Form 10-K

Commission File Number 1-31300
EXPRESSJET HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

713-324-2639
(Registrant's telephone number, including area code)

                Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

                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. [x]

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

                The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was $966.4 million as of June 30, 2003.

As of February 11, 2004, 54,201,543 shares of common stock were outstanding.

Documents Incorporated by Reference

                Certain information called for by Part III of Form 10-K (other than Item 12 as to information required by Item 201(d) of Regulation S-K) is incorporated by reference to the Proxy Statement for our 2004 Annual Meeting of Stockholders to be filed with the Commission within 120 days after December 31, 2003.

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PART I

Item 1.    Business

            ExpressJet Holdings, Inc. and its wholly owned subsidiaries, XJT Holdings, Inc. and ExpressJet Airlines, Inc. (which operates as “Continental Express”), are collectively referred to in this report as “ExpressJet”, “we” and “us” except as otherwise noted.

            Our website address is www.expressjet.com. In addition to other things, you may view the following materials on our website, free of charge:

                Stockholders desiring a printed copy of  any of the foregoing governance materials may obtain a copy by requesting it from the Secretary of the company at the address  listed on the cover of this report.

                As described in the Principles of Conduct, we have established means for our employees to report concerns of questionable accounting, auditing and other business practices to our Director of Internal Audit and to the Chair of the Audit Committee of our board.  One of these lines of communication is via the following email address: xjtinternalaudit@expressjet.com.  Persons desiring to communicate information directly to the independent members of our board of directors may do so by sending an email to this address.

Forward-Looking Statements

                This report contains forward-looking statements. Statements in the “Business”, “Properties” and “Management’s Discussion and Analysis of Financial Condition and Results of Operation” sections of this report, together with other statements including words such as “believes”, “intends”, “plans”, “anticipates”, “estimates”, “projects”, “expects” or similar expressions represent forward-looking statements that are based on management’s expectations in light of facts known by management on the date this report was filed with the SEC. Specifically, statements regarding our future results of operations, 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.

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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”); our dependence on Continental’s financial and operational strength; our high leverage; labor costs and relations, including the results of union contract negotiations; flight disruptions as a result of operational matters; our ability to implement our growth strategy; certain tax matters; the costs and other effects of enhanced security measures and other possible Federal Aviation Administration (“FAA”) requirements; competition and industry conditions; and the seasonal nature of the airline business. For further discussions of these risks, please see “— Risk Factors” beginning on page 21. The statements in this report are made as of February 13, 2004, and the events described in the forward-looking statements might not occur or might occur to a materially different extent than described in this report. 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

                General.  ExpressJet Holdings, Inc. was incorporated in Delaware in August 1996. We are the largest operator of regional jets in the world and the largest regional airline based on available seat miles. We are engaged in the business of transporting passengers, cargo and mail. Our principal 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 aircraft under a contract with Continental as “Continental Express”. As of January 31, 2004, we offered scheduled passenger service with up to 1,100 daily departures to 130 cities in 38 states, the District of Columbia, Mexico, Canada and the Caribbean.  We provide Continental all of its regional jet capacity at its hub airports in New York/Newark, Houston and Cleveland. We believe our operations complement Continental’s network 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’s mainline jets. Our available seat miles have grown at a compounded annual rate of 26.1% from 2.6 billion in 1998 to 8.4 billion in 2003.  We generated $1.3 billion of revenue and $108.2 million of net income for the year ended December 31, 2003.

                Our Initial Public Offering.  We completed the initial public offering (“IPO”) of our common stock (together with the related preferred stock purchase rights, the “Common Stock”) on April 23, 2002, issuing 10 million shares of our common stock for $160.0 million before underwriting discounts and expenses. We applied $146.8 million of the proceeds from the IPO to repay a portion of our note payable to Continental, which also sold 20 million shares of our common stock in the offering. We did not receive any of the proceeds from Continental’s sale of our stock.

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

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                Once the number of directors that Continental (or its successor) and its controlled affiliates are entitled to elect decreases, it cannot be increased.  However, even if Continental’s rights to designate directors under its preferred stock cease, it will be entitled to elect one director to our board during the term of our capacity purchase agreement.

                Our board is divided into four classes, three of which are comprised of two directors each who are elected by stockholders for a three-year term, and one of which is currently comprised of three directors elected by Continental pursuant to its Special Voting Preferred Stock (including two Continental officers).

                Our Internal Reorganization.  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 nonvoting preferred stock. The preferred stock accrues dividends at a rate of 14.0% annually, 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.  In connection with this reorganization, ExpressJet Airlines, Inc. was renamed “XJT Holdings, Inc.”, and New ExpressJet Airlines, Inc. was renamed “ExpressJet Airlines, Inc.”.

                    We expect this internal reorganization to reduce the amounts we must pay in the future to various tax authorities as a result of increasing the tax basis of our tangible and intangible assets to fair value. In connection with this reorganization, we entered into a tax agreement with Continental providing for, among other things, the payment by us to Continental of all or a significant portion of the tax benefits we realize as a result of the increase in the tax basis of our tangible and intangible assets.  Payments could be as much as $360 million over the 15-year period after the IPO.  During 2003, we made a net payment to Continental under the tax agreement of approximately $16.6 million.  See Item 8. “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 10” for detailed discussion of our income taxes, including the increase in the tax basis of our tangible and intangible assets to fair value.

                Continental’s Stock Ownership.  As of December 31, 2003, Continental held 30.9% of our outstanding common stock.  During the third quarter of 2003, we sold $137.2 million of senior convertible notes due 2023.  We used the proceeds to repurchase 9,835,125 shares of our common stock from Continental, reducing our outstanding common stock from 64.0 million shares to approximately 54.2 million shares and Continental’s beneficial interest in our common stock from 53.1% to 44.6%.  Subsequently, Continental contributed 7,435,000 shares of our common stock to its defined benefit pension plan on September 9, 2003, further reducing its ownership to 30.9%.  Continental has indicated that it intends to sell or otherwise dispose of some or all of its remaining interest in our common stock, subject to market conditions.  We do not believe that Continental’s sale of its ownership interest will have an adverse impact on our results of operation or financial position.

Business Strategy

                As one of the industry’s leading providers of regional airline transportation in North America, our strategy is to maximize our stockholders’ value and to build cash through a continuing focus on operating costs and improved reliability.  We believe that this orientation positions us well for long-term success with both our existing and any prospective airline partners.  In recent years, we have successfully achieved this objective through fleet simplification, employment of cost-effective technologies, and sizeable investments in training resources.  We will continue to seek additional efficiencies, as we believe that maintaining our low operating cost structure will further solidify our partnership with Continental and provide the platform to pursue future growth opportunities.

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                Nurture our relationship with Continental.  We believe our long-running relationship with Continental has and will continue to provide us with growth opportunities as defined in our capacity purchase agreement with Continental.   Our continuing success in this relationship can be largely attributed to our dedication towards improving the economics and reliability of the aircraft we operate within the Continental network.  We strive to match or exceed Continental’s service standards as measured by on-time reliability, cleanliness, bag handling performance, and other customer service metrics.  We believe that this dedication, combined with our proven ability to execute our fleet plan growth, launch new markets and work closely with Continental to fully exploit the mission capabilities of our aircraft, puts our relationship on solid ground.   As a result, we anticipate that our contract rate resetting process for 2005, as specified in the capacity purchase agreement, will be uneventful; however, we cannot fully predict the outcome at this time.

                Leverage our regional jet service.  Our strategy is to leverage our Empresa Brasileira de Aeronautica S.A. (“ERJ” or “Embraer”) 145 and ERJ-135 aircraft to provide Continental with a formidable growth option.  With our fleet under its scheduling control, Continental is able to extend service to more distant and smaller communities and better able to allocate its larger, longer-range aircraft.  We believe that these Embraer jets have worked well for Continental in the recent economic downturn and will be equally or more effective if and when there is an industry upturn for either Continental or other major airlines.

                Emphasize cost control.  Our goal is to maintain our low operating cost structure and identify operational efficiencies to further solidify our partnership with Continental and position us to seize growth opportunities.  We carefully monitor performance measurements such as operating cost per available seat mile and per block hour closely to meet our goal.  Additionally, with our all-jet fleet sharing almost 100 percent commonality from flight deck to spare parts, we have been able to increase efficiencies and productivity of our maintenance operation and gain benefits from working together with Embraer and other original equipment manufacturers to pioneer leading maintenance practices.  Our partner approach with maintenance vendors has also yielded numerous “win-win” power-by-the-hour agreements.  These contracts result in predictable maintenance expense and aligned maintenance reliability goals between the service providers and us.  Additionally, during 2003, we have consistently achieved maintenance reliability above 99.9%, ranking at the top of both the regional and major airlines.

                Provide our customers a first-rate experience.  As a partner of Continental, we operate in a culture that puts customers first.  Our operational reliability, all-jet experience and first-rate customer satisfaction are critical to attracting travelers.  We believe that our customer focus does and will facilitate our long-term success with both our existing and any prospective airline partners.

                Recognize our greatest assets.  Our strongest asset, however, is not on the balance sheet.  By any measure, it is our people — professional men and women dedicated to their careers.  Our people are the cornerstone of our success and the reason that ExpressJet was named by Air Transport World as Regional Airline of the Year for 2003.  We attempt to acknowledge our employees at every opportunity with events such as profit sharing day, on-time bonus awards, perfect attendance awards and pizza days for a job well done.  To further capitalize on this asset, we invest heavily in training and prefer to in-source work, such as heavy maintenance and ground handling, when possible and economically feasible.  Having just doubled the size of our state-of-the-art training center, we look forward to the day when it again needs to be expanded.

Capacity Purchase and Other Agreements with Continental

                General.  We currently derive substantially all of our revenue from our capacity purchase agreement with Continental. Under this agreement, we operate flights on behalf of Continental, 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.  We also have various other agreements with Continental that govern our relationship.

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                During the fourth quarter of 2003, we amended our capacity purchase agreement, administrative support and information services provisioning agreement and master facility and ground handling agreement with Continental.  The amendment to the capacity purchase agreement primarily clarified existing language and has no material financial implications. 

                The amendment to the administrative service agreement extended the agreement until March 2004, at which time the agreement will either be extended further or a mutually acceptable transition plan will be implemented.  The master facility and ground handling agreement was amended to clarify how rent expenses will be allocated at the airport locations where we operate.  Under this amendment, all terminal facility rents at the hub airports will now be borne by Continental and we will pay for incremental rent at other Continental managed locations, unless Continental does not operate any aircraft there.    In these situations, we are responsible for the rent expense. At our managed locations, rent will be allocated between Continental and us based on the number of passengers.  We estimate that this change will reduce our annual terminal facility rental costs by approximately $30 million.  As terminal facility rent is a fully-reconciled cost under the capacity purchase agreement, as described in our “—Payment” section below, we expect this change to result in a net reduction of approximately $3.3 million to our annual operating income on a pre-tax basis.

                Payment.  Under the capacity purchase agreement, we are entitled to payment for each block hour Continental schedules us to fly.  Payment is based on a formula that 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. The cost components used in this formula will remain in place until December 31, 2004, after which new rates will be established annually using the same methodology that we used to establish the initial rates.  Under the formula, a substantial portion of our costs is reconciled for differences between our actual costs and the expected costs included in our block hour rates. Our payments from Continental are adjusted to reflect these actual costs plus a 10% margin. We have exposure for most labor costs, some maintenance and general administrative costs, if the actual costs are higher than those reflected in our block hour rates.

                A reconciliation payment is made by Continental to us, or by us to Continental, if the operating margin calculated, as described below (“prevailing margin”), is not between 8.5% and 11.5% in any fiscal quarter. If the prevailing margin exceeds 11.5%, we make a payment to Continental in an amount sufficient to reduce the margin to 11.5%. If the prevailing margin is less than 8.5%, Continental makes a payment to us in an amount sufficient to raise the margin to 8.5%. Certain items are excluded from the calculation of the prevailing margin, including:

                If these excluded costs are higher than those anticipated in our block hour rates, our operating margin could be lower than 8.5% when these costs are taken into account, even after any reconciliation payment is made.  On the other hand, if these costs are lower than those anticipated in our block hour rates, our operating margin could be higher than 11.5% when these costs are taken into account, even after any reconciliation payment is made.

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                During 2003, our quarterly reconciliation payments to Continental totaled $30.1 million.   The table below 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.

Fully-reconciled costs: reconciliation payment, including 10% margin, to the full extent our actual costs differ from estimated costs.
• Fuel and into-plane expense (1) • Aircraft rent • Terminal facility rent • On-time bonuses and 401(k) company match   under current plans • Taxes (other than income taxes) • Passenger liability insurance • Hull insurance • War risk insurance • Landing fees	• Administrative services provided by Continental • Ground handling services • Third-party security and screening expenses • Substantially all regional jet engine expenses   under current long-term third-party contracts • Depreciation and amortization (2) • Pilot training volumes • Glycol, de-icing, snow removal • Mexican and Canadian navigational fees • Pilot soft time (3)
Costs within the margin band: if actual expenses in this category are sufficiently different from estimates used in the block hour rates so that our prevailing margin (calculated to exclude the impact of unreconciled costs, to the extent they differ from our estimated costs, and other items (4)) is less than 8.5% or greater than 11.5%, then a reconciliation payment will be made by Continental or us to the other so that this prevailing margin will be 8.5% or 11.5%, as applicable.
• Maintenance, materials and repairs not included   above • Passenger services	• Other rental expense • Other operating expenses
Unreconciled costs: No reconciliation payment for actual results that differ from estimated costs.
• Wages and salaries • Benefits not included above	• Corporate headquarter rent costs

(1)		We incur fuel expense equal to the lower of the actual cost of fuel or an agreed-upon cap of 66.0 cents per gallon based on our fuel purchase agreement with Continental. In 2003, our actual average cost of fuel was 66.0 cents per gallon, which was equal to our agreed-upon cap.
(2)		Depreciation is reconciled for assets and capital projects accounted for in the capacity purchase agreement or those approved by Continental if outside of the capacity purchase agreement.
(3)		Pilot soft time reconciliation ended March 31, 2003.
(4)		In addition to our unreconciled costs, the prevailing 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.

                In 2003, the fully-reconciled costs, costs within the margin band, and unreconciled costs under our capacity purchase agreement represented approximately 63.8%, 12.3% and 23.9% of total operating costs, respectively.  We believe that our costs in 2004 will reflect similar percentages.

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

                To the extent that our rate of controllable cancellations (such as those due to maintenance or crew shortages) is lower than our historical rate, we are entitled to incentive payments; conversely, we pay Continental for controllable cancellations above historical rates.  Because these incentive benchmarks are based on historical five-year rolling averages of monthly controllable cancellations, lower controllable cancellations that result in higher incentive payments in the near term will reduce our opportunity to earn incentive payments in the future.  Also, because we use monthly rolling averages, our opportunity to earn these payments in any particular fiscal quarter is affected by monthly variations in historical controllable cancellation rates.  We are also entitled to receive a small per-passenger fee and incentive payments for certain on-time departure and baggage handling performance.

                Scope of Agreement and Exclusive Arrangement.  The capacity purchase agreement covers all of our existing fleet of 224 aircraft, as well as the 50 aircraft subject to firm orders, at December 31, 2003.  We will be Continental’s exclusive provider of regional jets flying in or out of its hubs at Newark Liberty International, Houston’s Bush Intercontinental and Cleveland’s Hopkins International airports through January 1, 2007.  However, the capacity purchase agreement permits up to 10 regional jet flights per day at each of these hubs by regional airlines that have arrangements with Continental’s major airline code-share partners.  This exclusivity would automatically and permanently terminate upon the occurrence of a union-authorized strike.  Otherwise, the agreement does not prohibit Continental from competing, or from entering into agreements with other airlines that would compete, with routes we serve.

                The capacity purchase agreement provides that, during its term, we will provide regional airline services only for Continental at the foregoing hubs.  We are similarly restricted at any other airport where Continental, 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).  Consequently, without Continental’s consent, we cannot operate flights under our own code or for another carrier at these airports. In addition, we cannot operate any of our aircraft subject to the capacity purchase agreement or use our passenger-related airport facilities under the agreement for other carriers 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.

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

                The capacity purchase agreement also provides that Continental has the right to reduce the number of our regional jets covered by the agreement at any time, provided that we have received at least 12 months notice. Under the agreement, Continental is entitled to withdraw capacity with respect to:

	·		any regional jets subject to 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 removes regional jet aircraft from the terms of the agreement, we will have the option to:

	·		fly the released aircraft for another airline or under our own code, subject to our ability to obtain facilities, such as gates, slots, and our exclusive arrangement with Continental at its hub airports; or
	·		decline to fly these aircraft and cancel the related subleases with Continental.

                If we elect to fly the aircraft released from the capacity purchase agreement for another party or under our own code, the interest rate implicit in calculating the scheduled lease payments will increase by 200 basis points to compensate Continental 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 for these aircraft will be canceled and Continental will take possession of the aircraft. In that event, Continental will be responsible for all direct reasonable costs we incur in removing those aircraft from our fleet.

                In addition, upon a reduction in capacity, we will be entitled to meet and confer with Continental regarding the impact of the reduction on our cash flow and to negotiate, in good faith, a credit facility with Continental 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 has no obligation to provide this facility.

                Continental has the right to require us to exercise any of our aircraft options to purchase 100 ERJ-145XR aircraft and to include these aircraft under our capacity purchase agreement. If Continental 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, in which case we will be required to finance the option aircraft ourselves.  If Continental does not require us to exercise these options, we will retain the right to exercise them and fly these aircraft for other airlines or under our own code, 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 with Continental 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.

                Code-Sharing and Marketing.  The capacity purchase agreement authorizes us to use Continental’s 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 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 can earn rewards under Continental’s OnePass frequent flyer program. We do not pay fees with respect to these services.

                Aircraft Financing.  We currently lease or sublease all of our existing regional jets from Continental. Under the capacity purchase agreement, Continental is required to lease from Embraer or its designee all of our 50 firm order aircraft (as of December 31, 2003) and sublease these aircraft to us. However, Continental is not required to provide any financing for our Embraer option aircraft or any other aircraft that we may acquire outside of our capacity purchase agreement.

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                In addition, Continental may require us to substitute aircraft subject to our existing Embraer options for any aircraft that are removed in the future from the terms of the capacity purchase agreement (“uncovered aircraft”) and that we sublease from Continental. If Continental elects to do this, it will be entitled to terminate our sublease and take possession of the replaced aircraft five days after the earlier of scheduled delivery date or actual delivery date. We will be required to finance the aircraft independent of Continental.  If we are unable to finance the replacement aircraft or it is not delivered for any other reason, Continental will be entitled to cancel the sublease and take possession of the replaced aircraft five days after the option aircraft’s scheduled delivery date, provided that Continental gave us at least 30 days advance written notice prior to the expiration of our option to acquire the option aircraft. 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 exercises its right to consummate the exchange, the size of our fleet will be reduced. We are subject to a continuing risk of losing uncovered aircraft that we sublease from Continental.  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 or have aircraft to fly for ourselves.

                Continental may also terminate the sublease relating to, and take possession of any of our uncovered aircraft that we sublease from Continental to the extent that Continental 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 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 our subleases with Continental. 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 and Continental’s sublease will not be terminated.

                Airport Facilities, Slots and Route Authorities.  Most of the airport facilities that we use are leased from airport authorities by Continental. Under our master facility and ground handling agreement with Continental, 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. 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 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, except for rent expense at Continental’s hubs per the amended master facility and ground handling agreement. Continental 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 elects to provide baggage handling services at any facility at which we previously provided baggage handling services, Continental 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. If we exit a market at the direction of Continental (and we do not re-enter that market within six months flying under our own code or that of an airline other than Continental), in most cases Continental 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 to vacate airport terminal space subleased to us by Continental.

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                As of November 1, 2003, our master facility and ground handling agreement with Continental was amended to clarify how rent expenses will be allocated at the airport locations where we operate.  Under this amendment, all terminal facility rents at the hub airports will now be borne by Continental and we will pay for incremental rent at other Continental managed locations, unless Continental does not operate any aircraft there.    In these situations, we are responsible for the rent expense. At our managed locations, rent will be allocated between Continental and us based on the number of our respective passengers.   We estimate that this change will reduce our annual terminal facility rent costs by approximately $30 million.  As terminal facility rent is a fully-reconciled cost, as described in our “—Payment” section, this change will result in a net reduction of approximately $3.3 million to our annual operating income on a pre-tax basis. 

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

                Ground Handling.  At December 31, 2003, we provided baggage handling and other support services, including ground handling, station operations, ticketing, gate access and other passenger, aircraft and traffic servicing functions for Continental at several of the airports to which we fly. For providing these services to Continental and, if requested, to its code-share partners, Continental pays us an amount for each aircraft arrival and departure equal to our cost for providing such services. Continental provides these same services to us at some of the other airports to which we fly, including Continental’s existing hub airports.

                Most Favored Nations.  So long as Continental 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 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.

                Change of Control.  So long as Continental is our largest customer, if a change of control of our company occurs without Continental’s 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:

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

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                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 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 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 may terminate the capacity purchase agreement.

                Term and Termination of Agreement and Remedies for Breach. The capacity purchase agreement expires on December 31, 2010. Continental 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.

                Continental 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:

                Continental 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 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 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.

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

                Disposition of Aircraft upon Termination.  If Continental terminates the capacity purchase agreement for cause, it will also 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 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 for its continued participation in our lease financing arrangements.

                Amendment of Embraer and Rolls-Royce Contracts.   We are prohibited, without Continental’s 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’s rights under the capacity purchase agreement or our ability to perform our obligations under 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 under these agreements, provided that such amendment does not increase our obligations under these agreements.  We are also prohibited, without Continental’s 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 of our aircraft subject to the capacity purchase agreement.  During 2003, with Continental’s consent, we agreed to a five-year extension of our agreement with Rolls-Royce Corporation.  This change did not have a material adverse effect on our engine maintenance costs.

                Indemnification.  In general, we have agreed to indemnify Continental 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.

                Board Designee.  Under the capacity purchase agreement, we have agreed to endeavor to ensure that an individual designated from time to time by Continental (who will not be a director, officer or employee of Continental) 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 purchase agreement. This provision is not applicable, however, until after Continental 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 as described in “— Our Company — Our Initial Public Offering”.

                Summary.  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.

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                Administrative Agreement.    In connection with the capacity purchase agreement, we also entered into the administrative service agreement, under which Continental 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 Continental manages all of our fuel purchasing requirements. Continental charges us for these services and the cost is included in the block hour rate pricing arrangement in the capacity purchase agreement. We have transitioned some of these administrative services from Continental during 2003 and will continue to develop a mutually acceptable transition plan for the remaining services during 2004.  As of November 1, 2003, we extended our administrative service agreement until March 2004, at which time this agreement will either be extended further or a mutually acceptable transition plan will be implemented.

Aircraft Fleet

                Our Fleet.  Our focus on regional jet aircraft is instrumental in our long-term growth. Responding to 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.  In December 2002, we completed our transition to an all-jet air carrier by retiring or selling all of our remaining turboprop aircraft to Continental. Also, during the fourth quarter of 2002, we began to add to our fleet the new Embraer extended range ERJ-145 aircraft (“ERJ-145XR”), a 50-seat regional jet capable of 1,500-mile flights. At December 31, 2003, we operated an all-jet fleet of 224 aircraft, including 54 ERJ-145XR. Our regional jets’ operational capabilities have allowed us to successfully add service to new markets that did not have enough passenger traffic to support Continental’s mainline jet service, and were beyond the range of turboprop aircraft.  We plan to continue using these aircraft to begin service to new markets, principally out of the New York/Newark, Houston and Cleveland areas, and to expand service in existing markets.

                The Embraer regional jets are among the quietest commercial jets currently available and offer many of the amenities of larger commercial jet aircraft, including a stand-up cabin, overhead and under-seat storage, lavatories, in-flight meal and beverage service capabilities, and, in many cases, more leg room than larger jets.  The speed of Embraer regional jets is comparable to that of larger aircraft operated by the major airlines, and the ERJ-145 and ERJ-135 aircraft have a range of approximately 1,100 miles, while the ERJ-145XR has a range of approximately 1,500 miles.

                We also have options for an additional 100 ERJ-145XR aircraft. Continental has the ability to include any or all of the aircraft subject to options in the capacity purchase agreement. In addition, as described under “— Capacity Purchase and Other Agreements with Continental”, Continental has the ability to reduce the number of aircraft subject to the capacity purchase agreement below the numbers described in the paragraphs above.

                We have no obligation to take any of the aircraft under firm commitments unless they are financed by a third party and leased to us or Continental.  The capacity purchase agreement provides that all of the Embraer regional jets subject to our existing firm orders will be leased by Continental and then subleased to us. This same structure will be employed for any option aircraft included in the capacity purchase agreement with Continental.  We would, however, be responsible for obtaining financing for any such option aircraft acquired for a purpose outside of the capacity purchase agreement.  We have no orders for additional aircraft other than the Embraer regional jets.

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                Maintenance of Aircraft.  Using a combination of FAA-certified maintenance vendors and our own trained and FAA-certified personnel and facilities, we maintain our aircraft on both a scheduled and as-needed basis.  We emphasize preventive maintenance, in addition to inspection of our aircraft engines and airframes at intervals required by the FAA.  We perform line and heavy maintenance at our facilities in Burlington, Vermont, Cleveland, Ohio, Houston, Texas, Knoxville, Tennessee, Shreveport, Louisiana and Newark, New Jersey, as well as our satellite maintenance stations.

                We have a power-by-the-hour agreement with Rolls-Royce Corporation to maintain the engines on our aircraft through April 2015 as a result of a five-year extension entered into in 2003.  Under the agreement, we are charged a fixed rate based on flight hours incurred during a month.  The rates are subject to annual revisions based on specific Bureau of Labor Statistics labor and materials indices.  We also have power-by-the-hour agreements with other vendors to cover various components and systems on the aircraft, such as auxiliary power units, thrust reversers, avionics, environmental control, tires, wheels and brakes.

                We believe that these agreements, coupled with our ongoing maintenance program, reduce the likelihood of unexpected levels of maintenance expense during their terms.  We continue to maintain an inventory of aircraft spare parts to insure the reliability of the operation and utilize a computerized tracking system to increase maintenance efficiency and to avoid excess inventories of spare parts.

Industry

                Major, Low-cost and Regional Airlines.  The airline industry in the United States has traditionally been led by major airlines, including American Airlines, United Air Lines, Delta Air Lines, Northwest Airlines, Continental Airlines and USAirways.  These airlines operate generally under the hub-and-spoke model with large operations centered at a small number of domestic airports based in large cities from which they offer one-stop or connecting service through the hub between destinations on the spokes.  Hub airports permit airlines to transport passengers between large numbers of destinations with substantially more frequent service than if each route were served directly. The hub-and-spoke system also allows a carrier to add service to new destinations from a large number of cities using only one or a limited number of aircraft.

                All of these major airlines leverage their brand, distribution and marketing networks via code-sharing agreements with other carriers, including regional airlines.  Regional airlines, including us, Air Wisconsin, American Eagle, Atlantic Coast Airlines, Atlantic Southeast Airlines, Comair, Horizon Airlines, Mesa Airlines, Mesaba Airlines, Pinnacle Airlines, Republic Airways, SkyWest Airlines and Trans States Airlines, typically enter into such marketing relationships with major airlines.  Under these agreements, the regional carriers operate flights using the major airline’s brand and flight-designator code and share ticket revenues by means of a commercial agreement.  Several, including American Eagle, Atlantic Southeast Airlines, Comair and Horizon Airlines, are wholly owned subsidiaries of major airline holding companies.  Regional airlines typically operate smaller aircraft on lower-demand flights in the network.  This service allows the major airline to improve its schedule for its customers and add flights that cannot be operated economically with their larger aircraft.  Regionals generally do not establish independent route systems to compete with the major airlines.  Rather, they typically enter into these marketing relationships with major airlines and focus their efforts and resources on operations.

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                Low-cost airlines, such as Southwest Airlines, AirTran Airways, Frontier Airlines and JetBlue, generally offer fewer conveniences to travelers and have lower cost structures than major airlines, which permits them to offer flights to many of the same markets, but at lower prices. Some low-cost airlines utilize a hub-and-spoke strategy, while others, including Southwest Airlines, have offered predominately point-to-point service between designated city pairs. The reduction, withdrawal or historical absence of service on shorter routes by both major and low-cost carriers has provided increased opportunities for regional airlines to develop these markets.

Competitors

                The airline industry is highly competitive.  We compete not only with other regional airlines, but also with low-cost airlines and major airlines on many of our routes.  These competitors often take a variety of pricing and scheduling actions against one another, which typically leads to some tactical retaliation.  The airline industry is particularly susceptible to price discounting, because airlines incur only nominal variable costs to provide service to passengers occupying otherwise unsold seats.  We believe that the customer features, operating costs and versatility of our regional jets provide Continental with a useful tool for defending and expanding its network.

                We are the leading regional airline operating out of Newark Liberty International, Houston’s George Bush Intercontinental and Cleveland’s Hopkins International airports. We believe that our capacity purchase agreement with Continental, combined with Continental’s significant market share at those airports, provides us with a competitive advantage over other regional carriers. However, we face substantial competition from a number of airlines serving our hub cities and various other locations in our network.  We also face some competition from low-cost airlines, although they tend to serve different city pairs.  Continental currently has code-sharing agreements with several regional airlines where Continental acts as the primary code-share partner. In addition, some of Continental’s major airline code-share partners have arrangements with regional airlines that operate a few regional jet flights in and out of Continental’s existing hub airports. We cannot provide assurance that Continental will not expand these relationships in competition with us, including through the use of aircraft released from the capacity purchase agreement, or that Continental will not add regional jet capacity in competition with us, subject to our current exclusive arrangement at Continental’s three existing hub airports. Because our license from Continental to use the Continental Express name and other trademarks is non-exclusive, Continental is not prohibited from flying its own planes or permitting other regional airlines from operating under the Continental Express name.

Industry Regulation

                We operate under certificates of public convenience and necessity issued by the Department of Transportation (“DOT”). These certificates may be altered, amended, modified or suspended by the DOT if public convenience and necessity so require, or may be revoked for intentional failure to comply with the terms and conditions of a certificate. We are regulated by the DOT, primarily in the areas of consumer protection, fitness and related economic issues.

                We also operate under an air carrier operating certificate issued by the FAA which may be amended, modified, suspended or revoked by the FAA if safety in air commerce or air transportation and the public interest so require.  The airlines are regulated by the FAA, primarily in the areas of flight operations, maintenance, ground facilities and other technical matters. Under these regulations, we have established, and the FAA has approved, a maintenance program for each type of aircraft we operate that provides for the ongoing maintenance of these aircraft, ranging from frequent routine inspections to major overhauls.

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                In November 2001, the President signed into law the Aviation and Transportation Security Act (“ATSA”). The law federalized substantially all aspects of civil aviation security, and created a new Transportation Security Administration (“TSA”), which is now an agency within the Department of Homeland Security. Under ATSA, all security screeners at airports have become federal employees, and other significant elements of airline and airport security are now overseen and performed by federal employees, including federal security managers, federal law enforcement officers, federal air marshals and federal security screeners. Among other matters, the law mandates improved flight deck security, deployment of federal air marshals onboard flights, improved airport perimeter access security, airline crew security training, enhanced security screening of passengers, baggage, cargo, mail, employees and vendors, enhanced training and qualifications of security screening personnel, additional provision of passenger and cargo data to the U.S. Bureau of Customs and Border Protection and enhanced background checks.

                Funding for airline and airport security under the law is provided by a $2.50 per segment ticket tax (subject to a $5.00 per one-way trip cap), and an additional infrastructure fee on air carriers in an amount not to exceed the amounts paid in calendar year 2000 by air carriers for screening passengers and property. In February 2002, air carriers began collecting the new ticket tax from passengers, and became subject to the new fee on air carriers.  Collection of the new ticket tax was suspended for ticket sales from June 1 to September 30, 2003 by the Emergency Wartime Supplemental Appropriation Act of 2003, and the TSA is currently reexamining how it assesses the additional infrastructure fee.

                The law requires that the Undersecretary of Transportation for Security assume all the civil aviation security functions and responsibilities related to passenger screening called for under the law. The law also requires that all checked baggage be screened by explosives detection systems, which will require significant equipment acquisition by the government and may require the implementation of facility and baggage process changes. Implementation of the requirements of ATSA and other security laws and regulations may result in increased costs for airlines and passengers and may result in delays and disruptions to air travel. The TSA has issued regulations implementing ATSA, including requirements for air carrier security programs and substantial civil penalties for violations. Under the Arming Pilots Against Terrorism Act, TSA has established a program to arm volunteer pilots of air carriers to protect aircraft.

                Many aspects of operations are subject to increasingly stringent federal, state and local laws protecting the environment. Future regulatory developments could adversely affect operations and increase operating costs in the airline industry.

Employees

                As of January 31, 2004, we had approximately 6,000 full-time equivalent employees, including approximately 2,100 pilots, 1,000 flight attendants, 1,000 customer service personnel, 1,000 mechanics and 100 other maintenance personnel, 70 dispatchers and 700 management and support personnel. As is customary in the airline industry, we also use third parties to provide ground handling personnel in some stations; a majority of these personnel are currently provided by Continental.

                Labor costs are a significant component of airline expenses and can substantially impact our results. While there can be no assurance that what we regard as our generally good labor relations and high labor productivity will continue, an important component of our business strategy is the preservation of good relations with our employees, approximately 70% of whom are represented by unions.

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                Under the terms of a previous pilot flow-through agreement with Continental, which terminated in 2003 when Continental ceased to own more than 50% of our outstanding common stock, furloughed Continental pilots had the option to accept employment with us, which in turn displaced our pilots.  Since September 2001, 371 furloughed Continental pilots took positions at ExpressJet, with 336 still employed as of December 31, 2003.  As a result of this and other industry conditions, we furloughed 500 of our pilots since September 2001, 133 of whom were recalled in 2003.  As pilot positions become available at Continental, former Continental pilots on our payroll will likely return to Continental.  This will cause us to recall our furloughed pilots and hire additional new pilots as replacements.

                The following table, as of January 31, 2004, reflects our principal collective bargaining agreements and their respective amendable dates.

                We began labor negotiations with ALPA in July 2002.  In December 2002, we applied jointly with ALPA for a federal mediator.  Our negotiations are ongoing with the mediator and ALPA with no specified deadlines.  Our pilots conducted informational picketing at our hub airports in New York/Newark, Houston and Cleveland on specified days in January and February 2004.  Although, we do not expect these actions to have an adverse effect on our negotiation, we cannot predict the outcome of these negotiations.

                In September 2003, we began negotiations with the Teamsters and jointly applied for a federal mediator in December 2003.  Our negotiations are ongoing with the mediator and the Teamsters with no specified deadlines.  We cannot predict the outcome of these negotiations.

Risk Factors

Risks Relating to Our Capacity Purchase Agreement with Continental

We are dependent on the financial and operational strength of Continental.

                We are directly affected by the financial and operational strength of Continental because we depend on Continental’s ability to make payments to us under our capacity purchase and other agreements.   Despite improvements during the last year, the U.S. domestic airline environment continues to be extremely challenging. 

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                For the year ended December 31, 2003, Continental reported net income of $38 million, but only after asset-related gains of $183 million from disposition of all or part of its interest in us, Orbitz and Hotwire and $111 million in security fee reimbursements from the U.S. government, along with $15 million in other gains and $62 million in special charges (all net of tax).  For the year ended December 2002, Continental reported a net loss of $451 million.  Although Continental’s overall passenger revenue increased 3.5% during 2003 compared to 2002, business traffic, Continental’s most profitable source of revenue, continues to be down, and competing carriers continue to offer reduced fares to attract passengers, which could lower Continental’s passenger revenue and yields in the future. 

                Neither Continental nor we can predict when or if business traffic will increase.  Furthermore, the long-term impact of any changes in fare structures, most importantly in relation to business fares, booking patterns, low-cost competitor growth, competitor bankruptcies and other changes in industry structure and conduct cannot be predicted at this time, but could have a material adverse effect on both our and Continental’s financial condition, liquidity and results of operations. In addition, Continental has stated that it will be a struggle to break even in 2004 with persistently high fuel prices and that the economic environment must improve for it to be profitable.

                We believe Continental’s business and financial performance are subject to a number of additional risks, including the following:

Any material deterioration or sustained lack of improvement in Continental’s financial or operational strength could have a materially adverse impact on our operational results and financial condition.

                Continental’s collective bargaining agreement with its pilots became amendable in October 2002.  After being deferred due to the economic uncertainty following the September 11, 2001 terrorist attacks, negotiations recommenced with ALPA in July 2002 and are continuing.  Continental has advised us that it continues to believe that mutually acceptable agreements can be reached with its pilots, although the ultimate outcome of the negotiations is unknown at this time.

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                Even absent such adverse factors as further economic recession, additional terrorist attacks, continued unrest in the Middle East, decreased consumer demand and increased fuel prices, Continental may find it necessary to downsize its operations and further reduce expenses.  As noted above, Continental could reduce its commitment or utilization of our aircraft under the capacity purchase agreement, which could materially reduce our revenue and earnings.  Additionally, Continental leases from third parties a substantial portion of the aircraft and airport facilities it subleases to us.  If Continental declared bankruptcy or otherwise defaulted under these leases, we would have no right to these aircraft or facilities; our access to our aircraft and airport facilities would depend on negotiations between the lessors and us.  For a detailed discussion of Continental’s results of operations, please see its report on Form 10-K for the year ended December 31, 2003 filed with the SEC, which sets forth Continental’s disclosure of its future minimum non-cancelable commitments under the capacity purchase agreement.

Our capacity purchase agreement with Continental may be terminated, which would materially reduce our revenue and earnings.

                Substantially all of our revenue is currently received under our capacity purchase agreement with Continental, which covers all of our existing fleet and firm aircraft orders.  If the agreement were terminated, our revenue would be substantially eliminated and we would incur significant losses unless we were able to make other arrangements.  We cannot be certain that we would be able to enter into substitute arrangements or that the arrangements would be as favorable to us as our capacity purchase agreement with Continental.

                Our capacity purchase agreement terminates on December 31, 2010, subject to renewal by Continental through December 31, 2030.  However, Continental may terminate the agreement:

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If Continental terminates our capacity purchase agreement, we may lose access to all of our aircraft fleet and airport facilities and regulatory authorizations, as well as any services that Continental provides to us.

                We sublease or lease all of our aircraft from Continental.  In addition, all of the Embraer regional jets subject to our existing firm orders will be leased by Continental and then subleased to us.  If Continental terminates the capacity purchase agreement for cause, it will have the right to terminate our subleases for aircraft covered by the agreement at the time of termination. In that event, we would likely lose access to all, or substantially all, of our aircraft fleet.  Consequently, our business, operations and ability to generate future revenue would be materially adversely affected.

                If Continental terminated the capacity purchase agreement for any reason other than cause, we would 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.  If we canceled any of these subleases, we would lose access to the subject aircraft, reducing our fleet and impairing our ability to generate revenue and cash flow.  If we elected not to terminate these subleases, the interest rate implicit in calculating the scheduled lease payments would automatically increase by 200 basis points to compensate Continental for its continued participation in our lease financing arrangements, which would directly increase our expenses and adversely affect our earnings.

                If the capacity purchase agreement were terminated for any reason, we would likely lose access to all or substantially all of our airport facilities and other services that Continental provides to us, as well as our take-off and landing slots and route authorities.  Most of the airport facilities that we use are leased from airport authorities by Continental.  If the capacity purchase agreement is terminated, we can be required by Continental to vacate substantially all of the space it subleases to us.  In addition, Continental can require us, at any time, including upon cessation of flights scheduled on behalf of Continental (subject to some exceptions), to use commercially reasonable efforts to assign any lease for these airport facilities that is in our name to Continental or its designee (or to sublease the space to it or its designee).  Consequently, to offer airline service after termination of our capacity purchase agreement, we would have to arrange to use the same or other airport facilities, take-off or landing slots, route authorities and other regulatory authorizations used for our scheduled flights at higher rates.  Our inability to gain appropriate access to airport facilities, slots or other authorizations, or a significant increase in our cost to do so would have a material adverse effect on our operating results and financial condition.

                In connection with the capacity purchase agreement, Continental provides a number of important passenger, aircraft and traffic handling services to us.  Upon termination of the capacity purchase agreement, we would either need to provide these services internally or contract with a third party for them.  We might not be able to replace these services on a cost-effective basis, which could have a material adverse effect on our operating results and financial condition.

If we materially breach our capacity purchase agreement and Continental does not terminate the agreement, we may be forced to fly our aircraft for reduced rates.

                If we materially breach the agreement, for cause and other than for cause, and fail to cure the breach within 60 days after we receive notice of the breach, we will have to pay Continental an amount equal to the expected margin contained in the block hour rates for scheduled flights from the 60th day (or immediately, if the breach is for cause) until the breach is cured.  This payment would reduce our revenue under the capacity purchase agreement and would have a material adverse effect on our operating results and financial condition.

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Continental could reduce the level of its commitment under our capacity purchase agreement, which could materially reduce our revenue, earnings, ability to repay our debt and our expected growth.

                The capacity purchase agreement covers all of our existing fleet, and the Embraer regional jets that were subject to firm orders at December 31, 2003.  At any time, Continental has the right to reduce the number of regional jets covered by our agreement, provided that we receive at least 12 months notice.  See “— Capacity Purchase and Other Agreements with Continental — Scope of Agreement”.  Any future reduction in Continental’s commitment under the capacity purchase agreement could have a material adverse effect on our revenue, earnings, ability to repay our debt and our expected growth.

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

                We cannot assure you that we would be able to enter into a satisfactory agreement with another airline for the capacity released by Continental or, alternatively, fly successfully under our own flight designator code, including obtaining the necessary airport facilities and gates.  As long as Continental is our largest customer, if we enter into a capacity purchase or similar agreement with another major airline relating to 10 or more aircraft that is, in the aggregate, more favorable to the other airline than our capacity purchase agreement is to Continental, it has the right to amend its agreement to be equally favorable.  This “most favored nations” clause, as well as other provisions of the capacity purchase agreement described above in “— Capacity Purchase and Other Agreements with Continental”, may limit our ability to enter into alternative arrangements with other major airlines.

                On the other hand, if we terminate any of our subleases, we will lose access to the aircraft subject to those subleases, which would reduce the size of our fleet and our future ability to generate revenue and cash flow.

Reduced utilization levels of our aircraft under the capacity purchase agreement would reduce our revenue and earnings.

                The capacity purchase agreement does not require Continental to meet any minimum utilization levels for our aircraft.  In response to the events of September 11, 2001, Continental reduced utilization by accelerating the retirement of some of our turboprop aircraft and removed those aircraft from the capacity purchase agreement.  Even though the block hour rates paid under the agreement adjust based on our aircraft utilization levels to compensate us for our fixed costs plus a margin, if our aircraft are underutilized (including taking into account the average length of the aircraft flight, known as stage length, and frequency of our scheduled flights), we will lose both the ability to recover a margin on the variable costs of flights that would have been flown if our aircraft were more fully utilized and the opportunity to earn incentive compensation on such flights, reducing our revenue and earnings.

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Our capacity purchase agreement with Continental may result in losses, particularly if our future costs are higher than expected.  Other factors could cause our margins under the capacity purchase agreement to decline.

                Our capacity purchase agreement provides that we will receive block hour rates, based on a formula plus performance incentives, for all of the scheduled flights that we provide on its behalf.  The formula establishes our future block hour rates based, in part, upon our estimates of future costs and will adjust our future block hour rates for changes in some, but not all, of our costs.  In addition, although the formula adjusts the rates we receive under the agreement to maintain our operating margin in any fiscal quarter within its specified range, some costs, including most labor costs higher than those reflected in our block hour rates and costs resulting from more flight cancellations than are anticipated under the agreement, are not taken into account in these adjustments.  We cannot assure you that the estimates of our future costs will be accurate. 

                In addition, although we have the opportunity to renegotiate our block hour rates for each year beginning in 2005 based on the methodology used for determining the formula currently in effect (which formula includes the 10% targeted operating margin), we have no right to terminate the capacity purchase agreement in the absence of a material breach of the agreement by Continental, which can unilaterally extend the agreement until 2031.  If the costs not subject to adjustment under the capacity purchase agreement exceed our expectations, Continental has no obligation to renegotiate the block hour rates that are in effect through December 31, 2004 and, for subsequent years, we may not be successful in renegotiating rates with Continental to our satisfaction.  As a result, we may realize decreased profits or even losses under the agreement, we may be unable to generate sufficient cash flow to pay our debts on time and we may have to reduce our expansion plans.  If any of these events occurs, our operating results and our financial condition would be adversely affected, possibly for a sustained period of time.

                To date, our costs of operations under the capacity purchase agreement have been less than those projected at the time of entering into the agreement.  We have also realized substantial payments of incentive compensation based on achieving performance in excess of contractual standards.  Renegotiation of block hour rates may include adjustments to reflect our lower-than-projected costs and performance benchmarks governing incentive payments, which are determined on a five-year rolling average period, may become more difficult for us to achieve based on our current performance level.  Thus, we may be less likely to achieve in the future the margins and levels of incentive payments achieved in the past.

Continental may compete with us. 

                Under some circumstances, Continental may reduce the level of its commitment under our capacity purchase agreement and replace our capacity with its own aircraft, including any aircraft removed from the agreement and not retained by us, or the aircraft of another regional airline, which could have a material adverse effect on our revenue, earnings, ability to repay our debt and our expected growth.   See discussion of the exclusivity between Continental and us under the capacity purchase agreement in “— Capacity Purchase and Other Agreements with Continental — Exclusive Arrangement”. 

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

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Our exclusive arrangement with Continental at its hubs and other airports limits our ability to expand our operations.

                Our exclusive arrangement with Continental in the capacity purchase agreement prohibits us, during its term, from flying under our or another carrier’s code at Continental’s hub airports (or any other airport where Continental, together with its subsidiaries and all other regional jets operating under its code, operates an average of more than 50 flights per day in the future) without Continental’s consent.  See “—Capacity Purchase Agreement with Continental — Exclusive Arrangement”.  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 under the capacity purchase agreement on behalf of any other carrier or for flights under our own code.

We are dependent on Continental’s infrastructure and the services that Continental provides to us.

                In connection with the capacity purchase agreement, we also entered into the Administrative Agreement, which has been extended to March 2004.  See “— Capacity Purchase and Other Agreements with Continental – Administrative Agreement” for detailed descriptions of these agreements.  We cannot provide any assurance that after expiration or termination of these various agreements we will be able to replace the services with a comparable service or on terms and conditions as favorable as those we receive from Continental.

If a change of control of our company occurs without the consent of Continental, the block hour rates that we receive under the capacity purchase agreement will be substantially reduced.

                Under the capacity purchase agreement, so long as Continental is our largest customer, if a change of control of our company occurs without Continental’s consent, our block hour rates under the capacity purchase agreement will be significantly reduced, which would have a material adverse effect on our operating results and financial condition.  See the definition of a change in control under our capacity purchase agreement in “— Capacity Purchase and Other Agreements with Continental — Change of Control”.  The existence of these provisions in the capacity purchase agreement limits our ability to negotiate or consummate the sale of all or part of our business to another entity or otherwise participate in any further consolidation in the airline industry.  See “—Risks Relating to the Airline Industry — The highly competitive nature of the airline industry, as well as potential substantial consolidation in the airline industry, could adversely affect us.”

Risks Relating to Our Business and Operations

We have substantial debt obligations, and we may not be able to generate sufficient cash flow or otherwise raise funds to make required payments or pursue other business opportunities.

                Our high leverage may affect our ability to satisfy our significant financing needs or meet our obligations.  As of December 31, 2003, we had approximately $356.8 million of long-term debt and capital lease obligations and our stockholders’ deficit was $10.3 million.  This includes $193.2 million of outstanding indebtedness attributable to our note payable to Continental and the $137.2 million senior convertible notes due 2023 (see Item 8. “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 8” and “Note 9” for detailed descriptions of these obligations).  Under the terms of our note payable to Continental, we have installments of $27.9 million in principal and accrued interest due quarterly, with the entire unpaid balance due on March 31, 2007.  If we do not make these payments in a timely manner, Continental can reduce its monthly payments to us under the capacity purchase agreement to the extent necessary to offset our defaulted payments.

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                Under our senior convertible notes, the holders of the notes may require us to repurchase the notes on August 1, 2008, August 1, 2013 and August 1, 2018 (“Redemption Dates”) at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any.  While we can choose to pay the repurchase price for any such notes in cash, common stock or any combination thereof,  we intend to satisfy any such  redemption in cash.  However, we may not have sufficient cash to do so.

                Even if we are able to timely service our debt obligations, their size could negatively affect our operations in various ways, including increasing the cost or limiting the availability of additional financing for working capital, capital acquisitions or other purposes and limiting the ways in which we can use our cash flow.  Under the terms of our agreements with Continental, until April 23, 2004, if we or any of our subsidiaries issue or sell any capital stock of our company or any of our subsidiaries, other than issuance, or sales in connection with our employee benefit plans, we are required to use 75% of the net proceeds from those sales to make a principal payment on the note payable to Continental, unless in either case we receive Continental’s consent or at such time Continental and its controlled affiliates own less than 20% of our outstanding shares of common stock.

                Historically, Continental has provided financing and credit support to us. We expect this to end, except as required by the capacity purchase agreement. As a result, we could face increased borrowing costs, more restrictive covenants and reduced credit from lenders and suppliers, all of which would adversely affect our operating results, financial condition and ability to raise capital to pursue other business opportunities.

                Under the capacity purchase agreement and agreements with Embraer, Continental will acquire or lease from Embraer or its designee all of our current firm order aircraft and sublease these aircraft to us, although neither we nor Continental has any obligation to acquire or lease any of these aircraft that are not financed by a third party and leased to us or Continental. Continental is not required to provide any financing for our Embraer option aircraft or any other aircraft that we may acquire.

                Continental may require us to substitute aircraft that are 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. If Continental does this, it will be entitled to terminate our sublease and take possession of the replaced aircraft five days after its scheduled delivery date, regardless of whether it is actually delivered or we are able to finance its acquisition. Continental 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 it provides us with an equivalent replacement aircraft. We will be required to use commercially reasonable efforts to finance the replacement aircraft. 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. However, we cannot assure you that, if Continental exercised its rights to replace an aircraft, any alternative financing we might obtain would be comparable to that in our subleases with Continental.

Our tax agreement with Continental increases our exposure to its financial health.

                In connection with our IPO we undertook an internal reorganization that should reduce the amounts we must pay in the future to various tax authorities as a result of increasing the tax basis of our tangible and intangible assets to fair value.  We have agreed in our tax agreement with Continental to pay to it substantially all of these tax savings, which could be as much as $360 million, from 2002 to 2017.  See Item 8. “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 10” for a detailed discussion of our income taxes, including the increase in the tax basis of our tangible and intangible assets to fair value.  After paying these reduced amounts of taxes, if it is determined as a result of an income tax audit or examination that any significant amount of these tax benefits should not have been available, thus requiring us to pay additional taxes and/or penalties to one or more tax

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authorities, and if at that time Continental were insolvent or bankrupt or otherwise unable to pay us its indemnification for these amounts, then we could be responsible for such tax payments and/or penalties.

Increases in our labor costs, which constitute a substantial portion of our total operating costs, may directly impact our earnings.

                Labor costs constitute a significant percentage of our total operating costs, and are considered unreconciled costs under the capacity purchase agreement with Continental.  Under our capacity purchase agreement, our block hour rates contemplate labor costs that increase on a set schedule through 2004.  We are responsible for our labor costs, and will not be entitled to receive increased payments for our flights if our labor costs increase above the assumed costs included in the block hour rates.  In addition, although the capacity purchase agreement provides for adjustments to the rates we receive under the agreement to maintain our operating margin in any fiscal quarter within a specified range, the effects of our labor costs are not taken into account in these adjustments.  As a result, an unplanned increase in our labor costs could result in a material reduction in our earnings.

                The collective bargaining agreement between us and our pilots (who are represented by ALPA) became amendable in October 2002.  We began labor negotiations with ALPA in July 2002.  In December 2002, we applied jointly with ALPA for a federal mediator.  Our negotiations are ongoing with the mediator and ALPA with no specified deadlines.  Our pilots conducted informational picketing at our hub airports in New York/Newark, Houston and Cleveland on specified days in January and February 2004.  Although, we do not expect these actions to have an adverse effect on our negotiation, we cannot predict the outcome of these negotiations.

                The collective bargaining agreement between us and our mechanics (who are represented by the Teamsters) became amendable in February 2004.  In September 2003, we began negotiations with the Teamsters and jointly applied for a federal mediator in December 2003.  Our negotiations are ongoing with the mediator and the Teamsters with no specified deadlines.  We cannot predict the outcome of these negotiations.

                We expect to incur increased labor costs in connection with the negotiation of these collective bargaining agreements.

                If we are unable to reach an agreement with any of our unionized work groups on the terms of their collective bargaining agreements, we may be subject to work interruptions and/or stoppages. Any sustained work stoppages could adversely affect our ability to conduct our operations and fulfill our obligations under the capacity purchase agreement. In addition, certain other U.S. air carriers have experienced work slowdowns, strikes or other labor disruptions in connection with contract negotiations. Although we enjoy generally good relations with our employees, there can be no assurance that we will not experience labor disruptions in the future.

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We may not be successful in implementing our growth strategy.

                In order to meet our growth objectives, we have contracted to add additional aircraft to our fleet over the next several years.  Substantial risks accompany our growth plans.  Some factors that may impact our growth plans include:

                Many of these factors are beyond our control.  If we are incorrect in our assessment of the profitability and feasibility of our growth plan, or if unforeseen circumstances arise, we may not be able to grow as planned or our growth may have an adverse effect on our operating results and our financial condition.

We may be unable to obtain all of the aircraft, parts or related support services we expect from Embraer or otherwise operate the aircraft, which would materially adversely impact our operating results and financial condition.

                As of December 31, 2003, we had a firm order with Embraer for 50 regional jets through 2006 and options to acquire an additional 100 regional jets that are exercisable from 2005 through 2008.  We are dependent on Embraer as the manufacturer of all these jets, and we are Embraer’s largest customer.  Any disruption, such as Embraer’s inability to perform its obligations as a result of operational or financial difficulties, or change in the delivery schedule of these Embraer regional jets would affect our overall operations and could have a materially adverse impact on our operating results and our financial condition.

                Our operations could also be materially adversely affected by the failure or inability of Embraer to provide sufficient parts or related support services on a timely basis or the interruption of fleet service as a result of unscheduled or unanticipated maintenance requirements for our aircraft.  The issuance of FAA directives restricting or prohibiting the use of Embraer regional jets would have a material adverse effect on our business and operations.

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Risks Relating to the Airline Industry

Our industry has incurred significant losses as a result of weakened economies and political uncertainties.

                The airline industry is highly sensitive to the economy.  Weak global and domestic economies have significantly decreased overall revenue for the airline industry.  Corporate profitability has declined, resulting in reduced business travel, typically the most profitable source of revenue for mainline carriers.  Demand is further weakened by customer dissatisfaction with the challenges and delays of heightened airport security.  Under our capacity purchase agreement, Continental bears the risk of revenue volatility associated with fares and passenger traffic.  Therefore, although we are not directly affected by the decline in demand, so long as Continental is our largest customer, this factor could influence its commitments to us under the capacity purchase agreement and reduce our revenue.

                Terrorist attacks and threats, continued unrest in the Middle East or other world events could result in decreased load factors and yields and could also result in further increased costs for us and the airline industry.  For instance, fuel costs rose significantly during 2002 and 2003, and have been at historically high levels.  Premiums for aviation insurance increased substantially since the terrorist attacks in September 2001and certain aviation insurance could become unavailable or available only for reduced amounts of coverage that are insufficient to comply with the levels of insurance coverage required by aircraft lenders and lessors or by applicable government regulations.    Additionally, increased security measures mandated by the Transportation Security Administration have also increased operating expenses for us and the airline industry, despite various governmental aids.

The highly competitive nature of the airline industry, as well as potential substantial consolidation in the airline industry, could adversely affect us.

                Since its deregulation in 1978, the U.S. airline industry has undergone substantial consolidation, and it may experience additional consolidation in the future.  The impact of any consolidation or significant alliance activity within the U.S. airline industry could adversely affect our operations, our business prospects and our relationship with Continental.

                The airline industry is highly competitive.  We compete not only with other regional airlines, some of which are owned by or operate as code-sharing partners of major airlines including Continental, but also with low-cost airlines and major airlines on many of our routes.  Some of these airlines are larger and have significantly greater financial and other resources than we do.  Moreover, competitors could rapidly enter markets we serve for Continental and quickly discount fares, which could lessen the economic benefit we derive from servicing these markets.

Our business is subject to extensive government regulation, and we may incur additional costs to comply with such regulations.

                Our business is subject to extensive government regulation.  As evidenced by the enactment of the ATSA, airlines are subject to extensive regulatory and legal compliance requirements that result in significant costs.  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 wind shear avoidance systems, noise abatement and other environmental concerns, commuter aircraft safety and increased inspections and maintenance procedures to be conducted on older aircraft.

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                We expect to continue incurring expenses to comply with the FAA’s regulations.  In addition, if any of these actions by the FAA causes us to cancel flights, the resulting reduction in our revenue is not taken into account in the reconciliation payment made under the capacity purchase agreement to maintain our operating margin within a specified range.

                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.  Moreover, because of higher security and other costs incurred by airports after September 11, 2001, coupled with reduced fees paid by airlines to airports due to decreased flying and cargo, have caused many airports to significantly increase their rates and charges to air carriers.  Restrictions on the ownership and transfer of airline routes and take-off and landing slots have also been proposed.  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.  We cannot be certain that current laws or regulations, or laws or regulations enacted in the future, will not adversely affect us.

We may be adversely affected by factors beyond our control, including weather conditions and the availability and cost of fuel.

                Generally, revenue for airlines depends on the number of passengers carried, the fare paid by each passenger and service factors, such as timeliness of departure and arrival.  During periods of fog, icy conditions, storms or other adverse weather conditions, flights may be cancelled or significantly delayed.  Under our capacity purchase agreement with Continental, we are substantially protected against cancellations due to weather or air traffic control. However, if we decide in the future to operate our aircraft for another airline or under our own flight designator code, we may not be protected against weather or air traffic control cancellations, which could adversely affect our operating results and our financial condition.

                In addition, if we operate our aircraft for another airline or under our own flight code, we could be exposed to the risk of increased fuel prices.  Both the cost and availability of fuel are subject to many economic and political factors and events occurring throughout the world.  Significant changes or extended periods of high fuel costs or fuel supply disruptions would materially affect our operating results.  Our ability to pass on increased fuel costs through fare increases would be limited by several factors, including economic and competitive conditions.  In addition, if the unavailability of fuel causes us to cancel flights, the resulting reduction in our revenue is not taken into account in the reconciliation payment made under the capacity purchase agreement to maintain our operating margin within a specified range.  The cost and availability of adequate supplies of fuel could have a material adverse effect on our operating results and our financial condition in the future.

Our operations are affected by the seasonality associated with the airline industry.

                Due to greater demand for air travel during the summer months, revenue and capacity in the airline industry in the second and third quarters of the year is generally stronger than revenue and capacity in the first and fourth quarters of the year for most U.S. air carriers.  Our results of operations generally reflect this seasonality.

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Risks Relating to Continental’s Significant Interest in Our Company

As long as Continental owns a significant portion of our common stock, it will be able to influence us substantially.

                Continental owned approximately 30.9% of our common stock as of December 31, 2003.  As a result, Continental continues to significantly influence our board of directors and other matters affecting our company, including:

                Continental owns the sole share of our Special Voting Preferred Stock, which, among other things, provides it with the right to elect a designated number of our directors based on the percentage of our common stock that it owns, as described in “— Our Company — Our Initial Public Offering”.  In addition, during the term of the capacity purchase agreement, Continental has the right to designate one individual to our board of directors (who will not be a director, officer or employee of Continental) even after it is no longer entitled to designate any directors to our board under its Special Voting Preferred Stock.

Our existing agreements with Continental were not made on an arm’s length basis and may not be fair to us.

                The capacity purchase agreement, the tax agreement and the other contractual agreements we have with Continental were made in the context of an affiliated relationship and were negotiated in the overall context of our initial public offering.  In addition, these agreements may be amended from time to time upon agreement between the parties and, as long as Continental is a significant stockholder, it will have a significant influence over our decision to agree to any such amendments.  As a result of Continental’s control of us when these agreements were negotiated, the prices and other terms under these agreements may be less favorable to us than terms we might obtain in arm’s length negotiations with unaffiliated third parties for similar services.  In addition, these agreements may be more favorable to us than terms we might obtain in any arm’s length negotiations.  As a result, the terms of these agreements may not be representative of the terms of future agreements that we may enter into with unaffiliated third parties.

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Two of our directors are also directors and executive officers of Continental.

                Two of our directors are also directors and executive officers of Continental.  These directors owe fiduciary duties to the stockholders of each company and may have conflicts of interest in matters involving or affecting Continental or us.  This could create, or appear to create, potential conflicts of interest when our directors are faced with decisions that could have different implications for Continental than they do for us. 

Item 2.    Properties

Flight Equipment

            As shown in the following table, our operating aircraft fleet consisted of 224 regional jets at December 31, 2003. Our purchase commitments (orders) and aircraft options as of December 31, 2003 are also shown below.

            During 2003, we put into service a total of 36 new ERJ-145XR aircraft.  We will take delivery of 21 ERJ-145XR aircraft in 2004 and 2005 and the remainder of our firm orders through 2006.

            See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Commitments” for a discussion of our order for new firm commitment aircraft and related financing arrangements.

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Facilities

            We use the following principal facilities:

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            All of these facilities are leased on a net-rental basis, and we are responsible for maintenance, taxes, insurance and other facility-related expenses and services. Continental is the primary sublessor for these facilities, except for the Houston maintenance hangar, the Knoxville hangar and Shops facilities, the Shreveport hangar and Shops facilities, and the Richmond, Louisville, and Dayton satellite maintenance stations, which we lease directly. In addition, at each of Continental’s three domestic hub cities and many other locations, our passenger and baggage handling space is provided by Continental on varying terms dependent on the prevailing practice at each airport. If the capacity purchase agreement is terminated after our material breach of that agreement, we may be required to vacate these facilities that are subleased to us by Continental, and we may be required to use commercially reasonable efforts to assign to Continental or its designee any lease in our name for these facilities. See Item 1. “Business —  Capacity Purchase Agreement with Continental— Airport Facilities, Slots and Route Authorities.” For a period of five years following the termination of the capacity purchase agreement, if we wish to transfer our interests in any of our facilities used to fulfill our obligations under the capacity purchase agreement, Continental must consent to the transfer (where Continental is the sublessor) and has a right of first refusal to acquire our interests in those facilities that we lease from parties other than Continental.

Item 3.    Legal Proceedings

Legal Proceedings

            We are a defendant in various lawsuits arising in the ordinary course of our business. While the outcome of these lawsuits and proceedings cannot be predicted with certainty and could have a material adverse effect on our financial position, results of operations or cash flows, we believe that the ultimate disposition of these suits will not have a material adverse effect on our financial position, results of operations or cash flows.

Environmental Proceedings

                We are and may from time to time become involved in environmental matters, including the investigation and/or remediation of environmental conditions at properties we use or previously used by us. We are not, however, currently subject to any environmental cleanup orders imposed by regulatory authorities, nor do we have any active investigations or remediations at this time.

Item 4.    Submission of Matters to a Vote of Security Holders

            Not applicable.

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PART II

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

            Our common stock trades on the New York Stock Exchange. The table below shows the high and low sales prices for our common stock as reported on the New York Stock Exchange beginning April 18, 2002, the date following the pricing date of our initial public offering on which trading of our common stock on the New York Stock Exchange commenced.

               As of February 11, 2004, there were approximately 16 holders of record of our common stock.

               We have paid no cash dividends on our common stock and have no current intention of doing so.

               Our certificate of incorporation provides that no shares of capital stock may be voted by or at the direction of persons who are not United States citizens unless such shares are registered on a separate stock record. Our bylaws further provide that no shares will be registered on this foreign stock record if the amount so registered would exceed United States foreign ownership restrictions. United States law currently limits to 25% the voting power in us (or any other U.S. airline) of persons who are not citizens of the United States.

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Item 6.    Selected Financial Data

            You should read this selected financial data together with the consolidated financial statements and related notes and Item 7. “Management’s Discussions and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

            The following selected financial data for each of the five years ended December 31, 2003 and as of December 31, 2003, 2002, 2001, 2000 and 1999 have been derived from our audited financial statements. The financial information included in this report is not necessarily indicative of our future results of operations, financial position and cash flows, or reflective of what our results of operations, financial position and cash flows would have been had we been a stand-alone entity during the periods presented.

            We operated essentially as a division of Continental until January 1, 2001, providing passengers to its mainline jet operations. Our scheduling, pricing and revenue management were designed and operated to increase Continental’s overall system revenue rather than to maximize the profitability on flight segments we operated. In addition, our historical financial statements for periods prior to January 1, 2001 reflect a revenue-sharing arrangement between us and Continental that is different from our capacity purchase agreement, which became effective on January 1, 2001.  Under the revenue-sharing arrangement, we received a prorated percentage of the ticket revenue for passengers traveling one portion of their trip on our aircraft and the other portion of their trip on Continental’s aircraft, and all of the ticket revenue for passengers traveling their entire trip solely on our aircraft. All of the costs associated with our flights were either borne directly by us or otherwise allocated to us by Continental. Under the revenue-sharing arrangement, we realized increased revenue as ticket prices and passenger loads increased and decreased costs as fuel and other costs decreased. Conversely, we realized decreased revenue as ticket prices and passenger loads decreased and increased costs as fuel and other costs increased. Under our capacity purchase agreement, Continental pays us a rate calculated using a formula for each scheduled block hour by aircraft operated by us. Under the formula, our rates vary depending on the average length of our scheduled flights, our aggregate number of flights and the type of aircraft utilized, and are otherwise subject to specified adjustments.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

            The information contained in this section has been derived from our historical financial statements and should be read together with our historical financial statements and related notes included elsewhere in this report. The discussion below contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those expressed or implied in these forward-looking statements as a result of various factors, including those described in Item 1. “Business — Risk Factors” and elsewhere herein.

OVERVIEW

        Where we are…

                We are the largest operator of regional jets in the world and the largest regional airline in the world based on available seat miles. As of December 31, 2003, we offered scheduled passenger service with up to 1,100 daily departures to 130 cities in 38 states, the District of Columbia, Mexico, Canada and the Caribbean. We provide Continental all of its regional jet capacity at its hub airports in New York/Newark, Houston and Cleveland. Our available seat miles (“ASMs”) have grown at a compounded annual rate of 24.5% from 5.4 billion in 2001 to 8.4 billion in 2003, while our costs have increased at a compounded annual rate of 13.3% for the same period.  We seek to improve earnings growth and cash flow through our continuing focus on operating costs and improved reliability.  Our success to date is reflected by the slower rate of increase in our operating costs as compared to the growth in our operations.  We have successfully achieved these objectives through fleet simplification, employment of cost-effective technologies and sizeable investments in training resources. For the year ended December 31, 2003, we recorded net income of $108.2 million. 

                We receive substantially all of our revenue from Continental under our capacity purchase agreement, pursuant to which Continental purchases all of our capacity and pays us specified rates per scheduled block hour by our aircraft, together with certain incentive payments and reimbursements.  See Item 8. “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 2” for details related to the block hour rates and performance incentives.  Our operating revenue is reconciled and settled with Continental on a monthly basis, except for the quarterly reconciliation of our costs within the margin band, as defined by the capacity purchase agreement.  Please also read Item 1. “Business — Capacity Purchase and Other Agreements with Continental” for a more detailed description of this agreement.

                During 2003, we accepted 36 deliveries of the new ERJ-145XR.  This aircraft is a 50-seat regional jet capable of flights of 1,500 miles.  With these deliveries, we ended 2003 with 54 ERJ-145XR, 140 ERJ-145 and 30 ERJ-135 aircraft.  Our regional jets’ operational capabilities have allowed us to add service to new markets, expand service in existing markets, and ultimately allow Continental to extend service from its major hub cities to more distant and smaller communities, thus contributing to its growth options.  We currently expect to receive 21 new ERJ-145XR aircraft per year during 2004 and 2005 and eight new aircraft in 2006.  Additionally, we expect Embraer to arrange the financing for these aircraft to Continental, which will then sublease them to us.

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                As of December 31, 2003, we had $193.1 million in cash, including $3.2 million in restricted cash.  During 2003, we reduced our note payable to Continental by $132.3 million, entered into a loan agreement with Export Development Canada (“EDC”) for $17.3 million and completed the private placement of $137.2 million senior convertible notes due 2023.  Proceeds from our loan agreement with EDC were used to pay down our note payable to Continental.  Proceeds from our senior convertible notes were used to repurchase 9,835,125 shares of our common stock from Continental.  This repurchase reduced our outstanding common stock from 64,000,000 shares to 54,164,875 shares.  As a result of this transaction, Continental’s beneficial interest in our common stock decreased from 53.1% to 44.6%. 

                In addition, Continental contributed 7,435,000 shares of our common stock to its defined benefit pension plan on September 9, 2003, which further reduced its ownership to 30.9%.  Continental has indicated that it intends to sell or otherwise dispose of some or all of its remaining interest in our common stock, subject to market conditions.  Based on current information and our capacity purchase agreement with Continental, we do not believe that Continental’s sale of its ownership interest will have an adverse impact on our results of operations or financial position.

                Our cash flows from operations were sufficient to cover our capital resource and liquidity requirements during the three years ending December 31, 2003.  See discussion below in “— Liquidity and Capital Commitments”.

        Where we are we going…

                Our goal is to maximize our stockholders’ value and build our cash by:

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Critical Accounting Policies

            Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect reported amounts and related disclosures.  We have identified the accounting policies below as critical to our business operations and an understanding of our results of operations. The SEC has defined critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results and require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.  For all of these policies, we caution that future events rarely develop exactly as forecasted, and the best estimates routinely require judgment. The discussion below is not intended to be a comprehensive list of our accounting policies. For a detailed discussion on the application of these and other accounting policies, see Item 8. “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 1”.

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Revenue Recognition

                Under the capacity purchase agreement, we recognize our operating revenue based on agreed-upon rates for each scheduled block hour. The rates per hour were 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.  We also record revenue earned under certain incentive provisions of the capacity purchase agreement, such as the percentage of flights we complete, certain on-time departures and baggage handling, within the capacity purchase agreement. See Item 8. “Financial Statements and Supplementary Data  — Notes to Consolidated Financial Statements — Note 2” for details related to the block hour rates and the performance incentive payments.  Our operating revenue is reconciled and settled with Continental on a monthly basis, except for the quarterly reconciliation of our costs within the margin band defined in the capacity purchase agreement. 

                Amounts billed by us to Continental under the capacity purchase agreement are subject to our interpretation of the capacity purchase agreement.  Continental may dispute amounts billed and pay less than the amount invoiced.  If our interpretation materially differs from Continental’s, our revenue could be materially understated or overstated.  No such disputes existed as of December 31, 2003.  For the fourth quarter of 2003, our rebate to Continental was $9.5 million, as our operating margin used to calculate the reconciliation payment made by us to Continental (“prevailing margin”) exceeded 11.5% by 2.4 points.   Had Continental disputed any component of the prevailing margin calculation for the fourth quarter of 2003, leading to a one point increase in the prevailing margin, we would have had to pay approximately $4.0 million additional cash to Continental.  However, this additional cash outlay would have had an immaterial impact on our net income as the prevailing margin was above 11.5%.

Wages, Salaries and Related Expenses

                We are currently self-insured for some of our healthcare costs, workers’ compensation liability and other employee benefits and, as such, reserves for the cost of claims that have not been paid or benefit costs that have been incurred but not yet reported (“IBNR”) as of a given balance sheet date are estimated. Our estimates for these reserves are derived from actuarial estimates provided by third-party benefit administrators.  These estimates rely on historical claim experience, estimation of inflation on medical cost and future economic condition.  If the ultimate development of these claims is significantly different than those that have been estimated, the reserves for future health care claims could be materially overstated or understated.  Our third-party healthcare benefit administrator provided a range of IBNR from $2.0 million to $3.6 million.  As of December 31, 2003, we reserved $3.4 million related to these medical benefits.  Had our reserve equaled the low end of the estimate, our diluted earnings per share (“EPS”) would have increased by $0.01 per share.  If our reserve equaled the high end of the range, the change would have had no impact on our diluted EPS.  Additionally, our third-party workers’ compensation administrator provided a range of IBNR, calculated under various reserving methods, from $2.2 million to $3.2 million.  As of December 31, 2003, we reserved $2.8 million related to our workers’ compensation.  Had our reserve equaled the low end of the estimate, our diluted EPS would have increased by $0.01 per share.  If our reserve had equaled the high end of the range, the change would have had no impact on our diluted EPS.

                Our contracts with our pilots and our mechanics became amendable in October 2002 and February 2004, respectively.  At this time, we cannot predict the outcome these negotiations will have on our financial results in the future.

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Maintenance Repair Liability

                Maintenance repair liability falls into two categories: accruals for estimated costs and power-by-the-hour contracts. When parts and equipment on the aircraft become unserviceable or are due for scheduled maintenance, they are removed and replaced with serviceable parts from inventory. The parts in need of repair are sent to repair vendors, and a liability for that repair cost is recognized in that calendar month. In the event that an actual quote is received, the accrual will be based on the quote. Typically, repair costs are initially estimated based on the historical cost of a like repair for that specific part. If no historical cost information exists, then a percentage of replacement cost is used. The initial estimate is replaced by a quote from the repair vendor after they inspect the part and determine what the actual cost will be. The accrual is adjusted accordingly. Accruals are carried until the invoice is received, approved and paid.  Our initial estimate of repair costs can be materially different from the ultimate invoice amount.   At December 31, 2003, we had a maintenance repair liability of $3.6 million.  However, as our maintenance, material and repair expense is a cost within the margin band (see Item 8.  “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements —  Note 2”) and our prevailing margin was above 11.5%, the impact of such increase in expense would have had an immaterial impact on our net income and no effect on our diluted EPS.

                For those repairs and maintenance costs not covered by the above accrual method, power-by-the-hour contracts exist. The power-by-the-hour contracts dictate the method by which we pay a vendor based on our actual level of operations in exchange for vendor coverage on specific parts and equipment on our aircraft when those parts and equipment are in need of repair or replacement. Individual contracts are of varying terms and payment procedures and typically require a monthly payment based upon a specific operating statistic incurred. Accordingly, such payment amounts are expensed as incurred. On average, power-by-the-hour arrangements represent approximately 60% of our maintenance, materials and repair costs.  These contracts reduce the subjectivity of maintenance repair accruals and increase the predictability of maintenance expense.

Goodwill and Intangible Assets

                Under the Statement of Financial Accounting Standard No. 142 — “Goodwill and Other Intangible Assets” (“SFAS 142”), issued by the Financial Accounting Standards Board (“FASB”) goodwill and intangible assets should be tested at least annually for impairment.  Factors considered important when determining the impairment of reporting segments under SFAS 142 include items affecting the cash flows of the reporting segments; the reporting segments’ operational performance versus market expectations; the reporting segments’ performance compared to peers within the industry; the marketplace for and identification of the intangible assets of the reporting segments; significant changes in the underlying business strategy or operational environment; material ongoing industry or economic trends; or other factors specific to the asset or reporting segments being evaluated.  Any changes in the key assumptions about the business and its prospects, or changes in market conditions or other externalities could result in an impairment charge, and such a charge could have a material adverse effect on our financial condition and results of operations.  Based on our current impairment test, there would have to be a significant change in assumptions used in such calculation in order for an impairment to occur as of December 31, 2003.

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Summary

                In addition, we have made certain other estimates that, while not involving the same degree of judgment, are important to understanding our financial statements.  In general, we base our estimates on historical experience, on information from third-party professionals and on various other assumptions that we believe are reasonable under the facts and circumstances. We continually evaluate our accounting policies and the estimates we use to prepare our consolidated financial statements. Our estimates as of the date of the financial statements reflect our best judgment after giving consideration to all currently available facts and circumstances.  As such, actual results may differ significantly from these estimates and may require adjustment in the future as additional facts become known or as circumstances change.

                Management has discussed the development and selection of these critical accounting estimates with the audit committee of our board of directors, and the audit committee has reviewed the disclosures presented above relating to them.

Recently Issued Accounting Standards

                FASB has issued the following accounting standards that are applicable to us:

                See detailed discussion of the impact these accounting standards have on our financial condition, results of operations and liquidity in Item 8.  “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies – (q) Recently Issued Accounting Standards”.

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RESULTS OF OPERATIONS AND ANALYSIS

                The following table sets forth information regarding our operating expense components. Individual operating expense components are expressed as a percentage of our total operating revenues and as cents per ASM.

                We strive to provide Continental cost-effective services and to remain as competitive as possible compared to other regional air carriers.  During the last two years our costs as a percentage of revenue and our costs per ASM have decreased.  The following discussion provides an analysis of our results of operations and reasons for any material changes for the periods indicated.

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Statistical Information

                The following table provides an analysis of statistical information for each of the three years ended December 31:

(1)		Revenue passenger miles are the number of scheduled miles flown by revenue passengers.  As described in Item 8.  “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 2”, substantially all of our revenue from Continental is based on specified rates per scheduled block hour by our aircraft, together with certain incentive payments and reimbursements.
(2)		ASMs are the number of seats available for passengers multiplied by the number of scheduled miles those seats are flown.
(3)		Passenger load factor equals revenue passenger miles divided by available seat miles.
(4)		Operating cost per available seat mile equals operating expenses divided by available seat miles.
(5)		Includes government grant of $0.5 million and $24.9 million in 2002 and 2001, respectively.
(6)		Block hours are the hours from gate departure to gate arrival.
(7)		Operating cost per block hour equals operating expenses divided by block hours.
(8)		The average number of hours per day that an aircraft flown in revenue service is operated (from gate departure to gate arrival).

                We monitor the operational statistical information above closely to ensure that we are continually focused on our operational efficiencies and cost control.

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Comparison of 2003 to 2002

General

                Our operating income in 2003 reflected a 13.9% operating margin, compared with an operating margin of 13.6 % in 2002.  The 2003 operating margin included the benefits of cost savings and $12.9 million in performance incentive payments under our capacity purchase agreement.  We earned the incentive payments primarily by achieving a controllable completion factor of 99.8% in 2003. The payments are based on current controllable completions compared to historical controllable completions. Because the historical rates are measured on a rolling monthly average, higher controllable completion factors that result in higher incentive payments in the near term reduce our opportunity to earn incentive payments in the future.

                Under the capacity purchase agreement, a substantial portion of our costs are reconciled for differences between our actual costs and the estimated costs included in our block hour rates to allow us to operate within defined operating margin of 8.5% to 11.5% as described in Item 8. “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements — Note 2” (“prevailing margin”).  In 2003 and 2002, our actual costs were lower than the estimates used in the block hour rates; consequently, our margin (before reconciliation payments) exceeded 11.5%. The lower costs were primarily in maintenance, materials and repair and passenger servicing expenses. Our reconciliation payments to Continental totaled $30.1 million and $14.7 million for 2003 and 2002, respectively.

Operating Expenses

                As we have grown, our work force has grown.  This, combined with increased wage rates under some of our collective bargaining agreements, increased our wages, salaries and related costs by $34.3 million in 2003.  In addition, we incurred approximately $11.8 million higher employee benefit costs in 2003 due to increases in medical and workers’ compensation and 401(k) expense. 

                In the future, we expect our wages, salaries and related costs will continue to increase primarily due to:

                Our aircraft fuel expense increased in 2003 due to a 30.9% increase in fuel consumption and an 8.7% increase in fuel price.  Consumption rose due to a 19.9% increase in block hours combined with operating an all-jet fleet, since jets burn fuel faster than turboprop aircraft.  Under the capacity purchase agreement and the related fuel purchase agreement with Continental, our fuel price is capped and we pay the lower of the actual cost of fuel or the agreed-upon cap.  Our fuel price was capped at 66.0 cents and 61.1 cents per gallon for 2003 and 2002, respectively.    Until the termination of the fuel purchase agreement, our future fuel expense related to all aircraft covered under the capacity purchase agreement will be the lower of the actual cost of fuel or 66.0 cents per gallon.

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                The increase in maintenance, materials and repairs in 2003 was caused by a $24.8 million increase in our power-by-the-hour agreements as a result of a 35.7% increase in jet flight hours and an 8.6% rate increase under these agreements.  General maintenance expenses also increased to support the continuing growth and aging of our fleet, offset in part by a $4.3 million decrease in non-power-by-the-hour turboprop maintenance expense as these aircraft exited our fleet in 2002.

                Rentals and landing fees increased in 2003 because landing weights increased 18.0% and our rate per landing weight at various airport facilities increased 14.5 % in the aggregate.  These increases were partially offset by a $4.7 million decrease in other rentals as we decreased our use of outside simulators in favor of our own flight simulators.  In November 2003, our master facility and ground handling agreement with Continental was amended to clarify how rent expenses will be allocated at the airport locations where we operate. Under the amendment, all terminal facility rents at the hub airports will now be borne by Continental and we will pay for incremental rent at other Continental managed locations, unless Continental does not operate any aircraft there.   In which case, we would be responsible for the rent expense. At our managed locations, rent will be allocated between Continental and ExpressJet based on number of passengers.   It is estimated that this change will reduce our annual rental costs by approximately $30 million.  As terminal facility rent is a fully-reconciled cost, per the capacity purchase agreement, this change will result in a net reduction of approximately $3.3 million to our annual operating income on a pre-tax basis.

                Aircraft related and other insurance includes insurance premiums for our hull and war risk insurance (purchased through the private insurance market and the Federal Aviation Administration) and other corporate insurance policies such as directors’ and officers’ liability insurance, employment practices liability insurance, fiduciary liability insurance and other policies.   During 2003, the cost of hull and war risk related insurance decreased by $13.5 million because our insurance rates through both the private insurance market and the U.S. government decreased as a result of higher passenger liability insurance, which is reported as part of our other operating expense.  In addition, these decreases were partially offset by $2.3 million increase in the cost of our other corporate insurance policies, under which we now have coverage as a separate company because we are no longer majority owned by Continental.  Corporate insurance premiums are higher for us as a separate entity than when we were consolidated with Continental.

Nonoperating Expenses

                Our interest expense primarily relates to our loan agreement with EDC, our note payable to Continental and our senior convertible notes.  Our loan agreement with EDC accrues interest at the six-month London interbank offered rate (“LIBOR”) plus 1.75% per annum.  Our note payable to Continental bore an annual interest rate of 2.5% and 3.1% for 2003 and 2002, respectively.  Under our note payable to Continental, the interest rate was set at the three-month LIBOR plus 1.25% per annum, subject to a cap of 3.5% in 2002, 5.4% in 2003 and 6.7% in 2004.  There is no interest rate cap after 2004.  The annual interest rate on our senior convertible notes is 4.25%. The decrease in interest expense stemmed primarily from a decrease in our note payable to Continental from $325.5 million as of December 31, 2002 to $193.2 million as of December 31, 2003.  This decrease was partially offset by increases in interest expense related to our loan agreement with EDC and our senior convertible notes.

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Comparison of 2002 to 2001

General

                Our operating margin for 2002 was 13.6%, compared to 10.3% for 2001. Our 2002 margin included the benefits of costs savings and $14.7 million in performance incentive payments. The performance incentive payments resulted primarily from our high controllable completion factor of 99.9% in 2002.  Additionally, no revenue concession payments were made to Continental during 2002.  We made a $32.6 million revenue concession payment to Continental in 2001 in exchange for an 18-month extension of our note payable to it, a one-year extension of our right under the capacity purchase agreement to be Continental’s exclusive regional jet operator in its hubs and a six-month extension of the period during which Continental cannot withdraw jet aircraft under the capacity purchase agreement.

                As a result of cost savings from maintenance, materials and repair services and passenger servicing expenses in 2002, our prevailing margin before reconciliation payments exceeded 11.5%; consequently, we made reconciliation payments totaling $14.7 million to Continental. There were no such reconciliation payments to Continental during 2001.

Operating Expenses

                The increase in wages, salaries and related costs was primarily due to increases in our work force, as well as higher wage rates under our collective bargaining agreements.  These factors caused wages, salaries and related costs to increase by $14.0 million.  In addition, higher employee benefit costs as a result of increase in medical costs, 401(k) expense and profit sharing led to a $9.7 million increase in wages, salaries and related costs in 2002.

                The increase in aircraft rentals was due to a 37.2% increase in the number of regional jets, which have higher average rental rates than turboprop aircraft.  We eliminated all turboprop aircraft from our fleet as of December 31, 2002.

                Aircraft fuel expense decreased in 2002 from 2001. Although fuel consumption increased 14.1% due to our replacement of turboprop aircraft with regional jets, this was more than offset by a 20.1% decrease in the price of fuel to 60.7 cents per gallon during 2002 from 76.0 cents per gallon during 2001. Our on fuel was capped at 61.1 cents and 80.9 cents per gallon for 2002 and 2001, respectively.

                The decrease in maintenance, materials and repairs was primarily due to the in-sourcing of some of our routine maintenance activities in 2002, which reduced our maintenance expense by approximately $11.5 million, and fewer major maintenance overhauls and miscellaneous overhead, as our mix of aircraft during the year ended December 31, 2002 consisted of a higher number of the newer regional jets versus older turboprop aircraft.

                The increase in other rentals and landing fees was primarily due to higher facility rent in one of our hub airports and increases in landing fees as a result of increased rates imposed by airport authorities and increased regional jet departures.

                We experienced a sharp increase in aircraft-related and other insurance expense in 2002 as a result of the terrorist attacks on September 11, 2001.  Insurance rates increased significantly following the attacks.

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Nonoperating Expenses

                The majority of interest expense is related to the note payable to Continental, which bore an average annual interest rate of 3.1% and 4.7% for 2002 and 2001, respectively. Interest expense decreased during 2002 as compared to 2001, as we applied $146.8 million of our proceeds from our initial public offering to repay a portion of our note payable to Continental on April 23, 2002. In addition, we made additional discretionary principal prepayments on the note of $80.0 million during 2002.

Future Costs

                We remain committed to controlling our costs through identifying and executing cost saving initiatives; however, we believe that our costs may still be adversely affected in the future by:

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LIQUIDITY AND CAPITAL COMMITMENTS

Outlook

                We are directly affected by the financial and operational strength of Continental because we depend on Continental’s ability to make payments to us under our capacity purchase and other agreements.   Despite improvements during the last year, the U.S. domestic airline environment in which Continental operates continues to be extremely challenging. 

                For the year ended December 31, 2003, Continental reported net income of $38 million, but only after asset-related gains of $183 million from disposition of all or part of its interest in us, Orbitz and Hotwire and $111 million in security fee reimbursements from the U.S. government, along with $15 million in other gains and $62 million in special charges (all net of tax).  For the year ended December 31, 2002, Continental reported a net loss of $451 million.  Although Continental’s overall passenger revenue increased 3.5% during 2003 compared to 2002, business traffic, Continental’s most profitable source of revenue, continues to be down, and competing carriers continue to offer reduced fares to attract passengers, which could lower Continental’s passenger revenue and yields in the future. 

                Neither Continental nor we can predict when or if business traffic will increase.  Furthermore, the long-term impact of any changes in fare structures, most importantly in relation to business fares, booking patterns, low-cost competitor growth, competitor bankruptcies and other changes in industry structure and conduct cannot be predicted at this time, but could have a material adverse effect on both our and Continental’s financial condition, liquidity and results of operations. In addition, even though Continental has been able to raise capital, downsize its operations and reduce its expenses significantly, current trends in the airline industry, particularly if historically high fuel prices continue, make breaking even in 2004 for Continental unlikely.

                We believe Continental’s business and financial performance are subject to a number of additional risks, including the following:

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                Even absent such adverse factors as further economic recession, additional terrorist attacks, continued unrest in the Middle East, decreased consumer demand and increased fuel prices, Continental may find it necessary to downsize its operations and further reduce expenses.  Additionally, Continental leases from third parties a substantial portion of the aircraft and airport facilities that it subleases to us.  If Continental declared bankruptcy or otherwise defaulted under these leases, we would have no right to these aircraft or facilities; our access to our aircraft and airport facilities would depend on negotiations between the lessors and us.  For a detailed discussion of Continental’s results of operations, please see its annual report on Form 10-K for the year ended December 31, 2003 filed with the SEC.

                Continental can provide, at any time, 12-months notice of its intention to reduce the number of our regional jets covered by the agreement.  Under this provision, Continental is entitled to decline capacity with respect to any regional jets subject to our firm orders that Embraer has not delivered to us and up to 25%, over any rolling three-year period, of our regional jets that have been delivered under an agreed methodology.  If Continental reduced its commitment and utilization of our aircraft under the capacity purchase agreement, our results of operations and financial condition could be adversely affected.  While we have no reason to believe that Continental will reduce its commitment or capacity under the capacity purchase agreement, based on Continental’s continuing efforts to reduce costs and enhance passenger revenues as discussed in its annual report on Form 10-K for the year ended December 31, 2003 filed with the SEC, there can be no assurance that such circumstances will not occur in the future.  See Item 1. “Business –Risk Factors” for further details regarding risks related to our company and our industry.

                In addition, even though a significant portion of our costs (including fuel, aircraft rent, substantially all regional jet engine maintenance, passenger related facility rent, administrative fees from Continental and ground handling expenses) are reimbursed by Continental at actual cost plus a 10% margin under the capacity purchase agreement, certain other costs such as labor and related fringe benefit costs, other maintenance and general and administrative costs provide risk exposure to us.  We are currently engaged in labor negotiations with our pilots and mechanics.  At this time we cannot predict the outcome of these negotiations.

Sources and Uses of Cash

                Our primary source of liquidity is cash flow provided from our operations.  For the years ended December 31, 2003 and 2002, our operations provided $230.7 million and $162.1 million, respectively, in cash flow.  As of December 31, 2003, we also have $3.2 million of restricted cash, which is used as collateral for our workers’ compensation coverage.  Although our operations, as measured by ASMs, have grown over 35.5% (year-over-year), our costs have not increased ratably due to our efforts to exploit the efficiency of our all-jet fleet, with almost 100% commonality from the engines to the flight deck.  We continuously endeavor to provide cost-effective services to Continental and to remain as competitive as possible compared to other regional air carriers.  However, we cannot ensure that our future costs will not increase significantly due to factors beyond our control.   

                In 2003 and 2002, we spent $49.1 million and $55.1 million, respectively, on flight and ground equipment to support our fleet deliveries and the increase in our flight schedules under our capacity purchase agreement with Continental.

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Financing Activities

                Export Development Canada Loan.  We are party to a loan agreement under which EDC advanced us $10.7 million on May 23, 2003 and $6.6 million on September 30, 2003.  As of December 31, 2003, our outstanding balance under this agreement is $17.0 million.  The loan is secured by certain of our flight simulators, flight data software and other equipment related to the simulators.  We utilized all of the proceeds from the advances to reduce the principal under our note payable to Continental.  The amount due to EDC accrues interest at the six-month LIBOR plus 1.75% per annum.  The term of each advance to us is 96 months.  The financing arrangement has customary representations, warranties and covenants.  Continental is the guarantor of this loan, and a default under the guarantee would cause an acceleration of the loan.

                Note Payable to Continental.  The balance on our note payable to Continental as of December 31, 2003 was $193.2 million.  We made the quarterly principal and interest payments on our note to the extent required on March 31, June 30, September 30 and December 31, 2003, net of prepayments made in prior periods, to reduce the principal balance of our note payable to Continental.  Additionally, during 2003, we made voluntary prepayments totaling $83.3 million, which reduced our required quarterly principal and interest payments for September 30, 2003, March 31, 2004 and June 30, 2004.  While we expect to meet future obligations related to the terms of this promissory note on a timely basis, a reduction and downsizing of Continental’s utilization of our aircraft under the capacity purchase agreement could affect our ability to make full repayment of the note by March 2007.  Furthermore, under our promissory note with Continental, there are no restrictions on our ability to incur additional indebtedness in the future.

                Convertible Notes.    During 2003, we completed the private placement of $137.2 million of senior convertible notes due 2023, which were resold by the initial purchasers to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933. Cash interest is payable on the notes at a rate of 4.25% per year on the principal amount at maturity, payable semiannually in arrears on February 1 and August 1 of each year, beginning February 1, 2004.  The aggregate amount of the principal will be due on August 1, 2023.  ExpressJet Airlines, Inc., our wholly owned subsidiary, guaranteed the notes on an unsecured and unsubordinated basis.  We used the proceeds, net of initial purchasers’ fees, of our notes offering to repurchase 9,835,125 shares of our common stock owned by Continental.  Holders of the notes may convert all or a portion of their notes into 54.9451 shares (subject to customary anti-dilution adjustments for future events) of our common stock per $1,000 in principal under the following circumstances: (i) if the closing sale price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the fiscal quarter prior to such quarter is greater than 120% of the conversion price per share of common stock on such last day; (ii) subject to certain exceptions, during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the notes for each of the five trading days was less than 98% of the product of the closing sales price of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the notes; (iii) if the notes have been called for redemption; or (iv) upon the occurrence of specified corporate transactions.  As of December 31, 2003, none of the notes were converted into shares of our common stock as none of the listed circumstances has occurred.

                We can redeem the notes, in whole or in part, beginning on August 4, 2008, at a redemption price equal to 100% of the principal amount, plus accrued and unpaid cash interest, if any.  The holders of the notes may require us to repurchase the notes on August 1, 2008, August 1, 2013 and August 1, 2018 (“Redemption Dates”) at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any.  While we can choose to pay the repurchase price for any such notes in cash, in shares of common stock or any combination thereof, should we be required to redeem the notes at any of the Redemption Dates, we intend to satisfy that requirement in cash.  If the holders of the notes redeem the notes in 2008, we expect to have adequate cash to satisfy the redemption.  See Item 8.  “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 9” for a detailed discussion of the terms of the convertible notes. 

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                Capital Leases.  As of December 31, 2003, we had approximately $4.4 million (including current maturities) of capital lease obligations.

                Other than the financing activities described above, we do not have any other sources of long-term borrowings or available lines of credit.  Additionally, there is no covenant under any of our long-term debt agreements that restricts our ability to undertake additional debt or equity financing.  However, under our registration rights agreement with Continental, we have agreed that if we or any of our subsidiaries issue or sell any capital stock of our company or any of our subsidiaries (except in connection with our employee benefit plans) before April 23, 2004, we are required to use 75% of the net proceeds from that sale to make a principal payment on our note payable to Continental, unless Continental and its controlled affiliates then own less than 20% of our outstanding shares of common stock.  If we default on our payment obligations under the note or under our aircraft subleases with Continental, in addition to any other remedies it may have, Continental can elect to reduce its payments to us under the capacity purchase agreement by the amount of the defaulted payment.  If Continental defaults on the payment obligations it has to us under our tax agreement, then in addition to any other remedies we may have, we can offset the amount of the defaulted payments against amounts we owe to Continental under the note.  In addition, Continental or we can reduce any payments to the other party under the capacity purchase agreement in an amount corresponding to any defaulted payments by the other party under the foregoing obligations.

Collective Bargaining Agreements

                The following is a table of our principal collective bargaining agreements, and their respective amendable dates as of January 31, 2004:

                We are currently engaged in labor negotiations with our pilots and our mechanics. At this time we cannot predict the outcome of these negotiations.  Our other employees are not covered by collective bargaining agreements.

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Deferred Income Tax Assets

                At December 31, 2003, we had federal net operating loss carryforwards of approximately $60.7 million, which expire between 2004 and 2020.

                In conjunction with our IPO in April 2002, the tax basis of our tangible and intangible assets was adjusted to fair value.  This adjustment to tax basis should result in additional tax deductions being available to us through 2017. In accordance with our tax agreement with Continental, to the extent we generate taxable income sufficient to realize the additional tax deductions, we will be required to pay Continental a percentage of the amount of tax savings actually realized, excluding the effect of any loss carrybacks.  We will be required to pay Continental 100% of the first third of the anticipated tax benefit, 90% of the second third, and 80% of the last third. However, if the tax benefits are not realized by the end of 2018, we will be obligated to pay Continental 100% of any benefit realized after that date. Since these future payments are solely dependent on our ability to generate sufficient taxable income to realize these deferred tax assets, they are recorded as an obligation to Continental within the deferred tax asset accounts, and the portion we may retain in the future is offset by a valuation allowance.  At the IPO, the valuation allowance and the obligation to Continental offset the step-up in basis of assets in our long-term deferred tax asset account.  During 2003, the amount of tax basis recorded for our assets relating to the IPO was adjusted based on the filing of our federal income tax return with a corresponding offset to the valuation allowance/net tax agreement obligation to Continental.  The net payment we made to Continental during 2003 under the tax agreement was approximately $16.6 million. 

                Our tax agreement with Continental provides that Continental will reimburse us for any net increase in our cash tax payments resulting from any decreased availability of net operating loss carryovers related to the basis increase at the time our payment occurs.  The resulting receivable and/or payable with Continental related to the impact on net operating losses resulting from the basis increase is recorded within the deferred tax asset account since its performance is dependent on our ability to generate taxable income.

                No valuation allowance was established on our net operating loss carryforwards, or on our receivable from Continental for reimbursing carryforward losses utilized resulting from the basis increase, because we believe our stand-alone taxable income will be sufficient to utilize substantially all of these assets within the next several years.

                We believe that our IPO created a change in ownership limitation on the utilization of our federal carryforward tax attributes, primarily net operating losses.  This limitation, under Section 382 of the Internal Revenue Code, will limit our utilization of these attributes to offset up to approximately $43.3 million of post-change taxable income per year.  We do not expect this limitation to have any impact on our financial condition.

Purchase Commitments

                As of December 31, 2003, we had firm commitments to acquire 50 regional jets from Embraer. The estimated aggregate cost of these firm commitments is approximately $1.0 billion.  In addition, we are contractually obligated by our Rolls-Royce power-by-the-hour contract to purchase four additional spare engines for approximately $11.0 million in connection with the firm order jet aircraft.  We also have options to purchase an additional 100 Embraer regional jets.  We will not have any obligation to take any of the aircraft under firm commitments if they are not financed by a third party and leased to either Continental or us.  Furthermore, we currently do not have any financing in place for the four spare engines, and would have no obligation to acquire the spare engines if for any reason the firm order aircraft are not delivered to us.

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                We also have other contractual obligations of approximately $1.3 billion under our power-by-the-hour contracts with various service providers.  During 2003, we entered into new power-by-the-hour agreements covering various components and systems on our fleet.  We signed a 10-year contract to cover the repair, overhaul and replacement of tires, a 10-year contract to cover repair, overhaul and replacement of the avionics and engine start control systems and a 12-year contract to cover the repair, overhaul, replacement and inventory management of the environmental control system.  We also agreed to a five-year extension of our current power-by-the-hour agreement with Rolls-Royce Corporation.  As a result of these agreements, our overall future costs will not increase; however, our short-term future costs will be higher, as we forgo our warranty on these components and systems in return for future cost savings, insurance and more predictable maintenance expense.  These agreements better match expenses with the usage of the aircraft.

                For the year ended December 31, 2003, we spent $49.1 million on capital expenditures.  Approximately $27.6 million of our 2003 planned capital expenditures will be carried over as part of our planned 2004 capital expenditures.  We anticipate cash outlays for 2004 fleet-related capital expenditures to be approximately $11.6 million. Other 2004 cash outlays, exclusive of fleet plan requirements, relating to automation projects, facility improvements, toolings and ground equipment are expected to aggregate approximately $32.6 million.  We expect to fund our future capital commitments through internally generated funds together with general financings and aircraft financing transactions. However, there can be no assurance that sufficient financing will be available for all aircraft and other capital expenditures not covered by firm financing commitments.

Aircraft Leases

                We have significant lease and sublease obligations for aircraft that are classified as operating leases, which are not reflected as assets and liabilities on our balance sheet. These leases expire between 2013 and 2019. As of December 31, 2003, our expected total minimum annual rental payments for 2004 under current and future non-cancelable aircraft operating leases are approximately $281.9 million. Over 90% of our aircraft are leased directly by Continental from third parties and subleased by Continental to us. If Continental were to default under these leases, our ability to retain access to the aircraft could be adversely affected.  See detailed discussions of our risks related to our aircraft leases at Item 1. “Business -- Risk Factors – Risks Related to Our Business and Operations.”

                Furthermore, our credit status could decline as a result of our operating separately from Continental, and as a result, we might face increased borrowing costs, more restrictive covenants and reduced amounts of credit, which could result in a reduction in the size of our fleet or impair our ability to fly for other carriers. Our operations as a separate entity from Continental may have a negative impact on our ability to obtain credit on terms similar to those we were able to obtain previously. Historically, Continental has provided financing and credit support to us. We expect that, except as required by the capacity purchase agreement, Continental will not continue to provide us financing and credit support. As a result, we may face increased borrowing costs, more restrictive covenants and reduced credit from lenders and suppliers, all of which would adversely affect our operating results, financial condition and our ability to raise capital to pursue other business opportunities.

Contractual Obligations and Commercial Commitments

                The following table summarizes the expected effect our material debt, capital lease, operating lease and other contractual obligations have on our future cash flows as of December 31, 2003 (in millions):

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(1)		Based on our amended and restated promissory note agreement dated November 5, 2002, our quarterly payments to Continental for principal and interest on our note payable is $27.9 million, which commenced on June 30, 2003.  On March 31, 2007, the entire unpaid principal balance of this note, if any, together with all accrued unpaid interest, will be due and payable in full.  The expected effect of our note payable on our cash flows is calculated based on the three-month LIBOR on December 31, 2003 plus 1.25% per annum and based on our current principal balance and includes principal payments of $193.2 million and estimated interest payments of $7.8 million over the remaining life of the note payable.
(2)		The expected effect of our 4.25% senior convertible notes due 2023 on our future cash flows as stated in the table above assumes the notes will be due on August 1, 2008, the earliest date the holders of the notes may require us to repurchase the notes.  If the notes are held until August 1, 2023, the maturity date, our obligations outlined above would increase by $87.5 million as a result of additional interest expense related to these notes.  See Item 8.  “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 9” for detailed discussion of these notes.
(3)		Other long-term debt represents our obligations for the advances received under our loan agreement with EDC and our Series A Cumulative Mandatorily Redeemable Preferred Stock of Subsidiary due April 16, 2012 (“Series A Preferred Stock”).  See detailed discussion of our Series A Preferred Stock  and our financing arrangement with EDC in Item 8. “Financial Statements and Supplementary Data –Notes to Consolidated Financial Statements—Note 7”.  The expected effect of our financing arrangement with EDC and our Series A Preferred Stock on our future cash flows is calculated based on the six-month LIBOR on December 31, 2003 plus 1.75% per annum and includes principal payment of $22.0 million and estimated interest payments of $10.6 million.
(4)		Capital lease obligations are the minimum lease payments, including interest expense, for our spare engines and some of our ground service equipment that are under capital lease agreements. See Item 8. “Financial Statements and Supplementary Data — Notes to the Consolidated Financial Statements — Note 6.”

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(5)		Aircraft operating lease obligations are the minimum lease payments for all of our aircraft and spare engines under long-term operating leases from Continental at December 31, 2003. Our sublease agreements with Continental have substantially the same terms as the lease agreements between Continental and the third-party lessors, and expire between 2013 and 2019. See Item 8. “Financial Statements and Supplementary Data — Notes to the Consolidated Financial Statements — Note 6.”
(6)		Other operating lease obligations represent the estimated lease payments for our ground service equipment and substantially all of our ground facilities, including facilities at public airports, from Continental or the municipalities or agencies owning and controlling such airports that are under operating leases. Other operating lease obligations also include the lease payments related to one of our flight simulators.
(7)		Unconditional purchase obligations are related to our firm commitments to acquire 50 Embraer regional jets. The estimated aggregate cost of these firm commitments excluding estimated leasing costs is approximately $1.0 billion. Estimated leasing costs are calculated based on the terms of leases currently in place. The actual effects these unconditional purchase obligations may have on our future cash flows may differ materially from our estimates above due to the actual leasing or financing terms for these purchases.
(8)		Obligations under capacity purchase and other agreements with Continental represent fixed charges for ground handling costs at Continental stations, payment under our tax agreement related to 2003 and charges for administrative services provided by Continental, such as technology, accounting, legal, tax, treasury, human resources, and risk management. The amounts disclosed above are based on our best estimates at December 31, 2003 under the terms of our contracts currently in place.
(9)		Other contractual obligations include our power-by-the-hour contracts and our commitment to purchase spare engines based on aircraft deliveries in accordance with the capacity purchase agreement, our regional jet aircraft purchase agreement with Embraer and our power-by-the-hour agreement with Rolls-Royce Corporation.  We expect to fund these commitments with cash generated from operations. The estimated amount of future commitment is based on assumptions related to future level of operations and forecasted payment rates. The level of operations inherent in the estimated amounts detailed above is based on Continental’s most recent operating plan for us, which can be altered at Continental’s sole discretion. Contractual rate increases at actual time of occurrence may be different than the forecast rates inherent in the amounts detailed above. Under the power-by-the-hour contract with Rolls-Royce Corporation, we are required to purchase four spare engines related to our remaining 50 firm order aircraft.

Other Contingent Liabilities or Commitments

                We are parties to many contracts in which it is common for us to agree to indemnify third parties for tort liabilities that arise out of or relate to the subject matter of the contract. In some cases, this indemnity extends to related liabilities arising from the negligence of the indemnified parties, but usually excludes any liabilities caused by gross negligence or willful misconduct. We cannot estimate the potential amount of future payments under these indemnities until events arise that would trigger a liability under the indemnities. However, we expect that we would be covered by insurance for any such liabilities, subject to deductibles.

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Item 7A.     Quantitative and Qualitative Disclosure About Market Risk

                We have been and are subject to market risks, including commodity price risk (such as, to a limited extent, aircraft fuel prices) and interest rate risk.

AIRCRAFT FUEL

                Effective January 1, 2001, we entered into our capacity purchase agreement with Continental, which expires December 31, 2010 (subject to extensions by Continental through 2030 and its right to terminate the agreement without cause after January 1, 2007 upon 12 months’ notice or at any time for cause), and a related fuel purchase agreement with Continental, which terminates when the capacity purchase agreement terminates. Under these agreements, Continental provides all of our aircraft fuel needs for the aircraft covered by the capacity purchase agreement, and we incur an expense equal to the lower of the actual cost of the fuel or an agreed-upon cap. In 2003, the actual average cost of fuel was 66.0 cents per gallon (which was at our agreed-upon cap of 66.0 cents per gallon).  In 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 2001, our average fuel price was 76.0 cents per gallon (which was below our agreed-upon cap of 80.9 cents per gallon). Until the termination of the fuel purchase agreement, our fuel expense related to all aircraft covered under the capacity purchase agreement will be the lower of the actual cost of fuel or 66.0 cents per gallon. Under the capacity purchase agreement, we recover our fuel expense from Continental with a 10% margin.

INTEREST RATES

                As of December 31, 2003, we had firm commitments to acquire 50 Embraer regional jets, which we expect to lease from Continental. Changes in interest rates may impact the actual cost to us for the related leasing transactions in the future. However, under our capacity purchase agreement, our block hour rates will be adjusted higher or lower to reflect any changes in our aircraft rental rates. We also have potential exposure with respect to our note payable to Continental, which bears interest at a floating rate of the three-month LIBOR plus 1.25% per annum capped at 3.5% in 2002, 5.4% in 2003 and 6.7% in 2004. Beyond 2004 there is no cap on the interest rate.  The interest rate applicable to this variable rate note may rise, increasing our interest expense.  The impact of market risk is estimated using a hypothetical increase in interest rates up to the capped rate or by 100 basis points for our variable rate long-term debt. Based on this hypothetical assumption, our projected 2004 interest expense would increase by $1.9 million.  At December 21, 2002, an interest rate increase of 100 basis points during 2003 as compared to 2002 was projected to increase 2003 interest expense by approximately $3.1 million.  The impact of all other variable-rate debt would be immaterial.  We do not hold long-term interest-sensitive assets and therefore the value of our assets is not subject to interest rate fluctuations. We do not purchase or hold any derivative financial instruments to protect against the effects of changes in interest rates.

                As of December 31, 2003, we estimated the fair value of our $137.2 million (carrying value) fixed-rate debt to be $132.9 million based upon quoted market prices.  Market risk, estimated as the potential increase in fair value resulting from a hypothetical 100 basis point decrease in interest rates, was approximately $134.9 million as of December 31, 2003. 

                If 2004 average short-term interest rates decreased by 100 basis points over 2003 average rates, our projected interest income from cash, cash equivalents and short-term investments would decrease by approximately $2.4 million during 2004, compared to an estimated $1.4 million decrease during 2003 measured at December 31, 2002.

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Item 8.    Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
ExpressJet Holdings, Inc.

                We have audited the accompanying consolidated balance sheets of ExpressJet Holdings, Inc. (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

                We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

                In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

                As discussed in Note 1 to the Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standard No. 142 in 2002 and Statement of Financial Accounting Standard No. 150 in 2003.

ERNST & YOUNG LLP

Houston, Texas
January 16, 2004

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EXPRESSJET HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.