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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

ExpressJet Holdings, Inc.

713-324-2639

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to section 12(g) of the Act:

      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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.     þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was $835.2 million as of June 30, 2002.

      As of February 14, 2003, 64,000,000 of shares of common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      The information called for by Part III of this Form 10-K (other than Item 10 as to Executive Officers and Item 14) is incorporated by reference from ExpressJet Holdings, Inc’s Proxy Statement for the Annual Meeting of Stockholders to be held on May 7, 2003 to be filed with the Commission within 120 days after December 31, 2002.

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PART I

Item 1.     Business

      Our website address is www.expressjet.com. All of our filings with the U.S. Securities and Exchange Commission (“SEC”) are available free of charge through our website on the same day, or as soon as reasonably practicable after we file them with, or furnish them to, the SEC.

Forward Looking Statements

      This Annual Report on Form 10-K contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. ExpressJet Holdings, Inc. and its wholly owned subsidiaries, XJT Holdings, Inc., and ExpressJet Airlines, Inc., which operates as Continental Express (together “ExpressJet”, “we”, “us” and “our”), rely on the safe harbor of the act in making such disclosures. Statements in the Business, Properties and Management’s Discussion and Analysis of Operations and Financial Condition sections of this filing, together with other statements beginning with words such as “believes”, “intends”, “plans”, “anticipates”, “estimates” and “expects” include forward-looking statements that are based on management’s expectations given facts as currently known by management on the date this Form 10-K was filed with the SEC. Specifically, statements regarding our future operating costs, business prospects, growth and capital expenditures, including plans with respect to our fleet, are forward looking statements. These statements reflect our plans and assumptions about future events and are subject to uncertainties, many of which are outside our control. Important factors that could cause actual results to differ materially from the expectations expressed or implied in the forward-looking statements include known and unknown risks. Some of the known risks that could significantly impact our revenues, operating results, and capacity include, but are not limited to: our dependence on our capacity purchase agreement with Continental Airlines, Inc. (“Continental Airlines”); our dependence on Continental Airline’s financial and operational strength; the costs and other effects of enhanced security measures and other possible FAA requirements; labor costs and relations, including the results of union contract negotiations; flight disruptions as a result of operational matters; deliveries of additional aircraft; our ability to implement our growth strategy; our high leverage; certain tax matters; competition and industry conditions; and the seasonal nature of the airline business. For further discussions of these risks, please see “— Risk Factors Relating to Our Capacity Purchase Agreement with Continental Airlines”, “— Risk Factors Relating to Our Business and Operations” and “— Risk Factors Relating to the Airline Industry.” The statements in this Annual Report on Form 10-K are made as of February 14, 2003, and the events described in the forward-looking statements might not occur or might occur to a materially different extent than described in this filing. We undertake no duty to update or revise any of our forward-looking statements, whether as a result of new information, future events or otherwise.

Our Company

      ExpressJet Holdings, Inc. was incorporated in Delaware in August 1996. We are the largest operator of regional jets in the world and the second-largest regional airline based on available seat miles. We are engaged in the business of transporting passengers, cargo and mail. Our sole asset is all of the issued and outstanding shares of capital stock of XJT Holdings, Inc., the sole owner of the issued and outstanding shares of common stock of ExpressJet Airlines, Inc., which operates as Continental Express. As of January 31, 2003, we offered scheduled passenger service with approximately 1,000 average daily departures to 108 cities in 37 states, the District of Columbia, Mexico and Canada, providing Continental Airlines all of its regional airline capacity at its hub airports in New York/ Newark, Houston and Cleveland. We believe our operations complement Continental Airlines’ operations by allowing more frequent service, including off-peak-time-of-day departures, to smaller cities than could be provided economically with conventional large jet aircraft and by carrying traffic that connects with Continental Airlines’ mainline jets. Our available seat miles have grown at a compounded annual rate of 24.1% from 2.1 billion in 1997 to 6.2 billion in 2002. We generated $1.1 billion of revenue and $84.3 million of net income applicable to common stockholders for the year ended December 31, 2002.

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      We announced on February 12, 2003, that we reached agreements in principle to amend our capacity purchase agreement with Continental Airlines and our regional jet aircraft purchase agreement with Empresa Brasileira de Aeronáutica S.A. (“Embraer”). Under the terms of the proposed amendments, we will modify our scheduled deliveries of Embraer regional jets in 2003 to 36, from our original plan for 48 deliveries, and will take 21 aircraft deliveries in 2004, down from 36. Additionally, we will increase our aircraft deliveries to 21 and eight for 2005 and 2006, up from two and zero for these years, respectively. Continental Airlines proposed the amendment to the capacity purchase agreement in response to continuing weakness and uncertainty in the airline industry. In return for the deferred deliveries, Continental Airlines, among other items, extended ExpressJet’s guarantee as the exclusive provider of regional jet service in the hubs and Continental Airlines’ termination right without cause by one year, to January 1, 2007. These proposed amendments to the capacity purchase agreement and the purchase agreement with Embraer are subject to the execution of satisfactory definitive agreements and the approval by the Board of Directors of Continental Airlines.

      We completed the initial public offering (“IPO”) of our common stock, par value $.01 per share, and the related Preferred Stock Purchase Rights (collectively, the “Common Stock”), on April 23, 2002, issuing 10 million shares of our common stock for $160.0 million, before underwriting discount and expenses. On April 23, 2002, we applied $146.8 million of our proceeds from our IPO to repay a portion of our note payable to Continental Airlines. Continental Airlines also sold 20 million shares of our common stock in the offering. We did not receive any of the proceeds from the sale of our stock by Continental Airlines.

      One share of a series of preferred stock called special voting preferred stock is currently authorized, designated and outstanding and is owned by Continental Airlines. The special voting preferred stock can be owned only by Continental Airlines (or its successor) and its controlled affiliates. So long as the special voting preferred stock is beneficially owned by one of these parties, its holder will be entitled to elect to our board of directors:

	•	five directors, for so long as Continental Airlines and its controlled affiliates own shares representing 50% or more of our outstanding shares of common stock;
	•	four directors, for so long as Continental Airlines and its controlled affiliates own shares representing 40% or more (but less than 50%) of our outstanding shares of common stock;
	•	three directors, for so long as Continental Airlines and its controlled affiliates own shares representing 30% or more (but less than 40%) of our outstanding shares of common stock;
	•	two directors, for so long as Continental Airlines and its controlled affiliates own shares representing 20% or more (but less than 30%) of our outstanding shares of common stock; and
	•	one director, for so long as Continental Airlines and its controlled affiliates own shares representing 10% or more (but less than 20%) of our outstanding shares of common stock.

Our board now consists of nine members, with a non-executive chairman, five directors (four of whom are officers of Continental Airlines) elected by Continental Airlines pursuant to the terms of the special voting preferred stock and three directors nominated and elected by our board.

      Prior to the completion of our IPO in April 2002, our subsidiary, ExpressJet Airlines, Inc. transferred substantially all of its assets and liabilities to a newly formed entity, New ExpressJet Airlines, Inc., in return for shares of its common stock and preferred stock. The preferred stock of New ExpressJet Airlines, Inc. is non-voting, has a liquidation preference of $5.0 million, is mandatorily redeemable in April 2012 and is callable beginning in April 2005. Prior to the issuance of the preferred stock, ExpressJet Airlines, Inc. entered into a binding contract to sell all of the shares of preferred stock of New ExpressJet Airlines, Inc. to a third-party not affiliated with us or the underwriters for a note, with no rights of offset, in the original principal amount of $5.0 million. The note is due in April 2012. ExpressJet Airlines, Inc. retained the common stock of New ExpressJet Airlines. We expect that this internal

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Our Business Strategy

      Our goal is to strengthen our position as one of the leading regional airlines and to grow our regional jet fleet, revenue, earnings and cash flow by seeking to:

	•	Operate a modern, efficient aircraft fleet, focusing on regional jets. We currently operate an all-jet fleet comprised of 50 and 37 seat Embraer regional jet aircraft. We believe that our new regional jets provide greater comfort and enjoy better customer acceptance than turboprop aircraft. Further, we believe the focus on a family of regional jet aircraft simplifies our operations and lowers our cost structure. We expect to gain efficiencies in training, maintenance and flight operations by maintaining our all-regional jet fleet. In addition, the regional jets allow us to serve routes that cannot be served by turboprop aircraft.
	•	Minimize operating costs. We strive to maintain low operating costs by operating modern and efficient aircraft and maintaining high completion factors. We seek to reduce aircraft maintenance costs by using a combination of certified maintenance vendors and our own personnel and facilities and by fixing costs for engine maintenance through “power-by-the-hour” agreements with manufacturers.
	•	Maintain our long established relationship with Continental Airlines. We believe our long established relationship with Continental Airlines has provided and will provide us with significant growth opportunities. Flying solely on behalf of Continental Airlines from January 1, 1997 to December 31, 2002, our available seat miles have grown at a compounded annual rate of 24.4%. Continental Airlines has agreed to purchase, subject to the terms of our capacity purchase agreement, all of our existing capacity and all capacity relating to the 86 Embraer regional jets for which we have firm orders as of December 31, 2002. As a result, from 2002 through 2006, based on the long-term scheduling plans for our aircraft (see also “— Our Company — Recent Developments”), which take into account current estimates of future aircraft utilization and the anticipated size and composition of our fleet, our available seat miles are expected to grow at a compounded annual rate of approximately 17%. We intend to work closely with Continental Airlines to expand service to existing markets, open new markets and schedule convenient and frequent flights.
	•	Grow in the Newark/ New York, Houston and Cleveland markets. As of December 31, 2002, we held the largest market share of regional airline traffic at Newark Liberty International Airport (“Newark Liberty International”) (83% of regional flights), Houston’s George Bush Intercontinental Airport (“Bush Intercontinental”) (92% of regional flights) and Cleveland’s Hopkins International Airport (“Hopkins International”) (74% of regional flights). We believe these markets, particularly the Houston market, offer attractive opportunities for long-term, profitable growth of regional jet operations for Continental Airlines. The Newark/ New York area, Houston and Cleveland are each large business and population center that contribute to a high volume of traffic through their respective airports. Our operations out of the Newark/ New York area, Houston and Cleveland provide our passengers access to the entire East Coast, Midwest and southern United States as well as portions of Mexico and Canada.
	•	Capitalize on capacity purchase arrangements. Our capacity purchase agreement requires Continental Airlines to pay us a block hour rate for our regional jet and turboprop flights. We believe that capacity purchase arrangements provide more predictable results by reducing our exposure to fuel prices, fare competition and passenger volumes. In the future, to the extent that we have available capacity, we intend to seek additional capacity purchase arrangements with Continental Airlines or other airlines.

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	•	Focus on customer service. Customer service is a principal focus of our company. We believe our operational reliability is crucial to our other operational objectives and, together with our initiatives to improve baggage handling and customer satisfaction, is critical to attracting travelers. In 2002, our regional jet maintenance completion factor, which is a measurement of the percentage of our regional jet flights that are not cancelled or delayed more than 15 minutes because of mechanical problems, was 99.9%, which was 0.7 points better than that of the next highest completion factor for U.S. airlines flying regional jet aircraft.
	•	Promote employee participation and achievement. We believe that our employees are our greatest asset and the cornerstone of improved reliability and customer service. Our company has utilized a variety of programs, such as our profit sharing plan and on-time bonus program, to increase employee awareness and morale and foster a sense of shared community.

Our Capacity Purchase Agreement with Continental Airlines

      We currently derive substantially all of our revenue under a capacity purchase agreement with Continental Airlines. Under this agreement, we operate flights on behalf of Continental Airlines, which controls and is responsible for scheduling, pricing and managing seat inventories and is entitled to all revenue associated with the operation of the aircraft.

      Continental Airlines has proposed and we have agreed in principle, subject to the execution of satisfactory definitive agreements and the approval by the Board of Directors of Continental Airlines, to modify our future scheduled deliveries of Embraer regional jets. This modification pushes our future deliveries from years 2003 through beginning of 2005 to years 2003 through mid 2006. In return for this deferral of deliveries, Continental Airlines, among other items, extended ExpressJet’s guarantee as the exclusive provider of regional jet service in the hubs and its termination right without cause from January 1, 2006 to January 1, 2007. See “— Our Company — Recent Developments” for further discussion regarding the proposed revision.

      Under the agreement, we are entitled to receive a payment for each scheduled block hour calculated using a formula that will remain in place through December 31, 2004. The formula is designed to provide us with an operating margin of approximately 10% before taking into account variations in some costs and expenses that are generally controllable by us. Under the formula, a substantial portion of our costs, including those relating to fuel, aircraft ownership and financing, substantially all routine or normal regional jet engine maintenance, passenger-related facility rent, administrative fees and ground handling expenses paid to Continental Airlines, excluding most labor, other maintenance or general administrative costs, are reconciled for differences between our actual costs and the expected costs included in our block hour rates. Our payments from Continental Airlines are adjusted to reflect these actual costs plus a 10% margin. In addition, a reconciliation payment is made by Continental Airlines to us or by us to Continental Airlines, as applicable, if the operating margin calculated, as described below, in any fiscal quarter is not between 8.5% and 11.5%. As a result, if this operating margin exceeds 11.5%, then a reconciliation payment will be made by us to Continental Airlines in an amount sufficient to reduce the margin to 11.5%. If the operating margin is less than 8.5%, then a reconciliation payment will be made by Continental Airlines to us in an amount sufficient to raise the margin to 8.5%. For purposes of calculating this operating margin, we do not take into account unanticipated changes in most of our labor costs, any performance incentive payments, including payments from controllable cancellation performance (cancellations other than weather or air traffic control cancellations), litigation costs and other costs that are not included in our block hour rates (or covered by any adjustments to them) and are not reasonable and customary in the industry. If these excluded costs are higher than those anticipated in our block hour rates, then our operating margin, taking these costs into effect, could be lower than 8.5% even after any reconciliation payment is made. On the other hand, if these costs are lower than those anticipated in our block hour rates, then our operating margin, taking these costs into effect, could be higher than 11.5% even after any reconciliation payment is made. During the fiscal year ended December 31, 2002, our quarterly reconciliation payments to Continental Airlines were $3.0 million, $7.7 million and $4.0 million for the second, third and fourth

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      The table below further describes how variations in our actual costs from our estimated costs, as determined in the block hour rates, are treated under the capacity purchase agreement.

(1)	We incur fuel expense equal to the lower of the actual cost of fuel or an agreed-upon cap based on our fuel purchase agreement with Continental Airlines. For the year ended December 31, 2002, the actual average cost of fuel was 60.7 cents per gallon, which was below our agreed-upon cap of 61.1 cents per gallon. In 2003 and future years, the agreed-upon cap is 66.0 cents per gallon.
(2)	Depreciation is reconciled for assets and capital projects accounted for in the capacity purchase agreement.
(3)	Reconciliation for turboprop maintenance and Captain/ First Officer mix ended December 31, 2002.
(4)	Pilot soft time reconciliation ends upon ExpressJet’s hiring a new pilot or recalling a furloughed pilot.

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(5)

In addition to our unreconciled costs, the operating margin used to calculate the reconciliation payment does not take into account any performance incentive payments, including payments from controllable cancellation performance (cancellations other than weather or air traffic control cancellations), litigation costs and other costs that are not included in our block hour rates (or covered by adjustments to them) and are not reasonable and customary in the industry.

      Under the capacity purchase agreement, the fully-reconciled costs, the costs within the margin band, and the unreconciled costs represented approximately 63.9%, 12.3% and 23.8%, respectively, for 2002. We believe that our costs in 2003 will reflect similar percentages in these three cost categories.

      Additionally, under the capacity purchase agreement some marketing-related costs normally associated with operating an airline are borne directly by Continental Airlines. These costs include those associated with the following:

	•	Reservations and sales
	•	Commissions
	•	Advertising
	•	Revenue Accounting
	•	Fare and tariff filings
	•	Food and beverage

      Our base rate per scheduled block hour includes compensation for scheduled block hours associated with some cancelled flights, based on historical cancellation rates constituting rolling five-year monthly averages. To the extent that our rate of controllable cancellations, such as those due to maintenance or crew shortages, is lower than our historical controllable cancellation rate, we will be entitled to additional payments. On the other hand, we may make a payment to Continental Airlines for controllable cancellations above historical rates of controllable cancellations. Because these incentive benchmarks are based on rolling average historical rates of controllable cancellation, lower controllable cancellation rates that result in higher incentive payments in the near term will also reduce our opportunity to earn incentive payments in the future, when the lower controllable cancellation rates become part of the historical average. Also, because we use monthly rolling averages, our opportunity to earn these payments in any particular fiscal quarter is affected by seasonal variations in historical controllable cancellation rates. We are also entitled to receive a small per-passenger fee and incentive payments for certain on-time departures and baggage handling performance.

      We have agreed to meet with Continental Airlines each year beginning in 2004 to review and set the block hour rates to be paid in the following year, in each case based on the methodology (including the 10% targeted operating margin) used to set the original block hour rates. If we and Continental Airlines cannot come to an agreement on the annual adjustments, we have agreed to submit our disagreement to arbitration.

      The agreement, including the proposed amendment (see “— Our Company — Recent Developments”), covers all of our existing fleet, as well as the 86 Embraer ERJ-145XR subject to firm orders at December 31, 2002. However, beginning July 1, 2004, Continental Airlines has the right to reduce the number of our regional jets covered by the agreement, provided that we have received at least 12 months notice. Under the agreement, Continental Airlines is entitled to decline capacity with respect to:

	•	any regional jets subject to our firm orders that Embraer has not delivered to us before the effective date of the reduction in capacity; and
	•	up to 25%, over any rolling three-year period, of our regional jets that have been delivered.

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      If Continental Airlines removes regional jet aircraft from the terms of the agreement, we would have the option to:

	•	fly the released aircraft for another airline or ourselves, subject to our ability to obtain facilities, such as gates and slots, and our exclusive arrangement with Continental Airlines in its hub airports; or
	•	decline to fly these aircraft and cancel the related subleases with Continental Airlines.

      If we elect to fly one or more of the aircraft released from the capacity purchase agreement either for another party or for our own benefit, the interest rate implicit in calculating the scheduled lease payments will increase by 200 basis points to compensate Continental Airlines for its continued participation in our lease financing arrangements. See “— Aircraft Financing.” If we elect not to fly these aircraft, the sublease between us and Continental Airlines for these aircraft will be canceled and Continental Airlines will take possession of the aircraft. In that event, Continental Airlines will be responsible for all direct reasonable costs we incur associated with the removal of those aircraft from our fleet.

      In addition, upon a reduction in capacity, we will be entitled to meet and confer with Continental Airlines regarding the impact of the reduction on our cash flow and to negotiate, in good faith, a credit facility with Continental Airlines for up to $75 million in the aggregate for a term of up to two years and at an interest rate equal to the London interbank offered rate plus 200 basis points to help cover any potential cash needs as a result of the reduction in capacity. However, Continental Airlines has no obligation to provide this facility.

      Continental Airlines has the right to require us to exercise any of the aircraft options we hold to purchase 100 Embraer ERJ-145XR aircraft, and include these aircraft under the capacity purchase agreement. If Continental Airlines elects to do this, it may either lease or sublease the aircraft to us, or substitute these aircraft for aircraft in our possession that have been removed from the terms of the capacity purchase agreement and that we sublease from Continental Airlines, in which case we will be required to finance the option aircraft ourselves. If Continental Airlines does not require us to exercise these aircraft options, we will retain the right to exercise the options and fly these aircraft for other airlines or for other purposes, subject to some restrictions; however, we will have to finance our acquisition of these aircraft independently.

      So long as either scheduled flights under the capacity purchase agreement represent at least 50% of all of our scheduled flights or at least 200 of our aircraft are covered by the capacity purchase agreement, we are required to allocate our crews, maintenance personnel, facilities and other resources on a priority basis to scheduled flights under the capacity purchase agreement above all of our other flights and aircraft.

      Our capacity purchase agreement with Continental Airlines authorizes us to use its two-letter flight designator code (CO*) to identify our flights in the central reservation system, to paint our aircraft with its colors and/or logos and to market and advertise our status as being a part of the Continental Airlines route system. The agreement also gives us a non-exclusive license to fly under the Continental Express name. Passengers on our scheduled flights under the capacity purchase agreement may earn awards under the frequent flyer program of Continental Airlines (OnePass). We do not pay fees with respect to these services.

      Under the agreement, we are compensated for scheduled block hours, including block hours associated with some cancelled flights. If cancellations outside of our control, such as those due to weather or air-traffic control, exceed the historical average of cancellations for the applicable period, we will be paid for the cancelled flight at a reduced rate, calculated to cover our fixed costs. We will generally not be entitled to any payment for controllable cancellations, which include cancellations due to labor unrest, regulatory action, fuel unavailability, crew shortages or maintenance, and all other cancellations other than weather or air traffic control cancellations, above historical rates of cancellations, and in the event of a union-authorized labor strike we will not be entitled to payment for any controllable or uncontrollable cancellations.

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      We currently lease or sublease all of our existing regional jets from Continental Airlines. Under the capacity purchase agreement, Continental Airlines is required to lease from Embraer or its designee all of our 86 current firm order aircraft and sublease these aircraft to us. However, Continental Airlines is not required to provide any financing for our Embraer option aircraft or any other aircraft that we may acquire.

      In addition, Continental Airlines may require us to substitute aircraft subject to our existing Embraer options for aircraft that have been removed from the terms of the capacity purchase agreement and that we sublease from Continental Airlines. If Continental Airlines elects to do this, it will be entitled to terminate our sublease and take possession of the replaced aircraft on the option aircraft’s scheduled delivery date. However, we will be required to finance the option aircraft independent of Continental Airlines, and even if we are unable to finance the option aircraft or the option aircraft is not delivered for any other reason, Continental Airlines will be entitled to cancel the sublease and take possession of the replaced aircraft on the option aircraft’s scheduled delivery date. If we are unable to obtain alternative financing on terms that we find acceptable or at all, or the option aircraft is not delivered for any other reason and Continental Airlines exercises its right to consummate the exchange, the size of our fleet will be reduced. Since we will be subject to a continuing risk of losing aircraft removed from the terms of the capacity purchase agreement that we sublease from Continental Airlines if we are not able to finance a replacement option aircraft, we may be unable to enter into contracts with other carriers to sell the capacity of those aircraft.

      Continental Airlines may also terminate the sublease relating to, and take possession of, any of our aircraft that have been removed from the terms of the capacity purchase agreement to the extent that Continental Airlines provides us with an equivalent replacement aircraft. We will be required to use commercially reasonable efforts to finance the replacement aircraft. We cannot provide any assurance that, if Continental Airlines exercises its rights to replace an aircraft, we will be able to obtain alternative financing or that the terms of any alternative financing will be comparable to those in the subleases with Continental Airlines. If we are unable to obtain financing after using commercially reasonable efforts, we will not be required to exchange our aircraft for the replacement aircraft.

      Most of the airport facilities that we use are leased from airport authorities by Continental Airlines. Under our master facility agreement with Continental Airlines, we are entitled to use these facilities to fulfill our obligations under the capacity purchase agreement. However, we are generally not entitled to use those facilities that are airport terminal facilities to service other carriers or operate flights under our own code without the approval of Continental Airlines. Further, we must use those facilities that are non-terminal facilities on a priority basis to support our scheduled flights that we fly on behalf of Continental Airlines, for so long as those flights constitute at least 50% of our total scheduled flights. We are generally charged for our allocated portion of airport rental expenses associated with our flight activity. Continental Airlines is generally responsible for all capital and start-up costs for airport terminal facilities at its hub airports and at any other facilities where it elects to provide baggage handling services to us. If Continental Airlines elects to provide baggage handling services at any facility at which we previously provided baggage handling services, Continental Airlines will reimburse us for most of the capital and start-up costs we incurred at that facility. We are generally responsible for any capital and start-up costs associated with any airport terminal facilities at other airports to which we fly and any non-terminal facilities not also regularly used by Continental Airlines. If we exit a market at the direction of Continental Airlines (and we do not reenter that market within six months flying for our own account or for the account of an airline other than Continental Airlines), in most cases Continental Airlines will reimburse us for certain losses incurred in connection with the closure of the related facility. If the capacity purchase agreement is terminated, we may be required by Continental Airlines to vacate airport terminal space subleased to us by Continental Airlines.

      In addition, at any airport to which we fly scheduled flights on behalf of Continental Airlines, subject to some exceptions, Continental Airlines can require us at any time, including upon cessation of these scheduled flights to the airport, to use commercially reasonable efforts to assign any lease for these airport terminal facilities that is in our name to Continental Airlines or its designee (or to sublease the space to it or its designee). In addition, if the capacity purchase agreement is terminated after our material breach of that agreement, we may be required by Continental Airlines to vacate our non-terminal space (including our maintenance and training facilities) that is subleased to us by

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      In addition, Continental Airlines can require us, at any time, to use commercially reasonable efforts to transfer, subject to applicable laws, to Continental Airlines or its designee any of our airport takeoff or landing slots, route authorities or other regulatory authorizations used for our scheduled flights under the capacity purchase agreement.

      During 2002, we retired all of the 33 turboprop aircraft in our fleet. In accordance with the capacity purchase agreement, Continental Airlines covered all direct costs associated with terminating our 29 turboprop aircraft leases. Continental Airlines also purchased from us at net book value our four turboprop aircraft, as well as the related spare engines and spare parts inventory. During 2002, Continental Airlines remitted to us approximately $21.3 million as a result of this retirement.

      We currently provide baggage handling and other support services, including ground handling, station operations, ticketing, gate access and other passenger, aircraft and traffic servicing functions for Continental Airlines at approximately twelve of the airports to which we fly. For providing these services to Continental Airlines and, if requested, to its codeshare partners, Continental Airlines pays us an amount for each aircraft landing and takeoff equal to our cost for providing such services. Continental Airlines provides these same services to us at some of the other airports to which we fly, including Continental Airlines’ existing hub airports.

      In connection with the capacity purchase agreement, we also entered into an administrative support and information services agreement, under which Continental Airlines provides us with services such as information technology support, corporate accounting, internal audit, corporate communications, insurance, purchasing, payroll, human resources, legal, tax and treasury administrative services, and a fuel purchasing agreement, under which we purchase from Continental Airlines all of our fuel requirements. Continental Airlines reimburses us for the costs of all of these services through the block hour rate pricing arrangement in the capacity purchase agreement. We have the right to terminate the provision of services to us under the administrative services agreement at our election. Under the administrative services agreement, we and Continental Airlines have negotiated in good faith to transition some of the services with terms reasonably acceptable to each party. We will continue to work with Continental Airlines to transition the services and to provide for the termination of all of the services provided to us under the administrative services agreement over a period of time to be mutually agreed upon.

      The proposed amendment to the capacity purchase agreement (see “— Our Company — Recent Developments”) provides that we will be Continental Airlines’ exclusive provider of regional jets flying in or out of Bush Intercontinental, Hopkins International or Newark Liberty International through January 1, 2007. However, the agreement permits up to 10 regional jet flights per day from each of Continental Airlines’ existing hub airports by regional airlines that have arrangements with Continental Airlines’ major airline code-share partners. This exclusivity automatically and permanently terminates upon the occurrence of a union-authorized strike. Otherwise, the agreement does not prohibit Continental Airlines from competing, or from entering into agreements with other airlines that would compete, with routes we serve.

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      The capacity purchase agreement provides that, during its term, we will provide regional airline services only for Continental Airlines at its existing hubs at Bush Intercontinental, Hopkins International and Newark Liberty International, and at any other airport from which it, together with its subsidiaries and all other regional jets operating under its code as their primary code, operates an average of more than 50 flights per day (although currently there are no such airports). This means that, without Continental Airlines’ consent, we are prohibited from operating flights under our own code or on behalf of any other carrier in or out of these airports. In addition, during the term of the agreement, we are prohibited from operating any of our aircraft subject to the capacity purchase agreement or using our passenger-related airport facilities to fulfill our obligations under the capacity purchase agreement on behalf of any other carrier or for flights under our own code. Otherwise, the agreement does not prohibit us from flying aircraft on behalf of other airlines or under our own code, or from utilizing the airport facilities of those airlines or other airport facilities that we may obtain in the future.

      Continental Airlines currently has code-sharing agreements with several regional airlines where Continental Airlines acts as the primary code-share partner. These relationships provided Continental Airlines approximately 7.5% of its regional feed on an available seat miles basis in 2002. In addition, some of Continental Airlines’ major airline code-share partners have arrangements with regional airlines that operate a few regional jet flights in and out of Continental Airlines’ existing hub airports. We cannot provide any assurance that Continental Airlines will not expand these relationships in competition with us including through the use of aircraft released from the capacity purchase agreement, or that Continental Airlines will not add its own regional jet capacity in competition with us, subject to our exclusive arrangement at Continental Airlines’ three existing hubs.

      Because our license from Continental Airlines to use the Continental Express name and other trademarks is non-exclusive, Continental Airlines is not prohibited from flying its own planes or permitting any of these other regional airlines from operating under the Continental Express name.

      So long as Continental Airlines is our largest customer, if we enter into an agreement with another major airline to provide regional airline services on a capacity purchase or other similar economic basis for 10 or more aircraft on terms and conditions that are in the aggregate less favorable to our company than the terms and conditions of the capacity purchase agreement, Continental Airlines will be entitled to amend our capacity purchase agreement to conform the terms and condition of the capacity purchase agreement to the terms and conditions of the agreement with the other major airline.

      So long as Continental Airlines is our largest customer, if a change of control of our company occurs without Continental Airlines’ consent, our block hour rates under the capacity purchase agreement will be reduced by an amount approximately equal to the operating margin built into those rates. Under the capacity purchase agreement, a change of control of our company is defined as:

	•	our merger or consolidation with a major airline, defined as an airline (other than Continental Airlines or its subsidiaries) that had more than $500 million of revenue (or, if we are the surviving entity in the transaction, $1 billion of revenue), adjusted for inflation, during the most recently completed fiscal year;
	•	the acquisition by a major airline or group of major airlines acting in concert of more than 10% of our capital stock or voting rights;
	•	the acquisition by any other entity or group of entities acting in concert, other than Continental Airlines and its subsidiaries and passive investors, of more than 25% of our capital stock or voting rights, unless such entity or group reduces its ownership to below this threshold within 30 days of the acquisition;
	•	our acquisition of more than 10% of the capital stock of an airline (other than Continental Airlines or its subsidiaries) that had more than $1 billion of revenue, adjusted for inflation, during the most recently completed fiscal year, or airline assets that generated more than $1 billion of revenue during the most recently completed fiscal year;

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	•	our merger or consolidation with another entity following which our stockholders own less than a majority of the voting securities of the surviving entity;
	•	the sale or other disposition of all or substantially all of our airline assets to a major airline;
	•	the liquidation or dissolution of our company in connection with which we cease operations as an air carrier;
	•	a majority of our directors do not consist of either our current directors or individuals nominated by a majority of our board of directors; or
	•	our entering into definitive agreements relating to the foregoing matters.

      Upon the occurrence of a union-authorized labor strike, the capacity purchase agreement provides that:

	•	we will no longer have the right to be Continental Airlines’ exclusive provider of regional jets in or out of its hubs in Houston, Cleveland and Newark through January 1, 2006, regardless of the length of the strike;
	•	we will be compensated only for the flights we complete, and will not be compensated for any controllable or uncontrollable cancellations regardless of our historical cancellation rates;
	•	on each of the 2nd, 15th, 30th, 45th, 60th and 75th days of the strike, Continental Airlines will be entitled to terminate our subleases for, and take immediate possession of, up to 20 of our aircraft that are covered by the capacity purchase agreement, to a maximum of 120 aircraft if the strike extends to the 75th day;
	•	we will be required to provide to Continental Airlines or its designee, for the duration of the strike and 180 days thereafter and at market rates, first-priority access to all of our flight simulators, hangars, training and other facilities and inventory to the extent necessary to enable Continental Airlines or its designee to operate any aircraft of which Continental Airlines takes possession as a result of the strike; and
	•	if the strike continues for 90 days or more, Continental Airlines is entitled to terminate the capacity purchase agreement for cause, cancel our subleases and take immediate possession of all of the aircraft covered by the capacity purchase agreement.

      In addition, a labor disruption other than a union-authorized strike may cause us to be in material breach of the capacity purchase agreement. Under the capacity purchase agreement, whenever we fail to complete at least 90% of our aggregate scheduled flights (based on available seat miles) in three consecutive calendar months or at least 75% of our aggregate scheduled flights (based on available seat miles) in any 45-day period (in each case, excluding flights cancelled due to union-authorized labor strikes, weather, air traffic control or non-carrier specific airworthiness directives or regulatory orders), we will be deemed to be in material breach of the capacity purchase agreement. A labor disruption other than a union-authorized strike could cause us to fail to meet these completion requirements and, as a result, cause us to be in material breach of the capacity purchase agreement. If Continental Airlines gives us notice of a material breach and we fail to cure the breach within 60 days, or if a union-authorized labor strike continues for 60 days, we will have to pay Continental Airlines an amount equal to the expected margin contained in the block hour rates for scheduled flights from the 60th day until the breach is cured. In addition, if we fail to cure the breach within 90 days after notice of the breach, Continental Airlines may terminate the capacity purchase agreement.

      The agreement expires on December 31, 2010. Continental Airlines has the option to extend the term of the agreement with 24 months’ notice for up to four additional five-year terms through December 31, 2030.

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      Based on the current proposed amendment as discussed in “— Our Company — Recent Developments”, Continental Airlines may terminate the agreement at any time after January 1, 2007 upon 12 months’ notice, or at any time without notice for cause, which is defined as:

	•	bankruptcy of our company;
	•	suspension or revocation of our authority to operate as a scheduled airline;
	•	cessation of our operations as a scheduled airline, other than as a result of a union-authorized labor strike or any temporary cessation not to exceed 14 days;
	•	a union-authorized labor strike that continues for 90 days; or
	•	an intentional or willful material breach by our company that substantially deprives Continental Airlines of the benefits of the agreement, which is not cured within 90 days of notice of the breach.

      Continental Airlines may also terminate the agreement at any time upon a material breach by us that does not constitute cause and continues for 90 days after we receive notice of the breach. If we materially breach the agreement (including for cause) and, for breaches other than cause, fail to cure the breach within 60 days after we receive notice of the breach, we will have to pay Continental Airlines an amount equal to the expected margin contained in the block hour rates for scheduled flights from the 60th day (or immediately, without receipt of any notice, if the breach is for cause) until the breach is cured. In addition, Continental Airlines may terminate the agreement immediately without notice or giving us an opportunity to cure if it makes a reasonable and good faith determination, using recognized standards of safety, that there is a material safety concern with our operation of any flight under the capacity purchase agreement.

      If Continental Airlines materially breaches the agreement and fails to cure the breach within 60 days after we notify it of the breach, we will be entitled to obtain our payments directly from Airline Clearing House, Inc. from the 60th day for the duration of the default.

      In addition, we and Continental Airlines are each entitled to seek damages in arbitration and to all available equitable remedies.

      If Continental Airlines terminates the capacity purchase agreement for cause, it also will have the right at that time to terminate our subleases with it for aircraft covered by the agreement and take possession of these aircraft. If Continental Airlines terminates the capacity purchase agreement for any reason other than for cause, we have the option to cancel all or any number of our subleases with it for aircraft covered by the agreement at the time of termination. However, if we terminate any of these subleases, we will lose access to the subject aircraft, which would reduce the size of our fleet and our future ability to generate revenue. If we elect not to terminate these subleases, the interest rate implicit in calculating the scheduled lease payments under the relevant leases will automatically increase by 200 basis points to compensate Continental Airlines for its continued participation in our lease financing arrangements.

      We are prohibited, without Continental Airlines’ consent, from amending our aircraft purchase agreements with Embraer to change the pricing, financing or leasing arrangements, number or delivery schedule of firm order or option aircraft subject to the agreements, or to make any other changes that may be expected to adversely affect Continental Airlines’ rights under the capacity purchase agreement or our ability to perform our obligations under the capacity purchase agreement. We are also prohibited, without Continental Airlines’ consent, from amending our “power-by-the-hour” agreement with Rolls-Royce Corporation in any manner that adversely affects the engine maintenance costs to us or Continental Airlines of our aircraft subject to the capacity purchase agreement. We have also agreed to consent to any amendment of our Embraer aircraft purchase agreements that reduces the financing or other obligations of Continental Airlines under these agreements, provided that such amendment does not increase our obligations under these agreements.

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      In general, we have agreed to indemnify Continental Airlines and it has agreed to indemnify us for any damages caused by any breaches of our respective obligations under the agreement or caused by our respective actions or inactions under the capacity purchase agreement.

      Under the capacity purchase agreement, we have agreed to endeavor to ensure that an individual designated from time to time by Continental Airlines (who will not be a director, officer or employee of Continental Airlines) will be a member of the board of directors of our company and each of our subsidiaries that operate as Continental Express, for the full term of the capacity agreement. This provision is not applicable, however, until after Continental Airlines is no longer entitled to elect any directors to our board of directors under the terms of our special voting preferred stock held by Continental Airlines.

      We believe that our capacity purchase agreement allows us to focus on our operations, flight completion rates, cost-effective maintenance, employee training, labor costs and employee relations.

      We anticipate that substantially all of our growth over the next several years will be attributable to our capacity purchase agreement with Continental Airlines. However, in the future, we also plan to seek opportunities to provide regional airline service to other major carriers.

Our Markets and Routes

      Operating in conjunction with Continental Airlines principally out of its three main hubs in Newark/ New York, Houston and Cleveland, we operate, on behalf of Continental Airlines, a route network that spans the East Coast and reaches as far north as Quebec City, Canada, as far south as Villahermosa, Mexico, and as far west as California. We serve 108 cities in 37 states, the District of Columbia, Mexico and Canada from Continental Airlines’ three main hubs, each of which is located in a large business and population center, which contributes to a high volume of local traffic. In November 2002, we began operating a longer-range version of the Embraer ERJ-145 aircraft, the Embraer ERJ-145XR, which is able to fly approximately 1,500 miles (approximately 40% farther than the ERJ-145 aircraft) and gives us the ability to serve markets that we were previously unable to serve with direct flights.

      As of December 31, 2002, we operated 120 average daily departures from Newark Liberty International serving 46 cities in 23 states, the District of Columbia and 5 cities in Canada. All of our departures were served by regional jets. We operated approximately 83% of all daily departures of regional jets and turboprops from Newark Liberty International and approximately 30% of all daily departures of regional jets and turboprops from New York City’s three major airports (Newark Liberty, LaGuardia and John F. Kennedy).

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      The following map illustrates our routes out of Newark Liberty International:

      Continental Airlines operates the largest hub in the New York metropolitan area, which is the second largest aviation market in the world based on weekly departures. As of December 31, 2002, Continental Airlines operated 176 average daily departures from Newark Liberty International. We and Continental Airlines together operated approximately 65% of all daily departures from Newark Liberty International and approximately 25% of all daily departures from New York City’s three major airports. In addition to its 135 average daily domestic departures, Continental Airlines also flies to Europe, the Caribbean, Mexico, Canada, South America, Central America, Tel Aviv, Tokyo and Hong Kong from Newark Liberty International.

      Bush Intercontinental is the home of our operations and the operations of Continental Airlines. As of December 31, 2002, we operated 170 average daily departures from Bush Intercontinental serving 56 cities in 22 states and 11 cities in Mexico. We serve more destinations in Mexico than any other regional U.S. carrier. During 2002, we operated approximately 92% of all daily departures of regional jets and turboprops from Bush Intercontinental and approximately 85% of all daily departures of regional jets and turboprops from Houston’s two major airports (Bush Intercontinental and Houston Hobby).

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      The following map illustrates our routes out of Bush Intercontinental:

      As of December 31, 2002, Continental Airlines operated 290 average daily departures from Bush Intercontinental. We and Continental Airlines together operated approximately 82% of all daily departures from Bush Intercontinental and approximately 65% of all daily departures from Houston’s two major airports. Bush Intercontinental is also the focus of Continental Airlines’ operations in Mexico and Central America. In addition to its 241 average daily domestic departures, Continental Airlines also flies to Mexico, Central America, South America, the Caribbean, Canada, Europe and Tokyo from Bush Intercontinental.

      As of December 31, 2002, we operated 117 average daily departures from Hopkins International serving 43 cities in 26 states, the District of Columbia and 2 cities in Canada. All of our departures were served by regional jets. We operated approximately 74% of all daily departures of regional jets and turboprops from Hopkins International.

      The following map illustrates our routes out of Hopkins International:

      As of December 31, 2002, Continental Airlines operated 49 average daily departures from Hopkins International. We and Continental Airlines together operated approximately 62% of all daily departures from Hopkins

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      Our focus on regional jet aircraft has been instrumental in our long-term growth. Responding to our customers’ preference for regional jets over turboprop aircraft, we were one of the first airlines in the United States to adopt an all-regional jet strategy. We were the worldwide launch customer in 1996 for the highly successful line of regional jets from Embraer. As of December 12, 2002, we completed our transition to an all-jet air carrier by retiring and selling all of our remaining turboprop aircraft to Continental Airlines. Additionally, during the fourth quarter of 2002, we began to add the new Embraer extended range ERJ-145XR aircraft (“ERJ-145XR