TABLE OF CONTENTS

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

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1. June 30, 2003 amounts include the consolidation of ExpressJet Holdings, Inc. while June 30, 2004 and December 31, 2003 amounts do not. See Note 6 for further discussion.

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

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

In our opinion, the unaudited consolidated financial statements included herein contain all adjustments necessary to present fairly our financial position, results of operations and cash flows for the periods indicated. Such adjustments, other than nonrecurring adjustments that have been separately disclosed, are of a normal, recurring nature. The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2003 (the "2003 10-K"). As used in these Notes to Consolidated Financial Statements, the terms "Continental", "we", "us", "our" and similar terms refer to Continental Airlines, Inc. and, unless the context indicates otherwise, its consolidated subsidiaries. ExpressJet Airlines, Inc. ("ExpressJet"), a wholly-owned subsidiary of ExpressJet Holdings, Inc. ("Holdings"), and from which we purchase seat capacity, is accounted for as an equity investment in our June 30, 2004 and December 31, 2003 balance sheets and statement of operations for the three and six months ended June 30, 2004, and was consolidated in our financial statements prior to November 12, 2003 (see Note 6).

Certain reclassifications have been made in the prior period's financial statements to conform to the current year presentation.

Weighted average options to purchase approximately 6.3 million, 6.8 million, 6.3 million and 6.9 million shares of our Class B common stock were not included in the computation of diluted loss per share for the three months ended June 30, 2004 and 2003 and the six months ended June 30, 2004 and 2003, respectively, because the options' exercise prices were greater than the average market price of the common shares or the effect of including the options would have been antidilutive. Because we recorded net losses during the three and six months ended June 30, 2004 and the six months ended June 30, 2003, our Convertible Junior Subordinated Debentures Held by Subsidiary Trust and 4.5% Convertible Notes were also antidilutive. As a result, there was no difference between basic and diluted loss per share for the three and six months ended June 30, 2004 and the six months ended June 30, 2003.

Holders of our 5% Convertible Notes issued in June 2003 may require us to repurchase the notes on June 15 of 2010, 2013 or 2018 at par plus accrued and unpaid interest, if any. The indenture provides that we may at our option choose to pay this repurchase price in cash, in shares of common stock or any combination thereof. Should we be required to repurchase the notes at any of the redemption dates, it is our policy that we would satisfy the requirement in cash. Therefore, the 5% Convertible Notes are not considered to be potentially dilutive securities in the EPS calculation.

The following table sets forth the computation of basic and diluted earnings per share for the period presented in which we reported net income (in millions):

We account for our stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". No stock-based employee compensation cost for our stock option plans is reflected in our consolidated statement of operations, as all options granted under our plans have an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the pro forma effect on net income (loss) and earnings (loss) per share if we had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") 123, "Accounting for Stock-based Compensation" (in millions except per share amounts):

At June 30, 2004, our derivative financial instruments which qualified for hedge accounting consisted of petroleum call options contracts to provide short-term protection against a sharp increase in jet fuel prices and option and forward contracts to hedge foreign currency-denominated net cash flows. See Item 3. "Quantitative and Qualitative Disclosures about Market Risk" for further discussion.

As shown in the following table, our operating aircraft fleet consisted of 352 mainline jets and 235 regional jets at June 30, 2004, excluding aircraft out of service. The regional jets are leased by ExpressJet from us and are operated by ExpressJet. Our and ExpressJet's purchase commitments (firm orders) for aircraft, as well as options to purchase additional aircraft as of June 30, 2004 are also shown below.

As of June 30, 2004, we had 12 owned and 13 leased MD-80 aircraft and two leased DC-10-30 aircraft out of service.

The 12 owned out-of-service MD-80 aircraft are being carried at an aggregate fair market value of $24 million, and the remaining rentals and obligations for return conditions on the 15 leased aircraft have been accrued. As of June 30, 2004, we subleased both DC-10-30 aircraft and one leased MD-80 aircraft to third parties.

Additionally, we have 17 Embraer 120 turboprop aircraft and 13 ATR 42 turboprop aircraft out of service. We lease 22 and own eight of these aircraft. The eight owned aircraft are being carried at an aggregate fair value of $11 million, and the remaining rentals and obligations for return conditions on those leased aircraft accounted for as operating leases have been accrued. We currently sublease seven of the leased out-of-service turboprop aircraft to third parties.

We are currently exploring lease or sale opportunities for the remaining out-of-service owned aircraft and sublease opportunities for the out-of-service leased aircraft that do not have near-term lease expirations. The timing of the disposition of these aircraft will depend upon the stabilization of the economic environment in the airline industry as well as our ability to find purchasers, lessees or sublessees for the aircraft. We cannot predict when or if such stabilization will occur or if purchasers, lessees or sublessees can be found, and it is possible that our assets (including aircraft currently in service) could suffer additional impairment.

During the first half of 2004, we removed from service one leased 737-300 aircraft in conjunction with its lease expiration, four owned MD-80 aircraft and nine leased MD-80 aircraft with leases expiring between 2004 and 2007. We recorded charges of $49 million ($31 million after income taxes) associated with future obligations for rent and return conditions, net of estimated sublease income, on the nine leased MD-80 aircraft. Six of these removals occurred in the second quarter, resulting in a charge of $30 million ($19 million after income taxes). Continuing with our previously announced plans to remove all remaining MD-80 aircraft from service by January 2005, we will record similar charges as the eight remaining leased MD-80 aircraft exit revenue service and are permanently grounded.

Also during the first half of 2004, we took delivery of five 757-300 aircraft and six 737-800 aircraft, of which one 757-300 and three 737-800s were delivered in the second quarter. As of June 30, 2004, we had firm purchase commitments for 52 aircraft from Boeing, with an estimated cost of approximately $2.0 billion, and options to purchase an additional 84 Boeing aircraft. We currently expect to take delivery of five 737-800 aircraft over the remaining six months of 2004, seven Boeing aircraft in 2005 and none in 2006 and 2007. Delivery of the remaining 40 firm order aircraft is expected to occur in 2008 and 2009.

We currently have agreements for the financing of all five Boeing aircraft scheduled for delivery in the final six months of 2004, subject to customary conditions. We do not have backstop financing or any other financing currently in place for the remainder of the Boeing aircraft. Further financing will be needed to satisfy our capital commitments for our firm aircraft. We can provide no assurance that sufficient financing will be available for the aircraft on order or other related capital expenditures.

ExpressJet took delivery of 11 ERJ-145XR aircraft during the first half of 2004, including six in the second quarter. As of June 30, 2004, ExpressJet had firm commitments for 39 regional jets from Empresa Brasileira de Aeronautica S.A. ("Embraer"), with an estimated cost of approximately $0.8 billion. ExpressJet currently anticipates taking delivery of an additional ten regional jets over the remaining six months of 2004. ExpressJet does not have an obligation to take any of these firm Embraer aircraft that are not financed by a third party and leased to either ExpressJet or us. Under the capacity purchase agreement between us and ExpressJet, we have agreed to lease as lessee and sublease to ExpressJet the regional jets that are subject to ExpressJet's firm purchase commitments. In addition, under the capacity purchase agreement with ExpressJet, we generally are obligated to purchase all of the capacity provided by these new aircraft delivered to ExpressJet. We cannot predict wheth er passenger traffic levels will enable us to utilize fully regional jets scheduled for future delivery to ExpressJet.

Substantially all of the aircraft and engines we own are subject to mortgages. A significant portion of our spare parts inventory is also encumbered.

In the second quarter of 2004, we recorded a special charge of $30 million ($19 million after income taxes) associated with future obligations for rent and return conditions related to six leased MD-80 aircraft that were permanently grounded during the quarter.

In the first quarter of 2004, we recorded special charges of $55 million ($35 million after income taxes). Included in these charges were $19 million ($12 million after income taxes) associated with future obligations for rent and return conditions related to three MD-80 aircraft that were permanently grounded during the quarter and a non-cash charge of $34 million ($22 million after income taxes) related to the termination of a 1993 service agreement with United Micronesian Development Association.

In the first quarter of 2003, we recorded fleet impairment losses and other special charges of $65 million ($41 million after income taxes). These charges consisted primarily of a $44 million additional impairment of our fleet of owned MD-80s, which was initially determined to be impaired and written down to fair value in 2002. The remainder of the charges consisted primarily of the write-down to market value of spare parts inventory for permanently grounded fleets. These write-downs were necessary because the fair market values of the MD-80 fleet and spare parts inventory had declined as a result of the difficult financial environment and further reductions in capacity by U.S. airlines.

During the second quarter of 2003, we agreed to defer firm deliveries of 36 Boeing 737 aircraft that were originally scheduled for delivery in 2005, 2006 and 2007. These aircraft will now be delivered in 2008 and beyond. In connection with the deferrals, we recorded a charge of $14 million ($8 million after income taxes).

Activity related to the accruals for future lease payments, return condition and storage costs and closure/under-utilization of facilities for the six months ended June 30, 2004 is as follows (in millions):

Capacity Purchase Agreement. Our capacity purchase agreement with Holdings and ExpressJet provides that we generally purchase all of ExpressJet's capacity for a negotiated price, and we are at risk for selling all of the seat inventory at market prices. The rates we pay ExpressJet for scheduled block hours are subject to adjustment effective January 1, 2005 and each year thereafter. On July 1, 2004, we began negotiating with ExpressJet to adjust the scheduled block hour rates as required by the capacity purchase agreement.

Our obligations under the capacity purchase agreement and ExpressJet's fuel expense in excess of the cap provided in the capacity purchase agreement and a related fuel purchase agreement (71.2 cents per gallon, including fuel taxes), less our rental income on aircraft we lease to ExpressJet, totaled $328 million and $645 million in the three and six months ended June 30, 2004 and $266 million and $532 million in the three and six months ended June 30, 2003. The 2004 amounts are reported as "ExpressJet capacity purchase, net" and the 2003 intercompany amounts were eliminated in our consolidated financial statements.

Pension Plan. Net periodic defined benefit pension expense included the following components (in millions):

Although our minimum funding requirement for 2004 is only $17 million, we had originally planned to contribute approximately $250 million to our pension plan in 2004 to maintain the plan's funding at 90% of its current liability. However, due to the weak revenue environment and record high fuel prices, we may determine to contribute less (or make no contribution) to our pension plan in 2004. On June 28, 2004, we filed an election with the Internal Revenue Service ("IRS") to preserve our eligibility for deficit reduction contribution relief under the recently enacted Pension Funding Equity Act. Under the relief, we may reduce pension contributions otherwise due for 2004. We are continuing to evaluate our 2004 contribution options to fund the pension plan and expect to make a decision regarding the funding by mid-September 2004. We made no contributions to the plan in the six months ended June 30, 2004.

At June 30, 2004, our defined benefit pension plan held 1.4 million shares of Holdings common stock with a market value of $17 million.

Employee Stock Purchase Plan. On March 12, 2004, our stockholders voted to adopt the 2004 Employee Stock Purchase Plan. All of our employees (including Continental Micronesia, Inc. employees) are eligible to participate in this program beginning in the second quarter of 2004. Participants may purchase shares of our Class B common stock at 85% (or higher in certain circumstances) of the fair market value of the stock on either the first day or the last day of the option period (whichever is lower), limited to a minimum purchase price of $10 per share. In the aggregate, 3,000,000 shares may be purchased. These shares may be newly issued or reacquired shares. The first option period ended on June 30, 2004 and 249,160 shares were issued under this plan in July 2004 at a price of $10 per share.

We have two reportable segments: mainline and regional. The mainline segment consists of flights to cities with jets with a capacity of greater than 100 seats while the regional segment consists of flights with jets with a capacity of 50 or fewer seats. The regional segment is operated by ExpressJet through a capacity purchase agreement. Under that agreement, we handle all of the scheduling and are responsible for setting prices and selling all the seat inventory. In exchange for ExpressJet's operation of the flights, we pay ExpressJet for each scheduled block hour based on an agreed formula. Under the agreement, we recognize all passenger, cargo and other revenue associated with each flight, and are responsible for all revenue-related expenses, including commissions, reservations, catering and rent at hub airports.

We evaluate segment performance based on several factors, of which the primary financial measure is operating income (loss). However, we do not manage our business or allocate resources based on segment operating income or loss because (1) our flight schedules are designed to maximize the passengers flying on both segments, (2) many operations of the two segments are substantially integrated (for example, airport operations, sales and marketing, scheduling and ticketing), and (3) management decisions are based on their anticipated impact on the overall network, not on one individual segment.

Financial information for the three and six months ended June 30 by business segment is set forth below (in millions):

In August 2001, the City of Houston completed the offering of $324 million aggregate principal amount of tax-exempt special facilities revenue bonds to finance the construction of Terminal E and a new international ticketing hall facility at Bush Intercontinental Airport. In connection therewith, we entered into a long-term lease with the City of Houston requiring that upon completion of construction, with limited exceptions, we will make rental payments sufficient to service the related tax-exempt bonds through their maturity in 2029. We have also entered into a binding corporate guaranty with the bond trustee for the repayment of principal and interest on the bonds that becomes partially effective (based on a pro rata share of bond proceeds) upon completion of construction of the terminal or the international ticketing facility. The corporate guaranty could also become effective during construction in other limited circumstances. The guaranty became effective for the repayment of principal and i nterest with respect to $271 million of the bonds upon completion of the terminal during the first quarter of 2004. We expect completion of the international ticketing facility during the first quarter of 2005, at which time our corporate guaranty would become effective for the remaining portion of the bonds issued by the City of Houston in the amount of $53 million.

We also have letters of credit and performance bonds at June 30, 2004 in the amount of $51 million with expiration dates through June 2008.

General Guarantees and Indemnifications. We are the lessee under many real estate leases. It is common in such commercial lease transactions for us to agree to indemnify the lessor and other related third parties for tort liabilities that arise out of or relate to our use or occupancy of the leased premises. In some cases, this indemnity extends to related liabilities arising from the negligence of the indemnified parties, but usually excludes any liabilities caused by their gross negligence or willful misconduct. Additionally, we typically indemnify such parties for any environmental liability that arises out of or relates to our use of the leased premises.

In our aircraft financing agreements, we typically indemnify the financing parties, trustees acting on their behalf and other related parties against liabilities that arise from the manufacture, design, ownership, financing, use, operation and maintenance of the aircraft and for tort liability, whether or not these liabilities arise out of or relate to the negligence of these indemnified parties, except for their gross negligence or willful misconduct.

We expect that we would be covered by insurance (subject to deductibles) for most tort liabilities and related indemnities described above with respect to real estate we lease and aircraft we operate.

In our financing transactions that include loans from banks in which the interest rate is based on LIBOR, we typically agree to reimburse the lenders for certain increased costs that they incur in carrying these loans as a result of any change in law and for any reduced returns with respect to these loans due to any change in capital requirements. We had $1.6 billion of floating rate debt at June 30, 2004. In several financing transactions, with an aggregate carrying value of $1.1 billion, involving loans from non-U.S. banks, export-import banks and certain other lenders secured by aircraft, we bear the risk of any change in tax laws that would subject loan payments thereunder to non-U.S. lenders to withholding taxes. In addition, in cross-border aircraft lease agreements for two 757 aircraft, we bear the risk of any change in U.S. tax laws that would subject lease payments made by us to a resident of Japan to U.S. taxes. Our lease obligations for these two aircraft totaled $64 million at June 30, 2004.

We cannot estimate the potential amount of future payments under the foregoing indemnities and agreements.

Employees. Approximately 38% of our employees are covered by collective bargaining agreements. Of these, substantially all have contracts under negotiation or that become amendable in 2004. 

The collective bargaining agreement between us and our pilots (who are represented by the Air Line Pilots Association) became amendable in October 2002.  After being deferred due to the economic uncertainty following the September 11, 2001 terrorist attacks, negotiations recommenced in September 2002 and are continuing. 

Our mechanics, represented by the International Brotherhood of Teamsters ("Teamsters"), ratified a new four-year collective bargaining agreement in December 2002 that made an adjustment to current pay and recognized current industry conditions.  The agreement became amendable with respect to wages, pension and health insurance provisions on December 31, 2003.  Negotiations commenced with the Teamsters regarding these subjects in December 2003 and are continuing.  Work rules and other contractual items are established through 2006. 

The collective bargaining agreement between us and our dispatchers, who are represented by the Transport Workers Union ("TWU"), became amendable in October 2003.  Negotiations commenced with the TWU in September 2003 and are continuing.  The collective bargaining agreement between us and our flight attendants (who are represented by the International Association of Machinists and Aerospace Workers) becomes amendable in October 2004. 

We continue to believe that mutually acceptable agreements can be reached with all of these employee groups, although the ultimate outcome of the negotiations is unknown at this time.  In May 2004, we announced that if economic conditions in the industry do not improve, we will be forced to seek wage and benefit concessions and furloughs. Any labor disruptions that result in a prolonged significant reduction in flights would likely have a material adverse impact on our results of operations and financial condition. Moreover, other network carriers such as American Airlines, United Airlines and US Airways were able to achieve significant wage and benefit concessions only through bankruptcy or the threat of bankruptcy.

            ExpressJet is also currently engaged in labor negotiations with its pilots and mechanics.  ExpressJet and its unions have requested the assistance of federal mediators in the negotiations.  A labor disruption by either group resulting in a prolonged significant reduction in their flights would likely have a material adverse impact on our results of operations and financial condition.

            Environmental Matters.  We could potentially be responsible for environmental remediation costs primarily related to jet fuel and solvent contamination surrounding our aircraft maintenance hangar in Los Angeles.  In 2001, the California Regional Water Quality Control Board mandated a field study of the site and it was completed in September 2001.  We have established a reserve for estimated costs of environmental remediation at Los Angeles and elsewhere in our system, based primarily on third party environmental studies and estimates as to the extent of the contamination and nature of the required remedial actions.  We have evaluated and recorded this accrual for environmental remediation costs separately from any related insurance recovery.  We have not recognized any receivables related to insurance recoveries at June 30, 2004.

            We expect our total losses from all environmental matters to be $52 million, for which we were fully accrued at June 30, 2004.  Although we believe, based on currently available information, that our reserves for potential environmental remediation costs are adequate, reserves could be adjusted as further information develops or circumstances change.  However, we do not expect these items to materially impact our financial condition, liquidity or our results of operations.

IRS Examinations. The IRS is in the process of examining our income tax returns for years through 1999 and has indicated that it may disallow certain deductions we claimed. In addition, the IRS has begun an examination of our income tax returns for the years 2000 and 2001. We believe the ultimate resolution of these audits will not have a material adverse effect on our financial condition, liquidity or results of operations.

Legal Proceedings.  During the period between 1997 and 2001, we reduced or capped the base commissions that we paid to travel agents, and in 2002 we eliminated such base commissions.  This was similar to actions also taken by other air carriers.  We are now a defendant, along with several other air carriers, in a number of lawsuits brought by travel agencies relating to these base commission reductions and eliminations.

            Sarah Futch Hall d/b/a/ Travel Specialists v. United Air Lines, et al. (U.S.D.C. Eastern District of North Carolina). This class action was filed in federal court on June 21, 2000 by a travel agent, on behalf of herself and other similarly situated U.S. travel agents, challenging the reduction and subsequent elimination of travel agent base commissions.  The amended complaint alleged an unlawful agreement among the airline defendants to reduce, cap or eliminate commissions in violation of federal antitrust laws during the years 1997 to 2002.  The plaintiffs sought compensatory and treble damages, injunctive relief and their attorneys' fees. The class was certified on September 18, 2002.  On October 30, 2003, a summary judgment and order was granted in favor of all of the defendants.  Plaintiffs filed their appeal to this judgment and order on November 5, 2003.  Plaintiffs' appeal of this judgment is pending .

            Several travel agents who purportedly opted out of the Hall class action filed similar suits against Continental and other major carriers alleging violations of antitrust laws in eliminating the base commission:  Tam Travel, Inc. v. Delta Airlines, Inc., et al. (U.S.D.C., Northern District of California), filed on April 9, 2003; Paula Fausky, et al. v. American Airlines, et al. (U.S.D.C., Northern District of Ohio), filed on May 8, 2003; and Swope Travel Agency, et al. v. Orbitz LLC et al. (U.S.D.C., Eastern District of Texas), filed on June 5, 2003.  By order dated November 12, 2003, these actions were transferred and consolidated for pretrial purposes by the Judicial Panel on Multidistrict Litigation to the Northern District of Ohio.

Always Travel, et. al. v. Air Canada, et al. On December 6, 2002, the named plaintiffs in this case, pending in the Federal Court of Canada, Trial Division, filed an amended statement of claim alleging that between 1995 and the present, Continental, the other defendant airlines, and the International Air Transport Association conspired to reduce commissions paid to Canada-based travel agents in violation of the Competition Act of Canada.  Plaintiffs' motion for class certification is pending.

           In addition to the lawsuits brought by travel agencies discussed above, Continental is a defendant in an alleged securities fraud class action filed in federal court in Phoenix, Arizona relating to the sale of certain America West stock in 1998 brought against America West Airlines, America West Holdings Corporation and various other defendants, entitled Employer-Teamsters Joint Council No. 84 Pension Trust Fund v. America West Holdings Corp., et al. This action was first filed in March of 1999, but was dismissed. Plaintiffs then filed a Second Amended Consolidated Complaint in January 2001, which was dismissed with prejudice in June of 2001. Plaintiffs appealed that dismissal and in 2003 the Ninth Circuit Court of Appeals reversed and remanded the lower court's dismissal. In January 2004 the class was certified and the case is now set for trial in November 2004. Defendants' motions for summary judgment are pending.

            In each of the foregoing cases, we believe the plaintiffs' claims are without merit and are vigorously defending the lawsuits.  Nevertheless, a final adverse court decision awarding substantial money damages could have a material adverse impact on our financial condition, liquidity and results of operations.

            We and/or certain of our subsidiaries are defendants in various other lawsuits, including suits relating to certain environmental claims, and proceedings arising in the normal course of 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, liquidity or results of operations, it is our opinion, after consulting with outside counsel, that the ultimate disposition of such suits will not have a material adverse effect on our financial position, liquidity or results of operations.

The following discussion contains forward-looking statements that are not limited to historical facts, but reflect our current beliefs, expectations or intentions regarding future events. In connection therewith, please see the risk factors set forth in our 2003 10-K, which identify important factors such as terrorist attacks and international hostilities, the resulting regulatory developments and costs, our recent losses, our high leverage and significant financing needs, the significant cost of aircraft fuel, labor costs, competition and industry conditions, security requirements, regulatory matters, the seasonal nature of the airline business, certain tax matters and the Japanese economy and currency risk, that could cause actual results to differ materially from those in the forward-looking statements. In addition to the foregoing risks, there can be no assurance that we will be able to achieve the pre-tax contributions from the revenue-generating and cost-reduci ng initiatives discussed below, or even if achieved, that these initiatives will be sufficient to allow us to operate profitably in the current environment. We undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this report.

General information about us can be found at www.continental.com/company/investor. Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as well as any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC.

The current U.S. domestic network carrier financial environment continues to be one of the worst in history and could deteriorate further. We have had substantial losses since September 11, 2001 and expect to incur a substantial loss in 2004. Losses of that magnitude are not sustainable over the long term. With the current weak domestic yield environment caused in large part by the growth of low cost competitors and fuel prices at twenty-year highs, our cost structure may not be competitive over the long-term. Additionally, many of our large network competitors have utilized bankruptcy or the threat of bankruptcy to reduce their costs significantly, and may continue to restructure their costs downward.

The cost-cutting and revenue-generating measures that we have implemented in recent years have proven insufficient to return us to profitability in the current environment. In such an environment, we must achieve significant further cost reductions, which may require us to furlough additional employees and secure material wage and benefit concessions. Other network carriers, such as American Airlines, United Airlines and US Airways, were able to achieve such concessions through bankruptcy or the threat of bankruptcy. Delta Air Lines has threatened bankruptcy in the absence of achieving significant wage and benefit concessions from its pilot group, and US Airways is seeking its third round of wage and benefit concessions in a bid to avert its second bankruptcy in two years.

Absent additional adverse factors outside our control such as additional terrorist attacks, hostilities involving the United States or further significant increases in fuel prices, we currently believe that our liquidity will be sufficient to fund our current operations through 2005. However, we have significant financial obligations due in 2006 and thereafter, and we may have inadequate liquidity to meet those obligations if the current network carrier financial environment continues and we are unable to decrease our costs considerably. We will need to continue to implement additional revenue-generating, cost-cutting and other cash-generating measures beyond those previously announced in order to maintain adequate liquidity for our operations and debt service beyond 2005. In addition, it has become increasingly difficult for us to obtain financing in the face of significant losses and the current revenue and cost outlook. As a result, we may not be able to complete future financings that we may need to maintain adequate liquidity.

Among the many factors that threaten us and the network airline industry generally are the continued rapid growth of low-cost carriers and resulting downward pressure on yields, high fuel costs, high labor costs and unpredictable labor negotiations, increased security costs, and significant pension liabilities. These factors are discussed in the "Overview" section of Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2003 10-K.

The following discussion provides an analysis of our results of operations and reasons for material changes therein for the three and six months ended June 30, 2004 as compared to the corresponding periods ended June 30, 2003.

Consolidated Results of Operations

We recorded a consolidated net loss of $17 million for the second quarter of 2004 as compared to consolidated net income of $79 million for the three months ended June 30, 2003. We consider the key measure of our performance to be consolidated operating income, which was $43 million for the second quarter of 2004, as compared to $238 million for the second quarter of 2003. The results for the quarter ended June 30, 2003 include a $176 million security fee reimbursement. Operating income for 2003 also includes the consolidated results of ExpressJet, and were approximately $46 million higher than if ExpressJet had not been consolidated. As discussed in Note 6 to our consolidated financial statements, except for passenger revenue, the deconsolidation of ExpressJet in 2003 affected the comparability of our quarter-to-quarter financial results. Accordingly, the expense variance explanations discussed below exclude the effect of ExpressJet in 2003 unless the context indicates otherwise. Significant co mponents of our operating results attributable to the deconsolidation of ExpressJet and attributable to our business generally are as follows (in millions, except percentage changes):

1. Represents increase (decrease) in amounts had ExpressJet been deconsolidated in the second quarter of 2003 and reported using the equity method of accounting at the 53.1% ownership interest in effect at that time.
2. The taxes and fees are primarily U.S. federal transportation taxes, federal security charges, airport passenger facility charges and foreign departure taxes.

Explanations for significant variances, after taking into account changes associated with the ExpressJet deconsolidation, are as follows:

Operating Revenue. Total passenger revenue increased 15.1% during the second quarter of 2004 due to higher traffic and capacity in all geographic regions, combined with the negative impact of the war in Iraq and SARS on the prior year results. Mainline passenger revenue increased 12.9% and regional passenger revenue increased 26.3%. Passenger revenue for the second quarter of 2004 and period to period comparisons of passenger revenue, revenue per available seat mile (RASM) and available seat miles (ASMs) by geographic region for our mainline and regional operations are shown below:

The U.S. airline industry is one of the most heavily taxed of all industries. These taxes and fees have grown significantly in the past decade, and currently include (a) a federal excise tax of 7.5% of the value of the ticket; (b) a federal segment tax of $3.10 per domestic flight segment of a passenger's itinerary; (c) up to $18 per round trip in local airport charges; and (d) up to $10 per round trip in airport security fees. Various U.S. taxes and fees are also assessed on international flights that can result in additional taxes and fees of up to $43 per international round trip, not counting fees and taxes imposed by foreign governments. Certain of these assessments must be included in the fares we advertise or quote to our customers. In many instances, increases in these taxes and fees have been absorbed by the airline industry rather than being passed on to the passenger. As a result, passenger revenue can decrease when these taxes and fees increase. These taxes and fees, which are not includ ed in our reported passenger revenue, totaled $265 million and $237 million for the three months ended June 30, 2004 and 2003, respectively, and $509 million and $451 million for the six months ended June 30, 2004 and 2003, respectively.

Cargo, mail and other revenue decreased primarily due to decreased military charter flights substantially offset by higher freight volumes and revenue-generating initiatives.

Operating Expenses. Wages, salaries and related costs increased primarily due to a slight increase in the average number of employees, higher wage rates and higher flight activity. Aircraft fuel and related taxes increased due to a significant rise in fuel prices, combined with an increase in flight activity. The average jet fuel price per gallon including related taxes increased 28.7% from 88.10 cents in the second quarter of 2003 to 113.35 cents in the second quarter of 2004. When considering our expected fuel volume increases in 2004, for every one dollar increase in the price of a barrel of crude oil, our fuel expense increases by approximately $38 million on an annual basis.

In 2004, obligations under our capacity purchase agreement are reported as ExpressJet capacity purchase, net. In addition to the obligations for the purchased capacity, ExpressJet capacity purchase, net, also includes ExpressJet's fuel expense in excess of the cap provided in the capacity purchase agreement and a related fuel purchase agreement (71.2 cents per gallon, including fuel taxes) and is net of our rental income on aircraft we lease to ExpressJet. In 2003, intercompany transactions between us and Holdings or ExpressJet under the capacity purchase agreement were eliminated in the consolidated financial statements. The actual obligations under the capacity purchase agreement were higher in the second quarter of 2004 than in the corresponding quarter of 2003 due to ExpressJet's larger fleet and increased flight activity at ExpressJet.

Landing fees and other rentals were higher due to increased flights at certain airports and fixed rent increases. The most significant increases were at Liberty International Airport in Newark and Bush Intercontinental Airport in Houston, where Terminal E was completed. Maintenance, materials and repair expenses increased primarily due to higher repair expenses and increases in the engine cost per hour contract rates associated with a maturing fleet.

In the second quarter of 2004, we recorded a special charge of $30 million ($19 million after income taxes) associated with future obligations for rent and return conditions related to six leased MD-80 aircraft which were permanently grounded. The second quarter of 2003 special charge consisted of $14 million ($8 million after income taxes) related to the deferral of aircraft deliveries.

In May 2003, we received and recognized in earnings a security fee reimbursement of $176 million in cash from the United States government pursuant to a supplemental appropriations bill enacted in April 2003. This amount was reimbursement for our proportional share of passenger security and air carrier security fees paid or collected by U.S. air carriers as of the date of enactment of the legislation, together with other items.

Nonoperating Income (Expense). Equity in the income of affiliates included our equity in the earnings of Holdings and Copa Airlines in 2004 and Orbitz and Copa Airlines in 2003. Other nonoperating income (expense) in the three months ended June 30, 2004 included a loss of $6 million related to the adjustment to fair value of our investment in Orbitz, after associated compensation expense, and income of $12 million related to our tax sharing agreement with Holdings.

Income Tax Benefit.  Our effective tax rates differ from the federal statutory rate of 35% primarily due to certain expenses that are not deductible for federal income tax purposes, state income taxes and the accrual in 2003 of income tax expense on our share of Holdings' net income. The impact of these differences on our effective tax rate is generally greater in periods for which we report lower income (loss) before income taxes.

Minority Interest.  In 2003, minority interest represented the portion of Holdings' net income attributable to the equity of Holdings that we did not own.

Segment Results of Operations

We have two reportable segments: mainline and regional. The mainline segment consists of flights to cities with jets with a capacity of greater than 100 seats while the regional segment consists of flights with jets with a capacity of 50 or fewer seats. The regional segment is operated by ExpressJet through a capacity purchase agreement. Under that agreement, we handle all of the scheduling and are responsible for setting prices and selling all of the seat inventory. In exchange for ExpressJet's operation of the flights, we pay ExpressJet for each scheduled block hour based on an agreed formula. Under the agreement, we recognize all passenger, cargo and other revenue associated with each flight, and are responsible for all revenue-related expenses, including commissions, reservations, catering and terminal rent at hub airports. The rates we pay ExpressJet for scheduled block hours are subject to adjustment effective January 1, 2005 and each year thereafter. On July 1, 2004, we began negotiatin g with ExpressJet to adjust the scheduled block hour rates as required by the capacity purchase agreement.

We evaluate segment performance based on several factors, of which the primary financial measure is operating income (loss). However, we do not manage our business or allocate resources based on segment operating profit or loss because (1) our flight schedules are designed to maximize the passengers flying on both segments, (2) many operations of the two segments are substantially integrated (for example, airport operations, sales and marketing, scheduling and ticketing), and (3) management decisions are based on their anticipated impact on the overall network, not on one individual segment.

Mainline. Significant components of our mainline segment's operating results are as follows (in millions, except percentage changes):

The variances in specific line items for the mainline segment are due to the same factors discussed under consolidated results of operations, with the exception of aircraft rentals. Mainline aircraft rental expense decreased primarily due to lease expirations, lower rates on renewal leases and aircraft rent on permanently grounded leased MD-80 aircraft no longer requiring accrual since such amounts have been previously recognized, partially offset by new aircraft deliveries.

Regional. The deconsolidation of ExpressJet in 2003 affected the comparability of our regional segment's quarter-to-quarter financial results. Significant components of our regional segment's operating results attributable to the deconsolidation of ExpressJet and attributable to the segment's business generally are as follows (in millions, except percentage changes):

1. Represents increase (decrease) in amounts had ExpressJet been deconsolidated in the second quarter of 2003 and reported using the equity method of accounting at the 53.1% ownership interest in effect at that time.
   

The variances in specific line items for the regional segment are due to the same factors discussed under consolidated results of operations, with the exception of aircraft rentals. Regional aircraft rental expense increased due to the higher number of regional jets in ExpressJet's fleet.

ExpressJet capacity purchase, net increased due to increased flight activity at ExpressJet and the higher number of regional jets leased from us by ExpressJet. The net amounts consist of the following (in millions):