Capacity Purchase and Other Agreements with Continental Airlines

                General.  We currently derive substantially all 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.  Continental is entitled to all revenue associated with the operation of the aircraft.  We also have various other agreements with Continental that govern our relationship.

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

                Effective January 2005, we amended our capacity purchase agreement and the administrative support and information services provisioning agreement with Continental.  The amendments to the capacity purchase agreement incorporated the effects of an amendment to our power-by-the-hour agreement with Rolls-Royce Corporation ("Rolls-Royce") signed in September 2004, set our 2005 rates under the agreement and capped the ceiling of our prevailing margin as defined in the capacity purchase agreement at 10%, inclusive of labor cost performance (see "— 2005 Rate Negotiation" below).  The amendment to the administrative service agreement primarily extended its term through that of the capacity purchase agreement.

Table of Contents

                Payment.  Under the capacity purchase agreement, we are entitled to payment for each block hour that Continental schedules us to fly.  Payment is based on a formula designed to provide us with a target operating margin of 10% before taking into account variations in certain costs and expenses that are generally within our control.  The cost components used in this formula remained in place until December 31, 2004, after which new rates are established annually using the same methodology used to establish the original rates (see "— 2005 Rate Negotiation" below).  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.  Prior to 2005, we had exposure for most labor costs and some maintenance and general administrative expenses if the actual costs were higher than those reflected in our block hour rates.

                2001-2004.  A reconciliation payment was made by Continental to us, or by us to Continental, if the operating margin calculated, as described below (the "prevailing margin") was not between 8.5% and 11.5% in any fiscal quarter.  When the prevailing margin exceeded 11.5%, we paid Continental an amount sufficient to reduce the margin to 11.5%.  If the prevailing margin was less than 8.5%, Continental would have paid us an amount sufficient to raise the margin to 8.5%.  During 2001 to 2004, the quarterly prevailing margins were never below 8.5%.  Certain items were excluded from the calculation of the prevailing margin, including:

If these excluded costs were higher than those anticipated in our block hour rates, our operating margin could have been lower than 8.5% when taking these costs into account, even after any reconciliation payment was made.  Conversely, if these costs were lower than those anticipated in our block hour rates, our operating margin could have been higher than 11.5% when taking these costs into account, even after any reconciliation payment was made.

Table of Contents

                During 2004, our quarterly reconciliation payments to Continental totaled $61.0 million.   The table below describes how variations between our actual costs and our estimated costs, as determined in the block hour rates, were treated under the capacity purchase agreement through 2004.

Table of Contents

                In 2004, the fully reconciled costs, costs within the margin band and unreconciled costs under our capacity purchase agreement represented approximately 63.9%, 12.0% and 24.1% of total operating costs, respectively. 

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

                2005 Rate Negotiation.  As part of our 2005 rate negotiation, we agreed to cap our prevailing margin at 10.0%.  We also now include previously unreconciled costs within the margin band, although we will not be reimbursed if these costs are higher and cause our prevailing margin to fall below our 8.5% margin floor.  In addition, we are still entitled to receive incentive payments from Continental if our rate of controllable cancellations is lower than our historical benchmark; however, we will not be required to pay Continental a penalty for controllable completion factors below our historical benchmark unless the controllable completion factor falls below 99.5%.  We will also continue to receive a small per-passenger fee and incentive payments for certain on-time departure and baggage handling performance.

                The table below describes how variations between our actual costs and our estimated costs, as determined in the block hour rates, are treated under the capacity purchase agreement effective January 1, 2005.

Table of Contents

                Certain costs that were previously unreconciled under the capacity purchase agreement will now result in our making a reconciliation payment to Continental if the differences cause our prevailing margin to be greater than 10.0%.  However, if the differences cause our prevailing margin to be less than 8.5%, they will remain unreconciled.  These costs are:

                As a result of the rate resetting process for 2005, we expect our future operating margin, excluding incentives, to be closer to our target operating margin of 10.0%.

                We will negotiate with Continental to adjust the scheduled block hour rates annually as required under the capacity purchase agreement.  If we cannot agree on the annual rates, we have agreed to submit our disagreement to arbitration.

                Scope of Agreement and Exclusive Arrangement.  The capacity purchase agreement covers all of our existing fleet of 245 aircraft, as well as the 29 aircraft subject to firm orders at December 31, 2004.  The agreement provides that we will be Continental’s exclusive regional jet service provider at its hubs at Newark’s 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 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 permits us to fly under our own code or on behalf of other airlines.  However, during the term of the capacity purchase agreement:

                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.

Table of Contents

                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 (as of March 15, 2005, we have not received any such notice).  Under the agreement, Continental is entitled to withdraw capacity with respect to:

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

                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 related sublease between us and Continental 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 inter-bank 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 can include any of our 100 option ERJ-145XR aircraft under our capacity purchase agreement.  If Continental elects to do this, it may either lease or sublease the aircraft to us.  Continental can also substitute these option 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.  Based on Continental’s current public statements, we believe that it will not exercise the options for these aircraft.  If that is the case, we will have the opportunity to take delivery of all or some of the aircraft.  We have not yet decided whether we will exercise these options.

                So long as either scheduled flights under the capacity purchase agreement with Continental represent at least 50% of all 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 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.

Table of Contents

                Aircraft Financing.  We currently lease or sublease all of our existing aircraft from Continental. The capacity purchase agreement currently applies to our 245 existing aircraft and the remaining 29 aircraft under firm orders at December 31, 2004 ("Covered Aircraft").  Under the capacity purchase agreement, Continental is required to purchase or lease from Embraer or its designee these Covered Aircraft, as well as participate in the financing, and to lease or sublease these aircraft to us. 

                Our 100 option aircraft are currently excluded from the capacity purchase agreement ("Uncovered Aircraft").  If Continental chooses to exercise any or all of these options, as described later in "— Aircraft Fleet – Our Fleet," these aircraft become Covered Aircraft.  If Continental chooses not to exercise these options, but we exercise the options to fly for ourselves or for another party, Continental would not be required to participate in the financing arrangement. 

                If Continental releases an aircraft that was previously a Covered Aircraft and 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 ("Uncovered Aircraft Sublease"). 

                Continental has the right to terminate, at any time, any Uncovered Aircraft Sublease and take possession of the aircraft to the extent that they provide us a replacement aircraft.  If Continental elects to use an Embraer option aircraft as the replacement aircraft, it must provide at least 30 days written notice prior to the expiration of our option to acquire the aircraft.  In addition, Continental cannot select a replacement aircraft previously used as a replacement aircraft under another Uncovered Aircraft Sublease.  Continental is not required to participate in the financing of the replacement aircraft and may take possession of the Uncovered Aircraft whether or not we have found financing for the replacement aircraft.

                If Continental obtains the right or option to acquire additional Embraer aircraft other than the Covered Aircraft and our existing option aircraft and proposes to us in writing that they would like to replace an Uncovered Aircraft at least 30 days prior to the expiration of their right to acquire the aircraft, we must use commercially reasonable efforts to acquire financing for this aircraft.  If we obtain financing, then Continental can:

                If we do not obtain financing, Continental is not entitled to use the Embraer aircraft as a replacement aircraft for an Uncovered Aircraft Sublease.

                Continental does not have any obligation to finance, arrange to finance or participate in the financing of any aircraft acquired outside the capacity purchase agreement.

                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 airport terminal facilities leased by Continental to service other carriers or operate flights under our own code without Continental’s approval.  Further, we must use those facilities that are non-terminal facilities on a priority basis to support the scheduled flights that we fly on behalf of Continental so long as those flights constitute at least 50% of our total scheduled flights or at least 200 of our aircraft are covered by the capacity purchase agreement.  

Table of Contents

                As of November 1, 2003, our master facility and ground handling agreement with Continental was amended to clarify how airport terminal rent expenses would be allocated to us by Continental at the airport locations where we operate.  Under this amendment, all terminal facility rents at the hub airports are now borne by Continental and we pay for incremental rent at other Continental managed locations, unless Continental does not operate any scheduled aircraft there during a quarter.  We are responsible for the rent expense at any locations at which Continental does not operate any aircraft.  At locations we manage, rent is allocated between Continental and us based on the number of respective passengers.  This change reduced our annual terminal facility rent costs by approximately $30 million as compared to the method rent was allocated to us under our previous agreement with Continental.  As terminal facility rent is a fully reconciled cost, as described above under "—Payment," this change resulted in a net reduction of approximately $3.3 million to our 2004 annual operating income on a pre-tax basis. 

                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 ground handling services to us.  If Continental elects to provide ground handling services at any facility at which we previously provided ground 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 where we fly and any non-terminal facilities not 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), 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 to vacate the terminal facilities (or all facilities if the termination results from our material breach of the agreement) that are subleased to us by Continental, and to use commercially reasonable efforts to assign to Continental or its designee any lease in our name for these facilities.

                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.  We provide ground handling and other support services, including baggage handling, station operations, ticketing, gate access and other passenger, aircraft and traffic servicing functions for Continental at several of our airport locations.  In exchange, Continental pays us an amount equal to our incremental cost for providing these services.  Continental provides the same services for us at its stations, including its hub airports.  The cost for these services is based on the number of scheduled aircraft and the rates stipulated in the capacity purchase agreement.

                Most Favored Nations.  While Continental is our largest customer, if we enter into a capacity purchase or economically similar agreement with another major airline to provide regional airline service for 10 or more aircraft on terms and conditions that are, in the aggregate, less favorable to us than those in the capacity purchase agreement, Continental will be entitled to amend its agreement with us to conform to the terms and conditions of our new agreement.

Table of Contents

                Change of Control.  So long as Continental is our largest customer, if we experience a change of control without its 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:

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

Table of Contents

                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.  See further discussions below regarding remedies for breach of the capacity purchase agreement by either Continental or us.

                Term and Termination of Agreement and Remedies for Breach.  The capacity purchase agreement is scheduled to expire 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 our material breach 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.

                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 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 affect 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.

Table of Contents

                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, provided that the 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 in any manner that adversely affects Continental’s or our engine maintenance costs for the aircraft subject to the capacity purchase agreement.  With Continental’s consent, we agreed to a five-year extension of our agreement with Rolls-Royce and expanded the scope of its coverage in 2003 and 2004.

                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 capacity purchase agreement or caused by our respective actions or inactions under the 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 our board of directors and the board of directors of each of our current subsidiaries, during the term of the agreement.

                Other Agreements with Continental.   In connection with the capacity purchase agreement, we also entered into an administrative services agreement, under which Continental provides us with services such as information technology support, transaction processing, insurance and risk management and treasury administrative services, corporate real estate and environmental affairs.  We also have a fuel purchasing agreement with Continental, 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.  In addition, we have a tax agreement with Continental.  See Item 8. "Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 9" for a more detailed description of this agreement.

Aircraft Fleet

                Our Fleet.  We operate an all regional jet fleet consisting of 245 Embraer ERJ-135, ERJ-145 and ERJ-145XR aircraft at December 31, 2004.  We expect to take 21 additional aircraft in 2005 (four of which have been delivered as of March 15, 2005) and eight aircraft in 2006 for a total fleet count of 274 aircraft.  The capacity purchase agreement provides that all of the Embraer regional jets subject to our existing firm orders will be leased to Continental and then subleased to us.  As described under "— Capacity Purchase and Other Agreements with Continental Airlines," Continental has the ability to reduce the number of aircraft subject to the capacity purchase agreement below the numbers described above at any time with 12 months’ notice. 

                The operational capability of the ERJ-135 and ERJ-145 is 1,100 nautical miles.  The ERJ-145XR, with a 1,500 nautical mile range, created an opportunity for us to expand Continental’s network to cities beyond our prior reach.  The ERJ–145XR also features winglets, which provide more efficient fuel consumption.  Each of our aircraft is equipped with advanced technology and certifications that aid our operation in challenging weather conditions as well as allow for more cost-effective operations at higher flight levels. 

                Our fleet offers a seamless service experience to Continental’s passengers.  Our planes feature overhead baggage compartments, under-seat baggage storage, leather seating, lavatories, in flight meal and beverage service capabilities and jet-bridge loading in most locations.  Two differentiating features of our aircraft from mainline aircraft are the seating configuration (no middle seats) and the opportunity to gate-check luggage and continue onto their connecting flight without a trip to baggage claim. 

Table of Contents

                We have options for 100 ERJ-145XR aircraft.  Continental has the ability to include any or all of the option aircraft in the capacity purchase agreement as Covered Aircraft.  The same lease structure, as described above, will apply on the options if exercised by Continental.  Based on Continental’s current public statements, we believe that it will not exercise the options for these aircraft.  If that is the case, we have the opportunity to take delivery of all or a portion of the aircraft for ourselves. 

                We have no obligation to take any of the aircraft under firm commitments unless they are financed by a third party and leased to Continental or us.  We would, however, be responsible for obtaining financing for any option aircraft acquired for purposes outside of the capacity purchase agreement.  If Continental remains involved in the financing, we will pay 200 basis points over the interest rate we pay on Covered Aircraft.  We have no orders for additional aircraft other than the Embraer regional jets.

                Maintenance of Aircraft.  Using a combination of Federal Aviation Administration ("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; Richmond, Virginia; Louisville Kentucky; and Shreveport, Louisiana, as well as our satellite maintenance stations.

                We have a power-by-the-hour agreement with Rolls-Royce to maintain the engines on our aircraft through April 2015.  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 controls, tires, wheels and brakes.  For 2004, approximately 70% of our maintenance, materials and repairs cost consisted of power-by-the-hour expenses.  We believe that these agreements, coupled with our ongoing maintenance program, reduce the likelihood of unexpected maintenance expense during their terms.

                We maintain an inventory of aircraft spare parts to ensure the reliability of our operations and utilize a computerized tracking system to increase maintenance efficiency and avoid excess inventory 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 and US Airways.  These airlines operate primarily under the hub-and-spoke model, consisting of large operations in a small number of metropolitan areas (hubs) providing extensive local non-stop service, as well as a connecting point for traffic to or from other markets (spokes).

                The current strategies of the major carriers include:  lowering operating costs to match the revenue generating capability of their aircraft; continuing to focus on business travelers, who historically have paid higher fares; fighting to maintain capacity and market share against low-cost carriers; concentrating on revenue-generating markets, especially internationally; and bringing additional connecting traffic into their networks through new alliances.  Airlines have faced unprecedented challenges over the last five years, including the terrorist attacks in September 2001, severe acute respiratory syndrome, the war in Iraq and record high fuel prices.  Two additional items added pressure to the major airlines:  the Internet as a distribution system and low-cost carriers.  The Internet allows passengers to instantaneously compare all of the major network and low-cost airlines’ pricing, largely eliminating lucrative travel agent and corporate contracts.  In addition, the low-cost carriers continue to gain market share at the expense of the majors by offering passengers no-frills travel at low fares.  All of these factors have led two of the six major airlines listed above to file for Chapter 11 bankruptcy protection, and caused all of the six airlines to seek wage and work rule concessions from their employees, and concentrate on drastically reducing costs in their overall networks. 

Table of Contents

                Regional airlines typically operate under capacity purchase arrangements or prorate agreements with major airlines.  The capacity purchase arrangement allows a regional airline to sell all of its capacity to the major airline at a contracted price and concentrate on the operation and efficiency of the aircraft versus marketing and scheduling the airline.  The capacity purchase agreement provides some protection from industry conditions as well as a more predictable income stream.  In this model, major carriers use the regionals to serve smaller communities than can be economically served with larger jet aircraft, to backfill off-peak time channels in large markets to protect market share and to expand their network into new communities.  Prorate agreements are less common today and provide regional carriers a portion of the passenger revenue from the purchased ticket.  Under a prorate agreement, regional airlines are typically less insulated from industry conditions, such as low fares and high fuel prices.  However, prorate agreements allow regional airlines scheduling control of their aircraft, so the focus is to maximize profits rather than bring connecting traffic into the major’s hub.

                Currently, we, as well as Air Wisconsin, Mesa Airlines, Mesaba Airlines, Pinnacle Airlines, Republic Airways, SkyWest Airlines and Trans States Airlines, operate under some form of capacity arrangement.  Mesa Airlines also performs some prorate flying.  Other regional airlines, such as American Eagle, Atlantic Southeast Airlines, Comair and Horizon Airlines, are wholly owned subsidiaries of major airline holding companies. 

                The principal challenge facing the regional airline industry currently is the state of the airline industry and its effect on the major airlines.  Since all of the regional airlines depend upon agreements with the major airlines, the financial health of the major airlines is fundamental to the regional airlines’ business model.  Other items affecting regional carriers include:  increasing domestic air traffic making operating in high density environments more difficult, scope clauses limiting the regional airline’s ability for growth in aircraft type and size and passenger perceptions regarding regional aircraft. 

Competitors

                Our main competitors include Mesa Airlines, Mesaba Airlines, Pinnacle Airlines, Republic Airways and SkyWest Airlines.  We also compete with other regional airlines, such as American Eagle, Atlantic Southeast Airlines, Comair and Horizon Airlines, which are wholly owned subsidiaries of major airline holding companies.  The three main areas of competition are:  costs, customer service and operational reliability. 

                Because of the variations among the contracts under which regional airlines operate, cost comparisons between regional airlines are extremely difficult.  We believe that we are one of the most cost-efficient providers of regional jet service due to the efficiencies we realize by operating a single fleet type and the economies of scale we achieve as the world’s largest regional airline.  We also believe that we provide one of the highest levels of customer service in the regional industry as evidenced by our top-tier performance in the DOT’s monthly surveys on customer complaints, mishandled bags and on-time operations.  During the past year, we consistently ranked in the top three regional airlines in each of these categories.  In terms of reliability, we accomplished a controllable completion factor, which excludes weather and air traffic control cancellations, of 99.9% for the year ended December 31, 2004 versus our benchmark used for incentive payment calculations of 98.9%.  Our strong operational performance resulted in $11.5 million in incentive payments in 2004.

Industry Regulation

                We operate under certificates of public convenience and necessity issued by the 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.

Table of Contents

                We also operate under an air carrier operating certificate issued by the FAA which may be amended, modified, suspended or revoked if safety in air commerce or air transportation and the public interest so require.  The FAA regulates airlines, 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.

                The Aviation and Transportation Security Act of 2001 ("ATSA") federalized substantially all aspects of civil aviation security and created the Transportation Security Administration ("TSA") under the Department of Homeland Security. Under the ATSA, all security screeners at airports are now 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.  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 enplanement ticket tax (up to $5.00 per one-way trip), 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 Bush administration has proposed increasing the passenger security fee from $2.50 to $5.50 per enplanement, which, if implemented, would result in an additional annual tax of $1.5 billion on the airline industry, as estimated by the administration.  Under the capacity purchase agreement, Continental bears the risk of these increases, however, should we fly under our own code, the results of our operations would be adversely impacted by these ticket tax increases.

                The law also required the Undersecretary of Transportation for Security to assume all the civil aviation security functions and responsibilities related to passenger screening.  Checked baggage must be screened by explosives detection systems, which has required significant equipment acquisition by the government and the implementation of facility and baggage process changes.  Further implementation of the requirements of the ATSA and other security laws and regulations have resulted in increased costs for airlines and passengers, delays and disruptions to air travel and reduced demand. The TSA has issued regulations implementing the ATSA, including requirements for air carrier security programs and substantial civil penalties for violations.  Under the Arming Pilots Against Terrorism Act, the TSA has established a program to arm volunteer pilots of air carriers to protect aircraft.  The TSA is currently testing a new "Secure Flight" passenger screening program with the assistance of U.S. airlines.

                Our operations are also 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, 2005, we had approximately 6,700 employees, comprised of approximately 2,400 pilots and instructor pilots, 1,200 flight attendants, 1,200 customer service personnel, 1,000 mechanics and 100 other maintenance personnel, 80 dispatchers and 720 supervisors, management and support personnel.  We also use third parties to provide ground handling services in some stations; the majority of which are currently provided by Continental.

Table of Contents

                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, a crucial component of our business strategy is the preservation of good relations with our employees, approximately 70% of whom are represented by unions.

                Under the terms of a previous pilot flow-through arrangement with Continental that terminated in 2003, furloughed Continental pilots had the option to accept employment with us.  Since September 2001, 371 furloughed Continental pilots accepted positions with us, 128 of whom were still employed by us as of December 31, 2004.  In addition, 113 of our pilots have preferential rights to be hired by Continental when pilot positions become available at Continental.  As a result, when pilot positions become available at Continental, former Continental pilots on our payroll and our pilots with preferential rights will likely accept positions at Continental.  This will cause us to hire additional new pilots as replacements.

                The following table, as of January 31, 2005, reflects our principal collective bargaining agreements and their respective amendable dates.

                After amending our collective bargaining agreements with our pilots, mechanics and dispatchers, we began negotiations with our flight attendants in November 2004.  Our negotiations are ongoing with no specified deadlines.  We cannot predict the outcome of these negotiations.

Risk Factors

Factors that May Affect our Future Operating Results and Financial Condition

                Our actual results of operations and financial condition may vary materiallyfrom those anticipated, estimated or projected by us.  Among the key factors that may have an adverse effect on our operating results and financial condition are those set forth below.

We depend on the financial and operational stability of Continental

                We are directly affected by the financial and operational stability of Continental.  Continental provides substantially all of our revenue through our capacity purchase and other agreements.   Despite improvements during the past year, the U.S. domestic airline environment continues to be extremely challenging, at one point prompting Continental to warn that its liquidity might be insufficient to meet its obligations if it failed to lower costs sufficiently.

Table of Contents

                Since September 11, 2001, Continental has reported significant losses, excluding special items.  For the year ended December 31, 2004, Continental reported a net loss of $363  million and has indicated that its business and financial results are affected by and are subject to a number of factors, many of which are uncontrollable, including:

                On February 28, 2005, Continental announced that it had reached tentative agreements with its pilots, flight attendants, mechanics and dispatchers which, if ratified by union membership, will provide it with approximately $500 million of annual cost savings on a run-rate basis when these agreements are implemented and when coupled with prior concessions by its non-union employees (in addition to its previously announced cost-saving initiatives of approximately $1.1 billion).  This excludes the (i) non-cash cost of options to purchase approximately 10 million shares of Continental’s common stock that it expects to issue to its employees in connection with the pay and benefit reductions and (ii) accruals for certain non-cash costs or charges relating to items contained in the tentative agreements.  Continental also announced that its ability to achieve certain of the cost reductions will depend on the timely and effective implementation of new work rules, actual productivity improvement and implementation of technology and other items.  The timing and full impact of these items are difficult to estimate, therefore actual cost savings may be materially different from its current estimate.  Continental has also indicated that it expects to incur a substantial loss in 2005 even if these agreements are ratified.  If Continental fails to achieve timely ratification of these agreements, it could have inadequate liquidity to meet its obligations.

                We cannot predict the future impact of these factors on Continental.  Furthermore, the long-term impact of the changes in fare structures (most importantly in relation to business fares), booking patterns, low-cost competitor growth, customers’ direct booking on the internet, 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 Continental’s and our financial condition, liquidity and results of operations.

Our capacity purchase agreement with Continental may be terminated

                We receive substantially all of our revenue 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, if we could, that they would be as favorable to us as our capacity purchase agreement with Continental.

Table of Contents

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

If Continental terminates our capacity purchase agreement, we may lose access to all of our aircraft, 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 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.

                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 or leases 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, thus reducing our fleet.  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.

                Additionally, 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.  Continental leases most of the airport facilities that we use.  If the capacity purchase agreement is terminated, we may be required to vacate the terminal facilities (or all facilities if the termination results from our material breach of the agreement) that are subleased to us by Continental, and to use commercially reasonable efforts to assign to Continental or its designee any lease in our name for these facilities.  Consequently, to offer airline services 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 potentially higher rates.  We cannot provide any assurance that we would be able to gain appropriate access to airport facilities, slots or other authorizations, or would not incur a significant increase in our costs to do so.

                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.

Table of Contents

Continental could reduce the level of its commitment under our capacity purchase agreement

                The capacity purchase agreement covers all of our existing fleet and firm order aircraft.  Continental has the right to reduce the number of regional jets covered by our agreement at any time, provided that we receive at least 12 months’ notice (as of March 15, 2005, we have not received any such notice).

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

We cannot guarantee that we would be able to enter into a satisfactory agreement with another airline for the capacity released by Continental, fly successfully under our own flight designator code or obtain the necessary airport facilities and gates to do so.  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 scope clauses in the collective bargaining agreements of major carriers, may limit our ability to enter into alternative arrangements with other major airlines.

Our annual rate resetting process under the capacity purchase agreement with Continental may result in arbitration or cause our margins under the capacity purchase agreement to decline

                Under the capacity purchase agreement, we receive payment for each scheduled block hour in accordance with a formula designed to provide us with a target operating margin of 10.0%.  Although the 2005 rate resetting process was uneventful, we may not be successful in negotiating rates with Continental in future years.  As a result, we may have lower margins in the future.  See detailed descriptions of our 2005 rate resetting process at " — Capacity Purchase and other Agreements with Continental Airlines — 2005 Rate Negotiation."

We may not be successful in implementing any growth strategy

                We continue to evaluate various growth strategies including conducting our own flying, entering into capacity purchase agreements with major carriers other than Continental and diversifying from passenger related airlines services (such as aircraft maintenance, ground handling, etc.).  Substantial risks accompany these strategies, including:

Table of Contents

                Many of these factors are beyond our control.  If our assessment of the profitability and feasibility of our growth plan is inaccurate, 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.

Continental may compete with us

                Continental currently has code-sharing agreements with several regional or commuter airlines in which it 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 at Continental’s existing hub airports.  We cannot provide any assurance that Continental will not expand these relationships to compete with us, including with aircraft released from our capacity purchase agreement.  Also, there can be no assurance that Continental will not add its own regional jet capacity in competition with us, subject to the current exclusive arrangement we have at Continental’s existing hubs through December 31, 2006.

                Additionally, Continental has announced many cost savings initiatives in order to return to profitability; therefore, as Continental continues to reduce costs, certain routes currently operated by us may become more profitable for Continental to operate with mainline aircraft.

Continental’s stock ownership enables it to influence us

                Continental currently owns approximately 19.7% of our common stock.  In addition, 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.  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.  As a result, Continental continues to influence our board of directors and other matters affecting our company through its board designees, including:

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

                We have a tax agreement with Continental that provides, among other things, for our payment to Continental of all or a significant portion of the tax benefits we realize as a result of an internal reorganization performed before our initial public offering in 2002.  Since that time, we have made net payments of approximately $73.6 million to Continental under the tax agreement and could pay Continental as much as an additional $283.0 million through 2017.  See Item 8. "Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 9" for a detailed discussion of our income taxes and our tax agreement with Continental.  If it is determined, as a result of an income tax audit or examination, that a significant amount of these tax benefits should not have been available, thus requiring us to pay additional taxes, interest and penalties to one or more tax authorities, and if at that time Continental were unable to indemnify us for these amounts, then we could be responsible for such tax payments, interest and penalties.

Table of Contents

We may be unable to obtain all of the aircraft, parts or related support services we expect from Embraer to operate the aircraft

                Due to the fact that we operate a single fleet type produced by a single manufacturer, our operations could be materially adversely affected by:

Maintenance costs will likely increase as the average age of our fleet increases

                Similar to other air carriers in our industry, as the average age of our fleet increases, the maintenance costs for our fleet will likely increase proportionately.  We emphasize preventive maintenance, in addition to the 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; Richmond, Virginia; Louisville, Kentucky; and Shreveport, Louisiana, as well as at our satellite maintenance stations.

                We have a power-by-the-hour agreement with Rolls-Royce to maintain the engines on our aircraft through April 2015.  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.  Additionally, we continue to maintain an inventory of aircraft spare parts to ensure the reliability of the operation and utilize a computerized tracking system to increase maintenance efficiency and to avoid excess inventories of spare parts.  However, our maintenance costs could increase and adversely impact our results of operations in the event that we have to address new FAA and/or Embraer maintenance directives.  We are not aware of any directives or changes at this time that could adversely affect our maintenance costs.

The highly competitive nature of the airline industry, as well as potentially substantial consolidation in the 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.  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 major airlines 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 resources than we do.  Moreover, competitors could rapidly enter markets we serve for Continental and introduce discount fares, which could lessen the economic benefit Continental derives from servicing these markets, which would indirectly affect us.

Table of Contents

We compete with both low-cost carriers and other regional carriers, and our cost structure may not be competitive

                Because we do not control our own flight schedule under the capacity purchase agreement, only 43% of our costs are controlled by us.  All other costs are driven by the flight schedule determined by Continental, Continental’s own cost structure or factors that are outside our or Continental’s control (such as aircraft rent, fuel, insurance, property taxes, etc.).  As a significant portion of our costs are allocated and/or inherited, we may not be able to restructure our costs effectively to compete with other low-cost and regional carriers due to their capital and infrastructure.

Terrorist activities or warnings have dramatically impacted and will likely continue to impact our business

                Terrorist attacks and threats, continued unrest in the Middle East and other world events have negatively impacted the airline industry and could result in further increased costs or reduced demand for the airline industry and us.  For instance, fuel prices rose to historic levels during 2003 and 2004 and have recently begun to re-approach 2004’s all-time high prices.  Additionally, increased security measures mandated by the TSA have increased operating expenses for us and the airline industry, despite governmental assistance.

We have significant contractual obligations and may not be able to generate sufficient cash flow or otherwise raise funds to make required payments or pursue other business opportunities

                Our leverage and the fact that we are not rated by credit rating agencies may affect our ability to obtain and/or satisfy our significant financing needs or meet our obligations.  As of December 31, 2004, we had approximately $259.8 million of long-term debt and capital lease obligations.  This includes outstanding indebtedness of $98.8 million on our note payable to Continental and $137.2 million of senior convertible notes due 2023 (see Item 8. "Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 7" and "— Note 8" for detailed descriptions of these obligations).  We also have significant long-term lease obligations primarily relating to our aircraft.  These leases are classified as operating leases and therefore are not reflected as liabilities on our consolidated balance sheet.  At December 31, 2004, the minimum lease payments due under our long-term operating leases were approximately $4.2 billion.

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 conducted on older aircraft.

                We expect to continue incurring expenses to comply with these 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.

Table of Contents

                Additional laws, regulations, taxes and airport rates and charges are 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 since September 11, 2001, coupled with reduced fees paid by airlines to airports due to decreased flying and cargo, many airports have significantly increased 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, tsunamis 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 volatility of 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 and financial condition could be adversely affected as a result of an aviation accident

                An accident or incident involving one of our aircraft could involve repair or replacement of a damaged aircraft and its consequential temporary or permanent loss from service, as well as significant potential claims of injured passengers and others.  We are required by the DOT to carry liability insurance.  In the event of an accident, our liability insurance may not be adequate and we may be forced to bear substantial losses from the accident.  Substantial claims resulting from an accident in excess of our related insurance coverage would harm operational and financial results.  Moreover, any aircraft accident or incident, even if fully insured, could create a public perception that we are less safe or reliable than other airlines.

Table of Contents

Item 2.    Properties

Flight Equipment

                As shown in the following table, our operating fleet consisted of 245 regional jets at December 31, 2004. Our purchase commitments (firm orders) and aircraft options as of December 31, 2004 are also shown below.

                During 2004, we put 21 new ERJ-145XR aircraft into service.  We expect to take delivery of 21 ERJ-145XR aircraft in 2005 (four of which have been delivered as of March 15, 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.

Facilities

                We use the following principal facilities:

Table of Contents

                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 shop facilities, the Shreveport hangar and shop facilities, the Louisville maintenance facility, the Burlington maintenance facility, the Richmond maintenance facility and the Corpus Christi, Lake Charles and Charlotte satellite maintenance stations, which we lease directly.  In addition, at each of Continental’s three domestic hubs 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, we may be required to vacate the terminal facilities (or all facilities if the termination results from our material breach of the agreement) that are subleased to us by Continental, and to use commercially reasonable efforts to assign to Continental or its designee any lease in our name.  See Item 1. "Business — Capacity Purchase and Other Agreements with Continental Airlines — 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 were 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 remediation at this time.

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

                Not applicable.

Table of Contents

PART II

Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

                Our common stock trades on the NYSE.  The table below shows the high and low sales prices for our common stock as reported on the NYSE composite tape for the periods indicated.

                As of March 10, 2005, there were approximately 21 holders of record of our common stock.

                We have not paid any cash dividends on our common stock and have no current plans to do 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 the voting power in us (or any other U.S. airline) by persons who are not citizens of the United States to 25%.

Table of Contents

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.

                We operated essentially as a division of Continental until January 1, 2001, connecting passengers from small to medium-sized communities 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 prorate arrangement between us and Continental that is different from our capacity purchase agreement, which became effective on January 1, 2001.  Under the prorate 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 prorate 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 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.

Table of Contents

                The following selected financial data has 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 2000 and 2001.  For a discussion of some of the key factors that could have an adverse effect on our results of operations, financial position and cash flows, please refer to "Risk Factors" beginning on page 18 of this report.

Table of Contents

Table of Contents

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 in this report.

Executive Summary

                Where we are…

                We are the largest operator of regional jets and the largest regional airline in the world based on available seat miles.  As of January 31, 2005, we offered scheduled passenger service with an average of 1,175 daily departures to approximately 148 cities in 40 states, the District of Columbia, Mexico, Canada and the Caribbean.  We provide Continental Airlines, Inc. ("Continental") substantially all of its regional jet service out of New York/Newark, Houston and Cleveland and additional non-hub service.  From 2002 to 2004, our available seat miles ("ASMs") grew at a compounded annual rate of 29.4%, while our costs increased at a compounded annual rate of only 17.6% during the same period.  Our goal is to increase earnings and cash flow by focusing on operating costs and reliability.  Our success to date is evidenced by the slower growth in our operating costs than in our level of operations, all while we added more complexity to our network, increased capacity and achieved a 99.9% controllable completion factor.  We have achieved these results through fleet commonality, employment of cost-effective technologies and sizeable investments in training resources.  For the year ended December 31, 2004, we recorded net income of $122.8 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.  This operating revenue is reconciled and settled with Continental on a monthly basis, and we perform a quarterly reconciliation of our costs within the margin band as defined in the capacity purchase agreement.  Please see Item 1. "Business — Capacity Purchase and Other Agreements with Continental Airlines" for a more detailed description of this agreement.

                Fleet.  During 2004, we accepted 21 new ERJ-145XR aircraft.  This aircraft is a 50-seat regional jet capable of flights of 1,500 miles.  With these deliveries, we ended 2004 with 75 ERJ-145XR, 140 ERJ-145 and 30 ERJ-135 aircraft.  Our regional jets’ operational capabilities allowed us to add service to new markets, expand service in existing markets and ultimately have allowed Continental to broaden service from its major hub cities, as well as select communities, thus contributing to Continental’s growth options.  We currently expect to receive 21 new ERJ-145XR aircraft during 2005 (four of which have been delivered as of March 15, 2005) and eight new ERJ-145XR aircraft in 2006. 

                Labor.  As of January 31, 2005, approximately 70% of our employees were covered by collective bargaining agreements.  As contracts become amendable, we accrue for any expected increase in costs related to the new contracts.  The actual outcomes may differ from our estimates.

Table of Contents

                In 2004, we finalized the following collective bargaining agreements:

                The collective bargaining agreement with our flight attendants, represented by the International Association of Machinists and Aerospace Workers, became amendable in December 2004.  Negotiations began in November 2004 and are ongoing.  We cannot predict the final outcome of these negotiations.

                Liquidity and Financing Activities.  As of December 31, 2004, we had $215.2 million in cash and short-term investments, including $6.3 million in restricted cash.  During 2004, we reduced our note payable to Continental by $94.4 million and our loan agreement with Export Development Canada ("EDC") by $0.9 million.  In addition, we made $1.7 million in principal payments related to our capital leases.  Our cash flows from operations were sufficient to cover our capital resources and liquidity requirements during the three years ending December 31, 2004.  See discussion below in "— Liquidity and Capital Commitments."

                Relationship with Continental.  In January 2005, Continental contributed 6.0 million shares of our common stock to its defined benefit pension plan, which reduced Continental’s ownership of our common stock to 19.7%.  Pursuant to the share of our Special Voting Preferred Stock that it owns, Continental has designated one member to our board of directors and remains in a position to influence many of our corporate decisions.  Once the percentage of its common stock ownership drops below 10%, we will redeem the Special Voting Preferred Stock and this right will terminate; however, Continental will still have the right to designate a director to our board pursuant to the capacity purchase agreement.  Continental has indicated that it intends to 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 disposition of its remaining ownership interest in us will have an adverse impact on our results of operations or financial position.

                Pursuant to the capacity purchase agreement, we indemnify Continental for its losses resulting from some of our actions and it indemnifies us for our losses arising from some of its actions.  During 2004, we incurred $4.0 million in other operating expenses relating to a claim by Continental for costs incurred during the post-retirement storage of certain turboprop aircraft engines.  We paid Continental $4.0 million as full and final satisfaction of this matter.  In addition, one of our engines under an operating lease with Continental was damaged beyond repair while the aircraft was on the ground.  Consequently, we paid Continental $1.9 million to purchase the engine and recorded the purchase in other operating expenses.  As a result of this incident, we are also obligated to obtain a replacement engine to satisfy the spare engine requirements under our power-by-the-hour agreement with Rolls-Royce Corporation ("Rolls-Royce").

                During 2003, we finalized our 2002 income tax returns reflecting the tax impacts of our spin-off from Continental.  Upon reconciling the tax impacts of the spin-off in our deferred tax accounts, a deferred tax asset of approximately $6.7 million remained.  At the end of 2003, this asset was included in our deferred tax accounts.  In 2004, based on Continental’s agreement with our reconciliation and the conclusion that this asset was related to our spin-off from Continental, the item was reclassified as a receivable from Continental.  In December 2004, we reached an agreement with Continental under which it agreed to pay half of this balance.  As a result, we recorded a $3.4 million charge in other operating expenses.  Continental paid us the remaining balance as full and final satisfaction of this matter in January 2005.

Table of Contents

                Rate Resetting Process under the Capacity Purchase Agreement.  In July 2004, we began negotiating with Continental to adjust the scheduled block hour rates for 2005 as required under the capacity purchase agreement, pursuant to which we receive payment for each scheduled block hour in accordance with a formula designed to provide us with a target operating margin of 10.0%.  We completed the rate negotiations for 2005 and amended the capacity purchase agreement with respect to certain matters, including capping the ceiling on the operating margin defined in the agreement at 10.0%.  We will also include previously unreconciled costs such as actual labor cost performance in the calculation of this new ceiling.  Additionally, in 2005 we are only required to pay Continental a penalty for controllable completion factors below 99.5% instead of using our rapidly rising historical benchmark, which is expected to exceed 99.5% by 2006.  We expect our operating margin for 2005 and beyond to be approximately 10.0%.  Had the ceiling for the operating margin as defined in the capacity purchase agreement been capped at 10.0% and previously unreconciled costs been included in this calculation during 2004, our operating income in 2004 would have been reduced by approximately $58.9 million.

                In addition, as part of the 2005 rate resetting and as a result of Continental’s cost-saving initiatives, the cost for Continental to provide certain customer services to us such as technology infrastructure, ground handling and various other services will be reduced by approximately $5 million, $23 million and $19 million, respectively, in 2005.  As these are fully reconciled costs, we expect our operating income in 2005 to be reduced by approximately $5 million as a result of these cost reductions.

                We seek to provide the most reliable regional jet service available at a competitive price.  We continuously work with Continental to identify ways to lower our costs.  As this occurs, our results from operations could be adversely affected in the short-run when compared to historical results since our operating revenue is based on our underlying costs.

                New Venture.  We recently made a minority investment in a European start-up company that seeks to provide regional jet services to European air carriers.  The company is currently attempting to market this concept, but is not yet a certificated airline and has no firm commitments from any air carriers.  We are analyzing the implications of the Financial Accounting Standards Board Interpretation 46 – "Consolidation of Variable Interest Entities," ("FIN 46") at this time and expect to consolidate the results of operations and financial condition of this entity in 2005.

                Where we are going…

                We seek to enhance stockholder value by providing the most efficient and reliable regional jet service.  This tactical focus on costs and reliability generated improved earnings and strengthened our relationship with Continental.  As the airline industry continues to experience one of its most difficult periods, we believe this strategy has served us well over the past 12 months and will do so in the future.  We exceeded our 2004 financial objectives while at the same time lowering Continental’s cost and improving our reliability. 

                Our goal is to enhance our stockholders’ long-term value through:

Table of Contents

                Operational Guidance for 2005.  The following table summarizes our guidance for block hours, available seat miles and departures: 

We expect our departures for the first quarter of 2005 to be approximately 104,500.  However, since Continental controls and is responsible for our scheduling, our actual performance detailed above can be materially different from our estimates.

                We also expect our fleet to total 266 aircraft by December 31, 2005, which includes the delivery of 21 new aircraft during 2005. 

                Outlook.  Despite our efforts to contain costs and improve reliability, we are directly affected by the financial and operational stability of Continental because we depend on Continental’s ability to make payments to us under our capacity purchase and other agreements.  The current financial environment for U.S. domestic network carriers continues to be the worst in the industry’s history and could deteriorate further.  Continental recently announced that its current cost structure is not competitive due to the weak domestic yield environment, caused in large part by the fierce competition from low-cost carriers and record-breaking fuel prices.  Additionally, many of the other network carriers have reduced their costs significantly and may continue to restructure their costs downward.

                Continental has reported significant losses since September 11, 2001, excluding special items. For the year ended December 31, 2004, Continental reported a net loss of $363 million.  For the year ended December 31, 2003, Continental reported net income of $38 million, but only after asset-related gains of $183 million from dispositions of all or part of its interests in us, Orbitz and Hotwire, $111 million in security fee reimbursements from the U.S. government, $15 million in other gains and $62 million in special charges (all net of tax). 

                On February 28, 2005, Continental announced that it had reached tentative agreements with its pilots, flight attendants, mechanics and dispatchers which, if ratified by union membership, will provide it with approximately $500 million of annual cost savings on a run-rate basis when these agreements are implemented and when coupled with prior concessions by its non-union employees (in addition to its previously announced cost-saving initiatives of approximately $1.1 billion).  This excludes the (i) non-cash cost of options to purchase approximately 10 million shares of Continental’s common stock that it expects to issue to its employees in connection with the pay and benefit reductions and (ii) accruals for certain non-cash costs or charges relating to items contained in the tentative agreements.  Continental also announced its ability to achieve certain of the cost reductions will depend on the timely and effective implementation of new work rules, actual productivity improvement and implementation of technology and other items.  The timing and full impact of these items are difficult to estimate, therefore actual cost savings may be materially different from its current estimate.  Continental has also indicated that it expects to incur a substantial loss in 2005 even if these agreements are ratified.  If Continental fails to achieve timely ratification of these agreements, it could have inadequate liquidity to meet its obligations.  Continental expects the results of the ratification process for these agreements to be completed by March 31, 2005. 

Table of Contents

                Absent additional adverse factors due to external influences such as additional terrorist attacks, hostilities involving the United States or high fuel prices, Continental indicated that it believes its current liquidity to be sufficient to fund its current operations and other financial obligations through 2005 (if the tentative agreements are ratified and implemented).  However, a combination of some or all of several events, most of which are outside of Continental’s direct control, may result in its inability to maintain adequate liquidity through December 31, 2005.  These events include the failure of its unions to ratify and implement the tentative agreements, further significant declines in yields, and fuel prices higher than current levels for an extended period of time.

                Continental has reported that its business and financial performance are subject to a number of additional risks, including the following:

                Even if none of the foregoing factors occurs, Continental has indicated that it may have to further downsize its operations and further reduce expenses.  Under the capacity purchase agreement, Continental has the ability to reduce its level of commitment and utilization of our aircraft.  Currently, Continental can provide, at any time, 12-months’ notice of its intention to reduce the number of aircraft covered by the agreement.  Under this provision, Continental is entitled to decline capacity with respect to any undelivered regional jets subject to our firm orders as of the effective date, and up to 25%, over any rolling three-year period of our delivered aircraft under an agreed upon methodology.  If Continental reduces its commitment and utilization of our aircraft under the capacity purchase agreement, our results of operations and financial condition could be adversely affected.  There can be no assurance that such circumstances will not occur in the future.

                Additionally, Continental leases from third parties a substantial portion of the aircraft and airport facilities that it subleases to us.  If Continental breaches or otherwise fails to perform under these leases, we could lose our rights under the subleases, and our continued access to our aircraft and airport facilities would then depend on our ability to negotiate direct agreements with the third-party lessors.  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, 2004 filed with the Securities and Exchange Commission ("SEC").

Table of Contents

                Critical Accounting Estimates

                Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP").  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 estimates below as critical to our business operations and an understanding of our results of operations.  The SEC has defined critical accounting estimates as the ones that are most important to the portrayal of a 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 estimates, 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 estimates.  For a detailed discussion on the application of our accounting policies, see Item 8.  "Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements —Note 1."

Table of Contents

                In addition to our critical accounting estimates described above, we made 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, information from third-party professionals and various other assumptions that we believe are reasonable under the 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.

                We have 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.

Table of Contents

                Recently Issued Accounting Standards

                The Financial Accounting Standards Board has ratified or issued the following accounting standards that are applicable to us:

                See detailed description of these accounting standards and their impact 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 — (s) Recently Issued Accounting Standards."

Results of Operations and Analysis

                Statistical Information

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

Table of Contents

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

                The following discussion provides an analysis of our results of operations and reasons for any material changes for the periods indicated.

                Comparison of 2004 to 2003

                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 cost per ASM:

                We strive to provide Continental cost-effective services and to remain competitive compared to other regional air carriers.  Although most of the individual expense components increased during the year ended December 31, 2004, as compared to the same period in 2003 and 2002, the tables above and below demonstrate increased efficiencies in our operations based on our cost per ASM. 

                General

                Our operating income in 2004 reflected a 13.6% operating margin, compared with an operating margin of 13.9% in 2003.  The 2004 operating margin included the benefits of cost savings and $11.5 million in performance incentive payments under our capacity purchase agreement.  The payments are primarily based on the current controllable completion factor compared to a historical controllable completion factor benchmark.  Because the historical rates are measured on a rolling monthly average, higher controllable completion factors result in higher incentive payments in the near term but reduce our opportunity to earn incentive payments in the future.  Our controllable completion factor in 2004 was 99.9% and our historical benchmark completion factor was 98.9% for the same period.

Table of Contents

                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 at a 10.0% operating margin.  In addition, if our prevailing margin (before any reconciliation payments) falls outside our margin band of 8.5% or 11.5%, our revenue will be adjusted to bring us back to our floor or cap.  In 2004 and 2003, our actual costs were lower than the estimates used in the block hour rates; consequently, our prevailing margin (before reconciliation payments) exceeded 11.5%.  The lower costs were primarily due to lower maintenance, materials and repair and passenger servicing expenses.  Our reconciliation payments to Continental totaled $61.0 million and $30.1 million for 2004 and 2003, respectively.  As a result of the rate resetting process for 2005, we expect our future operating margin, excluding incentives, to be closer to our target contractual operating margin of 10%.

                Operating Expenses

                As our operations have grown, our direct labor groups such as pilots, flight attendants, mechanics, dispatchers and customer service agents have increased proportionally.  This larger work force and increases in wage rates under some of our collective bargaining agreements increased our wages, salaries and related costs by $20.3 million in 2004.  Increases related to our non-direct labor groups such as clerical and management positions were approximately $4.2 million in 2004.  We also incurred approximately $8.1 million in additional employee benefit costs in 2004 due to increases in medical benefit costs, workers’ compensation, payroll taxes and 401(k) expenses. 

                In the future, we anticipate our wages, salaries and related costs to be affected by the following factors:

                The increase in our aircraft fuel expense in 2004 was mainly due to a 21.8% increase in fuel consumption.  Consumption rose primarily due to a 23.0% increase in block hours, which was partially offset by our jets’ more efficient fuel burn.  Our actual price of fuel, including taxes, in 2004 and 2003 was 71.2 cents and 71.0 cents per gallon, respectively.  Under the capacity purchase agreement and the related fuel purchase agreement with Continental, we incur a fuel price and fuel tax equal to the lower of the actual cost of fuel and fuel tax or the agreed-upon caps.  Beginning in 2003, until the termination of these agreements, caps on fuel and fuel tax are 66.0 cents and 5.2 cents per gallon, respectively. 

                Approximately $29.3 million of the increase in maintenance, materials and repairs during 2004 was due to a 21.5% increase in flight hours and a 14.0% increase in rate-per-flight-hour related to our power-by-the-hour contracts.  The rate-per-flight-hour increase is mainly attributed to a higher number of power-by-the-hour contracts in place during 2004.  For the year ended December 31, 2004, approximately 10% more of our maintenance, materials and repairs cost consisted of power-by-the-hour expense versus the same period in 2003.  As a result of the increased coverage under our power-by-the-hour contracts, our airframe, avionics and engine component repair and replacement costs decreased by approximately $7.0 million.  Despite the increase in the cost of our power-by-the-hour contracts, as well as general maintenance expense and overhead to support the continuing growth and aging of our fleet, our maintenance, material and repair cost per flight hour decreased by 2.4% for the year ended December 31, 2004 versus the same period in 2003.  We expect our future maintenance, materials and repair expenses, adjusted for volume and further fleet aging, to mirror our current cost structure.

Table of Contents

                The decrease in other rentals and landing fees in 2004 was primarily due to a $21.3 million decrease in our terminal facility rents at Continental’s hub stations as a result of an amendment to our master facility and ground handling agreement in November 2003.  This decrease was partially offset by higher facility rent in non-hub stations of approximately $2.2 million, as the number of stations in which we operate increased.  In addition, our landing fees in 2004 increased by $10.7 million as a result of a 15.0% increase in landing weights and a 8.4% increase in landing fee rates.

                The increase in other operating expenses was mainly due to the following:

                Nonoperating Expenses

                Our interest expense is related to our senior convertible notes, note payable to Continental, loan agreement with EDC and the Series A Cumulative Mandatorily Redeemable Preferred Stock of ExpressJet Airlines, Inc. due April 16, 2012 ("Series A Preferred Stock").  As we issued our senior convertible notes in August 2003 and we entered into our loan agreement with EDC in May and September 2003, our interest expense increased by $4.2 million in 2004 as compared to 2003.  This was partially offset by a $2.3 million decrease in interest expense related to our note payable to Continental as we continue to reduce our outstanding balance.  We expect to pay off the entire note payable to Continental by March 2006.  Furthermore, our interest income increased by $1.6 million as a result of a 0.3 point increase in our returns from our investments and higher average cash and short-term investment balance of approximately $71.4 million in 2004 as compared to 2003. 

Table of Contents

                Comparison of 2003 to 2002