can provide no assurance that sufficient financing will be available for the aircraft on order or other related capital expenditures, or for our capital expenditures in general |
| At December 31, 2005, our senior unsecured debt ratings were Caa2 by Moodyapstas and CCC+ by Standard & Poorapstas |
| Reductions in our credit ratings may increase the cost and reduce the availability of financing to us in the future |
| We do not have any debt obligations that would be accelerated as a result of a credit rating downgrade |
| However, we would have to post additional collateral of approximately dlra45 million under our bank-issued credit card processing agreement if our debt rating falls below Caa3 as rated by Moodyapstas or CCC- as rated by Standard & Poorapstas |
| We would also be required to post additional collateral of up to dlra27 million under our workers &apos compensation program if our debt rating falls below Caa2 as rated by Moodyapstas or CCC+ as rated by Standard & Poorapstas |
| Our bank-issued credit card processing agreement also contains financial covenants which require, among other things, that we maintain a minimum EBITDAR (generally, earnings before interest, taxes, depreciation, amortization, aircraft rentals and income from affiliates, adjusted for certain special items) to fixed charges (interest and aircraft rentals) ratio of 0dtta9 to 1dtta0 through June 30, 2006 and 1dtta1 to 1dtta0 thereafter |
| The liquidity covenant requires us to maintain a minimum level of dlra1dtta0 billion of unrestricted cash and short-term investments and a minimum ratio of unrestricted cash and short-term investments to current liabilities of |
| Although we are currently in compliance with all of the covenants, failure to maintain compliance would result in our being required to post up to an additional dlra330 million of cash collateral, which would adversely affect our liquidity |
| Depending on our unrestricted cash and short-term investments balance at the time, the posting of a significant amount of cash collateral could cause our unrestricted cash and short-term investments balance to fall below the dlra1dtta0 billion minimum balance requirement under our dlra350 million secured loan facility, resulting in a default under such facility |
| We have defined benefit pension plans covering substantially all US employees other than employees of Chelsea Food Services and CMI Based on current assumptions and applicable law, we will be required to contribute in excess of dlra1dtta5 billion to our defined benefit pension plans over the next ten years, including dlra258 million in 2006, to meet our minimum funding obligations |
| Our labor costs may not be competitive and could threaten our future liquidity |
| Labor costs constitute a significant percentage of our total operating costs |
| In 2005, labor costs (including employee incentives) constituted 23dtta6prca of our total operating expenses |
| All of the major hub-and-spoke carriers with whom we compete have achieved significant labor cost reductions, whether in or out of bankruptcy |
| Even given the effect of pay and benefit cost reductions we implemented beginning in April 2005, we believe that our wages, salaries and benefits cost per available seat mile, measured on a stage length adjusted basis ( "e labor CASM "e ), will continue to be higher than that of many of our competitors |
| Although we enjoy generally good relations with our employees, we can provide no assurance that we will not experience labor disruptions in the future |
| Any disruptions which result in a prolonged significant reduction in flights would have a material adverse impact on our results of operations or financial condition |
| Our net operating loss carryforwards may be limited |
| At December 31, 2005, we had estimated net operating loss carryforwards ( "e NOLs "e ) of dlra4dtta1 billion for federal income tax purposes that will expire beginning in 2006 through 2025 |
| If we were to have a change of ownership under current conditions, our annual NOL utilization could be limited to approximately dlra81 million per year, before consideration of any built-in gains |
| For a further discussion of our NOLs, see Note 11 to our consolidated financial statements included in Item 8 |
| For financial reporting purposes, income tax benefits recorded on losses generally result in deferred tax assets |
| We are required to provide a valuation allowance for deferred tax assets to the extent management determines that it is more likely than not that such deferred tax assets will ultimately not be realized |
| Due to our continued losses, we were required to provide a valuation allowance on deferred tax assets beginning in the first quarter of 2004 |
| As a result, all of our 2005 losses and the majority of our 2004 losses were not reduced by any tax benefit |
| Furthermore, we expect to be required to provide additional valuation allowances in conjunction with deferred tax assets recorded on losses in the future |
| Risk Factors Relating to the Airline Industry Additional terrorist attacks or international hostilities may further adversely affect our financial condition, results of operations and liquidity |
| The terrorist attacks of September 11, 2001 involving commercial aircraft severely and adversely affected our financial condition, results of operations and liquidity and the airline industry generally |
| Additional terrorist attacks, even if not made directly on the airline industry, or the fear of such attacks (including elevated national threat warnings or selective cancellation or redirection of flights due to terror threats), could negatively affect us and the airline industry |
| The potential negative effects include increased security, insurance and other costs for us, higher ticket refunds and decreased ticket sales |
| The war in Iraq further decreased demand for air travel during the first half of 2003, especially in transatlantic markets, and additional international hostilities could potentially have a material adverse impact on our financial condition, results of operations or liquidity |
| Our financial resources might not be sufficient to absorb the adverse effects of any further terrorist attacks or other international hostilities involving the United States |
| The airline industry is highly competitive and susceptible to price discounting |
| The US airline industry is increasingly characterized by substantial price competition, especially in domestic markets |
| Carriers use discount fares to stimulate traffic during periods of slack demand, to generate cash flow and to increase market share |
| Some of our competitors have substantially greater financial resources, including hedges against fuel price increases, or lower cost structures than we do, or both |
| In recent years, the domestic market share held by low cost carriers has increased significantly and is expected to continue to increase, which is dramatically changing the airline industry |
| The increased market presence of low cost carriers, which engage in substantial price discounting, has diminished the ability of the network carriers to maintain sufficient pricing structures in domestic markets to achieve profitability |
| This has contributed to the dramatic losses for us and the airline industry generally |
| For example, a low-cost carrier began to directly compete with us on flights between Liberty International and destinations in Florida in 2005 |
| We are responding vigorously to this challenge, but have experienced decreased yields on affected flights |
| We cannot predict whether or for how long these trends will continue |
| In addition to price competition, airlines also compete for market share by increasing the size of their route system and the number of markets they serve |
| Several of our domestic competitors have announced aggressive plans to expand into international markets, including some destinations that we currently serve |
| The increased competition in these international markets, particularly to the extent our competitors engage in price discounting, may have a material adverse effect on our results of operations, financial condition or liquidity |
| Airline profit levels are highly sensitive to changes in fuel costs, fare levels and passenger demand |
| Passenger demand and fare levels are influenced by, among other things, the state of the global economy, domestic and international events, airline capacity and pricing actions taken by carriers |
| The September 11, 2001 terrorist attacks, the weak economy prior to 2004, turbulent international events (including the war in Iraq), high fuel prices and extensive price discounting by carriers have resulted in dramatic losses for us and the airline industry generally and have precipitated several airline bankruptcies |
| United, US Airways, Delta, Northwest and several small competitors have filed for bankruptcy protection |
| Other carriers could file for bankruptcy or threaten to do so to reduce their costs |
| US Airways and, more recently, United, have emerged from bankruptcy |
| Carriers operating under bankruptcy protection may be in a position to operate in a manner adverse to us and could emerge from bankruptcy as more vigorous competitors with substantially lower costs than ours |
| Since its deregulation in 1978, the US airline industry has undergone substantial consolidation and may experience additional consolidation in the future |
| We routinely monitor changes in the competitive landscape and engage in analysis and discussions regarding our strategic position, including alliances, asset acquisitions and business combination transactions |
| We have had, and expect to continue to have, discussions with third parties regarding strategic alternatives |
| The impact of any consolidation within the US airline industry cannot be predicted at this time |
| Additional security requirements may increase our costs and decrease our traffic |
| Since September 11, 2001, the Department of Homeland Security ( "e DHS "e ) and TSA have implemented numerous security measures that affect airline operations and costs, and are likely to implement additional measures in the future |
| Most recently, DHS has begun to implement the US-VISIT program (a program of fingerprinting and photographing foreign visa holders), announced that it will implement greater use of passenger data for evaluating security measures to be taken with respect to individual passengers, expanded the use of federal air marshals on our flights (thus displacing additional revenue passengers and causing increased customer complaints from displaced passengers), begun investigating a requirement to install aircraft security systems (such as active devices on commercial aircraft as countermeasures against portable surface to air missiles) and expanded cargo and baggage screening |
| DHS has also req uired certain flights to be cancelled on short notice for security reasons, and has required certain airports to remain at higher security levels than other locations |
| In addition, foreign governments also have begun to institute additional security measures at foreign airports we serve, out of their own security concerns or in response to security measures imposed by the US A large part of the costs of these security measures is borne by the airlines and their passengers, and we believe that these and other security measures have the effect of decreasing the demand for air travel and the attractiveness of air transportation as compared to other modes of transportation in general |
| Security measures imposed by the US and foreign governments after September 11, 2001 have increased our costs and therefore adversely affected our financial results, and additional measures taken in the future may result in similar adverse effects |
| See "e Industry Regulation and Airport Access - Federal Regulations "e above for a discussion of passenger and aviation security fees and their impact on us |
| Expanded government regulation could further increase our operating costs and restrict our ability to conduct our business |
| As evidenced by the security measures discussed above, airlines are subject to extensive regulatory and legal compliance requirements that result in significant costs |
| Additional laws, regulations, taxes and airport rates and charges have been proposed from time to time that could significantly increase the cost of airline operations or reduce revenue |
| The FAA from time to time issues directives and other regulations relating to the maintenance and operation of aircraft that require significant expenditures |
| Some FAA requirements cover, among other things, retirement of older aircraft, security measures, collision avoidance systems, airborne windshear avoidance systems, noise abatement and other environmental concerns, commuter aircraft safety and increased inspections and maintenance procedures to be conducted on older aircraft |
| We expect to continue incurring ex penses to comply with the FAAapstas regulations |
| Many aspects of airlines &apos operations also are subject to increasingly stringent federal, state and local laws protecting the environment |
| Future regulatory developments in the US and abroad could adversely affect operations and increase operating costs in the airline industry |
| For example, potential future actions that may be taken by the US government, foreign governments, or the International Civil Aviation Organization to limit the emission of greenhouse gases by the aviation sector are unknown at this time, but the impact to us and our industry is likely to be adverse and could be significant |
| Restrictions on the ownership and transfer of airline routes and takeoff and landing slots have also been proposed |
| The ability of US carriers to operate international routes is subject to change because the applicable arrangements between the United States and foreign governments may be amended from time to time, or because appropriate slots or facilities are not made available |
| We cannot provide assurance that current laws and regulations, or laws or regulations enacted in the future, will not adversely affect us |
| Our results of operations fluctuate due to seasonality and other factors associated with the airline industry |
| Due to greater demand for air travel during the summer months, revenue in the airline industry in the second and third quarters of the year is generally stronger than revenue in the first and fourth quarters of the year for most US air carriers |
| Our results of operations generally reflect this seasonality, but also have been impacted by numerous other factors that are not necessarily seasonal, including excise and similar taxes, weather, air traffic control delays and general economic conditions, as well as the other factors discussed above |
| For example, in the third quarter of 2005, Hurricanes Katrina and Rita disrupted our operations and resulted in unprecedented high prices and diminished supplies of jet fuel |
| As a result, our operating results for a quarterly period are not necessarily indicative of operating results for an entire year, and historical operating results are not necessarily indicative of future operating results |